Multinational tax proposals move closer to enactment with (some) taxpayer concessions

Thursday 17 May 2018

Authors: Graham Murray and Catherine Bunting

​​​​The Officials' Report on submissions on the bill containing new rules to combat "base erosion and profit shifting" (often referred to as BEPS) by foreign multinationals has finally been released together with the second reading of the bill.  Concerns that the new rules could impact foreign investment in New Zealand and therefore should be abandoned or deferred were largely rejected by Officials.  Officials are clearly committed to bringing the proposals into law in time for the 1 July 2018 target date, but did recommended some softening at the edges to address public concerns. 

Interest limitation rule on related-party debt

A key area of focus throughout the development of the BEPS proposals has been the "interest limitation rule".  This rule will look to limit interest deductions on related-party debt by deeming a New Zealand borrower to have a credit rating determined by reference to the credit rating of offshore group members who issue third party debt (subject to some exceptions).  The rule will apply to borrowers who are "high BEPS risk" taxpayers determined applying defined tests. 

Officials recommended the following headline changes to the interest limitation rule:

  • Removing the income-interest ratio test for determining if a taxpayer is high BEPS risk:  Officials accepted submissions that this test could result in taxpayers in a loss position or who have recently started trading being incorrectly categorised as high BEPS risk.  Whether a taxpayer is high BEPS risk will now turn on (i) whether they exceed the 40% debt percentage test (with additional buffer for highly-geared worldwide groups) or (ii) whether income from cross-border related party loans made to the taxpayer are taxed at less than 15%. 

  • Allowing the borrower to discount its relevant group member's credit rating by two notches:  Officials recommended that borrowers be able to discount their relevant group member's credit rating by two notches when calculating their allowable interest rate, but only where the parent's credit rating is BBB- or higher.  A one notch discount will be required where the relevant group member has a credit rating of less than BBB-. 

    The rationale given for the change is that it will alleviate concerns expressed by submitters that the rule could result in double taxation (i.e., a greater level of interest income to the offshore lender than the deduction permitted to the New Zealand borrower).  This change can logically be taken as acceptance by Officials that a one notch rule could have produced interest rates that are less than rates determined under the arm's length principle.  There continues to be strong feeling in the tax community that the restricted approach required is inconsistent with the arm's length principle, even with the additional notch discount recommended by Officials.

  • Allowing credit ratings to be implied from significant third party debt:  Officials recommended that high BEPS risk taxpayers also be allowed to derive a credit rating from their actual third party borrowings (if any), subject to conditions.  

Transfer pricing

Another controversial aspect of the BEPS reforms was the proposed extension of the time-bar for transfer pricing issues to seven years.  Officials took on board feedback about the certainty provided by the time-bar, and recommended that the extended seven year time-bar should only apply where the IRD has notified the taxpayer within the usual four year time-bar period that the period will be extended.  The exact form of that notice is not described.  It seems logical to assume that it should take the form of a notice of proposed adjustment formally triggering the disputes procedure in relation to the relevant issue.  It is reasonable to expect that the IRD will have developed its thinking to a sufficient stage within a four year period to know whether it intends to engage in the disputes procedure. 

Despite it not being in original BEPS proposals, Officials supported the idea that the transfer pricing rules generally should be extended to overseas investors who act in concert to control a New Zealand company.  Adjustments were however recommended to better target this extension – for instance, Officials thought that all controlling investors must be non-residents for the transfer pricing rules to apply.    ​

Hybrids and permanent establishment avoidance

For completeness, Officials also recommended relatively minor amendments to the hybrid mismatch rules.  Those rules remain highly complex and will be difficult to apply given that they require an understanding of tax rules in other countries.

The changes recommended to the new permanent establishment avoidance rule for large multinational enterprises were also relatively minor.  Concerns that this breaches New Zealand's international treaty obligations remain, but were resoundingly rejected by Officials.   

Where to from here?

At this point, companies impacted by the BEPS proposals should be accepting that they will be enacted, and will apply from as early as 1 July this year.  There is a very low likelihood of the proposals changing in any significant way from here on.  Companies should take stock on where the rules have landed and will need to start considering their approach to compliance.  It can only be assumed that the IRD will take a rigorous approach to enforcement.

If you have any questions regarding any issue raised above, please contact one of our team or your usual Bell Gully adviser.


Disclaimer

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.

For more information
  • Graham Murray

    Partner Auckland
  • Mathew McKay

    Partner Auckland
  • Jarrod Walker

    Partner Auckland
Related areas of expertise
  • Tax
  • Overseas investment
  • International