Many will be aware of the ongoing OECD proposals aimed at reducing incentives for aggressive international tax planning by multinational enterprises and harmful tax competition between jurisdictions. Most recently, the OECD-sponsored “Inclusive Framework” has formulated a two-pillar solution to address changes and tax challenges arising from the digitalisation of the global economy.
In May of this year, the New Zealand Inland Revenue released an officials’ issues paper (“Officials’ Paper”) that provides the basis for consultation on whether New Zealand should adopt the OECD’s Pillar Two initiative and how these rules could apply to multinational corporate groups (“MNEs”) headquartered or operating in New Zealand. The default position is that an MNE would fall within the scope of the rules if its annual turn-over exceeds €750 million in two of the last four years.
Pillar Two comprises two main rules, being the Income Inclusion Rule (“IIR”) and the Undertaxed Profits Rule (“UTPR”), the purpose of which is to ensure that “in-scope” MNEs pay at least 15% tax on their income in each jurisdiction where they report income. Although the Model Rules for the IIR and the UTPR have been formulated, each jurisdiction will implement the rules independently through domestic legislation.
New Zealand has signalled its commitment to the OECD proposals and endorsed the two-pillar solution, but this endorsement is not binding and the Government has not officially decided to adopt either Pillar One or Pillar Two. A unilateral New Zealand specific “digital services tax” has not been ruled out.
The Officials’ Paper details the complexities involved with the implementation of Pillar Two and its impact on MNEs doing business in New Zealand.
One interesting aspect in that regard is the potential interaction of Pillar Two initiatives with New Zealand’s imputation system. The purpose of Pillar Two is to impose additional tax on MNEs where they have been deemed to have underpaid tax on overseas income. This poses certain policy challenges in New Zealand for imputation purposes given the additional tax imposed may strictly relate to foreign income.
The New Zealand imputation system reflects the policy that income earned through a company should ultimately be taxed at a shareholder’s marginal rate. However, imputation credits are confined to income tax paid in New Zealand and are not recognised for foreign income tax paid as that has no benefit to New Zealand in the form of Government funding.
Although the imposition of tax under Pillar Two, particularly the IIR, is technically a New Zealand tax that would benefit the New Zealand economy, the Officials’ Paper identifies certain arguments against recognition of imputation credits in these circumstances.
First, the IIR is an attempt to correct insufficient tax being paid in a country outside New Zealand. Providing imputation credits would be against the objective of the Model Rules to provide a “level playing field” among all jurisdictions and to avoid distortions. The perceived risk is that the imposition of the IIR would be unwound on distribution of profits to shareholders. There is also a risk of incentivising companies with a substantial New Zealand shareholder base to migrate to, and pay tax in, New Zealand rather than overseas.
Second, the Officials’ Paper also discusses whether the availability of imputation credits would mean that the IIR imposed by New Zealand would not be recognised under Pillar Two as a qualified IIR. This would be due to the credits being considered a “benefit” being provided in relation to the IIR. This would potentially expose New Zealand headquartered MNEs to the UTPR in other jurisdictions which would be unacceptable for New Zealand as the MNEs would still be subject to New Zealand’s IIR in respect of their worldwide income.
There is also a question here as to whether imputation credits should be considered a “benefit” in the relevant sense. While that may strictly be the case on a literal interpretation, arguably imputation credits that arise commensurately with the top-up tax paid under the IIR are more a mechanism to prevent double taxation rather than a “benefit” of the type that the Model Rules are concerned with.
The Officials’ Paper concludes by proposing that tax paid in New Zealand under the new rules should not give rise to an imputation credit.
We now wait to see how these proposals develop further through the consultation process and what recommendations will ultimately be made by Inland Revenue Officials to the Government. The proposed implementation timing is tight and the expectation is that, if New Zealand does decide to implement the rules, a Bill will be enacted in 2023 following a comprehensive consultation process.
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