New compulsory online BEPS disclosure forms now required!
Tax Alert - November 2019
By Bart de Gouw and Annamaria Maclean
Somewhat unexpectedly, Inland Revenue have recently released guidance on the requirements for taxpayers to file new online BEPS disclosures via myIR online services, as part of the tax return process.
The requirement to file income tax disclosures online is a new approach that we expect is driven by Inland Revenue’s Business Transformation Programme and the increasing requirements for taxpayers to use myIR online services. We anticipate Inland Revenue will look to use this electronic data in new ways which may mean more data analysis that can be used for risk reviews and audits.
The disclosures ask taxpayers to confirm their compliance with three core changes that were introduced in The Taxation (Neutralising Base Erosion and Profit Shifting) Act 2018 (BEPS Act), being:
(i) Hybrid and branch mismatch rules.
(ii) Thin capitalisation: in particular, has your thin capitalisation group had a New Zealand group debt percentage for thin capitalisation purposes of 40% or higher at any measurement date during the income year?
(iii) Restricted transfer pricing rules: in particular, at any point during the year have you had $10 million or more of cross-border related party borrowing?
The first year for which BEPS disclosures are required, is for income years commencing on or after 1 July 2018. So this means that June 2019, July 2019, August 2019 and September 2019 balance dates need to be working on these now to ensure that the disclosures are in line with how they file their 2019 income tax returns (due on 31 March 2020).
The rules covered by the BEPS disclosures are technically complex and highly dependent on the facts and circumstances of the particular scenario. Even where significant work has already been undertaken by the taxpayer to assess the impact of the BEPS changes, further consideration may be required to complete the BEPS disclosures in an accurate and complete manner. Therefore, the BEPS disclosures should be considered as soon as possible and well before completion of your income tax returns. For many June to September 2019 balance dates, the tax return process is well underway, so taxpayers should be acting now to ensure that they are in a position to file these online disclosures appropriately.
Below is a summary of the key components of the BEPS disclosures to help taxpayers initially assess the potential impact of the rules and consider whether further work needs to be undertaken before the online questions can be completed.
Hybrid and Branch Mismatches
The BEPS Act included a comprehensive adoption of the OECD’s hybrid recommendations with modification for the New Zealand context. The proposed rules are complex and are designed to address mismatches in the tax outcomes between New Zealand and other countries. These mismatches result from differing treatment of financial instruments or entities that create either double deductions (in New Zealand and overseas), or a deduction in one country without a corresponding amount of income being recognised in the other country.
Along with the BEPS disclosure guidance, Inland Revenue have released a hybrids compliance and disclosure document (as replicated from the TIB Vol 31, No 3 and the special report on the hybrid and branch mismatch rules).
Some examples of common situations that can be impacted by the hybrid and branch mismatch rules include:
- Financial instruments (e.g. loans) that are treated as debt in one country but equity in the other;
- Financial instruments that have (or may have) a term of more than 3 years where the interest income is not recognised on a reasonable accrual basis or otherwise in an accounting period beginning within 24 months of the period in which a deduction is allowed for the interest expense;
- Branch operations in New Zealand or overseas;
- Limited partnerships and other entities that are treated differently for tax purposes in different jurisdictions;
- New Zealand unlimited liability companies (with a US “check the box” election);
- Dual resident entities; and
- Any payment on an ordinary cross border loan, which is funding a hybrid arrangement entered into between two non-resident members of a multinational group where the rules of those countries do not negate the hybrid outcome.
In this section of the BEPS disclosures, taxpayers must firstly identify the relevant hybrid disclosure type, being: a hybrid entity/branch/dual resident disclosure; hybrid payment disclosure; hybrid receipt disclosure; double deduction disclosure; or imported mismatch disclosure.
The online form then requires specific details for each hybrid arrangement to be disclosed. This includes details of the counterparty to the arrangement (including tax ID, tax resident jurisdiction), the arrangement’s terms, the amount of counteraction in New Zealand (denied deductions or inclusion of income), the counteraction in another jurisdiction, and a ledger of mismatch amounts and surplus assessable income.
Many taxpayers may read the last couple of paragraphs without much idea of what this means. We have assisted many taxpayers in navigating the complexity of the hybrid rules as well as working with officials to get legislative change where it is required. Completing the hybrid and branch mismatch disclosures is likely to take some time as the appropriate analysis will need to be undertaken on whether a hybrid arrangement exists, including obtaining the relevant information from group members in offshore jurisdictions, and then assessment of the related counteractions and mismatches.
