Large enterprises update (formerly Corporates contact) - 2009

Large Enterprises Update - Number seven: May 2009

• Regular thin capitalisation reviews are critical
• Cooperative compliance with large businesses
• Risk process
• Finance questionnaires
• Treaty of Waitangi settlements
• Redundancy tax credits
• Special tax codes or deduction rate
• Dunedin Non-resident Centre
• Systems issues
• Consolidated groups on tax agents' lists
• 2009 income tax filing season
• GST group registration
• From the editor

Regular thin capitalisation reviews are critical

The global recession has resulted in significant fluctuations in many markets, including foreign exchange and property. In some circumstances, these market fluctuations directly impact on taxpayers' thin capitalisation calculations, making it more important than ever for taxpayers to regularly monitor thin capitalisation.

In brief, the thin capitalisation rules apply to non-resident controlled groups and deny an interest deduction where a taxpayer's debt/asset ratio exceeds 75% (the safe-harbour threshold) or 110% of its worldwide ratio. For the purposes of the safe-harbour calculation, debts are measured by reference to the tax rules for financial arrangements and assets are measured by reference to generally accepted accounting practice. Here are some of the common errors and current market issues that should be considered during a thin capitalisation review.

• Debts and assets must be valued in New Zealand dollars for the safe-harbour calculation. Unanticipated foreign exchange fluctuations, of the nature seen in the current market, have the potential to cause unanticipated breaches of the safe-harbour threshold. Currency conversions are permissible at the spot rate on the taxpayers' measurement date(s) or at the forward rate applicable on the first day of the year. These options and exchange fluctuations need to be incorporated into taxpayers' regular reviews.
• In a number of circumstances, the valuation of a financial arrangement for tax purposes can vary significantly from the value of debt recorded for the instrument in the taxpayers' financial statements. It's important that taxpayers understand the implications of the relevant tax rules on their financial arrangements.

Assets are valued by reference to generally accepted accounting practice. Companies adopt accounting policy changes for a range of reasons and often these changes have no tax impact. However, where a taxpayer's debt/asset ratio sits near the safe-harbour threshold, it's important that the people responsible for tax compliance keep abreast of accounting policy changes, especially those relating to asset valuations.

The recent adoption of International Financial Reporting Standards (IFRS) provided additional safe-harbour headroom for some taxpayers on the revaluation of property assets, while debt/asset ratios were adversely impacted for others through asset impairment adjustments, eg, intangible property impairments. To the extent that taxpayers opted into the IFRS revaluation model on the upward market, the recent current market devaluation of many assets could again result in unanticipated breaches of the safe-harbour threshold.

The thin capitalisation rules require consistent treatment for a number of items such as controlling interests for grouping purposes and applicable measurement dates. It's important that taxpayers are aware of previous practices and elections made, particularly where there has been a change in personnel preparing the calculations.

Where taxpayers calculate their debt/asset ratio on a group basis, consideration must be given to the impact of any movements in the group structure during the year.

As can be seen from the above comments, where a taxpayer's debt/asset ratio is near the safe-harbour threshold, a thin capitalisation review based solely on management accounts will not be sufficient. To be effective, a review must consider the rules applicable in the taxpayer's specific circumstances, and in light of current market movements.

Cooperative compliance with large businesses

We have begun a review of the relationships between ourselves and large business taxpayers, particularly around complex and large tax issues.

The review has its origins in work undertaken by the OECD on enhanced relationships, which was completed in 2008. A key objective for us is to develop and foster relationships with large businesses based on two-way transparency and early disclosure of tax issues.

This enhanced relationships approach is likely to result in some taxpayers and Inland Revenue working together in real time. This will clearly result in mutual benefits but it's too early to say how this might look. However, overseas experience shows that two-way transparency and disclosure results in more certainty upfront and much less audit activity. Enhanced relationships also involve a sharing of the responsibility for putting effective compliance management systems in place. In practice, corporate governance serves a pivotal role in tax compliance.

Our feedback from large businesses is that they value their current relationships with us. However, you've also indicated how we can improve the way we work with you in some areas and we've taken this feedback onboard.

As the work continues we'll seek further input from you and your advisors.

Risk process

In response to feedback received from the Large Enterprises surveys, we've reviewed our risk procedures for entities with turnover above $300 million. The risk process for these larger taxpayers generally involves, as a minimum, Inland Revenue's account manager reviewing the income tax returns and accounts for that taxpayer to determine what risk we may want to make further enquiries about. We also undertake an effective tax rate calculation for each taxpayer. We are currently undertaking these risk reviews on the 2008 income tax returns.

