New Zealand: An election year in New Zealand

New Zealand was a relatively early adopter of the principles of transfer pricing, perhaps in recognition of the unavoidability of cross-border trade for a small country. Nowadays, agricultural exports, including dairy, meat, forestry and seafood products, continue to underpin New Zealand's economy and offshore investment in these sectors is relatively common, reflecting New Zealand's capital markets approach to its economy. New Zealand's economy does however show signs of increased diversification, as the technology sector, including software, electronics and telecommunications technology, grow in importance. New Zealand enjoys moderate economic growth of approximately 2% in annual GDP.

New Zealand's primary trading partner has historically been Australia though strengthening relationships between New Zealand and China (including China's first free trade agreement with any developed country) have led to this Asian powerhouse becoming a main trading partner of New Zealand for both imports and exports.

This year is an election year for New Zealand and a change in government is a possibility. New Zealand is relatively unusual in that it does not have a wide-ranging capital gains tax (CGT); however that may be set to change as the introduction of CGT is flagged to be a key election issue by opposition parties. The introduction of CGT would have flow on implications for transfer pricing, including assets valuations as part of business restructurings. This is an area which warrants monitoring for any multinationals with New Zealand operations which are considering restructuring, even without the added complexities of transfer pricing.

Unsurprisingly, given New Zealand's geographically isolated location, it is often at the end of the supply chain for multinational enterprises. With that comes a prevalence of intra-group pricing policies whereby the New Zealand entity earns a modest net margin return, and possibly receives funding from offshore, resulting in further interest deductions.

While Inland Revenue continues to review the consistency of the functional profiles of New Zealand entities with low profit margins (that is, questions whether the characterisation of the New Zealand entity as a limited risk distributor appropriate), inter-group financing is the current hot topic in transfer pricing in New Zealand. Indeed, in the cases we are seeing over half the current Inland Revenue's protracted disputes revolve around intercompany financing transactions, including loans, guarantee fees, debt factoring and foreign exchange risk management. We fully expect this focus on financing will persist.

For multinational groups with New Zealand entities having limited risk profiles, interest deductions remain an option for tax efficiently repatriating funds to parent entities. Accordingly, Inland Revenue has a keen eye on ensuring such transactions comply with the arm's-length principle.

Over the past few years, Inland Revenue has invested in developing significant expertise in the field of banking and financing. This has included hiring specialists with extensive experience in financial institutions who accordingly have detailed knowledge of the global credit markets. These skills are evident in the sophisticated technical approach of Inland Revenue to financing transactions, and the robust and thorough analysis required by taxpayers to support such transactions.

For example, for all loans exceeding NZ$10 million (US$8.4 million), Inland Revenue expects taxpayers to utilise credit assessment tools to evaluate the standalone credit rating of the borrowing entity; relying on generic credit rating data for the group or parent entities is strongly rebutted by the tax authority. The credit rating of the parent or group will only be considered by Inland Revenue in the context of determining whether the borrower may benefit from implicit credit support as a result of global affiliations. In our experience Inland Revenue is a strong proponent of notching up the credit rating of the New Zealand borrower where there is evidence of implicit credit support.

Taxpayers are then required to use market data to determine the arm's-length interest rate taking into account the credit rating of the borrower. In doing so the key terms of the loan at the time the loan is put in place need to be considered. In this regard, some taxpayers have contended that, as with commercial lending arrangements between third parties, charges such as commitment fees, line fees, establishment fees and break fees are appropriate. Inland Revenue has indicated that such fees may be valid in some circumstances; however quantification and supplying arm's-length evidence to support the charges remains a challenging area.

For loans of less than NZ$10 million but more than NZ$2 million, Inland Revenue takes a commercial approach and typically accepts a bank quote as reasonable evidence that the interest rate complies with the arm's-length principle. If taxpayers are to rely on such an approach, it is critical that the bank loan quote matches the intra-group funding in terms of all key elements (for example quantum, currency, security, time of drawdown, maturity).

For loans of less than NZ$2 million, or low-value loans as they are colloquially referred to, Inland Revenue has issued a safe harbour, thus recognising that investing significant time in determining the interest rates for these loans is generally unwarranted. Therefore, taxpayers can opt to rely on a safe harbour interest rate comprising of the relevant base rate plus a margin (set at 275 basis points). The margin is periodically revisited by Inland Revenue in reflection of capital market trends.

