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Service charges are one of the more common areas of focus for tax authorities examining the transfer pricing policies of multinational enterprises. Our rules are to be applied consistently with the approach to service charges as contained in Chapter VII (Special Considerations for Intra-Group Services) of the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations - July 2017.

Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD)

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 of reviewing international service charges.

Question Checklist

1

Understand the charge, go behind the label and document it (the actual services provided, the benefits arising, the basis of the charge, et cetera).

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 - 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 know-how 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 (in other words, no mark-ups).

10

Keep in mind other tax obligations such as withholding on services performed in New Zealand by offshore associates and royalties ('know-how and connected services').

Simplification measure

The OECD has introduced an elective, simplified approach for pricing low value-adding intra-group services. We recognise that there are considerable benefits for taxpayers in aligning our practice with international standards.

We have elected to implement this simplification measure for qualifying low value-adding intra-group services with a total value of below $1 million per annum. This measure will apply from income years commencing on or after 1 July 2018.

Simplification measures for transfer pricing


Detailed guidance on the application of this measure is contained in Chapter VII, Section D of the OECD's transfer pricing guidelines.

Specific benefit test for services

Our rules are to be applied consistently with the OECD’s transfer pricing guidelines for intra-group services. Central to the OECD approach is the application of the benefit test. Shareholder services, duplicated services and incidental services do not meet this central test.

Multinational groups often implement standardised cost allocation approaches to reduce transfer pricing compliance costs. In the absence of reasonableness checks, such approaches can result in inappropriate allocations. In many cases, the materiality of the New Zealand subsidiary may be small vis-à-vis the wider group which can exacerbate this issue. 

Reasonableness test

Our expectation is that New Zealand taxpayers undertake an in-market reasonableness test to confirm whether a service has actually been received and whether the offshore charge relating to it is arm's length within the context of the New Zealand business and the specific benefits arising.

New Zealand examples

Examples of costs allocated to New Zealand subsidiaries that on application of a New Zealand reasonableness test have been found to have fallen short of the central intra-group services test discussed above include the following.

Such costs generally do not provide specific benefits to the New Zealand business. In addition, an independent enterprise would not have been willing to pay for these costs and would not have performed such services in-house itself in comparable circumstances. Therefore, costs of this nature do not meet the central intra-group services test.

Costs that also do not meet the central intra-group services test include global restructuring costs where the purpose of the restructure is to benefit the shareholder. In these cases, the restructure does not result in any specific benefits for the New Zealand business, or may only result in benefits to New Zealand that are merely incidental. Again, these are not costs that an independent enterprise would have been willing to pay for or perform itself in-house in comparable circumstances.

In order to determine whether global or regional cost allocations meet the central intra-group services test, it is necessary to have a detailed understanding of the specific services provided to the New Zealand subsidiary and the benefits received. Without such details, it is not possible to ensure that shareholder services are not included within the charge and it is not possible to confirm the arm's length nature of the charge. In our view, a monthly or quarterly invoice does not in itself provide sufficient detail to support the arm's length test.

In cases where the costs of global IT applications are allocated to all subsidiaries of a multinational group, it is necessary to confirm whether the New Zealand subsidiary does in fact utilise each respective application. Establishing this is likely to require input from operational personnel in New Zealand.

There is also a high risk of duplicate services in the IT application area. That is, given specific regulatory requirements in some industries, it is necessary to develop a unique system in New Zealand. In these circumstances, the duplicate global systems are not actually used for operational purposes but are only used to enable head office to collate figures on a consistent basis.

Captive service providers

The centralisation of functions within a multinational group, particularly back-office functions, and the subsequent provision of services to other group members is a common feature in modern business.

In some instances, a subsidiary may perform a diverse range of business activities with the provision of centralised services being only one of those activities. In other instances, the provision of centralised services to group members is the subsidiary's core business activity.

This latter category of captive service providers share characteristics that may not be present in third party comparable arrangements and must be thoroughly explored in a taxpayer's functional and comparability analysis.

Complexity of functions

In our experience, there can be a tendency to overstate the functions performed by the captive service provider. In some instances, this occurs because the functional analysis does not break down the components of the wider process sufficiently. 

Where process components are not adequately identified, the entity responsible for that component can be overlooked. For example, in the context of captive service providers, if the service recipients are involved in designing the systems operated by the captive service provider then recognition must be given to this in the functional analysis.

Equally, with a view to undertaking a comparability analysis, it is important to identify typical process components that are not conducted by the captive service provider or any other member of the multinational group due to the group's specific requirements.

For example, marketing and business development activities are not usually conducted in captive arrangements; innovation and new product / market development activities may also be rare. Expenditure incurred to attract and maintain business will most likely be minimal.

Reduced risks

Captive service providers often assume less risk than third party service providers. For example, the captive nature of the arrangement can provide a guaranteed work-stream with virtually no credit risk. In addition to wider economic exposures, it is critical to review the inter-company contractual arrangements when assessing the risks assumed by these entities.

Pragmatic solution

Given the specific characteristics of captive service providers, as discussed above, it can be extremely difficult to identify highly reliable uncontrolled comparable data. In such situations, it is necessary to adopt a pragmatic solution based on available reliable data.

A sound analysis of the tested party and the reliable comparables will allow the taxpayer to select an appropriate point within the range of reliable data. For example, where it is determined that the functions and risks assumed by the tested party are less than those assumed by the comparables, the results of the tested party might be expected to fall below the median point in the range (perhaps at the lower quartile level).

Treatment in offshore regimes

We are aware that other jurisdictions adopt a variety of approaches in constructing the arm's length range and selecting an arm's length price within a range and that these approaches may conflict with the pragmatic solution suggested above.

In cases where the other jurisdiction is a New Zealand treaty partner and the differences have the potential to result in double taxation, taxpayers are encouraged to discuss their situations with us as early as possible, in particular, before a final position is taken by an overseas tax authority.

'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.

Local management responsibility

We have consistently emphasised that it is the responsibility 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.