In late 2013, the IRD released their Multinational Enterprises Compliance Focus Document. This document outlines the various areas the IRD will be focusing on for the next 12 months with regards to multinational enterprises (MNEs). This article summarises the must read sections of the document. These are important issues MNEs need to consider when assessing their tax risk and IRD audit risk.
The IRD is now obtaining more information from MNEs directly when their tax return is filed under direct compliance management and the Significant Enterprise Initiative. This now includes 500 groups who provide copies of financial statements, tax reconciliations and their group structure with their tax return.
Familiar “red flags” have also been included in the document. These are issues the IRD specifically focuses on
when assessing MNEs’ tax returns. These issues include transactions with low/no tax jurisdictions, the group’s effective tax rate, ownership changes and complex transactions such as group restructuring.
International financing arrangements are another key focus for the IRD and they are specifically watching entities with inbound loans over $10 million, outbound loans where no or low interest rates have been charged and New Zealand’s thin capitalisation rules. Transfer pricing risk is the final key focus for the IRD, this includes transactions that have no documentation, the payment of unsustainable royalty and management fees, transactions with low/no tax jurisdictions and MNEs with recurring losses. For New Zealand exporters, the IRD is focusing on benchmark commodity prices and the recovery of New Zealand costs such as research and development and head office overheads.
How the IRD manages multinational compliance
The IRD now has 500 major groups either under direct compliance management or groups subject to the Significant Enterprises Initiative. This means the IRD now receives copies of financial statements, tax reconciliations and their group structure when they file their tax return.
This information allows the IRD to carry out macro-analysis of industries and the IRD is using this information to examine a wider range of MNEs. With this in mind, MNEs should expect to receive more detailed information requests and audit inquires. The IRD’s expectation is to cover all groups with a turnover of $30 million and over with the above approach. It is a matter of when, and not if, the IRD information request arrives in the post.
Familiar red flags
The following issues have been identified by the IRD as their red flags when assessing MNEs’ tax returns. If the IRD note one of these red flags when assessing your group’s tax return you can almost guarantee a letter from
the IRD requesting documentation supporting the economic justification of the result. If there is no documentation economically justifying the result, your group is at high risk of an in-depth IRD audit.
The ten red flags are as follows:
- 1. Effective tax rate – when a group’s effective tax rate is substantially below the statutory rate of 28%.
- 2. Low/no tax jurisdictions – has the group participated in transactions with low or no tax jurisdictions?
- 3. Differences in treatment – are there material differences in the treatment of major items for financial reporting and tax reporting purposes?
- 4. Large tax benefits – has the group taken part in any transactions where the anticipated return is due to projected tax benefits?
- 5. Cross-border mismatches – are there differences in the tax treatment of a transaction between different jurisdictions?
- 6. Complexity – has the group been involved in any complicated arrangements e.g. major restructures, innovative financial arrangements?
- 7. Capital gains/tax credits – have any untaxed profits been derived (capital gains) or have any unusually high foreign tax or imputation credits been claimed by the group?
- 8. Tax losses – have uncharacteristic losses arisen (or been utilised) across the group as a whole?
- 9. Ownership changes – have there been any ownership changes that may affect continuity tests for tax losses and imputation credits?
- 10. Variances between years – are there material variances in profitability or tax payable from year to year?
International financing arrangements
Key issues with international financing arrangements include the pricing of interest, guarantee fees at market rates and New Zealand’s thin capitalisation rules. The IRD pay close attention to the following issues:
- structured financing arrangements
- hybrid instruments (e.g. mandatory convertible notes) and hybrid entities (e.g. certain foreign limited partnerships)
- unusual financings (e.g. long term subordinated debt facilities)
- exotic or novel financial products
- all inbound loans of more than $10 million
outbound loans of all sizes where there is no or low interest rates and/or no fees charged for guarantees
The IRD will also question groups where interest payments are made with no corresponding non-resident withholding tax or if the approved issuer levy has been returned. The IRD will also closely examine any capital restructurings which result in major reductions in New Zealand tax paid.
Tax payers carrying a high level of debt have a high risk of IRD audit if the transaction would not have taken
place in the open market. The IRD will then question the commerciality of the transaction.
The IRD’s main transfer pricing focus is in the reported bottom line of MNEs. The key question is, has the MNE reported sufficient profits in New Zealand? The major transfer pricing risks and key focus areas identified by the IRD are the following:
- no documentation to support transfer prices
- material levels of untested transactions
- major downwards shifts in profitability of the New Zealand entity when acquired by a multinational
- differing profits between the New Zealand entity and the other entities in the group
- New Zealand management accepting prices set by overseas associates without question
- payment of unsustainable levels of royalties and/or management fees
- transactions with no or low tax jurisdictions
- recurring losses
New Zealand entities exporting through overseas associates should be aware of the following issues identified by the IRD as areas of focus:
- use of correct commodity price benchmarks
- low or no interest loans
- recovery of New Zealand costs e.g. research and development and head office overheads
- offshore operations returning abnormally high profits
The IRD has provided the compliance focus document for MNEs to help assist decision makers in assessing
their IRD audit risk.