Tax policy report: Taxation of multinationals

Tax policy report: Taxation of multinationals

Date: 15 August 2013 Priority: High
Security Level: In Confidence Report No: T2013/2059
PAS2013/152

Action sought

  Action Sought Deadline
Minister of Finance Agree to the recommendations in this report Thursday, August 29th 2013
Minister of Revenue Agree to the recommendations in this report Thursday, August 29th 2013

Contact for telephone discussion (if required)

Name Position Telephone
Carmel Peters Policy Manager [Telephone numbers withheld under section 9(2)(a) of the Official Information Act 1982 to protect the privacy of natural persons.]
Steve Mack Principal Advisor, Treasury
Tom Broadhead Senior Policy Analyst

15 August 2013

Minister of Finance
Minister of Revenue

Taxation of multinationals

Executive summary

Since late 2012, there has been global media and political reaction to evidence suggesting that some multinationals pay little or no tax anywhere in the world. The wide range of international tax planning techniques that are used to achieve such results are collectively referred to as “base erosion and profit shifting” or “BEPS”. The Government has publicly released two tax policy reports on BEPS: one in December 2012 (T2012/3250, PAD2012/268) and one in April 2013 (T2013/927, PAS2013/63).

The central concern is that international tax standards have not kept pace with developments in the global economy. It will be difficult for any country, acting alone, to fully address the issue; it is a global problem that requires a global solution.

The OECD’s Action Plan on Base Erosion and Profit Shifting was released on 20 July this year. New Zealand officials participated in the development of the action plan. We strongly support the approach suggested by the OECD and the particular focus and priority given to the actions recommended in the plan. This report provides a summary of some of the key items in the OECD action plan.

While we will continue to be closely involved in, and guided by, the OECD work, this does not prevent us from addressing potential deficiencies in New Zealand’s own rules, which we have concerns about. To this end, we recommend that initiatives to protect the New Zealand tax base from BEPS should be a key focus when developing the next 18-month tax policy work programme.

This report outlines a number of projects that could be included in the work programme to strengthen our ability to combat profit shifting by multinationals and other investors, focusing on:

  • preventing multinationals shifting profits out of New Zealand using related-party debt
  • removing tax advantages from certain investment vehicles and ensuring effective taxation of offshore investments
  • ensuring tax rules keep pace with changes in the global economy – including examining options for collecting GST on online shopping.

The current work programme has resources allocated to develop BEPS projects and as previously noted we recommend this remain a key focus. We will discuss with you how these projects can be prioritised and sequenced to fit within the current and future resource allocations that support the BEPS initiatives. We expect to identify an initial tranche of projects that can be added to the work programme when it is updated in September.

Once we have established a sequence we intend to report separately on each specific proposal. Every proposal needs to be evaluated on its merits taking into account relevant trade-offs. In particular, the benefit of increased base protection from a proposed reform needs to be weighed against any adverse implications in terms of overall economic efficiency including increases in compliance costs. Any resulting reform needs to be consistent with the “broad base low rate” framework.

In addition, the decision to proceed with any proposals for reforms relating to BEPS needs to be evaluated more generally in the context of all of the Government’s priorities on the tax policy work programme.

Finally, if you decide a proposal for reform will be added to the work programme, it should be subject to the normal consultation process under the generic tax policy process.

Improving the disclosure of tax information

While it is important to ensure international and domestic tax rules are robust and fit-for-purpose, it is equally important 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.

We have identified a set of other measures that could be implemented to improve the quality and usefulness of tax information collected by Inland Revenue:

  • Improve information disclosure for large corporates.
  • Require large corporates to file their tax returns earlier.
  • Align information disclosure for approved issuer levies (AIL) with non-resident withholding tax (NRWT) disclosure requirements.

In addition, we suggest that Inland Revenue should consult with corporates on introducing a voluntary code of practice to promote good behaviour.

Recommended action

We recommend that you:

(a) Note that the OECD has recently published its Action Plan on Base Erosion and Profit Shifting, which outlines 15 actions that the OECD will take in the next one to two-and-a-half years.

Noted Noted

(b) Agree that New Zealand officials should continue to participate in the OECD work on base erosion and profit shifting and report to you on any significant developments.

Agreed / Disagreed Agreed / Disagreed

(c) Agree that initiatives to protect the New Zealand tax base from base erosion and profit shifting should be a key focus when developing the next 18-month tax policy work programme.

Agreed / Disagreed Agreed / Disagreed

(d) Note that this report outlines a range of other potential initiatives to protect the New Zealand tax base from base erosion and profit shifting and that officials will discuss with you how these can be prioritised and sequenced.

Noted Noted

(e) Note that we have also identified a set of administrative measures that could be implemented to improve the quality and usefulness of tax information collected by Inland Revenue.

