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New Zealand a front-runner on BEPS implementation

New Zealand, which prides itself on having a large impact relative to its size, has strongly supported the BEPS process.

New Zealand, a small open economy with a population of less than 5 million, depends on inbound investment, much of which is ultimately sourced from Australia, the United States and the United Kingdom.

In tax terms, the Government prides itself on having a much larger impact relative to its size. It has been strongly supportive of the BEPS process, and behind the scenes, its officials have made major contributions to the program.

“With draft legislation and application dates likely to be delayed by New Zealand’s pending general election, companies should use this time to consider the shape of their supply chain and financing.“

New Zealand already has a robust broad-base, low-rate tax system, with a modern treaty network, well-functioning transfer pricing, thin capitalization and source rules. It has a professional tax administration buoyed up by a series of court judgments in its favor. While little is needed to bring the tax system in line with the minimum BEPS standards, public opinion is strongly in favor of measures intended to force multinational enterprises to pay more tax. 

On 3March 2017, the New Zealand Government called for feedback on wide-ranging changes to its international tax rules in the wake of the Base Erosion and Profit Shifting (BEPS) recommendations from the G20 and the Organisation for Economic Co-operation and Development (OECD).

The proposed changes purposefully place New Zealand at the forefront of BEPS implementation. Not only do they point toward robust implementation of many BEPS minimum standards and recommendations, but they go further, with New Zealand effectively replicating Australia’s multinational anti-avoidance law (MAAL).

This new permanent establishment (PE) anti-avoidance law is proposed for multinationals with more than €750 million global turnover, targeting companies that Inland Revenue believes are structuring their sales to avoid a taxable presence in New Zealand.

As is often the case in New Zealand, the proposed reforms are heavily influenced by developments in Australia, its nearest neighbor and largest investment and trading partner.

Key proposals include:

  • Implementation of a PE anti-avoidance rule, effectively replicating Australia’s MAAL and elements of the United Kingdom’s Diverted Profits Tax (DPT)
  • Apparent rejection of the “best-practice” earnings-based fixed-ratio test in favor of an aggressive interest rate cap, which anchors the interest rate on related-party debt to the parent’s cost of funds, effectively abandoning the arm’s-length standard with respect to related-party debt in certain circumstances
  • Wide-reaching transfer pricing changes, bringing New Zealand’s transfer pricing regime in line with the recent revisions to the OECD Guidelines (BEPS Actions 8 to 10) and specific measures allowing for the reconstruction of transactions to align with the New Zealand Tax Commissioner’s view of economic substance
  • Signing up to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the MLI) at the earliest opportunity, with the intent that the MLI will apply across the majority of New Zealand’s tax treaties, including all applicable minimum standards and optional provisions

Viewed in concert, these complementary changes are expected to have a powerful impact on the tax framework for inbound multinational companies.

Driving the changes is significant public appetite for a “crackdown” on the tax affairs of multinationals, with growing media scrutiny on tax issues. With 2017 being an election year (the election will take place in late September), we expect the Government to move fast on these proposals. The initial time frame for submissions was short, and final decisions are expected by midyear.

All multinationals with cross-border transactions, especially related-party finance and/or global turnover in excess of €750 million, will need to work through the implications of the changes for their structure. 

Multinationals already contribute strongly to the New Zealand tax base

New Zealand is heavily dependent on its corporate tax revenues, to which multinationals are a major contributor. For the year ended 30 June 2016, Inland Revenue collected NZ$12.3 billion in corporate tax, representing 19% of total tax revenues[1].

This is an outlier: at 4.4% of gross domestic product, corporate tax revenue is among the highest in the OECD[2]. While official statistics are patchy, the Government has stated that 39% of all corporate tax is paid by foreign-controlled firms[3], mostly by larger inbound investors.

Therefore, it seems unlikely that substantial additional revenue can be raised without a material negative impact on inbound investment and the New Zealand economy. New Revenue Minister Judith Collins — seen as a heavy hitter on the domestic political scene — is on record as stating that most firms are not “gaming the system.”

Collins’ views are entirely consistent with our own experience[4], with corporate debt levels being relatively modest, multinationals not being significantly indebted compared to New Zealand-based companies, and Inland Revenue becoming increasingly sophisticated in transfer pricing enforcement. Nevertheless, Collins sees the proposals as a “considered, balanced” approach. 

Could the PE anti-avoidance rule be part of — or even catalyst to — a global trend?

