Family Business ~ Insight | The 2013 NZ Budget

Most of you have had the opportunity to read about the budget measures. The measures announced in the budget confirmed that the government’s priorities have not changed. The Governments’ desire to return to surplus is through cutting back government spending and collecting more revenue.  The IRD and Treasury have clearly signalled the need to get more blood out of the stone so to speak, and why a full capital gains tax is apparently not on the list, the budget was interesting in that it announced no other similar measures and was more of a tinkering nature than featuring radical new taxes.

The Government will allocate an additional $6.65M in annual funding, beginning in the 2014/2015 tax year for audit activity in relation to property investment tax compliance. In the past such endeavours have proved very successful for the IRD hence why they are high on the priority list.  In addition to tax measures, which are detailed below the Budget also focuses on helping low income families and the areas of health, education, social welfare and houses.

ACC Levies

There are no real surprises from a tax perspective other than the reduction in ACC levies of about $300M in 2014 increased to $1B in subsequent years. Details in relation to these changes will be released later on in the year, so watch this space. None the less this measure will be welcomed by businesses

R&D Expenditure & Tax Losses

Small start-up companies that invest in R&D will be allowed a tax refund if they generate tax losses as a result of their R&D expenditure. This is welcome news for small start-up businesses who are more often than not strapped for cash.

A public consultation will be issued in June 2013 which will provide details in relation to qualifying expenditure, the ceiling for refunds and how the system will operate.

Tax relief for “Black Hole Expenditure”

Certain business expenditure is not deductible or depreciable. This is often referred to as “Blackhole expenditure”. The budget proposes that these be made deductible as follows from 2014/2015 tax year:

  Depreciable Immediately deductible
Patents or plant variety rights Legal & administrative fees
Resource consents under Resource Management Act Expenditure incurred on certain fixed life resource consents Expenditure incurred on consents that are abandoned
Company administration costs All costs associated with payment of dividends to shareholders
Annual Fees Annual fees for listing on stock exchange
Shareholder meetings Annual shareholder meeting costs

These measures will provide additional savings to the tax payers. Whether you will be able to benefit from these savings will depend on the nature of your business activities; a large proportion of taxpayers will however not benefit from these measures at all.

Thin Capitalisation Rules – Non-residents

The rationale of these measures is to ensure that non-residents investing in NZ pay their fair share of tax; the proposed rules eliminate the ability of non-residents to introduce an excessive amount of debt into NZ and claim a deduction.  Legislation is planned to be introduced later on during the 2013 year with the proposed date of application starting at the beginning of the 2015/2016 tax year. Currently the rules apply where a single non-resident controls a company in NZ. What is proposed is that these rules will be extended to where 2 or more businesses control a NZ company in certain circumstances.

Whilst the legislation has not been finalised, the residents will not be affected by these measures.

If you would like to discuss the above points and their possible impact on your business or personal situation please contact Nigel Smith.

Family Business ~ Insight | Australia – Transfer Pricing Developments

Taxpayers doing business in Australia or with Australia through associated entities should take note of the new Transfer Pricing Legislation that was introduced to Parliament. The effective date of the new legislation is 01 June 2013 or the date on which the legislation receives royal ascent whichever is the earlier. In light of the new legislation it is advised that transactions between related parties are carefully reviewed. The review should focus on correct documentation of the arm’s length standard. Particular attention should be given to intra-group financing arrangements as this is a complex area that interacts with the thin capitalisation regime. In essence there is the requirement to establish the arm’s length price of debt.

The main points covered by the proposed legislation are as follows:

Arm’s Length Principle

  • Whilst it is a well-accepted principle that transactions between associated persons must be at arm’s length, taxpayers will be required to assess that this in fact is the case in relation to their Australian operations.  Basically related party transactions must be carried out on same/ similar terms as if the transactions were carried out between independent parties.

 

Reconstructive Powers

  • The new legislation gives power to the Commissioner to disregard and reconstruct transactions. The reconstructive powers are available in “exceptional circumstances”. Exceptional circumstances will exist where the transaction would not be entered into between unrelated parties and where a difference exists between the substance and the form of the transactions. The term” exceptional circumstances” is broad enough to allow the Commissioner flexibility in interpretation. Given the current climate and government’s drive to collect revenue, one can be almost certain that this power will readily be used by ATO.

