New Zealand transfer pricing update
Tax Alert - May 2015
By Bart de Gouw and Liz Donoghue
New Zealand Inland Revenue Transfer Pricing Focus for 2015 and 2016
Inland Revenue has recently released its transfer pricing focus areas for 2015 and 2016, encompassing the full range of both inbound and outbound associated party transactions.
Inland Revenue’s top priority will be the Significant Enterprises Segment which comprises some 560 taxpayer groups with a reported turnover exceeding NZ$80m, 50% of which are foreign-owned with a further 25% involved in international operations, mainly through controlled foreign companies. Inland Revenue note that these taxpayer groups account for over half of New Zealand's corporate tax base and 10% of overall tax revenue. Inland Revenue has indicated that these companies represent the highest risk of profit shifting due to the extent of their international transactions.
Inland Revenue will continue to refine its risk assessments of all significant enterprises through analysis of annual basic compliance packages (financial statements, tax reconciliations and corporate structures) supplemented by transfer pricing questionnaires.
In regard to issues across all segments of the corporate population, Inland Revenue will maintain a special focus on the following:
- Unexplained tax losses returned by foreign-owned groups;
- Loans in excess of NZ$10m principal and guarantee fees;
- Payment of unsustainable levels of royalties and/or service charges;
- Material associated party transactions with no or low tax jurisdictions;
- Supply chain restructures involving the shifting of any major functions, assets or risks away from New Zealand; and
- Any unusual arrangements or outcomes that may be identified in controlled foreign company disclosures.
Inland Revenue has also advised that it will continue to monitor the profitability of foreign-owned wholesale distributors (i.e. firms that purchase and on-sell goods to other firms without significant transformation), which are the most common multinational business form encountered in New Zealand. For small wholesale distributors (those under $30m in annual turnover), they will seek explanations for any performance resulting in a weighted average profit-before-tax ratio of less than 3%.
Intercompany Service Charges: Administrative Practice and Checklist
To further minimise compliance costs for multinational enterprises and to align with the administrative practice of the Australian Tax Office (ATO) for intercompany service charges, Inland Revenue has raised the de minimus threshold for services from NZ$600,000 to NZ$1m. The higher threshold applies from 1 January 2015.
The administrative practice allows taxpayers to apply a mark-up of 7.5% to the cost of certain non-core services and services with costs below the de minimus threshold of NZ$1m, in the absence of a detailed transfer pricing analysis or benchmarking study. For further detail on Inland Revenue’s administrative practice for services, including the criteria for application of the administrative practice, refer to paragraphs 557 – 570 of the Transfer Pricing Guidelines, noting that the de minimus threshold has not been updated in this document.
Service Charge Checklist
To assist companies operating internationally, including in particular a large number of New Zealand small to medium enterprises, Inland Revenue has compiled a checklist based on its experience in reviewing international service charges.
The message is to understand the charge, go behind the label and document it (the actual services provided, the benefits arising, the basis of the charge, etc).
The cost plus method is generally best, but never rule out the possibility of internal comparables (where similar services are being provided to third parties by the provider).
- Watch out for "duplicated services" - in particular, does the enterprise have an infrastructure in New Zealand which can and does provide the type of services for which charges are also being made from overseas?
- Be wary of charges for directors/chief executives (doing no more than investment monitoring), and overseas regulatory costs (for instance, Sarbanes Oxley compliance costs) - these are most probably non-chargeable "shareholder services".
- Get the cost base right (including New Zealand tax deductibility of items included in cost sharing arrangements) and apply a sanity check - does it make sense, especially in relation to the bottom line?
- Mark-ups must be fair and reasonable in relation to the nature of the service and the risks assumed - for example:
- No mark-up for simply on-charging third party costs;
- Minimal mark-ups for low risk supporting services;
- Higher mark-ups where specialist knowhow or expertise is involved.
- An allocation key should result in a charge proportionate to expected benefits - in this regard, turnover can be too simplistic and arbitrary (don’t just assume a close relationship between services provided and sales without further analysis).
- For outbound direct investment/New Zealand exporters, management and other support services provided to offshore associates (including controlled foreign companies) must be identified and fully charged.
- A branch is not legally distinct from the rest of the enterprise - service charges should therefore be allocated on an actual cost basis only (i.e. no mark-ups).
- Keep in mind other tax obligations such as withholding on services performed in New Zealand by offshore associates and royalties (e.g. knowhow and connected services).
If you require further guidance or for more information please contact a member of the Deloitte transfer pricing team.