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Transfer Pricing in New Zealand: Issues Arising and Methods Research Paper

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Updated: Sep 23rd, 2021


Transfer pricing is a process of allocating a particular value to a transaction, which represents the aggregate of other transactions that may have taken place in national or international markets. The underlying transactions mostly have commercial and financial implications for the organization applying the transfer prices. Such organizations draft and implement the system of transfer pricing with several objectives in mind. Mostly transfer pricing issues arise in relation to the operations of multinational organizations (MNOs) that operate in more than one jurisdiction. The transfer pricing policies of such MNOs are often vetted by the tax authorities of host jurisdictions with a view to both ensure better compliance to their own tax laws, as applicable, and to ensure compliance with bilateral or multilateral pacts to avoid or reduce the incidence of double taxation. Due to varied specific situations involving the MNOs and the multiplicity of the underlying transactions; the transfer pricing issues can be very complex and involved and the vetting of such a system to ensure compliance with domestic tax laws and multilateral or bilateral treaty becomes an equally involved and complex issue. It is variedly recognized in the literature that transfer pricing is less of a science-amenable to exact prescriptions, and, more of an art –open to various interpretations and conclusions. This paper examines the transfer pricing issues that arise in the context of New Zealand jurisdiction; compares and contrasts these issues with some other comparable jurisdictions –including prescriptions of OECD and concludes on the benchmark approaches and methods involving the core issues.


In all such discussions where basic theoretical precepts are already established and there exists a wide and elaborate body of arguments and issues in the literature; literature review and analysis is the most potent technique for establishing major strands of arguments so that new meaningful conclusions can be derived by synthesizing all the varied arguments analyzed. In the case of transfer pricing issues in the New Zealand context and international contexts there is a wide body of literature that addresses the issues of transfer pricing definition, methods applicable to various transactions, and core issues such as arm’s length principle within well thought out and discussed national and international guidelines, models and constructs; however, the emphasis of this literature has largely been restricted to the description of issues and problems and very rarely does the literature address either the issues of describing benchmarks or prescribed methods-either on stand-alone, single jurisdiction basis or in partnerships with other jurisdictions as in bilateral and multilateral tax pacts and agreements. This paper would, accordingly, take up a wide, broad, and in-depth review of the established body of literature on the issues of transfer pricing definition, methods applicable to various transactions, and core issues such as arm’s length principle, with the primary objective of identifying major arguments in relation to the research themes or objectives identified in the introductory paragraphs and rationale of this research.

Most of the documents being sourced in the library (ies) including those which provide electronic access over the internet. The research method essentially entailed the conduct of intensive interrogation of published documentary materials with the explicit aim of addressing the above stated issues which this paper deals with, providing a critique of existing theory and positions. It was ensured through out this process that an effective library –based method comprises a great deal more than just an extended literature review. This approach was found appropriate in the present context as the evidence. This meant that research published by others was utilized aplenty and not only was each document evaluated for its primary opinion but also narrative analysis was done to either concur or differ with such opinion. As an instance, a library-based project in Law can involve looking at law reports which set out court rulings or at large data sets such as New Earnings Survey or Working Employee Relation Survey. Also library-based projects are suitable when data or events sourced in other countries need to be analyzed, particularly when such events are to be studied with in an historical perspective. Thus given the research topic on hand and following this methodology fresh argument and issues were framed to supplement existing body of literature and to adopt a more guided stance on the issues of transfer pricing definition, methods applicable to various transactions, and core issues such as arm’s length principle. Standard search approaches were used to retrieve the sample of published and unpublished studies for this in-depth literature review. Appropriate online journals were also searched. Citations in bibliographies of identified studies were reviewed to uncover additional references. Retrieval using the ancestry method was the most fruitful approach. Informal contacts at a professional research conference were used to identify unpublished manuscripts. The search was not limited to studies published in the English language.

Criteria for inclusion of studies in this literature review were: (a) studies that explained the process of transfer pricing in the context of New Zealand jurisdiction as themes; (b) studies that had a focus on the process of transfer pricing in the context of other chosen jurisdictions like the USA, France, UK, Japan, Italy, OECD guidelines, etc within the overall primary theme; (c) the study designs dealing with the concepts of transfer pricing of some core generic transactions involving specific methods,(d) studies that dealt with various reports, industry forum findings, case studies, etc throwing light on the various transfer pricing issues and perspectives as practiced in international jurisdictions, and (e) Studies that dealt with outlining and explaining model approaches to the core transfer pricing issues as identified above in New Zealand and international contexts.

The sample studies were reviewed and coded for substantive and miscellaneous variables on a form developed for the study. The substantive variables were (a) transfer pricing issues and guideline in New Zealand-their roles, practices and culture, (b) the various similar issues faced in other jurisdictions including regional jurisdictions such as the OECD, and (c) the trends on various methods being deployed to take care of transfer pricing in major transaction types along with the identification of the areas for improvements, essentially leading to the classification of various arguments as per the research themes and rationale mentioned in the introductory paragraphs. The methodological variables of such studies were not coded instead conclusions were examined in the context of major arguments. The miscellaneous variables were (a) year and type of publication, (b) country of publication, (c) number and qualifications of authors, and (d) funding source. Each study was coded in informal consultation with other peers so as to gain insights into the main arguments. Invariably 100% agreement was achieved on coding of the substantive variables and the miscellaneous variables.

