Compounding this problem is where there is cross border related party debt; this is not just limited to large multinationals but SMEs, trusts and individuals as well. This is because Tax Authorities all over the world have been charged with collecting additional tax to mitigate the fiscal impact of governments’ significant covid-related support packages.
Transfer pricing rules and principles are used globally to determine in which country taxable income should be reported, buttressed by thin capitalisation rules to ensure profits aren’t moved through excessive debt being allocated to a particular country. New Zealand embraces these rules which also apply to cross border related party debt so the New Zealand tax base is not artificially eroded by manipulating interest rates and excessive borrowings. These include transfer pricing guidelines, restricted transfer pricing rules, thin capitalisation rules, non-resident withholding tax obligations and a Base Erosion Profit Shifting disclosure (used to identify risk areas and to share with other tax authorities around the world).
Cross-border related party loans in the spotlight: Could you inadvertently fall foul of the rules?
As with previous financial crises, times of economic uncertainty and downturns, tax authorities look to ensure they retain their piece of the global tax pie. While all cross border related party transactions will likely face increased scrutiny, it is the volatility of cross border related party loans which will likely pose the highest risk of tax leakage and fall firmly in the spotlight.
Interest rate and balance sheet impacts are often only reviewed periodically - if at all. But with interest rates spiking there is a risk that anyone could fall foul of the rules without realising it.
While Inland Revenue has a simplification measure for “small” loans, this only applies to loans under NZ$10million where an annually reviewed specific percentage over the 90-day bank bill rate can be applied to the loan without needing additional support. All other loans need support to demonstrate the interest rate is priced on an arms-length basis which also factors in the entity’s credit rating.
Interest rates have been low for a number of years, so there’s a risk little attention has been given to existing loans, and the relevant transfer pricing policies and documentation are unlikely to be fit for purpose.
Loan documentation: Time to get your house in order
With increasing liabilities on balance sheets, entities can quickly face having too much debt resulting in denial of interest deductions under the thin capitalisation rules.
To ensure policies around cross border related party loans are up to scratch, it’s important the loan documentation covers the following:
- Terms and conditions are clearly outlined including dollar value, repayment
- How the interest rate and associated fees meet the simplification measure or if not, how they are priced on an arms-length basis
- Cross border related party trade-payables are settled on normal trade terms and not unintentionally treated as debt
- Thin capitalisation calculation is undertaken to ensure interest deductibility is allowable
- Non-resident withholding tax has been withheld and necessary returns are filed
- Any required BEPS disclosures have been made
This is not a situation where you can agree a methodology and put it in the bottom draw to look at every three years. The impact on profit and balance sheets, taxable income and deductions will rapidly change during 2023.
There are many rules and guidelines applicable to related party cross border loans and can be an incredibly complicated area to navigate, which the Inland Revenue has acknowledged.
If you have cross border related party loans, now is the time to actively review your current position, and the impacts of inflation and interest rate rises, all while considering the likelihood of Inland Revenue asking you to justify your position.