The central theme of the PE and transfer pricing proposals is to align tax outcomes with the economic substance of a transaction. Economic substance involves subjectivity and raises concerns about the uncertainty the rules will likely create, and in particular, the potential for a rise in the level and complexity of cross-border tax disputes.

Under New Zealand’s proposed PE anti-avoidance, a nonresident will be deemed to have a PE in an arrangement under which:

  • The nonresident supplies goods or services to a person in New Zealand.
  • A related entity carries out an activity in New Zealand in connection with that particular sale for the purpose of bringing it about.
  • Some or all of the sales income is not attributed to a New Zealand PE of the nonresident.
  • The arrangement defeats the purpose of the double tax agreements’ PE provisions.

This wording is almost identical to the Australian MAAL and elements of the United Kingdom’s DPT, with the exception of the last portion (i.e., the MAAL and DPT instead require the arrangement be designed to avoid tax).

Materially, the proposal achieves the same outcome, which is to deem a PE of a foreign multinational to exist where an entity in New Zealand assists the nonresident in selling to New Zealand customers. The rule will apply only to multinationals with more than €750 million global turnover.

The Government has outlined certain structures that the PE avoidance rule will target. One such structure is where a foreign multinational sells directly into the New Zealand market from a low-tax country while a New Zealand subsidiary simultaneously provides sales support activities, such as advertising, finding customers and negotiating terms subject to parental approval.

The Government is also concerned when a foreign multinational engages with a third-party channel provider to sell the goods, but also has an entity in New Zealand performing sales promotion and services, dealing with the end customers to bring the sale about. While the proposal does not explicitly target digital services and goods, it is likely to have a material impact on the digital sector.

This potential adoption of a MAAL by a third country after the United Kingdom and Australia with their DPT — with France’s Constitutional Court rejecting similar proposals there, just before the New Year — is starting to represent momentum for this type of measure.

It raises the probability of more country-level uncertainty, at the time when the OECD’s post-BEPS agenda is seeking to achieve greater certainty by multilateral means. Indeed, in a recent interview with us, the OECD’s Pascal Saint-Amans seemed to reluctantly accept that other countries may move in this direction, saying that (in regard to the interim report on taxation of the digital economy, expected in spring 2018): “if we get the analysis of what is at stake right, then if countries do take unilateral measures, they will take the right route and make smart choices.”

Interest limitations: a novel “interest rate cap”

Echoing the final report on BEPS Action 4, the Government has expressed concern not only with the volume of debt but also with the price of such debt. This seems to have developed out of the Inland Revenue’s frustration at its ability to address high interest rates on related-party lending through the transfer pricing regime. In particular, the Government takes aim at loans lasting more than five years, and those with nonstandard terms, such as subordinated debt.

Where the Government differs from the OECD’s approach in Action 4 is that it has all but rejected the “best practice” approach of an earnings-based fixed-ratio test. The fixed-ratio test is seen as a risk to New Zealand’s commodity-based agribusiness and primary produce sectors, which are subject to considerable volatility in the international market.

However, conscious of the impact of artificially high interest rates to the New Zealand revenue base, the Government has proposed an alternative method of restricting interest rates on cross-border related-party lending: an “interest rate cap.”

The interest rate cap would limit the interest rate on cross-border related-party debt to what it calls a “reasonable approximation of the multinational’s cost of funds.” It will require loans to be priced from the perspective of the lender rather than the borrower (specifically, at the lender’s credit rating plus a margin, likely limited to that derived from bond yields one credit rating notch below that of the ultimate parent).

Further, the maximum loan term would be limited to five years, and the yield derived from senior unsecured corporate bonds — that is, nonstandard loan terms will be ignored.

The interest rate cap is an untested, novel approach. The Government acknowledges that it is “not aware of other countries imposing a similar interest rate cap.” As an arbitrary cap is in clear breach of the arm’s-length principle — despite Inland Revenue comments to the contrary — if enacted, the interest rate cap will likely result in double taxation.

It seems improbable that multinationals based in, for example, Australia, the United States or the United Kingdom, will be prepared to extend finance to New Zealand at rates below arm’s length or that revenue authorities in those countries will accept a lower transfer price. Tellingly, New Zealand does not propose a comparable rule for loans from a New Zealand parent to its foreign affiliates.

