Taxman sets sights on multinationals

By BRIAN FALLOW

WELLINGTON - The Inland Revenue is about to light the blow torch of transfer pricing rules and direct it at about 100 multinational companies it has picked for closer scrutiny.

Transfer pricing rules aim to prevent multinationals from ducking their fair share of tax by manipulating the prices paid in transactions between related companies in different countries. Broadly, companies are required to estimate an arm's-length price for such transactions, the price unrelated parties in a free market would pay.

Although the rules were toughened up with effect from the 1997 tax year, the IRD is only now starting to target this area and plan specific transfer-pricing audits, rather than looking at it in the context of a general multi-tax audit of a company.

The extra tax it may assess could be substantial.

"In our market," said KPMG partner John Burns, "if the Revenue come up with a tax adjustment of $100,000 taxpayers jump up and down. But the adjustments that can potentially arise out of transfer pricing are significantly more than that."

The IRD's chief adviser, international audit, John Nash, said the department was going through a "risk assessment" process, using information already on its database to select potential candidates for transfer-pricing scrutiny.

The sort of indicator that would attract attention is companies reporting losses or unusually low profits from substantial New Zealand operations, or dealings with low-tax jurisdictions. Size has also been a selection factor, on the grounds that more revenue is at stake.

From an initial list of around 250 it has identified about 100 where transfer pricing might be an issue.

They will receive, probably early next month, a three-page questionnaire.

Mr Nash said the questionnaire was modelled on returns corporates were routinely required to file in Australia and Canada.

"We will evaluate that information and if we still think there is a risk with a particular company we will ask it for further information or conduct a full, in-depth audit," Mr Nash said.

"Essentially our operation at the moment is about assessing risk, as opposed to actually collecting information to make amended assessments."

The companies concerned were spread across a wide range of industries, he said, reflecting the high level of foreign direct investment into New Zealand.

Leslie Prescott-Haar of Ernst and Young said that although the IRD had not detailed what information it would request, she expected it to include:

* The New Zealand company's profitability versus the profitability of its offshore associated parties.

* Circumstances impacting on its profitability.

* Its transfer pricing policies and documentation.

* Debt-to-equity ratios and interest expense.

The advice from tax professionals and the IRD to companies has been for some time to keep documentation on how prices are set, in case they are challenged.

In transfer pricing questions, unlike other tax matters, the burden of proof is on the IRD.

"If you can demonstrate you have put an effort into benchmarking transactions against some sort of comparable transaction, then you have discharged the burden of proof and it is over to the IRD to find a better method or a better comparable," Mr Burns said.

"We have been encouraging clients for a while to do something about it and a lot have, but the majority, I suggest, haven't. Those who haven't and who get one of these letters and a follow-up audit, will find they have the problem not only of burden of proof, but of penalties for carelessness."