Tax alert


Inland Revenue issues the first Large Enterprises Update of 2018

Tax Alert - April 2018

By Mel Meyer & Reyah Tham

In its most recent issue of the Large Enterprises Update (Issue 42, February 2018), Inland Revenue provided an update on several transfer pricing topics. Coming off the back of pending legislative reform currently being considered by the Finance and Expenditure Select Committee, the updates provide a timely indication of the increased awareness Inland Revenue has for developments in this area.

In this article we briefly discuss the Inland Revenue’s positon as indicated by the Large Enterprises Update, what this means and what steps potentially affected taxpayers should take.

Inland Revenue adopts OECD approach for services

Intercompany service charges are a common feature of a multinational’s transfer pricing arrangements, especially in the age of centralised administrative functions and shared services.

Most taxpayer financial controllers and tax specialists (especially in New Zealand and Australia) will be familiar with Inland Revenue’s administrative practice for intragroup services and the ubiquitous 7.5% mark-up on costs allowed without further support for either (1) non-core services or (2) any services with a total cost under the de minimis threshold of NZD1m.

This mark-up has been a common element going back to the introduction of the transfer pricing rules, and like many other elements of New Zealand’s aging transfer pricing regime, is about to receive a make-over.

Specifically, Inland Revenue has confirmed that it will adopt the new guidance provided by the Organisation for Economic Development and Cooperation (OECD) as part of the revised Chapter VII of the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines) for the pricing of “low value adding intra-group services,” to which Inland Revenue has given the somewhat unpronounceable abbreviation of “LVAIGS”.

LVAIGS is essentially a replacement for the current “non-core services” category, which typically refers to services without a direct connection to the group’s income generating activity – i.e. support services.

LVAIGS are similar to non-core services, with the OECD specifying that they:

  • Are of a supportive nature;
  • Are not part of the core business of the MNE Group;
  • Do not require the use, or result in the creation, of unique or valuable intangibles; and
  • Do not involve the assumption of control, or result in the creation, of substantial risk by or for the service provider.

The OECD Guidelines go on to provide some examples, such as

  • Accounting, finance and payroll services;
  • Human resources;
  • IT support;
  • Public relations and marketing;
  • Legal; and
  • General administration

Once LVAIGs have been identified, a mark-up of 5% on the costs incurred in providing the services will be considered to result in an appropriate profit margin. The process involved to apply this is simpler than the current Inland Revenue administrative practice.

The OECD also provides specified documentation and reporting expectations where the LVAIGS approach has been adopted, including specific limited-scope documentation, intercompany agreements and service fee calculations.

While Inland Revenue has indicated it will accept the OECD approach for LVAIGS, the continued application of the existing non-core services threshold (i.e. service fee must be less than 15% of revenue for outbound services or 15% of expenditure for inbound services) is as yet unclear. Inland Revenue has indicated that the existing de minimis threshold for intercompany services with a total cost of not more than NZD1m will remain in place.

If you are a New Zealand taxpayer in a multi-national group receiving or performing these types of intra-group services, now is the ideal time to review your transfer pricing practices and ensure that appropriate steps are taken to embrace the LVAIGs approach or mitigate any risks.

The new approach will apply from income years starting after 1 July 2018.

Inland Revenue comments on topical issues

1.    Guaranteed returns and risk

Inland Revenue issued a brief statement confirming its view on the relationship between guaranteed returns to an entity and its risk profile.

Specifically Inland Revenue has confirmed that the transfer pricing mechanism (i.e. a guaranteed return to the entity) cannot of itself determine the entity’s risk profile for the purposes of assessing the appropriateness of the transfer price, as this argument becomes circular. This is consistent with Inland Revenue’s established view, as well as the OECD’s positon.

We recommend that all multinationals keep this in mind when determining their transfer pricing approach and preparing documentation. Any arrangement involving a guaranteed return should be supported with reference to the limited functions and risks of the entity in commercial business terms, rather than relying on the guaranteed return policy as being evidence of a limited risk profile. 

2.    Synergistic benefits

Inland Revenue has also provided a brief update on its considerations regarding the transfer pricing aspects of group synergies which can arise from, for example, integrated system implementation and centralised procurement.

Inland Revenue does not view synergistic benefits as intangible property, meaning that they should not give rise to royalties or other charges to a New Zealand entity. When determining the allocation of cost savings (profit enhancements) arising from synergistic benefits, Inland Revenue notes that consideration should be given to which parties actually drive these benefits, so that the allocation appropriately reflects the parties’ contributions. For centralised procurement for example, Inland Revenue would not accept that cost savings are solely attributable to the activities of the procurement entity.

Inland Revenue also notes that where synergistic benefits have a material impact on a group’s business operations, comparability adjustments may be necessary when applying a transfer pricing method in the preparation of transfer pricing documentation.

If your group has arrangements that result in group level cost reduction, now would be a good time to consider how this is reflected in your transfer prices.

If you have any questions in relation to the above topics, or need any assistance with your transfer pricing generally, please reach out to a member of our national transfer pricing team. 

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