For multinational groups headquartered in New Zealand, though financing will still be a key focus area in terms of transfer pricing, market support payments should also be on the radar. Market support payments from a New Zealand principal to an overseas group entity are typically deductible for tax purposes but Inland Revenue prefers the payments to be based on specific costs. Documenting the specific costs being reimbursed is therefore critical.

Inland Revenue is also more likely to scrutinise market support payments when they continue over an extended period of time. This is because of the expectation on the part of Inland Revenue that in the longer term the overseas entity would become profitable or the New Zealand parent would decide not to pursue the market opportunity.

For many multinationals, the size of New Zealand operations is modest relative to the group's activities in other locations. From a New Zealand perspective, however, the domestic activities of the multinational can be significant, and very visible to Inland Revenue. Tax directors therefore would be well advised to take into consideration the relative size of the New Zealand economy when deciding what transactions to document from a transfer pricing perspective, as well as being open to dealing with Inland Revenue. As an indication of the quantum of transactions attracting Inland Revenue attention, New Zealand's safe harbour for intercompany loans only applies to loans of less than NZ$2 million (US$1.6 million).

The New Zealand Inland Revenue formally adopted the arm's-length principle in 1996 and has since developed significant technical expertise in the field of transfer pricing. This is clearly evident in the sophisticated, yet generally commercial, approaches taken by the tax authority in their interactions with taxpayers in relation to transfer pricing. In this regard, Inland Revenue nowadays places greater emphasis on the OECD Transfer Pricing Guidelines for Tax Administrations and Multinational Enterprises (OECD Guidelines) vis-a-vis the formal New Zealand transfer pricing guidelines which it released in 2000.

For many taxpayers, the receipt of a transfer pricing questionnaire will be the starting point for interactions with Inland Revenue in relation to their cross-border intercompany transactions. This questionnaire continues to be used by Inland Revenue as a risk assessment tool and is therefore designed to gather high-level information on factors such as the nature, quantum and pricing methodologies for related party transactions. Areas such as the activities and level of debt of the New Zealand entity relative to those of the group are also covered by the questionnaire.

The transfer pricing questionnaire includes a question as to whether transfer pricing documentation has been prepared to support the taxpayer's transfer prices in accordance with New Zealand transfer pricing guidelines. While at present there are no technical contemporaneous documentation requirements in New Zealand there is a practical requirement to have documentation in place from a compliance perspective. Specifically, New Zealand's legislation requires that a transfer pricing method is applied, which in practice must be evidenced through documentation. Therefore, responding in the negative to this question usually results in additional enquiries from Inland Revenue.

While Inland Revenue may issue a transfer pricing questionnaire independently of other enquiries, more commonly it arises as part of a general tax review or audit.

Inland Revenue has publicly endorsed the work of the OECD on base erosion and profit shifting (BEPS). New Zealand is an active participant at discussions regarding BEPS and has signalled that it will take a principled and co-operative approach to the recommendations of the OECD around this global focus.

Of those areas under consideration as part of BEPS, those relating to the disclosure of information and the digital economy may have the greatest implications for New Zealand taxpayers. To date, Inland Revenue has taken a practical, risk-based approach to gathering information from taxpayers on cross-border related party transactions. However, depending on the recommendations of the OECD around country-by-country reporting and the response from Inland Revenue, taxpayers may find themselves needing to revisit and extend their transfer pricing documentation approach. In response to this, some taxpayers are anticipating changes and restructuring their existing documentation to adopt a master file and country appendices structure.

Digital economy developments are important from a New Zealand perspective as New Zealanders purchase significant quantities of goods via the internet. These transactions are already on Inland Revenue's radar as they have revenue collection implications in terms of GST.

Looking forward, practical challenges remain for taxpayers importing goods into New Zealand which have been purchased from related parties. Legislative hurdles exist from a New Zealand Customs' perspective to using transfer pricing documentation to support the valuation of imported goods and, in many instances, customs and transfer pricing valuation methodologies lead to different results. While Inland Revenue and the New Zealand Customs Service are actively exploring options to alleviate the current difficulties, a resolution is not anticipated in the immediate future.

