Are foreign companies really paying too little tax?

A recent NZ Herald investigation which claims that foreign companies pay less than their fair share of tax in New Zealand is dramatic and headline grabbing. However, the full story is somewhat more nuanced and requires reflection on the realities of global business, writes Scott Mason.

Not just in New Zealand, but around the world, there is agitation for multinational companies to pay tax proportionate to their earnings in any one country. Despite a sense that anything less is somehow unfair and that this should happen immediately, there is a more complex reality rooted in the fact that tax rules around the world work differently and drive different outcomes.

It should also be noted at the very outset that, generally, any company will pay only that amount of tax which it is required to do under the laws and tax rules which are applicable to it in any given jurisdiction. To expect anything more, or less, than compliance with the law is unconscionable – and indeed, this is the approach taken by every normal Kiwi in his or her personal tax affairs.

International tax rules

Tax rules and double tax agreements, especially across the OECD, are reasonably clear as to what a multinational is required to do when calculating its tax obligations in any one jurisdiction. As in most other countries, New Zealand seeks to claim its share of tax under this framework and uses a range of international tax regimes, such as transfer pricing, to do so. Within this framework, the IRD can only enforce the rules that are currently in place.

With the differences in tax rules between various countries, multinationals will legitimately structure their affairs so that they benefit from those jurisdictions which have tax regimes favourable to that multinational’s business.

When there is ‘out-of-line’ rule setting (which ‘interferes’ with the even spread of tax rules) by some countries, like the USA, Ireland and Netherlands plus various tax havens, it undermines the effectiveness of international tax rule structures. In simple terms, it means these countries will attract more than their fair share of business by way of forfeiting a right to tax, as multinationals will seek to derive their income in the jurisdiction where the lowest rate of tax is applied – whether or not that income was derived in that country.

Under the current international frameworks, it is not illegal to do so.

Improving fairness

This has driven the world to join together to re-examine how it all works. However, no country can do this in isolation, especially a ‘net capital’ importer like New Zealand. Accordingly, local officials have been playing a lead role in the BEPS (Base Erosion, Profit Shifting) project at the OECD, which is looking at ways to improve the fairness of where tax is paid across the world through the introduction of new rules.

Dealing with downsides

With a sense that Google, Amazon and other multinationals that trade in New Zealand are paying too little tax, why not simply introduce rules which compel them to pay more? It isn’t as simple as that, and there can be unintended consequences for New Zealand, a country of exporters.

Many local companies trade overseas and pay very little tax there but large amounts here. If we were simply to increase tax on foreign companies in New Zealand, other countries could reciprocate and our exporters will end up paying less tax locally and more overseas, with a net result of a decrease in the New Zealand tax base.

This is a ‘double edged sword’ that presents a significant challenge for New Zealand in the BEPS negotiations in terms of determining the net gain or loss from any changes. Accordingly, the patient approach taken by the Government is to be commended not criticised. Leading-edge is okay but ‘bleeding edge’ is not.

For more information regarding this topic please contact Scott Mason, managing principal of tax advisory.