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Inland Revenue

Tax Policy

Chapter 3 - Should New Zealand adopt a digital services tax as an interim measure?

3.1 This chapter sets out the international context of a DST and an overview of how it works, followed by the OECD’s and Tax Working Group’s views on DSTs. Next, it sets out some general design principles for a DST and describes a potential DST for New Zealand. Finally, it sets out how a DST complies with New Zealand’s international obligations, and discusses the advantages and disadvantages of a DST.

International context

3.2 A proposal to adopt a DST needs to be evaluated in the context of international developments – particularly at the OECD.

3.3 As things stand, New Zealand’s current options for taxing the digital economy are:

  • continue to participate in the OECD discussion, with the aim of supporting an internationally agreed multilateral solution but do nothing in the interim; or
  • introduce a DST as an interim measure in 2020–21 if an OECD consensus is taking longer to emerge.

3.4 The Government supports an internationally agreed solution at the OECD. The advantages of an OECD solution are that it would:

  • address the problems with the international income tax framework directly (rather than indirectly, via a separate tax);
  • require a tax credit to be given for any additional tax payable in market countries and avoid double taxation; and
  • involve a single set of rules that would be applied by all participating countries.

3.5 We canvass the options currently being considered and progressed at the OECD in chapter 5. The Government wants to understand the effect of the measures being considered at the OECD on New Zealanders. This will help the Government develop its view on these options, which it can then take into account in its contribution to the OECD discussions.

3.6 However, there is a risk in simply waiting to see whether the OECD can achieve an international solution that receives broad international support from members of the inclusive framework. Doing so would significantly delay consideration of a DST, if no international solution could be found. In addition, any international solution achieved by the OECD may not take effect until 2025, even if it was achieved in 2020.

3.7 DSTs have recently been adopted by other countries as unilateral interim measures to tax the digital economy. The Government needs to now decide whether to join these other countries in adopting a DST as an interim measure while discussions continue at the OECD.

3.8 The Government will seriously consider a DST if the OECD cannot make sufficient progress this year. We explore the design of a DST and the implications for New Zealand in this chapter. The expectation is that any DST adopted would be temporary, and the Government would look to repeal it once an international solution was achieved and implemented.

Overview of the digital services tax

3.9 A DST is charged at a low rate on the gross turnover attributable to a country from certain highly digitalised business activities. A DST is not an income tax for DTA purposes. Consequently, countries can introduce a DST unilaterally, without the need for international agreement.

3.10 The United Kingdom recently announced it would introduce a 2% DST on the profits of certain digital companies that would apply from April 2020. Austria, the Czech Republic, France, India, Italy and Spain have also enacted or announced DSTs. The European Commission has proposed a 3% DST for Europe, however it has not been able to achieve the support of all European Union members. Australia consulted on a DST as an option for taxing the digital economy, but subsequently decided in March 2019 not to proceed with one at this time (deciding to instead focus on an OECD solution).

OECD’s view on a digital service tax

3.11 The OECD Interim Report noted that there was no consensus on the desirability of a DST among countries. It noted that many countries are opposed to DSTs due to their risks and adverse consequences.[11] Other countries acknowledge these issues but consider that they do not outweigh the need to adopt DSTs as interim measures. These latter countries also consider that the downsides of a DST can be at least partially mitigated through careful design. Because of this lack of consensus, the OECD report did not recommend for or against a DST.

3.12 The OECD Interim Report did however set out several guidelines that countries in favour of DSTs consider should be taken into account by countries wishing to adopt a DST. These guidelines are intended to limit the adverse consequences of a DST and provide a degree of uniformity to the DSTs adopted.

3.13 The guidelines state that any DST should:

  • Be compliant with a country’s international obligations. This means the DST could not be an income tax (or creditable against an income tax), but it could be an excise tax. The DST would also need to comply with any obligations of a country under its free trade agreements or the World Trade Organisation.
  • Be temporary – it should be repealed once an international tax solution is implemented.
  • Be targeted at business models which pose the greatest challenge to the current international income tax framework, namely those with scale without mass and which rely heavily on user participation and network effects (for example, social media, search and intermediation platforms). The DST should not apply to the sale of ordinary goods or services over the internet.
  • Minimise over-taxation (for example, be charged at a low rate).
  • Minimise its impact on start-ups, business creation and small business more generally. Any DST should have de minimis thresholds so it only applies to large businesses (for example, over €750 million consolidated annual global turnover) with a sufficient level of revenue from the relevant country.
  • Minimise cost and complexity, which could be by having meaningful de minimis thresholds and using existing GST collection mechanisms.

Tax Working Group’s view on a digital services tax

3.14 The Tax Working Group (TWG) also considered the current issues with taxing the digital economy. In its final report, the TWG concluded that New Zealand should continue to participate in the OECD discussions on changing the international income tax framework but should also stand ready to implement a DST if a critical mass of other countries move in that direction, and it is reasonably certain the New Zealand’s export industries will not be materially impacted by any retaliatory measures.

