New Zealand has been active in implementing measures to address BEPS. In this update we explain the latest proposals that include measures to address permanent establishment avoidance, significant changes to the transfer pricing rules and an interest rate cap (among other measures) to limit related party interest deductions.
The New Zealand government released three consultation documents on 3 March 2017, proposing changes to the country's income tax laws to implement BEPS measures:
- BEPS – transfer pricing and permanent establishment avoidance (PE and TP document);
- BEPS – strengthening interest limitation rules (interest limitation document); and
- New Zealand's implementation of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the multilateral instrument, or MLI) (MLI document).
PE and TP proposals
The PE and TP document proposes:
- An anti-avoidance rule in respect of structures that avoid creating a PE;
- Extending the circumstances in which income will be deemed to be New Zealand sourced;
- Strengthening the TP rules; and
- Increased enforcement powers.
Some measures would apply only to groups with turnover of at least €750 million (large multinationals) while other measures potentially apply to all taxpayers.
The PE avoidance rule (applicable to large multinationals only)
The proposed rule would deem a non-resident entity to have a PE in New Zealand if there is an arrangement under which:
- A non-resident supplies goods or services to a person in New Zealand;
- An entity, either associated with or commercially dependent on the non-resident, carries out an activity in New Zealand in connection with that particular sale for the purposes of bringing it about (the required link to a particular sale is intended to exclude from the rule preparatory work of a general nature, such as marketing);
- Some or all of the sales income is not attributed to a New Zealand PE of the non-resident; and
- The arrangement defeats the purpose of a double tax treaty's PE provision.
The PE and TP document suggests that factors relevant to determining whether an arrangement defeats the purpose of a DTA should include the commercial and economic reality of the arrangement, the relationship between the non-resident and the New Zealand entity, the services provided by the New Zealand entity and whether the non-resident would have a PE in New Zealand if it and the New Zealand entity were a single company. Other suggested indicators of PE avoidance are said to include the involvement of a low tax jurisdiction, specialised services, or if the New Zealand entity is allocated a low amount of profit on the basis that it is carrying out low value activities while having a number of well-paid employees.
The PE avoidance rule would also apply to arrangements involving third party channel providers, under which:
- The non-resident sells to a third party;
- The same goods or services are then to be on-sold by the third party to a particular customer;
- A related entity of the non-resident carries out an activity in New Zealand for the purpose of bringing that sale about; and
- The arrangement defeats the purpose of a DTA's PE provision.
The consequence of the rule applying is that the non-resident will have a PE for the purposes of all articles of the relevant DTA, not just the business profits article. For example, royalties paid to nonresidents in respect of supplies made through the deemed PE could be deemed to arise in New Zealand and, therefore, be able to be taxed in New Zealand consistently with the royalty article of the DTA.
In explaining the need for the PE avoidance rule, the consultation document notes that the MLI includes a widened PE definition to counter the avoidance of PE status, but that this is insufficient to address the problem because some of New Zealand's major trading partners are not expected to elect to include the widened PE definition. The proposed domestic law PE avoidance rule is, therefore, intended to counter arrangements that avoid a PE status, particularly under DTAs that do not incorporate the MLI amendments.
The document states that the PE avoidance rule should not conflict with existing DTAs, noting that the commentary to the OECD Model states that, as a general rule, there will be no conflict between antiavoidance provisions and a DTA. Nonetheless, it is proposed that the PE avoidance rule would apply regardless of anything in a DTA.
Expanded definition of source (applicable to all taxpayers)
New Zealand has detailed definitions for determining when income will be sourced in New Zealand. The PE and TP document proposes several extensions to this definition.
Income will be deemed to be sourced in New Zealand if New Zealand has a right to tax that income under the PE article of an applicable DTA. For non-residents in respect of whom no DTA applies, New Zealand's model treaty PE article will be incorporated into domestic law to apply as an additional source rule.
A non-resident's income will be deemed to have a New Zealand source if it would be New Zealand sourced and if the nonresident's wholly-owned group were a single entity. This rule is intended to catch arrangements under which activities have been divided between group members to avoid income being treated as New Zealand sourced. Amendments addressing perceived gaps in the source rules for certain life reinsurance arrangements are also proposed.
Strengthening the TP rules (applicable to all taxpayers)
The PE and TP document proposes numerous substantive and procedural changes to the transfer pricing rules. The document acknowledges that these changes will reduce taxpayer certainty and encourages taxpayers to seek advance pricing agreements.
The substantive changes would largely follow amendments that Australia made to its TP provisions in 2013, and would expressly incorporate the OECD TP guidelines into domestic law, endorse a substance over form approach, and provide Inland Revenue the power to reconstruct an arrangement when applying the TP rules if the arrangement would not be commercially rational if entered into between unrelated parties. In addition, the scope of the TP rules would be extended to arrangements under which groups of persons (typically a consortium of investors) act together in relation to an entity, even if each individual investor is not associated with the entity.
The government also proposes to reverse the onus of proof in transfer pricing matters, so that taxpayers will bear the burden. Presently, the onus is (with some exceptions) on Inland Revenue to demonstrate that an amount it determines as the arm's length amount is "more reliable" than the arm's length amount determined by the taxpayer.
