By Terry Baucher*
Former Minister of Revenue Peter Dunne was right when he said last week that global co-operation was necessary to resolve the growing tax issues arising from the new wave of online tech companies such as Google, Facebook and ride sharing service company Uber.
It’s a huge problem, and also one where there are no easy answers.
Uber is just the latest example of the problems for tax jurisdictions when new companies exploiting the internet to achieve a global reach, collide with tax laws written decades ago around national boundaries. But even by the standards of other tech companies such as Google and Facebook, Uber’s model seems particularly ingenious.
Whenever someone in New Zealand uses an Uber driver, the fare is not immediately paid to the driver. Instead it’s remitted to a Dutch company, Uber B.V. which then pays 80% of the fare back to the Uber driver. Part of the balance is paid as a marketing fee ($1,061,018 for the year ended 31st December 2014) to Uber New Zealand Technologies Limited. The majority of Uber B.V.’s 20% cut is paid as a royalty to another Dutch company, Uber International C.V.
At this point, the so-called “Double Dutch” tax planning structure comes into play, under which any royalties Uber International C.V. receives from Uber B.V are tax free for Dutch purposes.
Furthermore, because Uber International C.V. has no employees and its headquarters is in the Bahamas, it technically derives no business income in the Netherlands. Uber is therefore able to accumulate tax free the vast majority of the royalties it receives from around the world.
It’s therefore unsurprising that Uber’s aggressive tax planning practices have come under fire here in New Zealand.
Another critic is the New Zealand Taxi Federation which in June last year warned the Ministry of Transport Small Passenger Services Review about the potential loss of GST revenue from unregistered Uber drivers.
The NZTF may be protecting its turf, but its point about the tax risk from Uber’s business model is valid. At present 20% of an Uber fare will escape the New Zealand tax net. Consequently, there is a fiscal risk if Uber was to capture a significant portion of the estimated $400 million a year taxi industry. (Interestingly, recent Victoria University of Wellington research indicates some Uber drivers may be taxi drivers looking to supplement their income).
What hasn’t been examined so much is why the likes of Uber adopt such complex structures. Arguably, they have little choice but to adopt aggressive tax planning if their American investors are to achieve any realistic returns.
Consider the tax implications for an individual American shareholder in a “normal” structure such as the following:
How much would an individual shareholder in the United States finish up with after tax If the New Zealand subsidiary makes a pre-tax profit of $100,000 which it distributes as a dividend to its US Parent, which in turn paid it out as a dividend to the individual shareholder?
That’s an effective tax rate of over 93%. How?
The profits of the New Zealand subsidiary are taxed at 28%. The corporate tax rate in the United States is 35% and the top Federal tax rate in the United States for individuals is 39.6%. (We’ll ignore the effects of income taxes in States such as California for the purpose of this example). Applying these tax rates to a dividend of $100,000 results in the following:
|Pre tax profit in New Zealand subsidiary
less income tax @ 28%
|Net dividend distributed to U.S. parent company
less U.S. corporation tax @ 35%
|Net income distributed as dividend to U.S. shareholder
less U.S. income tax @ 39.6%
|Net after tax income of shareholder||$6,487|
Such potentially high tax rates are the background to Uber’s tax planning and why multinationals devise elaborate strategies such as the Double Dutch structure to shift pre-tax income from overseas subsidiaries either directly to the parent company, or to a subsidiary in a tax haven jurisdiction. The numbers involved are eye-watering.
For example, In March this year American Fortune 500 companies, including the likes of Apple, Google and General Electric, were estimated to have US$2.4 trillion of “permanently reinvested” profits sitting in tax havens such as the British Virgin Islands.
The OECD’s Base Erosion and Profiting Shifting (“BEPS”) initiative is one answer to this aggressive tax planning. Once implemented, it is likely to increase the overall tax take from multinationals. However, the problem of the cascade effect of taxation resulting in very high effective marginal tax rates will remain.
Reducing corporate tax rates therefore seems a reasonable approach. And worldwide the trend is for lower corporate tax rates. But how low? An IRD/Treasury working paper prepared for the 2009 Tax Working Group noted:
“Under the stringent assumptions required for the Production Efficiency Proposition to hold, a small open economy should levy no tax on capital invested in the economy which would imply a zero company tax rate.” ( See here, Appendix A, page 35)
A zero company tax rate? Good luck with getting voters to accept that.
One other alternative to deal with the cascade effect of tax would be to fully credit the tax paid in an overseas jurisdiction in a similar way to the current imputation or franking credit regime.
Unfortunately, even between such closely connected economies as Australia and New Zealand or the European Union, mutual recognition of tax credits has proved impossible to implement. After several European Court of Justice decisions required countries to provide imputation credits to non-residents where imputation credits were provided to residents, European countries began abandoning imputation regimes, concerned about the potential cost to their tax base.
Similarly, the stumbling block for recognition of imputation credits between Australia and New Zealand is the potential fiscal cost for Australia. The Australian Productivity Commission estimated this to be US$353 million per annum in April 2015.
If two such integrated economies as Australia and New Zealand cannot agree on mutual recognition of imputation credits, there is little chance of a similar initiative working worldwide.
Although the general mood of the public and tax authorities is against aggressive tax planning by Uber and other multinationals, BEPS is not likely to change drastically the economic imperatives for multinationals.
Zero company tax rates are politically unacceptable, so we can therefore expect to see ingenious tax planning by multinationals to continue for a long time yet.
*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »