With the world becoming increasingly globalised, perceived tax avoidance by international enterprises through multi-country business structures has been attracting increased media and public attention.
There is widespread concern that multinational corporations have the ability to structure their businesses across different countries to minimise their overall tax cost, as a result of different tax regimes in individual countries.
The Organisation for Economic Cooperation and Development (the OECD) has released a series of recommendations designed to close tax loopholes and make tax more equitable across the globe. Improvements to the world’s tax systems mainly focus on removing these deficits and increasing confidence in global markets. Estimates place the annual tax loss to governments across the world at between $100-$240 billion US dollars.
Data released by the IRD shows that approximately half the entities registered in New Zealand with turnovers greater than $80 million are foreign owned, with a further 25 percent involved in international business operations.
Due to the significance of these entities on our tax base, the New Zealand Government issued a discussion document earlier this year, seeking to adopt the majority of the OECD recommendations. The Government tax policy work programme for 2016/17 includes a list of measures focused on ‘International Tax and Base Erosion and Profit Shifting (BEPS)’ of which one of the most complex issues is addressing ‘hybrid mismatch arrangements’.
The ‘hybrid mismatch’ problem arises when multinational entities structure their business affairs to take advantage of different tax rules in different countries. A common example of this for businesses operating in both New Zealand and Australia is the use of loans structured as convertible notes.
Under New Zealand tax law they are treated as debt instruments, with interest payments being tax deductible.
Under Australian rules they are treated as an equity instrument – so the ‘interest’ payments are treated as dividends with the benefit of tax credits, which results in no tax to pay on the income. This can result in a mismatch: the NZ Company receives a tax deduction in New Zealand with no corresponding taxable income in the Australian Company.
A further example is the situation where a US parent company has a 100 percent owned NZ subsidiary. Under New Zealand tax rules, any payments made to the US parent can be tax deductible, however under US domestic law the receipt of this income can be treated as non-taxable. Again, this results in a mismatch: there is a tax deduction in New Zealand with no corresponding taxable income in the US.
The New Zealand Government intends to adopt the full range of OECD recommendations to combat hybrid mismatch arrangements. The proposed changes are complex, however they aren’t just relevant for global giants; the rules will need to be understood by all New Zealand businesses that engage in cross-border transactions, even relatively small NZ companies doing business in Australia.
Some of the key changes proposed to be implemented in New Zealand include:
- Denial of a tax deduction for a payment to an overseas related entity, where the payment is not treated as taxable income.
- Where foreign dividends received by a New Zealand company would normally be non-taxable, they will become taxable if there has been a tax deduction in the overseas company.
On a practical level, this is most likely to affect:
- New Zealand businesses with loan or share arrangements with businesses in other countries;
- New Zealand branches of foreign companies, or NZ companies with overseas branches;
- New Zealand companies, partnerships and trusts with overseas owners or investors, or with foreign investments.
Due to the global nature of these arrangements, the New Zealand Government recognises that our domestic policies can only be effective if the OECD recommendations are implemented worldwide. The Government is therefore closely following the changes adopted by the UK, EU and Australia before the new rules are passed into legislation here. However the US and some Asian countries are currently reluctant to adopt the OECD recommendations, so it will be interesting to see how the international markets react.
In addition to addressing hybrid mismatch arrangements, other measures aimed at improving global tax standards include an increased focus on transfer pricing and the robustness of double tax agreements.
Transfer pricing rules have been on the agenda for many years; they seek to ensure that where goods and services are sold between related parties of a larger enterprise, those sales take place at a fair value, so that an appropriate amount of revenue is recorded in the correct entity. Although these rules have been in place for some time, the increased focus on international arrangements means that IRD is likely to monitor such arrangements closely, so it is important that New Zealand businesses ensure their transfer pricing arrangements are fit for purpose.
The Government is also working closely with the OECD and current treaty partners to ensure international agreements remain fit for purpose. The double tax treaties with China and Korea are currently being re-negotiated; as key trade partners any New Zealand businesses operating in these countries will need to keep a close eye on resulting changes that could impact existing contracts.
The proposed changes are not simple. Recommendations that result in legislative change will need to be comprehensively understood by affected entities. Compliance with these intricate changes will have the potential to cause major headaches for New Zealand business looking to overcome the technical and practical difficulties of business on the international stage.
The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.