Like Australia, New Zealand’s thin capitalization regime limits a company’s deductible debt based on a debt/assets ratio. Under the proposals, defined “non-debt liabilities” will be excluded from the asset base, effectively moving the thin capitalization test to a debt/equity test. This change will impact industries with substantial provisions — insurers, miners and distributorships, among others.

Transfer pricing rules to align transactions to their economic substance

New Zealand’s current transfer pricing regime is substantially unchanged from when it was enacted in 1995. Administration of that regime, though, is developing rapidly. In recent years, Inland Revenue has placed increased scrutiny on the tax practices of multinationals, particularly around cross-border financing arrangements, transactions with related parties in low-tax jurisdictions, royalties, service fees, and the use or transfer of intangibles. 

The Inland Revenue has a close relationship with the Australian Tax Office. Notwithstanding the generally high level of compliance with transfer pricing rules by New Zealand multinationals, the Inland Revenue has clearly been convinced that much can be gained from emulating Australia’s 2012 reforms in this area.

As in Australia, the proposals will allow the Commissioner to reconstruct transactions that do not align with her view of the economic substance. The OECD Guidelines note that such reconstruction should be used sparingly but, consistent with the Australian approach, New Zealand does not intend to include reference to such “extraordinary circumstances” in the legislation.

The proposals would also shift the burden of proof on transfer pricing matters to the taxpayer, and extend the wording of the legislation from reference to an arm’s-length price to arm’s-length conditions, thereby widening the scope of transfer pricing documentation such that it should cover all conditions of a cross-border associated party transaction.

Implementation of all minimum and optional standards through the MLI, across the majority of New Zealand’s tax treaties

Collins anticipates signing the MLI in June 2017, and intends for the majority of New Zealand’s 40 double tax agreements (DTAs) to be covered agreements for the purposes of the MLI. In the New Zealand context, such a move makes sense, since with the economy depending on free trade and investment, a modern DTA network is clearly an advantage.

Consistent with its general approach to the OECD’s BEPS recommendations, New Zealand intends to adopt all minimum and optional standards through the implementation of the MLI, including the insertion of the principal purpose test (to prevent the granting of treaty benefits in inappropriate circumstances), the prevention of artificial avoidance of PE status, the neutralization of the effects of hybrid mismatch entities, and the provision of improved mechanisms for effective dispute resolution.

New Zealand will deposit a list of reservations, notifications and choices with the OECD at the time of signing in mid-2017. Following signing, the MLI will go through New Zealand’s treaty-making process, which will include the tabling of the MLI before the House of Representatives, consideration by Select Committee and then Cabinet approval. The Government has indicated that it is likely that the first modifications will occur in 2019.

Final thoughts

Fairness and certainty considerations are behind the implementation of the BEPS recommendations in New Zealand where such implementation responds to an observable problem. However, there is a strong argument that measures should be applied only to a small number of highly geared or structured outliers rather than imposing compliance costs on the many multinationals with a good compliance and tax paying history. 

With regard to the PE anti-avoidance rule based on Australia’s DPT, the Government has yet to provide a compelling case for the adoption of the measure ahead of implementing the MLI. Given the strength of New Zealand’s existing thin capitalization rules, there is arguably time for the government to reflect further before enacting the novel approach encompassed by a proposed limit on interest rates on related-party loans. 

We are engaged in discussions with the Government on the proposals and encourage businesses to do the same. With draft legislation and application dates likely to be delayed by New Zealand’s pending general election, companies should use this time to consider the shape of their supply chain and financing.

Read more: Global Tax Policy and Controversy Briefing


[1] Inland Revenue, 2016 Annual Report.

[2] OECD Revenue Statistics 2016, data for the year ended 30 June 2015 (in comparison, the OECD average corporate tax to GDP ratio is 2.8%).

[3] Policy and Strategy, Inland Revenue, BEPS – Strengthening our interest limitation rules, A Government discussion document, (figure quoted is for the year ended 30 June 2015), March 2017.

[4] See our new report, Do corporates pay their "fair share" of tax in New Zealand? at ey.com/Publication/vwLUAssets/ey-do-corporates-pay-their-fair-share-of-tax-in-new-zealand/$File/ey-do-corporates-pay-their-fair-share-of-tax-in-new-zealand.pdf.


Aaron Quintal                                                                                  

EY New Zealand Tax Policy Leader                                             

+64 27 489 9029                                                                            



David Snell

Executive Director – Tax                                                 

+64 21 845 361


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