NZ needs to seek the safety of the pack in changing the rules of international taxation

Monday, 18 February 2019

OPINION So the Government plans to look at ways to make internet giants pay a new tax, based not on the profits they make in New Zealand, but the sales they make here.

It is not the only government to realise that would be popular.

Many governments around the world, the European Union and the Organisation for Economic Cooperation and Development (OECD) are looking at the same opportunity, but so far very few have actually made the move – India being a notable exception.

India's 'equalisation tax' aims to ensure foreign internet giants pay the same amount of tax that they would if they were a local business.

* NZ could follow Europe and impose revenue tax on likes of Google and Facebook

The challenge may come in better taxing internet giants without unraveling one of the basic tenets of international tax law.

* Digital tax debate could make past arguments small beer

* Multinational tax rorts in Minister's sights**

The tax in India applies at the rate of 6 per cent to purchases of foreign digital advertising services and is paid by local businesses and individuals, which are obliged to deduct the tax from invoices charged by the likes of Facebook and Google.

Inland Revenue officials drew attention to the main problem with such approaches in advice it provided to the Tax Working Group in September, noting that so-called 'equalisation taxes' on digital companies might not be consistent with New Zealand's international obligations.

'If they are seen as a form of income tax, it is not clear that they are allowed under our double taxation treaties,' they said.

'If New Zealand were to implement an equalisation tax, there is a risk that we would be breaching the terms of all of our double tax agreements,' the advice warned.

On the other hand, if equalisation taxes were not considered to be income taxes, but were seen to be more like 'excise taxes', they would raise issues related to international trade, they said.

'They could be used by jurisdictions as a tariff to protect local businesses. This raises the question whether they would be compatible with World Trade Organisation obligations and New Zealand's various free trade agreements.

'Thus, if New Zealand were to impose taxes unilaterally, there is a risk of retaliatory taxes being imposed by our trading partners.'

That big concern is pretty well-founded.

One of the fundamental tenets of international tax law is that companies are taxed on their profits in the countries where the economic activity takes place that generates those profits, and not based on where they sell their goods and services.

Given that companies such as Facebook and Google only employ a couple of dozen staff in New Zealand that value creation – in any conventional sense – is clearly not taking place here to any big degree.

The OECD has been bending over backwards to find some kind of novel intellectual justification that would allow countries such as New Zealand to more heavily tax digital businesses, given valid concerns that it just too easy for these very large firms to call anywhere home when it comes to paying their tax.

But it wants to do so without sacrificing the key principle that profits should be taxed where the economic activity that generates them takes place.

That has led to some pretty tortuous manoeuvring.

The OECD's latest attempt came in a consultation paper it published on Wednesday.

It makes the case that it could be justifiable to tax social media companies and online marketplaces based on where their users are, because user-content is so key to their value.

But it also argues that it might instead be possible to tax a wider range of digital companies based on where they earn revenues because of something it describes as 'marketing intangibles', such as their brands, customer relationships and customer data.

Essentially it appears to claim that these amorphous intangibles could be viewed as profit-generating assets that promulgate outside of the companies' offices in the countries in which services are consumed.

Using the same argument, Kiwi farmers could probably be asked to pay tax in China because New Zealand's dairy industry has developed a brand reputation in China for being 'clean and green'.

From there, the OECD paper gets more obtuse.

But back to realpolitik.

It would be much easier for New Zealand to impose new taxes on the likes of Google and Facebook if more other countries moved first, preferably with the sanction of an umbrella organisation such as the OECD.

There would be safety in numbers.

The US appears certain to oppose any OECD rule change that justifies the kind of taxation the New Zealand government, the EU, Britain and Australia are talking about because so many of the companies that would be negatively impacted are American.

So while the OECD seeks an impossible consensus, countries such as Australia and the UK – and now New Zealand – are threatening to go it alone.

Britain, which has announced it will impose a digital services tax next year, and which is currently consulting on how it could be implemented, is certainly one of the countries to watch to see if this trend is really more than strong bluster.

The risks are high for New Zealand, given its small size and reliance on open trade make it particularly vulnerable to the types of retaliation that IRD officials were warning about.