Chapter Twenty-Two

New Zealand Transfer Pricing Developments

New Zealand issued transfer pricing guidelines as an appendix to the Tax Information Bulletin, Vol. 23, no. 10 (October 2000), doing so as a guide to section GD 13 of New Zealand’s Income Tax Act 1994. Earlier transfer pricing provisions go back to the Income Tax Act 1976, section 22. The New Zealand transfer pricing guidelines specifically address documentation and intangibles issues in detail as well as examining services and cost sharing issues.

Most recently, New Zealand’s current transfer pricing focus, as of May 14, 2008, addressed four issues related to transfer pricing: royalties, business restructuring, private equity, and intangible asset impacts. New Zealand transfer pricing is quite advanced, given the country’s population. Thus, for example, New Zealand has a fully developed advance pricing agreement (APA) program, completing 31 APAs as of March 31, 2008, and having 6 APA applications in progress.

NEW ZEALAND TRANSFER PRICING GUIDELINES

The New Zealand transfer pricing guidelines are 79 pages in length and comprise these areas:

• Introductory material
• Arm’s length principle
• Pricing methods: theoretical and practical considerations
• Principles of comparability
• Practical application of arm’s length principles
• Documentation: statutory considerations and the Inland Revenue’s approach
• Intangible property
• Cost contribution arrangements
• Changes from the draft guidelines

INITIAL DEVELOPMENTS

New Zealand follows closely the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. New Zealand’s Inland Revenue initially followed the OECD transfer pricing rules in their entirety during the development of the New Zealand transfer pricing guidelines. The New Zealand transfer pricing guidelines do not differ substantially from the OECD’s view on any point, but the New Zealand transfer pricing guidelines elaborate on intangibles and documentation beyond the OECD guidelines. The New Zealand transfer pricing guidelines, then, should be read as supplementing the OECD guidelines rather than superseding them. The OECD guidelines will form the basis for resolving transfer pricing disputes under the mutual agreement articles of New Zealand’s double tax agreements.

New Zealand’s Inland Revenue has issued documentation guidelines that fill the void in the OECD regulations. New Zealand reserves the right to make its own decisions when the OECD so permits. New Zealand has done so in the case of documentation, for example, staking out its own position. The New Zealand transfer pricing guidelines specify that documentation plays a key role in determining whether the Inland Revenue is likely to review taxpayers’ transfer pricing in detail.

The purpose of the New Zealand transfer pricing guidelines is to:

• Provide guidance as to the factors that the parties should consider in determining whether an amount constitutes an arm’s length price
• Determine how these factors might affect a transfer pricing analysis

In addition to reliance on the OECD, the New Zealand transfer pricing rules make specific reference to guidelines issued by the Australian Tax Office and to guidelines issued by the U.S. Internal Revenue Service. The New Zealand transfer pricing guidelines state that there should be no conceptual transfer pricing differences between the U.S. rules and the Australian rules. Nevertheless, the range of comparables and the scope of transfer pricing adjustments in Australia and the United States might differ from those in New Zealand.

These New Zealand transfer pricing provisions go back to 2000. The New Zealand Inland Revenue, or the taxpayer, as the case may be, might be able to claim that New Zealand can ignore Australian rules or U.S. rules issued subsequent to 2000, arguing that Australia or the United States diverged from the New Zealand rules after that point.

The New Zealand transfer pricing guidelines warn the taxpayer not to make corresponding adjustments or deductions directly on their tax returns. New Zealand’s tax law requires the taxpayer to use the actual transaction price unless the transfer pricing rules substitute an alternative price. The foreign tax administration’s substitution of an alternative price is insufficient for New Zealand’s purposes.

ARM’S LENGTH PRINCIPLE AND THE PRICING METHODS

The New Zealand transfer pricing guidelines focus on “market forces” as being the essential pricing determinant. An example determines this pricing analysis in a two-party context, using the “combined profit” of both parties as a starting point. New Zealand accepts five specific transfer pricing methods:

The profit split transfer pricing method typically refers to operating profit, but in some circumstances the parties can split profits based on gross profits rather than on operating profit. The parties can split the profits based on an “economically valid basis” approximating the division of profits that would have been anticipated and reflected in agreement made at arm’s length.

