Interest.co.nz talks to EY's David Snell about how US tax reforms could affect NZ (keep an eye on Australia's reaction), and why the NZ govt's multinational tax change proposals won't lead to a pot of gold

By Alex Tarrant

Watch Australia.

Our Tasman cousins’ reaction to (any) United States corporation tax changes is “the big unknown” regarding how US President Donald Trump’s tax plan might affect New Zealand, EY Executive Director David Snell says.

That plan would see the US headline rate cut from 35% to 15%.

Yes, it’s going to be tough for Trump to push the change through. And he’s having to look for ways to keep the move revenue neutral.

But what if it does happen?

Is ‘race to the bottom’ too strong a term? Isn’t the OECD club of rich countries working through proposals to try and stop ‘base erosion and profit shifting’ (BEPS) measures that trading partners appear to have used to undercut each other’s corporate tax rates?

I sat down the other day with Snell to chat about how the noises coming out of the US might affect New Zealand’s corporate tax base.

The good news is that even if the US cut is enacted, effective tax rates faced by US companies are unlikely to change much. They’re already at about 21% due to various tax breaks and other measures. ‘Race to the bottom’ is a bit strong, then, he says.

What will the Aussies do?

But still, Australia might react. That means we will have to as well – they’re the ones we benchmark ourselves against most.

“I know Australia wants to, in the medium term, reduce its rate,” Snell says. “If Australia’s rate did reduce substantially, given the way our economies are intertwined, that would put big pressure on New Zealand’s [corporate tax] base.

“If Australia doesn’t do that, I think there’s a fair chance we could keep broadly the corporate base that we have now,” he says.

So how’s that tax base doing? Our discussion also takes place against the backdrop of the NZ government proposing changes to how we tax multinational companies in a drive to expand our corporate tax take.

Every week there seem to be headlines that the Googles, Apples and Facebooks of this world are not paying their ‘fair share’ of corporate tax in New Zealand.

The government in March released three consultation documents describing its efforts to close off some tax practices used by some multinationals.

Revenue Minister Judith Collins reckons the changes will bring in an extra $300 million per year. Labour reckons it could impose reforms that would bring in at least an extra $500 million.

So what were the changes?

“The government is trying to bring more activity into being taxed in New Zealand through so-called Permanent Establishment Anti-avoidance Rules,” Snell explains.

“What that means is, don’t just tax the local distributor if the product is being sold from offshore, try and tax some of the profits on the offshore sale directly into the New Zealand market through setting up a notional taxable presence.”

“Another big step is limiting the amount of interest that can be deducted against the New Zealand tax base, for example by capping the interest rate, and also by limiting the amount of deductible debt on a balance sheet compared to equity,” he says.

“The third area is around tougher enforcement. Our so-called transfer-pricing rules. Transfer pricing being the setting of prices between goods and services of a related party of an overseas deal. We have rules to ensure that those prices are set at arms-length; those rules are being toughened.”

(Read more in Jenee Tibshraeny’s article here. And Brian Fallow’s take on the situation is here).

What chance is there that these changes will access a big pot of gold at the end of the rainbow?

I note a quote from Collins in March that: “I want to be clear that if the multinational is simply shipping goods or supplying services over the internet - and has no-one working for it in New Zealand - they are not the intended target of the proposed rule.”

The key point is, where value is generated and where that value should be taxed, Snell says.

At the moment, there’s a gap in the debate. A lot of these arguments are about who taxes what. And the OECD is meant to be bringing out more guidelines about the attribution of profit between different economies, where activities are naturally split across different economies.

“We’ve yet to see those guidelines. When we do, then things will become really interesting,” Snell says.

Business with versus business in New Zealand

But often, activities that create value aren’t really split across different nations. Value is typically created in a multinational’s home country where a product is developed, where all its intellectual property and design workforce is.

“So, a tech company that’s got a small sales staff here of…an office support liaison…how much value is being created in New Zealand, compared to the value of all the people who are working overseas developing their technology?”

This is the argument of business with versus business in New Zealand. Or as Robin Oliver puts in in Brian Fallow’s article, our farmers create their products and are taxed on their profits here – we wouldn’t want them to be taxed in China if no value is added to products there before they are sold.

It’s the same for us. How much value is added in New Zealand by these multinationals always in the headlines?

“I think most of those companies would argue very little of [their products’ value] is actually [created] in New Zealand. And I’d say realistically that’s right,” Snell says.

“The New Zealand market is not the key profit source for your big tech companies, and it’s going to be very, very hard for New Zealand to claim a larger share of that.”

Taking all the government’s international reforms in recent years, including to withholding taxes, and our Approved Issuer Levy, Snell says he can see something in the “low hundreds of millions of dollars” in extra revenue potential.

“I think $500 million would be quite a stretch, and I don’t think there’s a huge pot of gold in the proposals that Judith Collins has put out in March, which the government is still currently considering,” he says.

New Zealand’s actually in a pretty good place when it comes to corporate taxation levels, versus other OECD countries.

“Multinationals doing business in New Zealand already pay a substantial amount of tax here,” Snell says.

IRD figures show New Zealand brings in about $12 billion to 13 billion of corporation tax a year. The top 600 companies pay about half of that - $6 billion - and over half of that comes from 300 inbound multinationals.

That overall corporate tax take is also relatively large against the size of our economy, versus other OECD countries. The $12-13bn represents about 4.5% of New Zealand GDP.

“Compared to an OECD average of 2.8%, and a US figure by comparison of 2.2% of GDP…our businesses are already paying a lot of tax here,” Snell says.

We are in the top end of the OECD.

EY has also done work at a more micro level looking at gearing levels, which do not appear to be higher for multinationals than for domestic-owned companies in New Zealand, and looking at effective tax rates.

“Again, we could find no significant difference between multinationals and New Zealand-owned companies,” Snell says.

“That makes me feel that there’s not a huge pot of money for the government to tap into without significantly affecting inbound investment.”

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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4 Comments

What are the chances of a senior executive of the minnow NZ branch of a giant international accounting firm, concluding anything other than NZ tightening its BEPS rules would achieve little and is likely to adversely impact on inbound investment? One imagines a 'this is London HQ old chap' phone call would be not too far away if EY NZ had concluded anything else.

Snell says EY has investigated gearing levels and concluded there is little difference between NZ vs foreign companies. But he doesn't tell us the size of the sample nor reveal what EY's study showed on comparative interest rates. That a cap on rates is being considered by Collins implies some padding is occurring.

The interview also proceeds as though the base comparator of tax rates is the country where most value is added vs the end destination country of those goods or services. When in fact the applicable tax rate for much of that 'home country' value add activity is often that of a third party lower tax country. Home country tax rates are not an accurate measurement of the extent of incentive to maximise the benefits to corporations, of BEPS.

Thanks for the interest. As well as the effective tax rate study Gareth mentions, we have also released http://www.ey.com/nz/en/services/tax/ey-is-the-tax-crackdown-on-multinat... which focuses specifically on gearing levels (sample size was 153). Haven't released anything covering relative interest rates, which can't be done using public data, but the arm's length standard combined with thin capitalization rules is a pretty effective means of preventing excessive deductions.

seigniorage = the profit that Govt makes from creating currency.
A study has shown that Gt Britian Private Banks have made $23 billion dollars profit from their ability to create credit... ie.. seigniorage ... ( this is akin to a hidden subsidy from the Govt to the private banking system )
$23 billion is equivalent to 75% of banking profits..
Its an interesting read

http://neweconomics.org/2017/01/making-money-making-money/