My guest today is Craig Elliffe, Professor of Law at the University of Auckland. Craig has had a very distinguished and accomplished career. He was a tax partner at KPMG and then at Chapman Tripp before moving into academia at the University of Auckland. Craig was also a member of the Michael Cullen chaired Tax Working Group and in April this year published the award winning, and highly relevant book, Taxing the Digital Economy. He’s joining me today to discuss the recently announced agreements on international taxation.  Kia ora. Craig, welcome to the podcast. Thanks for joining us.

So what has been agreed and how important are these agreements?

Well, there’s been a lot of discussion, a lot of politics, and even just as recently as last month, a clear political statement by what are now at least 141 countries, representing greater than 95% of the world’s GDP. And what they’ve agreed is effectively two brand new pillars which they’re calling Pillar One and Pillar Two. They are a new consensus reached on how to tax global transactions.

There’s two parts, as you say, Pillar One and Pillar Two.  And Pillar Two, is the one attracting quite a bit of attention because it’s basically proposing a global minimum corporate tax rate of 15%. Is that high enough?

Well, many commentators say no. And I guess this is the thing when you have a global consensus, you don’t get a global consensus with an extreme of one sort or another because there will be some countries who don’t want a global minimum tax at all. And there’ll be some countries who fiercely want it for a variety of different reasons. In the end, I think 15% represents an amount which is certainly lower than most developed countries’ corporate tax rates.

But we’re in a period of time when I think Corporation Tax is under quite significant focus because there will be quite a few budgets that are both in deficit and economies with substantial borrowing. So my sense is that 15% is quite a good place to have landed in the sense that for those countries for whom the tax rate is viewed as competitive, they still probably feel as though they can do something. And for those who view this as a key element of cooperation amongst different countries, it’s significantly better than the than the current position with of not having one at all.

Yes, and just talking about those who haven’t joined Nigeria, Kenya and Pakistan were three of those countries.  Nigeria and Pakistan are in the top 10 most populous countries in the world, and Nigeria is also Africa’s biggest economy and Kenya is also a bit of a hub for East Africa. What do you make of this or are they just simply showing a bit of muscle about the politics here?

They might be doing that, but I often think it says more about the domestic politics than it might do about the international politics. If that’s the right way to describe it. Sri Lanka is another one that is in that situation. My sense is overall that what they are doing is they are playing to perhaps domestic incentives and domestic politics whereby they can’t commit to it because they believe that it would be giving away too much. The opportunities for incentives or for creating special hubs of a certain kind might be such that therefore they don’t want to join up. I wouldn’t focus on these holdouts. They represent such a small proportion of the world’s economy.  It sounds really rude to say that they’re not big players because they are obviously much bigger than we are, that’s for sure. But notwithstanding that in terms of world economic and GDP, you know that we’re talking about minor players, really. And certainly, when you compare all the countries that have signed up to it, this represents a hugely significant change.

It’s not that the amount of money here is so dramatic. Although there are reasonable sums of money, Pillar One, which is the new regime for taxing very large multinationals and digital companies, is expected to allocate US$125 billion to market jurisdictions. Pillar Two, which is the minimum corporate tax, is expected to raise US$150 billion of tax.

Those aren’t small sums of money, but the consequence, if you like, is more strategic than it is financial because this is a change to the world order of taxation. And this is why it has been 100 years in the making, really.

The key fundamental tenants that existed in the 1920s and the 1930s when the forerunner to the OECD struck the first tax deals, were focussed really on some really important principles, such as arm’s length profits. It had the concept of permanent establishment, which came out of the 1930s for business profits to relieve double tax. And it was a whole system which was predicated on the basis that taxation largely occurred in the country of origin, where the goods or services were manufactured, or where the capital was employed, rather than in the marketplace where the consumers were, or in the modern digital economy where the users are based. And this new agreement turns that on its head and allocates a percentage to that market jurisdiction.

So this is a very big change, not in terms of dollar amounts, but in terms of opening the door, the thin end of the wedge, I suppose, would be another way to describe it. This is the opportunity for a new fundamental architecture for the international tax regime. That’s a that’s a big issue really with ultimately very large consequences.

I agree. I think we’re seeing how the combination of the Global Financial Crisis and now the Pandemic has shifted all the thinking. This paradigm that we’ve been working in for the last 40 years of relatively low tax, low regulation, I think that’s gone. These agreements reflect trends I see emerging.

And one of the things I think we’ll see is the end of the traditional tax haven with zero corporation tax rates those are going to go. Most of them, really when you look at them, are such minor players they survived by grace and favour and now I think their days are numbered. It wouldn’t surprise me if in 10 years’ time they are gone, because they’re going to have to raise tax rates. For example, take the British Virgin Islands. They basically now have to have a 15% corporate minimum corporate tax as a result of this agreement.

