Skip to main content
Inland Revenue

Tax Policy

Chapter 2 - Background

2.1 This chapter sets out some important background information about the taxation of the digital economy. It explains New Zealand’s current taxation of multinationals and outlines the recent measures the Government has taken to improve this taxation. It explains the current problems with taxing the digital economy, and sets out the previous international response to them.

New Zealand’s current taxation of multinationals – the international tax framework

2.2 New Zealand’s ability to tax multinationals on their New Zealand income is determined by both our domestic tax rules and by the double tax agreements (DTAs) we have entered into with other countries.

2.3 The rules imposed by our DTAs, together with the related OCED guidance, form the international tax framework which countries have agreed to follow. Under our DTAs New Zealand can only tax a multinational on its business income if:

  • the multinational has a sufficient taxable presence in New Zealand; and
  • some of the multinational’s profit is attributable to that taxable presence.

2.4 For a multinational to have a taxable presence, it must operate in New Zealand either though a New Zealand resident subsidiary (in which case the subsidiary is taxable on its income) or through a permanent establishment (PE) of a non-resident group member. For a PE to exist, the multinational must have some kind of physical presence in New Zealand – either a fixed place of business, or a dependant agent which enters into contracts for it.[1] This is generally referred to as the nexus requirement.

2.5 If a non-resident does have a PE in New Zealand, then under our DTAs New Zealand can only tax the income that is attributable to that PE. The OECD has published detailed guidelines on how to attribute income to a PE, to which countries have agreed. The guidelines aim to attribute income to a PE by reference to the value generated by the non-resident at that PE, compared to the value it generates overseas. To do this, the guidelines look at the assets of the PE and the activities carried on through the PE by its personnel.

2.6 The effect of this is that a non-resident’s business income is only taxable in New Zealand under our DTAs to the extent the non-resident has assets or personnel here. If the non-resident has no assets or personnel here, they are not taxable on their New Zealand income.

2.7 These are referred to as the profit allocation rules. While the rules limit New Zealand’s ability to tax non-residents that do business here, they also benefit New Zealand by limiting the rights of other countries to tax New Zealanders who do business there.

2.8 Since these nexus and profit allocation rules are contained in New Zealand’s DTAs, we cannot change them unilaterally – it would require the consent of the other countries. In addition, the nexus and profit allocation rules in most DTAs are based on a common standard published by the OECD or the UN, which in turn reflect a consensus on international taxation established nearly a century ago. It would be difficult to fundamentally diverge from these nexus or profit allocation standards in our DTAs (although most DTAs diverge in some less significant respects).

2.9 Appendix 2 sets out New Zealand’s policy for taxing multinationals, some recent tax measures aimed at multinationals, and our economic framework for international tax.

The problem

2.10 The main problem is that the international tax framework was established nearly a century ago and has not kept up with modern business practices. These modern business practices, and digitalisation in particular, mean that a company can be significantly involved in the economic life of a country without being subject to income tax there. The OECD has identified that this is caused by three main factors:[2]

  • Scale without mass. Digital companies can transact with customers over the internet without having the physical presence (a PE) required by DTAs for income tax to be charged in the customers’ country. This is a problem for both the nexus and the profit allocation rules – even if the digital company was deemed to have a PE in the country, the lack of activities carried out in the country by the multinational means there would be no profit to attribute to that PE.
  • User value creation. Even where a digital company does have a PE, the profit allocation rules do not recognise the new kinds of value that digital companies can generate in their market countries. Digital companies can derive significant value from the active participation of their users, from data generated by the users, and from network effects. None of this value is recognised by the current profit allocation rules.
  • Intangible assets. Much of the value of digital companies can be attributed to intangible assets, such as trademarks and other intellectual property. These intangibles are hard to value. They are also mobile, meaning the income attributable to them can be easily moved to low tax countries.[3]

2.11 These factors are not all unique to digital companies – for example, many non-digital companies have valuable intangible assets. For this reason, some countries consider that the current problems with the international tax framework are not limited to the digital economy. However, all the above factors have been exacerbated by digitalisation, with the result that the problems with the international tax framework are particularly acute for digital companies.

