By Aaron Quintal*
For the past year, newspapers have regularly run stories about foreign companies not paying their ‘fair share’ of tax in whatever jurisdiction the paper happens to be based in.
The OECD members, in response to public pressure and the respective governments’ desire to raise more revenue, are banding together to do something about this. It is clear that the current boundaries in the international tax framework are not perfect, but they might be the least ugly option available.
It is certainly not guaranteed that New Zealand would be better-off overall if the boundaries were changed.
While New Zealand (as a country) wins if a foreign company pays more tax in New Zealand (so long as there is no other change in the company’s behaviour), New Zealand loses when our companies pay more tax offshore.
Offshore tax is a transfer of wealth from New Zealand businesses, shareholders and consumers to a foreign government to spend on its citizens. This is money that could have been spent, or taxed and then spent by the government, in New Zealand. This means that any change to the global tax rules will not make New Zealand unambiguously better off, even if foreign companies do pay more tax here.
To understand the problem with the current tax rules, you need to first understand one of the core principles that has underpinned the global tax system since at least the middle of the 20th century. The agreed approach is that governments don’t tax companies that do business with your country, only companies that do business in your country.
For most of the 20th century this concept was not too hard to apply in practice.
Take the example of a company in Japan that would make cars and sell them to a distributor in New Zealand (which might or might not be owned by the manufacturer). The car manufacturer was not taxable in New Zealand on their profit from selling cars to the distributor; they were doing business with New Zealand but from Japan and the profit on this leg of the transaction related to the value they had added in Japan.
The New Zealand based distributor was fully taxable on their profit in New Zealand (regardless of where they were owned from or where the business was legally established) because they were carrying on business in New Zealand.
All of this became much harder in the 21st century when someone could sell a software download from an offshore server, or offer adverting space to New Zealand customers on a global website. Are these overseas companies carrying on business with New Zealand customers or are they carrying on business in New Zealand?
And, just as importantly, should that distinction still matter? These are the questions the OECD is struggling with at the moment and here is where the risk lies for New Zealand companies.
If New Zealand agrees that foreign companies doing business with New Zealand should pay tax here, why should New Zealand companies selling logs or milk powder to China not pay tax there on a share of the profits they make from their New Zealand operations?
Should a New Zealand company selling high end electronics to Europe just pay tax on the profit the distributor makes in Europe, or also on a share of the profit arising from the New Zealand based intellectual property and Chinese based manufacturing?
Any global deal that comes out of the current OECD project on base erosion and profit shifting (BEPS) is not going to magically give more tax revenue to the New Zealand government without New Zealand companies paying more tax to foreign governments.
That’s not to say it is the wrong answer. It’s just that the people of New Zealand need to think hard about whether that is what they want before they ask the question.
*Aaron Quintal is a tax partner at EY.