Taxation (Neutralising Base Erosion and Profit Shifting) Bill

Thank you, Mr Chair. Yes, so continuing this discussion around this base erosion profit shifting bill—very good bill, very complicated, as we talked last time. It’s great to see the Minister in the chair, Stuart Nash, because I think this is an important bill—that everyone understands it. One of the areas we were talking a little bit about last time, although I’ve got to say I was cut off at the knees—I was rapt because I was talking about thin capitalisation rules, which I know that the Minister in the chair is a fan of and understands well. That’s why it’s also good to have the Minister, because I wanted to ask some questions about thin capitalisation.

Perhaps it’s just worthwhile, just for a sec, just to recap: what do we mean by thin capitalisation? Well, thin capitalisation, basically, means is there enough ownership equity or shareholders’ funds in a business to make sure that the business is well capitalised and can meet its future liabilities? Now, when you look at a balance sheet of a company, on one side you have capital—shareholders and assets—and on the other side you have liabilities—

💬 Hon David Bennett: Like the New Zealand First Party?

That’s right, Mr Bennett. And so the importance of thin capitalisation—what that refers to is that some companies, if they want to reduce their profits, what they will do is increase their debt as much as possible and, therefore, the interest cost on that debt is higher than what it might otherwise be and therefore the interest deduction comes off the profit and therefore the profit is minimised and, consequently, the tax payable by that entity is minimised. That is, basically, what BEPS is all about—base erosion and profit shifting. In many cases involves using either high interest rates—and we covered that previously to some extent—or a high amount of debt. And the thin capitalisation rules are about actually making sure that the debt levels—that component—is reasonable and fair.

Now, last time I was talking, and there are a number of submissions, but particularly there’s a very good submission from PricewaterhouseCoopers (PwC). They said that the treatment of non-debt liabilities should actually not be included in how you assess your liabilities, but specifically went on to say that if you are going to look at them, they need to better reflect how those liabilities are viewed. Now, there are a whole lot of different liabilities, and most people think about liabilities—if you’re Mr Twyford thinking about his housing situation: lots of liability.

There are other types. There are contingent liabilities that may not represent a real debt at this moment, or there are other aspects of the operation. The one that is most pertinent, I think, is the mining industry—the extractive industry—and I was just touching on this when I was, unfortunately, stopped last time. When you think about an extractive industry, where you’re mining a quarry or oil or whatever, at some stage at the end of that project you will have an obligation, a liability, to remediate that situation. It may be a quarry, or it may be some other area that you’ve exploited. That needs to be bought back, and it might be either to decontaminate it or it might be around how that quarry is brought back into an environmental shape.

Of course, what the argument of PwC was is if this non-debt component was being excluded, well, in some cases actually it should be included, because it’s actually a very relevant thing, and that’s something I think I’d like to hear the Minister’s view on. Of course, we had the officials’ view on it. They said that they’d work through this issue, and the standardisation approach that they are talking about allowed a New Zealand group to deduct up to 110 percent of the worldwide group debt within the context of a safe harbour—and that’s an area that we actually haven’t discussed previously—but that part of it was covered. I’m not so sure in terms of some of those specific entities, and particularly in relation to mining.

The other area is around thin capitalisation, and particularly deferred tax liabilities, and whether these should be included in non-debt liabilities. Again, we had a host of submissions on them from very reputable firms: Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Ernst & Young, KPMG, Powerco, PwC—

I rise to take a call on the Taxation (Neutralising Base Erosion and Profit Shifting) Bill. I want to dwell in my contribution on the permanent establishment rules. These are outlined, particularly in clauses 4, 34, 43—the definitions—and clauses 44 to 48.

Now, of course, the permanent establishment rules propose a new anti-avoidance rule for large multinationals that structure to avoid having permanent establishment and therefore a taxable presence in New Zealand. So the new rules that are proposed here both simplify the test for determining whether an item of income has a source in New Zealand and ensure that all items of income New Zealand is entitled to tax under a double tax agreement (DTA) will be taxable under domestic law.

