Double tax deals pose dilemma

By BRIAN FALLOW ECONOMICS EDITOR

News that Australia has signed a double tax agreement with Canada is unlikely to disturb the tranquillity of many New Zealanders. But it points to a growing dilemma for New Zealand as a capital-importing economy in a global age.

The agreement, among other things, lowers withholding taxes on dividends and interest payments flowing between the two countries. A similar deal between Australia and the United States in October also cut withholding taxes.

Combined with Australia's lower corporate tax rate, the result, as KPMG partner Craig Elliffe points out, is to give Australia a competitive advantage over New Zealand in attracting and retaining investment from North America.

As Australian companies would also have an advantage in investing in the US and Canada, it would provide another reason for New Zealand companies to move across the Tasman, he says.

In the past, Inland Revenue has explained its comparatively laggardly performance in renegotiating double tax agreements by saying it takes two to tango and other countries' dance cards, especially America's, tend to be full.

But there is a reason New Zealand might prefer a wallflower role.

The emerging trend in recent tax treaties, notably between the US and Britain, the Netherlands and Australia, has been to cut or even eliminate withholding taxes.

This reflects a preference within the rich nations' club, the OECD, to move from taxing multinationals' profits not where they are generated, but where the multinational is based (a switch from source to residence taxation, in the jargon).

Clearly, this trend is not in New Zealand's interests. Far more multinationals have branch offices than head offices in this country.

Hence the dilemma. Do we drag the chain in renegotiating tax treaties and risk reducing New Zealand's attractiveness to investors, or hasten to join a trend to residence-based taxation of multinationals which erodes our tax base?

The McLeod tax review was in the "If you can't beat them, join them" camp. It proposed cutting company tax for new foreign investment from 33c to 18c in the dollar.

It argued that in many cases the economic burden of New Zealand tax does not fall on the overseas investor but on New Zealanders in the form of lower wages or higher cost of capital.

Foreign companies routinely use debt financing and other wrinkles to minimise the tax they pay here.

Better, said the review, to make that reality transparent in the statutory tax rate and stand out from the crowd competing for investors.