Apple, along with other companies with global name recognition like Amazon, Gap, Google, Ikea, McDonalds, Microsoft and Starbucks, have had a lot of media coverage of late expressing concern that they pay little or no tax in the countries where they make sales around the world.
Most of the global brands are selling to New Zealanders, leading many commentators to observe that these entities seem to be paying little or no tax here. This article considers why that may be so under our current laws, and how changes to international tax policy settings could affect multinationals doing business here.
While politicians and tax policy makers have been upset about such tax strategies as Google’s “double Irish, Dutch sandwich” and have called for substantial reform of international tax settings and a new “fair share” approach amongst the various countries in which multinationals are doing business, it is important to understand that a century of international tax policy settings have left us with tax laws and state self-interest which facilitates, rather than discourages, tax minimisation behaviour.
Those policy settings, established in the pre-digital, pre-globalisation era, are now very much in the spotlight.
Corporate taxpayers that take advantage of differences in tax regimes around the world are operating legally and not contravening New Zealand or other country’s tax laws.
Often, they are legitimately utilising the benefits currently offered by double tax agreements between New Zealand and other jurisdictions, and the tax differences under the laws of different countries, to minimise their New Zealand tax costs.
How does a double tax agreement work?
In summary, double tax agreements are agreements between two countries designed to (amongst other things) facilitate investment and trade by preventing double taxation of taxpayers involved in cross-border transactions.
Double tax agreements are part of our law. They are treaties which override our domestic tax legislation. These treaties determine which country or territory has the right to tax specific types of income, or limit the level of tax payable.
The “deal” under these agreements is generally that a country “trades away” its right to tax income with a source in that country, taxing instead on the basis of the residence of the taxpayer.
New Zealand governments have long understood the benefits of these treaties, and currently has 39 double tax agreements in place.
How might this affect multinational corporates such as Apple?
Under New Zealand’s double tax agreements, New Zealand agrees not to tax a non-resident entity’s business income unless the non-resident has a “permanent establishment” in New Zealand. Even if a permanent establishment exists, not all of the non-resident’s sales income may be taxable in New Zealand.
Sales income may need to be apportioned between the permanent establishment and the non-resident’s home jurisdiction, and costs incurred in relation to those sales may be deductible.
Under long-established double tax agreements, multinational corporates such as Apple, Facebook and Google have quite legitimately minimised their New Zealand tax bill by not having a permanent establishment in New Zealand, despite having significant economic activity carried on in New Zealand.
How will the rules change? The Organisation for Economic Co-operation and Development (OECD), has responded to this issue by proposing to amend the definition of ‘permanent establishment’ in international double tax agreements, and most OECD member countries (including New Zealand) have agreed with that approach.
The proposed amendment will deem a non-resident entity (with a consolidated global turnover in excess of EUR €750m) to have a permanent establishment in New Zealand if a related entity carries out sales-related activities for it here.
As a result, tax policymakers anticipate that Apple and similar companies will pay tax on New Zealand sales.
Time will tell whether these changes will be effective in combating a multinational’s avoidance of a permanent establishment, as many non-resident multinationals may seek to restructure their New Zealand operations (or to cease to sell in New Zealand entirely) in light of these impending changes.
In addition to the changes in relation to the definition of a permanent establishment, there are related changes in New Zealand’s transfer pricing rules (including new rules promoting tax transparency by requiring reporting of sales activity), as well as certain aspects of our GST regime and thin capitalisation rules to strengthen New Zealand’s tax base.
New Zealand’s transfer pricing rules are being amended to align with the OECD’s guidelines as well as Australia’s transfer pricing rules. A transaction will be able to be disregarded if the legal form does not match its economic substance.
If independent entities would not have entered into the contracted conditions, proposed new rules would allow for those conditions to be replaced by arm’s length conditions (or allow the entire arrangement to be disregarded).
The burden of proof for demonstrating that the actual conditions align with arm’s length conditions will shift from the commissioner of Inland Revenue to the taxpayer. The “time bar” (i.e. the period of time within which Inland Revenue can amend taxpayer assessments of tax) for transfer pricing issues will also be increased from four to seven years.
The Government is also proposing to strengthen New Zealand’s thin capitalisation rules. It is proposed that the interest rate on related party debt will be based on the parent’s credit rating for senior unsecured debt, plus an appropriate margin.
Inland Revenue considers this broadly approximates the multinational’s cost of debt. It is also proposed that the calculation of ‘assets’ is changed in the thin capitalisation rules, whereby assets are netted off against ‘non-debt liabilities’ (such as provisions and trade creditors) in the balance sheet (but excluding loans that are equivalent to equity, such as interest-free shareholder loans).
Assets will also have to be valued (for thin capitalisation purposes) using values reported in financial statements, and assets and debts will have to be measured using average values during the year.
New Zealand’s GST rules were recently amended late last year through what has been coined the ‘Netflix Tax’. This has seen the imposition of GST on digital products and remote services (such as e-books, videos, music, and software downloads) supplied by offshore sellers to New Zealand private consumers.
When certain conditions are satisfied, an operator of an electronic marketplace (such as an app store) may also be required to register and return GST on supplies made through the marketplace, instead of the underlying supplier. GST registration under these rules generally operates as a ‘pay only’ system involving an obligation for offshore sellers to pay GST with no ability to claim GST on costs incurred.
New Zealand proposes to implement the permanent establishment, transfer pricing and interest deductibility limitation amendments, and has sought feedback from the wider public. Submissions for these proposed amendments closed on April 18, 2017.
The proposed amendments to the concept of a permanent establishment under New Zealand’s double tax agreements, our transfer pricing and thin capitalisation rules as discussed in this article may therefore not yet be in their final form, so watch this space.
Neil Russ leads Buddle Findlay’s tax practice. He specialises in corporate and international tax issues, as well as structured transactions. www.buddlefindlay.com