Proposed law changes a step backwards

17:27, Nov 09 2012

A dry piece of legislation going through Parliament will enhance corporate secrecy and reduce minority shareholder rights. Chalkie doesn't like it.

When Chalkie was a kid, a regular sport was to squelch out on to the mudflats looking for eels.

If that sounds a bit niche, it should be pointed out it was a far-away place and there wasn't much else to do.

Anyway, experience soon taught that the biggest eels could be found in the biggest hiding spots - a large slab of corrugated iron, for example, was ideal.

Looking under rocks and such has since become a habit, so you can imagine Chalkie's concern at the prospect of an incoming tide of legislation covering up a whole bunch of metaphorical rocks, leaving metaphorical eels undisturbed.

The legislation is the Financial Reporting Bill, which was introduced to the House on July 31 and has yet to make further progress.


Ostensibly the bill aims to tidy up the rules governing who reports what to whom, and when, but it also draws a veil over a large quantity of corporate information, permanently, and limits the rights of minority shareholders.

Taking the first issue first, the bill changes the financial reporting obligations of foreign-owned companies. Currently, all 100 per cent foreign-owned companies must file general purpose financial statements with the Companies Office. General purpose means they are designed to be read by anyone with an interest in the company.

In addition, companies that are at least 25 per cent foreign-owned must file accounts if two out of the following three criteria apply - total assets of more than $10 million, revenue of more than $20m and staff of more than 50.

Those provisions in the Financial Reporting Act mean we can see quite a lot of information about overseas corporate interests in New Zealand, including how much money they make, how much debt they have and how much tax they pay.

Granted, local companies don't have to lift their skirts in the same way, unless they issue shares or bonds, and foreigners think that's a bit unfair.

Diddums. Foreigners can access considerable tax benefits by using international structures, giving them a leg-up over locals in the New Zealand market. A bit of disclosure is not much to ask.

However, it appears the Government has gone all soft on our overseas cousins, because the bill proposes removing the disclosure requirement from all but the biggest companies that are at least 25 per cent foreign-owned. The threshold is to be set at total assets of at least $60m or revenue of $30m, in each of the previous two years.

The rationale is that compiling and filing accounts is an onerous burden and should apply only to companies with broad enough shoulders to bear it.

Superficially, it seems a fair point. Deep down, Chalkie reckons it isn't.

Google, for instance, is a foreign-owned company.

In New Zealand it dominates the market in online search advertising, outpacing local competitors by a considerable margin.

The overall interactive market for 2011 was estimated at $328m by the Advertising Standards Authority. Of that, $135.5m involved search and directories. If Google's revenue was proportionate to its share of site visits, which is a reasonable assumption, it would have pulled in, conservatively, about $110-$120m.

However, its financial statements show revenue of just $4.4m for the year to December, producing a loss of $52,325. It made a loss the previous year too, and the year before that, and the year before that.

The low numbers are due to Google's use of a tax structure known as the Double Irish, in which New Zealand billings go to Google Ireland, where company tax on trading income is 12.5 per cent.

The Irish company then pays commission on those sales to the unit in New Zealand, where the company tax rate is 28 per cent.

Hence Google NZ's low reported revenue and 2011 tax bill of just $109,038. We know this because the current Financial Reporting Act requires all foreign-owned companies to report their accounts.

The new law, as drafted, will hide Google's information in future because its revenue and total assets fall below the revised reporting threshold.

Details on countless other overseas-owned companies will also be submerged.

Chalkie reckons this is not a good thing.

After all, we didn't learn anything about the Double Irish from the IRD - which would in future be the only scrutineer of these businesses, and required to keep all taxpayer details secret.

This is bad enough, but the issue is amplified by the fact that once the law change is done, it can't be undone. As a Cabinet paper on the bill makes clear, free trade deals involving New Zealand prevent differential reporting obligations being reimposed on overseas-owned companies, once they have been removed.

In the official lingo: "Any unilateral liberalisation to these obligations will be automatically applied and subject to standstill with no roll-back mechanisms. Therefore, it will not be possible to reverse any such changes or impose additional obligations or requirements once the changes are made without breaching our obligations under those free trade agreements."

Chalkie wonders why the Government would care so much about irrevocably introducing laws of benefit only to overseas shareholders, while damaging global efforts to shine a light on multinational tax practices.

The Government's motivation for changing the rules on auditing requirements is also opaque.

Auditing exists mainly to give shareholders confidence their company's management are telling them the truth.

While the thought of a company's board telling porkies may be shocking, it apparently can happen, and the more remote shareholders are from management, the greater the risk of misinformation.

So shareholders hire auditors to make sure the numbers are a genuine reflection of how the business is going.

Resolutions authorising the board to hire and pay the auditor are usually rubber-stamped at annual meetings, but they represent an important shareholder power.

Currently, large private companies are required to have their accounts audited, but shareholders can choose to waive the requirement by unanimous vote - audits can be costly, so shareholders have the right to opt out if they are all happy with their company's governance.

However, the bill changes the opt-out to a simple majority vote, provided at least 95 per cent of shareholders take part.

It doesn't take long to think of situations where this could have bad consequences for minority shareholders.

In private companies it is not unusual for directors and controlling shareholders to be one and the same while minority shareholders are distant from the action.

Under the bill, controlling shareholders can vote through an opt-out, leaving minorities with no check on how the numbers are being reported.

The issue becomes more acute if the company gets involved in a deal where valuation is important - say, it pays in shares to buy a business, or its majority shareholders offer to buy out the minorities.

If the numbers have never been audited, can they be trusted?

Granted, auditors can be coaxed into bad practice - as Andersen was with Enron or Woodnorth Myers was with South Canterbury Finance - but Chalkie reckons they have their uses.

No doubt the Government is trying to cut compliance costs and some provisions in the bill will help small or medium-sized businesses.

This one, however, looks a bit half-baked.

With the legislation already flooding its way through Parliament, Chalkie feels like King Canute, but this bill looks to have at least two things wrong - and two wrongs don't make a right.

Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.

Waikato Times