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Navigating cross-border related party borrowing rules in New Zealand
In this article, I will talk about the complexities of cross-border related party borrowing (specifically, the related-party loans between non-resident lenders and New Zealand resident borrowers) and the associated rules in New Zealand. I will simplify these rules by categorising them based on borrowing amounts below or above NZ $10 million and explore the application of these rules. Furthermore, I’ll underscore the significance of proper documentation in related party borrowing.
Cross-border financings are integral to transactions involving New Zealand members of multinational groups. These transactions raise important considerations, such as establishing interest and guarantee fees at market rates while adhering to New Zealand’s interest limitation and thin capitalisation rules. These rules also apply to New Zealand-owned multinationals in their outbound financing endeavours. To ensure international alignment, New Zealand has adopted the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, last updated in July 2022.
Cross-border related borrowing below NZ $10 million
For cross-border associated party loans totalling up to NZ $10 million in principal, the Inland Revenue Department (IRD) has introduced a simplification measure. Under this approach, you are expected to apply the interest rate published by the IRD for small-value loans, currently set at 175 basis points over the relevant base indicator. This rate serves as a reliable benchmark for an arm’s length rate when no readily available market rate for a similar debt instrument exists. This approach reduces transfer pricing risks, minimising the need for extensive benchmarking.
It’s important to note that while the small value loan administrative practice is not mandatory for loans up to NZ $10 million, taxpayers should conduct a detailed analysis to determine the interest rate an independent borrower will pay in similar circumstances if they choose not to apply the IRD administrative practice. This typically involves assessing the borrower’s creditworthiness and identifying a range of arm’s length market interest rates that correspond to the borrower’s creditworthiness, while considering the parental implicit support.
Cross-border related borrowing above NZ $10 million
For cross-border associated party loans exceeding NZ $10 million in principal, the IRD mandates the application of “interest rate limitation” rules, also known as restricted transfer pricing rules. These rules involve a more intricate assessment to determine the appropriate deductible interest on the debt. Factors considered include credit ratings, loan terms, and other features to ensure the interest rate aligns with arm’s length conditions.
Features of the restricted approach
To calculate the deductible interest on related-party loans under the “interest rate limitation” rules, the IRD employs a restricted approach. This approach eliminates features not typically found in third-party debt, such as loan terms exceeding five years, subordination, payment other than in money, interest payment deferral beyond 12 months, options resulting in premiums on interest rates, promissory notes or instruments without default rights, and contingencies for interest payment.
Exemptions may apply when these features are present in third-party debt.
Documentation of cross-border related borrowing
A crucial aspect often overlooked is the documentation of the cross-border related borrowing, such as loan agreements between associated parties, as well as the documentation supporting the interest rates that justify the interest charge at arm’s length. IRD expects clear documentation of the following fundamentals:
- Purpose or Intention
- Parties involved
- Amount and Currency
- Interest rates (with a clear explanation or supporting documentation of its reasonableness)
- Interest payment dates
- Term and repayment
Navigating the cross-border related party borrowing and interest deduction limitation rules in New Zealand is essential for multinational groups and New Zealand-owned multinationals. These rules ensure that related-party loans are priced correctly and in line with OECD standards, encouraging fairness and transparency in cross-border financial taxation. Businesses operating in this landscape must stay informed and compliant with these rules to avoid potential pitfalls and penalties.
If you have questions or need assistance navigating these regulations, utilising the simplification measure for small-value term loans, or ensuring proper documentation for your cross-border related party borrowing, our expert team is here to help. Get in touch here.