Design considerations for a potential digital services tax

3.15 In designing a DST for New Zealand, we would aim to comply with the OECD guidelines discussed above, and our international obligations in particular.

3.16 There would also be real benefits to aligning our DST with the DSTs adopted by other countries. This would have several advantages. It would:

  • reduce the risk of the same amount of revenue being subject to multiple DSTs;
  • make it easier for multinationals to comply with our DST if it applies on the same basis as those adopted by other countries;
  • allow us to benefit from the design and implementation work done by other countries on their DSTs; and
  • reduce the risk of any reputational damage of New Zealand adopting a DST.

New Zealand’s proposed digital service tax

3.17 New Zealand’s DST would be a flat tax charged at 3% on the gross turnover attributable to New Zealand of certain digital businesses. It would be applied on a consolidated group basis. That is, it will be applied by treating a multinational group as a single entity, ignoring the legal separation of the various group members. Intra-group transactions would be ignored.

3.18 The application of New Zealand’s DST to a multinational group would involve these steps:

  • Determine if the DST applies to the group. The DST would apply if both:

1. the group’s business includes any of the activities defined to be in-scope; and

2. the group exceeds both the two de minimis thresholds for the DST.

  • If the DST applies, the group would calculate and pay its DST liability. This would involve these further steps:

3. the group determines the annual gross global revenue attributable to its in-scope business activities;

4. the group determines the proportion of those revenues attributable to New Zealand;

5. the group calculates the DST payable on those attributable revenues at the 3% DST rate; and

6. the group returns and pay the DST to Inland Revenue by the due date.

3.19 We explain each of these steps in the next section.

Does the digital services tax apply?

Step 1 – Are the group’s activities within scope?

3.20 New Zealand’s DST would apply to the services provided by business activities whose value is dependent on the size and active contribution of their user base. Specifically, the DST would apply to supplies made through:

  • intermediation platforms, which facilitate the sale of goods or services between people (like Uber and eBay);
  • social media platforms like Facebook;
  • content sharing sites like YouTube and Instagram; and
  • search engines and the sale of user data.

3.21 This means the DST would be narrowly targeted at certain highly digitalised supplies. It would not apply to:

  • The sales of ordinary goods or services (other than advertising or data) over the internet. It would not apply to goods sold online (for example, by Amazon itself).
  • The provision of online content, such as music, games, TV shows and newspapers. This means it would not apply to Netflix for example. The DST would apply to a platform which facilitated the sale of goods, services or content between buyers and sellers, such as Apple music. In this case, the DST would apply to the platform owner, but not to the people who made or supplied the good, services or content over the platform.
  • Services delivered directly through the internet, such as accounting services delivered via the cloud.
  • Information and communications technology (ICT) providers, such as telecommunication companies and internet service providers.
  • Standard financial services, such as credit cards and EFTPOS providers.
  • Television and radio broadcasting.

3.22 The above services do not derive as much of their value from active user participation, so it is not appropriate to include them within the scope of a DST.

3.23 The DST will likely need to apply to both New Zealand residents and non-residents. This is for reasons of consistency with New Zealand’s obligations under our World Trade Organisation (WTO) and free trade agreements (FTA) to not provide less favourable treatment to non-New Zealand service suppliers as compared to like New Zealand service suppliers. This is the same approach taken by most other countries that have recently announced or adopted DSTs.

Step 2 – Are both de minimis thresholds exceeded?

3.24 The DST would have meaningful de minimis thresholds, below which it would not apply. The OECD Interim Report notes the importance of de minimis thresholds to reduce compliance and administrative costs, increase the chance of the DST applying to profitable businesses, and reduce its impact on start-ups and small businesses. The OECD Interim Report recommends two separate de minimis thresholds (both of which would need to be exceeded in the previous tax year in order for the DST to apply):

  • A threshold based on the size of the group. For this purpose, the OECD Interim Report recommends the current threshold for country by country reporting, which is €750 million of consolidated annual turnover.[12] The European Commission’s original DST also used this threshold and the DSTs proposed by Austria, France, Italy and Spain all use this €750 million global turnover threshold. The United Kingdom DST has a similar threshold of £500 million of consolidated annual global turnover.
  • A threshold based on the amount of the digital group’s global revenue that is attributable to NZ users.[13] The European Commission’s original DST had a €50 million local threshold, while the United Kingdom has an effective threshold of £50 million. For their respective DSTs, Austria has a €10 million local threshold, France has a €25 million local threshold, Italy has a €50 million local threshold and Spain has a €3 million local threshold.

