Recent tax changes in New Zealand
Banking on Tax, Issue 10
There have been a number of recent tax changes in New Zealand. Some changes have followed consultation with taxpayers before proceeding through the law-making process. Other changes have been quite swift and subtle, by being included in a bill or enacted without much policy discussion. The changes outlined below should be on the tax management plan of each bank with operations in New Zealand, so that banks can participate in discussions to help educate policy-makers, and so they are cognisant of potential tax changes that might be enacted without a consultative process.
Thin capitalisation for securitisation trusts
The Inland Revenue released two papers on thin capitalisation, one in January 2013 and another in June 2013. As banks have their own thin capitalisation regime, it was not anticipated that these papers should impact banks.
However, part of the focus has been to extend the thin capitalisation rules to apply to trusts. In the January paper, submissions were made that this would make securitisation trusts subject to thin capitalisation – which would be inappropriate without further changes to reflect the heavily geared nature of these structures. The Inland Revenue specifically considered this, and responded in its June paper clearly stating that it thought it was appropriate for thin capitalisation to apply to securitisation trusts, and that it was more a matter of how the rules should apply. Further submissions are being made on this change. Given the Inland Revenue’s policy response, submissions are likely to focus on how the rules should apply to securitisation transactions.
Normally, securitisation trusts would benefit from the onlending concession. However, there will be assets to which the onlending concession won’t apply, for example, in-the-money derivatives and trade debtors (and other excepted financial arrangements).
The manner in which these rules are proposed to work could also present some issues. Thin capitalisation normally works on the basis of a taxpayer’s ‘New Zealand group’. However, for a trust, the group is deemed to include only the trust. There are restrictions on the amount of ‘associated party’ debt that the trust would be allowed, which could have a direct impact on any equity/credit enhancement that an originator provides to the securitisation trust. Concerns would also arise if the trust deed were structured such that the funding bank was also associated with the trust.
All banks should review their securitisation model and any legacy deals. A significant concern is the lack of discussion to date about transitional provisions. It could also become quite problematic if a trust is disallowed an interest deduction, but there is no flexibility in the deed.
Removal of financial arrangements election for excepted financial arrangements
Many banks have been unaware of the ending of the election for certain excepted financial arrangements (e.g. trade debtors, leases, etc.) to be treated as financial arrangements. This change became law on 17 July 2013 as part of the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act.
The amendment was aimed at the perceived mischief of a taxpayer’s deduction of the cost of a valuable supply contract. This deduction was achieved by making an election for the contract to be treated as a financial arrangement, so that only the net consideration was recognised for tax purposes.
These changes may have an unintended impact for banks that have acquired excepted financial arrangements. Many banks will have acquired ‘non-traditional’ debt (e.g. trade debtors or rent receivables) and followed their IFRS accounting treatment for tax purposes. There would be no reason to distinguish this from other ‘loan’ books that are acquired. In order to follow the accounting treatment, those debts need to be within the financial arrangement rules. The removal of the election could mean that there are some complicated tax calculation adjustments that will be required. There could also be a timing advantage that arises – if the correct answer is to recognise any gain/interest on a realised basis.
A last-minute exemption was introduced for debt-factoring companies, but it is unclear whether it should apply to banks. Unfortunately, if ‘collections’ is not a part of the bank’s business (e.g. it is outsourced), then the exemption would be difficult for a bank to apply. In our view, there is a case for an exemption for banks too, but this would now require a further law change to be introduced, given that the removal of the election has been enacted.
The change also brings into focus a grey area of the law, as to what constitutes a financial arrangement, compared to what constitutes acquiring an excepted financial arrangement. Transactions should be considered carefully, as this distinction is difficult to apply, with only a few examples having been considered. This is an area in which the industry might wish to lobby the Inland Revenue to clarify its views.
Bad debt deduction limitation for secondary purchasers of debt
The Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill will introduce a new bad debt limitation for secondary purchasers of debt, among other changes to the bad debt rules. This change has highlighted potential flaws in how the bad debt provisions currently interact with the financial arrangement rules and the base price adjustment (‘BPA’) calculation (which is the ‘wash up’ when a taxpayer ceases to be party to a financial arrangement).
The mischief that the Inland Revenue saw was ‘secondary debt purchasers’ who were taking a bad debt deduction for the face value of a loan where they only paid a small amount for it. However, when the detail of the financial arrangement rules and the BPA calculation is overlaid, there are some absurd results. This is because the BPA calculation includes as part of its formula, “the amount remitted by operation of the law” as being income. This will generally be the face value of the debt. The picture becomes clouded as it looks like there is a legitimate policy basis for taxpayers’ taking a bad deduction for the face value to offset this BPA income.
The issue is compounded by the Inland Revenue’s proposal of retrospective application of the legislation to create deemed income if a taxpayer has taken a bad deduction in previous years that it would not have obtained under these new rules.
Submissions have been made on these points and we expect that there will be a change in approach. However, this could take a number of paths. Banks should be ready with example transactions in hand – and a clear understanding of their technical position – to assist the Inland Revenue to make its determination. The complexity in this area seems unnecessary and our view is that there should be a policy discussion prior to the legislative process – as with the thin capitalisation rules – to agree a sensible approach.