A quality index for each study was calculated based on the criteria resting on first author expertise, number of arguments sourced in the study, the quality of the coverage of the transfer pricing process definition, methods applicable to various transactions and core issues such as arms length principle. Additional quality indicators pertinent to the topic were formulated in regard to the arguments that were offered in such literature exploring the link between transfer pricing issues with New Zealand and those that have arisen in the international fora in particular. Priority was assigned to various research studies depending upon their overall quality score; with highest scores receiving the first analytical attention of this research. A dependence relationship between some of the selected studies was also established in the sense that one study presented the main arguments and the related study either presented the supplementary arguments or supported the first study arguments by presenting new facts.

Following the above methodology the following broad categories of research studies/materials were chosen for analysis:

  • Journal Articles and government guidelines on transfer pricing issues in the New Zealand, its purposes and discussions.
  • Standard as well as topical texts on transfer prices issues and their treatment in tax policies in international jurisdictions.
  • Articles on major methods adopted in transfer pricing issues, covering some core and widely discussed transactions.
  • Journal articles linking transfer pricing issues with emerging consensus or otherwise on them.
  • Other texts offering for examination various model listing and discussion of benchmark practices in transfer pricing issues and methods involved in the issue based transactions apart from suggesting various models and constructs leading to better handling of transfer pricing issues in national jurisdiction and improved definition of issues, identification of exceptions, assessment and management within the overall tax policy in the New Zealand.

This part of the methodology was partly in the nature of the Meta analysis, frequently utilized in medical literature, without the emphasis on any statistical treatment leading to clinical recommendation(s).It resembled a Meta analysis in that a collection of identified literature was chosen to examine issue of the importance of transfer pricing definition, methods applicable to various transactions and core issues such as arms length principle. The paper, however, departed from meta-analysis in that its focus was not on a particular practice and statistical analysis leading to recommendations concerning use or otherwise of a particular practice but on the study of a phenomenon by developing arguments over and above those developed in other research in the area. In health research Meta-analysis is widely used to probe the literature view on adoption or otherwise of a particular clinical practice. However, this research used another widely used research construct in health research i.e. of Phenomenology. Below are cites some views from health research on the concept of Phenomenology. Phenomenology is a science that focuses on describing particular phenomena as lived experience (Speziale and Carpenter, 2003).

The method gives us a description of that experience as it is (Merleau-Ponty, 1962). Herbert Spiegelberg (1975) defined phenomenology as the procedure with the main aims of direct investigation and description of phenomena as experienced. Phenomenology has been described both as a philosophy and a method at the same time (Spiegelberg, 1975; Merleau-Ponty, 1962). Phenomenology is considered a more appropriate design in the present context as it would help address (describe and explore) the phenomena of the consensus or otherwise emerging on the core issues in transfer pricing in the context of New Zealand and international jurisdictions. Actually, phenomenology can be considered more as a way of thinking or perceiving the phenomenon than as a mere method (Speziale and Carpenter, 2003). Accordingly, the phenomenon of emerging understanding on the core issues in transfer pricing was sought to be understood more comprehensively through literature review and the major points supporting the research rationale and themes as have been identified above. Most of the literature analyzed in this literature review has been generously used in all sections of this report to build relevant arguments; however a majority of such literature is used to build further arguments in the sections that follow.. The entire process of intellectual development in relation to the choice of topic and research methods to adopt, as detailed above involved a huge amount of critical and reflective thinking. In fact, the concept of critical thinking had to be understood in full before such a process of intellectual up-gradation was taken up. It formed the foundation. Literature on critical and reflective thinking helped he process along. Starting as early as the1909, Dewy, the American philosopher, psychologist and educator we have a structured definition of the phrase critical thinking. He equated critical thinking to ‘reflective thinking’ and defined it as “Active, persistent, and careful consideration of a belief or supposed form of knowledge in the light of the grounds which support it and the further conclusions to which it tends” (Dewy, 1909, p.9). Building further on Dewey’s ideas, Glaser defined critical thinking as:

“An attitude of being disposed to consider in a thoughtful way the problems and subject that come within the range of one’s experience; (2) knowledge of the methods of logical inquiry and reasoning; and (3) some skill in applying those methods. Critical thinking calls for a persistent effort to examine any belief or supposed form of knowledge in the light of the evidence that supports it and the further conclusions to which it tends.” (Glaser 1941, p.5).

