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Insights from Inland Revenue's 2022 International Questionnaire - transfer pricing risk management

Tax Alert - October 2023

By Bart de Gouw & Riaan Britz

Inland Revenue has published the latest results of its 2022 International Questionnaire capturing responses from nearly 800 foreign-owned multinational companies operating in New Zealand. We summarise the interesting trends and global developments for international businesses navigating a post-pandemic world.

Mix of ownership

The USA continues to have the highest ultimate ownership of foreign-owned New Zealand companies with a 21% share. This is followed by Australia with 18% and Japan with 9%. Ultimate ownership by Chinese multinationals remains under the radar, although given New Zealand and China’s strong trading relationship, it is expected to increase in the future.

With the global trend of businesses adopting regional business models, it is not surprising to see that despite ultimate ownership potentially sitting in the US, Japan or elsewhere, many New Zealand subsidiaries have immediate ownership out of Australia increasing to 41% (up from 39% in 2021). The location of both the immediate and ultimate ownership of the New Zealand companies is important when considering the application of tax treaties for intercompany transactions.

Transfer pricing methods and wider New Zealand / OECD considerations

Perhaps a surprising trend is that the use of the transactional net margin method (TNMM), in its capacity as the primary transfer pricing method in New Zealand, is steadily increasing. 43% of respondents indicated that the TNMM is being used as the primary transfer pricing method in 2022, up from 40% in 2021 and 37% in 2020. The use of the profit split method remains very low at 3% (despite extensive OECD commentary on the approach).

Distributors/wholesalers make up the largest industry (27%) of those who have received the questionnaire. Groups operating in this industry will closely be monitoring the developments of the OECD, in particular Pillar One Amount B where there is a growing consensus to seek a streamlined approach to reaching an arm’s length price for baseline distributors. However, there is still a lot of water to flow under the bridge for the rules to be enacted globally. Given New Zealand’s unique market characteristics, care should be taken in selecting the most appropriate transfer pricing method that will produce the most reliable transfer price.

Risk-based questions

Inland Revenue have been clear that the International Questionnaire remains a key part of their risk assessment processes. Asking groups to answer targeted questions, allows Inland Revenue to assign risk ratings to companies that do not operate within the expected norm.

7% of respondents indicated that the New Zealand entity had over $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 make these jurisdictions more attractive to multinationals).

Businesses seem to be bouncing back after the pandemic as only 3% indicated that they have undergone restructuring during the 2022 income year (a similar level to that reported in 2017 and 2018).

12% of companies made cross-border supplies to related parties that exceed more than 20% of gross revenue and 33% of companies received cross-border supplies from related parties exceeding more than 20% of gross revenue. These companies have also for the first time been asked if they have prepared transfer pricing documentation to demonstrate their consistency with the arm’s length principle. The results of this question have not been published by Inland Revenue, but it is our understanding that active follow-ups are occurring in relation to the answers.

Now would be a good time for New Zealand entities to reconsider their transfer pricing governance if they rely on global transfer pricing documentation to support the arm’s length nature of the pricing of their cross-border associated party transactions.

Thin capitalisation

Consistent with prior results, most New Zealand companies in 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 importance is the application of the Restricted Transfer Pricing rules which apply to related party inbound debt and where restriction is triggered by a debt percentage of 40% or greater, which was relevant for 22% of respondents. The Restricted Transfer Pricing rules first came into effect on 1 July 2018 and many loans that were reviewed and amended to comply with the new regime are likely to need review and renewal shortly (as the regime restricts the pricing of debt to five-year tenures). Current financial market conditions will have a material impact when renewing loans that were entered into five years ago. We are also aware Inland Revenue is actively following up with companies that have loans coming up for renewal that are subject to the New Zealand Restricted Transfer Pricing rules.

What is next on Inland Revenue’s radar?

There is a continued drive by Inland Revenue to ask more and more taxpayers to provide contemporaneous transfer pricing documentation to support the positions they take in tax returns. This is evidenced by the fact that a specific question was added to the 2022 International Questionnaire that asked companies to disclose whether they have prepared transfer pricing documentation if their cross-border supplies (to or from associated parties) exceeded 20% of gross revenue.

Based on the type of questions that have been asked in the International Questionnaire, it is clear where Inland Revenue will be targeting their resources. It is our understanding that Inland Revenue is also actively following up companies that have been identified as part of their risk-based assessments and will continue to ask for relevant supporting documentation to support transfer pricing positions taken.

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.

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