Now, what I want to raise some questions for the Minister this evening about are some comments that have been made by officials, in particular, because while submitters were generally supportive of the proposed anti-avoidance rule—and while National shares that support—there were some aspects where concerns were outlined, and I just want to take a few of those this evening. So in particular, we had the concern raised that the proposed rules would have a detrimental effect on foreign direct investment. Of course, foreign direct investment is very important to the growth of New Zealand businesses, the provision of jobs, and income, and that is something that we want to ensure can happen in the proper manner.

So, in particular, there were submissions from Deloitte, the Corporate Taxpayers Group, PricewaterhouseCoopers (PwC), and the Chartered Accountants Australia and New Zealand noting that if other countries adopted similar positions in their domestic legislation, many New Zealand exporters could find themselves with permanent establishments (PE) overseas that they don’t currently have. Now, officials have of course responded to that concern, saying that New Zealand is undertaking these base erosion and profit shifting (BEPS) measures in line with most other OECD countries and that the expected tax revenue increase is expected to be relatively small.

So I just wondered, for one thing, whether the Minister would indulge us by commenting on whether or not he can update the House on the expected tax revenue increases as a result of this, and, secondly, whether he can give us any update on the progress of other OECD countries in undertaking these BEPS measures. Those would be useful things to have an update on.

Now, the second issue I want to comment on this evening was from a submission from KPMG, where they raised the important issue of the need for clear guidance in the officials’ report. Of course, members in this House know that the officials’ report has no official standing when it comes to interpretation of this legislation, so I want to raise two particular issues: one which was around determining whether an activity is sufficiently connected to a sale in New Zealand, and, if so, determining whether that activity is preparatory or auxiliary. What officials have said is that this information, this guidance, would be provided in a tax information bulletin on enactment of the bill. So I’m just wondering if the Minister, this evening, can confirm that that bulletin is in fact under preparation, and whether he can confirm in fact when that bulletin will be provided.

Another issue that I would like to comment on is this question of treaty override. So the proposed PE anti-avoidance rules—as members who have clearly read this bill in detail understand—is overriding some of New Zealand’s DTAs. Now, we had a number of submitters from Chapman Tripp, Chartered Accountants Australia and New Zealand, the Corporate Taxpayers Group, KPMG, the New Zealand Law Society, and Russell McVeagh raise a concern that this was a unilateral override. What officials have outlined is that this anti-avoidance rule is a measure that only applies if there is a more than merely incidental purpose of tax avoidance and, accordingly, it should not conflict with New Zealand’s DTAs in the vast majority of cases. I wondered whether it would give comfort to those submitters and to those looking at this legislation—because this House is supporting it—if the Minister was able to detail in fact the small number of cases where it would actually have any override, because I think what officials are saying here is that it would be a very small number of cases. It would probably be useful to outline what those are, if the Minister could do that.

It’s also noted that the wider PE definition will be added to the OECD model convention and so represents what the OECD considers to be the current best practice. Again, I ask you: has this happened yet? Has this wider PE definition—[Bell rung] Can I continue, Mr Chair?

CHAIRPERSON (Adrian Rurawhe): Nicola Willis.

So what I ask is simply—the member wishes to be better informed and I’m sure the Minister can inform her whether that widened PE definition will, in fact, be added to the OECD model convention, and so whether we have, in fact, had that representation of what the OECD considers to be best practice.

I now want to move to the issue of royalties and the deemed PE source rule. This is an issue that KPMG and PwC, in particular, raised a broader concern—that the proposed changes increased the risk of unintended consequences such as double taxation, and, of course, members of this House don’t want double taxation to be something that occurs incidentally. So what officials have told us in this regard is that the risk of double taxation can be seen as a disincentive to entering into PE avoidance arrangements, which they note are typically designed to achieve double non-taxation. So, essentially, officials have said that they don’t think the risk of double taxation exists because of the nature of current arrangements. I wonder whether the Minister can enlighten the committee a bit further by detailing evidence for the claim that the risk of double taxation is actually seen as a disincentive to entering those PE avoidance arrangements in the first place.

