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Proving arm’s length pricing is set to become a taxpayer’s burden

Tax Alert - December 2017

By Bart de Gouw and Julian Bryant

Included in the Government’s recent announcements in relation to Base Erosion and Profit Shifting (“BEPS”) (for further details see our March 2017 Tax Alert article) is a proposal to shift the burden of proof for transfer pricing matters from the Commissioner of Inland Revenue to the taxpayer.

This is part of a wide package of measures including an extension of the time bar for transfer pricing matters from four years to seven years, and the granting of greater power to Inland Revenue to collect information from multinational enterprises (“MNE”). The shifting of the burden of proof is likely to require taxpayers to put a greater focus on ensuring that transfer pricing positions are documented appropriately.

Current position

Under New Zealand’s current rules, taxpayers determine the arm’s length amount for their cross-border dealings with related parties. If the Commissioner disagrees with this assessment, she generally has the burden of proof in demonstrating that the related party dealings are not consistent with those that would be agreed by third parties operating at arm’s length.

Shifting the burden of proof

In the discussion documents released in March 2017 and subsequent Cabinet Papers released in August 2017, the Government has confirmed its intention to shift the burden of proof for transfer pricing matters to the taxpayer. This change is expected to be enacted early next year and would apply from income years commencing on or after 1 July 2018. Under the revised position, taxpayers will have the primary obligation of proving that their related party dealings are consistent with those that would be agreed by third parties operating at arm’s length. Inland Revenue considers this change to be consistent with both international practice and other taxation matters under New Zealand’s tax legislation. Further, Inland Revenue considers that given the increasing complexity of multinational structures and transactions, MNEs hold the relevant information and are in a better position to justify the nature of their own transfer pricing practices. 

What this means for you

We anticipate that Inland Revenue may be more aggressive in transfer pricing disputes once it is unshackled from its burden to prove an alternative position to be more reliable. Taxpayers will likely be faced with the prospect of being told that they have not adequately proven their positions, especially if facts are disputed and external benchmarking is not directly on point. Taxpayers will also continue to be exposed to “lack of reasonable care” penalties for incorrect transfer pricing positions taken where there has been a failure to adequately document transfer pricing positions at the time the tax positions are taken.

Transfer pricing documentation will become ever more important in supporting a taxpayer’s position.  In that regard, New Zealand has endorsed the OECD’s recommendations for transfer pricing documentation, which requires documentation to be in the form of a master file and a local file. The master file should provide a high level overview of the MNE’s global operations and transfer pricing policies and will typically be prepared in the jurisdiction in which the MNE is headquartered. Conversely, the local file should provide specific detail on the material related party transactions in the specific jurisdiction that a taxpayer is operating in.

While taxpayers should be able to leverage a global master file that has been prepared in another jurisdiction according to the OECD guidelines, local files prepared in other jurisdictions would almost certainly be insufficient to document the particular features and transactions of the New Zealand entity. A New Zealand local file that explains the New Zealand operations and transfer pricing methodologies would need to be prepared.

Next steps

A Bill in relation to the BEPS measures including the shifting of the burden of proof was introduded in Parliament on 6 December 2017, for enactment by July 2018.

Now is a good time to review your current transfer pricing documentation and supporting evidence to ensure your cross-border related party transactions are accurately and appropriately documented in accordance with OECD guidelines and to a level of detail that would enable the burden of proof to be discharged.

Please contact your usual Deloitte advisor if you would like to discuss these requirements further including the steps you can take to mitigate any potential risks.

December 2017 Tax Alert

December 2017 Tax Alert contents

Tax Alert - December 2017

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