Deciding Tax Residency
The new transfer law was enacted in New Zealand in Section GD13 of the Income Tax Act, 1994 with an intention to improve the taxpayer disclosure and reporting of New Zealand source based income and while reducing the manipulation and shifting of profits to lower tax jurisdiction through cross border transactions. The guidelines developed are in consensus with Organisation for economic cooperation and development, the principal body for Base Erosion and Profit Shifting (BEPS). Further, the law developed was consistent with New Zealand Double Tax Avoidance Agreement.
(IRD, 2018)
In terms of the OD 7 and OD 8 of the New Zealand Income Tax Act, 1994, associated enterprise shall mean the following:
- When two companies under any time under the year are under control of group of persons or individual holding more than 50 % of voting interest in the company;
- When both the companies are controlled by a third party;
- The market interest of both the companies exceeding 50% are controlled by third entity;
- If under any circumstance a company and any person other than a company holds at any time voting interest in the company equal to or exceeding 25% or The market interest of the company exceeding 25%;
- The two person concerned are relatives to each other;
- A partnership under which any person is a partner in the partnership or he is associated with the partner in the partnership
(New Zealand Government, 2018)
In terms of HHF3 of the New Zealand Income Tax Act, 1994, relative shall mean the following:
- Connected by blood relationship;
- Marriage;
- Partnership;
- Adoption;
- Trustee of trust when an individual is beneficiary to that trust.
(New Zealand Government, 2018)
On the basis of above deliberations, in the present circumstance, Andy is going to raise an invoice on the company Smith-On plc business which has been founded by him and has an interest of 51% which satisfies the conditions stated here-in-above. Hence, Smith-On plc and Andy are associated enterprise and transaction between the shall be governed by transfer pricing rules as laid down under New Zealand Income Tax Act, 1994.
Further, w.r.t the second transaction for supply of equipment’s by Smiley Braces Ltd to the Smith-On plc. In this regard, since both the entities are under the ownership of Andy with Andy being holding a substantial interest in the company. The transaction between the two enterprises shall come under the purview of transfer pricing rule as stated on account of definition of associated enterprise stated above.
Further, the law of transfer pricing states that transaction between two associated enterprises shall be carried out at arm’s length. The basis of computation of such arm’s length price has been detailed here-in-below
Methods of Transfer Pricing in New Zealand in terms of Section GD 13(7) of the New Zealand Income Tax Act, 1994
- Comparable Uncontrolled Price Method;
- Resale Price Method;
- Cost Plus Method;
- Profit Split Method;
- Comparable Profits Method.
The first three methods are described as traditional method while the later two are transactional methods for determination of Arm’s Length Price for transaction between two associated enterprises.
The Comparable Uncontrolled Price Method, commonly known as the CUP method is the most direct and reliable method amongst all the methods. Under the CUP method, the price charged for goods or services transferred in a controlled transaction is compared to the price charged in a comparable uncontrolled transaction. It is a price for identical or nearly identical goods traded between two independent parties under the same or similar circumstances. The method assumes that a known comparable uncontrolled price exists for the sale or purchase of the same or similar goods between independent parties.
Further, in case of similar transaction the adjustment shall be made on account of differences in the following manner:
- identify the price charged or paid for property transferred or service provided in a comparable uncontrolled transaction;
- adjustments on account of difference between price charged in the International Transaction or Specified Domestic transaction and that charged in the uncontrolled comparable transaction, which materially affect the price charged in open market;
- the adjusted price is considered as the arm’s length price in respect of the property transferred or services provided in the International Transaction.
Further for typical transaction for which CUP shall be used includes the following:-
- Transfer of goods;
- Provision of Service;
- Intangibles;
- Interest on loans.
In the present circumstance, since the transaction involve sale of goods by Smily Braces Limited to Smithe-on-Plc and hence the same shall be benchmarked by using Comparable Uncontrolled Price Method. Further, the comparable for the said product shall be find in the external market or the price at which the same good is sold by Smily Braces Limited to non-associated enterprise shall be taken as CUP.