Elsewhere the literature has defined critical thinking as a thought process appropriately moved by reasons (Norris and Ennis, 1989; Fisher and Scriven, 1997). Ennis defined critical thinking as reasonable, reflective thinking that is focused on deciding what to believe or do (Norris and Ennis, 1989). In an interesting definition that follows a slightly different trajectory, Siegal believes that “thought processes are influenced by phenomena rather than by reasons such as fears, reinforcement, and consequences” (Craver 1999, p. 97). Thus Siegal brought in the concept of the phenomenon in the definition of thought process surrounding the phrase critical thinking, on the one hand, and on the other, he gave a place of layered importance to the role of reason in his conception of critical thinking. For him, critical thinking is appropriately moved by reasons and the reason assessment component is the main aspect of any critical thought process. Ennis, on the other hand, added a very important concept to the description of critical thinking i.e. that of reflection element to round up a full definition of critical thinking as reasonable and reflective thinking. Ennis had also included the assessment of reasons in his conception of critical thinking. In a 1962 paper, he defined critical thinking as the correct assessment of statements and emphasized the necessity of judgment to critical thinking (Ennis, 1987). He also identified three dimensions of critical thinking and described twelve aspects involved in critical thinking which have been categorized according to these dimensions: the logical (understanding relationships between meanings of words and statements), the criteria (having knowledge of the criteria for judging statements) and the pragmatic (judging sufficiency in light of the purpose of the judgment) (Ennis, 1987).

Following these definitions and concepts of reflective thinking within the overall concept of critical thinking the present research was viewed as a study of a phenomenon.

Literature Review & Analysis and Findings

World trade has turned more integrated and widespread with the advent of globalization. The lowering of tariff barriers and freer movement of capital and goods across the international borders has meant increasing the presence of multinational organizations in world marketplaces through affiliates, subsidiaries, and group companies. As this observation puts the present world trade, dominated by the operations of the MNOs, in the right perspective for New Zealand, “Over two-thirds of world trade involves multinational enterprises (“MNEs”). Well over 50% of world trade comprises associated party transactions which must be transfer priced for taxation purposes. MNEs are a significant force in New Zealand’s economic environment”. (General, 2006).

The operations of two separate entities in a commercial transaction are marked by the emergence of a clear price at which the transaction takes place. The commercial and financial considerations that go in the determination of such a price are largely market controlled or even if the variables are controlled by the state through various legislations; such state control is already discounted by the markets in which the transactions take place. This distinction between a transaction involving two independent parties and two related entities is brought home by the following observation, “When independent enterprises deal with each other, market forces ordinarily determine the conditions of their commercial and financial relations. By contrast, when members of a multinational deal with each other, external market forces may not directly affect their commercial and financial relations in the same way”. (Transfer, 2000) The related parties’ dealings which involve the conveyance of capital, intangibles, goods, services, expenses, incomes to related entities like affiliates, distributors, subsidiaries bring about the concept of transfer pricing into the internal accounting of the parent and related entity organizations. Deloitte & Touché explain the concept of transfer pricing in clear terms as follows, ” The pricing of services and products between one segment of an organization for a service or product that it supplies to another segment of an organization or to an affiliate is referred to as “transfer pricing.” Transfer pricing is largely dependent on the types of transactions involved and should be performed on a transactional basis. Transactions may include transfers of services and products for sale, transfers of services and products not for sale, and the transfer of capital assets. When a regulated utility provides services and products to a non-regulated affiliate (and vice-versa) or transfers capital assets to its non-regulated affiliate (or vice-versa), regulator concerns, largely centering on the issue of cross-subsidization of affiliate business operations, exist. (Deloitte,1999).

However transfer pricing brings about a clash of intents between the parent MNO, its related affiliates, and the tax jurisdictions in which such affiliates and parents operate. While the internal objectives of an MNO in setting in place a transfer pricing system may range from evaluating a region, a function, a set or group of personnel, to shifting profits where uneconomic activities abound to subsidizing a particular set of operations which are essentially an expenditure head; the objectives of the tax jurisdictions normally focus on maximizing tax collections by appropriate recognition of the income derived from their jurisdiction. The tax loss has become a global issue as the globalization trend intensifies. The entire phenomenon is put in the right perspective by the following observation, “As global trade continues to grow substantially, so too has the interdependence between multinational enterprises (MNEs) and national economies. The World Trade Organization data of 2003 estimate that 45% of export trading in monetary terms relates to subsidiary trading. MNEs were estimated to be in the vicinity of 65000 entities with over 185000 subsidiaries and at least two-thirds of MNEs are usually rooted or controlled by a head or parent company with the decision on how the overseas entities are structured being largely determined by global tax considerations. The usual corporate structure by a resident company based in any part of the world in setting up operations overseas is through an overseas branch or an overseas resident subsidiary. Regardless of the choice of structure of the MNE what is evident would be the direct relationship or association between Parent or Head Company and the overseas branch or overseas subsidiary. For the MNE, what is critical is not the profitability of any particular component or branch in isolation but the overall group or enterprise profitability.