3.25 For New Zealand, we propose the following:

  • Also using the Country-by-Country reporting threshold of €750 million of consolidated annual turnover. This threshold is already used in the Income Tax Act 2007 for provisions targeted at large multinationals (such as the permanent establishment anti-avoidance rule in section GB 54) and it would make sense to apply it here as well. All of the DSTs announced so far also use a €750 million consolidated annual turnover threshold (other than India’s and the United Kingdom’s – and the United Kingdom uses a comparable figure).
  • Including a New Zealand specific threshold of $3.5 million a year – which would produce approximately $100,000 of DST. All of the DSTs announced so far also include a local country threshold, which varies with the size of the countries.

3.26 Both these thresholds would need to be exceeded in the previous income year for a DST to apply in the current income year.

3.27 The setting of these thresholds also needs to consider New Zealand’s international obligations under FTAs and the WTO. As these thresholds would apply to both New Zealand and foreign companies they do not explicitly discriminate against non-New Zealanders. However, they could still contravene our obligations if in practice they modify the conditions of competition in favour of New Zealand companies as compared to like non-New Zealand companies. Accordingly, we may need to change the size of the thresholds.

Calculate and pay the digital services tax

Step 3 – Determine the in-scope global revenue

3.28 The next step is to determine the global revenue for the group’s in-scope business activities.

3.29 The DST would apply to any revenue from in-scope business activities. For example, it would apply to:

  • revenue from advertising provided through social media platforms and search engines; and
  • commissions charged on transactions carried out through intermediation platforms.

3.30 If the group carries on both in-scope and out of scope business activities, then only the revenue from in-scope business activities would be included. Accordingly, the group would need to apportion its total revenues between in-scope and out of scope activities.

3.31 The revenue is the gross amount received, without any deduction for expenses. This reflects the fact that a DST is charged on the supply of the relevant services. It is not charged on the profit made by the supplier for those services.

3.32 To simplify this step, the DST could allow a group to use the revenues from its financial accounts.

Step 4 – Determine the amount attributable to New Zealand

3.33 A group’s in-scope global gross turnover would be apportioned to New Zealand. This could be done based on the proportion of global users in New Zealand.

3.34 For example, suppose a digital group had $10 billion of total gross global revenue and one percent of its total global users in New Zealand. The revenue attributable to New Zealand would be $10 billion × 1% = $100 million.

3.35 In attributing the global revenue, it is only the location of the users that is relevant, not the location of the customers paying the digital group for its services. Therefore the $100 million of revenue in the example above would still be attributed to New Zealand under the DST even if no actual payments were made to the digital group from New Zealand.

3.36 One issue with this global attribution method is that different users might be worth different amounts in different countries. For example, a user in highly developed Country X might be worth $1.00 to the digital company, while a user in developing Country Y might be worth only $0.50.

3.37 Another option for addressing this would be to use the actual contribution of users in a particular country to a digital company’s gross turnover. We understand that some digital companies already calculate this, however it may be more difficult for others to do.

3.38 An important consideration for New Zealand will be the consistency of our attribution method with those adopted by other countries. At this stage the original European Commission DST proposed formulary apportionment and the DSTs proposed by European countries also seem to adopt this approach. On the other hand, the current United Kingdom proposal uses the actual revenues attributable to United Kingdom users (although the United Kingdom Government is consulting on this point). It is not clear if there will be a consistent method adopted by countries.

3.39 Regardless of the method used, attribution of turnover to New Zealand users will require a definition of a “user”, and a way of determining the location of that user.

3.40 The definition of a user would primarily be anyone who used the platform or service, however the exact definition would vary depending on the type of platform and revenue. For example, for advertising revenue, a user would be anyone who views or clicks on the advertisement (with the same person possibly counting as multiple users if they view or click on it multiple times). For intermediation platforms, a user could be a person who enters into a transaction using the platform (to either buy or sell), with each transaction counting as a separate user. In any case the definition of a “user” for each type will need to be something that the relevant digital business can easily determine.

3.41 In order to determine the location of the user, we propose using the same method as currently used for the supply of cross border online services under the Goods and Services Act 1985. Section 8B(2) of that Act provides this list of indicators that can be used to determine whether a recipient of a supply should be treated as a New Zealand resident:

  • the person’s billing address;
  • the internet protocol (IP) address of the device used by the person or another geolocation method;
  • the person’s bank details, including the account the person uses for payment or the billing address held by the bank;
  • the mobile country code (MCC) of the international mobile subscriber identity (IMSI) stored on the subscriber identity module (SIM) card used by the person;
  • the location of the person’s fixed landline through which the service is supplied to them; or
  • other commercially relevant information.

3.42 These indicators aim to identify whether the recipient of a supply is a resident of New Zealand, rather than whether the recipient is in New Zealand at the time of supply. Accordingly, the indicators would apply to New Zealand residents that use a platform while they were out of the country, and they would not apply to non-residents who used a platform while they visited New Zealand. However, this is an area where the Government considers certainty may be more important than absolute precision. It would also simplify the application of the DST for non-residents that are also subject to GST on their online supplies to New Zealanders. The Government welcomes feedback on this point.

