The New Zealand Government took another big step last week toward implementation of the OECD Base Erosion and Profit Shifting (BEPS) project – releasing three discussion documents.
Proposals include the adoption of rules that are more modest in scope but share features with the diverted profits taxes introduced in Australia and the UK.
Earlier BEPS inspired changes, some implemented and some proposed, include the 2015 GST regime for remote services in late 2015, amendments to our non-resident withholding tax rules (expected to be enacted later this month) and plans to address hybrid mismatches released late last year.
New permanent establishment anti-avoidance rule
A new anti-avoidance rule is proposed to apply to large multinational enterprises with a global turnover of more than EUR750m (MNEs). Where a non-resident member of the multinational group sells goods or services into New Zealand, it will be deemed to have a permanent establishment (PE) in New Zealand if:
- a related entity (either associated or commercially dependent) carries on activities in New Zealand in relation to the sales, and
- some or all of the sales income is not attributed to a PE of the non-resident, and
- the arrangement defeats the purpose of the PE provisions in a relevant double tax agreement (DTA).
If a PE is deemed to exist, the normal profit attribution rules will apply to determine the tax payable in New Zealand. Other provisions of the DTA will also apply, for example royalties paid by the PE to another non-resident may be subject to NZ withholding tax.
Related changes will be made to our source rules to ensure income of the deemed PE has a New Zealand source and to ensure the same tax outcome arises in cases where no DTA applies.
The new PE avoidance rule would apply to income years beginning on or after the enactment date.
Significant overhaul of the transfer pricing regime
Transfer pricing rules would be updated to follow the OECD's most recent guidelines and the recent Australian reforms. Changes will include:
- a focus on substance over form
- allowing for reconstruction of the conditions of a contract (or complete disregard of the arrangement) where not consistent with what unrelated parties would enter into
- shifting the burden of proof in transfer pricing matters from the Commissioner to the taxpayer
- increasing the time bar for reassessment from four years to seven, and
- extending coverage to investors “acting together" (for example, private equity investors).
The new regime would apply to income years beginning on or after the enactment date.
Harsh new administrative rules for MNEs
Proposed new administrative rules for MNEs, to apply from the date of enactment, would enable the IRD to:
- issue assessments earlier (and based on information held at the time) where the MNE does not co-operate, and
- require that disputed taxes payable under the transfer pricing rules, source rules or in relation to the application of a DTA be paid “up front".
Stronger information gathering powers and new penalties are also proposed.
Chapman Tripp comment
The PE and transfer pricing proposals are not surprising given the political and media attention around these issues and action taken by other countries (particularly Australia and the UK). However, there must be an argument that the PE changes are (at least in part) not required.
If the activities performed in New Zealand by the related entity see that entity appropriately remunerated (under robust transfer pricing rules), the taxable income in New Zealand may be little different to that arising from attributing income to a deemed PE.
The transfer pricing proposals will put the focus squarely on the economic substance of arrangements and may require reconstruction of those arrangements (an area more usually associated with application of the general anti-avoidance provision). The combination of the shift in the burden of proof and extension of the time bar to seven years seem to us to go beyond justification (the Commissioner should not need seven years to reassess if the taxpayer has the burden of proof).
It will be critical that the proposed administrative rules are not imposed in a heavy handed way and it is encouraging that the discussion document appears to recognise this.
Strengthened thin capitalisation regime
In a move that is likely to be viewed positively by taxpayers, the Government is not following the OECD's suggestion to limit interest deductibility based on a percentage of EBITDA (earnings before interest, tax, depreciation and amortisation).
Instead, related party debt deductions would be limited through the application of an interest rate cap, set by reference to the non-resident parent's credit rating for senior unsecured debt, plus a margin. Similar restrictions would apply to the deductibility of guarantee fees.
The interest rate cap would apply to banks, notwithstanding that they are subject to a special thin capitalisation regime. A de minimis for application of the interest rate cap is proposed for groups where the principal of all cross-border related party debt is less than $10m.
Other changes proposed in the thin capitalisation discussion document include:
- total assets for thin capitalisation purposes must be reduced by the amount of any non-debt liabilities in the financial accounts (other than certain debts that are considered akin to equity)
- measurement of assets must follow financial reporting purposes, and the value of assets and debt can no longer be determined on the last day of the income year (instead they must be valued based on average values at the end of every quarter or every day)
- a de minimis for inbound investments along the lines of the existing de minimis for outbound investments, and
- a special rule for infrastructure projects that allow third party limited recourse debt of special purpose entities to exceed the 60% safe harbour (but subject to various restrictions and with denial of interest deductions for other non-qualifying debt).
The thin capitalisation changes would generally apply from the first income year after the date of enactment.
Chapman Tripp comment
While the proposed interest rate cap is likely to be seen as a preferable alternative, there is a real question as to why any change is needed as robust transfer pricing rules should accomplish the desired objective. Implementation will also raise difficult practical issues, including the obvious question of the appropriate margin to apply above the non-resident parent's rate.
The proposed change to reduce total assets by the amount of non-debt liabilities will also need to be considered carefully, particularly by taxpayers with sizeable provisions or other non-debt liabilities (such as insurers, mining companies and distributors).
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS allows the implementation of a number of recommended OECD changes to DTAs without the need for bilateral re-negotiation. New Zealand expects to sign it in June this year.
The Government has indicated its intention to implement all applicable minimum standard and optional provisions, including the strengthened DTA PE provisions (separate from the PE changes discussed above) and the new principal purpose test to prevent treaty abuse.
The submission deadlines are tight - 7 April 2017 for the multilateral instrument document and 18 April 2017 for the discussion documents dealing with PE, transfer pricing and thin capitalisation changes.
We would be happy to assist you in the preparation of submissions.