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:
- the use of correct commodity price benchmarks
- recovery of head office costs
- recovery of research and development costs
- low/no interest outwards lending
- free/low rate outwards credit support (guarantees)
- offshore operations returning abnormally high profits.
The exporter's checklist
A large number of New Zealand small and medium enterprises engaged in exporting operate through associates abroad. Recognising this, we have developed the following short checklist in the form of answers to the 10 most frequently asked questions.
As some jurisdictions have reputations for aggressiveness, should more income be left there 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.
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 small and medium enterprises operate through small buy-sell distributors and/or service providers - do their operating margins reflect commercial reality?
What effect does a brand or know-how have on transfer pricing?
- It is important to establish both where legal ownership lies and which members of the group have contributed to the value creating activities of the intellectual property. The ultimate benefit of any intellectual property should lie with the members of the group who have contributed to its development, enhancement, maintenance, protection and exploitation.
- For New Zealand exporters, we typically observe that both legal ownership and value creating activities lie in New Zealand. Where this is the case, the New Zealand group member who has contributed to the value creating activities may be rewarded either through the pricing of goods sold to the overseas distributor or directly through a royalty charge.
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.
- Where this is undertaken at the direction of the New Zealand parent, 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 intellectual property.
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.
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.
How should management and other support services provided to offshore associates be identified and charged out?
- Consider the application of the OECD guidelines on Low Value Adding Intra-Group Services, essentially cost plus.
- Also, keep an eye out for any services requiring specialist know-how or expertise provided from New Zealand which require higher mark-ups.
Simplification measures for transfer pricing
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 by applying our simplification measure for small value loans will be fair and reasonable for loans under $10 million in loan principal.
What should a New Zealand exporter do if a foreign tax authority is disputing the transfer pricing positions taken by offshore associates?
- Consider approaching our International Revenue Strategy team by sending an email to: [email protected]
- 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.
When should a New Zealand exporter consider an advance pricing agreement?
- Advance pricing agreements 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.