Thin Capitalisation Rules and Treaties: Does the Ratio in the New Zealand Thin Capitalisation Rules Contravene New Zealand’s Tax Treaty Obligations?

New Zealand Business Law Quarterly, Vol. 18, No 4, pp. 307-332, 2012

32 Pages Posted: 1 Aug 2012 Last revised: 17 Feb 2013

See all articles by Craig Elliffe

Craig Elliffe

University of Auckland - Faculty of Law

Date Written: July 31, 2012

Abstract

This article examines the potential conflict between thin capitalization rules and the OECD Model article on non-discrimination using the New Zealand regime exempli gratia. It is discriminatory to impose a higher tax burden on an enterprise funded with foreign capital. Yet that is the basis for the New Zealand - and many other countries' - thin capitalization regimes. The OECD rationalize this conflict by agreeing that thin capitalization rules are effective against non-discrimination provisions in a treaty when they operate on an arm's-length basis.

A thin capitalization regime can therefore successfully prevent the transfer of profits in the guise of interest up to an arm's-length level. Beyond this arm's-length amount the thin capitalization rule is providing tax protectionism which is discriminatory. The application of the non-discrimination principles to the New Zealand thin capitalization rules will be of interest to other jurisdictions in the design of their thin capitalization regimes because they may be contemplating a similar approach. New Zealand makes use of two safe harbor fixed ratio formula in its thin capitalization rules: a 60 percent total debt to total assets calculation, and a ratio of 110 percent of worldwide debt to worldwide assets. Debt includes both related party and non-related party borrowing.

After revisiting the basis upon which these tests were formulated, and categorizing the various types of non-discrimination approach, this article concludes that: these fixed ratios offend the arm's-length principle in some circumstances, because of their low rates and application to total debt; and New Zealand entities which are controlled by shareholders resident in certain jurisdictions will be protected under the applicable double tax treaty from the application of the New Zealand thin capitalization rules.

The conclusion that the New Zealand thin capitalization rules do not work for entities with arm's length debt applies to three important trading nations (China, India and the United Kingdom) and leads inevitably to the suggestion that New Zealand should, for example, follow the Australian approach of allowing a taxpayer to show it is compliant with thin capitalization rules when its funding is on an arm's-length basis.

Keywords: thin capitalisation, tax treaties, non-discrimination article, Article 24, anti-avoidance, do treaties override thin capitalisation rules

JEL Classification: K34

Suggested Citation

Elliffe, Craig Macfarlane, Thin Capitalisation Rules and Treaties: Does the Ratio in the New Zealand Thin Capitalisation Rules Contravene New Zealand’s Tax Treaty Obligations? (July 31, 2012). New Zealand Business Law Quarterly, Vol. 18, No 4, pp. 307-332, 2012, Available at SSRN: https://ssrn.com/abstract=2120839 or http://dx.doi.org/10.2139/ssrn.2120839

Craig Macfarlane Elliffe (Contact Author)

University of Auckland - Faculty of Law ( email )

Private Bag 92019
Auckland Mail Centre
Auckland, 1142
New Zealand

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
431
Abstract Views
2,827
Rank
123,455
PlumX Metrics