22 November 2013
Address to Deloitte National Tax Conference
Deloitte Centre, Auckland
Thank you for inviting me here today to talk about base erosion and profit shifting (or “BEPS” as it’s known as).
BEPS is a matter of growing importance and an issue of real concern to both the OECD and the G20. But there is nothing new in ensuring that international tax rules are robust – it’s been an important part of our international tax reforms in recent years. For that I am immensely grateful and greatly comforted as it means that our tax rules are in a strong position to face this issue.
I’d like to talk today about the current and planned work addressing this issue, but I’ll start with a little background.
The emergence of BEPS as an issue comes through a change in technology and business practices and is part of globalisation. Globalisation of course is not new. But in the last 20 years, the flow of goods and services between countries and international capital flows has exploded worldwide through the growth of the internet and the relentless march of information technology.
Before the economic reforms of the 1980s, the New Zealand economy was one of the most protected outside the Iron Curtain. Since then, economically, socially and intellectually we have built our society around active involvement with the rest of the world.
It’s a good thing and absolutely the correct path to follow for a relatively small and geographically isolated economy such as ours and tax policy has reflected that.
International tax reforms since 2009 have made New Zealand a better place to base an international business as have improvements in New Zealand’s network of tax treaties and reductions in New Zealand’s company rate.
But at the same time, we need to recognise that with globalisation come problems and risks. Tax rules designed for a very physical age of steam power and iron are ill-suited to a world of intangible transactions occurring in cyber-space.
Our rules need to adapt to fit the new reality while still ensuring that New Zealand is attractive to base a business and for businesses to invest and create jobs while ensuring that a fair amount of tax is paid.
Where countries have shared taxing rights because of cross-border trade, they have been at pains to ensure that double taxation does not occur. But what’s happening now of course, is double non-taxation where a company is taxed nowhere in the world.
International tax policy should not be a question of “double or nothing”.
Increasingly, profits can be located anywhere in the world and quite separate from manufacturing and selling activities. Obviously where the profits are located is where the tax base is located.
And to add further complexity, the real value of a multinational enterprise is not to be found in its manufacturing expertise, which is increasingly outsourced, but in the brand name and marketing of the product, in the company’s ability to innovate and its intellectual property.
An increasing challenge for revenue authorities of countries in which goods and services are sold or produced is to ensure that a reasonable proportion of profits are attributable to, and taxable in, their countries.
While it is easy to see where physical production takes place, it is much harder to tell where value is created when a large amount of value creation can relate to intangible assets such as intellectual property.
The rules for determining where multinational profits are located are becoming less clear as knowledge capital rises in importance relative to physical capital and as enterprises become more global.
Ensuring tax is still levied, but at an appropriate level, will require increased international co-operation between tax authorities and increased levels of sophistication by tax authorities.
The internet means it’s quite common for a company to be heavily involved in the economic life of a country without any physical presence which might give rise to a taxing right. And as businesses increasingly integrate across borders and tax rules remain uncoordinated there are a number of technically legal structures which take advantage of differences between international and domestic rules.
Since the Global Financial Crisis there has been a growing awareness of the business practices of these multinationals and a growing concern at the implications for government revenues. And the public are outraged because of the unfairness and because it’s so artificial.
After all, if I were to buy half a pig from a hunter friend I'd be pretty surprised if he was sending 75% of that money to the British Virgin Islands because that’s where he’s sold the intellectual property of his pig hunting technique to.
It’s absurd. Something has to be done. Which brings me to the concrete actions we’re going to be taking to address BEPS.
I’ve said it before, but I think it bears repeating: New Zealand’s international tax rules are in good shape.
Compared with some other jurisdictions we have a robust Controlled Foreign Companies regime, thin capitalisation rules and broad, effective anti-avoidance rules. And our broad base, low rates tax framework means we are freer of the kinds of tax incentives attractive to multinationals for exploitation.
But there is no room for complacency — not by a long shot.
A global response has been led by the OECD and I am very proud that New Zealand has been an active participant in this work and is represented on the OECD’s tax working parties. These groups are focused on ways to address BEPS and to deliver the action plan.
In evaluating our rules as they compare against the OECD action plan, it’s clear that we have work to do. Related-party debt provides an opportunity for multinationals to shift profits. Interest expenses incurred and paid by borrowers are tax deductible, so there is a danger of tax deductible debt or interest rates paid on related-party debt becoming artificially inflated.
