1.2 If the Committee is holding hearings on this matter, then we would appreciate the opportunity to be heard in support of this submission.

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1 22 December 2017 Committee Secretariat Finance and Expenditure Committee Parliament Buildings WELLINGTON SUBMISSION: INTERNATIONAL TREATY EXAMINATION OF THE MULTILATERAL CONVENTION TO IMPLEMENT TAX TREATY RELATED MEASURES TO PREVENT BASE EROSION AND PROFIT SHIFTING 1. SUMMARY Introduction 1.1 This letter sets out Russell McVeagh's submissions on the international treaty examination of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting ("MLI"). Partners Frederick Ward Pip Greenwood Brendan Brown Malcolm Crotty Joe Windmeyer Guy Lethbridge John Powell Ed Crook Tim Clarke Sarah Keene Andrew Butler Sarah Armstrong David Hoare Shaun Connolly Matthew Kersey David Butler Craig Shrive John-Paul Rice Deemple Budhia Mei Fern Johnson Bronwyn Carruthers Daniel Jones Polly Pope Allison Arthur-Young Christopher Curran David Raudkivi Tom Hunt Kylie Dunn Daniel Minhinnick Troy Pilkington Marika Eastwick-Field Ian Beaumont Stephen Rendall Cameron Law Joe Edwards Benjamin Paterson 1.2 If the Committee is holding hearings on this matter, then we would appreciate the opportunity to be heard in support of this submission. Summary of submissions 1.3 The MLI is an efficient means of amending Double Tax Agreements ("DTAs") to which it applies, to implement measures to prevent base erosion and profit-shifting. We support New Zealand's decision to sign the MLI. 1.4 Upon signing the MLI, New Zealand, like other countries, gave provisional notification of its reservations and notifications in respect of the MLI's optional provisions. There is no prohibition on New Zealand altering its initial reservations and notifications on the MLI before ratification New Zealand has provisionally opted into all but two articles of the MLI, 2 in circumstances where our major trading partners appear to have taken a more cautious approach. Some provisions New Zealand has provisionally opted into would impose additional compliance costs on cross-border trade and investment. 1 See OECD "Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting Information Brochure" at 7. 2 One of these articles is not applicable to New Zealand's network of DTAs v1 1 of 6 russellmcveagh.com Auckland Vero Centre, 48 Shortland Street, PO Box 8, Auckland 1140, New Zealand DX CX10085 P F Wellington Dimension Data House, 157 Lambton Quay, PO Box , Wellington 6143, New Zealand DX SX11189 P F

2 1.6 Particular issues that could prove problematic (and which we address in more detail in this submission) are: (a) (b) Article 4, which would make it more difficult for dual resident companies to determine in which country they are tax resident for the purposes of a DTA, and to qualify for relief from double taxation. We submit that New Zealand should, either, not adopt Article 4 in the MLI as ratified, or should put in place protocols (at least with Australia) for streamlining the application of Article 4 of the MLI once it is in force (see Part 2 below). The relationship between the anti-avoidance provisions introduced by the MLI, and our existing general anti avoidance rule ("GAAR") in the Income Tax Act 2007 ("Act") is unclear and could result in overlapping provisions and processes: litigation before the courts in the case of the GAAR and the mutual agreement procedure and potentially arbitration under a DTA in the case of DTA anti-avoidance provisions. We submit that Inland Revenue should provide clarity as to how it will administer these provisions, and in particular confirm that it will not seek to apply the GAAR in a way that conflicts with applicable DTA anti-avoidance provisions (see Part 3 below). 2. NEW ZEALAND SHOULD NOT ADOPT ARTICLE 4 OF THE MLI (DUAL RESIDENT COMPANIES) OR IN THE ALTERNATIVE SHOULD AGREE ON PROCESSES STREAMLINING THE APPLICATION OF ARTICLE 4 First submission: New Zealand should not adopt Article 4 of the MLI 2.1 Currently, most DTAs to which New Zealand is party contain a tie-breaker test for a company that is a resident according to the domestic law residence tests of both countries. The tie-breaker is important because New Zealand has a broad definition of residence for companies, which increases the risk of a company being resident in both New Zealand and another country. The usual tie-breaker is the 'place of effective management test', which provides that a dual resident company must be treated, when applying the DTA, as resident solely in the country in which it has its place of effective management. 2.2 Article 4 of the MLI would replace the place of effective management tie-breaker with the following article (the competent authority referred to in the Article is a senior official nominated by each country to represent it in questions of application of a DTA): 1. Where by reason of the provisions of a Covered Tax Agreement a person other than an individual is a resident of more than one Contracting Jurisdiction, the competent authorities of the Contracting Jurisdictions shall endeavour to determine by mutual agreement the Contracting Jurisdiction of which such person shall be deemed to be a resident for the purposes of the Covered Tax Agreement, having regard to its place of effective management, the place where it is incorporated or otherwise constituted and any other relevant factors. In the absence of such agreement, such person shall not be entitled to any relief or exemption from tax provided by the Covered Tax Agreement except to the extent and in such manner as may be agreed upon by the competent authorities of the Contracting Jurisdictions v1 2 of 6

