There are fears the Government’s plans to prevent foreign controlled banks from slipping under the taxman’s radar, could end up hitting their New Zealand customers in the pocket.
The Inland Revenue Department (IRD) is proposing to impose a higher tax burden on non-resident investors who get income from interest, dividends and royalties.
In its consultation paper entitled, ‘Non-Resident Withholding Tax: related party and branch lending’, it suggests ways to strengthen the existing law, which hasn’t been significantly reformed since it was introduced in 1964.
Minister of Revenue Todd McClay says that without changes to the rules, there is an incentive and ability for non-residents to shift profits out of New Zealand with no or minimal New Zealand tax paid.
He says that the IRD’s audit activity had uncovered instances where large multinationals were using sophisticated techniques to defeat the tax rules.
Banks – aka bank customers – expected to feel the pinch
However a Deloitte partner who’s advised a number of banks, Patrick McCalman, has issues with the way non-residents, who provide loans to New Zealand, will come under the IRD’s magnifying glass.
He says the problem is New Zealand's big four Australian owned banks still require international markets for funding, so will be stung by the law change.
If banks are asked to fork out, it’s likely they’ll ask their customers to pick up the cost by paying more interest.
“The New Zealand banking system still relies to an extent on foreign financial markets to fund New Zealand’s balance sheet,” McCalman says.
“Reserve Bank of New Zealand data shows that as at 31 March 2015 there was $74.6 billion of non-resident funding through foreign currency. We suspect most of this will be through structures which will now be subject to the Approved Issuer Levy (AIL).”
While this duty on the gross interest paid to a non-resident (where the payer and the payee are not associated) is only 2%, McCalman says the figure could end up being quite high, especially once interest rates overseas bounce back up.
In other words, if banks pay an average interest rate of 2% for borrowing that $74.6 billion, they could end up paying an extra $30 million in tax.
Therefore, he says it should be legislated that banks are exempt from paying non-resident withholding tax if the law change goes through.
McCalman says this would also keep New Zealand aligned with our trading partners – Australia, the UK, and the US – which provide exemptions from withholding tax in similar circumstances to ensure that tax doesn’t act as a barrier or cost to capital flows.
He says it is important New Zealand remains competitive when it comes to attracting capital investment.
Furthermore, McCalman points out, “The proposals seemingly run contrary to the changes in 2011 which provided limited exemptions from AIL for listed bonds.
“These changes had their origin in the Capital Markets Task Force which recognised the barriers to foreign financial markets that AIL imposed.
“The design and background to the AIL regime recognised the legitimacy of these structures and was intended to afford New Zealand companies a choice between putting in place such structures (with associated costs) or paying a simple 2% AIL.
“That original recognition of the legitimacy of these structures seems to have disappeared.”
The IRD paper itself says applying non-resident withholding tax to bank interest would be likely to increase the cost of capital for all borrowers in New Zealand significantly, should the banks increase their level of related party funding into New Zealand.
"For these reasons non-resident withholding tax is likely to be inappropriate for this lending," says IRD. "Officials therefore suggest that banks be allowed to pay AIL on interest paid to non-resident associated lenders. This would only apply when the borrower is a member of a New Zealand banking group, as already defined for thin capitalisation purposes."
'Banks take their tax obligations very seriously'
Kirk Hope, CEO of bank lobby group the New Zealand Bankers' Association, said the banking industry will study the proposals in the IRD discussion paper closely, and make a full submission on the recommended changes.
“New Zealand banks take their tax obligations very seriously and the industry supports tax reform that makes sense in the New Zealand economic and business environment, and gets the balance right between workable regulation and economic growth," Hope said.
“It’s important to note though that the New Zealand economy relies on offshore capital to fund our businesses and households. Any tax changes that unnecessarily make raising this capital more expensive will potentially mean increased lending costs for New Zealand businesses and households,"
IRD tight-lipped on how much the Government’s aiming to earn
The IRD hasn’t made a single mention of how much it plans to earn from the proposed law change, in its 42-page long paper.
McCalman says, “If it’s not worth a lot, then you sort of say, “Why do it?” So it must be worth something.”
EY tax specialist Joanna Doolan says she’d like to see the IRD front up with some figures.
“Often there’s too much of a PR spin on some of the changes that are coming through and not enough economic comment on how they will actually impact New Zealand”, she says.
“We can’t just look at things from a tax perspective. It has to be considered around the total economic impact on New Zealand. It’s irresponsible to look at tax in isolation from the rest of the economy.”