Issues relating to high priced debt and abuses of the NRWT rules will all be Considered as part of the new work programme. Hybrid entities and instruments are also areas for further consideration as these are frequently used by multinationals to exploit differences between countries’ domestic tax rules.
In addition to work on these specific issues my officials are continuing to work closely with the OECD. Many of the concerns raised by BEPS cannot be resolved by a single country working in isolation.
At the same time, while we have committed to the OECD global response, that doesn’t mean that we sit on our hands and wait to be told what to do with regard to our own domestic laws.
But first I want to reassure you that the pendulum is not swinging too far in the opposite direction.
Following the Global Financial Crisis and the growing threat of BEPS, it’s easy to bring in knee-jerk responses which reverse the trend towards freer international markets and removing tax impediments. We do not want a return to the pre-1980s Fortress New Zealand.
New Zealand's double tax agreements (usually referred to as DTAs) help New Zealand-based businesses compete abroad and help make New Zealand a more attractive place to invest in. There has been a major focus on the DTA network in recent times. I am looking to continue expanding it, bearing in mind that DTAs provide more bang for our buck when there are (or are likely to be) strong investment and trade flows.
DTAs recently signed with Viet Nam and Papua New Guinea, will bring our network to 39, covering nearly all of our major investment and trading partners – comparable with Australia’s network of 44.
Since 2008 we’ve also focused on bringing our DTAs into line with international norms by securing lower withholding tax rates on dividends and royalties and have updated DTAs with five of our top ten investment partners: Australia, Canada, Japan, Singapore, and the United States.
Negotiating and entering into double tax agreements is not without cost. They also give up revenue, lock in certain positions, and affect our ability to change tax policy. DTAs can provide real benefits for our economy, but we need to be astute in our choices of DTA partners so that they can stand the test of time.
Meanwhile, in line with New Zealand’s commitment to a global, unified approach to combating tax avoidance and evasion, New Zealand will be taking the final procedural step for ratification of the multilateral Convention on Mutual Administrative Assistance in Tax Matters, which will now come into force for New Zealand on 1 April 2014.
The Convention provides the 61 current signatory countries including New Zealand, an extra weapon in their arsenal against avoidance and evasion. As with our DTAs and Tax Information Exchange Agreements, the Convention will allow Inland Revenue to request information from other tax authorities and to seek assistance in collecting outstanding tax debts from taxpayers who’ve move overseas.
A range of initiatives is also being developed to improve the quality and usefulness of information collected by Inland Revenue. As well as beefing up international and domestic tax rules, it’s equally important to ensure that tax authorities have the information they need to assess specific revenue risks and identify any deficiencies in how these tax rules operate in practice. This work includes a simple, high level disclosure form, more detailed information from AIL payers and exploring a code of practice for large corporates.
These are some of the actions the Government will be taking to address the issue of base erosion and profit shifting. It’s a priority because a New Zealand without a fair and efficient tax system would be an economic disaster. One need only look abroad to countries where tax evasion is a national pastime to see why a threat to our tax system is a threat to our economy.
Our tax system relies on voluntary compliance and to work, must be seen to be fair to encourage everyone to pay their fair share of tax. If multinationals can legally avoid paying income tax, then voluntary compliance is threatened.
Addressing these issues is critical both for securing the Government’s revenue and levelling the playing field for businesses. Proposed solutions to the problem will have to take into account all the factors involved, including any compliance costs.
So consultation with New Zealand’s business community and tax practitioners will be a big part of our approach.
New Zealand is a good place to do business and Government policy aims to continue to make New Zealand a better place for businesses to base themselves, invest and grow jobs.
On the international front we continue our focus on ensuring that our tax rules are internationally competitive and, where it is sensible, that our rules on the taxation of offshore investment are in line with international norms.
Today the biggest threat to fairness in the tax system is base erosion and profit shifting by large multinationals, who, not unreasonably, want to maximise their profits. But by doing so through tax avoidance and evasion, they jeopardise the integrity of the tax system.
Engagement with tax professionals such as yourselves will be important in ensuring that tax changes to address BEPS are well targeted and fully
considered and do not lead to unintended tax outcomes.
Media contact: Rob Eaddy 027 459 6200