I think it’s interesting to note the submission from the Corporate Taxpayers Group on the scope of the PE anti-avoidance role. In terms of permanent establishment, they are very clear in reminding this House that we should be careful that the scope of the rule should not be widened in future. So they’re very careful that the scope as it currently stands is appropriate, but to widen it in future would not be appropriate. It has been heartening to have officials confirm that they have no intention of widening that anti-avoidance rule beyond its current scope, and it would be useful to have the Minister confirm that that is the Government’s intention with this part of the legislation.

I now want to move to the issue of the application of the permanent establishment rule—in particular, as it relates to the threshold that may still result in the rule applying to smaller New Zealand resident entities. So what Chartered Accountants Australia and New Zealand raised as an issue was the idea that the EU has estimated that there are about 6,000 multinationals that fit the definition in the bill around the threshold of turnover of €750 million, but officials note that the rule only applies if the non-resident has a related party in New Zealand that carries on sales-related activities. So it’s actually a two-part test: one, do they meet that EU turnover threshold, and, two, do they have a related party that carries on sales-related activities in New Zealand? So my question is: do we have an estimate from officials, or does the Minister have information, that can tell us actually how many entities in New Zealand we think this rule might apply to? I suggest it would give submitters a lot of comfort to know it’s a lot fewer than the 6,000 that meet the first test, once we think of that second test in terms of sales-related activities. So it would be useful to have that number.

I now move to the issue of the proposed application dates, because some submitters, of course, were clear that they didn’t think they allowed sufficient time for multinationals to restructure. Of course this is a legitimate concern, because what this is about is multinationals saying “Yes, we do want to meet the law as it stands. It is appropriate that we do so.” but acknowledging that in some cases, it takes some time to rearrange tax affairs to meet the law. So again, officials have considered that and have given some comfort by saying that inland revenue will take any current restructuring process into account when it investigates or assesses a multinational following the introduction of the proposed rule. I think it would be very useful for the Minister to put on the record of this House in the Hansard that, in fact, that is the approach that inland revenue will take. Furthermore, I would be very interested to understand what conversations the Minister has had with the IRD about this and whether any directions have been given or whether he intends to give the IRD any directions on this in the future.

I now turn to the issue of the facilitator rule and the matters that it may cover—

💬 Andrew Bayly: Ah, the facilitator rule.

That’s right. So the chartered accountants—again, they’ve been heavy submitters obviously on this bill, as you would expect, and clearly play a very important role in ensuring that this legislation be interpreted well by businesses and by those operating in New Zealand. What they have iterated is that they believe that it should cover sales only, and not extend to activities that don’t relate to a specific sale, such as warehousing, marketing, and advertising. Now, of course, in the commentary to the bill, those preparatory or auxiliary activities are—

I move, That the question be now put.

Thank you, Mr Chair. It’s great to be able to talk on this bill as well, and I just want to focus on one part of it, and that is the hybrid and branch mismatch arrangements.

💬 Hon Member: I’m looking forward to this.

You should be looking forward to it. A hybrid or branch mismatch arrangement can result in a deduction with no corresponding taxable income for the Government, or it could result in a double deduction, so, in both cases, the Government could lose out on revenue. So of course in this legislation, which is there to increase Government revenue, it has sought to deliver a solution in regard to these issues. Now, the solution that’s been proposed in the original bill was a very comprehensive solution that is based on the OECD approach and is very generalistic. The submissions were to have a much more specific regime that took into account the New Zealand environment and how things operate here and how our commercial arrangements are structured. It is good that the committee has taken on board those submissions, in many cases, and delivered some good outcomes that actually have a much more rational approach that takes into account how New Zealand commercial affairs operate, rather than seeking to have a comprehensive approach just because it is easier to do so.