Well, that’s right. If they choose to operate on their existing level, then companies that own British Virgin Islands entities or individuals that are based in a jurisdiction that has signed up to Pillar Two, will be obliged to tax the profits in the British Virgin Islands up to 15% if the BVI government doesn’t decide to impose a minimum tax. So yes, a whole new change.

And I think you’re right. The big trend I see here is firstly towards more effective source taxation, I’ve just written a paper on this issue. I think that’s a by-product of more than just the big, wealthy OECD countries being involved in these agreements.  The big source-based countries like India, Brazil and China, were involved and had powerful negotiation stances. So one trend will be more effective source taxation.

Next is multilateralism, which is the technique which involves not only just the process of getting the consensus, which is the group of countries operating in the inclusive framework, but also the mechanism that they achieve it by which is through multilateral treaties.   These are much more sophisticated and much more effective in terms of rapidly rolling out changes.

And then lastly, away from competition and towards cooperation. And I think that’s what you were alluding to before in terms of looking at the rights to tax. What we’ve got is something which is much more cooperative and may well be that that taxation may deal with world problems in a more co-operative manner.

But these types of issues are going to emerge, you can see it already. We’ve already had the health crisis. We’ve got an environmental crisis that’s been going on for a long period of time. And so we need countries to be operating in this cooperative way, using multilateral instruments and processes to solve problems which are not just purely domestic, but are in fact international.  This change stems from multinational tax and the lack of payment by some of the big multinationals became domestic politics for most jurisdictions.

You know, there were the big Senate enquiries in the US, the British parliamentary committees and the Australians had enquiries as well. So suddenly, politicians with domestic agendas were trying to grapple with issues which involved international agreements. And so we’ve seen, if you like, the popular democratic process having an impact on the need to negotiate and get consensus at a worldwide level. It’s quite a fascinating time.

Oh, very much so. You would have seen this on the Tax Working Group with submissions from the public about multinationals not paying their fair share.   I see this regularly in general commentary.  Last week for example we had the Radio New Zealand report about Uber’s tax practises. Personally, I think Uber is an extreme worst case of tax avoidance, which is why I won’t use Uber.

But it’s an interesting point, that domestic politics is now coming to bear.  Multinational companies may not like it, but they seem to be accepting that you can’t push the envelope as far as they have done without getting pushback from the politicians.

When you were on the Tax Working Group, you would have looked at the question of international taxation. And so have these changes come quicker than you expected at that time, or perhaps hoped might happen?  I think you could see this trend developing, but I don’t know if you and the group were saying we’ll see big change in the next three years.

It’s a good question. No, I didn’t expect the changes to come as quickly as they hit. But I certainly would have hoped that they may have come that quickly. And so I’ve been pleasantly surprised. When I set out to write Taxing the Digital Economy it was interesting because  it was during a period of great change. But I began writing at a point in time where it had been 100 years since there had been such a significant change. So I wasn’t confident at all that I wasn’t going to be spending greater than the year writing the book doing something that was relevant.

As it turns out, and I think that the thing to remember in terms of tax changes is that when you have a status quo, an existing situation, which is unacceptable, you have to expect that there will be change. It’s just a question of what that change is. Now we had it definitely in international tax because you had the largest, most profitable and most successful businesses in the world not only not paying tax in source jurisdictions where they were operating, but they also actually weren’t paying that much tax in their home jurisdiction because of the inadequacies of residency taxation which was particularly true for the United States. So, there was always going to be some significant change.

And it’s another reason why, by the way, as a complete aside from this topic, why there’s a pretty reasonable chance that at some point in time in this country, we will have additional tax on capital because the current proposition is largely unsustainable as the population ages. The long-term Treasury forecasts suggest that something has to give.   I know in discussing this with you that I’m already preaching to the converted, but there are plenty of unconverted people out there!

That is indeed a whole other conversation.

When you were writing Taxing the Digital Economy was it surprising to see what was happening around for you? You sound as if you happened to hit that fortunate, Zeitgeist moment when you’re writing something and it’s becoming ever more relevant as you’re progressing.

Yeah, look, I think that’s right, Terry. I was very lucky. I was based in Oxford alongside the Oxford International Tax Group and I spent a lot of time with people like Michael Devereaux and John Vella and they were very kind. It was only just a short trip across to Paris to talk to the OECD, and so it was a great place to be. I need to thank enormously the New Zealand Law Foundation for the fellowship that they gave me, which enabled me to live in Oxford for those six months. So that was a real advantage.

But I think to answer your specific question about what sort of dynamic was emerging, I think it was one of those sorts of situations where people were looking for alternatives to the current system and the Oxford Group in particular are very keen on change. Speaking with Michael Devereaux at dinner one night he gave an insight that he had really spent quite a lot of time considering  why and how consumption taxes such as GST are so effective. And the simple answer was because they tax on the residency of the consumer, and that’s a much more difficult thing to manipulate and very hard to change.

