October 8, 2024 2024-1846 New Zealand Inland Revenue releases 2024 MNE Compliance Focus document - The New Zealand Inland Revenue Department (IR) has released a refreshed Multinational Enterprise Compliance Focus document, setting out IR's views on the New Zealand tax compliance landscape as it relates to multinationals.
- The document provides risk indicators for both base erosion and profit shifting (BEPS) and transfer pricing, in addition to providing some relevant pointers for what areas corporations should pay particular attention to, including in tax corporate governance.
- The need for New Zealand customization of transfer pricing and tax corporate governance documentation is emphasized.
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Executive summary Inland Revenue has released its updated Multinational Enterprise Compliance Focus 2024 document (the document). This release is significant, as the previous summary was last issued five years ago in 2019. The document outlines IR's broader compliance strategy with regard to multinational entities (MNEs) active in New Zealand (NZ MNEs), highlighting areas for focused review, key risk indicators as well as issues that have "room for improvement." IR is continuing work to ensure that all taxpayers conducting business cross-border pay their fair share of tax. The broader compliance landscape in New Zealand has materially shifted since the document was last updated. The current Government's focus on prudent fiscal management and resulting request for active tax base maintenance by IR has resulted in a renewed focus on audit. Taxpayers who may have escaped closer scrutiny in years past can now expect renewed attention from IR. The key takeaways from the Compliance Focus document include: - Inland Revenue has additional resources. These resources will be deployed to ensure that MNEs are complying with their obligations. New Zealand is a net beneficiary of increased global information sharing and IR intends to use this intelligence to inform risk assessment, enforcement activity and future more-targeted compliance campaigns.
- BEPS risks continue to be monitored. IR seems generally comfortable that earlier legislative reforms to prevent BEPS behaviors have achieved their desired effect. In particular, IR observed an overall reduced reliance on debt by NZ MNEs to manage local effective tax rates. However, the document notes that IR is continuing to monitor BEPS risks and lists its top risk indicators in this respect. Taxpayers should assess their New Zealand position accordingly and expect further questions where risk factors are present.
- Transfer pricing continues to be a focus with local customization required. As well as providing a list of transfer pricing risk indicators, the document details IR's expectations for New Zealand transfer pricing compliance. Interestingly, IR noted the need for local benchmarking and documentation to be adequately customized, reflecting New Zealand's unique market settings. IR specifically noted that reliance on comparable data from Asian economies will likely be challenged due to the lack of market comparability.
- Corporate tax governance is overall "progressing well" but there is room for improvement. The document notes that corporate governance efforts in NZ are at the "progressing" stage. Officials would like to see governance overall move to the "established" stage, and the document notes areas where improvement is expected. Again, customization for the local market will be expected with less tolerance for "lift and shift" from other territories. IR also emphasized that good governance is moving away from mere documentation to clear evidence of adherence in practice. Governance failures are expected to impact overall risk ratings as well as give rise to penalties.
