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Inland Revenue

Tax Policy

Chapter 2 – New Zealand’s approach

New Zealand’s inbound investment framework

2.1 New Zealand relies heavily on foreign direct investment (FDI) to fund domestic investment. FDI can also bring ancillary benefits to New Zealand, such as new technology and management practices. As such, the Government is committed to ensuring New Zealand remains an attractive place for non-residents to invest.

2.2 At the same time, it is important that firms operating here pay a fair amount of tax. Base protection measures, such as interest limitation and transfer pricing rules, are important to protect the tax base and ensure that New Zealand collects an appropriate amount of tax on non-resident investment.

2.3 As noted in New Zealand’s inbound investment framework,[2] the amount of tax payable to New Zealand on an investment is substantially affected by the choice of how it is funded. Investments funded with equity are subject to full taxation at 28%. In contrast, since interest paid on debt-funded investment is deductible, the New Zealand tax paid on debt is generally limited to non-resident withholding tax (NRWT) on the interest payments (at either 10% or 15%).

2.4 However, an important factor in determining the tax impost on FDI is how the foreign investor is taxed in their home jurisdiction. This is illustrated in the framework document with a hypothetical decrease in the thin capitalisation safe harbour to 50 per cent.

2.5 For some investors, this would decrease the attractiveness of New Zealand as an investment destination while for other investors it would have no impact.[3] As discussed by the Tax Working Group,[4] choosing the thin capitalisation safe harbour threshold involves trade-offs between the potential effect on the desirability of New Zealand as an investment location and the benefits to New Zealand arising from having taxes paid in New Zealand.

2.6 This discussion document does not propose a change to the thin capitalisation safe harbour. It does, however, suggest some changes that will reduce the ability for some foreign-owned firms to take interest deductions. This involves similar trade-offs to those discussed above.

2.7 The analysis of thin capitalisation rules in the inbound investment framework applies only if a firm borrows at a reasonable interest rate – at the very least, the marginal cost of debt should be no more than the marginal return from further investment. If this is not the case, the use of debt will depress tax payments in New Zealand by far more than discussed in the framework.

2.8 With regards to the proposed adjustment for non-debt liabilities discussed in chapter 3, the fundamental question is whether a firm’s total assets should be determined on a gross basis or net of non-debt liabilities. The inbound investment framework paper did not consider this matter; it assumed a company’s assets would only be funded with debt and equity. As discussed in chapter 4, we consider measuring total assets net of non-debt liabilities is more consistent with the objectives of the thin capitalisation rules, and accordingly propose a change.

2.9 Overall, the Government considers that this package of proposals strikes an appropriate balance between ensuring New Zealand is an attractive place to invest while helping ensure that firms operating here pay a reasonable amount of tax.

Link to the OECD’s BEPS Action 4

2.10 Because of the large potential for interest to be used to shift profits internationally, the OECD developed best-practice interest limitation rules as part of the OECD BEPS project (BEPS Action 4).[5]

2.11 There are two broad approaches to the design of an interest limitation rule. One is the approach adopted by New Zealand, which is to limit the amount of tax deductible debt a company can have, usually based on either its level of assets or equity. By restricting debt levels, allowable interest deductions are also restricted, albeit in an indirect manner. The second approach is to directly limit the interest a company can deduct based on some measure of the company’s profits (normally either EBIT or EBITDA).[6]

2.12 There are advantages and drawbacks to each approach, which are outlined in the BEPS Action 4 Final Report (September 2015). These include the following:

Interest limitation rule comparisons
  Rule based on the level of debt relative to assets Rule based on the level of interest expense relative to earnings
Advantages Disadvantages
1 The level of debt is more stable than profitability and is more within the control of management. The amount of interest expense may vary due to interest rate changes that are outside the control of management.
2 An assets-based approach is typically stable and predictable. Measuring economic activity using earnings, which might be relatively volatile, means it is hard to anticipate the level of interest expense that will be permitted from year to year.[7]
3 There is no need to have specific provisions to deal with the effect of losses. Entities and groups with negative earnings (losses) require specific rules.
  Disadvantages Advantages
1 BEPS risks will not be addressed where an excessive rate of interest is applied to a loan. This rule is much less vulnerable to excessive rates of interest.
2 An assets-based approach requires a consistent and acceptable model for valuing each class of assets Concerns over the recognition and valuation of assets is less of an issue.
3 The level of debt may vary throughout a period, so debt on a particular date may not be representative of an entity’s true position. The level of interest expense in an entity will reflect all changes in borrowings throughout the period.

