Tax systems around the world have historically focused on the physical presence of an offshore business, and New Zealand is no different. Broadly, if an offshore business is physically present in New Zealand and, therefore, is doing business there, it will pay tax on income sourced from that presence, subject to any relief that may be available under New Zealand’s network of tax treaties.
With a highly digitised world, which allows multinationals to enter and sell to markets remotely without the need for physical presence and to exploit deficiencies in the existing international tax rules that were written for the “physical” economy, the question has arisen:
“Is the tax system still fair and fit for purpose?”
New Zealand has been working with the OECD and other countries as part of the Inclusive Framework on base erosion and profit shifting to adopt a globally driven solution, but it appears that New Zealand is unwilling to wait for such consensus. Other countries also have been unwilling to wait; for example, Austria, France, Hungary, India, Poland, Portugal, Spain, Turkey and the UK have introduced unilateral measures in the form of a digital services tax (DST) to ensure that digital businesses pay tax reflecting the value they derive from income derived in jurisdictions in which they are providing services, and other countries (e.g., Canada, Italy) have proposed a DST.
New Zealand is jumping on the DST bandwagon. On 31 August, the government presented a Digital Services Tax Bill and Commentary to Parliament that would introduce a DST on a group’s gross revenue attributable to New Zealand from covered activities. If enacted, the DST would apply to large multinational organisations that:
- Provide digital services to customers in New Zealand without having a physical presence in the country; and
- Derive global revenues of EUR 750 million or more from the provision of such digital services.
In-scope digital services would include services provided via intermediation platforms, social media and content sharing platforms, and internet search engines, as well as any activity incidental to one of these services. For those affected, the DST would impose a 3% ‘tax’ on gross revenues generated from covered services provided to New Zealand customers/consumers where those revenues exceed NZD 3.5 million.
The DST would be based on gross revenue rather than net taxable income so that tax liability would arise with reference to total sales regardless of whether the activities in New Zealand are profitable. The underlying presumption is that, given the high threshold before the DST would apply, multinationals that would be subject to the DST would be profitable on their New Zealand endeavours. Applying the DST on a gross basis should disincentivise the legitimate structuring of affairs to reduce overseas profitability and help to ensure the rules have teeth.
If approved, the DST would apply from 1 January 2025, although the bill contains a provision that would defer the commencement date for up to five years if sufficient progress is made towards implementing a long-term multilateral solution.
As mentioned above, the core international tax framework is not aligned with how businesses currently operate and access markets. New Zealand took a first step in taxing the remote provision of services by amending the Goods and Services Tax (GST) rules in 2016 to require overseas companies providing these services to non-GST-registered customers in New Zealand to collect and pay GST (which, depending on the elasticity of demand, merely shifts the burden of tax to the consumer). However, the income tax framework has not yet addressed this digital shift.
From the perspective of fairness, one could argue that the introduction of a DST would be a step in the right direction. However, as the proposed tax would largely impact U.S. organisations, caution should be taken and the risk of retaliation acknowledged.
So why now? Whether the DST could have a short shelf-life or no shelf life at all, considering the OECD’s two-pillar plans to reform the international tax rules, is open to question. In particular, the UK has signalled it will withdraw its DST if the OECD’s pillars are accepted. It is unclear why the New Zealand bill has been introduced now, even though the DST would not apply until 2025. However, this early warning may be a courtesy to allow affected large multinationals to implement appropriate internal systems or reassess whether the New Zealand market would remain tenable.