Documentation

  • Whilst there is no requirement to keep transfer pricing documentation in line with the new regulations, taxpayers who do not keep adequate transfer pricing documentation, will not be able to argue that they have adopted an acceptable and reasonable position. This will result in tax shortfalls and harsher penalties being imposed by the ATO. At a practical level, often the level of documentation required is not complex or hard to put together so if you don’t have documentation it is recommended that you contact us so we can advise you as to the minimums required to at least try and protect your position.

Statutory Limitation

  • New legislation proposes a shorter time limit of 7 years of assessment during which a transfer pricing adjustment can be made. This is a welcomed approach as the current transfer pricing legislation does not prescribe a time limit.

 

In summary, it is recommended that all intra-group transactions and policies be reviewed, carefully documented and carried out on arm’s length basis. If you wish to discuss and/or assess any potential exposures your business may be facing or require any further information on this topic, please do not hesitate to contact us.

Family Business ~ Insight | Alesco Case

The recent IRD’s win in the Alesco tax avoidance case is a clear indication how far the tax law has moved.  The case involved an Australian company Alesco, which acquired two New Zealand companies. The acquisition was financed through the use of optional convertible notes (OCN). OCN is a hybrid financial instrument that consists of debt and equity component.

Alesco could have financed the acquisition using either interest bearing debt or the OCN. Income tax legislation allows a deduction for interest should interest bearing debt be used. There is a special determination, issued by the Commissioner, which prescribes how the OCN is to be treated for tax purposes and prescribes a calculation methodology for notional interest deduction.

The alarming issue resulting from the decision is the fact that the IRD has invoked anti-avoidance in relation to a genuine commercial transaction just because Alesco has chosen the means of financing that IRD did not like, on the grounds that Alesco apparently did not suffer a real economic cost – i.e. because the interest deduction they claimed pursuant to the IRD’s own determination was notional. We find it really hard to understand the logic that was applied by the IRD and the Courts given the fact that the determination, written by the Commissioner, specifically prescribes the tax treatment of OCN and a methodology for quantifying a NOTIONAL interest deduction. Notional means fictitious.

Furthermore, the use of OCN as means of financing resulted in Alesco obtaining a lesser interest deduction than if an interest bearing debt was used.  The sad reality is that Alesco has in fact chosen a financing option in relation to a genuine commercial transaction that resulted in greater tax payable than if an alternative means of finance was used and yet was penalised for this.

Another alarming issue, besides understanding how anti-avoidance provisions can be applied to a commercial transaction where the highest amount of tax is paid, is the fact that the Commissioner or Courts did not allow Alesco the next best alternative. One would hope, in societies where the tax system is fair and just, that the taxpayer would have at least been allowed a reconstruction using next best alternative. This however was not case here.  Even though the counsel for the tax payer has clearly pointed out that higher amount of deduction would have been available for Alesco if interest bearing debt was used. The Courts have rejected this argument on the grounds that there was no documentary evidence that interest bearing debt was contemplated by Alesco.  The IRD and the courts therefore simply denied the notional deduction with no reconstruction.

What does all this mean?

This clearly indicates that the environment is more uncertain than it ever was. The Commissioner and Courts are stretching the boundaries in applying the legislation as they deem fit depending on which way the wind blows. Furthermore, this demonstrates that the Courts and the Commissioner are more interested in paper evidence (i.e. notes, minutes from directors meetings) rather than common sense and what is actually prescribed by legislation.

There is no need to highlight that our country relies heavily on foreign investment and jobs that are created as a result of foreign investment. The government should therefore stop and look at what is happening. It should put a stop to the Commissioner’s total disregard to commercial transactions and her almost unlimited power to invoke anti-avoidance legislation as and when she chooses to do so. Anti-avoidance provisions are specific provisions and should be applied where avoidance is present. It should not be used where genuine commercial transactions exist, which are structured in a way that results in a greater tax payable than if an alternative structure was used.

This total disregard creates a great uncertainty for foreign investors and may result in them choosing alternative more favourable jurisdictions. There is obviously no need to say what this would mean to our economy and our jobs. Moreover, it will make both taxpayers and their advisers question what is legitimate tax planning in this modern world.

In summary, this case resulted in a horrible outcome and a greater uncertainty for tax payers. If you are considering any transaction of sizeable value, make sure that you have a documentary evidence of alternatives you have considered. The only alternative way to obtain a certainty, in relation to a transaction you may be considering, is to obtain a ruling from the IRD.

