Tax Tips Alert - PwC

Tax Tips AlertNew Zealand’s international tax rulesMay 2018It’s a brave new world for New Zealand’s international tax rules:Now is the time to get prepared and be ready for the significant wave of changesThe anticipated changes to New Zealand’s cross-border tax regime are now very close to becoming a reality.On 15 May, the Finance and Expenditure Committee (the FEC) reported back to Parliament on the Taxation(Neutralising Base Erosion and Profit Shifting) Bill (the Bill), which was released before Christmas last year. TheFEC supports the proposed application date of 1 July 2018. If your business has a connection outside of NewZealand, now is the time to ensure you are up to speed with the changes and the effect they might have onyour business. Your PwC team want to help, and can draw on our experts in this area to assist.Our December 2017 Tax Tips Alert provides moredetail on the proposed changes as first introduced.The FEC has recommended proceeding with theproposals largely unchanged, albeit with someimportant exceptions outlined in this Tax Tips Alert.The new rules are expected to take effectfor income years starting on or after 1July 2018. This also includes the newPE rules where there was previouslyuncertainty about the application date.We are pleased to see clarifications on some of theuncertainties identified during the consultationprocess. However, overall, it is disappointing tosee the number of submissions rejected by theFEC. Despite some improvements in drafting anddesign in various areas, we consider that the Billremains overly complicated, difficult to understand,and unworkable in some cases. We welcome therecommendation that further Inland Revenueguidance will be provided on some (but not all) ofthe changes. However, we question the timelinessof the guidance for taxpayers wanting to restructuretheir arrangements now to comply with the newrules before they take effect.1

Pricing of related-party loans –proposals proceeding with limitedamendmentsThe FEC has recommended proceeding with theproposed ‘restricted transfer pricing rule’, which willimpose significant restrictions under the transferpricing rules to the pricing of inbound related-partyborrowing exceeding NZD 10 million.The FEC’s most notable recommended changes tothe original proposals aim to reduce compliancecosts associated with undertaking a credit ratinganalysis for related-party borrowing and include: removing the income-interest ratio from thehigh BEPS risk test. Whether a borrower is ahigh BEPS risk will instead be determined onlyby reference to the borrower’s leverage ratioand the tax rate applicable to the correspondinginterest income in the lender’s jurisdiction allowing credit ratings for related partyborrowings to be implied from significant,unsubordinated, and unsecured third partydebt, where available, and allowing high BEPS risk borrowers that havean identifiable parent to use a credit ratingequivalent to two notches (extended from onenotch) below that of the member of the Groupwith the most debt, provided this does not resultin a credit rating lower than BBB- (otherwise,the result needs to use one notch below). HighBEPS risk borrowers with no identifiable parentwill still be limited to a credit rating of BBB- inmost instances for this pricing rule.In addition to the above, the FEC has recommendedredrafting the legislation to correct draftingerrors and provide more clarity on its application.However, it is disappointing that the revised draftrules remain so extensive in scope and complicated.The changes will do little to reduce the additionalcompliance burden that will be imposed ontaxpayers. We expect this rule will continue toresult in cross-border interest rate mismatches(and double tax) in instances where the relatedparty lender is required to price the loan based onthe Organisation of Economic Cooperation andDevelopment’s (the OECD) arm’s length principle.As no further changes to the ‘restricted transferpricing rule’ are expected, we strongly recommendtaxpayers consider the impact of these changes fortheir related-party borrowings now.It is disappointing that the revised draftrules remain so extensive in scope andcomplicated. The changes will do little toreduce the additional compliance burdenthat will be imposed on taxpayers.2

Permanent establishments – significantextension to the proposals that covertravelling employeesThe FEC has recommended a significant extensionof the original proposals to specifically captureemployees of large multinationals (groupturnover exceeding EUR750m) with ‘fly in, flyout’ arrangements in New Zealand (e.g. travellingsalespeople). These arrangements may be subjectto the proposed domestic permanent establishmentanti-avoidance rule irrespective of the timeemployees are physically located in New Zealand.The FEC has also recommended proceeding withthe original permanent establishment-relatedchanges, and has provided clarity on some aspectsof the legislation, including that existing advancepricing agreements will not protect taxpayers if theproposed domestic permanent establishment antiavoidance rule is enacted.Our commentsNon-residents operating under arrangementswhere employees fly in and out of New Zealandmay previously have thought the new rules will notapply to them if there was no entity in New Zealand.Any non-residents in this situation should urgentlyconsider the potential application of the proposedrule (and the prescribed criteria) to employees whotravel to New Zealand.In our view, the statutory language remains toobroad. There is still significant uncertainty as towhat specific sales-related activities will be caughtwithin the proposed rules, although the FEC hasrecommended that further guidance in this area(including specific examples) should be issued in aTax Information Bulletin (TIB) following enactmentof the Bill.Despite being an area of contention for a long time,the Officials’ Report to the FEC on Submissionson the Bill unfortunately provides no furtherdirection on how profit should be attributed to apermanent establishment. Comprehensive examplesare expected to be published in the TIB. We welcome/ urge comprehensive guidance and examples fromInland Revenue in this area as it is crucial to enablepotentially affected taxpayers to accurately assesstheir tax outcomes under the proposed changes.In our view, the statutorylanguage remains toobroad. There is stillsignificant uncertainty as towhat specific sales-relatedactivities will be caughtwithin the proposed rules.3

