Compliance Focus for Multinational Enterprises
Tax Alert - November 2016
Inland Revenue has released an updated compliance focus document (“the Document”) for multinational enterprises. Although the Document is targeted at multinational enterprises, it will also have relevance for New Zealand based enterprises expanding offshore and high-wealth individuals with complex affairs.
Its three years since this document was last updated and in that time a lot has happened, particularly with a lot of progress made on the Base Erosion and Profits Shifting project (commonly known as BEPS), New Zealand’s response to it and the misconceptions being perpetuated by some in the media.
Inland Revenue is very keen to dispel these misconceptions. In fact, the Commissioner of Inland Revenue acknowledges the contribution made by multinational enterprises to the overall tax take. The 600 largest taxpayer groups (known as Significant Enterprises), whose tax affairs are reviewed every year, actually contribute more than $6 billion of tax to New Zealand annually.
For the last four years, Significant Enterprises have been required to submit a basic compliance package annually comprising the group structure, financial statements and tax reconciliations which are all examined closely. Further, for the last two years, foreign-owned groups have been required to complete an international questionnaire designed to help Inland Revenue improve their understanding of major international tax risks for New Zealand. As a result of this questionnaire, Inland Revenue reports the following facts (in respect of 292 foreign owned groups).
- Most foreign owned companies have ultimate ownership in Australia (77%), followed by the US, then Japan.
- 79% had transfer pricing documentation,
- Only 14 groups exceeded the 60% thin capitalisation threshold.
The Document notes that the coverage will expand next year to all foreign-owned Significant Enterprises with over $30 million of turnover. However, there is perhaps a surprising statistic to come out of this questionnaire, and that is the fact that only 48% had tax governance documentation.
Corporate tax governance
This is the hot topic of the moment, particularly since the OECD’s Forum on Tax Administration has released guidance on tax control frameworks which has been recommended by Inland Revenue. Inland Revenue also recommend that Boards of Directors consider endorsing a set of overarching tax principles and cite as an excellent example the Business & Industry Advisory Committee’s (BIAC) Statement of Tax Principles for International Business.
At a minimum, the following questions should be routinely addressed by Boards.
- Is there a documented tax strategy and has it been kept up to date?
- Have effective systems, procedures and resources been put in place to manage risks and, if so, is a clear statement made in the annual report to that effect?
- Is annual reporting sufficiently transparent such that all stakeholders have the capability to analyse and effectively interpret the information provided on taxes paid?
This recommendation comes on the back of a comment made by Revenue Minister Woodhouse earlier this year that “major multinationals have been “deafeningly silent” in the wake of allegations that some had been shirking their fair share of the tax burden”. Multinationals have been reluctant to get into this debate publically because they are damned if they do and damned if they don’t. It is hoped that if Significant Enterprises start explaining their tax positions in more detail in documents such as their annual reports, it will go some way to clearing up this misconception.
Areas of focus
While the tax environment and culture towards paying a fair share of tax has shifted significantly for multinational enterprises in the past five years, there are still issues on Inland Revenue’s radar.
International financing arrangements
Cross border financing forms a significant part of associated party dealings by New Zealand members of multinational groups. Key risks include pricing interest and guarantee fees at non-market rates, or having inadequate loan documentation.
Transfer pricing remains a key issue and all inbound and outbound associated party transactions are closely monitored. Unexplained losses, loans in excess of $10 million principal and guarantee fees, cash pooling arrangements, payment of unsustainable royalties and/or service charges are among the issues that will attract scrutiny.
The profitability of foreign-owned wholesalers and distributors is monitored, particularly those that purchase and on-sell goods to other firms without any significant transformation.
Inland Revenue endorses the OECD recommendation that transfer pricing documentation be held in two forms: a master file providing a high level overview of the multinationals’ global business operations and transfer pricing policies, and a local file providing detailed information regarding material related party transactions.
There is increased scrutiny of transfer pricing issues by other tax authorities as countries continue to update their transfer pricing rules. To minimise issues, multinationals should know the nature and extent of all overseas operations and all cross-border associated party transactions, check margins to ensure they reflect commercial reality, fully document any market development strategies and be prepared to explain swings in profitability.
Controlled foreign companies (CFCs)
Recent reviews have focussed on the active business test calculations as well as calculations of taxable income or losses attributed from CFCs. The Document helpfully lists the common compliance issues to watch out for in this regard.
Familiar red flags
The 10 familiar red flags make a repeat appearance in the Document. These comprise a useful checklist of particular issues that will attract attention from Inland Revenue such as an effective tax rate that is substantially less than 28%, use of low or no tax jurisdictions, differences in accounting treatments, large tax benefits, cross-border mismatches, complexity, derivation of large capital gains or claiming of large tax credits, uncharacteristic tax losses, ownership changes and material variances between years in profitability or tax payable.
New Zealand’s response to BEPS
The Document would not be complete without mentioning New Zealand’s response to BEPS. BEPS is a global problem which requires a global solution and New Zealand is certainly playing its part, having already signed up to the automatic exchange of information and tax rulings between tax authorities, country by country reporting and the endorsement of new transfer pricing guidelines.
The Government is also committed to strengthening New Zealand’s domestic tax rules. For example, GST is already being collected on remote sales of services (a.k.a the Netflix tax), the foreign trust disclosure rules have been arguably rushed through in response to political pressure and the rules regarding NRWT on related party debt are undergoing a major overhaul. And, as reported in our last Tax Alert, hybrid mismatches are currently being consulted on, with new interest limitation rules to be consulted on next year. Later this year, the Government is expected to sign up to a multilateral instrument which will amend the signatory countries’ network of tax treaties to insert a new anti-treaty abuse article, a new permanent establishment definition, anti-hybrid entity rules and dispute resolution articles.
How successful these measures are in tackling BEPS will depend on the extent to which other major countries also buy in and adopt the reforms. New Zealand can make very little impact if we operate in isolation and we also risk becoming uncompetitive.
The Compliance Focus Document for multinationals is an important document that companies and Boards of Directors need to be aware of. We certainly endorse Inland Revenue’s call for companies to ensure they have tax governance documents in place and think Boards need to seriously consider providing more transparency in annual reports around tax principles, the taxes paid and how tax risks within the business are managed. Some New Zealand companies are already starting to lead in this respect.
Note, the Compliance Focus Document is not available electronically until 18 November. If you would like to receive a copy please contact your usual Deloitte tax advisor for more information.
November 2016 Tax Alert contents
- Compliance Focus for Multinational Enterprises
- Australian GST to apply to low value goods from 1 July 2017
- PAYE Reporting proposals finalised
- Farmers to face increased compliance costs
- Facts and figures as Inland Revenue reports on its performance
- A snapshot of recent developments