Information is Key: The Proposed Tax-related Amendments to the Overseas Investment Act 2005
Tax Alert - May 2020
By Matthew Scoltock and James Hickey
After extensive and thoughtful consultation between Government and industry in 2019, the Overseas Investment Amendment Bill (No. 2) (the 'Bill') was introduced to the House on 19 March 2020. At its core, the Bill included a suite of proposed amendments to the Overseas Investment Act 2005 ('OIA') that were targeted at significantly reducing the complexity and cost of Overseas Investment Office ('OIO') consent for foreign ownership or control of 'sensitive New Zealand assets.'
As an important part of the Government’s short-term response to COVID-19, the Bill has since been withdrawn and (in substance) split in two. Some tax-related features of the Bill are now included in the Overseas Investment (Urgent Measures) Amendment Bill (the 'Urgent Measures Bill'), which is comprised of the most time-sensitive proposed amendments to the OIA that '... the Government considers need to be put in place urgently to mitigate the economic effects of COVID-19,' and which the Government is hoping will be in force by mid-June 2020. The other tax-related features of the Bill have been included in the Overseas Investment Amendment Bill (No. 3) (the 'Other Measures Bill'). The Government does not believe the Other Measures Bill to be critical to its response to COVID-19, and it is therefore likely to have a slightly more lenient timeframe for scrutiny.
The proposed amendments to the OIA represent a potentially seismic shift, not only for the OIO consent process, but also for the M&A lifecycle - including in relation to tax. As it stands, the statutory 'investor test' does not explicitly contemplate tax. While a foreign investor’s history of tax compliance is no doubt inherent in demonstrating 'good character' (or lack thereof), and may be taken into account by the decision-maker, it is not a mandatory consideration in relation to a foreign investor’s potential 'entry' into New Zealand (and, in our experience, is rarely considered). As a result of the Urgent Measures Bill and the Other Measures Bill, that is about to change - and in a material way.
Overview of the Bills (as they relate to tax)
A key aspect of the Urgent Measures Bill is a 'new' investor test. The Explanatory Note to the Urgent Measures Bill states that the new investor test '...applies for almost all overseas investments. The new section [18A] clarifies that the purpose of the test is to determine whether investors are unsuitable to own or control any sensitive New Zealand assets, by assessing whether they are likely to pose risks to New Zealand, based on factors relating to their character and capability.' As set out in the proposed section 18A(4) of the OIA, a foreign investor’s tax compliance history is an explicit consideration under the new investor test.
In particular, under section 18(4)(e), the new investor test asks whether or not the 'relevant overseas person' (i.e., the foreign investor), or any foreign individual with 'control' of the relevant overseas person (if the relevant overseas person is not an individual), has in the last 10 years been liable to penalties in respect of an 'abusive tax position' or 'evasion' under sections 141D or 141E of the Tax Administration Act 1994, or under an equivalent enactment in any other jurisdiction. In addition, under section 18A(4)(f), the new investor test also asks whether or not the relevant overseas person, or any foreign individual with control of the relevant overseas person, has outstanding unpaid tax (including interest and penalties) of NZ $5 million due and payable in New Zealand, or an equivalent amount due and payable in any other jurisdiction, at the time of its application for OIO consent.
A significant clause of the Other Measures Bill is the proposed section 38A of the OIA, pursuant to which the Governor-General may, by Order in Council, make regulations that require a foreign investor to:
'... provide information that the Commissioner of Inland Revenue considers necessary or relevant for any purpose relating to—
(a) the administration or enforcement of an Inland Revenue Act (within the meaning of the Income Tax Act 2007):
(b) the administration or enforcement of any matter arising from, or connected with, a function lawfully conferred on the Commissioner.'
Section 18A(4)(e) and (f) is reasonably 'black and white,' and does not - on its face - appear to be particularly burdensome.