Step 5 – Calculate the DST payable

3.43 The DST would be paid on the revenues attributable to New Zealand at 3%. For example, if an in-scope business had $100 million of revenue attributable to New Zealand users, New Zealand would charge 3% tax on that $100 million of revenue, for total tax of $3 million.

3.44 The proposed United Kingdom DST includes an alternative safe harbour DST calculation method. Under this method, a group can elect to pay DST at a higher rate on its profit (rather than its gross turnover). This method is intended to ensure a DST does not place a disproportionate burden on taxpayers with losses or low profit margin.

3.45 The safe harbour method uses this formula:[14]

Profit margin × Attributable revenues × Rate


  • Profit margin is the profit margin made on transactions with United Kingdom users. Since this method allows costs to be deducted in order to determine the profit, it would require an agreed approach to determine which costs were deductible, and how to apportion global or regional overheads to United Kingdom users. It would also need to exclude extraordinary items. Alternately the global consolidated accounting profit margin could be used, although this would be less accurate.
  • Attributable revenue means the revenue attributable to United Kingdom users. This would be the same as for the standard United Kingdom approach.
  • Rate is the rate at which the DST would be charged under this method. The United Kingdom have proposed a rate of 80%, to ensure the method is only attractive where there are very low profit margins. However, it is consulting on this.

3.46 At this stage the Government does not propose including a similar safe harbour in New Zealand’s proposed DST. We consider that such a safe harbour would significantly complicate the DST. However, the Government welcomes feedback on this point.

Step 6 – Return and pay the DST

3.47 Finally, the DST would need to be paid to Inland Revenue. This raises some questions about how a DST would be administered.

3.48 At this stage we propose using an online supplier registration model, similar to that used for GST on remote sales. This would require a group to register with Inland Revenue and file a short return with their DST liability.

3.49 We would also need to determine the period over which a DST is assessed and the frequency of payments. We currently allow non-residents to pay GST on their online supplies on a quarterly basis. It may make sense to align the DST and GST reporting and payment requirements, so that companies paying GST could incorporate the satisfaction of their DST obligations into their existing GST return and payment process. Quarterly filing also aligns with common commercial practices for foreign businesses to produce quarterly accounts and with VAT/GST filing periods for several overseas jurisdictions.

3.50 Alternately we could make DST payable on an annual process, aligned with a group’s financial reporting balance date. This would make it easier for a group to use its financial reporting information to determine its DST liability.

3.51 We note that the United Kingdom has proposed that its DST payment and reporting be aligned with its income tax. This means the DST reporting period would be the tax year, and the DST would be payable in four quarterly instalments (as with income tax for large companies).

3.52 The Government does not propose to follow the United Kingdom’s approach at this stage – it seems to us that a DST is more closely aligned with GST than income tax, so it would make more sense to align a DST’s calculation and payment requirements with GST. However, we would welcome feedback on this point.

3.53 The digital group will need to nominate a member to return and pay the DST. All group members will be jointly and severally liable for the DST until it is paid.

Interaction with income tax – creditability and deductions

3.54 New Zealand’s DST would not be an income tax. This means the DST could not be credited against our income tax either. The DST would however be considered a business expense, and so would be deductible in accordance with the ordinary income tax deduction rules.

Example 1: Application of the proposed New Zealand digital services tax

SocMed is a multinational group that operates a popular social media platform. It derives its income from providing targeted advertisements on this platform.

SocMed’s total global annual revenue is €20 billion dollars according to its financial statements. It has 0.5% of its global user base in New Zealand.

Application of the proposed New Zealand DST to SocMed would involve these steps.[15]

Determine if the DST applies to the group

Step 1: Does the group’s business includes any of the activities defined to be in-scope? In this case SocMed’s only activity is operating its social media platform, which is an in-scope business activity.

Step 2: Does the group exceed both the de minimis thresholds for the DST? In this case the de minimis thresholds are:

• €750m consolidated global annual turnover – SocMed exceeds this as it has €20 billion in annual turnover.

• NZ$3.5 million in turnover attributable to New Zealand users. In this case SocMed has €20 billion turnover × 0.5% global users in New Zealand = €100m turnover attributable to New Zealand users. €100 million = NZ$167 million (converted at a 0.6 NZD/EUR spot-rate). Therefore, SocMed will exceed this threshold.

• Therefore, the DST will apply to SocMed.

Calculate and pay the amount of the DST

Step 3: Determine the annual gross global revenue attributable to in-scope business activities. In this case, SocMed’s only business activities are in-scope. Therefore, its in-scope revenue will be its total gross turnover of €20 billion, as shown in its financial statements.

