Exporters

Outbound direct investment/exporters

In recent years, we have widened our transfer pricing coverage considerably and now routinely address transfer pricing risks in respect of exporters. In particular, we focus on:

• use of correct commodity price benchmarks
• recovery of head office costs
• recovery of R&D costs
• low/no interest outwards lending
• free/low rate outwards credit support (guarantees), and
• offshore operations returning abnormally high profits.

The exporter's checklist

A large number of New Zealand SMEs engaged in exporting operate through associates abroad. Recognising this, we have developed the following short checklist in the form of answers to the ten most frequently asked questions.

1. Some jurisdictions have reputations for aggressiveness, should more income be left in those jurisdictions to avoid conflict?
   Definitely not - overseas associates should pay the right amount of tax, giving due regard to international best practice, especially the arm's length standard as espoused by the OECD and respected by all our major tax treaty partners.
2. How can a New Zealand exporter get a quick picture as to major international transfer pricing risks?
   Examine closely the bottom-line returns of associates. In particular, most of our SMEs operate through small buy-sell distributors and/or service providers - do their operating margins reflect commercial reality?
3. What effect does a brand or knowhow have on transfer pricing?
   The benefit of any intellectual property should lie with the owner. It is important to establish both where the IP has been created and also where it is legally owned. It would be expected that, for an exporter, such ownership would lie in New Zealand. The owner of IP can be rewarded either through the pricing of goods sold to the overseas distributor or directly through a royalty charge.
4. How do you readily identify if any intellectual property has been created by offshore associates?
   Examine closely any research and development costs and/or above average marketing expenditure, including any expenditure on market penetration. Consideration should be given to either a reimbursement of such expenditure by the New Zealand parent (but not in hindsight years later) or some other reward strategy to ensure that there can be no claim that the overseas associate owns IP.
5. Have any targeted strategies been pursued?
   These may not be easy to explain to tax authorities some years later especially should plans not quite work out. If a market development strategy has been pursued, make sure it is fully documented at the outset as to expenditure, sales, cost savings, duration and likely pay-back period.
6. How do you establish if offshore associates are performing any specialised functions or providing additional services?
   Staff remuneration is a good barometer, with highly paid staff generally providing special skills (leading to greater economic value added). Job descriptions are also useful in this regard.
7. How should management and other support services provided to offshore associates be identified and charged out?
   Consider the application of Inland Revenue's guidelines in this area, essentially cost plus 7.5% for non-core/deminimis services. Also, keep an eye out for any services requiring specialist know how or expertise provided from New Zealand which require higher mark-ups.
8. Have market rates of interest been charged for loans to offshore associates?
   In general, the credit rating of an offshore associate will not be as strong as the New Zealand parent, so interest charges should exceed the parent's domestic weighted average cost of debt. In our experience, an interest rate set at bank bill rate plus 300 basis points will be fair and reasonable for small value loans (under $2 million in loan principal).
9. What should a New Zealand exporter do if a foreign tax authority is disputing the transfer pricing positions taken by offshore associates?
   Consider approaching the International Audit Unit. New Zealand has an extensive network of double taxation treaties which include Mutual Agreement Procedure articles to resolve double taxation disputes. It has been our experience that the earlier a request for competent authority assistance is made, the more likely the matter can be brought to a successful conclusion.
10. When should a New Zealand exporter consider an advance pricing agreement (APA)?
    APAs represent a more co-operative approach to addressing transfer pricing compliance. They produce not only time and cost savings, but also certainty going forward. They are ideal for complex cases, especially those involving intangibles.

Date published: 02 Dec 2010

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