The New Zealand transfer pricing guidelines and legislation do not establish an explicit hierarchy for the transfer pricing methods. The New Zealand Inland Revenue looks to the transfer pricing method that will “provide a more reliable result” than others. Inland Revenue equates the comparable profits method as used in the United States as being equivalent to the OECD’s transactional net margin method. Note that the availability of data is frequently an issue in New Zealand, given the small market in the country, and this fact may impact the taxpayers’ choice of pricing method as well as the use of foreign entities as tested parties.

As to the real-world constraints that impact transfer pricing, the New Zealand transfer pricing guidelines focus on two areas:

The New Zealand transfer pricing guidelines recognize real-world constraints imposed on manufacturers, as opposed to distributors, in seeking such a comparable independent firm.

The New Zealand transfer pricing guidelines appear to be enamored with the profit split transfer pricing method, speaking of a split based on an economically valid basis, approximating the division of profits that the parties would have anticipated, and reflected in an agreement made at arm’s length. The New Zealand transfer pricing guidelines speak of the profit split method in the context of the ownership and division of intangible property.

BASICS OF THE TRANSFER OF INTANGIBLE PROPERTY

In economic terms, the New Zealand transfer pricing guidelines refer to intangible property as something that an entity owns; tangible property is something that enables the entity to earn more from a particular activity than the entity could earn if the entity did not own the property. The issue becomes the delineation between the use of the term “intangible” in the economic sense as opposed to in the legal sense. The New Zealand transfer pricing guidelines refer to that term in the economic sense but refer to legal ownership positions.

The New Zealand transfer pricing guidelines, like the OECD guidelines, delineate two types of intangible property:

The New Zealand transfer pricing guidelines emphasize the importance of ascertaining to which party the intangible’s return should accrue. As a general matter, the returns should accrue to the party that created the intangible, typically the party that paid for the creation of the intangible. Thus, the retailer might use the cost plus method to determine the arm’s length price that it created as to the intangible. The manufacturer might use the resale price method to determine the arm’s length price created as to the intangible.

The New Zealand transfer pricing guidelines, in discussing intangible property, focus on risk and reward in the legal context. The development of intangible property involves some degree of risk for the party bearing that risk. The firm undertaking that risk as to intangible property would expect to be compensated for that risk. Ultimately, it will be the legal ownership of property concerned that determines which party benefits directly from the exploitation of the property. The compensation to the party that risks the development of the intangible depends on whether the creator of the intangible is the legal owner of that property or not. The legal ownership of the intangible property determines the property that benefits directly from the intangible property.

Two situations apply to the treatment of the creator of intangible property, depending on the legal ownership of that intangible property:

The New Zealand transfer pricing guidelines view the ownership of the intangible property as being entirely with the legal owner of the intangible property, most typically the foreign parent company that established the brand in its home country. The New Zealand Inland Revenue expects the foreign parent company to compensate the New Zealand subsidiary in one of two ways if the New Zealand subsidiary builds up its brand:

At arm’s length, an independent party would expect something in return for incurring costs and risks. The New Zealand transfer pricing guidelines provide these examples of this return:

• By reducing the price of inventory sold by the foreign manufacturer to the New Zealand subsidiary
• Reimbursing the New Zealand subsidiary on a cost plus basis

PROFIT SPLIT METHOD AND THE JOINT OWNERSHIP OF INTANGIBLE PROPERTY

As a practical matter, more than one party to the transaction might own the intangible property. Consider the case of a foreign party that develops its technology elsewhere, imports the technology to New Zealand, and the New Zealand subsidiary develops its own brand name. Both parties in this instance would be creating valuable intangible property. The parties then need to ascertain:

• The total value that is attributable to the intangible property
• How the parties are to allocate the intangible property

It is rarely feasible to ascertain benchmark rates for these intangibles. Instead, the New Zealand Inland Revenue in essence recommends that taxpayers apply the profit split method. The parties then would:

• Determine the aggregate profit from the transaction.
• Divide this aggregate profit from the transaction between the parties on their relative economic contributions.

