IRD eyes use of excessive royalty rates to reduce tax bills

By ADAM GIFFORD

Inland Revenue believes local technology companies are lowering their tax bills by setting royalty rates too high, as the delivery of a multi-million-dollar bill for back taxes to Unisys across the Tasman brings the tax policies of multinationals into the spotlight.

IRD's chief adviser for international audit, John Nash, said the department had been looking closely at whether information technology and communications companies were using transfer pricing to reduce their taxable earnings.

The work came out of an earlier study of the results filed by major multinational companies.

"Inland Revenue sees the ITC sector as particularly at risk in terms of transfer pricing because of the high proportion of material associated party transactions," Nash said.

He refused to say whether IRD had taken action against specific companies, because of confidentiality rules.

The Australian Tax Office recently asked Unisys to pay A$92.7 million, which included A$83.3 million in unpaid company tax, interest and penalties between 1993 and 1999, and A$9.4 million withholding tax due on royalty payments for licence revenue generated in Australia.

On this side of the Tasman, Nash said the IRD was focusing on companies reporting losses or low profits to ensure abusive transfer pricing policies were not behind the poor results.

"We are heartened that so far we have found a general absence of related party transactions involving tax haven associates - most related party transactions are with comparable tax jurisdictions such as the United States," Nash said.

"However, we are concerned that some companies may be using royalty rates that have been set on a global basis rather than setting their rates for the smaller New Zealand market and there may be a basis for stepped royalties which start low and escalate as certain sales targets are met in New Zealand."

Adrian Sawyer, a senior lecturer in tax and business law at the University of Canterbury, said the issue of royalty rates was important because it affected the transfer price, and therefore the country in which income was attributable and expenses were charged.

He said the Inland Revenue's views could make some companies review their transfer pricing strategies.

Nash said Inland Revenue also looked at the tax risks posed by the considerable merger and takeover activity in the sector. It needed to identify exactly what functions, assets and risks were being carried on in New Zealand.

"Where is the technology being developed in the global supply chain? If New Zealand is merely an end seller carrying no R&D risks for example, then the super profits will generally not belong here.

"This also applies to low-risk contract R&D. Sure, we expect a margin, but it is towards the lower end for this type of activity."

When companies blamed IT project disasters or other domestic reasons for poor results, Inland Revenue demands such matters are quantified and substantiated by documentation.

Nash said it looked at how well parent companies were doing on a consolidated basis worldwide.

"Are we getting our fair share?

"There has also been a major emphasis placed on sales which has not necessarily been translated into bottom-line profitability.

"There has also been some creative accounting in this industry in terms of how revenue has been recognised for public reporting purposes in the United States in respect of sales that cover several periods."

Despite the apparent lack of tax some companies may be paying, Inland Revenue may still collect considerable sums at source through non-resident withholding tax, charged at 10 per cent on interest and 15 per cent on royalties made to overseas parties. It also collects PAYE on New Zealand wages or salaries.