Multinationals come under the compliance spotlight
Last week Inland Revenue released a compliance focus document aimed at multinationals. The term multinational is used as the document draws a lot of its themes from the current global focus on multinationals and base erosion and profit shifting concerns. However, all medium to large New Zealand companies should be cognisant of the proposals in this document.
While there are some useful checklists included, this document is also peppered with statements which can effectively be interpreted as “you have been warned, so get your ducks in order before we come calling” which is no doubt intended to encourage compliant behaviour by taxpayers. Some comments however, also run the risk of frightening off those that want to do business in New Zealand or New Zealand enterprises who wish to expand internationally as tax outcomes of doing business could be less certain or more costly.
Cross-border financing arrangements
As cross-border financing typically forms a substantial part of total associated party dealings, it is top of the hit list for Inland Revenue. Particular issues include:
- Structured financing arrangements
- Hybrid instruments (e.g. mandatory convertible notes)
- Hybrid entities (e.g. certain limited partnerships)
- Unusual financing arrangements, exotic or novel financing products
- All inbound loans of more than $10million
- Outbound loans of all sizes with no interest or where no fee is charged for a guarantee
Using these arrangements will likely attract attention and so the key message is to ensure your reasons for using these types of arrangements are commercial first and foremost and that all internal and external documentation support this.
The emerging trend is for Inland Revenue to threaten to use the general anti-avoidance provision even though taxpayers may meet the black letter tax provisions. The example cited in this document is where a taxpayer satisfies the debt to asset ratio provided for in the thin capitalisation rules. Inland Revenue go on to state that if a loan would not have taken place in the open market it may question the commerciality of the financing arrangement between the parties and would consider using the anti-avoidance provision.
Interest deductions and NRWT
There is a growing focus around interest deductions and checking to see if any corresponding non-resident withholding tax or approved issuer levy has been paid. In the latest Tax Policy Report on the Taxation of Multinationals (see article on this elsewhere in this issue) there is a further comment about being aware of the “wide range of arrangements that can be used to defer or circumvent NRWT on related party interest payments”. There may well be a legitimate concern if the NRWT rules are being circumvented such that NRWT is never paid.
However it should be pointed out that the tax law states NRWT is not payable until the income on which it is payable is distributed, credited or dealt with on a lender’s behalf. This is completely different from the test that is applied by the New Zealand borrower claiming the deduction for interest and so applying the legislation correctly can actually produce a timing mismatch. This position is long standing, well understood and is supported by case law. It has also been challenged and conceded by Inland Revenue in the past and so if this is what Inland Revenue are alluding to, and it is no longer considered the correct policy outcome, then it’s time to change the law rather than assert there is some mischief in this.
The major transfer pricing risks are:
- Not having documentation to support transfer prices
- Having a material level of untested transactions
- A major downward shift in profitability of a New Zealand company when acquired by a multinational group
- Widely differing profits between the local company and members of the global group as a whole as well as the industry
- New Zealand management accepting prices set by overseas associates without question
Inland Revenue come right out and say they want their fair share of the multinational tax pie. The problem with this is that other countries also want their “fair share”. We are not sure there is enough pie to go around! Inland Revenue acknowledge that some jurisdictions have aggressive tax policies. Regardless, it states that taxpayers should definitely not be tempted to leave more profit in that jurisdiction to avoid conflict. Best practice is therefore to negotiate an advance pricing agreement. Not having this in place could mean having to resort to the competent authority process in order to resolve any dispute which could be more costly and time-consuming.
Controlled foreign companies
Inland Revenue is closely watching to see that taxpayers are technically complying with the new controlled foreign company (CFC) rules. In particular it is monitoring any possible abuse of the rules through aggressive tax planning. Fair enough we say. However Inland Revenue say it will also look at any changes in CFC operations between the old and new CFC rules such as restructuring operations or shifting functions, assets and risks so that active CFCs qualify for total exemption. In other words the implication is that restructuring operations to fit within the active income exemption rules is not acceptable? Presumably the new focus on transfer pricing as part of the CFC rules necessitates that a review be carried out in terms of where functions, assets and risk sit and action taken to reflect the reality of operations.
The familiar red flags
Inland Revenue has compiled a list of “familiar red flags” which will attract Inland Revenue’s attention. It suggests taxpayers should have explanations prepared with supporting documentation in the event these flags are raised. As Inland Revenue points out, these issues are not new and may seem obvious, but are still worth checking off before that tax return is filed.
Familiar red flags
Is the effective tax rate below 28%?
Has the group been involved in any complicated arrangements?
Has the group participated in any material transactions involving a low or no tax jurisdiction?
Are there any untaxed profits, or high levels of foreign tax credits or imputation credits claimed?
Are there material differences between accounting and tax treatment for major items?
Have uncharacteristic losses arisen or been utilised?
Has the group taken part in any transactions where the anticipated net return is predominantly due to tax benefits?
Have any mergers, takeovers or ownership changes affected the continuity tests for losses and imputation credits?
Are there any differences in the tax treatment of a transaction or entity between countries (e.g. treated as debt in one but equity in another?)
Are there any material variances between the years in profitability, tax payable or line items in the financial statements
Addressing common GST areas
A review of GST returns over the past 12 months has revealed five key errors that need more attention. These are:
- Failing to recognise the GST implications of associated party transactions, particularly with regard to property leases, management services, the provision of employee time and supplies of trading stock.
- Incorrect treatment of non-routine transactions, for example insurance settlements which can be subject to GST.
- Time of supply issues when accounting for GST, particularly for part payments, deposits or when any invoice is received.
- Treating exported goods as zero-rated when the conditions for zero-rating are not met.
- Errors in GST returns – transposition of numbers, arithmetical errors, fields left blank and not including items in the correct return period.
Executive remuneration and payments to non resident contractors
We have noted a new focus on executive remuneration packages (see our article on employee share schemes elsewhere in this issue) and payments to people who are not New Zealand tax residents (non resident contractors). Inland Revenue confirm this saying they commonly find mistakes in the less common benefits provided to executives and they also recommend that care be taken around tax equalisation arrangements.
For non-resident contractors, Inland Revenue recommends close attention is paid to correctly complying with Non-Resident Contractors Tax (NRCT) rules. For example, where non-resident contractors apply for an exemption certificate from NRCT, we have noticed increased scrutiny by Inland Revenue checking and sometimes challenging the assertion that the non-resident doesn’t have a permanent establishment in New Zealand.
On the matter of tax governance, Inland Revenue suggests that New Zealand members of a multinational group need to ask themselves the following key questions:
- Are appropriate resources applied to tax matters?
- Are sufficient internal controls, checks and balances in place and are they actually carried out?
- Is there good tax awareness in critical business areas beyond the central tax or finance team?
- Are you aware of legislation changes affecting your business?
There is also a section on bribery awareness and 10 key questions to ask in order to assess your risk.
This is an important document that companies and their executives need to be aware of. It may be timely to review and update tax governance documents – tax policies, tax management plans and tax risk profiles.
On the question of dealing with uncertainty, taxpayers will have to consider seeking advance pricing agreements, using the binding rulings process, or at the least seek indicative reviews as a matter of course.
Please contact your usual Deloitte tax advisor for more information about this document.
Tax Alert November 2013 contents:
- Multinationals come under the compliance spotlight
- Regular pattern of building and selling houses catches up with trustees
- The OECD Base erosion and profit shifting project – how New Zealand might respond
- Chinese tax and business regulatory framework: evolving landscape and hot topics
- GST and mixed use assets
- Equity based remuneration
- Records in the cloud