MNEs may therefore be indifferent as to which jurisdiction it pays the tax but at the same time mindful of its overall profitability after worldwide taxation. In the absence of a Transfer Pricing legislative regime, there is the real threat of MNEs using transfer pricing techniques to artificially achieve minimum taxation within such jurisdiction. There is no global tax system in place and different tax rates and rules between states provide a potential incentive for MNEs to manipulate their Transfer Prices to recognize lower profits in states with higher corporate tax rates and vice versa”. (Transfer, 2006) Thus transfer pricing has acquired the status of one of the top line tax issues confronting both the MNOs and the various tax jurisdictions today (Ernst and Young, 1997) due to the fact that it affects in a critical manner both MNOs’ profits and host and home jurisdictions’ tax revenues. However, tax authorities must consider the fact that an MNO’s transfer pricing policy is not only determined by the issues sourced in their tax regime but also on a host of other factors that may be prevailing in the host and home jurisdictions; these factors which may make an MNO manipulate transfer pricing policy may include a level of customs duties; repatriation policies; the extent of exchange risk; asset capitalization policies; anti-monopoly charges; dumping charges; and cost-sharing concerns (Plasschaert,1994). Because of these various other factors that may compel a corporate MNO-related entity to evolve specific transfer pricing mechanisms to reduce its tax liabilities; many tax jurisdictions have unstinting faith in the application and collection of corporate taxes which also form an important portion of their overall collection. As this observation puts the matter in the right perspective for many developing countries “[Developing countries], have long relied on corporate income taxes as a principal means of revenue. These taxes account for up to a third of revenue in some developing countries” (Cohen, 1995).

The objectives, which are often sourced in the internal marketing cum expansion strategy of an MNO, underlying a particular transfer pricing system may be varied. In most jurisdictions, such objectives are set by the MNO and their strategic arm keeping in mind the peculiarities of the tax jurisdiction-which is invariably studied ahead of setting up a transfer pricing system. For instance, many tax jurisdictions believe that a complete viewpoint of the overall MNO’s FDI strategy is critical to decide on many transfer pricing issues “because appropriate transfer pricing policies can sustain and guarantee the original investment decision” (Emmanuel, 1996) As this observation makes clear the slew of transfer pricing objectives considered by an MNO in its transfer pricing scheme, “For example, a multinational may be more concerned with its overall profitability than it is with the allocation of those profits between its members. On the other hand, the multinational may well have set its transfer prices with a view to determining accurately the profit attributable to a local operation, perhaps for the purpose of measuring accurately the relative performance of its managers. (Transfer, 2000) The conflict or disagreement of these internal objectives of the MNO are brought in sharp contrast to the objectives of the tax jurisdiction authorities by the following observation, “The upshot is that there are many factors that might drive a multinational’s transfer pricing policies. However, these factors can conflict with the objectives of a host government. For this reason, special rules have been adopted to determine transfer prices for tax purposes.

The New Zealand jurisdiction is quite clear in maintaining its tax objectives-it does not wish to lose any pie of tax from international operations on its land and wishes to attribute all the incomes and profits derived from operations in New Zealand to such tax laws; at the same time taking adequate care that the taxed entity is not subject o double taxation in host and home jurisdictions. This intent of tax authorities has been made clear in a various forum; one such observation is reproduced below which clearly explains the logic behind New Zealand’s view of various transfer pricing schemes confronted by it for vetting: “New Zealand taxes all persons on their income sourced in New Zealand, which means exercising its jurisdiction to tax foreign-based multinationals on profits attributable to their New Zealand operations. These profits, in theory, are expected to be commensurate with the economic contribution made (including commercial risk borne) by those New Zealand operations. New Zealand’s transfer pricing rules are intended to measure the amount of income and expenditure of a multinational properly attributable to its New Zealand operation”. (Transfer, 2000).

This goal of the tax system in New Zealand is made further clear by the following stated objective of the transfer pricing issues in government guidelines, “The overall goal of Inland Revenue’s transfer pricing enforcement program is to maintain New Zealand’s share of multinational tax in accordance with our tax law, acceptable income recognition principles and best international practices. We are not alone in wanting to maintain our fair share of the MNE tax pie – tax authorities around the world are implementing and updating their rules and regulations on international transactions as well as increasing their audit activities.. (General, 2006) This goal of the New Zealand tax authorities is neither unique nor unparalleled. In most jurisdictions around the world tax loss emerging out of manipulated transfer pricing is being closely monitored in order to check the leakage from the tax collections. In the largest jurisdiction of the US, for instance, ” in a 1999 study, the IRS tentatively estimated the loss due to transfer pricing at $2.8 billion in income taxes. An ongoing study being prepared for the Congress estimates that the use of inflated and undervalued transfer prices by MNE groups allowed them to avoid paying $53 billion in U.S. income taxes in Tax Year (TY) 2001″. (Current,2003).

New Zealand also seems to prefer a cooperative mode of resolving to transfer pricing-related taxation issues. It has mostly catered to its relatively small transfer pricing jurisdiction through advance pricing agreements which, in fact, represent agreements entered on a unilateral or bilateral basis to treat transfer pricing issues in a specific and predetermined manner. This brings about the certainty of approach and the assessee is ready for the treatment it gets. New Zealand’s focus on advance pricing agreements is brought home by the following observation, contained in the guidelines, “advance pricing agreements (“APAs”) represent a more cooperative approach to addressing transfer pricing compliance. An APA is an agreement either between the tax authority and the taxpayer (unilateral) or between two tax authorities (bilateral). In New Zealand, unilateral agreements are carried out under our binding rulings process set out in Part VA of the Tax Administration Act 1994. Bilateral agreements are entered into pursuant to the Mutual Agreement Procedure Article in our various double taxation agreements.. (General, 2006).