3 2.3 A taxpayer that is not deemed resident in only one of the two countries is denied the relief usually available under the DTA. The effect of Article 4 of the MLI, therefore, is that a dual-resident company will be unable to access DTA relief unless and until the competent authorities of each country agree otherwise. 2.4 Processes requiring agreement by the competent authorities have their limitations. DTAs typically include a dispute resolution process known as the mutual agreement procedure ("MAP"). 3 The average time taken to resolve a MAP complaint in 2016 was 22.5 months. 4 While the process contemplated by Article 4 of the MLI is not the same as MAP, the statistic indicates that any process requiring agreement of the competent authorities is unlikely to be rapidly concluded, and that further adding to the responsibilities of the competent authorities could result in longer timeframes generally. In our view, this Article would reduce certainty, impose additional compliance costs and increase the risk of double taxation for New Zealand businesses in circumstances where the dual residence often results from inadvertence and does not secure a tax benefit. 2.5 A not unusual scenario in which dual residence arises involves (say) an Australian incorporated subsidiary ("Aus Co") of a New Zealand resident company ("NZ Co"). Aus Co is intended to be tax resident solely in Australia, and so holds its directors' meetings in Australia and has its senior executives located in (and making management decisions in) Australia. Subsequently, however, directors of Aus Co who are based in New Zealand make strategic and management decisions for Aus Co without formal directors' meetings being convened in Australia. This results in Aus Co becoming resident in New Zealand under section YD 2(1)(d) of the Act as "its directors exercise control of [Aus Co] in New Zealand, even if the directors' decision-making also occurs outside New Zealand" (ie, it is enough that some decision-making by directors occurs in New Zealand for the company to become tax resident in New Zealand). The entity is therefore dual resident (in Australia due to incorporation, and in New Zealand under section YD 2(1)(d) of the Act). 2.6 Dual residence in this example arises inadvertently. The scenario will often affect businesses expanding their operations internationally for the first time, who are not as experienced in managing cross-border tax issues. Presently, most DTAs will provide a solution; the entity will be deemed to be tax resident in the country where it has its place of effective management, and will be entitled to DTA relief on that basis. 2.7 The result of Article 4(1) of the MLI is that entities like Aus Co will not be entitled to DTA relief from double taxation unless the Competent Authorities of New Zealand and Australia agree otherwise. A provision that can result in double taxation due to mere inadvertence (and without being targeted at cases of tax avoidance) is not a desirable provision in New Zealand's DTAs, and should not be adopted. 3 MAP is a dispute resolution procedure which requires the two countries party to a DTA to endeavour to resolve a complaint by a taxpayer that a country is taxing it otherwise than in accordance with the DTA. MAP is an alternative dispute resolution process to requiring the taxpayer to enforce the DTA through litigation. If, however, the two countries cannot agree, or agree on a resolution that the taxpayer does not accept, the taxpayer may still dispute the position in the courts. 4 OECD "Mutual Agreement Procedure Statistics for 2016" < (accessed 14 December 2017) v1 3 of 6

