Post-BEPS transfer pricing legislation refresh requires taxpayer action
Tax Alert - May 2018
In August 2017 the New Zealand Government announced a comprehensive package of tax measures impacting multinationals, which were motivated by base erosion and profit shifting (BEPS) concerns. These proposals are now contained in the Taxation (Neutralising Base Erosion and Profit Shifting) Bill, which is before parliament and expected to be enacted by 30 June 2018.
Within these proposals are significant changes to New Zealand transfer pricing legislation, including modifications to the rules for establishing and defending arm’s length amounts for cross-border related party transactions, and a prescribed approach to the pricing of related party debt. Combined with related proposals to expand Inland Revenue’s audit powers, and similar developments by tax authorities in other jurisdictions, there is a heightened importance in focussing on transfer pricing issues in the current environment.
We set out below considerations and actions for taxpayers to undertake prior to and immediately following the enactment of the Bill into legislation.
Limitations to interest deductibility on cross-border associated party debt
As set out in our earlier Tax Alert article (available here), the Bill introduces significant changes to the methods for determining the appropriate interest rate on in-bound associated party loans, which may impact a taxpayer’s ability to claim a deduction for interest costs. Specific rules can apply to determine the credit rating of a New Zealand entity (typically one notch below an ultimate parent’s credit rating) and to remove “exotic” features of a loan (e.g. terms greater than 5 years).
In advance of the proposed interest limitation rules (set to apply to income years commencing on or after 1 July 2018) taxpayers should assess the financial impact of the changes on their inbound related party debt in order to plan tax payments and financing arrangements.
The rules will have the most significant impact on taxpayers with loans exceeding NZD $10 million where there is considered be a high “BEPS risk”, which will typically occur when any of the following factors are present:
- A high leverage ratio, i.e. a debt percentage exceeding 40%.
- The lender is located in a low tax rate jurisdiction, i.e. where there is a tax rate of less than 15%.
As there is a lot of complexity in the rules including specific exceptions in certain cases, now is the time to be considering potential impacts and whether any action is required.
If you consider you may be impacted by the proposed interest limitation rules, then please reach out to your usual Deloitte advisor or the Deloitte transfer pricing team directly. We have developed an impact assessment tool which may assist in determining potential impacts of these proposed rules.
Other changes to the transfer pricing rules
The Bill also includes significant modifications to the rules for the calculation of arm’s length amounts for non-debt cross-border transactions. Primary amongst the changes is the adoption of the revised 2017 OECD Transfer Pricing Guidelines (“OECD Guidelines”) into domestic legislation. The OECD Guidelines reflect global trends towards greater transparency and adopting a substance over form approach.
In relation to transfer pricing arrangements, the revised transfer pricing rules require a determination of arm’s length conditions through “accurately delineating” an arrangement, using the approach set out in Chapter 1 of the OECD Guidelines. This is a substance-based approach which requires detailed consideration of the relevant facts and circumstances - and often requires, in addition to a review of contractual form, a consideration of which personnel are responsible for performing important decision-making and risk controlling functions. The revised transfer pricing rules also allow Inland Revenue to reconstruct or disregard transactions in cases where the arrangements would not be entered into by third parties operating at arm’s length.
With the heightened focus on substance and conduct, it is important for taxpayers to reflect on whether the pricing methodology they adopt in respect of their intercompany transactions is appropriate and reflects the functionality of the relevant businesses. Particular challenges can arise where key management personnel are based in a different location to staff or important assets (including intangible property).
It is also important to reflect on whether appropriate and up to date supporting documentation has been prepared demonstrating that appropriate analysis has been carried out. The OECD Guidelines provide guidance in relation to matters that need to be considered. For example, where there are significant risks impacting the business, it is important to identify which personnel are responsible for specific risk management functions, including decisions in relation to taking on, responding to, and mitigating risks, and who is responsible for financially bearing those risks; and where there are transactions involving intangible assets, it is important to identify (as one element) which personnel are responsible for key decisions in relation to the development, enhancement, maintenance, protection and exploitation of the intangibles.
OECD Guidelines requires taxpayers to set out the relevant details in a two-tier documentation format including a group master file (which could be produced by group headquarters in another jurisdiction) and a New Zealand local file, which should include the range of information listed in Chapter 5 of the OECD Guidelines. While the group master file will only need to be prepared in New Zealand for New Zealand owned MNEs, in our experience this two tier documentation requires significantly more work than a one tier/one sided analysis. Inland Revenue has endorsed the two tier approach and has provided no express de-minimis threshold in respect of the preparation of documentation. How these rules will be applied in practice is still uncertain.
Preparing contemporaneous documentation is generally more cost-effective and efficient than dealing with queries from a tax authority down the track. Lack of documentation or inconsistent intercompany agreements also risks Inland Revenue establishing its own view and assumptions in respect of the nature of a taxpayer’s business, which could result in lengthy arguments to correct the position. Under the proposed changes to Inland Revenue’s audit powers, the onus of proof for demonstrating that a transfer pricing position aligns with arm’s length conditions is shifted from Inland Revenue to the taxpayer, and the time bar for transfer pricing matters will extend from four years to seven years. This shifting of the onus of proof will greatly increase the importance of preparing annual documentation on a contemporaneous basis.
We consider that the key actions for taxpayers to take now include the following:
- Consider whether New Zealand entities have, or are likely to have, in-bound associated party debt exceeding NZD $10 million at any time during the year. If so, we recommend considering the impact of the proposed rules as described above.
- Review intercompany agreements and consider whether they accurately represent the substantive economic and commercial relationship between group entities, and whether third parties at arm’s length would enter into such arrangements.
- Review supporting documentation prepared for New Zealand entities and consider whether the documentation is in the prescribed form with appropriate detail on the relevant businesses and relationships.
If you would like to discuss with us the most effective way of ensuring that your cross-border transactions are appropriately supported under the new transfer pricing rules, please contact us.
May 2018 Tax Alert contents
- New Zealand GST on low value imported goods announced
- Buyer beware: ring fencing may be here
- Australia’s GST on low value goods - what you need to know
- Research & development tax incentive
- Employee Share Schemes – It’s time to act
- Are you ready to file your final FBT return?
- Post-BEPS transfer pricing legislation refresh requires taxpayer action
- How non-residents can get an IRD number without a bank account
- Have your say on taxing short-term accommodation
- Recent Developments