Thin capitalisation – proposalsproceeding as planned with somelimited relaxationsThe FEC has recommended proceeding with thethin capitalisation proposals as previously outlined,with several important changes: The requirement for taxpayers to reduce grossassets by deferred tax liabilities (as non-debtliabilities) has been amended to extend theexclusion criteria for deferred tax liabilitieson assets such as buildings that are nondepreciable or depreciable at a rate of zero(provided the other exclusion criteria are metwhich are aimed at deferred tax liabilities thatwill not create a cash tax liability if the asset issold). The proposal to change the safe harbour to100% of worldwide debt for taxpayers whoseworldwide group is the same as their NewZealand group (such as taxpayers controlledby either a non-resident owning body or by anon-resident trustee) has been clarified, withgrandparenting of the existing 110% worldwidedebt threshold extended to 5 years. The NZD 1 million interest de minimisthreshold seems to now only be availableto taxpayers subject to the outbound thincapitalisation rules, and even then additionalcriteria will need to be met (this limitation doesnot seem to be intended).With respect to the proposals for thin capitalisationfor public private partnerships, the FEC’srecommendations were limited to redraftingamendments (albeit significant) to ensure that therules operate as the policy intended.Our commentsWe welcome the changes around the relevanceof deferred tax liabilities (but were pushing formuch wider exception criteria). However, the thincapitalisation provisions affecting the changes inthe Bill remain difficult to understand and applyin practice overall. The FEC declined to accept themajority of submissions from taxpayers, industrygroups, and professional advisers, with the exceptionof some proposals in respect of public infrastructureprojects. The rejection of submissions to removedeferred tax liabilities from non-debt liabilities is ofparticular concern. We expect that, from a practicalperspective, this will likely mean that most taxpayerswill be required to include all deferred tax liabilitycomponents as a reduction to assets along withother non-debt liabilities in their thin capitalisationcalculations, subject to specific and limitedexemptions e.g. certain buildings.If your business is currently subject to the thincapitalisation regime, you need to understand theimpact of these new rules as soon as possible. Youmay need to consider restructuring if your ratio isexpected to exceed the safe harbour ratios.If your business iscurrently subject to thethin capitalisation regime,you need to understand theimpact of these new rules.4

Transfer pricing proposal largelyunchanged; with recommendedrestriction on 7 year time barThe proposed changes to New Zealand’s transferpricing regime will be implemented largely asoriginally signalled. The most notable exception tothis relates to the proposed extension of the time barfrom 4 years to 7 years. The FEC has recommendedthat the time bar can only be extended to 7 years ifInland Revenue has commenced a transfer pricingtax investigation within 4 years of the relevant taxreturn being filed, and has notified the taxpayer ofthis investigation.All other proposals in legislation remain, albeit withsome recommended drafting amendments to: more clearly define which taxpayers are caughtby the transfer pricing rules, by removingreference to ‘control group’, reinstating thereference to ‘associated person’ and addingspecific reference to capture New Zealandcompanies owned by investors who act together,and more clearly set out the process for calculatingan arm’s length amount.In effect, the proposed legislation will require legalarrangements to be commercially rational andconsistent with their economic substance, and willshift the onus of proof to the taxpayer to provethat the arrangements are on arm’s length terms(rather than Inland Revenue having to disproveit). The Officials’ Report commented that thischange to the onus of proof “will effectively requiremultinationals to analyse and prepare transferpricing documentation for their related partytransactions”.Our commentsWhile we welcome the minor amendment to thetime bar, this does little to remove the significantuncertainty facing taxpayers in relation to transferpricing. We recommend that you consider yourbusiness’s current transfer pricing arrangementsand prepare detailed and contemporaneous NewZealand-specific transfer pricing documentation inline with the new legislation and following closelythe analysis as set out in the new OECD guidelines.In effect, the proposed legislation will requirelegal arrangements to be commerciallyrational and consistent with their economicsubstance, and will shift the onus of proof tothe taxpayer to prove that the arrangementsare on arm’s length terms5