4 Second submission: if Article 4(1) is adopted, New Zealand should seek to agree processes to stream-line its application 2.8 If New Zealand nonetheless ratifies the MLI on the basis it will adopt Article 4(1), we suggest that New Zealand seek to enter into agreements with other tax authorities to streamline the process by which the competent authorities decide on cases of dual residence. Australia should be the initial (and main) focus of these efforts, since in most cases of dual residence, Australia will be the other relevant country, given our close economic ties with Australia. 2.9 Such agreements should seek to provide that a company's residence for DTA purposes be determined primarily by reference to the taxpayer's place of effective management (which is the existing test in most DTAs). If the place of effective management cannot be determined, the competent authorities will have reference to the other factors in Article 4(1) of the MLI It would be desirable, particularly in the case of an agreement with Australia, to include some ability for taxpayers to "self-assess". For example, there could be provision for the taxpayer to advise the competent authorities of its place of effective management. The competent authorities would then either accept this as the country of residence for DTA purposes, or decline to accept it and make an independent determination based on the factors set out in Article 4(1) of the MLI In either case, we consider that the arbitration provisions introduced by the MLI should be available when the competent authorities cannot determine the taxpayer's place of residence within a specified time period (we would suggest six months). This is an important protection for taxpayers who may otherwise be subject to double taxation if the competent authorities, for whatever reason, cannot agree on which country the taxpayer is deemed to be resident in. 3. INLAND REVENUE SHOULD NOT APPLY THE GAAR IN A WAY THAT CONFLICTS WITH APPLICABLE DTA ANTI-AVOIDANCE PROVISIONS AND DTA DISPUTE RESOLUTION PROCESSES Background 3.1 The OECD recognised in its BEPS Action 14 Final Report that whether DTA relief should be denied (whether under a DTA or a domestic law anti-abuse provision) should not be for one country to determine unilaterally, but rather should be able to be referred to MAP: 5 Countries should provide MAP access in cases in which there is a disagreement between the taxpayer and the tax authorities making the adjustment as to whether the conditions for the application of a treaty anti-abuse provision have been met or as to whether the application of a domestic law anti-abuse provision is in conflict with the provisions of a treaty. [Emphasis added] 5 OECD "Making Dispute Resolution Mechanisms More Effective, Action 14: Final Report" (OECD Publishing, Paris, 2015) at recommendation v1 4 of 6

5 3.2 New Zealand domestic law, and New Zealand's provisional reservations in respect of the MLI, go against this OECD recommendation in two respects. Relationship between domestic law GAAR and DTA anti-avoidance provisions 3.3 First, New Zealand recently enacted an amendment to section BH 1 of the Act, with the effect that (contrary to the usual position in respect of DTAs, which is that the DTA applies to provide relief from tax otherwise payable under the Act) section BG 1 (the GAAR) will apply to prevent DTA relief from operating. In itself, allowing a domestic law GAAR to override a DTA is not unusual. Other countries, including Australia, have had similar rules for some time. 3.4 What is problematic is that the MLI will potentially introduce multiple layers of antiavoidance rules, some targeted (eg, Articles 8 and 9), and others more general (eg, the principal purpose test in Article 7). This may result in increased uncertainty as to the relationship between the DTA provisions and the (domestic law) GAAR. In addition, if New Zealand were to invoke its GAAR in circumstances where the various anti-avoidance provisions in the DTA are not satisfied, New Zealand could well be in breach of international law. The general rule of international law is that a state may not invoke its domestic law to avoid or override its obligations under an international treaty. This is provided for in Articles 26 and 27 of the Vienna Convention on the law of treaties which state: Article 26. "Pacta sunt servada". Every treaty in force is binding upon the parties to it and must be performed by them in good faith. Article 27. Internal law and observance of treaties. A party may not invoke the provisions of its internal law as justification for its failure to perform a treaty. This rule is without prejudice to article 46. New Zealand's reservation to Article Second, New Zealand's provisional reservations include a reservation to Article 28 of the MLI, that would permit New Zealand to exclude from the scope of Part VI (Arbitration) any case involving the application of New Zealand s general antiavoidance rule contained in section BG 1 of Act. If the GAAR is excluded from DTA dispute resolution mechanisms, there will be an obvious incentive for a tax authority to tactically invoke the GAAR as a means of preventing the taxpayer from accessing MAP and arbitration, in the very cases in which those processes may be of most value to the taxpayer. 3.6 This would leave the taxpayer, in such cases, without access to MAP (a process which the OECD has described as being "of fundamental importance to the proper application and interpretation of the [DTA]"). It would also mark a less cooperative (and more unilateral) approach to international base erosion and profit-shifting concerns, in contrast to the cooperative approach New Zealand has supported to v1 5 of 6

6 date, and again, could raise questions as to whether New Zealand may be in breach of its international obligations. Submission 3.7 Consequently, we submit that: (a) Inland Revenue should issue firm administrative guidance that any tax avoidance based challenge to an arrangement should be brought under the DTA anti-avoidance rules instead of the domestic GAAR. This should ensure that taxpayers can access their rights under the DTA (including MAP and arbitration) and also prevent domestic override of bilaterally negotiated treaties; 6 and (b) New Zealand should remove its reservation to Article 28. Yours faithfully RUSSELL McVEAGH Brendan Brown Joshua Aird Partner Solicitor Direct phone: Direct fax: brendan.brown@russellmcveagh.com joshua.aird@russellmcveagh.com 6 This would also be consistent with New Zealand's obligations under Articles 26 and 27 of the Vienna Convention and the duty to perform obligations under a treaty in good faith and not to use domestic law to prevent a treaty's application v1 6 of 6