Service charges

Service charges are one of the more common areas of focus for tax authorities examining the transfer pricing policies of multinational enterprises.

Checklist for international service charges

To assist companies operating internationally, including in particular a large number of New Zealand small to medium enterprises, we have compiled the following checklist based on our long experience in reviewing international service charges:

1. Understand the charge, go behind the label and document it (the actual services provided, the benefits arising, the basis of the charge, etc).
   
   
2. The cost plus method is generally best, but never rule out the possibility of internal comparables (where similar services are being provided to third parties by the provider).
   
   
3. Watch out for "duplicated services" - in particular, does the enterprise have an infrastructure in New Zealand which can and does provide the type of services for which charges are also being made from overseas?
   
   
4. Be wary of charges for directors/chief executives (doing no more than investment monitoring), and overseas regulatory costs (for instance, Sarbanes Oxley compliance costs) - these are most probably non-chargeable "shareholder services".
   
   
5. Get the cost base right (including New Zealand tax deductibility of items included in cost sharing arrangements) and apply a sanity check - does it make sense, especially in relation to the bottom line?
   
   
6. Mark-ups must be fair and reasonable in relation to the nature of the service and the risks assumed - for example:
   • no mark-up for simply on-charging third party costs;
   • minimal mark-ups for low risk supporting services;
   • higher mark-ups where specialist knowhow or expertise is involved.
   
   
7. An allocation key should result in a charge proportionate to expected benefits - in this regard, turnover can be too simplistic and arbitrary (don’t just assume a close relationship between services provided and sales without further analysis).
   
   
8. For outbound direct investment/New Zealand exporters, management and other support services provided to offshore associates (including controlled foreign companies) must be identified and fully charged.
   
   
9. A branch is not legally distinct from the rest of the enterprise - service charges should therefore be allocated on an actual cost basis only (ie no mark-ups).
   
   
10. Keep in mind other tax obligations such as withholding on services performed in New Zealand by offshore associates and royalties ("knowhow and connected services").

For a more detailed analysis, the most authoritative source is the OECD Transfer Pricing Guidelines at Chapter VII (Special Considerations for Intra-Group Services).

Administrative practice

We have recently updated the de minimis threshold for services and described more fully in paragraphs 559, 561 and Table 8 of our October 2000 Transfer Pricing Guidelines (under "Forms and guides"). In view of the extent of Trans-Tasman trade and investment between associated parties, we have raised the de minimis threshold from NZ $100,000 to NZ $600,000 in alignment with that applied by the Australian Taxation Office to further minimise compliance costs for multinational enterprises ("MNEs"). The new threshold applies from 1 July 2010.

"Strategic management" services

We have reviewed a number of cases where claims have been made about the contribution of strategic management from an offshore site. Our position is that the cost plus method is generally the right approach to services and will always be considered first, in light of the facts and circumstances, before reverting to other methods. As management is naturally strategic, the use of this term has not altered our approach.

Warning

We have consistently emphasised that it is the resonsibility of local management to ensure transfer prices are in accordance with the arm's-length standard. Local management cannot ignore situations where contracts are only partly performed (for example, services charged have not been provided) or there was no capability to perform. Inland Revenue has zero tolerance for tax evasion - due care and diligence must be taken when signing off on cross-border transactions, especially in respect of service charges.

Date published: 18 Apr 2011

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