Noted Noted

Steve Mack
Principal Advisor
Tax Strategy
Treasury

Carmel Peters
Policy Manager
Policy and Strategy
Inland Revenue

Hon Bill English
Minister of Finance

Hon Todd McClay
Minister of Revenue

Background

1. The global international tax framework reflected in tax treaties and countries’ domestic law assumes that multinational corporates will be taxed somewhere on their cross-border income. As mentioned in our report in December 2012, it is envisaged that income will be taxed either in the country where the income is earned (the source state) or the state where the taxpayer is resident (the residence state).

2. Since late 2012, there has been global media and political reaction to evidence suggesting that some multinationals pay little or no tax anywhere in the world. The wide range of international tax planning techniques that are used to achieve such results are collectively referred to as “base erosion and profit shifting” or “BEPS”.

3. The problem is that international tax standards have not kept pace with developments in the global economy. For example, multinational profits increasingly relate to brands, intellectual property or digital services that can be located anywhere in the world. Other problems arise from complex interactions between different countries’ tax rules.

4. For these reasons, it will be difficult for any single country, acting alone, to fully address the issue. This is a global problem that requires a global solution.

5. The OECD has been leading the global response and has recently produced an action plan that identifies 15 specific actions that OECD member countries and G20 nations will work together to implement.

6. Although BEPS is a global problem, it can affect New Zealand’s ability to collect tax. If other countries do not effectively tax their multinationals, this may have a knock-on effect of giving these multinationals incentives to shift profits or minimise their taxable presence in New Zealand (and therefore pay no tax anywhere in the world).

7. In New Zealand, there has been significant media and corporate interest in BEPS and the Government’s response. The Government has publicly released two tax policy reports on BEPS: one in December 2012 (T2012/3250, PAD2012/268) and one April 2013 (T2013/927, PAS2013/63).

The OECD’s action plan

8. Inland Revenue and Treasury officials are closely involved in an OECD/G20 project that is developing measures that countries can implement to counter BEPS. This work builds on our existing involvement in the OECD tax working parties, which includes chairing the Aggressive Tax Planning Steering Group.

9. The OECD’s action plan is designed to be comprehensive (given there are a wide range of BEPS concerns) and multilateral (as countries can’t address many of the concerns on their own, and there is a risk that poorly co-ordinated or “knee-jerk” reactions could harm cross-border trade and investment).

10. Some of the more significant areas of work are:

  • considering whether special tax rules are needed to tax digital goods and services that are provided over the internet (Action 1)
  • reviewing hybrid mismatches, which occur because countries have different tax rules for distinguishing between debt and equity or companies and partnerships (Action 2)
  • improving rules for controlled foreign companies (CFCs), which allow countries to tax their multinationals on passive/mobile income that they earn through foreign subsidiaries (Action 3)
  • reviewing domestic rules for limiting interest deductions (for example, thin-capitalisation rules) (Action 4)
  • preventing the misuse of tax treaties (for example, by investors who shouldn’t qualify for tax relief under a tax treaty) (Action 6)
  • improving the “permanent establishment” rules for determining when an overseas business has a taxable presence in a foreign country (Action 7)
  • improving “transfer pricing” rules (which ensure that a market price is paid on related-party transactions), particularly in relation to debt (Action 4) and brands and intellectual property (Actions 8 to 10).

11. In each area of work, the OECD will develop specific recommendations for countries to implement.

12. Some of these recommendations could be implemented through a multilateral agreement or updates to the OECD’s existing guidelines and commentaries (including transfer pricing guidelines and model tax agreement commentary). Such changes will require a broad consensus among OECD and G20 countries. The challenge will be building this consensus in the proposed OECD timeframes.

13. Other recommendations will rely on countries being willing and able to make amendments to their domestic laws. This approach provides countries with more control and flexibility on the specific design of any reforms. There is a risk, however, that some countries may opt out or may delay or water-down their reforms in an effort to attract profits or mobile business activity from countries with tougher rules.

14. New Zealand officials will continue to be closely involved in the OECD work on BEPS and will report to you on any significant developments, including recommendations for improving our international tax policy settings in New Zealand.

Protecting the New Zealand tax base from base erosion and profit shifting

15. The starting point is that, like other countries, New Zealand taxes non-residents on income that is earned (“sourced”) in New Zealand. However, non-resident investors who invest or have operations in New Zealand may have incentives to reduce or eliminate their tax liabilities in New Zealand by shifting income out of New Zealand.

16. New Zealand also taxes its residents on their world-wide income. (The main exception to this rule is firms that have foreign subsidiaries earning “active income” – ie income from manufacturing etc.) However, residents who have operations offshore may seek to reduce their New Zealand tax obligations by shifting income offshore – including by increasing deductions taken in New Zealand.

17. In either case, the result is that income earned in New Zealand, either by non-residents or residents, is not fully taxed in New Zealand.

18. The OECD’s action plan highlights the wide variety of techniques and structures that multinational businesses can use to shift profits away from where the economic activity is carried out and into more lightly taxed entities or countries.

