Tax abuses by overseas firms in IRD's sights

Robin Oliver

Inland Revenue has launched a crackdown on alleged abuses primarily by Australian-based companies it fears will rapidly erode the New Zealand tax base.

The IRD has also signalled it is no longer prepared to buy the PR line mounted by some offshore companies that clamping down on abuses of the tax base will discourage foreign investment here.

IRD deputy commissioner Robin Oliver says: "Our message to the corporate sector is that we will fight back to maintain our source-based taxation.

"We are prepared to put resources into it because to raise $4 billion or half the corporate tax base if we went down to the level of US tax collections we would have to get it [the $4 billion] off individuals.

"That would be a significant increase in the tax burden."

Oliver said the IRD had begun to make its position clear in one-on-one private discussions with Australian corporates that have invested here, several of which, the Herald has learned, are already facing IRD transfer-pricing audits.

"Our concerns with the foreign-owned companies are numerous but we're obviously concerned with Australia because that is where most of our [foreign direct investment] comes from," said Oliver.

The IRD deputy commissioner emphasised many of the loopholes closed in recent years had been exploited by Australian companies with significant investments here to reduce their tax burden as that country's investment footprint over New Zealand grows.

He notes the Australian imputation system, like New Zealand's, encourages tax paid in the home country. But IRD is concerned at the ease with which foreigners can "suddenly turn" what is New Zealand-generated income into foreign-related income simply by moving intangible assets around, loading local subsidiaries with debt and extracting "profit" through so-called "interest" payments, or issuing redeemable preference shares which are really geared to shipping what should be New Zealand-paid tax offshore.

Among the weapons in the IRD arsenal:

* Targeted, sophisticated auditing.

* Potential policy changes through new legislation.

* The immediate need for clearer imputation rules about what is acceptable practice.

Oliver concedes the IRD could be criticised for recommending ad hoc solutions in the past ("and we accept that") but says the present rules are not robust enough.

"We need to protect our tax base but we need to put it into a coherent framework so that people know what is acceptable."

Tax experts such as PricewaterhouseCoopers chairman John Shewan believe the problem could be reduced if the Government negotiated with the Australians to enable mutual recognition of imputation or franking credits.

Bank of New Zealand chairman Kerry McDonald, who co-chairs the Australia-New Zealand Leadership Forum, said the issue must be made a policy priority when Finance Minister Michael Cullen and Australian Treasurer Peter Costello hold their next annual talks.

Oliver concedes mutual recognition would take some of the pressure off.

But it would obviously have to be raised and agreed to by both countries. "There's no value to us in unilaterally recognising Australian imputation credits at all. To date that hasn't been on the transtasman tax agenda."

Shewan and McDonald are among several corporate leaders who have warned that the overall company tax rate of 33c is getting dangerously out of sync with other tax jurisdictions as countries engage in competition to reduce top company rates to well below 30c.

But Cullen has so far resisted their argument that the tax rate must be cut to remove the incentives to transfer profits offshore to lower-rated countries, particularly Australia.

Oliver concedes there are incentives for companies to move their incomes to lower tax jurisdictions. "But if we had a substantially lower rate, we'd still face the issues because of the different imputation systems and the fact that a lot of countries have tax rates of around 20 per cent or lower than that."

He said trying to deal with the problem by matching New Zealand's rate to the 12.5 per cent posted by Ireland or the around 20 per cent rates in Eastern European countries could lead to a halving of the corporate tax base, potentially costing the Government some $4 billion in lost revenue.

Oliver also foreshadowed that the IRD was losing patience with the practices of some foreign investors to exaggerate the effects of more stringent tax policing on New Zealand's image with foreign investors.

There was a time when it was not so clear cut that the Government was focused on source-based taxation of non-residents because of the arguments that non-residents could invest anywhere in the world and that taxes on non-residents were discouraging investors.

"There is an element of truth to that. But with respect to a lot of established businesses, these are highly profitable businesses - the revenues are so heavy and the businesses are already here - that we're not going to lose out too much economically by imposing this tax," Oliver said

"So we are signalling we don't have doubts about this."

The IRD has previously cracked down on alleged abuses by Australian banks of the tax system through structured finance deals.

It assessed the banks for back taxes it alleges are due and pushed through legislation to cut off further use of the loophole. The banks are contesting the assessments in court, with Westpac in particular arguing it based its decision to proceed with the structured financing deal after first obtaining a binding ruling from the IRD.

A mechanism used by Australian publisher APN News & Media, owners of the Herald, relating to masthead financing, was closed after fellow Australian publisher Fairfax tried to exploit the method to boost returns from its acquisition of the INL media assets in New Zealand.

The Government also moved last year to close off an imputation credit loophole used by Fairfax which had issued redeemable preference shares effectively to direct imputation credits away from foreign shareholders, who could not use them, to a special group of local investors, who generally could, and, at the same time make the payment deductible as interest in Australia.