PROFIT SPLIT METHOD

The New Zealand transfer pricing guidelines refer to the OECD profit split methods as applicable in New Zealand:

• Residual profit split approach
• Contribution analysis approach

The New Zealand transfer pricing guidelines distinguish between the profit split methods and global formulary apportionment. The guidelines argue that global formulary apportionment “is determined without considering what the parties are actually contributing.”

RESIDUAL PROFIT SPLIT ANALYSIS

The New Zealand transfer pricing guidelines favor the residual profit split analysis if the parties are to split profits. The residual profit split involves these processes:

• The first step in applying the residual profit method is to utilize a basic return, doing so to both the manufacturer and the retailer, based on what return independent firms would provide, such as by applying the cost plus method.
• The second step looks to the residual amount, which is the excess return over and above the basic return rate. The parties would then divide this amount, based on the parties’ relative contribution to the intangible property. This profit split process involves judgment as to what factors contribute to the residual profit and their relative contributions of these factors, making this process a “somewhat subjective measure.”

The New Zealand transfer pricing guidelines acknowledge that, as far as the profit split method is concerned, “there are difficulties in applying this method in practice” and taxpayers need to be aware, therefore, that not all jurisdictions will readily accept the determination of an arm’s length price based on the profit split method.

TRANSACTIONAL NET MARGIN METHOD

The New Zealand transfer pricing guidelines provide that the transactional net margin method (TNMM) is considered, in international practice, along with the profit split method, to be a method of last resort. Nevertheless, the New Zealand transfer pricing guidelines provide that information constraints may dictate the TNMM as the only practicable approach in many cases. Further, the New Zealand transfer pricing guidelines provide that intangible property in the production process may further complicate the issue. A TNMM based on some cost base (excluding the transfer price) may, therefore, be an appropriate way to determine the basic return for the manufacturer’s functions.

Both members of a multinational may own valuable intangible property. The valuation of this intangible property may make the application of the transactional methods or the TNMM methods impractical. The New Zealand transfer pricing guidelines conclude that it may be appropriate to consider applying the profit split method in such circumstances.

MARKET PENETRATION TECHNIQUES

New Zealand’s Inland Revenue may apply a number of factors in evaluating a taxpayer’s claim that it is following a strategy, such as a market penetration strategy, that temporarily decreases profits in return for higher long-term profits:

• Inland Revenue could examine the conduct of the parties to determine whether that conduct is consistent with the party’s professed business strategy. Inland Revenue could expect the party undertaking a market share strategy to use unusually intensive marketing and advertising efforts along with that market share strategy.
• Inland Revenue could examine the market penetration strategy to ascertain whether the strategy is consistent with the taxpayer bearing the costs of that strategy.
• Inland Revenue could examine whether there is a plausible explanation that the business strategy will produce a return that is sufficient to justify its costs within a period of time that would be acceptable in arm’s length arrangements.

AUSTRALIA’S FOUR-STEP PROCESS TO ASCERTAIN THE ARM’S LENGTH APPROACH

New Zealand’s Inland Revenue views with favor the four-step process developed by the Australian Tax Office (ATO) to determine arm’s length prices:

DOCUMENTATION

The New Zealand transfer pricing guidelines emphasize the importance of documentation in the transfer pricing process and provide the taxpayer with broad general parameters and nothing more. The New Zealand transfer pricing guidelines contain no explicit statutory requirement to prepare and maintain transfer pricing documentation. Thus, the New Zealand transfer pricing guidelines fail to provide specific guidance, as would the U.S. transfer pricing provisions, leaving instead extensive discretion on the part of the New Zealand taxpayer. The New Zealand taxpayer is not expected to prepare levels of documentation that are disproportionate to the amount of tax revenue at risk in their transfer pricing transactions.

