New Zealand Inland Revenue proposes new weapons in its transfer pricing arsenal

The years 2016 and 2017 have seen unprecedented levels of change in the New Zealand transfer pricing landscape. KPMG professionals have observed significantly increased audit activity of multinationals, evidence of increased information sharing between tax authorities, in addition to which three consultation papers were released in March 2017 which seek to impose far reaching changes to the New Zealand transfer pricing legislative environment.

As a consequence, multinational entities operating in New Zealand are now exposed to a much higher level of uncertainty and risk, and will need to ensure that they have appropriate and robust transfer pricing documentation in place which supports pricing models implemented.

In March 2017 the New Zealand government released three consultation papers proposing changes to New Zealand's transfer pricing, permanent establishment and thin capitalisation legislation. Not only do these measures seek to align New Zealand with the prevailing position of many global tax authorities in relation to the ongoing BEPS measures, they appear to go further, adopting many of the rules recently introduced in Australia on re-characterisation and permanent establishment avoidance.

As a consequence of these rules, KPMG professionals expect increased disputes between taxpayers and Inland Revenue. It would therefore be prudent for multinationals operating in New Zealand to ensure they have worked through the implications of proposed rules for their transfer pricing operating models.

While still subject to consultation, final rules are expected to be issued at some stage after the New Zealand general election in September 2017, with application anticipated to be from April 1 2019 (for March balance dates).

Key proposals are discussed below:

The proposals are aimed at strengthening New Zealand's transfer pricing rules by:

• Allowing Inland Revenue to disregard transfer pricing arrangements where legal form does not align with economic substance. This will effectively allow Inland Revenue to re-characterise transactions to impute what it considers to be arm's length conditions;

• Shifting the burden of proof for transfer pricing disputes from Inland Revenue to taxpayers, and extending the period Inland Revenue can challenge a transfer pricing matter to seven years (from the current four years); and

• Increasing Inland Revenue powers to access information, including allowing it to issue an adjustment to large multinationals that are uncooperative based on the information available at the time. This will still be subject to the normal disputes process, although it is proposed that the disputed tax will need to be paid earlier in the process.

The introduction of a transfer pricing re-characterisation rule is aimed at commercially irrational arrangements that would not be entered into by third parties. Like the permanent establishment avoidance rule, it follows Australia in introducing such a rule.

It is worth bearing in mind that some transactions within a multinational group only arise by virtue of it being a multinational. This does not mean that the transactions are commercially irrational. KPMG in New Zealand has submitted that an exceptional circumstances condition for application of the re-characterisation rule should be included in the new rules if the intention is to only apply it to aggressive arrangements (as is supported by the OECD's position on re-characterisation). If not, this has the potential to drastically increase uncertainty for multinationals operating in New Zealand.

Another key change is to the onus of proof in transfer pricing matters, moving from Inland Revenue to taxpayers. This change is less surprising and has long been signalled by Inland Revenue as a likely change to the transfer pricing rules.

The new administrative rules to buttress Inland Revenue's access to information will allow the Commissioner to impute an uncooperative large MNE's tax liability based on information it holds. The justification is the asymmetry of information held by Inland Revenue versus the multinational (again, to encourage affected multinationals to comply). However, KPMG considers that in the current environment, information asymmetry cuts both ways, as Inland Revenue receives information from other tax authorities (e.g. under country-by-country reporting and other information exchanges). The Inland Revenue may also have comparables data the taxpayer does not on which it bases its assessment.

The proposal to shift the transfer pricing "statute bar" to seven years has been justified by Inland Revenue on the basis that transfer pricing issues can take longer to investigate (and other countries, notably Canada and Australia, having similar time frames). The aim of Inland Revenue's ongoing business transformation project, whereby Inland Revenue's systems and process are being redesigned for the 21st century, is faster, more certain action by Inland Revenue. Extending the statute bar period would seem to be contrary to Inland Revenue's business transformation goals.

The proposals centre around a rule to stop large multinationals (i.e. with global turnover greater than €750 million ($836 million)) avoiding a New Zealand permanent establishment by using a New Zealand-related party to support local sales activities. The rule will apply:

• Where there are sales to New Zealand consumers or businesses by a non-resident supplier;

• A related entity in New Zealand (e.g. a subsidiary or dependent agent) carries out activities in New Zealand using local employees to bring about those sales;

• Some or all of the sales are not attributed to a New Zealand permanent establishment; and

• The arrangement is designed to defeat the intention of New Zealand's tax treaties.

This permanent establishment avoidance rule is broadly based on elements of the diverted profits tax in the UK and Australia's multinational anti-avoidance law. This is aimed at what the government considers are in country sales, rather than sales to consumers in New Zealand. However, it is worth noting that use of third party as well as related party sales channels can create a New Zealand permanent establishment under the proposals. Inland Revenue states that the aim is to change large foreign-owned multinational behaviour, rather than collect revenue.

Where sales are attributed to a New Zealand permanent establishment, transfer pricing concepts will be required to allocate the correct level of income and expenditure to this permanent establishment.

While the government is not proposing to replace the current thin capitalisation interest limitation rules (which are based on debt-to-assets), it is proposing a number of changes to strengthen these rules, including:

• Limiting the interest rate on related party debt to that based on the credit rating of the ultimate parent (plus a margin), i.e. an interest rate cap. The applicable margin proposed has been the equivalent of one credit rating notch below that of the ultimate parent. This cap is designed to anchor New Zealand interest deductions to a wider multinational's total cost of funds (i.e. that of the multinational group and not the credit rating of the New Zealand borrower).

• Requiring an adjustment to assets in the thin capitalisation calculation to require these to net-off against non-debt liabilities in the balance sheet other than interest-free loans (e.g. trade creditors and provisions).

