Multinationals are the focus of the IRD for the next two years
Transfer pricing has again hit the headlines and the IRD is tightening its review of multinational businesses and their related party cross border transactions. In a release dated 10 April, the IRD stated a two year focus on the Significant Enterprises Sector being taxpayer groups with turnover in excess of $80m. This sector comprises 560 tax payer groups and although only half of these are foreign-owned, the IRD has identified particular transactions that will be actively reviewed affecting multinational businesses of all sizes.
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The specific transactions the IRD will be actively reviewing are;
- Unexplained tax losses
- Loans in excess of $10m
- Payment of unsustainable royalties and service charges
- Material transactions with low tax jurisdictions
- Supply chain restructures out of New Zealand
- Unusual arrangements or outcomes
Most of the above transactions can be identified by the IRD in the IR10 disclosure filed with each year’s income tax return. Other information will be obtained through the IRD’s transfer pricing questionnaires, something the IRD are using in increasing numbers.
Intercompany loans and service charges are two of the most common transactions for New Zealand multinationals, overseas owned subsidiaries or branches of overseas companies. These transactions are specifically disclosed to the IRD in the income tax return therefore it would be highly recommended that New Zealand entities with loans over $10m and/or service charges prepare transfer pricing documentation and/or update existing documentation. This is increasingly important should the entity also be in a tax loss position as this covers three of the IRDs focus points.
Lack of adequate transfer pricing documentation in the above situations creates a high level of IRD audit risk.
The most interesting change in the IRD’s update was relating to service charges, often identified by many businesses as management fees. The IRD has increased the de minimis threshold for its administrative practice for service charges to NZ$1 million to align with our Australian counterparts. This means that adequate transfer pricing documentation for these transactions is no longer a huge compliance cost for the tax payer.
Given the increased focus on related party cross-border transactions, it is important tax payers review their transfer pricing documentation to ensure it is up-to-date. The IRD’s narrative on documentation states that although there is no statutory requirement to prepare transfer pricing documentation;
“if a company’s documentation inadequately explains why its transfer prices are considered to be consistent with the arm’s length principle, we are more likely to audit those transfer prices in detail”
Given there is no statutory documentation requirement, there is a common misconception among New Zealand businesses that a simple agreement between the related parties or a calculation of how the transfer price is arrived at is sufficient. This is not the case and the above implies a higher level of documentation is required.
Further to identifying specific transactions for review, the IRD has branded wholesale distributors as the most common form of multinational business in New Zealand. This means entities in this sector automatically have a high level of IRD audit risk. For those wholesale distributors defined as small, turnover of under $30m, the IRD has stated they will seek clarification where performance results in a weighted average profit-before-tax of less than 3% of sales.
If you would like to find out more detail, please call your usual advisor at RSM.