At a minimum, Inland Revenue would expect the taxpayer to provide this documentation:

• An identification of the cross-border transactions for which the taxpayer has transfer pricing exposure
• A broad functional analysis of the taxpayer’s operations so as to identify the taxpayer’s functional functions being performed
• An estimation of the business risk of not undertaking and documenting a more detailed transfer pricing analysis
• An estimation of the costs of complying with the transfer pricing rules

New Zealand does not apply the contemporaneous documentation concept but approaches the contemporaneous documentation concept in many respects. Inland Revenue considers that a taxpayer should, as far as practicable, seek to collect and retain documentation that is:

• Existing at the time that the taxpayer was developing or implementing any arrangement that might raise transfer pricing issues, or
• Brought into existence close to the time the transaction occurs.

DOCUMENTATION AND THE BURDEN OF PROOF RULE

The New Zealand statutory provisions address the burden of proof shifting in the transfer pricing context. The price determined by the taxpayer is the arm’s length price unless one of these conditions applies:

• The Commissioner can determine “a more reliable measure” of the arm’s length amount than the measure of the arm’s length amount determined by the taxpayer.
• The taxpayer does not cooperate with the Commissioner’s administration of the transfer pricing rules.

A taxpayer electing not to prepare transfer pricing documentation leaves itself exposed on two counts:

Inland Revenue views adequate documentation as being the best evidence that the taxpayer can produce to demonstrate that it has complied with these documentation rules. A taxpayer’s failure to prepare and provide transfer pricing documentation, coupled with Inland Revenue’s ability to demonstrate a more reliable measure of the arm’s length amount, can cause the taxpayer to be subject to penalty. New Zealand has two specific penalties:

INLAND REVENUE SEEKS TO ASCERTAIN THE RISKS TO THE REVENUE

The New Zealand transfer pricing guidelines provide that the primary determinant as to whether Inland Revenue will examine the taxpayer’s transfer price in detail is the extent to which Inland Revenue perceives that the transfer prices present a “risk to the revenue.” Inland Revenue is likely to conclude that a taxpayer’s transfer pricing practices constitute a low revenue risk if the taxpayer can establish to Inland Revenue that it has set its prices in accordance with the arm’s length principle and has documented how it determined these prices. In that event, Inland Revenue’s role would then be one of monitoring the results.

The New Zealand transfer pricing guidelines view the documentation process as having two parts:

Inland Revenue expects the taxpayer to consider the trade-off between the cost of compliance and the risk that Inland Revenue will audit the taxpayer’s transfer prices and adjust the results. A taxpayer’s determination of the arm’s length price will be more persuasive in the face of an inquiry by Inland Revenue if the taxpayer’s analysis is sound and is supported by good-quality documentation. Inland Revenue is likely to use a taxpayer’s documentation, or the lack of it, as an important factor in determining whether the taxpayer’s transfer prices present a risk to the revenue and whether they should receive further attention. Inland Revenue does not expect taxpayers to prepare levels of documentation that are disproportionate to the amount of tax revenue at risk in their transfer pricing transactions.

Inland Revenue rates these six factors as suggesting low risk when it comes to transfer pricing:

RETENTION OF RECORDS

A New Zealand taxpayer must keep records for these time periods:

• Seven years after the tax year for which these records apply
• Three additional years if the Commissioner requests the extension

New Zealand taxpayers should extend the record retention period in these circumstances:

• In the case of long-term contracts
• In the case of licenses and similar arrangements

New Zealand normally requires the taxpayer to maintain the documents in New Zealand, and in English. The taxpayer can request the Commissioner to keep some records outside New Zealand or to maintain these records in a language other than in English.

