Financial Structure and Tax Avoidance: Non-Resident Investors in New Zealand

Abstract

Like most countries, New Zealand imposes income tax on a residency and source basis. This being the case, non-residents are only liable to domestic tax if they derive domestically sourced income. The rate of tax imposed on such income generally depends on its nature. Thus non-residents are taxed on a source/schedular basis. This source/schedular basis of taxation creates opportunities for tax avoidance. Multinational enterprises are able to avoid domestic taxes by either shifting income offshore or by converting one type of income into another which attracts a lower tax rate in the source country. The former method is most commonly achieved by the imposition of non-arm's length transfer prices with regard to transactions between associated parties in different jurisdictions. The latter conversion can be achieved by thinly capitalising a local subsidiary with debt finance provided by the offshore parent. Although the reasons why multinational enterprises may wish to limit the amount of income sourced in any particular jurisdiction are varied, the greatest scope for economic benefit arises from avoiding taxes. The potential threat to the New Zealand tax base posed by such means of avoidance is significant due to the high levels of foreign investment in New Zealand and the continued and rapid growth of multinational enterprises. Until recently, New Zealand's legislative efforts to counter manipulative transfer pricing and thin capitalisation practices were inadequate and did not afford any significant protection to the New Zealand tax base. This has been recognised by the Government which has introduced new transfer pricing and thin capitalisation regimes with application from April 1996. Prior to the introduction of the new regimes both means of tax avoidance are likely to have been used in New Zealand. The objective of this thesis is to determine whether in the period 1983-1991 non-resident controlled companies operating in New Zealand were thinly capitalised. To achieve this objective debt/equity ratios and the interest expense of a sample of non-resident controlled companies were analysed and compared with those of a sample of New Zealand resident controlled companies. The results obtained suggest that while non-resident controlled companies have operated in New Zealand with relatively high levels of current debt, such debt may not have been interest bearing. This may indicate that thin capitalisation has not been widely used as a means of avoiding New Zealand tax. A preference for transfer pricing, which is less easily detectable in comparison, might explain why thin capitalisation has seemingly not been employed to a greater extent.