19. New Zealand and other countries have various rules to guard against profit shifting of this nature. The OECD action plan is focused on the use of these rules generally and how to make them work effectively. (Annex 3 provides a table comparing our rules with areas of focus of the OECD action plan.)

20. We will be closely involved in, and guided by, the OECD work. However, this does not prevent us from addressing potential deficiencies in our own rules, which we have concerns about.

21. To this end, we recommend that initiatives to protect the New Zealand tax base from BEPS should be a key area of focus when developing the next 18-month tax policy work programme.

22. Officials have identified a range of initiatives that could be considered in terms of potential additions to the tax policy work programme. These are outlined below and described in detail in Annex 1.

Preventing profit shifting using related-party debt

  • Examine problems with the thin capitalisation and transfer pricing rules that are designed to prevent profit shifting by non-residents who fund their New Zealand investment using related-party debt, that gives rise to deductible interest payments.
  • Explore whether New Zealand should restrict interest deductions on hybrid instruments where the interest payment is not taxed in the foreign jurisdiction.
  • Address problems with the application of NRWT on interest on related-party debt.

Removing tax advantages from certain investment vehicles and ensuring effective taxation of offshore investments

  • Explore the need for an anti-arbitrage rule for offshore entities which allow double non-taxation of income or double deductions of expenditure by taking advantage of differences between countries’ tax rules.
  • Examine incoherence relating to different tax treatment of “look-through vehicles” and structures.
  • Design the active income exemption for offshore branches to ensure it does not facilitate profit shifting through repatriation of losses.

Ensuring tax rules keep pace with changes in the global economy

  • Review the tax treatment of foreign trusts.
  • Explore options for collecting GST on goods and services bought online.

23. The current work programme has resources allocated to develop BEPS projects and as previously noted we recommend this remain a key focus. We will discuss with you how these projects can be prioritised and sequenced to fit within the current and future resource allocations that support the BEPS initiatives. We expect to identify an initial tranche of projects that can be added to the work programme when it is updated in September.

24. Once we have established a sequence we intend to report separately on each specific proposal. Every proposal needs to be evaluated on its merits taking into account relevant trade-offs. In particular, the benefit of increased base protection from a proposed reform needs to be weighed against any adverse implications in terms of overall economic efficiency including increases in compliance costs. Any resulting reform needs to be consistent with the “broad base low rate” framework.

25. In addition, the decision to proceed with any proposals for reforms relating to BEPS needs to be evaluated more generally in the context of all of the Government’s priorities on the tax policy work programme.

26. Finally, if you decide a proposal for reform will be added to the work programme, it should be subject to the normal consultation process under the generic tax policy process.

Improving disclosure of tax information

27. The availability of relevant, timely electronic tax and financial information can greatly assist tax authorities in assessing revenue risks and identifying any deficiencies in how tax rules operate in practice.

28. The OECD’s action plan on BEPS has also called for improved transparency of multinationals’ tax affairs. However, this improved transparency is in the context of additional collection and disclosure of information to tax authorities. This includes collecting aggregate statistical data on the extent of BEPS (Action 11), requiring taxpayers to disclose aggressive tax planning arrangements (Action 12), and requiring multinationals to provide all relevant tax authorities with information on the global allocation of their income as well as transfer pricing documentation (Action 13).

29. We have identified a set of initiatives that New Zealand could consider to improve the quality and usefulness of tax information collected by Inland Revenue. The following initiatives are described in more detail in Annex 2:

30. Separately, other countries, including the United Kingdom, South Africa and Spain have sought to encourage large taxpayers to take a public stance against aggressive tax planning by introducing a voluntary code of practice. We believe this is an idea worth exploring, and it is discussed in more detail in Annex 2.

31. In response to public concerns about the amount of tax paid by multinationals, Australia has recently introduced legislation that will require the Australian Taxation Office to publish the tax liabilities of corporate taxpayers with accounting incomes of $100 million or more a year.[1] The rationale for this legislation is that it may put consumer or shareholder pressure on large taxpayers to refrain from aggressive tax planning. One difficulty with this approach is that reported tax liabilities can be low for a variety of other reasons such as prior-year losses or intended tax concessions and in these cases the published information may not be a good indicator of taxpayer behaviour.

32. The Financial Reporting Bill, which is currently awaiting the Committee of the Whole House stage, relaxes some current public reporting rules which apply to subsidiaries of multinationals. This would appear to move in a contrary direction to the Australian proposal by reducing the public availability of some information. We reported to Ministers on this point earlier this year (T2013/1194, PAS2013/79; and T2013/2067, PAS 2013/156 refer) and we understand the matter is under consideration. The issue is one of appropriate trade-offs: on the one hand, the compliance costs the current rules impose on businesses, and on the other, the benefits of public transparency.

 

1 The legislation still needs to be passed by the Australian Senate