TRANSFER PRICING IN COUNTRIES WITHOUT A DOUBLE TAX AGREEMENT

New Zealand Inland Revenue will look more closely at transactions with countries in which New Zealand does not have a tax agreement. Transactions with low-tax jurisdictions are particularly subject to Inland Revenue scrutiny. New Zealand might enforce exchange of information provisions when available. It may therefore be prudent for the taxpayer to prepare higher-quality documentation when the transactions involve nontreaty countries.

Taxpayers should consider the three-part delineation:

A nonresident parent company might dictate the transfer price to the New Zealand subsidiary. Such a subsidiary might have limited, if any, documentation that would demonstrate why its transfer prices comply with the arm’s length principle. In that event, the Inland Revenue might have recourse to the documentation held by the nonresident parent if the Inland Revenue reviews the taxpayer’s transfer pricing.

Inland Revenue acknowledges that taxpayers might face difficulties obtaining information from foreign-related parties that the taxpayers would normally not encounter if Inland Revenue required the taxpayers to produce only their own documents because:

• The subsidiary lacks control.
• Accounting standards and legal documentation requirements might differ.
• Prudent management might not suggest that the taxpayer keep these documents.
• The cost and expense of translating and producing these documents might be prohibitive.

Section 21 of the Tax Administration Act 1994 relates to payments the taxpayer makes for acquisitions made from a related foreign party. The taxpayer has an obligation to provide information as to that payment within 90 days of receipt from the Commissioner’s request. If the taxpayer fails to comply with the Commissioner’s request, the taxpayer then could not use that information in evidence in judicial proceedings.

The Inland Revenue does not intend, as a matter of course, to use non–publicly available information in an attempt to substitute that information as an alternative measure of the arm’s length amount. It appears that the New Zealand Inland Revenue does not use secret comparables as an evidentiary standard but will use these secret comparables in ascertaining which taxpayers could be most responsive to transfer pricing adjustments.

INTANGIBLE PROPERTY AUDITS

Intangible property may be more problematic to audit than tangible property because it is difficult to apply intangible comparables and because multinational enterprises may structure their arrangements in ways different from independent firms. Functional analysis is critical in determining the real nature of the property being transferred because it seeks to identify:

• The owner of the intangible
• The factors that have led to the creation of intangible value
• The location as to where the rewards to that intangible accrue

The quest for comparables becomes paramount in the intangible property context. One such comparability approach is to compare the return to a manufacturing function that incorporates equivalent intangible property, a cost plus approach. The taxpayer may find that when using internal (or in-house) comparables, the transfer of the same property to an independent third party, if available, could provide a valuable source of information. It might not always be practicable to ascertain comparables directly. Inland Revenue cautions that it may be better to apply no comparable than to apply a patently wrong comparable. The profit split method requires a less rigorous determination of comparables than do other transfer pricing methods. As an alternative, taxpayers should consider valuing reliable projections of cash flow.

TRADE INTANGIBLES AND MARKETING INTANGIBLES

The OECD, like New Zealand, delineates two broad categories in intangible property: trade intangibles and marketing intangibles. The OECD guidelines are the basis behind the New Zealand rules:

The New Zealand transfer pricing guidelines recognize that the boundary between trade intangibles and marketing intangibles might become blurred in many instances. As such, the New Zealand transfer pricing guidelines deemphasize this classification and instead emphasize the awareness of the factors that lead to the creation of value for intangible property of different natures.

ASCERTAINING THE ARM’S LENGTH AMOUNT FOR INTANGIBLE PROPERTY

The New Zealand transfer pricing guidelines recognize that there are inherent difficulties in ascertaining the arm’s length amount for intangible property:

• It may be difficult to discern the precise nature of a transaction. Thus, a transaction might represent a number of components, both tangible and intangible, which are bundled together.
• The intangible property might have a special character that complicates the search for comparables. This special character might make it difficult for the taxpayer or the tax authorities to determine the comparables.
• Multinational businesses may adopt structures that are different from the structures of independent firms. For example, the multinational firm might transfer intangible property to an affiliated party that the multinational firm might not transfer to an independent firm.

