Inland Revenue’s Minimum Financial Reporting Requirements for SMEs are now finalised: What does this mean for taxpayers?
The amendments contained in the Financial Reporting Act 2013 eliminate the need for many small-to-medium enterprises (SMEs) to prepare general-purpose financial statements. The intention is to reduce compliance costs for most New Zealand SMEs (approximately 95% of all New Zealand enterprises) by excluding them from the requirement to produce complex financial statements under the Financial Reporting Act.
Instead they will be required to prepare special-purpose financial statements to the minimum requirements specified by Inland Revenue. On 13 March 2014 Inland Revenue released an Order in Council that specifies for tax purposes the minimum financial reporting requirements for companies. The taxpayers that are affected by these minimum requirements are all active companies that do not have a statutory obligation to prepare general-purpose financial statements except certain small companies that are not part of a group of companies and that do not derive income or incur expenditure in excess of $30,000.
The original minimum requirements proposed by Inland Revenue would have actually increased compliance costs for many SMEs. A number of the more “onerous” requirements that were originally proposed have been excluded from the finalised minimum requirements. However, there are still some aspects of the finalised minimum requirements that will increase compliance costs for many companies.
The new minimum financial reporting requirements apply for periods commencing on or after 1 April 2014.
Currently under the Financial Reporting Act 1993, New Zealand companies that are not issuers, overseas companies or are a subsidiary or have subsidiaries, must prepare general-purpose financial statements if they meet two or more of the following criteria:
- Total assets more than $1 million; or
- Annual turnover greater than $2 million; or
- More than 5 full-time equivalent employees.
Under the Financial Reporting Act 2013, New Zealand private companies will not have to produce general-purpose financial statements unless they are “large”, defined as:
- Total assets more than $60 million; or
- Total revenue more than $30 million.
However, overseas companies conducting business in New Zealand (including their branches), and subsidiaries of overseas companies, have a lower threshold of:
- Total assets more than $20 million; or
- Total revenue more than $10 million.
Those overseas companies and subsidiaries of overseas companies that exceed the threshold will still be required to prepare audited general-purpose financial statements and make those financial statements public by filing them with the New Zealand Companies Office.
Non-large private companies with ten or more shareholders are required to prepare general-purpose financial statements (and have them audited) unless they opt out via an appropriate shareholder resolution.
Inland Revenue, as the largest user of financial statements in New Zealand, has had to give careful consideration to the level of information it needs now that the requirement for many SMEs to prepare general-purpose financial reports is being removed. The purpose of the minimum financial reporting requirements is to ensure companies accurately determine their tax positions and complete IR 10s on the basis of appropriate financial statements.
What are the new minimum financial reporting requirements for SMEs?
The minimum financial reporting requirements are as follows:
- The financial statements must consist of a balance sheet setting out the assets, liabilities and net assets of the company as at the end of the income year and a profit and loss statement showing income derived and expenditure incurred by the company during the income year.
- They must be prepared applying double-entry and accrual accounting principles.
- The financial statements may disclose amounts using the following valuation principles:
- Tax values, when those values are consistent with double-entry and accrual accounting;
- Historical cost, when tax values are not consistent with double-entry or accrual accounting or when historical cost provides a better basis of valuation; 3. Market values when market values provide a better basis of valuation than those in 1 and 2 above.
- A statement of accounting policies and changes thereto that is sufficiently detailed that a user can understand the material policies that have been applied or changed in the preparation of the financial statements.
- The financial statements must disclose whether they have been prepared on a GST inclusive or exclusive basis.
- A reconciliation of the company’s financial statements and taxable income for the income year.
- An appropriately detailed taxation-based fixed asset and depreciation schedule.
- If a forester, a statement of cost of timber as at balance date and a reconciliation of movements.
- If a specified livestock owner, detail of livestock valuation methods, valuations and calculations for taxation purposes
- Comparable figures for the last year should be disclosed.
- All relevant amounts that the IR 10 form requires to be copied from the company’s financial statements.
- Sufficient notes to support amounts required to be disclosed as an exceptional item on the IR 10 form.
