With a new top personal tax rate on its way in New Zealand and amid ongoing rumbles around expanding New Zealand’s tax base, it would be easy to miss the slow grind towards what could be one of the most significant international tax developments in history.
That slow progress might change in 2021. Reports released toward the end of last year by an Organisation for Economic Co-operation and Development (OECD) / G20 group revealed apparent progress in securing multilateral consensus on international proposals to allocate tax on profits of large multinational digital and consumer-facing businesses to the markets they operate in, and to bring in a global minimum tax on large multinational entities.
With those reports, the group – which represents over 135 jurisdictions working together on the proposals – restated its commitment to a long-term consensus solution and signalled an intention to move swiftly, with a view to reaching final agreement by the middle of 2021.
The path to consensus among the participating jurisdictions is not straightforward. There is work to be done on a number of outstanding political and technical issues associated with the bold proposals, and achieving agreement in a highly political environment will be challenging.
In particular, with the treatment of U.S. technology giants a key issue, there’s been much speculation about how U.S. President Joe Biden’s position may differ from that of the Trump administration, which threatened trade retaliation against tax measures it viewed as discriminating against U.S. companies. President Biden may take a more multilateral approach in general, but when it comes to U.S. tax revenue, he too will be looking to shore up his country’s tax base.
Some have argued there’s a lot at stake. In October, the head of the OECD, Angel Gurria, warned that countries must come together on a consensus solution or risk a trade war at a time when the global economy is already suffering enormously. The OECD has estimated failure to reach agreement could reduce global GDP by more than 1 percent annually if the worst case scenario comes to pass, and a global trade war is triggered by imposition of unilateral digital services taxes worldwide. The director of the OECD’s Center for Tax Policy and Administration, Pascal Saint-Amans, described 2021 as a ‘do or die’ year for the international plan.
So, international efforts are critical, but what will it mean for New Zealand if they are successful? There’s no straightforward answer. Some elements of the OECD proposals offer advantages to New Zealand – but in other cases it is very difficult to see any growth in tax revenue even if new rules are agreed.
A closer look at the framework for taxation of large digital and consumer facing multinationals shows a major departure from the status quo. The most significant change would be to grant countries where consumers of particular goods and services reside a new taxing right over certain super profits from these businesses, regardless of whether or not the multinational has a physical or other taxable presence in that country.
Among the outstanding issues, yet to be resolved, are final decisions around the types of businesses that will be in scope for the new taxing right. The proposal is currently targeting “automated digital businesses” and “consumer-facing businesses” that are carried on by large multinational entities (the threshold for “large” is to be confirmed), where non-domestic in-scope profits of the business exceeds a certain threshold (also to be determined). Certain industries may be excluded from the new regime, including natural resources and financial services (among others).
New Zealand may see gains from this proposal. Many foreign digital and consumer-facing multinationals operate in the New Zealand market but do not need any form of physical presence to do so, and under current tax settings are not liable to tax in New Zealand in any significant way. Granting a new taxing right to New Zealand that does not rely on the traditional requirements for having a taxable presence in New Zealand should deliver new tax revenue.
However, the tax revenue may be modest; for starters the taxing right attaches only to in-scope super profits, and it is also hard to imagine that anything more than a minuscule percentage of such profits would be attributable to the relatively small New Zealand market. The proposal may impact New Zealand based multinationals that are in scope (that is, who meet the business type, size and non-domestic revenue requirements) and could lead to New Zealand having to offer credits for tax allocated to market jurisdictions where previously no such credits needed to be granted. The loss of tax revenue for New Zealand-based multinationals may of course be outweighed by revenue gains from an allocation of tax in respect of foreign multinationals.
The proposed global minimum tax, on the other hand, reaches beyond digital and consumer-facing multinationals. It would affect any large multinational company and has the purpose of discouraging the use of low tax jurisdictions to accumulate profits (for example, by holding intellectual property in a low tax jurisdiction, and transferring profits from related entities in high tax jurisdictions to that low tax jurisdiction through royalty payments). It is the countries that serve as bases for such large multinationals that will be the main beneficiaries of any extra tax revenue that may be generated.
If the tax paid within a multinational group in a particular jurisdiction is below the minimum level, then top-up tax is payable in the jurisdiction where the parent of the group is resident. Top-up tax would be allocated to other jurisdictions in some limited cases, for instance, where the parent jurisdiction has not incorporated the global minimum tax into its domestic law. It is hard to predict whether the global minimum tax will produce tax revenue gains for New Zealand, although the ancillary benefit of discouraging the use and utility of low tax jurisdictions may shore up New Zealand’s tax revenue base.
Implementing a global minimum tax system will be challenging in practical terms. Information will need to be shared, so different countries know when they can collect tax, and how much they can collect. Avoiding double taxation will be essential.
New Zealand’s focus so far has been on digital services taxes. The Government continues to express willingness to go-it-alone and implement its own domestic digital services tax if international consensus does not materialise or takes too long. As recently as October 2020, Revenue Minister David Parker told the OECD that while the international solution is preferred the Government would “seriously consider a DST if the OECD is unable to reach a solution”. Others, including the UK and France, have already taken steps to impose their own unilateral digital services tax, with subsequent ripples in international trade relations.
A New Zealand unilateral digital services tax may regain momentum if international progress stalls, but in our view it would need to be very clear indeed that the international process has ground to a halt before going down that path. Further, we anticipate New Zealand would not go it alone, and would take its lead from other jurisdictions who are strong in their convictions that unilateral measures are necessary. A unilateral digital services tax comes with a significant list of issues. The tax may generate little revenue and New Zealand may have difficulty in enforcing such a tax on multinational digital companies that operate outside New Zealand. The cost of the tax may be passed on to New Zealand customers. Uncoordinated unilateral measures creates the risk of double taxation or the inadvertent taxation of loss-making businesses.
Broader issues include the international trade consequences if the US considers such a tax discriminatory and retaliates, and the toll that a unilateral digital services tax might take on New Zealand’s broader reputation as a business-friendly nation.
It seems there are no easy answers, whichever path is taken. But with many eyes on the fiscal position of governments around the world as a result of the Covid-19 pandemic, pressure is mounting in 2021 to agree a way forward on what may prove to be a historic turning point in the structure of the global tax system.
October 2020 – OECD points to ‘substantial progress’ by the international community towards the goal, and agrees to keep working towards an agreement by mid-2021. Details of the ‘blueprints’ for the tax proposals are released for public consultation.
June 2019 – The Government releases a discussion document outlining New Zealand’s options for taxing the digital economy.
May 2019 – The international community agrees a road map for resolving the tax challenges arising from the digitisation of the economy and commits to continue working toward a consensus-based solution by the end of 2020.
February 2019 – New Zealand Government announces its intention to consult on the design of a New Zealand digital services tax, as an interim measure until the OECD reaches agreement.
January 2019 – The OECD announces the international community has made progress, with agreement to continue working multilaterally towards achievement of a consensus-based long-term solution in 2020.
March 2018 – An initial group of more than 110 countries and jurisdictions agree to review two key concepts of the international tax system, with a mandate from the G20 Finance Ministers to work on the implications of digitalisation for taxation.
October 2015 – The OECD/G20 Base Erosion and Profit Shifting Project publishes a report analysing these tax challenges and presenting a package of measures to be discussed by the G20.
July 2013 – OECD publishes an Action Plan to address tax base erosion, and profit shifting between countries – which calls for work to address the tax challenges of the digital economy.
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