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Opinion: Double tax treaties are the toughest nut to crack

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Business Day


Last updated 12:16, March 29 2016

OPINION: The prime minister admits that he doesn't think the current situation with New Zealand tax on multinationals is fair. It has been suggested that 20 multinational companies operating in New Zealand pay just $1.8 million of tax on revenue of $10 billion.

While the net profit on turnover of $10b will be much smaller-let's say at 10 per cent, the net profit is $1b - this still makes the effective tax rate 0.18 per cent. If you paid tax at that rate on a salary of $100,000 a year, you would hand over a measly $180.

So, what are governments and tax authorities doing about aggressive multinational tax planning and what is yet to be done?

On a co-ordinated basis, the OECD and G20 are focusing on a far-reaching action plan to combat base erosion and profit shifting (BEPS).

Their plans are designed to prevent treaty abuse, foil hybrid mismatches, prevent unusual and aggressive transfer pricing, and encourage much more timely and comprehensive information sharing.

The Inland Revenue Department is involved in these discussions and is actively participating in measures that are being considered by our Government alongside the tax community.

New Zealand is in good shape to respond to the threats identified and can make good progress in the international fight against multinational tax aggression.

There will be new proposals discussed and debated relating to hybrid mismatches with a discussion document expected in July this year. There is the possibility of changes to our thin capitalisation rules again later on in the year.

But it is our double tax treaties that are the most significant threat because they are being used in a way that significantly reduces the ability of New Zealand to tax New Zealand sourced business profits.

We have the right to tax these profits only when a foreign multinational operates through what is known as a "permanent establishment" in New Zealand.

At the heart of the problem is that some multinationals can operate their business operations without triggering a tax liability due to the way in which they can step around the taxation of business profits using (legitimately) these permanent establishment provisions of double tax agreements.

Sometimes this might be because they can deliver their services online, or because they can sell goods online and have them physically delivered without breaching the permanent establishment threshold.

The OECD is doing some further work on the taxation of business profits, but this is the toughest nut to crack because it is difficult, if not impossible, to separate legitimate activities from aggressive tax planning.

Major OECD countries are unlikely to agree and may find it impossible to manage their own multinationals and the clear competitive advantage that they currently enjoy.

While the world awaits an integrated solution to this taxation of business profits, a second level of governmental response to BEPS is emerging and involves purely domestic taxation legislation introduced on a unilateral basis.

This is not co-ordinated and it is controversial because it is designed in some circumstances to override existing treaty obligations.

Countries with appropriate legal systems, such as the United Kingdom, Australia, and our own, can deliberately override their international tax treaty obligations.

The question is whether such countries should be able to do so, or whether they should only be able to do so in certain circumstances. This is the unilateral domestic law solution that has been employed in the UK (with their diverted profits tax) and Australia (with their multinational avoidance law).

Where multinationals are acting aggressively and improperly, a domestic law treaty override is a justified and acceptable course of action in my view. Many of these multinationals are not paying tax in the home jurisdiction - they have structured their affairs so that the double tax treaties are creating a situation of double non-taxation.

Seen in this light, recent developments involving new tax rules made by the UK and Australia appear reasonable rather than unreasonable, even if they are examples of unilateral legislative treaty override (which the UK and Australia would likely contest).

The approach taken in these jurisdictions, being grounded in preventing abusive structure and transactions, is consistent with one of the purposes of double tax treaties and is therefore justified.

New Zealand should look carefully at the alternatives provided by these two countries.

By Professor Craig Elliffe, of the University of Auckland, faculty of law (author of the book International and Cross-border Taxation in New Zealand)