Changes afoot to combat profit shifting

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This time last year, we discussed the New Zealand Government’s intentions to adopt recommendations from the Organisation for Economic Cooperation and Development (OECD) in relation to BEPS(Base Erosion and Profiting Shifting).

The new Government endorsed these proposals in December by introducing the Taxation (Neutralising Base Erosion and Profit Shifting) Bill into Parliament.

If enacted as proposed, the provisions could come into effect from July 1 this year or in the case of the new deemed permanent establishment rules, from the date of enactment.

Base erosion and profit shifting (BEPS) encompasses tax planning strategies used to exploit gaps and mismatches between countries’ tax rules to shift profits to low or no-tax jurisdictions.

Although the provisions introduced in the December bill are aimed at large multinationals, they could affect any business that engages in cross-border transactions.

The provisions proposed in the Bill will prevent multinationals from using:
– Artificially high interest rates on loans from related parties;
– Cross jurisdiction hybrid mismatch arrangements to achieve an advantageous tax position;
– Artificial arrangements to circumvent having a taxable presence (or ‘permanent establishment’) in New Zealand; and
– Related-party transactions to shift profits offshore in a manner that does not reflect the economic activity undertaken in each jurisdiction.

We briefly outline these key proposals below.

The Bill proposes to implement a ‘restricted transfer pricing rule’ to price related-party debt (for borrowings more than $10m). It will require borrowings from an offshore-related party to be priced using a credit rating one notch lower than the ultimate parent’s credit rating, and any features not typically found in third-party debt must be removed.

As currently drafted, the legislation is complicated and complying with it could result in high compliance costs and cross-border interest rate mismatches.

Hybrid mismatches typically arise where a payment is deductible in one jurisdiction, but the receipt is not taxable in another. The new rules will either deny deductions or trigger taxable income. If enacted when proposed, New Zealand will be the second country globally to adopt these rules, which could result in transitional cases where the New Zealand rules apply, until the other country has enacted the rules.

The Bill will change the way thin capitalisation ratios are calculated which could lead to further restrictions on the deductibility of interest and excessive debt levels. For example, the debt percentage under the thin capitalisation regime is currently calculated based on an entity’s interest-bearing debt relative to its gross assets. The Bill will require an entity’s asset value to be reduced by the amount of its “non-debt liabilities”, such as trade payables.

A deemed permanent establishment (PE) rule targeted at large multinational groups who have a total global turnover of more than €750 million will be introduced. If a member of the group conducts sales activities in New Zealand on behalf of a non-resident, the non-resident is deemed to have a PE in New Zealand thereby triggering a New Zealand tax liability. These rules will apply regardless of any applicable Double Tax Agreement (DTA), unless the DTA incorporates the OECD’s latest PE article, which has a similar scope.

Finally, the BEPS Bill extends the reach of the transfer pricing regime and will enable Inland Revenue to adopt a more stringent approach.

The concept of a “control group” – a group that acts together or in concert to effectively control a taxpayer – will be introduced.

New Zealand companies owned by investors in the same control group will become subject to the transfer pricing regime.

IRD will also be able to disregard or displace legal arrangements where the commercial rational and economic substance are uncommercial. The onus of proof will also shift to the taxpayer to prove arrangements are on an arm’s length basis, rather than the Inland Revenue having to disprove it.

Inland Revenue has estimated that the new proposals could raise $200 million per year, but they are extremely complex, far-reaching and will affect numerous businesses.

With the proposed enactment date less than five months away, there is not much time for taxpayers to prepare.

We recommend becoming familiar with the proposed provisions and evaluating how they will impact your business.

The comments in this article of a general nature and should not be relied on for specific cases. Taxpayers should seek specific advice.

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About Author

Hayden Farrow

Hayden Farrow is a PwC Executive Director based in the Waikato office. Email: hayden.d.farrow@nz.pwc.com