The implementation of an interest rate cap would make New Zealand unique around the world. This has the potential to be a blunt instrument, for what will be widely varying circumstances across taxpayers. It assumes the New Zealand operations have the same assets, risks and functions as the parent (or rest of the group). To demonstrate otherwise, the New Zealand subsidiary (or group) will need its own public credit rating. The adoption of this rule has the potential to not only put New Zealand out of step with the majority of counter-party jurisdictions, it will also significantly limit interest deductions for New Zealand members of multinational groups and may lead to double tax.

The change to net rather than gross assets has the potential to shift the thin capitalisation "safe harbour" more significantly and much less predictably. Its effect will vary compared to the current 60% safe harbour depending on the role and size of non-debt liabilities. KPMG professionals expect this will push up thin capitalisation ratios, thereby increasing the incidence of interest deductions being denied for New Zealand members of multinational groups.

The government has signed the multilateral instrument on June 8 2017. This consultation paper confirms the broad shape of how the multilateral instrument will be implemented in New Zealand. New Zealand's preferred approach is for comprehensive adoption of the substantive multilateral instrument BEPS provisions (including those that are not minimum standards for adopting the MLI). This compares with potentially more selective adoption of the multilateral instrument BEPS provisions by other countries. This may impact which of New Zealand's double tax agreements will be covered agreements under the multilateral instrument.

Despite the dramatic shifts proposed above, Inland Revenue has remained steadfast to its position that no legislation is necessary to require country-by-country reporting for New Zealand members of multinationals in New Zealand.

Consistent with this, Inland Revenue has not, and at this stage has no intention of, legislating to require the adoption of the master and local file approach by New Zealand members of multinational groups. However, in practice Inland Revenue has specified on a number of occasions that it considers the master and local file approach to be the 'norm' for taxpayers.

While no specific increase in resourcing in the transfer pricing space has yet to occur, Inland Revenue now has access to a range of risk assessment tools to better identify and target transfer pricing matters. These now primarily include:

• A basic compliance package (BCP) issued to all New Zealand taxpayers with turnover greater than NZ$30 million ($21 million), requiring submission of financial information and group structure details; and

• An international questionnaire to foreign-owned taxpayer groups, which requests information in relation to the taxpayer's financing/debt and transfer pricing.

These risk assessment tools have been supplemented with greater access to information from foreign tax authorities under wider information sharing powers.

As expected, this has led to the highest volume of Inland Revenue dispute activity seen to date. Not only is this in terms of the number of multinationals under audit, but also the duration and scope of these audits. KPMG professionals have observed a number of instances where Inland Revenue appears to be following on closely from the audit activity being undertaken by the Australian Tax Office (ATO). In particular, we have seen audit activity focus on foreign-owned multinationals (as opposed to New Zealand-owned multinationals), with close attention on service-providers across the technology (and related) industries, where revenue generated from local New Zealand customers is being contracted for and recorded by an offshore entity within that multinational group (i.e. targeting perceived permanent establishment avoidance, or insufficient compensation for New Zealand value adding functions).

KPMG professionals have also seen a continued focus by Inland Revenue on cross border financing activity, where inbound loans exceed NZ$10 million, with a number of long-term disputes involving multinationals currently in progress.

This increase in audit activity has inevitably led to an increased level of unilateral and bilateral advance pricing agreements (APAs), as taxpayers seek to minimise the risk and uncertainty associated with a prolonged New Zealand transfer pricing dispute.

The past 12 months have seen a significant shift in the transfer pricing landscape for multinational entities operating in New Zealand. The increasing incidence of lengthy transfer pricing disputes, driven by BEPS and the combination of more focused risk assessment, in conjunction with greater information sharing between overseas tax authorities, has led to a much greater need for multinationals to consider the unique aspects of New Zealand transfer pricing. Inland Revenue has further layered this uncertainty through its proposed transfer pricing and thin capitalisation rules. As a consequence, multinationals will need to carefully watch upcoming developments in New Zealand, and to ensure that their documentation and pricing models are sufficiently robust and detailed in order to navigate this increased complexity.

Kim Jarrett

Partner KPMG in New Zealand 18 Viaduct Harbour Avenue, Auckland Tel: +64 9 363 3532 kmjarrett@kpmg.co.nz Kim leads KPMG in New Zealand's transfer pricing team, with experience advising on transfer pricing issues, advance pricing agreements, documentation and dispute resolution. Kim has guided many foreign based multinationals investing into New Zealand, assisting them with establishing appropriate transfer pricing policies and complying with related customs obligations. Kim has the ability to communicate at the highest level and has experience presenting to directors, senior executives and Inland Revenue and has chaired and presented at many customs and transfer pricing seminars both in New Zealand and overseas.

Kimberley Bruneau
	Director KPMG in New Zealand 18 Viaduct Harbour Avenue, Auckland Tel: +64 9 367 5854 kbruneau@kpmg.co.nz Kimberley is a director in KPMG in New Zealand's transfer pricing team. Kimberley has over ten years' transfer pricing and international tax experience, including four years working with KPMG in Hong Kong.

Jordan Taylor

Senior Manager KPMG in New Zealand 18 Viaduct Harbour Avenue, Auckland Tel: +64 9 363 3474 jordantaylor@kpmg.co.nz Jordan commenced his transfer pricing career at KPMG in 2009, and has specialised in providing advice to clients on a range transfer pricing, supply chain and commercial issues, advance pricing agreements, audits, documentation and dispute resolution. Jordan's experience covers both New Zealand-headquartered multinationals, as well as New Zealand-based subsidiaries of foreign owned multinationals. Jordan has supplemented his New Zealand experience by undertaking secondments to KPMG in the UK's London practice and KPMG in Indonesia, as well as spending time working at one of Australasia's largest banks.