Address to IFA
In his address to the International Fiscal Association, the Minister of Revenue Todd McClay discussed some of the key aspects of base erosion and profit shifting (BEPS) and also the digital economy and their implications for the tax system. For more information, please read the full speech.
Address to IFA annual conference
Thank you for inviting me to be here today — the most prestigious tax policy conference in New Zealand.
This is my first time addressing you and I imagine I am but the latest in a long line of Revenue Ministers you've seen. I'm told that IFA was founded in 1938. It was a very different world then.
For instance, today we all use terms like 'apps', 'software', 'googling' and 'Facebook', which I am not planning to close down by the way.
My counterpart from 1938 would think we speak a different language.
The point is that these linguistic changes are indicators of positive changes that New Zealand and the rest of the world are going through: the effects of electronic communication and globalisation.
It is also worth reminding ourselves of the sheer volume of work Inland Revenue deals with these days. During the last financial year IRD had nearly 7.5 million registered customers; it collected $53.8 billion worth of revenue, received 4.6 million phone calls to its call centre, and had 18.4 million hits on its website.
On anybody's scale these are big numbers, which makes it even more important to ensure that revenue gathering is as efficient and customer-orientated as possible.
In this context let me briefly touch on the economy, although I am aware the Minister of Finance will be speaking to you in more detail about this later today.
The Government's economic programme is delivering positive results.
On average, wages are increasing faster than inflation, business confidence is at its highest level in 20 years and the terms of trade remain high. There are over 66,000 more people employed now than a year ago, and the unemployment rate, currently at 6 per cent, continues to drop.
The New Zealand economy continues to expand, growing at 3 ½ per cent in the year to September 2013. This was among the higher annual growth rates in the developed world.
However, while the economic recovery is gathering momentum, the global environment still remains uncertain.
It is important, therefore, to maintain clear and credible economic and fiscal settings, as this is the best way to encourage growth, create new jobs, raise incomes, and help families get ahead.
The Government is on track to deliver a modest surplus in 2014/15.
However, that is not a reason to throw the baby out with the bathwater.
Unlike our opponents the National-led Government remains committed to responsible long-term fiscal management, we will not be sucked into an election year lolly-scramble as Labour and the Greens will be.
Budget 2014 will continue the Government's priorities of:
Responsibly managing its own finances and returning to surplus.
Pushing ahead with wide-ranging microeconomic reforms to create a more productive and competitive economy.
Driving better results and better value for money from public services.
And supporting the rebuilding of Christchurch.
Providing we continue to responsibly manage the recovery, New Zealand is well-placed to take advantage of the many economic opportunities available to us over the next few years.
Looking into the future, New Zealand faces the need to fund the rising expenditures associated with an ageing population.
With our broad tax base, there are not many candidates for further revenue-raising by broadening tax bases.
Therefore it is critical to maintain the revenue raising capacity of our existing tax system.
A misguided attempt to direct economic activity by reintroducing cost-ineffective tax incentives into the tax code could severely impair our ability to fund critical government expenditures in the future.
So we need to consider how we gather revenue.
Two areas are important in this regard: tax policy and the administration of the tax system.
First, let me talk about tax policy.
While we embrace globalisation, it comes with its own challenges.
In taxation we see globalisation changing the way we view national tax policies. On the one hand, the ability of a government to tax its citizens and the income generated in its country according to rules it determines is fundamental to national sovereignty.
On the other, tax policy must increasingly consider global contexts.
We in New Zealand, as in many other countries, remember only a few decades ago that trade flows were significantly hampered by import barriers, and international capital flows strictly controlled by the central bank.
And in the early 80s we also saw tax bases reduced by a plethora of special deductions and exemptions, leading to complexity for tax administrations and taxpayers, uncertainty of tax revenues for government and distortions of economic activity.
A series of avoidance schemes caused unanticipated shortfalls in government revenues. In turn, the need for frequent amendments to the law to plug the loopholes increased business uncertainty and the sense of complexity.
That has now dramatically changed, to the great benefit of our economy and our standard of living.
Our broad base, low rate framework for tax policy acts to promote revenue integrity. It keeps administrative and compliance costs as low as possible. And by avoiding complex rules and frequent change of the system, it promotes business certainty.
Businesses can plan their affairs without worrying about the future tax consequences of their decisions.
Our focus has been on ensuring that the burden is fairly and efficiently shared, in fact, as well as theory. That is, everyone pays the tax that they should. Otherwise taxes on other taxpayers must rise which discourages productive activity.