If you have any of the above arrangements in your group then we would recommend getting in touch to work through the rules.
Thin Capitalisation Group Information
This section of the online form requires taxpayers to disclose details that, essentially, unpack information contributing to their thin capitalisation calculation where their New Zealand group debt percentage is 40% or higher at any measurement date during the year.
Broadly the thin capitalisation rules stop foreign-owned New Zealand companies overloading on debt. A number of changes have been made to the thin capitalisation rules to restrict the amount of debt the New Zealand company can have that gives rise to deductible interest. The new rules have imposed a “net asset” test, which means that the debt percentages will now be based on an entity’s assets reduced by the value of “non-debt liabilities” on the company’s balance sheet.
This change is likely to mean that many companies historically complying with the thin capitalisation rules will fall foul of them under the new test, and will have to either restructure their debt or accept that some interest deductions will effectively be denied for tax purposes.
This section is focused on taxpayers with a New Zealand group thin capitalisation percentage of 40% or more, which is below the usual safe harbour threshold of 60%. The 40% test is however connected to the “high BEPS risk” test in the restricted transfer pricing rules as discussed below.
Restricted transfer pricing rules
This section is required to be completed where a taxpayer has NZ$10 million or more of cross-border related party borrowing and therefore is subject to the restricted transfer pricing rules.
The disclosure asks three core questions on the nature of the borrowing for the restricted transfer pricing rules, including whether the interest rate on an existing loan has been reduced (a pricing change), the amount of non-deductible interest under the rules, and whether any concessions have been applied.
The restricted transfer pricing rules provide a prescriptive approach for determining the borrower’s credit rating and determining whether certain features of the loan should be modified or disregarded.
Generally this means that debt that is subject to the regime may have to be priced based on the assumption that the borrower’s credit rating is one notch below the credit rating of the member of the worldwide group with the highest unsecured third party debt (or two notches where the resulting credit rating for the New Zealand-resident borrower will be BBB- or higher), regardless of that borrower’s actual credit rating. This has resulted in a significant change in credit rating for some New Zealand subsidiaries for the purposes of pricing cross-border related debt for tax purposes.
Whether or not this “deemed” credit rating must be used depends on whether the borrower is considered to be at a high risk of BEPS behaviour, having failed one or more of the following tests:
- The borrower has a greater than 40% thin capitalisation ratio, and they exceed the 110% worldwide debt test; or
- Borrowing comes from a jurisdiction, that is not the ultimate parent jurisdiction, where the lender is subject to a lower than 15% tax rate.
Once a credit rating is established, some features of the debt may have to be disregarded or modified when pricing the debt. These features include (among other things) the term of the loan, whether the payment of interest can be deferred for more than 12 months, changes to interest rates that are controlled by the borrower or lender, and whether the debt is subordinated.
In our experience, it has taken considerable time and effort to work through these rules for our clients. In addition, the BEPS disclosures appear to require taxpayers to quantify and disclose the level of non-deductible interest that can be attributed to the adjustment to the borrower’s credit rating and the modified or disregarded features of the loan. In order to undertake this analysis, taxpayers would effectively need to show a reconciliation between the new restricted interest and the arm’s length interest that was applied previously.
Given the level of analysis required, we would recommend that affected taxpayers undertake a comprehensive review of their cross-border related borrowing to ensure there is sufficient documentation to support any interest deductions and the level of analysis required to complete the BEPS disclosures.
As outlined above, the BEPS disclosures require immediate attention for taxpayers with June to September 2019 balance dates.
The BEPS changes are also now in effect for all taxpayers and therefore October 2019 to May 2020 balance dates should already be considering how the rules may impact their tax positions and whether arrangements or financing need to be adjusted.
The rules are complex and affected taxpayers should consider testing application of these rules as soon as possible to ensure there is sufficient analysis and documentation to support the tax positions taken.
If you have any questions or concerns regarding the BEPS disclosures or have not yet considered how the BEPS rules would apply to you, we recommend you contact one of the authors or your usual Deloitte tax advisor before the BEPS disclosures are completed online.
November 2019 Tax Alert contents
· OECD proposes a “unified approach” to addressing the digitalization of the economy
· New compulsory online BEPS disclosure forms now required!
· Stop Press: Inland Revenue releases Multinational Compliance Focus
· Thin capitalisation calculations in a BEPS world
· Attention Wholesalers & Distributors – Are you part of the chosen few?
· Provisional tax changes: Two years on
· Uncertain tax positions – it’s now time to report these in your financial statements
· Deducting holding costs for privately used land that is taxable on sale