The ethics of multinational taxation
There has been considerable global press in recent months about the ethics of multinational companies using tax structures to minimise the tax they pay globally. The low tax take from the multinationals that do business here has brought New Zealand into the middle of this international debate.
Today’s budget has done little to alleviate the issue of multinationals taxation in New Zealand, with some minor technical adjustments to the thin capitalisation regime as the only government response at this stage. Thin capitalisation refers to the level of debt permitted in New Zealand operations to ensure that excessive levels of debt are not carried, and thus profits repatriated through interest payments at a lower tax rate.
Many people are unclear as to what the core problem is and why it can’t be easily solved. Fundamentally, the problem arises from the application of internationally accepted principles of taxation. These principles require people and organisations to be taxed based on either their residency in a particular country, or the country from which the income is sourced.
If a multinational has a New Zealand registered subsidiary company, New Zealand will tax the profits of that company. However, if a company is not registered in New Zealand, only profits sourced from New Zealand will be taxed here.
Herein lies the first problem. Even once a company’s residency and source rules have been determined; there is still confusion about how much profit is attributable to a country, structure or transaction. This is commonly referred to as the transfer pricing debate.
Under transfer pricing principles, the extent of the profit is determined by reviewing the legal arrangements between the parties to determine what profit would arise in an arm’s length transaction. For example, an organisation is not free to rearrange the amount of profit earned between countries simply because it controls the transactions. The amount of profit is determined by understanding the functions, assets and risks of each component part of the organisation.
This brings to light the second problem. If tax principles are based on legal form, a multinational can structure, or re-structure, the legal relationships between parts of the corporate empire to adjust the profits earned in each country – provided they comply with the arm’s length rule.
Peter Dunne has commented that the solution of ensuring that globally an “appropriate” amount of tax is paid, and which country it is paid to, is not an easy one. He has repeatedly cited New Zealand’s tax avoidance rules as our key tool in the war against multinationals (as indicated by the recent run of successes against multinationals such as Alesco). He has also reiterated that New Zealand’s active participation in an OECD think tank to deal with this issue is fundamental to achieving a long-term solution. One might see this as code for a concession that the real solution to this situation is beyond New Zealand’s control. Hence the reason for no specific government response in today’s budget.
Due to globalisation, the problems around multinational taxation are much bigger than when the rules were first developed. Historically, international transactions were based around bricks and mortar, a physical presence. To access global markets a business used to be required to have a physical presence in a particular country and real people operating from real premises. As such, it was far easier to identify a business’s presence in a country and how much profit was made from transactions with that country.
In a global economy, anyone can undertake a transaction from anywhere with the click of a button. And with the delivery of physical goods being overtaken by the online delivery of content such as music, films and books, the world in which we operate has changed dramatically.
The problem is that a large chunk of profits made globally are allocated to countries where little or no tax is paid. And some countries unashamedly tout for that profit, such as the traditional tax havens like the British Virgin Islands, Cayman Islands and the Bahamas. Ireland has also revolutionised its economy by offering a 10% tax rate to encourage multinationals to base their head offices and intellectual property there.
Currently, the Revenue Authorities of countries seek to challenge these global structures through a range of different measures including:
- arguing tax avoidance – structures to avoid tax, but difficult to combat if its foreign tax avoided
- a sham – where reality doesn’t match with legal form
- information sharing – to ensure an understanding of the structures is disclosed and real transactions are identified.
In some countries, domestic tax rules are structured to try and defeat these global arrangements, such as:
- controlled foreign company rules, which bring worldwide income of controlled countries back to the ultimate owners, but generally only for passive investments
- force of attraction rules – attributing profits to the source country
- aggressive transfer pricing – demanding a higher level of profit by arguing a high arm’s length benchmark
- legislating global taxation, such as in the USA by taxing based on citizenship.
These rules typically favour large economies with domestic resident investors that are exporters of capital or economies that are well known for their aggressive tax policies, such as USA, China and India.
Unfortunately, New Zealand doesn’t fall into any of these camps. So while we use traditional models of taxation to capture multinationals as best it can, a revamp of the principles of taxation is the only real hope for change.
Relying on the OECD, to provide a radical change to accepted rules of taxation that will apply globally (when the OECD does not represent all countries and certainly has the notable omission of the BRIC countries – Brazil, Russia, India and China) when all countries tax in different in ways and at different rates, is searching for utopia that is more esoteric than real.
New Zealand’s best chance is growth in the global market and encouraging our own people to stay. The growth of domestic business that delivers to the global markets should be actively encouraged and research, innovation and efficiency should be invested in. That way, our slice of the global tax pie will increase as a by-product of a much healthier economy.
Further enquiries, please contact:
Grant Thornton Partner, Tax and Privately Held Business
T +64 (0)21 291 7332
F +64 (0)4 474 8509