This emphasis is not without basis.New Zealand has experienced good tax revenue growth after it deployed a good inventory of APAs in settling transfer pricing issues. Within APAs the New Zealand jurisdiction prefers bilateral APAs which are more comprehensive in coverage and cover a stratum of MNOs at one go. This is borne by the following admission of the Inland revenue authorities, “Inland Revenue has grown its APA program progressively as the best answer to complex cases with difficult facts and circumstances. The product is ideally suited to issues involving intangibles which can result in a wide range of opinions as to pricing. Our clear preference is for bilateral APAs.; A unilateral APA only affects in the jurisdiction in which it is agreed. Nothing in a unilateral APA will affect an associated taxpayer or a tax authority in another jurisdiction. However, a bilateral APA, being an agreement between two tax authorities, will have an effect in both jurisdictions. Accordingly, in each country, the taxpayer and the tax authority will be bound by the terms of the bilateral APA. Thus, such bilateral agreements also represent the ultimate solution to potential double taxation problems.

New Zealand’s APA inventory may be summarized as follows:

Completed before 2005 16
Applications currently in progress 9
Prospective applications for 2006 4
Total 29

Due to the extraordinary reliance of APAs in New Zealand, the assessment issues in relation to transfer pricing have been brought under the systematic scrutiny of the contents of the APAs.Here the approach is predefined and the cannons for interpretation of arm’s length rule are clearly enunciated. Despite this, the interpretational possibilities in specific situations are abundant and have to be discovered and even invented while taking up specific MNO cases, and hence it is a widely held view with the New Zealand tax jurisdictions that interpretations of transfer pricing issues is rather an art than a prescriptive science. This is acknowledged in New Zealand tax jurisdiction to such an extent that transfer pricing instructions are issued as guidelines than prescriptive rules and it is clearly stated that the OECD model, which was followed earlier, is to be the lender of last resort for any interpretational difficulties. New Zealand guidelines clearly state that ” It is often said that transfer pricing is more of an art than a science. Co-operation rather than conflict makes more sense in an environment of uncertainty. In this regard, Inland Revenue is particularly pleased with the ongoing interest in APAs as a most effective means of resolving difficult and/or complex cases. APAs produce significant time and cost savings for both tax authorities and MNEs in comparison with adversarial audits. They encourage up-front taxpayer compliance and, for bilateral APAs, eliminate double taxation. They are well worth serious consideration in the current international environment”. (General, 2006).

Theoretically, the arms-length principles simply state that all transactions, internal to an MNO, ought to be done at prices that are near or about the same as the prices for such transactions which could have been determined in free markets.. Ideally it seeks to eliminate all elements of subsidization, transfer, and shifting and aims at assessing a profit and capital profile which would be determined by free-market forces. The New Zealand guidelines do not mince words in this respect when they state as follows, ” Fundamentally, the arm’s length principle is based on the notion that the operation of market forces results in a true return to the economic contribution of participants in a transaction. By seeking to remove the effect of the common ownership, the arm’s length principle seeks to reduce a transaction within a multinational to one that reflects the conditions that would have existed had the pricing of the transaction been governed by market forces. In this way, the true return to economic contribution for each member of the multinational is determined. The arm’s length principle has been enacted into New Zealand legislation in section GD 13(6): “[The] arm’s length amount of consideration must be determined by applying whichever… method… will produce the most reliable measure of the amount completely independent parties would have agreed upon after real and fully adequate bargaining. This rule does not say that an arm’s length price will result if a multinational sets its prices based on real and full internal bargaining. Rather, it recognizes that real and fully adequate bargaining between unrelated parties is a feature of the operation of market forces in a transaction. Section GD 13(6) therefore requires a multinational to adopt the price that may have arisen had its controlled transaction been governed by normal market forces”. (Transfer, 2000).

As has been stated above that the objective of the New Zealand tax regime, in relation to transfer pricing issues. has been to plug tax evasion through manipulative transfer pricing by the MNOs operating in its jurisdictions. This is sought to be achieved through a cooperative approach the foundation of which is built on the immediate agreement with the global consensus of major transfer pricing issues –including the core issue of determining the arm’s length transactions. The modality of which is through bilateral APAs. New Zealand guidelines are abundantly clear on the issue and state as follows, “To address this concern, an important principle followed in developing New Zealand’s rules was the need for consistency with the international norm. To this end, both the legislation and New Zealand’s guidelines have been based on the international consensus expressed in the OECD guidelines, which deal with the appropriateness and application of the arm’s length principle in transfer pricing matters”. (Transfer, 2000).

