Apologies to Star Trek fans, but Friday 8 October was a landmark day for international tax diplomacy with 136 countries, including New Zealand, signaling a commitment to proceeding with “BEPS 2.0”.
What is BEPS 2.0?
BEPS 2.0 is a continuation of the Base Erosion and Profit Shifting (BEPS) project commenced by the OECD in 2013 in response to Government and civil society concerns around multinationals not paying their “fair share of tax”.
BEPS 1.0 was aimed at addressing some obvious shortcomings in the current international tax rules, which are a product of the 1940s. Those changes left tackling the taxation of highly “digitalised” businesses and business models to another day. That is the genesis of BEPS 2.0, although the focus has moved away from only digital economy businesses.
BEPS 2.0 aims to more fairly allocate taxing rights over multinationals’ profits to countries where they operate (so-called “market countries”) for a few very large global groups. This is “Pillar 1” of the proposed BEPS 2.0 package. The second part (“Pillar 2”) of the package, which is more substantial, is an agreement to a minimum 15% effective tax rate applying to the global profits of many more global multinational groups.
The OECD expects US$125 billion of profit to be reallocated to market countries under Pillar 1. Pillar 2 is expected to raise US$150 billion in additional tax.
A minimum tax of 15% on accounting profit
Pillar 1 is likely to garner the headlines, but Pillar 2 will have more impact, not least for New Zealand. In short, Pillar 2 will require tax on profits in any country where a qualifying multinational operates to be at least 15%. (The qualifying threshold for a multinational is global group turnover of at least EUR750 million each year). Wherever the effective tax rate is less than 15%, a top up tax will be payable.
15% might seem a low tax rate compared to New Zealand’s 28% corporate tax rate. The important point is that this rate is applied to accounting profit. Accounting profit is likely to be different to taxable income as we define it (it is more likely to be closer to what economists have termed “economic income”). In New Zealand, for example, accounting profit will include capital gains which are not taxed. The Pillar 2 rules are therefore more like a minimum tax on economic income. This may throw up some surprising and unexpected outcomes.
New Zealand multinationals which are caught and subsidiaries of global multinationals operating locally will not be able to assume that New Zealand’s 28% company tax rate will automatically shelter them from the Pillar 2 rules. They will have to do the work to confirm that is the case. The result of the rules might be that further top-up tax is payable on New Zealand profits but not necessarily in New Zealand.
Why has New Zealand agreed to implement BEPS 2.0?
The OECD’s arguments for BEPS 2.0 are that:
- a common approach will prevent the proliferation of unilateral tax measures by countries, such as taxes targeting digital economy firms, which can create tax complexity and adverse economic outcomes. Examples of these are digital services taxes, which New Zealand has considered but not enacted pending the BEPS 2.0 project outcome.
- BEPS 2.0 will reduce if not eliminate harmful tax competition (specifically, a race to the bottom on corporate tax rates) while preserving the incentives for real economic activity
- more tax will be paid in more countries with a fairer allocation of taxing rights, including to countries where consumers and the economic activity resides.
- a “fair share” of tax will be paid by multinationals.
The overall impact of BEPS 2.0 for New Zealand is unclear. As a small market, New Zealand’s share of the BEPS 2.0 tax, likely in the tens of millions, is not significant compared to the forecast NZ$93 billion tax take for the 2022 year. So, why bother?
New Zealand’s commitment to BEPS 2.0 is a sign that it accepts the OECD arguments around the greater global good. This means the complexity created for some businesses and the potential restrictions on our tax policy choices is considered to be worth it. Similar to New Zealand’s embrace of the BEPS 1.0 measures, there is the desire to be a good global citizen and play our part in the expectation that a multilateral approach will be of greatest benefit.
The analysis supporting New Zealand’s BEPS 2.0 commitment will be of interest, when released. Inland Revenue’s upcoming Long Term Insights Briefing will look at the impact of tax on productivity and the cost of capital. The additional tax that BEPS 2.0 might impose is unlikely to shift the dial on investment decisions. However, the cost of complying might. The BEPS 2.0 rules and their application will be complex, no matter how much simplicity is desired.
So not necessarily a case of “live long and prosper”, more “may you live in interesting times”?
Timing – where to from here?
The implementation timeframe, particularly for Pillar 2, is ambitious with finalisation of model rules later this year. These model rules will need to be legislated in 2022 to apply for 2023. That is a very tight timetable for New Zealand to allow the Generic Tax Policy Process to apply.
Multilateral instruments (similar to BEPS 1.0) to implement BEPS 2.0 in tax treaties is proposed to be ready for signature for mid-2022. These will need to be ratified on a similar tight timeframe to make them effective for the relevant start dates.