So let’s have a definition of a hybrid and branch mismatch arrangement. That’s a cross-border arrangement that exploits the “differences in the tax treatment of an instrument, entity, or branch under the laws of two or more countries.” I remember doing a member’s bill, which was very similar to this, that looked at the international treatment under the different laws. It was a bill that the Hon Chris Finlayson took great delight in as well, because he was very much involved in that in his legal practice. So, as I say, that can actually potentially lead to a deduction without any corresponding taxable income to the Government, or even in the case of a double deduction, which is even less income coming to the Government.

So let’s have a look at some of these changes that were proposed by submitters and were taken on by the committee and actually accepted—and that’s a rare thing in our select committee process to actually see, but actually it did happen in this case. So the first one that we’ll look at—and this is probably one of the smaller ones—is the transitional period. In this case, this was a submission of the Chartered Accountants Australia and New Zealand and the Corporate Taxpayers Group, and was accepted in part, subject to officials’ comments. The officials agree that a transitional period would help taxpayers comply with parts of the rules and situations where another country’s rules are implemented part-way through the taxation year, and that’s particularly relevant in the case of the entity-based rules due to possible interaction of other countries’ dual inclusion income rules and New Zealand’s surplus assessable income concept.

So that is very much taxation-speak, but, effectively, to actually see that the officials see that this should be accepted, in part, takes into account that there is a bit of an issue there, and that needs to be recognised and taken into account through this legislation. So a transitional period was submitted. It should be included in the measures in relation to other countries implementing hybrid and branch mismatch rules, particularly Australia—and our biggest trading partner is Australia, so that makes a lot of sense—and the advisers and the committee have come to a point that actually takes partly into account that request.

Another one was to widen the corresponding hybrid mismatch legislation. Now, that submission was accepted, and there was an appropriate change made to the definition of hybrid mismatch legislation to clarify that comprehensive anti-hybrid rules are not required. Another one where there has been a submission—in this case, it was a submission from KPMG—[Time expired]

I will answer a couple of the questions that have been asked, but I would like to say that a number of the questions that have been asked this afternoon already I did actually answer on Tuesday night, and I’m not going to repeat those. The permanent establishment (PE) anti-avoidance rule is very similar to Australia’s multinational anti-avoidance law and one aspect of the UK’s diverted profits tax. It’s also based on a permanent establishment definition—the 2017 OECD model double tax agreement—and New Zealand would not look to widen the scope beyond the OECD definition.

Revenue from the PE anti-avoidance rule and changes from the transfer pricing rule would raise about $50 million per year once fully implemented. The Tax Information Bulletin—of course, the officials will publish administrative guidance in a tax information bill shortly after the legislation is enacted. They do this for every single piece of legislation.

Mr Bayly’s not here. Well, I will just mention—

💬 Hon Andrew Little: Answer the question anyway.

Yeah, I’ll answer the question anyway. The amendment in the bill makes New Zealand’s thin capitalisation rules consistent with Australian rules, and, as we know, Australia has a major mining industry.

And I would just say to the member who spoke last David Bennett and the one before then, Nicola Willis, that to all questions that you asked about whether the officials were right in their advice, my answer to that is of course yes, they are. As we know, you had plenty of time in the Finance and Expenditure Committee to test the veracity of the officials’ advice. So please don’t expect any questions to be answered if you ask me “Are the officials right?”, because, as mentioned, this went through a long, involved select committee process. There were a number of highly complex submissions, which I think the officials did a brilliant job of distilling down into official reports—which I read and I know the members have read as well—and I think you’ve come to a very good spot in this bill. It is a piece of legislation that, obviously, we all support right across this House.

The officials, I think, have done a sterling job. I’ll reiterate something again that I said on Tuesday night, and that is that in terms of our contribution at the OECD around base erosion and profit shifting measures and legislation and guidance, we absolutely box above our weight. In fact, we are recognised as having experts in certain areas on this.