Tax managers and all stakeholders with responsibility for New Zealand tax should read the document and self-assess compliance against the check-lists and risk indicators listed. Actions should be taken to address areas for improvement to ensure tax issues are appropriately managed. Detailed discussion "Right from the start" strategy maintained The overarching compliance strategy focusing on helping taxpayers "get it right from the start" has remained constant. Under this approach IR expends the majority of its time and effort on "compliance by design," ensuring that settings across policy, legislative and system processes are designed to ensure compliance by default. IR will be able to identify gaps by using its analytics and intelligence capability and leveraging a wealth of intelligence shared through global information sharing networks. This allows IR to focus its direct compliance efforts on the minority of taxpayers who need to be brought into line through active intervention. The objective is "to head off any non-compliance before it occurs, by close monitoring, advance pricing agreements and practical guidance to allow MNEs to better self-manage their international financing and transfer pricing risks." With NZ MNE's paying NZ$6.1b toward New Zealand's 2022/23 tax take, IR officials express a degree of comfort that "MNEs in New Zealand are paying their fair share." Nevertheless, the document is clear that IR will continue to carefully monitor compliance, and taxpayers should not become complacent with respect to their New Zealand tax positions. Top BEPS risk indicators confirmed Efforts to manage BEPS risk in New Zealand to date have focused largely on legislative reforms. Overall, the document notes that IR is content with its progress. Observable trends have seen an aggregate decrease in debt levels of MNEs in New Zealand. When assessing BEPS risk, IR focuses on a wide range of factors including MNE-specific contextual information and industry insights. The document lists IR's "Top Ten BEPS risks" which include: - Avoidance of permanent establishment (PE) status
- Circumvention of withholding taxes, including treaty shopping
- Excessive interest deductions through thin capitalization
- Hybrid mismatch arrangements (including imported mismatches)
- Misuse of low/no tax jurisdictions
- Mispricing of debt instruments
- Profit stripping arising from tax-driven supply chain restructures
- Non-commercial arrangements driven by aggressive tax planning
- Non-arm's-length transfer pricing of tangible and intangible goods and services
- Inappropriate apportionment of branch profits
However, IR notes that "there is no single element capable of providing a complete picture of the existence and scale of BEPS." Triggering multiple flags, particularly when coupled with low relative profitability, compounds the perceived BEPS risk and increases the likelihood of further review. Taxpayers should monitor these risks closely and ensure that contextualizing information is available to respond to further information requests. Transfer pricing risk in focus In addition to BEPS risks, the document lists high-level transfer pricing risk indicators, which can be used to gauge likelihood of further review on New Zealand transfer pricing positions. Most of these indicators are consistent with the 2019 Compliance Focus, and are as follows: - Tax losses in two of last three years [previously it was two consecutive years of losses]
- Negative earnings before interest and tax (EBIT)
- >5% cost plus margin on service charges
- Royalties >33% earnings before interest, tax and exceptional items (EBITE)
- <5% Retailer EBITE
- <7% Manufacturer EBITE
- <3% Distributor EBITE
- Interest >20% earnings before interest, tax, depreciation and amortization (EBITDA)
- Debt >40% (assets — non-debt liabilities)
- Cross-border associated-party transactions = 20%+ of gross revenue [this is a new indicator, although it has featured in recent International Questionnaires]
- Purchases + other operating expenses > NZ$30m (involving low/no-tax jurisdictions) [previously the threshold was >NZ$20m]
Taxpayers are put on notice that those who have one or more of the above transfer pricing risk indicators should not be surprised if IR asks for additional information. Contextual information in transfer pricing documentation that explains any sudden changes in positions taken or sudden triggering of a risk indicator is particularly useful. Inland Revenue's expectations for New Zealand transfer pricing The document also notes IR's expectations around New Zealand (NZ) transfer pricing and notes in particular: - A need for NZ customization — The document clearly indicates that a simple "lift-and-shift" approach in which a NZ MNE's operations are pulled into group transfer pricing approaches is often seen as insufficient and more likely to be challenged.
- An expectation of higher NZ margins — IR sees the New Zealand market as having "unique features" that should be reflected as higher margins for inbound New Zealand MNE's, influenced by:
- The geographic remoteness and low levels of competition in New Zealand
- New Zealand distributors' tendency to undertake more functions and hold higher levels of inventory.
- Appropriate benchmarking data is crucial — IR notes that large Asian economies (the document specifically cites economies such as China, India, Japan and Korea) are not seen as comparable to New Zealand. As a consequence, reliance on comparable information from these economies will be seen as insufficient and, as already evident, will likely lead to further IR review and challenge.
- Risk in bundled intangible property rights — The top "insight" IR has gained from recent compliance campaigns is that bundled intangible property poses a heightened risk. In particular, the report notes some difficulty in identifying (and pricing) the individual elements with specificity. Given recent experience in Australia with the Australian Taxation Office (ATO) challenging embedded royalties, it is somewhat unsurprising to see IR echoing this concern. It remains to be seen to what extent similar challenges will be mounted in New Zealand; for now, IR and taxpayers in New Zealand are watching these developments with a "weather eye."