Step 4: Determine the proportion of those revenues attributable to New Zealand. This is determined by reference to the proportion of the Group’s total global users that are located in New Zealand. In this case 0.5% of the Group’s total users are in New Zealand, so 0.5% of its global gross turnover is also attributable to New Zealand. This means that the revenue attributable to New Zealand is €20 billion × 0.5% = €100 million. This is then converted into NZD at the applicable spot rate (0.6 NZ/EUR) to give total NZD attributable revenues of €100 million ÷ 0.6 = NZ$167 million.

Step 5: Calculate the DST payable. This is determined by multiplying the total revenues attributable to New Zealand (in New Zealand dollars) by the 3% DST. This gives $167 million × 3% = $5 million DST payable.

Step 6: Return and pay the DST by the due date. SocMed would need to return and pay the DST via an annual return,[16] which would be due on a date following the publication of its annual financial statements.

Compliance with our international obligations

3.55 The DST would be designed to comply with our international obligations. These consist of our obligations under our DTAs, and our obligations under the WTO and our FTAs.

Compliance with double tax agreements

3.56 The DST would be payable by a non-resident even if it did not have a physical presence in New Zealand. New Zealand’s DTAs require a non-resident to have a physical presence before we can impose income tax on their sales income. However, Article 2 of our DTAs state that they only apply to income taxes or taxes substantially similar to an income tax.[17] This means that a DST would not conflict with New Zealand’s DTAs, provided the DST is not an income tax or substantially similar to an income tax.

3.57 The starting point here is that Article 2 of our DTAs is clearly not intended to cover all taxes. For example, it is clear that our DTAs do not apply to GST. The question then is whether the New Zealand DST is substantially similar to an income tax, or whether it is more like other types of tax, such as excise taxes and GST.

3.58 The OECD’s Interim Report[18] notes that taxes on income focus on the recipient of the income, rather than on the consumer of a supply of specific goods or services, and usually look at the characteristics and economic situation of the recipient of the income (for example, profitability). This reflects the fact that an income tax is generally a tax on profits, rather than gross turnover. Consequently, if a DST was imposed on the supply itself (rather than the supplier) and focussed on the expenditure side of the payment (that is, the nature and value of the supply) it would more likely not be considered an income tax.

3.59 However, as the Interim Report notes, tax on gross turnover can still be an income tax in some circumstances. For example, a gross withholding tax that is creditable against the income tax liability of the recipient. We consider the key factor here to be that a tax levied on gross turnover must affect the person’s income tax liability in some way (other than by deduction) in order to be an income tax, for example by being creditable against the income tax liability, or by being charged in lieu of income tax.

3.60 Bearing this in mind, the Interim Report considers that a DST would be less likely to be an income tax where it is:

  • levied on the supply of a certain defined category or categories of e-services and imposed on the parties to the supply without reference to the particular economic or tax position of the supplier;
  • charged at a fixed rate, calculated by reference to the consideration paid for those services (without reference to the net income of the supplier or the income from the supply); and
  • not creditable or eligible for any other type of relief against income tax.

3.61 Based on this guidance, we consider that our proposed DST would not be an income tax. It would be levied on the supply of narrowly defined services (being those provided by in-scope business activities), it would be charged at a fixed rate by reference to the consideration paid (that is, the gross turnover attributable to the in-scope business activities) and not the net profit of the recipient, and it would not be creditable against New Zealand income tax. In particular the DST would be paid in addition to our income tax, so it is not in any way in lieu of income tax.

3.62 This conclusion is consistent with the United Kingdom’s view on their proposed DST. In its November 2018 consultation paper,[19] the United Kingdom Treasury argued that, as their proposed DST was not a listed tax under their DTAs, nor identical or substantially similar to any listed taxes, the question of whether the DST was an income tax had to be resolved with reference to the ordinary concept of income.[20]

3.63 In this regard, the United Kingdom paper considers the concept of income to be a measure of the net accretion to a taxpayer’s wealth between two points in time, calculated by measuring the taxpayer’s gross receipts and deducting the relevant costs and expenses incurring in generating those receipts.[21] On this basis, the United Kingdom DST would not be a tax on income, as it would be a tax on gross receipts from certain digital business activities rather than net income.

3.64 The United Kingdom paper also notes that, although there are examples of taxes applied to gross receipts which meet the definition of an income tax, these typically arose where the taxation of gross receipts was in lieu of income tax. The United Kingdom paper does not consider that its proposed DST meets these criteria, as its DST will apply separately to, rather than in lieu of, its income tax.[22] Furthermore, the United Kingdom DST will not be creditable against United Kingdom income tax.

3.65 We consider the United Kingdom paper’s views on their DST apply equally to our own proposed DST, given their very similar design features.

3.66 Finally, we note that the United States has criticised the DSTs proposed by the United Kingdom and the European Union, but they have not alleged that the DSTs were income taxes charged in contravention of DTAs.

