Section 4: Impact Analysis Option 1 (interest rate cap) Option 2 (restricted transfer pricing) Option 3 rule) Option 4 (administrative guidance) Status quo Efficiency and neutrality + Option 1 will provide a strong limit on related-party interest rates, reducing the ability for some firms to profit shift. This would level the playing field for firms, providing efficiency gains. However, for some firms the interest rate allowed under the cap may be too low, which lowers the efficiency benefits. ++ Option 2 will provide a reasonably strong limit on related-party debt interest rates, reducing the ability for some firms to profit shift. This would level the playing field for firms, providing efficiency gains. 0 Option 3 will provide an effective limit on all interest expenses (including related-party interest expenses). However, it also increases the uncertainty of returns on New Zealand investment, since whether or not interest is deductible turns on a taxpayer’s EBITDA, which can be very variable. + Some taxpayers would benefit from the certainty provided by the administrative safe harbour. However, for taxpayers willing to exceed the safe harbour, this option is no different than the status quo – excessive interest on related-party debt would still be possible. 0
Fairness and equity ++ Option 1 has fairness benefits as it would ensure taxpayers cannot have excessive interest rates on their related-party debts. ++ Option 2 has fairness benefits as it would ensure taxpayers cannot have excessive interest rates on their related-party debts. 0 On the one hand, option 3 would be somewhat effective at preventing excessive interest rates. On the other hand, it could result in interest denial for firms with very conservative interest rates and debt positions (say, for example, if a taxpayer is in loss). 0 Option 4 would not prevent firms from achieving excessive interest rates on related-party debt. For taxpayers willing to exceed the administrative safe, harbour this option is no different to the status quo. 0 Efficiency of compliance ++ Option 1 would reduce compliance costs for many taxpayers – the allowable interest rate on related-party debt would be set on a clear objective factor (the credit rating of the foreign parent). However, in some cases – where the non-resident parent has no credit rating – compliance costs will stay the same or could potentially increase. + Option 2 would reduce compliance costs somewhat, as the interest rate cap would be available as a safe harbour. Taxpayers not utilising the safe harbour will still be required to do a transfer pricing analysis (i.e. same as status quo) 0 Compliance costs in some instances would reduce under option 3, as there would be fewer transfer pricing disputes about debt. However, an rule would be a + Option 4 would reduce compliance costs somewhat, as the interest rate cap would be available as a safe harbour. Taxpayers not utilising the safe harbour will still be required to do a transfer pricing analysis (i.e. 0
fundamental shift in our interest limitation rules – taxpayers and agents would have to come to grips with an entirely new regime. same as status quo). Efficiency of administration ++ Option 1 would avoid the need for potentially complex and expensive disputes over whether the interest rate on related-party debt is set appropriate. ++ Option 2 would reduce the need to review the interest rates of taxpayers utilising the safe harbour. For the remaining taxpayers, the restrictions (e.g. striking out exotic terms) would simplify the transfer pricing analysis. + Option 3 would reduce administration costs because there would be less need to review and challenge related-party loans under transfer pricing. + Option 4 would reduce the need to review the interest rates of taxpayers utilising the safe harbour. 0 Sustainability + Option 1 would apply to taxpayers that have structured their affairs to strip the maximum profits out of New Zealand; however, it could also affect the interest rates of less aggressive taxpayers. ++ Option 2 should generally only affect taxpayers with more aggressive debt structures. 0 Option 3 could result in interest deduction denial even if a taxpayer has conservative debt levels. + Option 4 not prevent firms from achieving excessive interest rates on related-party debt. 0 Overall assessment + ++ Recommended option 0 + 0
Key: ++ much better than the status quo + better than the status quo 0 about the same as the status quo - worse than the status quo - - much worse than the status quo Allowable debt levels Option 1 (non-debt liability adjustment) Option 2 (adjustment with no deferred tax) Status quo Efficiency and neutrality + Option 1 will reduce the allowable debt levels for taxpayers with little equity (and high levels of non-debt liabilities). This will help ensure taxpayers have a more commercial level of debt. It will also equalise the thin capitalisation outcomes for taxpayers in otherwise similar situations. + Option 2 will reduce the allowable debt levels for taxpayers with little equity (and high levels of non-debt liabilities). This will help ensure taxpayers have a more commercial level of debt. It will also equalise the thin capitalisation outcomes for taxpayers in otherwise similar situations. 0
This should improve efficiency. However, submitters have argued that in some instances deferred tax (a type of non-debt liability) does not represent real liabilities; to the extent this is correct, reducing allowable debt levels in relation to these liabilities could hamper efficiency. This should improve efficiency. However, this option carves out all types of deferred tax – yet, in many instances, deferred tax will represent a future tax payment a taxpayer will be required to make. To the extent this is the case, this option would allow some taxpayers to have too high a debt level. Fairness and equity + Taxpayers with the same level of accounting profit will have the same thin capitalisation outcomes. This option therefore + Taxpayers with the same level of accounting profit will have the same thin capitalisation outcomes. This option therefore 0
improves fairness. However, submitters have argued that in some instances deferred tax does not represent a real liability. To the extent this is correct, including deferred tax in the liability adjustment be seen as unfair. improves fairness. However, this option excludes all deferred tax – yet, in many instances, deferred tax will represent a future tax payment a taxpayer will be required to make. To the extent this is the case, this option will not treat taxpayers in the same situation the same. Efficiency of compliance 0 Neither option will have a significant impact on compliance costs. The result of both options is just a change to how the existing thin capitalisation calculations are carried out. However, there may be some one-off compliance costs if the changes mean taxpayers breach their thin capitalisation limits and, as a result, decide to restructure their borrowing. 0
Non-monetised costs Administration costs Low High Expected benefits of proposed approach, compared to taking no action Regulated parties Compliance costs: Reduction in compliance costs for firms that utilise safe harbour. Medium High Regulators Revenue: Tax collected will increase. Administration Reduction in costs for ensuring related-party interest rates are appropriate. Approximately $40m per year Medium Medium High Wider government Other parties Total Monetised Benefit Revenue Approximately $40m per year Medium Non-monetised benefits Compliance and administration cost reduction Medium High Allowable debt levels While a preferred option is not recommended, the costs and benefits of any option that is selected will be similar Affected parties (identify) Comment: nature of cost or benefit (eg ongoing, one-off), evidence and assumption (eg compliance rates), risks Impact $m present value, for monetised impacts; high, medium or low for non-monetised impacts Evidence certainty (High, medium or low) Additional costs of proposed approach, compared to taking no action Regulated parties Tax payable: It will result in additional tax paid. Approximately per year (depending on option) High Regulators Wider government parties Total Monetised Cost Tax payable Approximately per year High