By Andy Archer & David Snell*
In what will be the biggest change to the international tax rule book since it was put in place before World War 2, the OECD will tomorrow (4 am Tuesday 6 October) release its final recommendations for combating multinational companies’ tax avoidance strategies.
Almost three years in the making, the OECD’s BEPS (Base Erosion and Profit Shifting) project’s implementation will require extensive changes to tax law and treaties. At its heart, BEPS aims to address the widespread perception that MNCs (multinational corporations) don’t pay their fair share of tax. The project has been driven by a rise in activism, and more media scrutiny and public interest in how businesses pay tax.
The tax changes, expected to be backed by the G20 Finance Ministers’ meeting in Lima on Thursday and the full G20 Leaders’ Summit in Turkey on 15 November, will affect all businesses with cross-border operations. They can expect greater compliance burdens, greater scrutiny and possible disputes, greater potential tax costs and to invest more time and resources in adapting their current tax and operational frameworks.
The New Zealand government has endorsed BEPS and we can expect a raft of changes to our tax system in the next few years.
But there will not necessarily be a net gain to the total New Zealand tax take. While many companies prefer to pay tax here rather than overseas, others may end up paying more tax to foreign governments and less tax here. For example, 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?
The OECD’s key recommendations:
Limitations on interest deductions.
The proposals here are far-reaching and depart from many countries’ existing practice. They go far beyond our already-low thin capitalisation restrictions and seek to deny interest deductions that exceed global group indices. This is a complex matter. Outliers such as the banking and insurance sectors face extra challenges as their business models depend on having much higher gearing than the average trader or manufacturer. That means there will need to be some carve-out reliefs from the new rules. We expect Inland Revenue to set out its ideas in early 2016 and it may become harder for multinationals to deduct interest expenses here in New Zealand.
The OECD is worried about companies using hybrid financial instruments and entities to achieve double non-taxation and recommends domestic law change to prevent this. New Zealand already has rules attacking outbound hybrids but further changes appear certain, with announcements next year.
The OECD recommends multinationals with global revenue of more than €750 million will be required to file country-by-country reports from 1 January 2016. While the threshold eliminates most New Zealand-headquartered groups, some of our larger companies will confront material reporting requirements, with increased foreign tax department scrutiny. The IRD will receive reports from other tax authorities on multinationals with subsidiaries here. Corporates affected by this will need to take a global approach to disclosure to ensure it is consistent. Many corporates not affected by mandatory disclosure are, nonetheless, using such disclosure to promote their good corporate citizen image which can be an advantage in times of vilification of corporate tax planning.
Under most double tax treaties, a firm’s income is taxed only in the country where it has a permanent establishment or fixed place of business, based around physical presence. The OECD is widening the ambit with changes to preparatory and auxiliary activities and commissionaire-style arrangements that will now risk meeting the permanent establishment test and being subject to tax.
These changes are important as many small and medium-sized New Zealand enterprises go offshore early in their business lifecycle. Incremental activity means it will become easier to become taxable overseas by mistake. While New Zealand’s policy response to BEPS action has been restrained, we are seeing a tougher BEPS-labelled approach to IRD audits and disputes with taxpayers. What’s happening in individual investigations doesn’t always match the reassurance we’re hearing from Inland Revenue’s leadership team.
In summary, BEPS is more than just a technical tax issue.
• Global rules are changing. These changes will affect many aspects of how business is done worldwide.
• There will be more scrutiny of business’ tax affairs. Businesses need to be ready for more transparency. They will soon be required to report on what they earn and how much tax is paid on a country-by-country basis. That information will be shared between tax authorities worldwide.
• Many businesses will need to rethink their approach to cross-border financing and may need to alter their operating structure.
• Tax reforms could affect the value attributed to future mergers and acquisitions.
• Moves are underway for public disclosure of company tax affairs. Many businesses operate in a global market for talent. Where people are based and how they travel will be affected by changing tax rules.
• It will be important to ensure the way employees are incentivized is consistent with their position and the work they are really doing. Many jurisdictions, including New Zealand, are considering reforms in their employee/contractor rules to align with their desired tax policy outcomes.
*Andy Archer is a partner at EY and international tax specialist. David Snell is executive director of tax policy at EY.