While Inland Revenue's standard of technical analysis is extremely robust, communications between the Inland Revenue and taxpayers are generally less adversarial than may be expected by taxpayers who are used to dealing with the authorities in jurisdictions such as Canada and Australia. Inland Revenue promotes full disclosure of information, frank dialogue and is typically commercial in its approach to transfer pricing. Therefore, when entering into discussions with Inland Revenue, taxpayers would be advised to approach the process with a cooperative mindset. Creating the impression that a taxpayer is hindering the provision of information or is stalling for time can have particularly negative consequences.

The prevalence of unilateral advance pricing agreements (APAs) as a mechanism for minimising compliance costs and resolving transfer pricing audits is perhaps higher than in most other jurisdictions globally. Therefore, for taxpayers looking for certainty around transfer pricing within a purely domestic New Zealand context, a unilateral APA is likely to be an attractive option. On a practical level, in our experience Inland Revenue has a highly cooperative attitude to taxpayers which proactively approach the tax authority.

At an Inland Revenue policy level, APAs are strongly supported and encouraged for taxpayers and, accordingly, Inland Revenue has set itself ambitious target timeframes for concluding agreements. Encouragingly the timeframes, such as six months for a unilateral APA, are usually achieved. Further, Inland Revenue has publicly stated that they will support taxpayers in a mutual agreement procedure (MAP) if the taxpayer has previously entered into a unilateral APA with Inland Revenue in relation to the contended transaction.

Biography
		Kim Jarrett KPMG in New Zealand 18 Viaduct Harbour Avenue Auckland 1140 New Zealand Tel: +64 9 363 3532 Fax: +64 9 367 5871 Email: kmjarrett@kpmg.co.nz Kim heads KPMG's New Zealand transfer pricing and customs practice is also instrumental in the international trade services team. She is a cross-border tax specialist and has a broad range of general tax, transfer pricing and customs experience. Kim has significant experience advising inbound and outbound clients on transfer pricing and customs issues and assisting New Zealand headquartered clients develop efficient global transfer pricing strategies. Kim has an excellent reputation for her technical skills, her approach to the management of transfer pricing disputes, and her strong focus on service delivery. She has guided a number of New Zealand based clients investing offshore, including which structure fits the group's operating and commercial structure best. Kim has the ability to communicate at the highest level, and has direct experience in presenting on transfer pricing matters to directors, senior executives and Inland Revenue.

Biography
		Kimberley Bruneau KPMG in New Zealand 18 Viaduct Harbour Avenue Auckland 1140 New Zealand Tel: +64 9 367 5854 Fax: +64 9 367 5871 Email: kbruneau@kpmg.co.nz Kimberley is a senior manager in KPMG's New Zealand transfer pricing team. Kimberley commenced her career with KPMG New Zealand in 2004 in the tax division where she provided assistance with corporate tax, transfer pricing and customs. In this role she built a strong foundation from which to advise clients on the broader tax implications of transfer pricing strategies. Kimberley spent three years with KPMG Hong Kong as part of the Asia Pacific regional transfer pricing team. There she was heavily involved in transfer pricing projects with a regional or global focus, including those establishing and defending group-wide transfer pricing strategies. In this role she gained exposure to the diverse spectrum of tax authority approaches to transfer pricing, and developed a commercial approach to intra-group pricing. Kimberley now leverages her international experience in the international trade service team and assists New Zealand companies looking to expand into the global market.

Biography
		Kyle Finnerty KPMG in New Zealand 18 Viaduct Harbour Avenue Auckland 1140 New Zealand Tel: +64 9 367 5951 Fax: +64 9 367 5871 Email: kylefinnerty@kpmg.co.nz Kyle has been with KPMG since 2006 and part of KPMG's transfer pricing practice in Canada and now New Zealand since 2011. Kyle is a Canadian Chartered Professional Accountant and has worked in the transfer pricing, auditing and IES practices during his tenure at KPMG. The experience he has gained from the diverse range of disciplines allows him to bring a broader international trade services perspective of business understanding when advising clients on transfer pricing issues. Kyle has provided transfer pricing advice on a variety of topics from guarantee fees to management fees, for most industries such as pharmaceutical, energy and technology. As part of KPMG Canada's transfer pricing team, Kyle specialised in dispute resolution with experience in taxation authority audits, preparing notices of objection and competent authority requests. On KPMG New Zealand's transfer pricing team, Kyle specialises in interest rate benchmarking for related party cross-border loans.