The New Zealand Law Society says there is no sound basis for an Inland Revenue proposal to put a cap on the deduction permitted for interest paid by a New Zealand borrower to a non-resident related-party lender.

In a submission to Inland Revenue on the Government discussion document BEPS - Strengthening our Interest Limitation Rules, the Law Society says the Government proposes a cap on the amount of interest deductible by a New Zealand borrower on debt funding from a related non-resident party by reference to the interest rate that the borrower's ultimate parent could borrow on standard terms.

"An analysis of the justifications advanced in the discussion document in support of the interest deduction cap suggests to the Law Society that there is no sound basis to depart from the transfer pricing regime for related-party debt arrangements," it says.

"The Law Society submits that the interest deduction cap cannot be expected to produce outcomes that correspond to outcomes produced following application of traditional arms' length pricing principles."

It says the practical result of the departure from the arm's length principle will be the economic double taxation of multinational groups advancing debts to New Zealand subsidiaries.

As an alternative, the Law Society proposes adoption of an approach that incorporates the interest deduction cap as a safe-harbour adopted by election of taxpayers.

"Taxpayers would be permitted to deduct at least an amount of interest up to the proposed cap. However, if a taxpayer could establish that the application of the arm's length principle supported a greater level of deductible interest in New Zealand, then that level of deduction should be permitted."

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