Tax Consequences of Non-Filing Income Tax Returns
Further, w.r.t. provision of service the above reason shall hold and the method shall apply accordingly.
The Resale Price Method, commonly known as the RPM is applicable when a product is sold by one associated enterprise to another and then the same is resold to an unrelated enterprise. The price, which the unrelated enterprise pays, is the benchmark in this case. The method determines the arm’s length price for transfers affected to associated enterprises, which resell or distribute to unrelated parties without significant value additions.
Since in the said case, there has not been any resale of such goods and service, the said method cannot be used for the purpose of benchmarking.
The Cost Plus Method, commonly known as CPM, is generally suitable for transactions between associated enterprises in relation to (a) sale of semi-finished goods, (b) long term buy-and-supply arrangements, (c) subsidiaries performing the role of sub-contractors, etc.
Since in the said case, there has not been any aforesaid circumstance, the said method cannot be used for the purpose of benchmarking.
The OECD Transfer Pricing Guidelines observes that the total profits arising out of the Associated Enterprise transactions must be split in an economically valid basis, each reflecting the functions and risks of each party engaged in the transaction.
Under the Profit Split Method (PSM), the relative contribution made by each of the associated enterprises is evaluated with reference to external data in respect of un-associated enterprises performing comparable functions under similar circumstances. This method intends to eliminate special conditions imposed in controlled transactions on the levels of profits to be earned by the associated enterprises. The advantage PSM has over other methods is that it can also be used in cases where comparable transactions between non-associated enterprises cannot be identified.
Under this method, the combined profits from controlled transactions are divided between the associated enterprises on the basis of relative value of the functions performed by each of the associated enterprises participating in the transaction. This method ensures the attribution of both (a) income, and (b) expenses to the associated enterprises involved in the transaction on a consistent basis.
Since in the said case, no function has been performed by the Smith on Plc, the said method cannot be used for benchmarking.
The Comaprable Profit Method is generally used where data available is inadequate or unreliable to apply to the traditional methods. The object of comparison in this method is the net profit margin earned in an International Transaction.
Thus under the said method, Profit of Smiley Braces and Andy w.r.t the particular transaction shall be compared with the margin earned from the industry. Thus, the benchmarking shall be done by this method.
In terms of New Zealand Income Tax Act, 1994, when a payment is made to foreign worker (not a worker of company) for services rendered in New Zealand tax shall be deducted at source in terms of local law of Double Tax Avoidance Agreement of the residence country of the worker whichever is beneficial. Further, the law states that if the person is a worker of the company PAYE shall be se deducted in terms of the Act as if he is a resident employee. However, the person shall be eligible to claim the exemption under New Zealand tax system under 92 day rule and Double Taxation Avoidance Agreement.
Transfer Pricing Regime and Its Application to Associated Persons
If the employer fails to pay PAY E tax then the foreign worker is responsible to pay the same provided the employer makes disclosures in Employer Monthly Schedule – if e-filing , Employer Schedule – if paper filing, Employment information Schedule if you are a pay day filer. Failure to do so can impose fines ranging from $ 25000 for first offence and $50000 for subsequent offence.
When cash payment are made to an employee they are generally made with an intention to avoid taxes there on as the payment is not made through proper channels and finding track or trails is quite difficult for them as they are not accounted in the books and the same is not under the banking system which can be tracked by the department. Further no legal documents are attached to the same. However, that is negative side of the coin. There may be instances when payment are made in cash not with an intention to avoid cash and proper disclosure are made under the Act depending on the amount of pay made to the worker. It is not mandatory for a foreign worker to be made payment in his home currency, he can be paid in cash. Thus, holding a firm view that every cash payment made is tax avoidance is myopic as certain payment can be genuine and within the purview and legal boundaries of law.
