Tech-firm taxes a red herring
As the political furore about the meagre taxes collected from tech companies gains global momentum, New Zealanders should focus on the real issue: how we can best attract and retain more of the real value-adding functions of these companies.
Labour revenue spokesman David Clark has jumped on the bandwagon, claiming Facebook New Zealand, with 2.2 million users in this country, pays little more tax than the average wage earner.
He labels as a “rort” the “double Irish” structure reportedly used by Facebook, and other global tech companies.
Earlier, Assistant Treasurer David Bradbury announced a crackdown in Australia on companies using complex offshore structures that “aren’t paying their fair share of tax on economic activity in Australia”.
Bradbury named Google and Apple as two such companies.
Revenue Minister Peter Dunne has released a more subdued statement, acknowledging that “our tax laws need to evolve” but the issue is “a global problem requiring a global response”.
Using an Irish structure, where the corporate tax rate is low, is a red herring as far as New Zealand is concerned. Facebook could be making its sales to New Zealand through a US company and New Zealand would collect no more tax.
A quick internet search reveals Google and Facebook have around 2500 and 400 employees in their respective European headquarters based in Dublin. That’s hardly the best platform from which to allege a tax dodge.
The issue is not where the company selling the goods/services is located but whether that company is conducting business in New Zealand through a “permanent establishment”, according to New Zealand’s numerous double tax treaties.
That can include the situation where employees in New Zealand are essentially making sales here on behalf of a foreign affiliate.
Many companies do not require people permanently on the ground in New Zealand to make their sales. On-line commerce is an obvious example where people and equipment involved in the sale can be based offshore.
But even foreign manufacturers of consumer goods sold at retail in New Zealand can be structured in a way that they pay no tax here. For some, their stock is warehoused in New Zealand to fill orders for the retailers, but the selling occurs all offshore.
Facebook New Zealand’s financial statements show the company employs few people and has few assets here. It earns service fees from its Irish affiliate for supposedly doing marketing and related activities in New Zealand.
If a tech company used its New Zealand subsidiary to invoice the sale to the consumer, the sale would be subject to New Zealand tax.
But the tax take on those sales may still not be impressive.
Transfer pricing rules dictate that most of a tech company’s profit will end up offshore via royalty payments and for other management services performed offshore. Payment of royalties is not profit-shifting as many politicians would have us believe. Just like drug companies, the royalties rightly compensate those offshore affiliates for the substantial investment risk they take in creating intellectual property. At least with royalty payments, Inland Revenue would usually collect 10% of the payment in the form of withholding tax.
How governments intend to “crack down” on what Bradbury claims are tech companies “free riding on the efforts of others” is not clear.
Minister Dunne has mentioned New Zealand’s participation in the OECD project on “Base Erosion and Profit Shifting”. This project is examining a number of pressure areas, including the application of tax treaties to profits from digital goods and services.
Governments can, of course, unilaterally create new tax laws to target specific transactions or industries.
For example, specific tax rules were long ago developed to deal with non-resident insurers writing business against New Zealand risks or non-resident shippers on outbound freight.
These regimes deem a portion of the payments made to the foreign companies to be taxable in New Zealand. But many of these foreign companies still enjoy tax exemptions through a double tax treaty.
Getting consensus among developed countries to modify long standing international tax rules as they may apply to tech companies will not be a quick nor simple process. The real challenge for New Zealand is how to attract more of the real value-adding activities of these tech companies into New Zealand and keep more profits here.
Mark Loveday is a transfer pricing partner at EY