BEPS guidance released to provide clarity
Tax Alert - September 2018
By Brendan Ng
On 27 June 2018 the Government’s taxation bill to address Base Erosion and Profit Shifting (BEPS) concerns received Royal Assent, finally bringing the BEPS proposals into New Zealand’s domestic legislation, with the majority of the proposals applying to income years starting on or after 1 July 2018.
While Royal Assent would normally signal the end of the road, the breadth and complexity of the BEPS changes has seen Inland Revenue release draft guidance material, in the form of five special reports, to ensure the changes are as clear and understandable to the public as possible. This is an ambitious task, but a necessary one, and feedback is requested on the usefulness of the draft guidance (which is to be finalised and published in early 2019).
We have outlined the key areas covered by the guidance in the special reports below, noting that some areas of the guidance will need to be clarified and refined, and other areas could benefit from further examples and direction. You can read a summary about the BEPS bill as it was reported back from Parliament here and our December Tax Alert on the changes as originally proposed.
Interest limitation rules
This special report covers the new restricted transfer pricing approach, thin capitalisation changes and infrastructure project finance changes. In particular the report covers:
- The new rules requiring related-party loans between a non-resident lender and a New Zealand-resident borrower to be priced using a restricted transfer pricing approach. The report includes a flowchart outlining the process for determining a New Zealand borrower’s credit rating (i.e. whether transfer pricing rules apply, a credit rating adjustment is required or no credit rating adjustment is required), with each step explained in further detail.
- If a credit rating adjustment is required, the process for determining the rating is set out in another flowchart. The concepts of ‘high BEPS risk’, implicit parental support, group borrower’s credit rating and long term senior unsecured debt are also explained further.
- The new economic substance and reconstruction provisions that disregard legal form where it does not align with the actual economic substance of the transaction, or to allow transactions to be reconstructed or disregarded where the arrangements are commercially irrational and would not be entered into by third parties operating at arm’s length. A flowchart is included to illustrate the overall process to be taken in determining the interest rate on a particular instrument.
- The approach required for financial institutions (“insuring or lending persons”) where they are generally required to use their parent’s credit rating rather than the default credit rating, restricted credit rating or group credit rating (including a flowchart determining whether a feature can be included in pricing).
- The changes to the thin capitalisation rules so that debt percentages will now be based on an entity’s assets net of its “non-debt liabilities”, explaining what is / what isn’t a non-debt liability with examples.
- The other changes made to strengthen the thin capitalisation rules including a de minimis rule for the inbound thin capitalisation rules, reducing the ability for companies owned by a group of non-residents to use related-party debt, new rules around asset valuation and an anti-avoidance rule for when a loan is substantially repaid just before year end.
- Amendments that have been made to provide entities carrying out eligible infrastructure projects with a limited exception from the thin capitalisation rules by allowing them to claim deductions on debt that exceeds the thresholds set out in the legislation.
This special report covers the strengthening of New Zealand’s transfer pricing rules, providing for closer alignment with the OECD’s transfer pricing guidelines and Australia’s transfer pricing rules. These changes include:
- Extending the application of the transfer pricing rules to circumstances when there are transactions between members of non-resident owning bodies and companies and to specifically refer to cross-border related borrowings.
- Adding in a reference to using the 2017 OECD transfer pricing guidelines as guidance for how the transfer pricing rules are applied, noting that any changes to the OECD guidelines will be considered with a view to updating the section YA 1 definition of the OECD guidelines to refer to the most recent version.
- Giving the economic substance of a transaction and actual conduct of the parties to the transaction priority over the terms of the legal contract and requiring the arm’s length amount of consideration to be determined using arm’s length conditions. Where a transfer pricing arrangement is not commercially rational because it includes unrealistic terms that unrelated parties would not be willing to agree to, the approach in the new OECD guidelines may apply to disregard and, if appropriate, replace the transaction.
- Placing the onus of proof onto the taxpayer for providing evidence that their transfer pricing positions are correct, acknowledging that there may be a range of conditions that can be considered to be arm’s length conditions. The special report endorses the three-tiered approach to transfer pricing documentation, where a master file, local file and Country-by-Country report are prepared and links to supplementary Inland Revenue guidance on what is required (in addition to the OECD guidelines).
