A tax bill introduced alongside the budget commits the government to global rules aimed at stopping the likes of Meta and Google NZ sending their profits offshore. Terry Baucher explains the story so far.
Tax is full of acronyms; PAYE, GST, FBT… and BEPS. If you’re not familiar with BEPS, it stands for Base Erosion and Profit Shifting, and every time you call an Uber or log onto Facebook, their ultimate parent companies Uber Inc and Meta Inc are using BEPS to transfer income overseas from Aotearoa New Zealand.
As I explained to John Campbell last week, BEPS at its most basic level means shifting income from a higher tax country, in this case New Zealand with our corporate income tax rate of 28%, to lower tax jurisdictions. This profit-shifting erodes our tax base, hence the term BEPS.
BEPS is how Facebook New Zealand earned gross advertising revenue of over $154 million last year, but only reported net profit before tax of $3.3 million and ended up paying just over $1 million of income tax. That’s because during 2022 Facebook New Zealand paid a related company, Meta Platform Ireland Limited, over $149 million for the purchase of services. The corporate income tax rate in Ireland is 12.5%, the lowest in the European Union.
BEPS also explains why Uber’s New Zealand operations earned over $220 million in 2021 but the final income tax liability was just $545,000 income tax after fees of $117 million were paid to its Dutch holding company Uber International B.V. As Uber International B.V. is a holding company a preferential zero tax rate applies for Dutch tax purposes.
These numbers are dwarfed by those of Google New Zealand which in 2022 paid over $870 million in service fees to offshore affiliates, mostly to the Singapore-based Google Asia Pacific Pte. Limited. As you have probably guessed, Singapore has a preferential tax regime which is perhaps why Mastercard and Visa also route payments through Singapore.
In total, based on the latest financial information, Facebook, Google and Uber have paid more than $1.1 billion in service fees to overseas affiliates. In theory, at the corporate income tax rate of 28% this represents over $319 million in potential tax.
That’s just the impact in Aotearoa New Zealand. Globally, according to the Organisation for Economic Co-operation and Development (OECD), BEPS practices cost countries US$100-240 billion (NZ$159-382 billion) in lost revenue annually.
Surely such manoeuvres are not legal? At the moment, yes. The problem is that the rapid development of the digital economy has outstripped the rules of the current international tax system. These are based on principles developed after World War 1 and critically centre on where economic activity is physically carried out.
But in today’s digital economy driven by the immensely valuable intellectual property wrapped up in the algorithms and apps of Facebook and Uber, it’s virtually impossible to apply a location basis of taxation.
With the old rules rendered ineffective, how are governments reacting to this threat to their tax base?
Individual tax authorities are investigating the level of service fees charged. According to Meta Inc’s financial report for the year ended December 2022, filed with the US Securities and Exchange Commission, it had accrued US$5.49 billion (NZ$8.7 billion) in respect of “uncertain tax positions”. These relate to transfer pricing with its foreign subsidiaries, including “licensing of intellectual property, providing services and other transactions.”
It’s not clear from its latest financial statements whether Inland Revenue is currently investigating Facebook New Zealand.
Meta is not the only tech company being investigated. Uber is mired in several tax audits and arguments around the treatment of its contractors. Alphabet Inc, the owner of Google, has also been under investigation. In 2019, its Australian subsidiary paid over $500 million in settlement of a tax dispute with the Australian Tax Office.
Some countries including India, France and the United Kingdom have introduced a digital services tax, which impose a low flat tax rate on the value of digital services provided within the country. Inland Revenue has consulted on the topic but not proceeded with implementation.
But a more comprehensive approach is required which is why the OECD together with the G20 group of nations launched the Inclusive Framework on BEPS initiative. At present 138 jurisdictions nations including Aotearoa New Zealand have agreed to the Inclusive Framework. This led to the so-called Pillar One and Pillar Two proposals, a provisional agreement on which was reached in October 2021 (although arguments over implementation are still ongoing). These proposals target the largest multinationals with annual revenue exceeding €750 million.
Pillar One aims to ensure a fairer distribution of profits and taxing rights between countries for these larger multinationals. In other words, how much of the digital pie each country can tax. Critically, the intention is for Pillar One to replace any country-specific digital services taxes (which, as you can imagine, the likes of Meta loathe).
Pillar Two is the biggie as it aims to restrict the impact of lower tax jurisdictions by imposing a global minimum of 15% for those multinationals with annual revenue exceeding €750 million. This will be done by Global Anti-Base Erosion (GloBE) rules.
This month’s budget was accompanied by a tax bill introducing the relevant legislation required for the implementation of the GloBE rules. The legislation and commentary include a heap of new tax acronyms including DIIR (Domestic Income Inclusion Rule), POPE (Partially Owned Parent Entity) and QDMTT (Qualified Domestic Minimum Top-up Tax), which a rather cynical overseas tax advisor has suggested should be pronounced Q-Dammit.
The commentary to the tax bill explains the legislation will only take effect once a “critical mass of countries” has adopted the GloBE rules. This is thought to be “very likely, though is not certain”. If that critical mass is reached, then the rules will be phased in starting from 1 January 2024.
Assuming Pillar Two does proceed then how much will it raise? Not much. According to the regulatory impact statement (RIS) released with the tax bill, the GloBE proposals should be worth $25 million annually with another $16 million coming from taxes on amounts which would have otherwise been shifted to lower tax jurisdictions. The RIS explains this “modest amount” is because of a number of factors including that only 20-25 multinationals will be affected.
The GloBE rules therefore represent a beginning not an end. With the colossal sums of money involved in the digital economy the incentives are high for the tech companies and their tax planners to keep one step ahead of the chasing tax authorities. Until public outrage at the aggressive tax planning of the likes of Alphabet, Meta and Uber translates into rejecting their products and political action to curb their worst excesses, it’s a race the tech companies will continue to win. We may hate the sinner, but we love the sin.