2.12 As a result of these problems, multinational digital companies generally pay significantly less tax than ordinary companies. In Europe, the traditional international business model has an average tax rate of 23.2%, whereas the average tax rate for a digital company is only 9.5%.[4]

2.13 This under-taxation of the digital economy impacts the sustainability of Government revenues and public perceptions of the fairness of the tax system. It also provides a competitive advantage to overseas digital companies compared to local businesses, which are subject to full income tax.

2.14 New Zealand’s previous measures to tax multinationals do not address these problems with the international tax framework. This is because those measures only prevent multinationals from avoiding the current international tax framework. However, taxing the digital economy requires a fundamental change to that framework.

2.15 For the same reason a diverted profits tax, of the kind adopted by Australia and the United Kingdom would not solve the current problems with taxing the digital economy. This is because a diverted profits tax also just prevents multinationals from avoiding the current international tax framework (similar to the changes in the Taxation (Neutralising Base Erosion and Profit Shifting) Act 2018).

2.16 It is important to note that the digital economy is generally subject to GST in New Zealand. The problems with taxing it are specific to income tax. In particular, New Zealand introduced GST on remote services in 2016 (which applies to most online purchases of services by New Zealand consumers from offshore) and has announced plans to impose GST on low value imports (which should apply to most online purchases of goods by New Zealand consumers from offshore).

The international response

2.17 The taxation of the digital economy was first widely addressed at a 1998 OECD Ministerial Conference on electronic commerce in Ottawa. The OECD Secretariat presented a report for the conference, Electronic Commerce: Taxation Framework Conditions.[5] The report basically concluded that the existing international tax framework was sufficient to address the digital economy. This conclusion was repeated in 2005 by the OECD’s Business Profits Technical Advisory Group.

2.18 However, concerns with the taxation of the digital economy have grown with the digital economy’s increasing size. The OECD considered the taxation of the digital economy again as part of its BEPS project. The OECD’s 2015 BEPS report noted the current problems with taxing the digital economy[6] and considered three possible solutions:

  • Widening the definition of a PE to include a non-physical significant economic presence.
  • A withholding tax on payments to internet companies.
  • A DST (referred to as an equalisation tax in the report).

2.19 The OECD did not recommend adopting any of these solutions at the time. This was due to a lack of consensus and because the OECD wanted to see whether the other BEPS measures would mitigate the issues.[7] Accordingly the OECD initially stated it would reconsider the taxation of the digital economy in 2020, but countries could adopt any of the solutions provided they respected existing treaty obligations.[8]

2.20 However, pressure to find a solution increased following the issue of the OECD’s 2015 report. Several countries began considering unilateral measures. In particular, the European Commission proposed a DST for the European Union on 21 March 2018 and the United Kingdom also issued a position paper supporting a DST in November 2017.

2.21 In response to this pressure, the OECD accelerated its further consideration of the digital economy and released an interim report on the taxation of the digital economy in March 2018[9] (Interim Report).

2.22 The Interim Report noted that countries had different views on the digital economy. One group considered that the digital economy created unique problems for the international tax framework, which should be addressed by targeted changes to the nexus and profit allocation rules. Another group considered that the problems with the international tax framework went beyond the digital economy, and so required a broader solution. Finally, a third group considered that the current rules were working well following the OECD’s BEPS project and so no changes were required.

2.23 As a result of this disagreement, the Interim Report does not make any recommendations or reach any firm conclusions on taxing the digital economy. There was agreement, however, that a consensus solution was preferable to countries adopting unilateral measures. Accordingly, countries committed to achieving a consensus based long-term solution by 2020. This solution will involve changes to both the nexus and the profit allocation rules.

2.24 The Interim Report did not recommend that countries adopt DSTs. However, it did recognise that some countries may want to introduce them as interim measures before a consensus solution was reached. The report set out some least harm type guidelines that countries should follow (discussed in chapter 3 of this discussion document).

2.25 The OECD has continued working on an international solution following the interim report and has developed two measures. One measure would reallocate more taxing rights to market countries, while the other measure would ensure that multinationals paid a minimum level of tax on its profits from low tax countries. These measures are discussed in chapter 4 of this document.

2.26 The measures have been developed on a without prejudice basis, meaning that, while the participating countries have agreed to them being further developed and discussed, they have not committed to ultimately supporting them. The OECD is aiming to obtain approval of the G20 group of large economies for its preferred measures at the G20’s meeting from 28–29 June 2019.