- Increasing the time bar for transfer pricing positions to 7 years where the Commissioner of Inland Revenue has notified the taxpayer that a tax audit or investigation has commenced within the usual four-year time bar. The example provided applies the four years from the date of filing the tax return, so the actual position will need to be clarified with Officials as the legislation and guidance are not consistent.
Permanent establishment avoidance
This special report covers the new anti-avoidance rule for large multinationals (those with over EUR750m turnover) that structure to avoid having a permanent establishment in New Zealand, as well as the widening of the source rules. In particular:
- The special report explains the new permanent establishment (PE) avoidance rule that deems a non-resident to have a PE in New Zealand if a related entity carries out sales-related activities for it under an arrangement with more than a merely incidental purpose of tax avoidance (plus other requirements are met). This moves away from the previous test of habitually concluding contracts and instead places the focus on whether the representative of the non-resident habitually plays a principal role leading to the conclusion of contracts.
- An analysis of the criteria that, if met, deems a PE to exist in New Zealand is included in the report, as well as a table of examples that illustrate when the criteria are met. Also included are analysis and examples in relation to whether there is a more than merely incidental purpose of tax avoidance and the consequences of this.
- The new source rules are covered, whereby if income is attributable to a PE in a country, then it will be deemed to have a New Zealand source under our domestic rules. This is contrary to the current position where to tax a non-resident on its New Zealand sales income, it is necessary to show that the income both has a New Zealand source and is attributable to a PE under a DTA.
This special report covers a number of the administrative changes made in relation to “large multinational groups”, as newly defined in the Income Tax Act 2007 (ITA). These include:
- The increased ability of Inland Revenue to request information from large multinational groups, including the ability for Inland Revenue to impose a civil penalty of up to $100,000 for multinationals who fail to respond to requests for documents. An example sets out the process by which Inland Revenue will request information held by non-resident members of large multinational groups, and the consequences of the failure to provide this information.
- The ability of Inland Revenue to collect tax owed by a non-resident member of a large multinational group from another wholly-owned group member who is a New Zealand resident or that has a PE in New Zealand, and the requirement to file country-by-country reports.
Hybrid mismatch arrangements
The longest of the special reports covers the changes to introduce the OECD hybrid and branch mismatch arrangements recommendations into New Zealand domestic legislation, with modifications for the New Zealand context. As noted in the report, while the new rules are relatively complex, they will have no impact on the vast majority of taxpayers. This report covers:
- The rules in subpart FH addressing the hybrid and branch mismatches arising from hybrid financial instruments, disregarded hybrid payments and deemed branch payments, reverse hybrid and branch payee mismatches, deductible hybrid and branch payments resulting in double deductions, dual resident payers and imported mismatches.
- The ability for taxpayers with inbound hybrid financial instruments to elect to treat the instrument as a share for New Zealand income tax purposes and the ability to irrevocably elect to treat a wholly-owned outbound foreign hybrid entity existing on 6 December 2017 as a company for New Zealand income tax purposes. Taxpayers must send these elections to the following email address: email@example.com.
- The consequential changes to the FIF rules, NRWT and thin capitalisation as a result of the introduction of the hybrid mismatch arrangement rules.
If you managed to read through all of that without having to take a break, remember that we are still yet to really see this legislation and guidance in force. For those entities that are affected by these rules (which is the majority of multinational taxpayers), these changes add another level of complexity and consideration to their operations. Further, even with refinement and the inclusion of more examples, the effect of these rules and their compliance burden will depend on the operational approach taken by Inland Revenue.
The majority of the new rules will become law for income years beginning on or after 1 July 2018. For companies with June balance dates, this means they effectively apply from 1 July 2018, despite the guidance on applying the rules not likely to be finalised until early 2019.
If all that isn’t enough to consider, the Government has indicated that this may not be the end of the BEPS journey, and we may yet see further changes to our international tax rules – watch this space.
For more information please contact your usual Deloitte advisor.
September 2018 Tax Alert contents
- Tax Alert - September 2018
- IRD guidance on withholding tax for non-resident directors fees
- GST change for non-profit organisations: Inland Revenue’s proposals released
- Transfer pricing: developments in debt pricing
- BEPS guidance released to provide clarity
- Automatic refunds and new tax return rules for individuals
- Recent developments