Taxation of Lease Inducement Payments

On 27 September 2012, the Minister of Revenue, the Hon Peter Dunne, released details of the Government’s decisions on lease inducement payments. Although lease inducement payments by commercial landlords to tenants will be taxable, some important changes have been made as a result of the recent consultation process.

The initial proposal to tax lease inducement payments was contained in the officials’ issues paper released in July 2012. Changes to the initial proposal include the following:

  • The changes will apply to lease inducement payments on commercial leases entered into on or after 1 April 2013.
  • The proposed changes will make lease inducement payments tax deductible by overriding the “capital limitation” on deductions. In the original proposal these were not automatically deductible.
  • Income and expenditure arising from the lease inducement payments will be spread evenly over the term of the lease.

The proposed changes will also apply to lease surrender payments made by tenants to exit a lease early. Currently these are taxable to the landlord, but non-deductible to the tenant. The purpose of these changes is to create a level playing field, thus the lease surrender payments made on or after 1 April 2013 will be tax deductible to the payer and taxable to the recipient.

The reform will not affect residential tenants.

The reform package will be included in a tax Bill scheduled for introduction later this year.

Abusive Tax Position Penalty

The New Zealand Inland Revenue Department released an item on the 25th September which discusses whether the abusive tax position penalty under s 141D of the Tax Administration Act 1994 applies automatically where there is a “tax avoidance arrangement” under s BG 1 of the Income Tax Act 2007. The item outlines that:

“The abusive tax position penalty under s 141D does not apply automatically where there is a “tax avoidance arrangement”. This is because:

  • Section BG 1 requires the tax avoidance purpose or effect of the arrangement to be more than merely incidental. Section 141D requires the dominant purpose to be avoiding tax. Therefore, the tests in the two provisions are fundamentally different.
  • The intention expressed in the pre-legislative material was that the abusive tax position penalty would only apply to “abusive avoidance”.
  • The courts have identified that there is a different test under s 141D than under s BG 1.

To determine whether the abusive tax position penalty applies it is necessary to decide whether the dominant purpose of the arrangement is avoiding tax. In order to determine that, the tax purposes must be weighed against any other purposes of the arrangement (such as commercial or family purposes) with reference to the specific structure of the arrangement. The factors that may be considered may include artificiality, contrivance, circularity of funding, concealment of information and non-availability of evidence, and spurious interpretations of tax laws”.

For more information refer to: http://www.ird.govt.nz/technical-tax/questions/questions-shortfall/

Australian Tax Focus

DEBT FORGIVENESS

The Australian government has made an announcement in their Federal Budget to amend the Income Tax Assessment Act, whereby deductions for bad debts will be denied between related parties that are not members of the same consolidated group  where the bad debt written off will not be included as part of the debtor’s income.

It is proposed that in such situations the creditor will have a capital loss rather than a deduction for income tax purposes. This situation will arise where for example the creditor is resident in Australia and the debtor is resident in New Zealand. This has not yet been enacted, but once done it will be back dated to 8th of May 2012.

This will add further layer of complexity to the already complex rules. For example, there is already a tax adjustment when a debt is forgiven: the beneficiary of the forgiveness loses (in descending order) tax losses, capital losses, the tax cost of depreciating assets and the cost base of capital assets up to the extent of the amount forgiven. Related parties can currently choose to forego the losses and the tax consequences.

ATO’s COMPLIANCE PROGRAM

ATO’s annual compliance program was released in July 2012. It identifies areas of compliance risk where ATO’s focus will be directed. Namely:

  • Taxation of Financial Arrangements (TOFA):
    • Validity of elections made for the purposes of TOFA
    • Correct application of tax timing methods
  • Profit shifting  between jurisdictions,
    • Transfer pricing and thin capitalisation
    • Entities with significant asset revaluations that may not be able to meet the safe harbour debt values without these revaluations
  •  Corporate restructuring
    • Mergers and acquisitions
    • Complex and unusual financial arrangements
    • Pre-restructuring activities
    • Changes to the effective ownership and control where the result may be deferral or avoidance of taxation
  • Consolidations
    • Inclusion of foreign partnerships in consolidated groups aimed at achieving a deduction of interest  in two jurisdictions
  • Further Audit activity will be in areas of:
    • GST
    • Research & Development