IR's clear call to action from a transfer pricing perspective is the need to ensure that New Zealand documentation reflects on the ground conditions. If a taxpayer's documentation presently relies on global positions with relatively generic information, it may be time to revisit ahead of any risk reviews kicking off. Tax corporate governance — some room for improvement The emphasis on tax corporate governance continues, with the document noting that "[w]e have endeavored to foster an environment of mutual trust and cooperation by working with taxpayers, and their representatives, and not taking a prescriptive or adversarial approach." Inland Revenue has highlighted some key "work-ons" to lift overall corporate tax governance: - Documentation of tax strategy and tax control framework — not just relying on key personnel
- Regular testing and updating of tax controls — not just "set and forget"
- Executive reporting to boards — prevents risk of organizational lack of direction by setting a "tone from the top"
- Customization to NZ — for MNEs with overseas models, customization to the New Zealand environment is crucial; a "lift-and-shift" of overseas developed documents will not suffice
Failure to implement adequate corporate tax governance procedures can be costly. The document notes that IR will "not only consider the adequacy of tax governance in arriving at annual risk ratings for MNEs, but if adjustments arise as a result of future compliance activities, will also take into account whether an MNE has paid sufficient attention to tax governance in our penalty deliberations." Page 19 of the document provides a self-assessment checklist for MNEs regarding their tax governance compliance strategy. MNEs active in New Zealand should review the checklist and considering whether additional steps should be taken to lift adherence. What's next? Having now reset the compliance focus for 2024, it is fair to ask what's next for New Zealand Inland Revenue. - Many more audits anticipated — Although the MNE taxpayer population is seen as broadly tax-compliant in New Zealand, the Government wants to see IR lifting compliance activity to help drive increased tax collection. The 2024 Budget saw additional compliance funding going to IR, with an expected NZ$8 return for each dollar invested. Given that the MNE population ordinarily accounts for one-third of the total corporate tax base in New Zealand, one can expect closer and more frequent reviews than in years past.
- Nature of IR enquiries expected to change — Taxpayers should expect a call for in-person discussions with key tax personnel, a preference for on-site reviews and a general acceleration of risk review straight to audit. This reflects a move toward auditing process and controls, and not merely auditing results.
- Analytics and data processing capabilities expected to expand — IR's reformed information technology (IT) system has significantly improved data processing capability. As better deployment of the new system takes effect, one can expect increased reliance on its analytics capability. Although more broad-based questions are likely at the outset, taxpayers should prepare for enquiries to quickly become more sophisticated, targeted and mandating an equally technology-enabled response.
- Pillar Two compliance-process design likely a key focus for 2025 — Although the population of New Zealand-headquartered MNEs that are likely to be in scope of Pillar Two is small (expected to be 27 groups), the compliance impact of the new requirements should not be underestimated. IR is aware of this. It has offered to work collaboratively with taxpayers to reduce the burden where possible and appropriate.
- Digital solution anticipated for information disclosures — IR remains keen to see its annual International Questionnaire digitalized. Although this has been true for some time, there is confidence that online completion will be available in coming years.
- Extensive legislative reform seems unlikely — The current New Zealand Government has not identified a preference for further extensive legislative reform in tax settings that impact MNEs. Although we should expect adoption of changes led by the Organisation for Economic Co-operation and Development and similar environmental responses, large-scale domestic reform is not anticipated. Of course, a potential exception to this includes whether New Zealand follows through with the Digital Services Tax proposal (presently legislation has been introduced but not further progressed).
- Developments expected in relation to IP and payments for technology — IR is known to be keeping a weather eye on developments in Australia, including in regard to the taxation of intellectual property and technology-based income flows, including developments in the Pepsi case. (For details, see EY Global Tax Alert, Australian Full Federal Court reverses finding of embedded royalty in arm's length contract, dated3 July 2024). Some reform can be expected in this area, given that the tax law has largely not kept pace with the impact of technology on cross-border supply chains.
* * * * * * * * * * | Contact Information | For additional information concerning this Alert, please contact: Ernst & Young Limited (New Zealand) | Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor |
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