A lot of his thinking when he began writing about destination basis of taxation for corporate taxation is linked to this idea that the place of destination is where the consumer resides. Now, it’s really important to not get this confused with consumption taxes that is, you know, they are the same groups of people, but one is a tax on consumption, the other is a corporate tax that’s on the supplier of the goods or services, not on the consumer. And the corporate is simply allocating some of its income to the demand side rather than the supply side of its of its economic chain. So it’s an allocation of income issue and it’s going to the marketplace rather than the country of origin. So that’s the logic behind it.

That’s fascinating. I mean, we talked about this international agreement, and you touched on something earlier when you said the tech giants were part of this agreement. What is its likely impact for New Zealand? Are we talking tens of millions or hundreds of millions of dollars additional revenue in a year?

Look, I don’t truly know. I suspect that we’re talking tens of millions and not hundreds of millions. I think, for New Zealand, most of the revenue, I suspect, will actually come about through Pillar One, through the allocation of mostly digital companies with their transactions with our user base and our market jurisdiction, which is currently largely escaping tax. So that, I think, is probably the area where New Zealand will pick up a bit of tax.

In terms of Pillar Two because we have very good and pretty effective controlled foreign company rules, I can’t see that the New Zealand economy will benefit greatly to the same extent. But it is possible the impact that we might actually have would be on foreign owned multinationals operating here in New Zealand and that if they don’t pay sufficient tax in New Zealand, then there is a chance that those foreign owned New Zealand based multinationals will end up with Pillar Two responsibilities elsewhere.

And probably the major issue, I think, is New Zealand capital gains made by for example, a French multinational which owns a New Zealand subsidiary that it sells and makes a huge capital gain.  In this case the French multinational’s effective rate of tax here in New Zealand is going to be low, possibly lower than 15%. So, there might be some issues there. There is some talk that New Zealand might actually impose some minimum tax in such a case because if someone is going to pay tax, we might as well get it. So, there is a possibility that we might have some domestic based top up tax designed really to get in first on Pillar Two ahead some of the foreign multinational.

That’s interesting. I hadn’t even considered that one.

One of the things that may have fallen by the wayside are digital services taxes (DSTs) which the Tax Working Group would have considered. Are these gone for good? I’m surprised India signed up to this agreement. I think this was significant, because it has some DSTs in place.

As the agreement stands DSTs are to go once everything is in place, but will we see them come back in a different way? We’ve just been talking about the tech companies like Google, for example. We have no idea exactly how much Google takes out of New Zealand, but estimates run to $600 million or more. Yet its reported taxable profit is about $12 million. Pillar One may increase that, but still, that’s a big discrepancy and it’s gutted our media industry.

So would we see the sneaky old “We’ll call a tax a different thing”, to get round this prohibition, something like a “Digital Advertising Levy”, which I think is what India has looked at. And I saw something about Maryland in America imposing such a charge.

Yes, you’re right. I mean, the first thing we have to realise about DSTs is that they are extremely ugly taxes. They are ugly because they’re not creditable. [May be offset against corporate tax liabilities]. In order to be effective, they need to apply to both residents and non-residents so that they’re not discriminatory under the World Trade Organisation obligations. To work in conjunction with double tax treaties they can’t be regarded as corporate taxes, they must be turnover taxes, not income taxes.

So they are a tax of last resort if one looks at it from a purist perspective and their purpose was to bring the Americans in particular to the table in order to fit the multi-lateral consensus.

My own personal view, not the view of the Tax Working Group, nor indeed the view of the New Zealand Government, was that it was good and sensible for us to be considering the implementation of one up until the point in time, we would get a multilateral consensus. We now have that. I suppose if the consensus doesn’t work for any reason, that if the rules on the Pillar One are not what we would hope for or in some way fall away, then we will possibly end up looking at digital services taxes again.

But consensus that’s really a Plan B or Plan C, and what we’ve got is actually something which is more which is vastly superior, actually, because it is creditable, it’s designed not to have a double tax effect. It’s simply a reallocation of taxing rights for what is really the top 100 companies in the world. They all have a turnover of greater than 20 billion euros, and they’re all profitable. What’s been agreed is sort of a trial period with the big players, and then it’ll roll itself out to smaller companies.

So as time goes by and we will get used to this idea, I think.  The common misconception, unfortunately, is that changes everything and it sort of does, but only really for the biggest players. I mean, no companies in New Zealand will be affected by Pillar One at this point in time. I think in terms of the future, as far as Pillar Two is concerned, there certainly will be some that will be affected by it.

But you know, this is the opening of the door, the thin end of the wedges. There will be changes and generally I think it’s good they’re happening.

Well, that seems to be a good place to leave it perhaps, Craig. Thank you so much. It’s exciting times, as always. We’ve both been in tax for a long time, and it’s things like this which keeps us fresh and energised and interested in what’s going on around us.

Thank you for inviting me on. It’s been a pleasure.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!