New Zealand’s transfer pricing legislation, in section GD 13(7), prescribes that the arm’s length price is determined using one or more of the following methods:

  • The comparable uncontrolled price (CUP) method.
  • The resale price method.
  • The cost-plus method.
  • The profit split method.
  • Comparable profits methods. (Transfer, 2000).

The comparable uncontrolled price (CUP) method focuses directly on the price of the property or services transferred between parties to a transaction. The price charged between independent parties forms the basis for determining the arm’s length price under the CUP method.

The resale price method focuses on the gross margin obtained by the distributor. This margin represents the amount from which a reseller would seek to cover its selling and other operating expenses and make an appropriate profit in relation to its functions performed, assets used, and risks assumed. The margin obtained by independent distributors performing similar functions, bearing similar risks, and contributing similar assets is used as the basis for determining the appropriate margin for the member of the multinational.

The cost-plus method focuses on the gross markup obtained by the manufacturer. The arm’s length price is determined by adding a mark-up to the costs incurred by the member of the multinational to determine an appropriate profit in relation to its functions performed, assets used and risks assumed. This mark-up is determined by reference to the mark-ups earned by comparable independent manufacturers performing comparable functions.

The profit split method starts by identifying the combined profit to be split between the related parties in a controlled transaction. In general, combined operating profit is used, although gross profits may be appropriate in some circumstances (paragraph 3.17, OECD guidelines). That profit is then split between the parties based upon an economically valid basis approximating the division of profits that would have been anticipated and reflected in an agreement made at arm’s length.

The comparable profits methods are a range of methods that examine the net profit margin realized by a taxpayer from a controlled transaction relative to an appropriate base. Possible bases include the return on assets, operating income to sales, and other suitable financial ratios.

New Zealand’s legislation does not impose a hierarchy for the transfer pricing methods. However, there is effectively a hierarchy in that certain methods may provide a more reliable result than others, depending on the quality of available data, and a taxpayer’s circumstances. The availability of data is likely to be very important in taxpayers’ choice of method. New Zealand is a small market, and this means reliable comparables may be very difficult for taxpayers to locate. Inland Revenue acknowledges this concern, and this is reflected in the guidelines’ approach to the use of foreign entities as tested parties and analyses prepared for foreign jurisdictions. In addition, section GD 13(7)(d) contemplates the use of the profit split method, which is less dependent on comparables than the other pricing methods.

As a general rule, the most reliable method will be the one that requires fewer and more reliable adjustments to be made. (Transfer, 2000).

The several comparable jurisdictions are not far from the New Zealand approach. As there seems to be a convergence of major issues concerning transfer pricing issues. The legislations in independent jurisdictions have evolved around the same lines. This makes it possible to have a wide-ranging APA approach on a bilateral basis. Australian transfer pricing guidelines, for instance also recognize the above five generally accepted arm’s length pricing methods: 1. “traditional transaction methods” – Comparable Uncontrolled Price (CUP) method, Resale Price method and Cost Plus method; and 2. “transactional profit methods” – Profit Split method and Transactional Net Margin Method. Australian transfer pricing guidelines also do not prescribe any hierarchy for use of these methods; the method to be used should be the most appropriate to give the most reliable estimate of an arm’s length outcome given the facts and circumstances and availability of data as to comparable uncontrolled transactions.(Australia,2006). Italian guidelines prescribe as follows: “ Circular Letter no. 32/9/2267 of 22 September 1980 refers to the TP methods as described in the 1979 OECD Report. This regulation explicitly provides for the hierarchy among TP methods in compliance with the OECD Guidelines. As from 1995, tax examiners received instructions by senior tax inspectors to follow the 1995 TP Guidelines when applying ALP”.(Italy,2006) In contrast, the UK transfer pricing law does not specify any transfer pricing method though it makes a specific reference to the OECD model on transfer pricing(the UK,2006) French transfer price guidelines specifically follow the OECD model and prescribe all the transfer pricing methods without specifying any hierarchy within them. ( France,2006) The US has its own transfer pricing model enunciated in various treasury guidelines which are at variance with the OECD model in several ways. There is an elaborate enunciation of transfer pricing methods as is stated in the OECD country profile of the US on transfer pricing issues: “Treasury Regulation 1.482-2(a) (loans or advances), 1.482-3 through 1.482-6 (tangible and intangible property), 1.482-7 (cost-sharing arrangements. Temporary Treasury Regulation 1.482-9T (b) – (g) (services)” (US, 2006).

The trickiest portion of transfer pricing issues seems to belong to the treatment of conveyance and passage of intangibles between the members of an MNO. Literature has been rife with the issue of international transfer pricing and intangible assets, essentially, based on traditional techniques of doing international trade and business. The literature in respect of accounting for the transactions involving intangibles is full of generally prescribed remedies that seem neat on the theoretical board but face several practical problems in implementation.( Abdallah 2001; and Abdallah 2002;Abdel-Khalik and Lusk, 1974; Anctil and Dutta, 1999; Eccles, 1985; Emmanuel and Mehafdi, 1994; Grabski, 1985; Leitch and Barrett, 1992). These intangibles may include items such as brands, customer lists, technical, designs, databases, and content-related intellectual property, such as patents or software, patent and unpatented technology in addition to the more traditional product and process formulations (Walsh; 2001). Abdallah Murtaza(2006) provides lucid tables evaluating the six transfer pricing methods deployed in dealing with the intangibles transactions.