ASCERTAINING THE OWNERSHIP OF INTANGIBLE PROPERTY

As a general matter and as a rule of thumb, the party that owns the intangible property initially bore the risks and expenses of the risks associated with its development, whether the party incurs these risks and expenses directly or indirectly through recompensing another entity undertaking work on its behalf. The owner of that property is entitled to all of the income that the property generates.

The initial owner of the intangible may choose to transfer some or all the rights to exploit the intangible. The initial owner should impose an arm’s length charge for the transfer of these rights. The transferee would then be entitled to the income that is attributable to the transferred rights.

There might be situations in which the party that developed the intangible property does not acquire ownership of the property. The legal owner of the intangible property nevertheless would be the owner of the property even though the legal owner of the property did not contribute to its development. The developer non-owner of the intangible property can expect to receive arm’s length consideration for its development services either through:

• Cost reimbursement, together with a profit component
• Lump-sum compensation, including a profit component

FACTORS IN ASCERTAINING THE NATURE OF INTANGIBLE PROPERTY

The New Zealand provisions follow the OECD rules in focusing on factors that ascertain the nature of intangible property:

TERMS AND CONDITIONS OF THE INTANGIBLE PROPERTY TRANSFER

There can be various conditions for transferring the intangible property. Two of the most common conditions for the transfer include:

The New Zealand transfer pricing guidelines warn that it may be difficult to monitor the conditions for the transfer of the intangible. For example, it might be difficult to differentiate between a transfer of an intangible and a supply of a product or service that benefits from the intangible.

The treatment of embedded intangibles is an area of potential confusion. Such embedded intangibles include tangible property that carries the rights to use a trade name or trademark. This embedded intangible situation arises where the manufacturer sold the intangible to a related distributor.

The taxpayer needs to address a number of issues when dealing with the transfer of tangible property that includes an intangible element, such as a trademark:

• The taxpayer should consider whether the taxpayer has actually transferred the intangible rights. For example, the transfer of branded goods from one party to another typically does not involve the transfer of intangible rights.
• If the taxpayer has already transferred an intangible right, the taxpayer should then consider whether it should value that right separately from the intangible property. The taxpayer may need to consider the available comparable data and the available transfer pricing methods. In addition, the taxpayer might need to consider industry-specific factors in determining the value of the intangible.

VALUING INTANGIBLE PROPERTY

The valuation of the intangible property might be uncertain when the transferor transfers the intangible property. One question to consider is whether the tax administrations can properly review the transfer price by reference to a form of arrangement that differs from the arrangement the taxpayer adopted.

The New Zealand transfer pricing guidelines take the approach that the parties to the transfer will share the risks and rewards when they transfer that intangible property. The structure of the arrangement may involve the sharing of the market, credit, country, and other risks between the parties. The form of the transaction rarely controls the transaction; substance over form controls. The central issue should be whether the taxpayer assumes an allocation of rewards, including the royalty rate, which is consistent with the risks that the taxpayer assumes. Functional analysis is paramount.

In New Zealand, the Inland Revenue will, in evaluating the transfer price, need to benchmark its analysis against an objective external standard. Yet the taxpayer’s arrangement may be unique. The Inland Revenue might need to look to the arrangements that independent enterprises might make in comparable circumstances. Thus, Inland Revenue might inquire as to whether the associated enterprises made adequate projections, taking into account all feasible reasonable developments, making this determination without resorting to hindsight.

The taxpayer’s documentation is crucial, documenting why the taxpayer structured the transaction as it has. The taxpayer needs to document how it determined the components of that price. The taxpayer should make this determination in reference to what independent parties in similar circumstances would have done.

The question then arises as to whether a small country, such as New Zealand, should automatically accept a multinational enterprise’s royalty rate that the other countries accept. New Zealand Inland Revenue might inquire as to whether the empirical royalty rate is the stated royalty rate and as to whether the markets are sufficiently similar, taking into account the economics of the situation.