However, we understand that, in the OIO’s view, penalties for an abusive tax position or evasion may be taken into account under the new investor test once they have been 'imposed' by Inland Revenue or a foreign tax authority, whether or not they have been litigated in court. We understand the OIO’s view is that such penalties must only be disregarded by the decision-maker once they have been overturned by a court. This view does not appear to be controversial with respect to penalties that have been agreed (e.g., by way of a settlement with Inland Revenue or a foreign tax authority). However, it is concerning that penalties may be taken into account under the new investor test if they are being contested (e.g., by way of a formal dispute resolution process with Inland Revenue or a foreign tax authority, or before a court), and may ultimately be proved to be unfounded. In our view, section 18A(4)(e) ought to be refined to only allow penalties to be taken into account if they are final (e.g., agreed to by the foreign investor, ordered by a court, etc.).
If a foreign investor has never been subject to penalties for abusive tax positions or acts of evasion, or does not have outstanding unpaid tax of NZ $5 million or more, it is difficult to envisage any form of disclosure or enforcement other than the foreign investor being required to certify its history before the OIO. It is certainly our hope that a common-sense approach to section 18A(4)(e) and (f) is adopted (provided, of course, that certification is made in good faith), and that the burden of proof with respect to a foreign investor’s tax history is minimised - particularly if it is envisaged that the Government can request information from foreign tax authorities (under New Zealand’s network of tax treaties or tax information exchange agreements) in the event that the decision-maker is, say, sceptical of the information that a foreign investor has disclosed.
The section 38A regulations, however, have the potential to be tremendously broad in their application. The Explanatory Note to the Other Measures Bill states that '... the Bill strengthens how the [OIA] manages risk by... requiring investors to disclose information relating to their proposed investment structure and tax treatment to Inland Revenue, to support the integrity of New Zealand’s tax system (once regulations are made)…' [emphasis added].
The OIO has provided a helpful (albeit high-level) list of the tax information disclosure that is expected to be prescribed by the section 38A regulations, such as: (a) a description of the foreign investor’s 'plan' for the New Zealand asset (or assets) over the next three years, including any significant capital expenditure; (b) the jurisdiction (or jurisdictions) in which the foreign investor, its immediate parent, and its global ultimate parent are resident for income tax purposes; (c) debt funding, equity funding, or the use of a 'hybrid' legal entity or instrument to fund the investment; and (d) the nature and extent of anticipated cross-border related-party transactions (e.g., sales and purchases of goods or services, interest or guarantee fees, royalties, etc.).
The disclosure of such tax information was indicated as one of the potential amendments to the OIA during the Government’s consultation in 2019. The Government has said that any tax information that is required to be provided to the Commissioner under the section 38A regulations will not be considered by the decision-maker in consenting (or not consenting) to an OIO application. Rather, we understand that it will be used by Inland Revenue to monitor the foreign investor’s subsequent compliance with New Zealand’s tax laws, and to inform broader audit and policy decision-making. Presumably, though, the need to disclose an investment structure upfront - and the fact that such disclosure may be used by Inland Revenue in the future - will influence design and spur more conservative behaviour (i.e., less 'aggressive' tax planning) than might otherwise be the case.
This is a significant change, and one that is likely to disrupt the traditional M&A lifecycle. The investment structure is, in some circumstances, not considered in great depth until an M&A deal is well-advanced (e.g., due diligence is complete, the sale and purchase agreement is being negotiated (or has even been signed), etc.). It will be critical going forward that the investment structure is designed much earlier than is now often the case, with the relevant tax information being pro-actively compiled and reviewed, so that OIO consent (and, therefore, completion) is not unduly delayed - that is, so that tax does not risk becoming the 'tail that wags the dog.'
Given the possible breadth of the section 38A regulations, it may be helpful to look to Australia as a guide for what is to come.
The Australian experience
In February 2016, Australia’s Foreign Investment Review Board ('FIRB'), in consultation with the Australia Taxation Office ('ATO'), published a very detailed checklist of the tax information that must be included with every application for consent (except in relation to residential real estate). Among other things, a foreign investor must disclose to the FIRB its proposed debt and equity funding mix, including the interest rate on any cross-border related-party debt to be issued - requiring transfer pricing analysis and a self-assessed risk rating.
