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OPINION: Digital services tax presents a classic risk/reward trade-off for New Zealand

June 17, 2019

Contacts

Partners Barney Cumberland
Senior Associates Paul Windeatt

Tax reform (Tax Working Group)

Barney Cumberland and Paul Windeatt argue that discretion may be the better part of valour in the Government’s consideration of a digital services tax.

The Government has recently released a discussion document that reaffirms, and explains why, it is seriously thinking about introducing a digital services tax (DST).

The proposed DST would be "targeted at business activities whose value is dependent on the size and active contribution of their user base", such as large social media platforms (eg Facebook), internet marketplaces that facilitate the sale of goods and services (such as Airbnb, Apple and Uber), content sharing sites (YouTube and Instagram), and search engines (eg Google). It would not apply to other digitally-based enterprises such as Amazon and Netflix, who sell goods, content or services on-line.

The proposed DST would be a 3% tax on the gross turnover (as opposed to net profit) attributable to NZ of the in-scope digital business.

It would apply to turnover in an income year where, in the previous income year, the consolidated digital group's annual global turnover was at least €750 million and where the amount of the digital group’s annual global revenue that is attributable to NZ users was at least NZ$3.5 million. Only in-scope revenue would be included, such as revenue from advertising provided through social media platforms and search engines, and commissions charged on transactions carried out through intermediation platforms. 

The apportionment of revenue to NZ would not be based on the location of the customers paying the digital group for its services, but on the location of users of the platform or service, who may pay nothing. 

The amount of revenue attributable to NZ would be based on the proportion of global users "located" in NZ. As a proxy for location, the residency of the user would be used. This is the same method used in the GST Act to deem a supply of cross-border online services to be made in NZ if the recipient is a NZ resident. Its use in a DST context would mean that use of a platform by NZ residents outside of NZ would be included in determining the percentage of NZ users, but not use of a platform within NZ by a non-resident. 

Any such DST is primarily being flagged by the Government as an interim measure, pending a decision by the OECD on how to tax the digital economy. 

Concern has already been raised in the media about NZ "going it alone" and not waiting for an OECD decision. The fear is that NZ could face retaliatory measures from its large trading partners, particularly from the US, where opposition to a similar UK tax has been expressed in some quarters.

The Government acknowledges that the implications of adopting a DST for NZ's export sector would need to be considered, particularly given stated US opposition.

Those non-tax implications are not addressed in the discussion document, but it is said that the design of the DST would comply with OECD guidelines intended to limit the adverse consequences of such a tax. This would also provide a degree of uniformity with other DSTs adopted by countries which do not wish to wait for a global solution.   

Furthermore, the Government believes that implementing a DST may assist to incentivise countries to reach such a global solution, which is its preference. The document notes that the OECD is aiming to get G20 approval of its preferred measures this month and that, if approval is given, then an OECD solution is more likely.

Consequently, it may be no coincidence that the discussion document has been issued just weeks before the G20 summit on 28-29 June. 

Of course NZ cannot single-handedly influence the decision-makers of the world's largest economies, but we would not be alone. Due to the lack of sufficient progress by the OECD, DSTs have or are being introduced in the UK, France, India, Italy, Spain and the Czech Republic – all with intentions to repeal the tax if and when an OECD solution is reached. 

Attempts have also been made to introduce a DST in the EU. So, rather than going it alone, the Government would be adding New Zealand’s voice to those countries which are trying to encourage the OECD to reach a decision. 

This may justify talk of a DST, but should NZ actually introduce one if OECD progress continues to be slow?

The Government accepts that a DST is unlikely to be a significant revenue earner, roughly estimating that a DST would initially raise a mere $30 to $80 million annually (about a third of the total daily tax take in NZ), and would have both administrative and compliance costs.  

So why bother, if it could lead to retaliatory measures? Alluding to public concern about the under-taxation of high-profile digital companies, it is said that the DST could have the benefit of improving public confidence in the fairness of the tax system.

However, it is doubtful that such a small revenue raiser would assuage public concern, given the size of the businesses that would be the target of this tax. So this justification has the air of the necessity for the Government to be seen to be doing something, rather than nothing. 

Perhaps a better reason is that, as the Government notes, the digital economy is growing as a proportion of the total economy, so it will become more important to find a way to tax these digital businesses. But that fact would seem to necessarily increase the pressure on the OECD to act, regardless of whether NZ enacts a DST. 

Putting aside using a DST as a way to incentivise the OECD, it is said that NZ might still want to introduce this tax even if an international solution is found. This is because implementing any OECD solution will require countries to agree to amend their double tax agreements, and a DST could be a tool to tax digital companies operating out of countries that do not implement the solution.

But that does not justify introducing a DST now. How to address a currently hypothetical situation, whether alone or in conjunction with compliant countries, is surely a matter to be considered if and when it becomes a live issue.

The Government also states that there is risk in waiting. Even if the OECD agree in 2020, there is concern that any international solution may not take effect for another three to five years, based on recent experience with the base erosion and profit shifting (BEPS) measures. 

But is this a "risk" or just an inevitable delay that, while perhaps frustrating, does not in itself justify an interim DST that will earn relatively few tax dollars? At best, such a DST may encourage countries to act faster in implementing any OECD decision, but it could complicate negotiations to amend NZ's double tax agreements.

In March, after hearing submissions on a similar consultative document, Australia decided not to introduce an interim DST, but instead to focus its efforts on a multilateral solution.

While it is clear that taxation of the digital economy is an important issue that needs addressing, we suggest that NZ should follow Australia's approach at this time. Little will be lost in the meantime and, in this context, it is the preservation of NZ’s reputation as a cool and measured head at the international tax policy table that matters most, rather than the Government playing to its electoral base.