Restructuring

Low risk operations

Change is constant, particularly for MNEs endeavouring to drive efficiencies from their global networks. As MNE business operations evolve, supply chains are inevitably restructured in the ongoing quest to maximise revenue and minimise costs. New Zealand operations of MNEs do not exist in a vacuum and we are a very open economy by world standards. We have three principal concerns in our examinations of supply chain restructures:

• the economic substance underlying purported low risk operations such as contract manufacturers and limited risk distributors
• the consistent return of routine profits, and
• the commercial rationale of the rearrangement, taking into account each step in the structure.

Structural changes made must be of real significance

In terms of economic substance, structural changes made must be of real significance and not paper only. The revised contractual terms must be consistent with the conduct of parties in practise. If risks are removed offshore, does the party now assuming those risks have the capacity and capability to control and manage them effectively? The assignment of credit risk offshore, for example, must be matched by personnel able to evaluate and monitor the risk as well as the capital resource to sustain any related loss.

Clearly charging a stripped risk distributor in New Zealand for the costs associated with a penetration strategy can not be contemplated. Similarly, charging regional office expenses that are not commensurate with the size of New Zealand operations will not be accepted. In a stripped risk distributor or commissionaire situation it is normal to review the profitability using a Berry ratio approach either as the primary methodology or as a significant reality check.

Consideration also needs to be given to the risk of a commissionaire arrangement giving rise to the existence of an overseas associated supplier having a branch in New Zealand. One of the difficulties with any sales type function is that the people on the ground are human and may not follow instructions given by a distant head office. There may also be transfer pricing questions as to compensation for the transfer of assets such as customer lists or the early termination of a distribution agreement in addition to the usual taxation issues arising (sale of revenue account property, depreciation recovery, deemed dividends where plant and equipment are sold for inadequate consideration and deductibility of restructuring costs).

We don't look at restructures only from a transfer pricing perspective

Restructuring proposals as a whole must make sense commercially without the associated tax benefits. Each step in a wider arrangement also needs to make sense as a business proposition on its own account. If there are unnecessary steps in the arrangement, circularity of fund-flows or novel instruments exhibiting artificiality, the general anti-avoidance rule will be considered in addition to our transfer pricing rules.

Documenting major restructures

In documenting major restructures, to ensure compliance with our transfer pricing rules, the following questions need to be addressed by companies and their tax advisers:

• What is the fundamental basis for restructuring:
  • group-wide restructure?
  • regional restructure?
  • one-off local restructure?
• Has a three-step functional analysis been carried out:
  • before restructure?
  • acquisitions and disposals identified?
  • after restructuring?
• What consideration has passed:
  • for the transfer of tangible assets and liabilities?
  • for the transfer of intangibles (description required)?
  • for compensation?
• Does the acquirer of the functions, assets and risks have the capital and human capability to support the acquisition?
• Does the reduced entity provide functions previously undertaken as part of its business activity as a service to the new business owner?
• Is the reduced entity rewarded for all functions, assets and risks including those that were not specifically transferred and can still be regarded as profit drivers?
• Does the new owner of the restructured business:
  • carry on business wholly or partly in New Zealand?
  • have a permanent establishment in New Zealand?
• Who has borne the restructuring costs and has any deduction being claimed on fixed life intangible property as a result of the restructure?
• Have valuations been prepared for all asset transfers?
• Is documentation available for transfer pricing before and after the restructuring and are documents available in support of the restructuring itself (such as feasibility studies, business plans and consultants' reports)?

OECD guidance

The OECD Transfer Pricing Guidelines contains a new Chapter IX on Business Restructurings. Inland Revenue fully endorses this detailed international guidance. However, we also recognise that no general guidance can ever cover off all aspects of complex restructures, so we suggest the best solution is to work co-operatively with us and obtain an advance pricing agreement.

 

Date published: 18 Jan 2011

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