The Inland Revenue Department (“IRD”), as we expect, is continuing its work tightening the so called “loopholes” in New Zealand’s (“NZ’s”) current tax regime for multinational enterprises (“MNE’s”). Following continued public and media scrutiny, the IRD have introduced several measures as part of the rollout of the OECD’s action plan to combat the base erosion and profit shifting (“BEPS”) of its member countries tax base.
These measures include the introduction of Goods and Services Tax (“GST”) for overseas providers of online services to NZ consumers introduced on 1 October 2016, a direct result of the OECD’s work on taxing the digital economy, and the signing of the OECD’s Multilateral Competent Authority Agreement to facilitate information sharing of Country-by-Country Reports (“CbC Reports”) between tax authorities.
In addition to the measures already introduced, the NZ Herald last week released an IRD briefing document which contained valuable information on the IRD’s future directive towards BEPS. The document identifies that the IRD are looking at proposed changes to interest limitation rules. An IRD spokesperson confirmed to the NZ Herald that discussion documents would likely be released early next year. The OECD’s BEPS action plan identifies interest deductions as a key issue to BEPS for its member countries tax authorities. The action plan further recommends tax authorities to introduce new rates for calculating the maximum deduction allowable for interest payments. This is more commonly referred to as thin capitalisation.
NZ is often thought of as having robust thin capitalisation measures which are currently calculated as a proportion of the tax payer’s debt to total assets. The OECD’s recommendations have identified that maximum interest deductions should be calculated as a portion of earnings before interest tax, depreciation and amortisation, EBITDA, as this clearly has a more direct correlation with a tax payers taxable income. The OECD’s recommended ratio of interest versus EBITDA is between 10% and 30%. Although discussion documents from the IRD are yet to be released, NZ MNEs should now review their interest to EBITDA ratio. Breaching this OECD recommended threshold may result in additional risk and the possibility of time consuming and costly refinancing for the group.
Arguably the most concerning development identified in the IRD briefing document is the consideration of “re-characterisation rules and switching burden of proof for transfer pricing cases”. Currently, the burden of proof lies with the IRD. This means the IRD must provide proof that the MNE tax payers transfer prices are incorrect before proposing a more reliable arm’s length amount. The IRD states that this “reverse burden of proof” reduces taxpayer’s compliance costs.
A change in the burden of proof would essentially require all NZ MNE tax payers to prepare transfer pricing documentation. Without documentation, the taxpayer cannot prove to the IRD that their transfer prices are in accordance with the arm’s length principle. Transfer pricing documentation therefore provides a degree of risk reduction for the tax payer by putting the burden of proof back on the IRD.
This is all a timely reminder of the importance of transfer pricing documentation. Although many MNE groups see their NZ operations as low-risk compared to the global group, the cost of preparing adequate transfer pricing documentation is minimal in comparison to the costs involved with long lasting transfer pricing information requests and IRD audits.