By Leslie Prescott-Haar, Stefan Sunde, & Sophie Day of TP EQuilibrium | AustralAsia LP
New Zealand Inland Revenue on 29 April published final international tax and transfer pricing guidance implementing recently amended legislation that aims to align to the OECD base erosion and profit shifting (BEPS) actions with New Zealand law.
The guidance is comprised of five separate reports, addressing special transfer pricing interest limits for controlled inbound financing, transfer pricing in general, administrative measures, hybrids, and permanent establishments.
The revised legislation, the Taxation (Neutralising Base Erosion and Profit Shifting) Act 2018 (BEPS Act), and Inland Revenue guidance are generally effective for income years beginning on or after 1 July 2018, though some provisions have application from 1 July 2018.
This article will address aspects of the reports on interest limitations, transfer pricing, and administrative measures.
Interest limits on controlled inbound financing
New sections GC 15 – GC 19 of the Income Tax Act 2007 mandate a step test to determine the interest rate applicable to controlled inbound financing transactions.
The key changes contained in the new step test are a prescribed approach to borrower credit rating assessment, with four possible approaches; extension of the rules to foreign lenders that are not simple associated parties through shareholding; and the disregard of certain features for pricing purposes, such as tenors exceeding five years, subordination, and other ‘exotic’ features (payment in kind, interest deferral, promissory notes, etc.), where such features are not comparably evidenced in third-party financing of the lender.
While much commentary has focused on the prescribed credit rating approach, admittedly a significant development, sometimes overlooked is the extension of the rules to foreign lenders, not simply associated through shareholding.
As such, taxpayers must first determine whether the step test could apply to a New Zealand borrower and inbound finance transaction based on the ownership and control structure of the parties outlined in section GC 6 (3B).
In this regard, the New Zealand guidance provides the following:
To be a cross-border related borrowing funds must have been provided to the borrower under which deductible expenditure arises and one or more of the following factors:
- the lender and borrower are associated;
- there is a person or group of persons that has an ownership right of at least 50% in the lender and the borrower;
- the funding is provided through an indirect associated funding arrangement (detailed further on); or
- the lender is part of a non-resident owning body or other group of non-residents acting in concert and that body or group has an ownership right of at least 50% in the borrower.
The first limb refers to subpart YB of the Income Tax Act where New Zealand’s standard tests of association between companies are included.
The second limb expands the concept of association for transfer pricing purposes and aligns this to the thin capitalisation rules to cover other direct control interests in the New Zealand borrower including:
- shareholder decision-making rights in the borrower; which are decision making concerning:
- dividends or other distributions
- constitution of the company
- variation in capital
- appointment of a director
- a right to receive income of the borrower
- a right to receive any of the value of the net assets of the borrower
The new guidance focuses on the possibility that a person or group of persons can control over 50% of one or more of the above-outlined control interests while controlling less than 50% of the share capital of the New Zealand borrower.
Wherever a control interest exceeding 50% is evidenced, a related party borrowing will exist in the case of an inbound finance transaction.
The third limb seeks to “prevent a lender from circumventing the restricted transfer pricing rule by channelling funding through an unassociated person to a New Zealand borrower where direct funding would be covered by one of the other limbs of the cross-border related borrowing definition”. This excludes cash pooling arrangements.
The fourth limb is of particular interest. Where at least 50% of the control and/or ownership rights of a New Zealand borrower are held by a group of foreign unassociated persons, and the foreign unassociated persons ‘act in concert’ (i.e. act cooperatively) in respect of the inbound finance transaction, such a group will be deemed a coordinated group, and subject to the interest limitation rules.
In this regard, if the borrower is owned by a single non-resident with no other business activity, such as a special purpose vehicle, and that non-resident is itself controlled by a coordinated group, the New Zealand borrower will be treated as controlled by a co-ordinated group and therefore subject to these rules.
The expanded definition of ‘related borrowing’ captured in section GC 6 (3B) represents a more comprehensive transfer pricing regime in respect of finance transactions than previously enforced in New Zealand.
Lack of awareness of the extent to which existing inbound financing arrangements are captured under the new rules may be problematic.
In the months ahead, all taxpayers with inbound financing arrangements are encouraged to review these in light of the new rules.
A cooperative and consultative approach should be taken with the New Zealand tax authority wherever possible, in the awareness that these changes were in part a result of the tax administration’s monitoring of such arrangements in recent years.
