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Transfer pricing
Te Utu Whakawhiti

Losses

Transfer pricing concerns about losses apply not only to foreign-owned multinational enterprises ("MNEs") operating in New Zealand, but also to New Zealand-owned MNEs with loss-making associates abroad. A constant period of losses may suggest commercially unrealistic transfer pricing policies. Care should be exercised with losses arising in any jurisdiction, not just New Zealand.

In the current economic environment, there may be any number of good reasons behind a loss result, such as:

  • a significant reduction in the "topline" (reduced demand, increased discounting, etc)
  • excess fixed costs supporting much lower turnover
  • excess inventory and related carrying costs
  • bad debts
  • foreign exchange losses, and
  • increased financing costs.

The pursuit of the following can also contribute to a loss result:

  1. deliberate market penetration strategy
  2. new business line, or
  3. heavy involvement in Research and Development (R&D).

We recommend that the reasons behind a loss result should be measured and documented simultaneously where possible, along with the strategies taken to overcome these problems. Following this process will demonstrate the legitimacy of losses, and should, in fact, be part of normal risk management.

Most business strategies are geared to making operations more efficient and/or competitive with an aim of increasing profitability in the medium term. If poor management is the cause for losses, we would not expect to find executives being rewarded with increased salaries and bonuses.

Importation of losses

We are on the lookout for any arrangements made to import losses from overseas associates through non-market pricing. For example, increases in inbound management service charges with a view to recovering increased global costs will be closely reviewed to ensure that the amount paid is an arm's length price for the services actually received by the New Zealand subsidiary. The same principle applies to New Zealand groups seeking to import losses from overseas subsidiaries by way of non-arm's length subsidies and support payments.

Limited risk structures

We recognise that there is a strong temptation to share the pain of the international downturn around a multinational group. Internationally, the last decade has seen considerable restructuring of MNEs, typically removing functions and risks from group subsidiaries. MNEs operating such structures in New Zealand (usually described as limited risk distributors, commissionaires or contract/toll manufacturers) have been returning relatively lower but consistent levels of profit commensurate with their limited functions and risks

It's our expectation in the current economic climate that there will be consistency of approach. For subsidiaries with a limited risk profile we expect profit levels to be maintained, unless there are very good reasons for them not to be. Arrangements where the subsidiary is required to bear losses in respect of risks to which it has not been exposed, will not be considered arm’s-length behaviour.

It is recognised that the recession has produced some issues that may impact the results of a company and that are not a part of normal trading. We recognise that there may be costs that are nothing to do with intra-group pricing. For instance, a fall in sales that can not be matched by a reduction of fixed overheads is likely to be considered a domestic loss and would not necessarily be reimbursed by an offshore associate.

Early disclosure works best

The January 2008 OECD "Study into the Role of Tax Intermediaries" noted that taxpayers who provide full disclosure and transparency may achieve earlier, increased certainty of their tax affairs and reduced compliance costs. We strongly recommend early dialogue with the transfer pricing specialists rather than searching for solutions amongst limited economic data.

In the 9 July 2009 edition of "Tax Management Transfer Pricing Report"; our economist, Andrew Fung, has commented in detail on several new approaches to comparability analysis in recessionary times. Our conclusion is that we must not lose sight of fundamental principles in our analyses and it is important to remain consistent in good times and bad.

The management team of a MNE will understand the business far better than we ever will, and by working together we can assist you in arriving at the correct transfer pricing answers in these difficult times. We have already had a number of MNEs advise us of their changed business circumstances and the significant impacts on their profitability in some detail. We welcome such early disclosure and constructive dialogue while memories and records are fresh - this is vastly preferable to potentially unnecessary audit activity some years later when staff have moved on and records are patchy.

 


Date published: 02 Dec 2010

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