Our tax system relies on voluntary compliance which works as long as most people see that the tax system is fair.
One area that is critical to having a fair distribution of taxes is combatting tax avoidance. The area where this issue is most in the news is Base Erosion and Profit Shifting or "BEPS".
BEPS is a problem where companies can arrange their affairs so that profits earned in a taxable jurisdiction are either allocated to a low-tax jurisdiction, or are subject to arrangements that result in no taxable profits being declared anywhere.
New Zealand has not been sitting on its hands.
In domestic rules applying to such income, we have already made considerable progress. The international tax review, which exempted active income of companies that was earned abroad from New Zealand tax, contained a number of provisions that were designed to protect New Zealand from the base erosion strategies that have been identified as part of the BEPS project.
These rules included the thin capitalisation rules, taxation of passive income of controlled foreign companies and a series of anti-arbitrage rules. Such rules limit the ability of companies to shelter income from any tax by exploiting differences in the tax rules of different countries.
Work continues to refine our domestic rules. I think it's fair to say that New Zealand's rules in this area are as good as any, and better than most.
Further progress on the BEPS issue will require collective action by the international community led by the OECD, the principle standard setting body in the area of international taxation.
Decisions by the OECD can have an impact on the interpretation of tax treaties and can affect the allocation of taxes among countries. It is important that New Zealand participates in the development of these standards to ensure that they apply properly in the New Zealand context. At the same time, work at the OECD may help New Zealand in its on-going process of ensuring that its domestic rules in this area are best practice.
Proposals have been identified and the OECD sub-committees are scheduled to report from as early as September this year. Compared to the typical rate of progress in international bodies, this is rapid response.
At the same time it must be recognised that the eventual success of the exercise will depend upon other jurisdictions updating their domestic tax laws to international best practice.
I am greatly encouraged to see the BEPS proposals announced last week by President Obama. This signals that this anti-BEPS work is real. It's happening. Governments are taking it seriously and it's moving out of the realm of working parties and into solid proposals.
And I want to emphasise that being anti-BEPS is not anti-business. This is not a tax grab.
The goal is to make company taxes more transparent and even in their application across companies and countries. Companies should pay tax somewhere; ideally in the right place.
It is not in the interest of New Zealand businesses and individual taxpayers, if multinational companies can avoid paying their fair level of taxes in New Zealand or elsewhere.
Countering BEPS helps to level the playing field. Moreover, if New Zealand suffers base-erosion due to BEPS, other taxes must increase to make up the difference, which can reduce the efficiency and competitiveness of the New Zealand economy.
Linked to BEPS is the question of taxing high profile companies which operate online.
The challenge of taxing the digital economy has attracted a lot of press coverage and comments. This is a complicated area. There are three main issues that arise with the digital economy, and it is important not to confuse them.
Some firms in the digital economy are able to arrange their affairs so that they do not pay tax anywhere, i.e. the BEPS problem.
Some aspects of the current taxing framework may not be well adapted to how business is conducted in the digital economy.
Firms can derive income from advertising and using data from users in a country, without paying tax in that country.
The digital economy and BEPS
Non-taxation of income from digital firms through allocation of income to tax havens or through financing, use of hybrids and transfer pricing of IP is neither new to, nor confined to, digital industries.
There may be some extra pressure due to the high level of profits attributable to IP in the digital economy. But the policy issues are essentially the same as with more traditional sectors.
Anti-BEPS rules, such as CFC rules, anti-tax haven rules, and addressing shifting profits through moving IP, are equally applicable to digital and non-digital industries.
Customers provide value
Much commentary has arisen from the fact that some companies do not pay tax in countries where the consumers of their services reside. The company does not need to establish a physical presence within the country of residence of the consumer.
Revenue arises from the sale of advertising and marketing data, arising from that use, to third parties who may reside in other countries altogether. Moreover, in many cases, there is no purchase of goods and services by the consumer.
This is similar to the situation where a foreign business exports widgets to New Zealand.
Under standard international rules, this does not give New Zealand a taxing right on the income of the firm. New Zealand only obtains that right if the business has a physical presence established in New Zealand.
It has been suggested by some in the OECD that taxation of profits should move more towards where consumption of products and services occur. But this would be a sea change.
It would mean that New Zealand exporters would be taxed on their income when they export goods or services to other countries. This sort of change could impede international trade and is not likely to happen in the near future, if ever.