NON-OWNER’S MARKETING ACTIVITIES

An enterprise that does own the trademarks or trade names might undertake to promote the product through its marketing activities. A question then arises as to how the owner of the trade names and trademarks should compensate the marketer for promoting these products. A second-tier question then arises as to whether the owner of the trade names and trademarks should compensate the marketer as being a service provider or, alternatively, as sharing in any additional return attributable to the marketing intangible.

A distributor having its own marketing activity would expect to share in the potential benefits of these activities. However, the distributor might not be able to justify an extra return. Consider these cases:

• The distributor might have a long-term distribution contract for the trademarked product. In that event, the distributor may benefit directly from its investment in developing the value of the intangible because of its turnover and market share.
• There would be no justification for a distributor to receive any additional margin relative to an independent distributor unless a distributor bears expenditures beyond what an independent distributor with similar rights would bear.

It is important to consider the extent to which the distributor is bearing real risk compared with the risk that an independent firm in the market would bear. A controlled distributor might bear relatively greater risk than comparable independent firms. In that event, the controlled distributor is entitled to receive a greater margin from its activities.

The analysis should consider the impact of the marketing activities with the price of the tangible product. For example, the foreign manufacturer might undercharge the New Zealand subsidiary for the product it receives, but the New Zealand marketer might be incurring excessive expenses. The transfer price for the product and the expenses can be viewed together, compensating one for the other.

APPLYING THE PROFIT SPLIT METHOD TO INTANGIBLE PROPERTY

The New Zealand transfer pricing guidelines provide that, in many cases, taxpayers will face difficulties in identifying reliable comparables on which to base a sound transfer pricing analysis. Nevertheless, it will be very important to identify that the independent transaction used as a benchmark is truly comparable. Taxpayers may need to examine alternative approaches for performing this analysis.

One option that is available to taxpayers is the use of the profit split method. According to the New Zealand transfer pricing guidelines,

a key feature of the profit split method is that it requires a less rigorous application of comparables than is required for analysis under any other methods. The downside of this, however, is that because the method tends to be more subjective in application than the other methods, it can increase the potential for disagreement between taxpayers and Inland Revenue over what transfer pricing are appropriate.

The New Zealand transfer pricing guidelines provide that “the profit split method might be a useful alternative approach” (emphasis added) for providing an analysis. In stark contrast, the OECD Guidelines provide that “the profit split may be relevant although there may be practical problems in its application” (emphasis added). Despite the OECD’s cautious approach to the profit split method, New Zealand’s Inland Revenue “considers the profit split method could represent a useful tool.”

INTANGIBLE PROPERTY PLANNING

The taxpayer and the tax administration face special difficulties when addressing intangible property, especially in determining the arm’s length price for that intangible. The taxpayer may have undertaken complex arrangements. As such, the taxpayer and the tax administration will find it difficult to ascertain comparable transactions. As to the question of ascertaining comparable transactions, one party to the transaction might not have contributed intangible property to the transaction. In that event, then, the most straightforward analysis is to test the party that did not provide the intangible.

It is important to look to the costs of maintaining the intellectual property. A subsidiary might be bearing the cost of this maintenance, but an independent party might not have to bear these costs.

The analysis of the intangible property may depend on a subjective judgment, especially when applying the profit split method. The taxpayer and tax administration may have limited resources to ascertain reliable comparables. In finding these comparables, the taxpayer should ensure that each party to the transaction obtains a return that is broadly consistent with the functions performed, assets employed, and risks assumed as to the transaction involving the intangible.

It might be appropriate to value intellectual property based on realistic projections of future benefits. It is then necessary to determine arm’s length royalty rates to discount future benefits to present value.

A company undertaking marketing activities might not own the marketing intangible. The owner of the intangible needs to compensate the non-owner for undertaking these marketing activities. That compensation needs to be commensurate with what independent entities would charge given the rights and obligations under the marketing arrangement.