So I don’t think anyone can be concerned about the measures in this bill. They have been tested and tested again and—as mentioned—put in front of the select committee, and I know, from the chair of the select committee and also the members, that there were very robust discussions. Some of the parts of the bill were changed because of those discussions, but as a consequence of the select committee process, I think we’ve ended up exactly where we need to be, with a very good piece of legislation that will go a long way to mitigating avoidance by multinational organisations operating in this country. Thank you.

Thank you very much, Mr Chair, for the opportunity to speak to the Taxation (Neutralising Base Erosion and Profit Shifting) Bill. I had such a good time—and I know that everyone who heard me would have also had such a good time—speaking to this the other night that I feel moved to do, again, likewise.

I’d like to focus on the implications of the mismatch situation that Mr Bennett has already given a pretty good dissertation on in relation to banking groups—so, specifically, clause 29C, which amends the formula for a banking group’s funding debt. The first part of that is simply to add into the formula the punctuation and then the word “mismatch”—so the punctuation is the “–”, meaning, of course, a minus. So what we have as the net effect of that is that the formula for a reporting bank to calculate the funding debt of its New Zealand banking group is as follows: the total interest plus interest deductions, minus shares, and, now—the new element—minus the mismatch, all divided by days in the quarter.

Of course, for that to be meaningful, we need to examine what the mismatch is. I won’t belabour that point because it’s already been covered in very good fashion, indeed, by Mr Bennett, but, essentially, as I understand it from reading the commentary on the bill, a mismatch situation is one that gives rise to a denial of a deduction or assessable income. So whether that’s, effectively, a plus or a minus, it will be factored into the equation—the formula, so-called—to work out the funding debt of a reporting bank as defined in the Act.

What then is a mismatch in this context, I hear you ask, Mr Chair, and, indeed, many others are asking that, no doubt. Well, the answer to that is provided in this amendment to the bill, helpfully, so that at subclause (2) we have a new provision, paragraph (cb), whereby “mismatch” is defined as being “the same proportion of the financial value of a debt or financial arrangement included in paragraph (a) or (b)”, which I will just note briefly is that total interest and also the interest deduction that I mentioned earlier. So, having taken that as “the proportion of the total interest expenditure under the debt or financial relationship in the income year that is denied”, then one of three scenarios applies. It is either “a deduction in the income year under section FH 3(2)”, which, broadly speaking, is “(Payments under financial instruments producing deduction without income)”, or is one of the other two scenarios, being “an unrecognised amount” or—broadly speaking, again—providing for the matching of deductions from multi-jurisdictional arrangements, which I think is pretty clear.

But none the less, I do have a couple of questions, and they, I suppose, at a reasonably high level, are seeking from the Minister—who I acknowledge has obviously put in a lot of care and attention and has some expertise in the area—just, essentially, an assurance that this particular mechanism, where we’re adding in a somewhat broad kind of addition to the formula whereby we’re trying to catch any kind of situation where a mismatch would otherwise occur, really fits the sort of comprehensive nature of the bill. Obviously, the whole purpose of the thing is to be as comprehensive as possible and to avoid missing out on any sorts of situations whereby, deliberately or otherwise, an entity or a group of entities with a parent overseas and a New Zealand operation as well might, again, deliberately or inadvertently avoid—not to say “evade”—their tax obligations. So the first question is whether that aids the comprehensive nature, and the second question goes to alignment.

So I just seek the assurance, really, that this will enable us to say that we have arrangements in this respect that are aligned with Australia and other overseas jurisdictions whom we seek to have similar arrangements to—again, for the clarity, for the certainty, and, indeed, for the overall international feeling that these kinds of arrangements should be avoided whereby those who can and should pay tax have been managing to avoid doing so. I think that probably concludes my current questions to the Minister, and I do look forward to the response.

I move, That the question be now put.