Compliance with WTO and FTA obligations.

3.67 New Zealand has international obligations under the World Trade Organisation and free trade agreements that require us to accord equivalent treatment to overseas service suppliers as we accord to like New Zealand service suppliers. New Zealand also has similar obligations under the non-discrimination articles of our DTAs with Australia, Mexico and Japan. These will need to be taken into account in the design and structure of any DST as well as the setting of relevant thresholds.

Should New Zealand adopt a digital services tax?

Benefits of adopting a DST

3.68 As discussed above, there is a problem with the current international tax framework. A DST would be a way of collecting some tax from those types of businesses that present the greatest challenge to this framework, and which have been paying little tax either in New Zealand or overseas. Further, a DST should be relatively simple to calculate and administer compared to income tax. In addition, the size of the digital economy is growing as a proportion of the total economy. Consequently, it will become increasingly important for New Zealand to ensure that the digital economy is taxed appropriately.

3.69 A DST is unlikely to be a significant revenue earner in New Zealand. As a rough estimate, we expect a 3% DST would raise between $30 million and $80 million of tax,[23] depending in part on how it is designed.

3.70 While the revenue raised would not be large, a DST could have other benefits. Much of the recent public concern about the under-taxation of multinationals has focussed on high-profile digital companies that do not have a physical presence in New Zealand (and so are not subject to income tax). By taxing these companies, a DST could improve public confidence in the fairness of the tax system, which is an important factor underlying voluntary compliance.

3.71 In addition, there is a risk in simply waiting to see whether the OECD can achieve an international solution. Doing so would significantly delay consideration of a DST, if no international solution could be found. Further, any international solution achieved by the OECD may not take effect until 2025, even if it was achieved in 2020. In the meantime, digital multinationals would continue to be unfairly taxed.

3.72 In addition, there are some upsides to adopting DSTs in terms of the OECD’s solution. DSTs incentivise countries to agree to an international solution that would otherwise make their residents worse off, as the international solution would result in the repeal of a DST.

3.73 There is also an issue as to the adoption of any internationally agreed solution. This solution will require amendments to DTAs, which will ultimately need to be optional (as there is no way to force a country to change its DTAs). Accordingly, New Zealand might still want to introduce a DST even if an international solution is found, in order to tax digital companies operating out of countries that do not implement that solution.

Issues and potential drawbacks of a digital services tax

3.74 There are potential issues with a DST.

Double taxation and over-taxation

3.75 The DST would need to apply in addition to income tax. This could result in both DST and income tax applying to the same income of some firms (including possibly some domestic firms). We consider that this is mainly an issue for any New Zealand businesses, as they are already taxed here on all their income. Non-resident digital businesses pay low rates of income tax generally and are not currently subject to New Zealand income tax on any income attributable to users in New Zealand.

3.76 Another issue is that, as a tax on gross turnover, the DST would apply to firms in loss, or with low margins. This is something that can be partially mitigated with high de minimis thresholds, as the larger firms tend to be more profitable. A lower DST rate also helps to mitigate this issue. However, these features cannot eliminate the issue altogether.

Impact on investment, innovation and growth

3.77 As with any tax on the supply of particular services, a DST will increase the cost of capital, reducing the incentive to invest with a resulting negative effect on growth. As a measure that only applies to digitalised sectors, a DST risks slowing down investment in innovation for those businesses that are subject to the tax or indirectly affected by it. Although the effect will also depend on the financing of the investment, without proper constraints, like an exemption for SMEs, a gross basis tax could effectively penalise start-ups and other growing firms with losses or limited profitability and provide a competitive advantage to mature profitable incumbents, helping to create a barrier to entry that cements the dominance of established firms.

3.78 The digital sector has important benefits for New Zealand, and the Government is committed to supporting it. Accordingly, it is important that any DST does not reduce the growth of the digital sector in New Zealand, particularly start-ups and SMEs. For this reason, any DST would need robust de minimis thresholds, to ensure it only targets established and profitable digital businesses.

Impact on welfare

3.79 The OECD Interim Report notes that an additional hurdle with a tax on a gross basis is that it is equivalent to a tax on inputs. This implies that it is likely to distort firms’ choices of inputs thus distorting production itself. In other words, when such a tax is introduced, either production could decline or more resources will need to be employed to reach the same level of production. Consequently, according to the OECD Interim Report, there is likely to be a negative impact on the overall welfare of an economy and on its output. The size of the effect will depend on elasticities of substitution and will be smaller the more targeted the measure is.

3.80 In response to this issue, we note that the current international tax rules favour investment in the digital sector. This unequal tax treatment compared with more traditional businesses is inefficient, as it incentivises investment into certain digital firms (which can most benefit from the flaws with the current rules). As a DST is intended to reduce the unfair tax advantages enjoyed by such digital businesses, we would expect a DST overall to improve economic efficiency, and thus welfare.