2.13 The OECD acknowledged that fixed ratio rules are blunt tools which do not take into account the fact that groups operating in different sectors may require different amounts of leverage. However, it encourages countries to make their rules robust and effective. To avoid double taxation for groups leveraged above the fixed ratio level, countries are encouraged to combine a fixed ratio rule with a group ratio rule, as New Zealand has already done within its current interest limitation rules.

2.14 The OECD concluded that the advantages of a profit-based interest restriction outweighed the drawbacks. The best-practice rule it developed involves restricting interest deductions to between 10–30 per cent of a company’s EBITDA. However, the OECD outlined a number of issues that should be considered in designing a profit-based approach, including:

  • Whether to base earnings on EBITDA or EBIT.
  • Whether to adopt a worldwide group ratio rule.
  • Whether to apply a de minimis to remove entities which pose the lowest risk from the scope of an interest limitation rule.
  • Whether to address volatility concerns, for example by carrying forward or backwards disallowed interest and/or unused interest capacity, or by averaging EBITDA over a three-year period.
  • Whether an entity in a loss-making position is able to deduct its net interest expense in the current period, or whether alternative mechanisms will be used to limit interest deductions when profits are negative.

2.15 The final report from the OECD did note that there are other effective methods to address profit shifting through interest – including a well-designed rule based on a company’s level of debt.

2.16 This discussion document does not consider the issue of whether New Zealand should change to an EBITDA-based rule. No decision on this has been taken at this stage. The purpose of this discussion document is to explore whether there are some rules that could address some of the disadvantages of an asset based rule outlined in the table above.

2.17 This is because, overall, we consider that our current approach to limiting interest deductions is working well. Accordingly it seems preferable to put forward specific proposals that seek to address some of the problems we are currently seeing in our rules without abandoning this general framework.

2.18 In particular, we consider an asset-based thin capitalisation regime must be bolstered by rules to restrict the ability of taxpayers to use excessive interest rates for related-party loans. A proposed rule to prevent this is discussed in chapter 3. We also consider that our rules will be more robust and effective if there is a change to how total assets are determined. A proposed rule to achieve this is discussed in chapter 4.

2.19 If it is not possible to address the problems in our rules, we acknowledge that an alternative approach would be to use an EBITDA based rule, as suggested by the OECD. We welcome submissions on which approach is preferable.


2 The draft framework is available at

3 An investor who is tax exempt on interest income would face a lower effective tax rate on a New Zealand investment if they took advantage of the lower safe harbour. In contrast, an investor who is taxed at 28% or more on interest income would likely be indifferent to the change: increasing the gearing of their New Zealand investment would not reduce total tax paid (and could actually increase tax paid).

4 Debt and equity finance and interest allocation rules (2009), Background paper for the Tax Working Group.

5 Limiting Base Erosion Involving Interest Deductions and Other Financial Payments (2015), OECD.

6 Earnings before interest and tax, and earnings before interest, tax, depreciation and amortisation, respectively.

7 Based on responses to Inland Revenue’s International Questionnaires, 54 groups had net finance costs greater than 30 per cent of EBITDA in the 2014 financial year; of these, only 23 (43%) had net finance costs greater than 30 per cent of EBITDA in the 2015 financial year. The variation was more extreme for groups with net finance costs and negative EBITDA; 20 groups had negative / nil EBITDA in the 2014 financial year; whilst the total number was similar in the 2015 financial year, only five (11%) had negative / nil EBITDA in both years.