As a result of our internal review many taxpayers in this group will notice an increase in communication with our account managers - most likely through one or more visits.

The purpose of these visits is to ensure our staff fully understands your business and to discuss how we could work together in the future to make our annual risk reviews as efficient and as timely as possible.

Our staff will discuss the findings of our reviews with each taxpayer before we decide whether certain risks require further investigation.

We hope through this increased communication around the risk process and understanding of the taxpayer's business that we will be able to identify risks effectively. If no risks are identified we'll give taxpayers earlier confirmation that based on the information we have reviewed, there will be no further investigation action on the returns.

To further enhance our risk identification we will use questionnaires more often to get information on certain areas where we see a risk. We'll send questionnaires direct to taxpayers.

They will be similar to the transfer pricing questionnaires we have used for some time to help us in our review of the transfer pricing risk.

Finance questionnaires

We recently issued a number of finance questionnaires to both large enterprises (LE) and small and medium enterprises (SME) taxpayers. We have used questionnaires in the past to get information from a number of taxpayers, eg, the transfer pricing questionnaire, in a way that does not result in significant compliance costs to taxpayers, but focuses on key risks.

We've seen an increased diversity in the type of financing structure instruments used by taxpayers. While not all of these structures give rise to compliance problems, the ones that are creating the greatest concern involve hybrid instruments where the tax treatment in New Zealand differs from that in other jurisdictions. These differing tax treatments give companies arbitrage opportunities which may result in tax planning opportunities.

It's important that taxpayers don't implement these structures purely to take advantage of arbitrage opportunities. One of the key considerations here is determining whether the transaction entered into is commercially workable. Transactions that aim to take income tax deductions where there is no economic cost are less likely to be commercially successful.

We established the finance questionnaire to find out more about the way in which taxpayers were financing their New Zealand operations. Another reason was the request for details of thin capitalisation levels of our foreign-owned corporate groups.

We have sent out 102 questionnaires (at 5 March) and received 68 responses. This is a good response rate so far. We'll shortly be following up taxpayers who haven't responded. We'll also send out further questionnaires as part of the risk assessment process this year.

Treaty of Waitangi settlements

The "Questions we've been asked" item on "Payments made in addition to financial redress under Treaty of Waitangi settlements - income tax treatment" has been finalised and issued by the Office of the Chief Tax Counsel (OCTC) as QB 09/01.

This item addresses the income tax treatment of payments (referred to in the item as "settlement interest") made by the Crown in addition to the agreed financial redress under settlement, that relate to the period from settlement agreement being reached through until the financial redress is paid. The OCTC concluded that the settlement interest payments are a capital receipt and not taxable, and in particular, they are not interest within the statutory definition, not income under a full financial arrangement and not income under ordinary concepts.

The full item has been published in the April 2009 Tax Information Bulletin.

Redundancy tax credits

Employees who have been made redundant since 1 December 2006 may be able to claim a 6% tax credit up to a maximum of $3,600 for each redundancy. They can claim this by completing a Redundancy tax credit claim (IR524) form.

Special tax codes or deduction rate

Employees may apply to Inland Revenue for a special tax code using a Special tax code/student loan special repayment rate application (IR26BS) to allow PAYE or student loans (but not KiwiSaver deductions) to be deducted at a special rate. Many of these certificates apply for the full financial year from 1 April to 31 March. The certificate may be addressed to you as the employer or "to whom it concerns" when the employee has more than one source of employment or contact income.

Employers must show the details on their employer monthly schedule (EMS), as STC for tax code.

If the STC applies to normal PAYE "the earnings not liable" part of the EMS is not completed unless it also has redundancy payments or payments over the ACC maximum.

Special tax codes apply to all payments, including bonuses and extra employment payments. It's the employee's responsibility to correctly estimate their annual income when they apply.

Dunedin Non-resident Centre

If you're a non-resident, as shown in the list below, or have a query about the type of non-residents shown, please contact our Dunedin Non-resident Centre.

Phone	+64 3 951 2020
Fax	+64 3 951 7106
Email	nonres@ird.govt.nz

Dunedin Non-resident Centre customers are:

• living overseas, non-resident for tax purposes, and have a continuing source of New Zealand income
• non-resident companies with no presence in New Zealand
• NRWT payers and approved issuer levy (AIL)
• non-resident film renters.