The economic incidence of the tax

3.81 The issue here is whether a DST would just be passed on to New Zealand customers. Given the importance of this issue, we consider it in some detail below.

3.82 Some digital multinationals provide a free service to end-users, which they monetise through payments from other parties, for example, for online advertising. To the extent the cost of a DST was passed on, we would expect it to be passed on to the parties currently paying the digital multinational for its services. We would not expect a DST to result in a digital multinational charging consumers for a service that is currently free. For example, consider a social media platform that is currently free to end-users and which raises revenue through online advertising. We would expect any costs from the DST to be passed on to the persons buying advertising from the multinational, and not the end-users of the platform (who should continue to enjoy a free service).

3.83 There are arguments each way on the extent to which a DST would be passed on to consumers. On the one hand, digital companies might be expected to have very low marginal costs. In that case a DST is similar to a tax on profits. If the digital company is earning infra-marginal returns (economic rents that is, the amount above the return that the investor needs in order to make the investment), then a tax on those profits might be very efficient and not be passed on to New Zealand customers. On the other hand, if some services are more competitively supplied and there is low substitutability of the services, the tax might be expected to be mostly passed on.[24]

3.84 The European Commission’s Impact Assessment for its proposed DST briefly considered the economic incidence issue and considered that there was no single answer for the variety of digital services such a tax would apply to. The Impact Assessment notes that:[25]

There is scarce evidence on the pass-on effect of a new tax on turnover, but economic theory and experiences with VAT indicate that there is no uniform answer for the variety of digital services considered. As a proxy, one could look into the effect of an increase in the VAT rate on consumer prices. Economic theory suggests that the pass-through of a VAT increase on consumer prices is influenced by several factors: competition setting, the elasticity of demand and other factors (for example, country-specific ones). The higher the price elasticity of demand, the lower the degree to which a VAT rate increase can be shifted into final consumer prices. An increase in the VAT rate would thus translate to different degrees in higher consumer prices or reductions in suppliers’ profit margins, depending on the market conditions. On average, for a rather broad range of goods and services, Benedick et al. (2015) found that only around one-third of a VAT change is passed on to consumer prices.[26] In the case of paper-based books and e-books, a Commission-ordered study documented a pass-on rate of one-half, which was however considered imprecise.[27]

For online retail, there is some evidence that consumers purchasing online are price sensitive and react strongly to price increases – this would limit the possibility for companies to pass additional tax onto consumer prices. Existing work on internet tax sensitivity dates back to the influential work of Goolsby (2000). Sales taxes that are directly passed onto prices of products sold online have been shown to strongly reduce demand. More recently, Einar et al (2014), using data from eBay which accounts for 11–13 percent of Internet retail commerce in the U.S., estimate that on average, the application of a 10 percent sales tax reduces purchases by 15 percent among buyers who have clicked on an item.

3.85 The Impact Assessment to refers an IMF study on the pass through of VAT increases (Benedek et al). This study looked at the VAT reforms in the Eurozone from 1999–2013 (which involved 1,231 VAT changes – 1,009 VAT increases and 222 decreases) and their effect on consumer prices. The study found:

  • changes in standard VAT rates which affect most goods and services, have a one hundred percent pass through rate or more;
  • changes in reduced VAT rates, which only affect a few types of goods or services, have only a thirty percent pass through rate (meaning only thirty percent of the extra cost or saving was passed on to consumers); and
  • reclassification of goods (that is, moving a particular good from a reduced rate to standard rate and vice versa), which had the narrowest application, had pass through rate of close to zero.

3.86 This shows a strong association between the share of consumption affected by a VAT reform, and total pass-through. Pass through is relatively small for VAT reforms that affect a small consumption share and is highest (close to full) for VAT reforms affecting around half of all consumption.[28] In particular, pass through is not significantly different from zero when the VAT applies to a consumption share less than ten percent.

3.87 A DST would only affect a small share of consumption. If the results above holds, the pass-through rate for a DST (which, as a tax on gross turnover, has a similar economic impact to a VAT) would be similar to the pass through rate for a VAT reclassification or reduced rate – that is thirty percent (or lower).

3.88 In addition, the pricing structure of some digital services mean the cost of a DST could not be passed on. For example, where online advertising is priced under a bid system, it might be difficult to increase the final price by the amount of DST charged.

3.89 Based on the above, we would roughly expect between thirty and fifty percent of the cost of a DST to be passed on to New Zealand consumers.

The effect on New Zealand’s reputation as a good place to do business

3.90 New Zealand is a small open economy and we compete for capital with the rest of the world. That means we want New Zealand to be an attractive place for non-residents to do business. Imposing a DST may create a negative impression of New Zealand in this regard.

3.91 We consider that this risk would be reduced to the extent other countries adopt or announce DSTs (which some have already done).

