In early June the Government released a discussion document on New Zealand's options for taxing the digital economy.
The discussion document considers whether New Zealand should implement an interim “digital services tax", and provides an update on the OECD's wider review of the current international tax framework as it applies to digital enterprises. Any long-term OECD solution to this issue could represent a radical departure from current international tax settings.
Background to the DST
In February the Government announced its intention to introduce a digital services tax (DST) that would apply to digital enterprises operating in New Zealand.
The June discussion document provides further detail on what a DST would look like, if implemented. The DST would be charged at a flat 3% rate on the gross turnover from a defined set of “in scope" digital business activities. The digital businesses within scope of the rule would include:
Intermediation platforms which facilitate the sale of goods and services between people (e.g., Uber, eBay);
Social media platforms (e.g., Facebook);
Content sharing sites (e.g., YouTube and Instagram); and
The common theme of these in scope activities is that users tend to create value for the digital enterprise. That value typically arises through the sale by the enterprise of user data, and/or from the “network effects" that an increased user base generates (i.e., some platforms become more valuable through the addition of users).
Will New Zealand actually implement a DST?
The discussion document confirms that a final decision has not yet been made on whether to implement a DST. However, it indicates that the Government will “seriously consider" adopting a DST if the OECD cannot make sufficient progress on a long-term international solution during the course of 2019.
If New Zealand was to implement a DST, it would not be alone. The United Kingdom has announced that it will introduce a DST from April 2020. India and a number of European countries have also enacted or announced DSTs. On the other hand, Australia has recently confirmed that it will not implement a DST, and that it will instead focus on achieving a consensus solution to the issue at the OECD level.
The decision on whether to adopt a DST will also be influenced by a cost/benefit analysis. The potential benefits of a DST as identified in the discussion document include a tax take of between NZ$30-80m per annum, improvement of public confidence in the fairness of the tax system, and providing an incentive for countries to reach an international solution (the idea being that a DST might strong-arm other countries to reach a long-term agreement which would replace it).
Those (frankly limited) benefits are weighed against the potential issues with a DST:
It will result in double taxation, particularly for any New Zealand enterprises who become subject to the DST. The DST cannot be designed as an income tax for a variety of reasons, and therefore it cannot be creditable against income tax. Enterprises with a taxable presence in New Zealand will therefore be subject to both income tax on their profits, and the DST on their in scope revenues.
The burden of the DST would likely be passed on to New Zealand customers (the discussion document estimates that between 30-50% of the cost would be passed on).
A DST may reduce the growth of the digital sector in New Zealand.
It may adversely impact New Zealand's export sector. Some trading partners, particularly the United States, may be opposed to a DST. This could lead to the introduction of retaliatory measures. Arguments may also be advanced that it would effectively result in discrimination against foreign companies operating in New Zealand, and therefore be in breach of New Zealand's international trade obligations. Resisting those arguments may require the DST to be designed with particularly low de minimis thresholds meaning that a less than ideal number of New Zealand digital businesses are impacted.
The cost of administering and complying with the DST may be significant, particularly having regard to the relatively low tax take of only NZ$30-80m per annum.
A potential OECD consensus solution
The discussion document also provides an update on the potential long-term OECD consensus solution to the issues posed by the digital economy. At this stage the OECD proposals have only been developed at a high level, but are likely to consist of two broad measures.
First measure: lower the bar for when countries have the right to tax foreign digital services
The first measure would amend current settings to lower the bar for a market country to be provided with taxing rights. Under current international tax settings such profits can typically only be taxed at source where the enterprise has a sufficient physical presence in the source jurisdiction (e.g., a subsidiary, or a “permanent establishment" such as a branch or dependent agent), and where the profits can be allocated to that presence.
There are currently three proposals that are being considered by the OECD in relation to this first measure. Expressed generally, the three proposals (only one of which would be adopted) consist of:
A limited proposal granting taxing rights to market countries in respect of certain digital services. The scope of the proposal might be similar to the DST (i.e., it could only apply to platforms which generate value from user participation).
A broader “market intangibles" proposal which would require a multinational to allocate its profits based on certain marketing intangibles created in other jurisdictions (e.g., customer data and lists, brands and trade names). This proposal would apply beyond the digital economy, and could impact a number of New Zealand exporters.
A “significant economic presence" model, which would apply to the digital economy at large (i.e., not just to platforms relying on user-generated value). This proposal would allocate taxing rights between countries to a multinational's worldwide income under a formulaic method, and by reference to various factors which indicate that a multinational enterprise has an economic presence in a jurisdiction.
The second measure: minimum tax
The second measure being considered by the OECD is a “minimum tax" measure which seeks to ensure that a multinational pays a sufficient level of tax on its worldwide income. This second measure could be achieved through implementation of two rules:
The first rule would apply to a resident who has a foreign branch or subsidiary that pays a low level of foreign tax on its profits. A minimum tax rate would be set (say, 10%) at which such income must be taxed. To the extent that the income was subject to foreign tax at a lower rate, top-up tax would be payable in the residence jurisdiction in order to ensure that the minimum tax rate was paid.
The second rule would deny deductions and/or tax treaty relief where a related party payment was made to a foreign company that was not subject to the minimum tax rate on that receipt.
The implementation of these two measures in conjunction could represent one of the most significant changes to the international tax framework in recent years. The potential breadth of the measures, and their possible application beyond the digital economy, will mean that a number of businesses could be impacted.
The Government has requested submissions on the discussion document by Friday 18 July. A final decision on implementation of the DST will likely be made later in 2019. If a decision is made to adopt a DST, legislation would probably be introduced in 2020, with implementation by 2021.
The OECD process is likely to take significantly longer to play out. While member countries have continued to agree that a consensus solution is the desirable way forward, there appears to be significant disagreement as to the nature of the solution required. However, the OECD continues to target agreement on a consensus solution by 2020. If consensus is reached, it could nevertheless be expected that implementation of that solution (probably by way of a multilateral instrument) would not be effective until 2025 at the earliest.
The DST proposed by the Government in the discussion document brings with it a laundry list of problems while raising only limited revenue. This dynamic indicates that perhaps the Government would be better off not proceeding with the DST as a stopgap measure, and instead following Australia's approach in focussing on the OECD solution.
If you would like to discuss how the digital economy taxation proposals might affect your business, please contact the authors or your usual Bell Gully advisor.
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.