Further, in case tax avoidance is detected by the department penalty shall be imposed to the tune of 150% of the tax owing. Further, if you are a habitual offender jail upto 5 years can be imposed.
In terms of Section BG 1 and Part G of the New Zealand Income Tax, 1994 commissioner of Inland Revenue has the power to counteract any arrangement or colourable device which has been done with an intention to avoid tax or has been carried out unintentionally to avoid tax. Further, the advantage that has been achieved under such colourable device shall be disallowed by the commissioner of Inland Revenue. Further, the arrangement shall be considered void and penalty may be imposed on the same.
The penalty provisions shall be applicable on all taxes and duties encompassing PAYE, deduction, GST, fringe benefits etc.
There are categories of penalties that can be imposed:
- In case of absolute liability offence : $ 4000 for first offence, $8000 for second one and $ 12000 for any subsequent offence
- Further, in case tax avoidance is detected by the department which is knowledgeable penalty shall be imposed to the tune of $ 25000 for first offence and $ 50000 for subsequent offence. Further, if you are a habitual offender jail upto 5 years can be imposed.
In terms of New Zealand Income Tax Act, 1994 if a voluntary disclosure is made by an individual before audit notification of commissioner by the Inland Revenue Department then the IRD shall allow a reduction in the penalty rate as defined below:
- By 100% under the section 141G(3)(a)(i) if tax payer makes the disclosure pre notification and the shortfall is on account of not taking reasonable care or on account of unacceptable tax position or interpretation which is not acceptable;
- By 100% under section 141J(2)(a)(i) if a disclosure has been made by the tax payer prenotification and is on account of gross carelessness, tax position taken which is abusive or tax evasion or any similar act;
- By 75% u/s 141J(2)(b) of New Zealand Income Tax Act, 1994 if a disclosure has been made by the tax payer prenotification and relates to a temporary tax fall or makes a post notification disclosure and the penalty for shortfall has been levied u/s 141A to 141EB of the Income Tax Act, 1994
- By 40% under section 141G(3)(b) if disclosure is made post notification by the tax payer
Thus, the disclosure can be made both prenotification and post notification by an individual
(IRD, 2018)
References
Edmunds, S. (2018, October 24). Cash payment will always leave a trail, Inland Revenue says. Retrieved from stuff.co.nz: https://www.stuff.co.nz/business/100078541/cash-payments-will-always-leave-a-trail-inland-revenue-says
IRD. (2018, October 24). SPS 09/02 Voluntary disclosures. Retrieved from ird.govt.nz: https://www.ird.govt.nz/technical-tax/standard-practice/shortfall/sps-09-02-voluntarydisclosures.html
IRD. (2018, October 24). Transfer Pricing Guidelines. Retrieved from taxpolicy.ird.govt.nz: https://taxpolicy.ird.govt.nz/sites/default/files/2000-other-transfer-pricing-guidelines.pdf
IRD. (2018, October 24). Transfer pricing regime. Retrieved from www.ird.govt.nz: https://www.ird.govt.nz/resources/2/5/256c4a94-b125-4d28-9625-756e83fab7a2/tib-vol07-no11a.pdf
IRD. (2018, October 24). Types of tax offences. Retrieved from www.ird.govt.nz: https://www.ird.govt.nz/how-to/debt/penalties/criminal-penalties/criminal-penalties.html
New Zealand Government. (2018, October 24). Income Tax Act 2004. Retrieved from www.legislation.govt.nz: https://www.legislation.govt.nz/act/public/2004/0035/70.0/DLM277112.html
New Zealand Government. (2018, October 24). Income Tax Act 2004. Retrieved from www.legislation.govt.nz: https://www.legislation.govt.nz/act/public/2004/0035/70.0/DLM264309.html
Tax Accountant. (2018, October 24). What is a voluntary disclosure? Retrieved from taxaccountant.kiwi.nz: https://taxaccountant.kiwi.nz/nz-tax-questions-and-answers/259-what-is-a-voluntary-disclosure
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