The potential effect on our export sector

3.92 The implications of adopting a DST for our export sector would also need to be considered. Some trading partners, particularly the United States, would likely express continued opposition to any unilateral approach to digital taxation. Members of the United States Congress and United States tech industry players have previously claimed that DST proposals by the United Kingdom and the European Commission would amount to double taxation, and that proposed turnover thresholds would result in discrimination against United States companies in breach of World Trade Organization (WTO) national treatment provisions. The United States preference is likely to be to continue efforts to tackle the issue within the OECD.

The period of time for which a DST would be applicable

3.93 The OECD expects that any DSTs would be repealed once a multilateral solution is achieved. Other countries that have recently proposed DSTs have also said they will do this. Accordingly, if agreement was reached quickly at the OECD, then it may not be worth designing a DST that would only apply for a short period of time.

The administration and compliance costs of introducing a new tax

3.94 This is particularly an issue given that a DST is not expected to raise significant revenue. In addition, given a DST would be expected to (at least predominantly) apply to companies outside of New Zealand, there are fewer tools available to Inland Revenue to enforce the tax.

3.95 On the other hand, a DST is simpler than an income tax, and so would be easier to administer and comply with. The Government would also aim to make the DST as simple to comply with as possible. There would be real benefits here of aligning New Zealand’s proposed DST with those adopted by other countries so that multinationals did not have an additional set of DST rules to comply with.

3.96 In terms of enforcement, this could be addressed in part by making any wholly owned group member of the multinational in New Zealand jointly and severally liable for the DST. In addition, we have found multinationals generally willing to comply with local laws (where they minimise tax, they do so by structuring their affairs to reduce the tax legally payable, rather than by ignoring our tax laws altogether). For example, there has been high compliance with the recent GST on remote services, which applied to many non-residents with no physical presence in New Zealand.

Repeal of a digital services tax

3.97 The DST is intended to be an interim measure. Accordingly, the Government would repeal the DST if an international solution at the OECD was achieved. In terms of timing, the DST would be repealed when the international solution took effect for tax purposes, which could be four to five years after it is first agreed.

3.98 However, it may be the case that not all countries adopt the OECD’s international solution. If this was the case, then the Government would consider retaining the DST for residents of those countries that have not adopted the international solution.

Questions for submitters

  • What do you think of the proposed DST?
  • To what extent do you expect it would be passed through to New Zealand consumers?
  • Do you think it would comply with New Zealand’s international obligations?
  • What impact do you expect it would have on New Zealand’s international relationships (particularly in light of other countries already moving in this direction)?
  • Do you agree with the advantages and disadvantages set out above?
  • How do you think it would affect New Zealand businesses and consumers?
  • How would the proposal affect the development of the digital economy in New Zealand and globally?
  • Do you agree with the scope of the proposed DST?
  • How easy would it be to comply with?
  • What technical and administrative issues do you see arising from the proposed DST?
  • What other design features should it incorporate?
  • Is there anything else we should consider?

[11] The OECD report included an overview of these risks and adverse consequences. We have incorporated this into our discussion of the downside of a DST.

[12] Paragraph 450 and following.

[13] This would be determined the same way as in steps 3 and 4.

[14] We have simplified this by removing the allowance component, which functions as part of the United Kingdom’s de minimis threshold.

[15] These steps assume that DST will be payable on annual basis rather than a quarterly basis (which has not yet been decided).

[16] The Government is also considering whether DST should be payable quarterly, like GST on remote sales.

[17] The non-discrimination articles in our DTAs with Australia, Mexico and Japan apply to all taxes, and so would potentially be within the scope of a DST. We discuss the impact of these articles in the next section, as they are similar to our WTO and FTA obligations.

[18] Paragraph 6.3.1.

[19] HM Treasury and HM Revenue & Customs, Digital Services Tax: Consultation, November 2018,

[20] Page 32.

[21] Page 32.

[22] Page 33.

[23] This is based on a rough bottom-up estimate of what we think a DST would raise in New Zealand, combined with top down estimates based on what the European Union and United Kingdom have forecast their DSTs to raise, adjusted for differences in GDP and exchange rates.

[24] This is less of a concern with the proposals to change the international tax framework, as those proposals involve broadening the application of income tax to the digital economy. Accordingly, the economic incidence of any tax raised by those proposals should be the same as for income tax generally.

[25] SWD(2018) 81 Final, page 75.

[26] See Benedek et al., 2015, page 16,

[27] See European Commission, Economic Study on Publications on all Physical Means of Support and Electronic Publications in the context of VAT, 2012, page 98, The pass-on rates vary also country-wise – see pages 95–96.

[28] The study also found that pass through is again smaller for VAT reforms affecting more than a fifty percent share of consumption, although there were not enough data points for such VAT reforms to be confident of this conclusion.