Inland Revenue's 2023 International Questionnaire campaign – are you an audit target?

By Bart de Gouw, Riaan Britz & Tayla Wheeler

Inland Revenue has recently released the findings from its 2023 International Questionnaire, comprising responses from over 800 foreign-owned multinational companies operating in New Zealand. This article summarises the key insights and global trends identified from the questionnaire results and asks one broad question – are you ready for the increased investigative activity expected from Inland Revenue in the coming year?

Data based risk assessment

The questionnaire is described by Inland Revenue as a key part of its annual risk assessment process and the intelligence from the analysis is used to inform key policy and operational decisions. The targeted questions allow for the assignment of risk ratings to companies that deviate from expected norms or standards. The information gathered by the International Questionnaire is used as part of the taxpayer selection process for transfer pricing risk reviews and audits.

The four areas identified by the International Questionnaire that are most likely to cause a higher risk profile are:

• No transfer pricing documentation available to support material cross-border associated party transactions;

• Material transactions with low-tax jurisdictions;

• Structural changes to the business;

• High levels of debt; and

• Transfer pricing method selection and application.

Transfer pricing documentation

The number of companies that do not have transfer pricing documentation is not reported by the Inland Revenue, so it is not possible to determine whether this is a commonly identified risk area. However, good quality and up-to-date transfer pricing documentation is a requirement for multinationals if there are significant cross-border associated party transactions that need to be supported as being at arm’s length.

The questionnaire results show that 12% of companies made cross-border supplies to related parties that exceeded 20% of gross revenue. 33% of companies received cross-border supplies from related parties that surpassed the same 20% gross revenue threshold, consistent with the figures from 2022. These respondents were also asked if they prepared transfer pricing documentation. The onus is on the taxpayer to prove that its cross-border associated party transactions are conducted at arm’s length, so robust New Zealand-specific transfer pricing documentation remains the most important starting point.

Not having documentation would likely place a company high on the risk radar. Inland Revenue has published transfer pricing worksheets on its website to assist with a self-assessment of compliance risk.

Transactions with low-tax jurisdictions

8% of respondents indicated that the New Zealand entity had over NZD 30 million of expenditure on goods and/or services with associated parties in Hong Kong, Ireland, Luxembourg, the Netherlands, Singapore and Switzerland (countries with low company tax rates and/or incentive regimes that have historically made these jurisdictions more attractive to multinationals). This result is consistent with prior years and represents over 60 respondents who may expect to be on the risk radar.

Structural changes to the business

Moreover, a snapshot of post-pandemic recovery emerges with a mere 3% of respondents indicating material business restructuring during the 2023 income year, aligning with pre-covid-19 reported levels.

The 22 groups that reported they had undergone structural changes in 2023 are likely to be different to the companies that reported structural changes in 2022. Businesses undergoing structural changes should ensure they adhere to the New Zealand restructuring provisions, and again, the preparation of robust documentation is key, noting that the OECD Transfer Pricing Guidelines have a chapter specifically addressing business restructuring.

Thin capitalisation

Consistent with prior results, the majority of New Zealand companies within the sample have low levels of debt, with 63% of companies having a debt percentage of less than 20%. Only 9% of companies have debt percentages where interest deductions could be subject to denial under the thin capitalisation regime.

Also, of relevance is the application of the Restricted Transfer Pricing (RTP) rules. These rules apply to related party inbound debt higher than NZD 10 million and restrictions can be triggered by a New Zealand debt percentage of 40% or greater. 21% of respondents had New Zealand debt greater than the 40% threshold, which can lead to deductible interest on intercompany debt being lower than debt priced on an arm’s length basis. We are aware that Inland Revenue is very active in this space, and it is considered that this will remain a focus point for the year ahead.

Many arrangements subject to the RTP rules will have come to the end of their first pricing period in 2023 (the RTP rules first came into effect in 2018 and limit the pricing to a five-year term). Our November 2023 Tax Alert article provides further background on this. Accordingly, we expect many loans will need to be renegotiated. Failure to re-price these loans (and prepare supporting documentation for the tax positions taken) can pose a risk, particularly in a volatile interest rate environment.

Transfer pricing method selection and application

The Transactional Net Margin Method (TNMM) is the primary transfer pricing method used in New Zealand. The Cost Plus method was the second most used method, this is surprising but perhaps is a result of a common error in identifying the method used where the TNMM is applied to a net cost plus margin profit level indicator, but referred to as a cost plus method. In 2023, 44% of respondents reported primarily using the TNMM, a slight rise from 43% in 2022 and 40% in 2021.

Meanwhile, the use of the profit split method remains low at 3%, despite extensive OECD commentary on its application, reflecting the complexity generally associated with this method. Even at 3%, this represents approximately 24 companies out of the sample using this method as their primary method.

Among the 2023 International Questionnaire participants, distributors/wholesalers constituted the largest group (27%) of respondents, consistent with 2022. Inland Revenue’s existing transfer pricing simplification measures for small foreign-owned wholesale distributors would generally not apply to these companies as their revenue would be too high (more than NZD 30 million).

In anticipation of more questioning by Inland Revenue, care should be taken in selecting the most appropriate transfer pricing method that produces the most reliable transfer price through application.

What is next for Inland Revenue?

In response to the Government’s 2024 Budget, Inland Revenue is gearing up for increased activity and placing a focus on compliance with additional funding allocated towards tax compliance and services to protect the integrity of the tax system, including investigation, audit, and litigation activities. This funding will provide Inland Revenue with greater resources and capabilities to tackle compliance tasks on a larger scale. In the area of transfer pricing, Inland Revenue has appointed new transfer pricing case leads, which underscores the importance of transfer pricing capabilities and resources within Inland Revenue.

If you would like to discuss any of the issues raised above in more detail, please contact your usual Deloitte advisor who will refer you to our specialist Transfer Pricing team.