EY has released its latest report on transfer pricing. It makes crucial reading for any business trying to anticipate future audit risk.
Key risk areas for audits and disputes
Controversy avoidance and resolution is the third report in EY’s 2016-17 Transfer Pricing Survey Series. The report focuses on the closely related areas of controversy avoidance and dispute resolution and highlights the key risk areas as:
- Transfer pricing of intangible property.
- Transfer pricing of intragroup financial arrangements.
- Permanent establishments (PEs).
We see the same risks in New Zealand and have recently seen a spike in the number of audits and disputes relating to intangible property, intragroup financing and PEs.
Transfer pricing of intangible property
The pricing of intangible property is an area of increasing focus as more global business profits are driven by valuable intangibles.
Intangible property is one of the most complex areas in transfer pricing as it can be hard to recognise, define and value.
- For a New Zealand owned group, Inland Revenue is interested in whether overseas subsidiaries are paying an arm’s length amount for any benefit received from the use of intangibles developed and owned in New Zealand.
- For New Zealand subsidiaries of an overseas owned multinational, Inland Revenue will focus on whether the New Zealand entity is deriving a benefit from any intangible property and whether the remuneration for the use of the intangible property, usually by way of a royalty payment, is arm’s length.
Transfer pricing of intragroup financial arrangements
We are seeing heightened Inland Revenue audit activity in relation to intragroup funding, in particular on inbound loans and any non-vanilla lending.
The Government has recently announced it is considering implementing a cap on the deductible interest rate on inbound loans. As covered in our March 2017 Tax Watch, under the new proposals, loans would be priced based on a maximum five year term and priced as senior unsecured debt, by reference to the parent company’s credit rating.
These changes are driven by the view that parent entities of New Zealand borrowers are incorporating commercially unrealistic terms in loan agreements in pursuit of higher interest rates. In this climate, when pricing inbound debt, taxpayers must give careful consideration to the New Zealand proposals and current Inland Revenue activity. Expert advice is essential when implementing and reviewing intragroup funding arrangements.
PEs are especially at risk - and not just from lack of substance
Despite proposed changes not yet being enacted, Inland Revenue is already asserting PEs exist in New Zealand, particularly in respect of low tax jurisdictions. Inland Revenue has been increasing its resources and appetite to push through formal disputes in these areas.
We have also seen Inland Revenue arguing, at the same time the Australian Tax Office challenges the substance of the branch, that the company as a whole is resident in New Zealand on the basis its centre of management is, in effect, its New Zealand branch. This outcome can have adverse tax consequences in both New Zealand and Australia.
What can you do?
Revenue authorities have more information than ever before and are already working out the most effective audits to undertake. To get ready for this, the report recommends:
- Assess your structure and risk profile. The best way to address disputes is to avoid them in the first place.
- Good governance is key to managing risk. It is essential to maximise communication channels within the wider business including Human Resources, Group Counsel, regulatory, tax and treasury functions of multinationals.
- Get your documentation in order. Having your case ready to go can improve your stance with authorities, leading to a quicker and more likely positive resolution.
- Centralising the management of audits (and any disputes). A centralised team for handling disputes is essential.
- Pursue advance pricing arrangements (APAs). Where risks are significant or material, companies should seek to mitigate their downside with unilateral, bilateral or even multilateral APAs.
We are seeing New Zealand taxpayers proactively undertaking PE reviews to identify the key pressure points, reviewing intragroup financing transactions and compiling audit readiness evidence files to help facilitate the swift and comprehensive response to Inland Revenue queries.
Information sharing with other revenue authorities
Inland Revenue is increasingly sharing the information it receives from audits with other revenue authorities, allowing revenue authorities to capitalise on any inconsistencies in the company’s position. Although in a global sense the dollars at stake in New Zealand may be small, the exchanges of information between revenue authorities around the world means that New Zealand can represent a bigger risk than anticipated.
EY and EY Law have assisted a number of multinational clients in assessing their transfer pricing and tax controversy risk and providing practical recommendations for managing these risks. Please contact us for further information.