Earlier this year, Prime Minister Jacinda Ardern announced the Government's intention to introduce a new digital services tax (DST) that would apply to multinational digital companies operating in New Zealand.
The DST is seen to be necessary because many digital platforms are able to derive significant income from the size and activity of their user bases. It has become increasingly common for digital enterprises to derive such income without a physical presence in the jurisdiction of their user bases. Current international tax settings require the presence of a permanent establishment in a source jurisdiction as a prerequisite for taxing the business profits of a non-resident enterprise (typically, a physical presence by way of a fixed place of business, or a dependent sales agent). Proponents of a DST argue that these settings have allowed multinational digital companies to extract value from their New Zealand users without paying local income tax on those earnings.
The Government is involved in talks at the Organisation for Economic Co-operation and Development (OECD) to come to a consensus on how to tax the digital economy, with the hope being for plans to be approved by the G20 in June. There remains optimism that these talks will be successful, however it is not anticipated that any consensus solution would be implemented for at least 3-4 years. As an interim measure, a DST is currently being considered for implementation.
Based on the design of similar taxes in other jurisdictions, it is likely that the proposed DST would be applied as a 2-3% levy on gross revenues from certain digital platforms. Depending on the design of the tax, it could raise between NZ$30 million and NZ$80 million. The Government has also suggested that a DST could have the positive effect of depriving overseas companies of the competitive edge they currently hold over local businesses who are subject to income tax.
However, there are a number of potential pitfalls associated with the implementation of a DST. First, given the small size of the expected revenue the cost of introducing new tax law may not be justifiable, especially as it would only apply as an interim measure until any OECD consensus solution is implemented. Equally, Inland Revenue may have difficulty in enforcing the tax on multinational digital companies that operate outside New Zealand. Where it could be enforced, there is the risk that companies will simply pass on the cost of the DST to New Zealand customers. Additionally, if the DST does not mesh well with the existing tax system, it could result in double taxation of currently compliant businesses or the taxation of businesses operating with a loss.
There are also international consequences for the design of the DST. As most multinational digital companies are based in the United States, there is the chance that the United States will consider the tax to be discriminatory, which could lead to the imposition of retaliatory measures. The DST is also unable to be designed as an income tax because doing so would render it ineffective as a result of New Zealand's existing double taxation agreements. It would likely need to be designed as an excise tax in order to not be covered by those double tax agreements. However, if designed as an excise tax the DST would then be subject to the World Trade Organisation's free trade agreements, which include non-discrimination obligations.
A further concern is that the introduction of a unilateral DST in advance of other nations or a global solution could damage New Zealand's reputation as a business-friendly nation. This is likely why the Tax Working Group recommended that a DST be prepared, but only implemented once there are a significant number of countries doing the same. Similarly, a background paper released by the Tax Working Group contained a recommendation that New Zealand be a fast-follower rather than an early adopter of a DST.
Whether the Government will follow the Tax Working Group's recommendation to adopt a cautious approach should be known shortly. The Government has signalled that a discussion document on the taxation of the digital economy, including the potential introduction of an interim DST, will be released in late May. That discussion document should provide greater clarity as to the likelihood, timing and potential design of a DST in New Zealand.