As an important part of the FIRB consent process, the ATO will provide a 'low,' 'medium' or 'high' risk rating for each proposed transaction, and issue qualitative advice on the likely risk to tax revenue and the integrity of the tax base. A high risk rating will be influential to the FIRB’s overall assessment; and, in theory, it is possible for tax to be the reason that a proposed transaction is 'blocked'. Alternatively, the ATO might agree with an application subject to certain 'tax conditions' in relation to the foreign investor’s post-completion tax compliance. These ordinarily range from requiring basic compliance with Australia’s tax laws and co-operating with the ATO (e.g., by regularly providing to the ATO certain routine information in a complete/timely manner), to requiring a foreign investor to negotiate (in good faith) an advance pricing agreement or request a binding ruling.
Our experience to date in Australia has suggested that the disclosure of tax information has not been a significant 'pain point' in the FIRB consent process - or for M&A activity in general. We understand (anecdotally) that the requirement to disclose tax information has not, in general, resulted in tax playing a larger role in the M&A lifecycle than it otherwise might; provided, of course, that it is considered early and comprehensively. Therefore, we believe that the key learning from Australia is that upfront management by both of the parties (i.e., the purchaser and the OIO) ought to minimise undue complexity or delay downstream.
Where to from here?
The Government’s 2019 consultation document, Reform of the Overseas Investment Act 2005: Facilitating productive investment that supports New Zealanders’ wellbeing, states that '[t]he OIO generally imposes a condition on consent holders that individuals with control will continue to satisfy good character requirements, and this could include tax compliance.' With each foreign investor’s history of tax compliance becoming an explicit consideration under the new investor test, it will be interesting to see if the 'tax conditions' that are often imposed in Australia become characteristic of foreign investment in New Zealand, and whether or not (and how) ongoing compliance with 'good character' will become a focus of due diligence in the future.
If the Other Measures Bill is enacted during the current Parliamentary term, the next step for the Government (in relation to tax, at least) will likely be to decide the exact ambit of the section 38A regulations. The detail in which an investment structure is required to be disclosed will be particularly significant. Will the section 38A regulations reflect the granularity currently required in Australia (e.g., will it be necessary for a foreign investor to have performed transfer pricing analysis to set an arm’s-length interest rate on cross-border related-party debt so far in advance)? Or, will they be more macro in nature (requiring, for example, only very high-level disclosure of debt, equity or 'hybrid' funding)? As the Explanatory Note to the Other Measures Bill puts it, '... the [OIA’s] purpose [is] that it is a privilege for overseas persons to own or control sensitive New Zealand assets.' The Government will clearly need to strike a balance between protecting the integrity of New Zealand’s tax base and ensuring that the requirement to disclose tax information is not so onerous that quality foreign capital is discouraged, and New Zealand’s reputation as a friendly place to do business is therefore compromised.
Encouragingly, as we have seen in Australia, heightened consideration of tax early in the M&A lifecycle does not appear to be overly burdensome, or necessarily result in greater cost for the foreign investor than might otherwise be incurred. It will be essential, however, that any requirement to disclose tax information is unambiguously framed and carefully considered. It will also be critical that every foreign investor engage with its New Zealand tax advisor as early as possible to ensure that the most tax-efficient investment structure can be finalised before applying for OIO consent. If an investment structure is not well considered, such that it needs to be revised, the OIO consent process may well be delayed.
May 2020 Tax Alert contents
- COVID-19: Loss carry-back rules – fine in theory, but watch for fishhooks
- COVID-19: Employment tax updates for a remote workforce
- COVID-19: What impact will COVID-19 travel restrictions have on your company’s tax residence?
- COVID-19: Practical relief from consequences of COVID-19 travel restrictions for individuals
- COVID-19: Customs Considerations for Exports and Imports
- Information is Key: The proposed tax-related amendments to the Overseas Investment Act 2005
- There’s more to overseas rental properties than meets the eye
- Employee or independent contractor?
- COVID-19: Common questions in relation to the Wage Subsidy Scheme, the Extended Wage Subsidy Scheme and the Small Business Cashflow Loan Scheme
- Snapshot of recent developments