- Interest should always be grossed up for resident withholding tax.
- Dividends should be grossed up for imputation credits to the extent that the dividend is taxable and the credits are usable to reduce the taxpayer’s tax liability for that year.
- For income years commencing on or after 1 April 2015, certain associated party transactions between the company and associated persons that are either (1) shareholders who are not companies, including individuals (including non-residents) and trusts or (2) non-resident companies, must be disclosed in the company’s financial statements. This will include interest paid, loans advanced, payments for services, leases and payments for the acquisition or use of intangible property. There is also a requirement to include a reconciliation of movements in shareholders’ equity and certain loans and current accounts.
These are minimum financial reporting requirements. Hence, financial statements can still be prepared to any level above the minimum requirements. Taxpayers will be free to include additional disclosures if they choose and to produce partially or fully GAAP-compliant financial statements in addition to complying with the minimum requirements.
The minimum financial reporting requirements released this month have removed a number of disclosure requirements that were originally proposed. The requirements removed include the requirement to track available subscribed capital and realised capital gains.
That said, there are still a number of elements of the finalised minimum financial reporting requirements that will increase compliance costs for many companies. Although the associated party transaction requirements are much reduced from the original proposals they will still give rise to additional work for many companies. This may include subsidiary companies of large corporates. If those subsidiaries are not required to prepare general-purpose financial statements then the minimum financial reporting requirements will apply to them including the associated party transaction requirements where they have, for example, transacted with non-resident companies within their wider group. Some of the information required to be disclosed will not only be an increase over what is currently required but it will repeat information that may have been included in other tax returns such as Resident Withholding Tax returns and Non-Resident Withholding Tax returns. The Inland Revenue has acknowledged the potential complexity of associated party transaction information that will be required. The associated person rules are complicated and there are likely to be errors made despite the best efforts of taxpayers and their advisors. As a consequence, this disclosure requirement has been delayed 12 months and will apply from the 2015/16 income year. The delayed application date will give software developers more time to update their accounting software for this significant change in disclosure requirements. It also recognises the additional work that will likely be required by businesses and their advisors to provide this information. A couple of questions that must be asked are: Will the Inland Revenue actually look at all this additional information they are mandating? Will they use technology to enable them to effectively review and analyse this information? If the answer to either of these questions is no then why not simply require this information to be provided on request rather than put taxpayers to all this extra work preparing information that may go nowhere. If the answer is “yes” to both these questions, then it is probably simply a sign of the times with the increased focus on both tax avoidance and transfer pricing.
Taxpayers should also be aware that the income tax treatment of certain expenditure (such as the deductibility of research and development expenditure and the deferral of deductions for research and development expenditure) refers to the accounting treatment prescribed by financial reporting standards. If the relevant financial reporting standards are not followed in the taxpayer’s financial statements then this may give rise to adverse tax consequences. When this was raised with an Inland Revenue official at the time the proposal was being debated the response was that the proposal outlines minimum financial reporting requirements and taxpayers are welcome to adopt specific financial reporting standards (either partially or fully) in their financial statements. Therefore, if SMEs wish to fall within certain aspects of the income tax legislation they will need to adopt certain financial reporting standards and/or disclosures over and above the minimum requirements prescribed by the Inland Revenue.
Inland Revenue officials have been participating in the New Zealand Institute of Chartered Accountants’ SME Working Group which is recommending an accounting framework for special-purpose financial statements for SMEs. We understand the framework is scheduled for release shortly and that compliance with the new accounting framework should meet Inland Revenue’s minimum requirements.
Clearly the minimum requirement special-purpose financial statements prescribed by Inland Revenue are not intended to satisfy all users of financial information. Businesses with loans and overdrafts from banks and other financial institutions will likely have additional financial reporting obligations. Similarly, the proposed minimum requirements are no substitute for high quality appropriately detailed financial information which gives owners and managers of businesses the tools they need to make informed decisions about the future direction of their business.
If you would like to discuss Inland Revenue’s minimum financial reporting requirements for SMEs in more detail please contact your Deloitte advisor.
Tax Alert April 2014 contents