New Zealand transfer pricing guidance
Modified section GC 13 of the Income Tax Act 2007 adopts a similar approach to that of subdivision 815-B of Australia’s Income Tax Assessment Act 1997, which has led to significant changes in Australian transfer pricing obligations.
Section GC 13 (1) codifies, in accordance with the final 2017 OECD transfer pricing guidelines, a requirement for taxpayers to identify and accurately delineate the tested transaction (GC 13 (1B)) alongside those arm’s length conditions (GC 13 (1)(b)) and benchmarked amounts (GC 13 (1)(c)) that would have been agreed to by independent parties.
Crucially, new provisions within section GC 13 (1C) focus taxpayers on the questions of whether uncontrolled parties dealing at arm’s length would have agreed to either a different transaction or not agreed a transaction at all based on the requirements of the OECD transfer pricing guidelines, paragraph 1.122.
Where the actual identified transaction does not align in substance with the determined arm’s length transaction, the Commissioner of Inland Revenue is given broad discretionary powers to “amend an assessment for a tax year (the assessed year) in order to give effect to this section and to sections GC 6 to GC 12 and GC 14 to GC 19” (GC 13 (6)).
Modified section GC 13 (6) also extends the time bar on transfer pricing matters by allowing the Commissioner to amend an assessment within a seven year period of the tax year for which the relevant tax return was filed if the Commissioner notifies the taxpayer that a tax audit or investigation has commenced within the usual four year time bar.
The arm’s length conditions test outlined above, as in Australia, represents a step-up for taxpayers forced to defend their transfer pricing positions. Evidence that contract terms align with the conduct of the parties, supported by commercial rationale, will be a key focus of New Zealand Inland Revenue.
Onus of proof
Repeal of sections GC 13 (4) and (5) of the Income Tax Act 2007 has shifted the onus of proof in section 149A(2)(b) of the Tax Administration Act 1994 (TAA) for transfer pricing issues onto the taxpayer for income years commencing on or after 1 July 2018.
While this change brings New Zealand in line with most comparable OECD countries, as the Inland Revenue final special reports indicates, “a lack of adequate documentation may make it difficult for the company to rebut alternative arm’s length conditions proposed by [Inland Revenue]”.
In the context of New Zealand’s historic low level of transfer pricing compliance requirements and prior law, which generally placed the burden of proof on the Commissioner, taxpayers should review the new rules closely and holistically and consider forward-looking pricing setting exercises given the material nature and extent of the changes.
Administrative measures
New rules contained in the TAA provide New Zealand Inland Revenue with enhanced powers to collect information and tax from large multinational groups, i.e., companies with global consolidated annual revenues exceeding EUR 750 million.
New section 17 (1CB) of the TAA extends Inland Revenue’s powers to request information under section 17 to include all global members of a multinational group.
New section 21BA enhances Inland Revenue’s ability to enforce compliance in requesting information, barring information not reasonably provided during the investigation and audit phases from being admitted in any court proceedings unless admission would be in the interests of justice.
New section 139AB allows Inland Revenue to impose a penalty of up to $100,000 on large multinational groups that do not co-operate with requests for information.
The final guidance outlines the stepped approach Inland Revenue must take to apply the measures listed above, which includes the issuance of failure to provide notices to the taxpayer.
Tax collection
New section HD 30 allows Inland Revenue to collect tax owed by a nonresident member of a large multinational group from another wholly-owned group member who is a New Zealand resident or that has a permanent establishment in New Zealand.
As such the New Zealand entity is treated as an agent of the foreign-parented large multinational company, and required to pay the tax levied.
New Zealand typically represents a relatively small proportion of turnover for large multinational groups. In recognition of this, Inland Revenue has been a strong proponent of enhanced information and tax collection powers, which powers will inevitably ensure enhanced cooperation and compliance from large multinational groups.
These provisions will likely provide a sharp, and potentially painful, wake-up call to some taxpayers in the years ahead.
The amendments to insert new sections 17(1CB), 21BA, and 139AB into the Tax Administration Act 1994, as well as new section HD 30, apply from 27 June 2018.
— Leslie Prescott-Haar is a Managing Director with TP EQuilibrium | AustralAsia LP
— Stefan Sunde is a Manager with TP EQuilibrium | AustralAsia LP
— Sophie Day is a Senior Analyst with TP EQuilibrium | AustralAsia LP
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