BEPS proposals now before New Zealand Parliament
Tax Alert - December 2017
By Robyn Walker
On 6 December 2017 the New Zealand Government introduced a taxation bill into Parliament addressing Base Erosion and Profit Shifting (BEPS) concerns.
Once enacted, the Taxation (Neutralising Base Erosion and Profit Shifting) Bill will generally apply to income years starting on or after 1 July 2018.
We outline the key proposals below, noting there is a lot of detail and complexity in the proposed rules which we don’t fully explain here and in some instances there are conflicts between the words of the legislation and the proposal articulated in the Bill Commentary.
Interest Limitation Rules
Historically New Zealand has used its thin capitalisation rules to limit the amount of debt that can be held in New Zealand, with transfer pricing rules applying to ensure the rate of interest on debt is appropriate. There has been a concern expressed by Officials that the transfer pricing rules are too fact dependent and subjective, too hard to police, and overall not wholly effective at keeping interest deductions in New Zealand to an appropriate level.
The new rules were perhaps the most controversial proposals when consultation occurred earlier this year, however some refinement of the original proposals has taken place. At a high level, the new rules are as follows:
- Introducing a “restricted transfer pricing” approach to pricing related-party loans between a non-resident lender and a New Zealand-resident borrower. Under this approach, there are a series of real or assumed credit ratings that can be applied to determine the appropriate interest rate in certain circumstances. In limited circumstances it could be the borrower’s own credit rating for long-term unsecured debt; in others it will be higher of BBB- and the rating that would be given if the borrower had a debt ratio of less than 40%; in other circumstances it will be the higher of the borrower’s credit rating and the highest credit rating in the borrower’s worldwide group minus one notch (this option is referred to as the “safe harbour” option). The option a taxpayer uses will be influenced by whether the taxpayer is considered to be at a high risk of BEPS behaviour. A taxpayer is categorised as a high risk of BEPS if they fail one or more of the following tests:
- The borrower has a greater than 40% debt to asset ratio, or they exceed the 110% worldwide debt test; or
- Borrowing comes from a jurisdiction where the lender is subject to a lower than 15% tax rate; or
- The borrower has an income-interest ratio of less than 3.3 (this is referred to as an EBITDA test).
A de minimis rule applies to exempt taxpayers from these rules if related-party cross-border loans are less than $10million.
- Once a credit rating is established, further features of the debt need to considered and/or disregarded when pricing the debt. These features include the term of the loan and whether the debt is subordinated.
- Specific rules apply to taxpayers who are insurers or in the business of lending.
- Amendments are being made to the existing thin capitalisation rules, including:
- Changing the way debts and assets are measured by subtracting non-debt liabilities from the value of assets for the purposes of the thin capitalisation calculation;
- Introducing a de minimis rule to reduce compliance costs for smaller businesses;
- Amending the rules for taxpayers caught under the “acting together” tests to ensure the rules work as originally intended;
- Clarifying the circumstances in which a taxpayer can use an alternative asset valuation from that used in the financial statements;
- Introducing a further avoidance rule to prevent manipulation of debt and asset values at balance date;
- Extending owner-linked debt provisions to trusts;
- Providing a limited exemption from the thin capitalisation rules for certain government infrastructure projects.
Permanent Establishment Rules
New rules will target large multinationals (at least €750million consolidated global turnover) that structure arrangements to avoid having a permanent establishment (PE) in New Zealand. The new rules will deem a non-resident entity to have a PE in New Zealand if a related party is conducting sales activity in New Zealand in a manner designed to avoid tax. These rules attribute activities for the related party to the PE. Of some concern is that these rules have been explicitly designed to apply regardless of any contrary positions under New Zealand’s Double Tax Agreements (DTAs), unless that DTA incorporates the OECD’s latest PE article (Article 12(1) of the Multilateral Convention).
Transfer Pricing Rules
A raft of changes are being made to the transfer pricing rules to make them more robust and to achieve greater alignment with Australian transfer pricing rules. Changes include:
- Including a reference to the OECD transfer pricing guidelines in the Income Tax Act 2007;
- Giving priority to the economic substance and conduct of parties over the terms of a legal contract;
- Providing Inland Revenue with the ability to disregard or replace transfer pricing arrangements which are not commercially rational;
- Extending the application of the transfer pricing rules to transactions where non-resident investors are “acting in concert” to effectively control a New Zealand entity;
- Shifting the onus of proof from the Commissioner to the taxpayer (consistent with the approach for other tax matters);
- Extending the time bar that limits Inland Revenue’s ability to reassess transfer pricing positions from four years to seven years.
The requirement for New Zealand headquartered multinational groups with annual consolidated group revenue of €750million or more to prepare and file a country-by-country report will be codified in legislation.
Hybrid and Branch Mismatch Rules
The Bill includes a comprehensive adoption of the OECD hybrid recommendations with modification for the New Zealand context. The proposed rules are designed to address the following hybrid and branch mismatches:
- Hybrid financial instruments;
- Disregarded hybrid payments;
- Structures producing double deductions;
- Reverse hybrids;
- Dual resident entities;
- Imported mismatches; and
- Deemed branch payment and payee mismatches.
Other policy matters
A number of other policy matters are included in the Bill:
- The Bill proposes amendments to allow the Commissioner to request offshore information held by large multinational groups and introduces a new civil penalty imposing fines of up to $100,000 on a large multinational group member who has failed to comply with a request for information. This rule will apply from the date of enactment.
- A new rule is proposed to allow Inland Revenue to collect tax owed by a member of a large multinational group from any wholly-owned (local) group member.
- A new deemed source rule is proposed which will deem an item of income to have a New Zealand source if New Zealand has a right to tax that item of income under a DTA.
- An amendment is proposed to ensure that no deductions for the reinsurance of life insurance policies are available if the premium income on that policy is not taxable in New Zealand.
This Tax Bill contains some of the most complex legislation produced in recent memory. It will take considerable time and effort to come to grips with all the proposals contained within the Bill and what they mean for taxpayers. Of most concern is the manner in which the rules propose to override existing OECD arm’s length concepts for the pricing of debt and existing DTAs. The concern is that such proposals have New Zealand going against existing international norms as well as effectively seeking to legislate itself out of previously agreed DTA positions.
With most proposals coming into effect from income years beginning on or after 1 July 2018, this doesn’t leave much time for taxpayers to prepare.
The next steps are for the Bill to be read in Parliament for a first time, after which it will be referred to the Finance and Expenditure Committee who should then call for public submissions on the Bill.
Keep an eye on www.taxathand.com or our Tax@Hand mobile app for more detailed commentary on these proposals.
For more information please contact your usual Deloitte advisor.
December 2017 Tax Alert contents
- Tax Alert - December 2017
- BEPS proposals now before New Zealand Parliament
- Terms of reference announced for Tax Working Group
- R&D Tax Credits: Reflections from New Zealand and Australia
- Is AIM the right provisional tax method for you?
- GST on online shopping – the holiday is coming to an end
- Proving arm’s length pricing is set to become a taxpayer’s burden
- Impact of changes to the look-through company rules
- Are your GST processes and controls up to scratch?
- Recent tax developments