Transfer Pricing Strategies of Intangible Assets
Table 1
Transfer Pricing Strategies
Table 2

The New Zealand guidelines also reiterate the above stance, essentially drawn from the US and the OECD transfer pricing issues in relation to intangibles. The New Zealand guidelines also emphasize the fact that the prices that are determined in the conveyance of the intangibles should be as near to the market rates as possible and the transaction of conveyance of intangible should be premised on market-related logic. The assessed organization should be capable of supporting its claim with data that support the price of the transaction as well the economic compulsions of entering into the transaction. New Zealand guidelines are very clear in acknowledging the difficulties inherent in transfer pricing of the intangibles; however, these guidelines clearly mention the key precautions that can be taken to avoid any possible pitfalls leading to leakage of tax revenue. This is stated in the following words: “The process for applying the arm’s length principle to the intangible property is no different than for other property. It can be more problematic to apply, however, because: Valid comparables can be difficult, if not impossible, to locate; For entirely commercial reasons, multinational enterprises (MNEs) may structure their arrangements in different ways to independent firms.[The] Functional analysis is critical in determining the real nature of the intangible property being transferred. The value of the intangible property can be more sensitive to small differences than other property, so it is important that the nature of the transaction (and relevant pricing factors) be fully understood. If one party to a transaction does not contribute intangible property, the most straightforward analysis is likely to involve using that party as the “tested party”, even if it is outside New Zealand. The value of the intangible property is broadly based on perceptions of its profit potential. If there are no reliable comparables on which to apply the pricing methods directly, alternatives may be to: Apply the profit split method, which requires a less rigorous application of comparables than do the other methods. Value intangibles based on evaluations of profit potential. When dealing with marketing activities of firms that do not own the marketing intangible, it is important to ensure that their compensation is commensurate with what independent entities would have accepted given the rights and obligations under the arrangement”. (Transfer,2000)

The New Zealand guidelines explain comprehensively the various factors that must be reckoned while evaluating transfer pricing in relation to conveyance or passage of intangibles. These are listed below for addition to the discussions herewith:

  1. “The expected benefits from the intangible property, determined possibly through a net present value calculation.
  2. The terms of the transfer, including the exploitation rights granted in the intangible, the exclusive or non-exclusive character of any rights granted, any restrictions on use, or any limitations on the geographic area in which the rights might be exploited.
  3. The stage of development of the intangible in the market in which the intangible is to be exploited, including, where appropriat. The extent of any capital investment, start-up expenses, or development work required, and necessary governmental approvals, authorizations, or licenses required.
  4. Rights to receive updates, revisions, or modifications of the intangible.
  5. The uniqueness of the property and the period for which it remains unique, including the degree and duration of protection afforded to the property under the laws of the relevant countries, and the value that the process in which the property is used contributes to the final product.
  6. The duration of the license, contract, or other agreement, and any termination or negotiation rights.
  7. Any economic and product liability risks to be assumed by the transferee.
  8. The existence and extent of any collateral transactions or ongoing business relationship between the transferee and transferor.
  9. The functions to be performed by the transferee, including any ancillary or subsidiary services”.(Transfer, 2000).

The two specific areas that the New Zealand guidelines guard against while dealing with transactions involving intangibles are also stated very clearly in the guidelines: “Two particular areas where sufficient care is often not taken are:

  • A local operation is meeting costs for maintaining intellectual property that an independent party would not be required to meet, while at the same time paying the same amount as the independent firm for property it acquires (a double deduction).
  • Analysis being based on what outwardly appear to be reliable comparables but that is not reliable, because the nature of the intangible property (potentially high price variations for differences that superficially appear quite small) has not been considered adequately”. (Transfer, 2000).

There has been a growing global consciousness on the increased scale of multinational activities in world trade. It is not only the volume of such trade which has come to the notice of various regulators; but also its turnover speed which is hastening with vastly improved communication and transport facilities that define the efficient logistics of the globalization process. The transactions over the internet are a part and parcel of such quick turnovers. Considering these quick turnovers and the findings of some ongoing surveys that have found out the incidence of tax evasion through innovative transfer pricing mechanisms; the tax jurisdictions the world over have renewed their focus on transfer pricing issues and there have been concerted attempts to derive consensus on issues like arms length principles and the methods for establishing the transfer prices. To address such issues there has been a spate of transfer pricing-related legislation and policymaking in the last decade and a half. While the most common modality which has emerged out of such global focus has been the growing inventories of APAs(particularly of the bilateral variety). As Fanaroff(2006) explains in relation to the US evolution of transfer pricing legislation which keeps an eye on the similar evolution in major trading partners’ jurisdictions, “Transfer pricing enforcement continues as a top agenda item for the taxing authorities of our most important trading partners.