Non-resident Contractors Team

The Non-resident Contractors Team (a segment of Large Enterprises, Assistance) deals with all tax issues relating to non-residents who perform contract activity in New Zealand (except for non-resident entertainers). Please contact the team direct if you have any queries about the obligations of a non-resident contractor, or a contract payer.

Phone	+64 4 890 3056
Fax	+64 4 890 4510
Email	nr.contractors@ird.govt.nz

Customers of the Non-resident Contractors Team are:

• non-resident companies or other non-individual entities, receiving contract payments for activity undertaken in New Zealand. This includes payments received for the use of personal property in New Zealand. The company may or may not have a branch or fixed establishment in New Zealand
• non-resident self-employed individuals receiving contract payments for activity undertaken in New Zealand including payments for the use of personal property.

Non-resident Entertainers Unit

The Non-resident Entertainers Unit (a segment of Large Enterprises, Assistance) deals with all tax issues relating to non-resident entertainers who perform entertainment activity in New Zealand. Please contact the Non-resident Entertainers Unit direct if you have any queries about the obligations of a non-resident entertainer.

Phone	+64 9 984 4329
Fax	+64 9 984 3082
Email	nr.entertainers@ird.govt.nz

Customers of the Non-resident Entertainers Unit perform in public or in front of a camera and include:

• actors, entertainers, musicians, singers, dancers, or other artists, whether alone or in a group
• sportspeople and athletes in any sporting event or game
• lecturers and speakers, whether on a casual or regular basis.

A non-resident entertainer can be an individual, company, partnership, trust or any other entity.

Systems issues

Some of the due dates in our system are not recording correctly. As a result, you may get statements of accounts showing incorrect late payment penalties and use-of-money interest. If this happens please call us on 0800 443 773 or call your account manager and we'll make the correction. This may take some time to correct - thank you for your patience.

Consolidated groups on tax agents' lists

When companies are members of a consolidated group the balance date may not always show correctly, because our system does not have a period summary screen for members. It will automatically default to 31 March. However, the group's IRD number will always show the correct balance date. Contact us if this date is incorrect.

2009 income tax filing season

2009 returns filing is now well under way. Here are some ideas to help speed up the process and improve the accuracy of our data (or make it more trouble-free).

• Use 2009 returns because the key points change from year to year.
• Make sure losses carried forward are correctly entered.
• Show complete details of losses or shareholder salaries from IR4 returns on your IR4S.
• Put staples in the top left-hand side of the form instead of the middle. It's difficult to key in data when staples are in the middle.
• Only losses can be negatives.
• Show a valid IRD number on all returns.
• Only accounts should be placed inside returns. Attach all correspondence to the top of the return so it can be detached and lodged in our correspondence system. This includes special transfer requests, provisional tax elections, loss letters.

Example page from the IR4:



Larger version of image

Points to remember

Box 3 - only update this if the company has changed its trading name from the one previously given to us. Don't use this to indicate that the company has changed its legal name. Please call us instead. By updating this box with a legal name change our system records it as a trade name and won't change the company name.

Box 4, Box 5 and Box 7 - don't show your tax agent's street or postal address or phone number in these boxes. The system will be updated and may overwrite the correct details on your account. Changes to agent linking/delinking must be done through INFOexpress, by phone, or on an IR795 form.

Box 36L (for individuals), Box 30F (for companies) - don't tick these boxes for a refund by cheque if you have a bank account loaded by us. It will override all your bank account details.

When filing an IR4J please tick the box to show whether the amount is a debit or credit. If you don't, our system will automatically update the amount as a debit and send you a bill. If it should have been a credit you will then need to contact us to make a correction.

GST group registration

Businesses carrying out a taxable activity that have an annual turnover above $60,000 must register for GST. For convenience and to reduce costs a group of companies can register as a GST group. Find out more about GST group registration, or read our GST guide (IR375), which includes information on the criteria and the effects of group registration. The guide can be found under "Forms and guides" > "Goods and services tax (GST)".

The group representative may make changes at any time, but please advise us before the proposed date, not after.

Group registration is more common for companies, or branches within one company. However other persons may also qualify.

If you need more information please call us on 0800 443 773.

From the editor

Large Enterprises Update comments generally on topical tax issues relevant to large enterprises. While every attempt is made to ensure that the law is correctly interpreted, articles are intended to be a brief overview only and are not a full commentary or analysis of the law. The examples provided are not intended to cover every possible factual situation.

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Date published: 26 May 2009

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