Finally, it is proposed that the limitation period will be increased from four years (after the end of the year in which the return is filed) to seven years. This proposal is especially controversial because, in combination with the other proposed changes to the TP rules, it could herald more prolonged and aggressive TP audits than is already the case.
Increased enforcement powers (applicable to large multinationals only)
A number of changes to tax payment obligations are proposed. Inland Revenue would be given the power (in cases where Inland Revenue considers the large multinational to have been uncooperative) to accelerate the making of an amended assessment. In addition, large multinationals would be required to pay the tax in dispute before the dispute is resolved if the dispute relates to transfer pricing, the application of the source definition or application of a DTA. A new collection power would also provide that tax payable by a member of a large multinational group could be collected from any wholly-owned subsidiary of the multinational in New Zealand.
It is also proposed that Inland Revenue be given the right to require a New Zealand entity within a multinational group to provide information held by a member of that group outside New Zealand. A related proposal is to extend the scope of a provision under which a deduction is denied for cross-border payments in respect of which a person fails to provide requested information.
A civil penalty of up to NZ$100,000 is proposed if a large multinational fails to comply with an information request. Existing law provides criminal law sanctions for failure to comply with an information request, but the advantage of a civil penalty for Inland Revenue is that it can be imposed without bringing a prosecution before the courts.
Interest limitation proposals (applicable to all taxpayers)
Interest rate cap
New Zealand has thin capitalisation rules based on debt to total asset ratios (with a safe harbour of 60% for inbound and 75% for outbound investment), or (in the case of banks) the required equity for tax purposes. The government is proposing to maintain that basic framework and does not, at this stage, plan to implement an earnings-based limitation on deductible interest expenses, as recommended in the OECD's BEPS Action 4 Final Report.
The government is, however, concerned about high-priced related party debt and proposes a cap on the interest rate on such debt for the purposes of determining the amount of deductible interest expense. The cap would be based on an actual or assumed credit rating of the New Zealand borrower, depending on the circumstances.
For example, if the borrower's ultimate parent has a credit rating for senior unsecured debt, the New Zealand borrower's interest rate cap would be set based on that credit rating, notched down by one notch. If the New Zealand borrower is itself rated, the cap will be determined based on the higher of the New Zealand borrower's actual rating and the assumed rating based on the parent's rating.
Where the New Zealand borrower's ultimate parent does not have a credit rating, the New Zealand borrower's interest rate cap would be determined based on the rate at which the ultimate parent could raise senior unsecured debt, plus a margin. The document calls for submissions on how such a margin should be determined.
Where the New Zealand borrower does not have an ultimate parent, the cap could be determined based on the borrower's credit-worthiness assuming either an arm's length amount of debt, or that related party debt was equity. The assumptions on the amount of debt are considered necessary to prevent the New Zealand borrower from justifying a higher rate of interest on the basis of artificially high debt levels.
The interest rate cap as proposed would make no allowance for related party debt being issued on subordinated terms. Furthermore, it would assume a term of no more than five years, even if the actual term is longer. This aspect of the proposals seems problematic. For the financial sector, long-dated or perpetual subordinated debt is issued (not uncommonly between related parties) in order to meet regulatory capital requirements. Moreover, for infrastructure companies, it is common to issue debt for a term extending longer than five years and/or on subordinated terms.
Amendments to thin capitalisation rules for non-banks
Various amendments are proposed to the thin capitalisation rules for non-banks. One that could have a significant impact for some groups is that in calculating the debt to total assets ratio, assets would be measured net of most liabilities that are not treated as debt for thin capitalisation purposes. A commonplace example is trade creditors that (because they are not interest-bearing) are not debt for thin capitalisation purposes.
Other proposed changes include an exemption from the thin capitalisation rules for foreign-controlled SPVs entering into public private partnerships. Entities using this exemption would be able to deduct their full interest expenditure on third party debt that has limited recourse to the SPV even if the entity's debt to total assets percentage would exceed the thin capitalisation thresholds. An entity applying this exemption would be denied a deduction for interest on related party debt.
The New Zealand government has indicated that it will sign the MLI in June 2017 and intends to adopt all minimum standards and optional articles in the MLI including the arbitration provisions. Article 5 of the MLI is not applicable to New Zealand's DTAs because New Zealand applies the credit method and not the exemption method in all of its double tax treaties.
Which of New Zealand's DTAs will be covered by the MLI (and which of the MLI options will be adopted in each case) will depend on the positions adopted by the relevant DTA partners. That should become apparent over the next few months.
New Zealand is due to hold a general election in September 2017. Although the government is expected to have made, in principle, decisions about the proposals it will seek to implement before the election, draft legislation is not expected to be introduced until after the election. The legislative amendments would, therefore, be unlikely to be enacted until sometime in 2018.
The consultation documents contain only brief comments on the proposed application dates for the planned amendments. Generally, it is proposed that changes to Inland Revenue's enforcement powers would apply from the date of enactment, while the other amendments would apply to income years beginning on or after the date of enactment. In some cases, for example, where the new enforcement powers apply to an existing dispute with Inland Revenue, or where the interest rate cap applies to an arrangement that was entered into in an earlier income year, there is potential for the amendments to have retrospective application. This is one of many issues expected to generate debate as businesses work through the detail of these farreaching proposals.
This article first appeared in the International Tax Review here.
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