Taking a “conservative” tax position in the U.S. may reflect prudent tax planning here, but could raise audit questions abroad. Foreign-initiated adjustments–cases in which a foreign government (rather than the IRS) makes a tax adjustment that results in double taxation–account for two-thirds of the IRS inventory of double-tax cases. An IRS official recently called this a trend that he expects to continue. The U.S. provided complete relief from double tax in 88 percent of its cases this year. Foreign governments actively audit transfer pricing but also work cooperatively with the Internal Revenue Service through tax treaties to avoid double taxation.


Canada and the United States recently took unprecedented steps to better eliminate double taxation. Turning around years of lethargic case processing and a growing backlog, three Memoranda of Understanding (MOU) signed this year detail the governments’ plan. The countries committed to providing relief for double taxation in all cases (Canada provided complete relief in only 80% of its cases this year), moving the backlog of existing unresolved cases and quickly reaching an agreement on the facts of a case. The two countries have struggled over factual disputes, often at the heart of transfer pricing cases, such as whether a manufacturer takes the risks of a full-fledged or a contract manufacturer. Failure to agree to the facts quickly will send a case to the recently created administrative entity, the Appeals Review Panel (ARP), consisting of Appeals personnel from Canada and the U.S. Both governments hope that the threat of the ARP will encourage agreements.


Japan believes strongly in the Advance Pricing Agreement (APA) process: APAs make up the majority of its double-tax case inventory. Reflecting years of practical experience negotiating transfer pricing cases, Japan has added two methods to its list of three acceptable methods for resolving transfer pricing disputes. They are the Transaction Net Margin Method (a close parallel to the profit-based comparable profits method widely used in the U.S.) and the Profit Split Method. These methods open up new options for resolving transfer pricing disputes with Japan.


China’s State Administration of Taxation (SAT) aggressively audits transfer pricing issues. It opened 193 audits in 2005 and entered into 178 advance pricing agreements in 2004. According to government officials, starting in 2008, the SAT plans to add transfer pricing penalties and to charge interest on adjustments. Other than its first bilateral case with Japan, all of China’s APAs are unilateral, covering companies with affiliates in the Far East.


If approved, reforms circulating in Mexico’s Congress will impact companies doing business in Mexico. Mexico’s proposed legislation implements a new hierarchy of transfer pricing methods and commits its tax authority to more transfer pricing audits. The reforms respond to a peer review by the Organization for Economic Cooperation and Development which generally praised Mexico’s transfer pricing enforcement, but pointed out deficiencies in the areas slated for reform. The proposed legislation also imposes strict independence requirements for CPAs. Mexican companies, public or not, reaching a stated threshold must have a CPA file a tax report with their audited financial statements. Also, auditors will no longer be able to provide tax advice to tax compliance clients. We will update the progress of the legislation as it becomes available.


Meeting on a regular (though infrequent) basis since 1999, India and the U.S. regularly settle double tax cases including transfer pricing matters. Indian officials said they recently had their most productive meeting yet with the U.S., settling seven cases, 50 percent of their total inventory. The governments discuss transfer pricing cases, but India has not yet established an APA Program”.


The above discussions clearly reveal that the New Zealand stance on the transfer pricing issues has been centered around the OECD model since the evolution of the OECD guidelines; even after the emergence of independent guidelines for the New Zealand the overall stance has been one of falling in line with the global consensus on conceptual issues in the context of the transfer pricing matters. The New Zealand guidelines are prescriptive and focus on specific situations so as to evaluate the true economic motives and economic benefits derived out of the transfer pricing transaction in the New Zealand jurisdictions. The modality chosen by New Zealand is also in line with the global consensus on such modality and it comprises in building a health inventory of APAs –particularly of the bilateral variety. However, it is felt that some new approaches need testing and adoption in the area of corporate transactions involving member transactions of a multinational organization. One approach is t contractually codify most such transactions so as to minimize the occurrence of interpretations and attributing. Durst(2000) explains the recent changes in transfer pricing legislations and then explains his contractual approach t transfer pricing, ” The recent global round of transfer pricing rulemaking, however, has changed the environment in three ways that suggest a more powerful role for comprehensive systems of inter-company contracts.

First, the new rules typically focus more explicitly on the apportionment of business risks in determining transfer prices. Second, the new rules generally provide a wide scope for the examination of factual issues in transfer pricing examinations. Third, the recent round of rulemaking seems to be accompanied by more intensive enforcement of transfer pricing rules in many countries. All three developments favor the wider use of inter-company agreements that identify comprehensively the risks to be borne by particular entities and the net compensation that those entities are to receive…..Inter-company contracts accomplishing overall characterizations of entities for transfer pricing purposes already are increasingly common in practice; forms for such agreements are available commercially. Most commonly, such contracts are used to establish the characterizations of particular entities as, for example, limited risk distributors or manufacturers. In addition, contracts can be used to memorialize the respective functions and risks of different entities engaged in the core intangibles-producing functions of a multinational group, and to specify the manner in which each entity will be compensated under a profit split approach”.

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