Adapting current rules to the digital economy
There are a number of important questions to consider.
Does the digital economy allow business structures that do not fit well within current OECD taxing frameworks? Can digital businesses carry on substantial activity in a jurisdiction, but remain below the radar of taxation? Should the threshold for taxation be modified as a consequence?
These are being addressed at the OECD. We are there, at the table. They are not areas where New Zealand can go it alone.
Common Reporting Standards
Another concern on the fair sharing of the tax burden arises where domestic taxpayers are able to hide assets abroad and so escape domestic taxation.
But in order to tax this income it must be reported.
The OECD project on Common Reporting Standards, to implement automatic exchange of information, is intended to help countries find income earned by its residents from offshore sources.
Under this initiative, companies where the funds are held would have an obligation to determine the country of residence of investor/depositors, and report the information to their home taxing jurisdiction.
It is about ensuring that taxes are broadly and fairly applied, consistent with BBLR and we are working with the OECD to develop approaches to a common reporting standard that facilitates compliance across jurisdictions.
I am aware that an area of considerable interest to New Zealand business in this area would be the compliance burden it can impose.
On the other hand, an automatic exchange of information is in our national interest, since measures to improve compliance by the few, non-compliant taxpayers allow lower taxes for the vast majority of taxpayers who voluntarily comply with their tax obligations.
New Zealand will therefore participate in this work and a key focus for us will be on minimising the compliance burden.
Active income exemption for offshore branches
All of these BEPS issues are large and complex. And for the sake of our economy and tax system and indeed our global reputation, I want my officials to devote their time and energy to them.
Active income exemption for branches is associated with BEPS and we will address this, but at present, I want our main policy focus to be directed towards the big ticket items, so I have decided to defer this reform for the time being.
But big or small, these issues represent a new phase for tax policy in a more globalised, connected world. For policy proposals to work, we will need to ensure that the voice of all interested parties — business and academics — are heard.
A particular strength of New Zealand's tax system is its reliance on consultation and the willingness of the tax community to engage.
For instance, the amount of effort by private sector individuals who volunteered their time, and the professionalism of their input in a number of reviews of the tax system over the last few years, is, I believe, unprecedented across countries internationally.
I would like to personally thank these individuals, many of whom are in this room, for their contribution to making the New Zealand tax system, a very good tax system indeed.
Our ability to work together across government, business, tax professionals and academia is one of New Zealand's greatest strengths.
We'll be looking for your input again.
IRD is organising a workshop on April 1 with Business New Zealand that will provide more detail on the areas that are being examined by the OECD. This will offer an opportunity for dialogue. And certainly, if changes to domestic law arise from the process, they will be subject to the generic tax policy process.
My officials will be working together with representatives from the business community on these issues to make sure we get the best result for New Zealand and New Zealand businesses.
However, much of the action will happen at the OECD level. The OECD has established mechanisms for business to comment on developments there.
Let me now turn briefly to tax administration.
The second crucial area in making our tax system fair and efficient is its administration.
The best tax rules in the world are to no avail if failures of tax administration mean that they are not applied appropriately.
In fact, New Zealand stands up well in comparisons to tax administrations across the world. But we want to turn better into best.
Accordingly, the IRD has set in motion a process to modernise its administrative systems.
It's not just about new computer systems for the IRD. It is a chance to review all of the internal and external processes to ensure that they are consistent with these objectives.
This is a once in a generation opportunity to establish the basis of the future administration of the tax system. So we should aim high.
The objectives are:
To ensure better public services by making sure our tax administration collects the correct amount and distribution of tax in as cost-effective manner as possible;
To ensure that the tax administration process and systems are flexible enough to implement government priorities; and,
To reduce compliance costs to taxpayers as much as possible.
There is a session at this conference on Saturday morning that will outline what is under way at the IRD and put it within its strategic framework.
Your input will be an extremely valuable part of this process.
To that end, I am pleased to announce that there will be a public conference in June on Tax Administration in New Zealand. Its purpose is to seek outside input into the future development of tax administration.
I'll be announcing details of this conference in the coming weeks.
In conclusion, the New Zealands tax system is up there with the best, but it will need to evolve and adapt to meet the needs of the 21st century and an increasingly globalised and interconnected world.
Tax policies will need to adapt to fit these challenges and so will our tax administration.
The OECD is leading the charge at an international level, but at home, to make it work for us, we need the public to engage.
I hope you have an enjoyable conference.
Media contact: Hayden Cox 021917339