Will a Digital Services Tax proceed in New Zealand or has the OECD done enough?

By Bart de Gouw and Riaan Britz
 

In its pre-election tax policy release the Labour Party agreed to continue to work with the OECD to find a workable global solution for taxing digital services. However, it also had a clear message from its finance spokesperson Hon Grant Robertson that if insufficient progress is made by the OECD, Labour’s policy is to implement a digital services tax (DST) for tax highly digitalised businesses:

“Labour will continue to work to get an international agreement that will see a comprehensive regime for multinational corporations to pay their fair share. But we also need to be prepared to put in place our own rules to ensure fairness, if that agreement is not possible. We will be prepared to implement a Digital Services Tax (DST). Current projections from IRD estimate a DST will raise between $30 million and $80 million of revenue a year.”

On 12 October 2020, the G20/OECD Inclusive Framework released a number of lengthy documents in relation to its work on Addressing the Tax Challenges Arising from the Digitalisation of the Economy. Deloitte has released a summary of the key materials.

Although no agreement has been reached yet, the OECD is of the view that the blueprints provide a solid foundation for future agreement. The OECD’s aim is to bring the design process to a conclusion by mid-2021. Full implementation across our trading partners of any agreed upon rules could well take several more years and take us into the next New Zealand election cycle.

The question now is whether the OECD’s progress to date is considered sufficient to park the implementation of a New Zealand DST. The Labour Party has not released further details of its DST policy other than the framework set out in the previous Government’s discussion document: 'Options for taxing the digital economy', released in June 2019. The OECD is not in favour of such unilateral actions and its impact assessments are clear that the widespread use of unilateral DSTs and the likely trade retaliations would be worse for the global economy than the implementation of the so-called Pillar One proposals. Politicians and policy officials will have been following the escalation of trade tensions between France and the US following the adoption of a DST by France.

Pillar One proposals would shift some taxing rights to the so-called “market countries” away from the brand owning and production countries. The scope of the proposals is not settled and may capture digital companies as well as consumer facing businesses. The OECD has also incorporated some “simplification measures” hidden in the Pillar One proposals that may cost New Zealand exporters dearly. While the tax impact globally of Pillar One is not significant it has the potential to have a large negative impact on taxation collected in New Zealand (rather than in the markets to which we sell) as we are small consumer market but have aspirations to sell high value-added branded products to the world.

Consumer Facing Businesses

The scope of Pillar One’s transfer of taxing rights may be wider than just digital businesses and could also include Consumer Facing Businesses selling non-digital products and services. This would include any businesses that meet the size criteria (yet to be determined) and sell goods or services of a type commonly sold to a consumer, whether directly or indirectly. The OECD proposals as currently drafted would exclude most bulk agricultural, fishery and forestry products, certainly those goods that do not aspire to be differentiated and value adding. If adding value and getting closer to the consumer is what the New Zealand producers and exporters are aspiring to do, then these proposals may well transfer the right to tax some of the resulting profits offshore to another tax authority. The line to be drawn will need to be nuanced, which creates complexity, risk and compliance costs. The report specifically calls out some products where nuance is required including fruit, fishery, forestry (including paper), bottled water and specialty cheeses. That list accounts for a large part of our export sector.

Baseline Marketing and Distribution Activities

All New Zealand exporters with an in-country distributor (no matter how narrow its scope may be) could be impacted by the new standardised benchmarked return for Baseline Marketing and Distribution Activities (i.e. “Amount B” in the Pillar One proposal). Given the way New Zealand companies set up their in-country distributors (in most cases opting for a lean approach), it is most likely that the application of the new standardised approach would lead to a higher level of offshore taxation being paid. The proposal specifically mentions that Amount B would not supersede previously agreed advanced pricing agreements (APAs) and exporters could consider entering into bilateral APAs before the rules come into play to provide certainty for the near term.

Pillar Two

As well as the abovementioned Pillar One work the OECD also released Pillar two proposals. These seek to introduce a set of complex interlocking international tax rules designed to ensure that large multinational business pay a minimum level of tax on profits. Deloitte Global has released some commentary on these rules.

Comment

Given the sentiment of many previous New Zealand Governments has been to ensure New Zealand is closely aligned with OECD recommendations on BEPS, it seems hard to envisage the new Labour Government abandoning the OECD process too prematurely. That said, there is growing frustration with the lack of progress and increased scepticism that an agreement can be reached; add in the need for tax revenue, and the chances of something happening outside of the OECD process seems higher. The ultimate tax impact for multi-national taxpayers operating in NZ will depend on individual facts and circumstances and the final detail of the rules that are ultimately adopted in NZ and other countries. But one thing is certain: there will be significant compliance costs if these types of rules are adopted. We recommend that group tax functions of multinational groups continue to monitor developments with the Pillar One and Pillar Two proposals.

If you have any questions please contact your usual tax advisor.