Transfer pricing and dividend withholding taxes

By Bart de Gouw, Young Jin Kim & Jordan Kelly-Houston

On 30 August 2024, the Commissioner released CS 24/02 (the Statement), which clarifies his view on withholding tax obligations when the transfer pricing rules deny a deduction for a payment to an associated person outside of New Zealand.

Ideally, when a taxpayer is a party to a transaction that is a transfer pricing arrangement, an analysis to derive an appropriate arm’s length amount for the transaction should be performed. Depending on what type of transaction it is (e.g., a payment of interest, a royalty payment, or a purchase/sale of goods), a taxpayer would determine any withholding obligations, including the impact of any Double Tax Agreements (“DTA”) to see if it can provide relief on the rate of withholding. Sounds like a logical progression in the analysis right? But what happens if you withheld (or did not withhold) non-resident withholding tax (NRWT) on the basis that you were making a payment of interest or purchasing some goods from a non-resident parent, and you later find out that Inland Revenue considers a non-arm’s length amount of consideration was paid?

It's a dividend… a deemed dividend

To the extent that a taxpayer has made a payment to a non-resident associated party that is denied a deduction under the transfer pricing rules, the excess is likely to be a considered a deemed dividend under the Income Tax Act 2007 (the Act). So, what then? The devil is in the detail. Let us explain, or better yet, let the Commissioner explain with an example taken from the Statement:

Example 1 – interest payments

A New Zealand subsidiary enters into an agreement to borrow an amount from its non-resident parent. For the year in question, the New Zealand subsidiary pays interest of $1.5m to the non-resident parent. The arm’s length amount is $1m, and an adjustment would be made under the transfer pricing rules treating this amount as the amount payable for the purposes of calculating the New Zealand subsidiary’s income tax liability.

The excess $0.5m is a transfer of value from the New Zealand subsidiary to the non-resident parent, resulting in a deemed dividend subject to NRWT. Interest NRWT previously paid in relation to this excess amount could be refunded or offset against the dividend NRWT liability provided the applicable provisions in the Act are satisfied.

The above example is fairly common as interest rates continue to be volatile, making it challenging and compliance intensive for multinationals to derive an appropriate arm’s length interest rate in respect of borrowing/lending. Importantly, the Restricted Transfer Pricing regime that applies to inbound loans in excess of $10 million principal is unique to New Zealand and may result in denial of interest deductions that are considered arm’s length in the lender’s jurisdiction. The denied interest is then treated as a deemed dividend in New Zealand and creates potential double taxation and a mismatched characterisation of the nature of the payment.

There are 6 examples in the Statement that may apply to transfer pricing arrangements, but these are not exhaustive. The Commissioner’s Statement has some helpful guidance on the impact to the taxpayer where a deemed dividend arises in relation to a transfer pricing arrangement. The guidance clarifies that the dividend will generally constitute a non-cash dividend (the rationale for which is not entirely clear or logical), and relief from NRWT on the deemed dividend may be available, for example:

• Imputation credits may be retrospectively attached to transfer pricing arrangement dividends, pursuant to section OB 62.

• A fully imputed non-cash dividend is subject to 0% NRWT pursuant to section RF 10(5B).

• The dividend NRWT liability may also be reduced or removed by applying section CD 42, which allows for dividends to be repaid in certain circumstances if certain requirements are met.
  

If you are seeking relief under any of the sections of the Act described above (or through a provision in a DTA), it is important to note that you will be met with compliance obstacles. The Statement is silent on the more complex aspects that may need to be considered, some of which may not even relate to tax, for example:

• Would a DTA partner accept the recharacterisation of the non-deductible payment as a dividend if it leads to a higher level of NRWT?

• Does a retrospective dividend statement need to be prepared?

• How are deemed dividends disclosed for financial reporting purposes?

• Which party can and should request a refund of over withheld NRWT and how would that party request it?

We recommend getting in touch with your Deloitte advisor if you think there may be any deducations that are at risk of being denied due to transfer pricing as further thought may need to be given to the resulting tax implications (over and above what is expressed by the Statement in CS 24/02).