2.27 The progress made at the OECD has not been sufficient to allay the concerns of several countries, who have announced or introduced DSTs as unilateral interim measures to tax the digital economy. The United Kingdom recently announced it would introduce a 2% DST from April 2020. Austria, the Czech Republic, France, India, Italy and Spain have also enacted or announced DSTs. The European Commission introduced a proposal for a DST in March 2018, but it has not been able to achieve the support of all European Union members yet[10].

2.28 The DSTs announced so far are not intended as alternatives to the OECD’s international solution. Instead they are intended to be an interim measure, which would cease to apply when an OECD solution was achieved. This reflects the fact that the countries which support DSTs still consider an international agreement at the OECD to be the best long-term solution to the issue. They are just sceptical of the OECD’s ability to achieve this solution in a reasonable timeframe. To reinforce this preference, all the countries which have announced a DST (other than India) have stated that they will repeal them if and when an international solution is achieved.

The Australian approach

2.29 The Australian Government released a discussion document on the taxation of the digital economy on 2 October 2018. The document set out the Australian Government’s views on the digital economy, explored new options for taxing it (being the introduction of a DST and the proposals being considered at the OECD), and invited public feedback on those options.

2.30 The Australian discussion document observed that digitalised businesses provide significant benefits to Australia. However, under the current international tax rules, digitalised companies can have a significant economic presence in Australia but pay little tax. This is particularly an issue with ride-sharing and accommodation platforms, multi-sided platforms (like eBay), and digital advertising.

2.31 On 20 March 2019 Australia announced that it would not adopt a DST at this time. Instead it will focus on achieving a multilateral solution at the OECD. The announcement noted that:

  • the Australian Government firmly believes that digital firms, like all firms, must pay their fair share of tax;
  • the submitters overwhelming supported Australia continuing to engage in the ongoing multilateral process at the OECD; and
  • many submitters raised significant concerns about the potential impact of an Australian DST across a wide range of Australian businesses and consumers, including discouraging innovation and competition, adversely affecting start-ups and low margin businesses and consumers, and the potential for double taxation.

Other measures for taxing the digital economy

2.32 Some other countries also widened their domestic income tax framework in order to capture some of the profits earned there by highly digitalised companies (including Chile, Colombia, India, Israel, Italy, Slovakia and Uruguay). However, such domestic law changes will not be effective unless there is no applicable DTA.

Questions for submitters

  • Do you agree that there are problems with taxing the digital economy or with the current international income tax framework? If so, are the problems with the current international tax framework limited to the digital economy, or do they apply more broadly?
  • Are there any other measures New Zealand should consider to address these problems?

[1] The latest OECD model treaty only requires that the dependant agent play a principal role leading to the conclusion of contracts by the non-resident, provided they are routinely entered into without material modification. However, this provision does not appear in most of our DTAs. In addition, section GB 54 of the Income Tax Act 2007 also contains an anti-avoidance provision, which can deem a non-resident to have a permanent establishment in New Zealand in certain circumstances.

[2] For example, see OECD’s Tax Challenges Arising from Digitalisation – Interim Report 2018, Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, 2018, paragraphs 3.83–3.86.

[3] The use of intangibles for this purpose was considered as part of BEPS Actions 8–10, which attempted to align taxation more with the economic substance of a multinational’s activity. However, many countries are concerned Actions 8–10 did not prevent a multinational from allocating significant profits to intangibles located in low tax countries.

[4] See the European Commission’s Impact Assessment for its digital services tax (SWD(2018) 81 Final), page 18,

[5] Available at

[6] OECD, Addressing the Tax Challenges of the Digital Economy, Action 1 - 2015 Final Report, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, 2015,

[7] The 2015 OECD report also considered the application of VAT (or GST) to the digital economy and made several recommendations. These recommendations have since been widely adopted, meaning the 2015 report was a success in terms of VAT.

[8] Although the first two proposed solutions were inconsistent with most DTAs.

[9] OCED, Tax Challenges Arising from Digitalisation – Interim Report 2018: Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris, 2018,

[10] The European Commission DST has recently been narrowed to apply only to digital advertising, in an attempt to reach consensus.