Standard practice statements: General statements

SPS 05/12 - Loss offset elections between group companies (Feb 06)

Introduction

1. This Standard Practice Statement ("SPS") sets out certain practices which the Commissioner will accept for offsetting losses by election between group companies. It also sets out the consequences of specific events that can impact on a loss offset and how these should be addressed.
   
   
2. The SPS does not consider all questions relating to loss offsets within a group of companies and accordingly is not a fully comprehensive guide to section IG 2 of the Income Tax Act 2004. For instance, i t does not consider what constitutes a group of companies, the question of dual residency and subvention payments.

Application

3. This Standard Practice Statement will apply to group company loss offset elections where the year of offset is the 2005-2006 or later income year and the election is made on or after the date of this Standard Practice Statement. However it may be used as a guide in respect of earlier income years, as it reflects current Inland Revenue policy.

Summary

4. The Income Tax Act 2004 ("the Act") makes provision for the sharing of losses between companies that are in the same group of companies. Where a company has made a loss it may elect to give another group company or companies that are in profit the benefit of the loss that it has sustained. It does this in respect of "the year of offset," ie the year in which it has a net loss (which may result from carrying forward earlier losses partly or wholly) and to which its election relates. The amount so elected is then offset against the net income of the profit company in the same year of offset. Another method of sharing a loss is for the profit company to make a "subvention payment" to the loss company. A subvention payment is a payment made by a profit company to a loss company and is offset against the profit company's net income and reduces the loss company's available net losses. The same level of benefit is obtained, but the subvention payment involves a real movement of money from one company to the other. Both methods may be used together.
   
   
5. This SPS provides for the consistent application of certain aspects of the loss offset provisions in Subpart IG of the Act where such elections are made. It discusses the requirements for giving notice, in particular whether a specific amount must be elected or whether a formula may be used, the Commissioner's practice with respect to part year losses, and what should happen when the loss company's loss or the profit company's profit is increased or reduced.
   
   
6. Briefly, the standard practice for valid elections is as follows:
   
   
   1. They may be given either manually (paper based) or electronically;
      
      
   2. An election should refer to an amount that is identifiable as a specific dollar amount at the time the notice of election is made;
      
      
   3. For part years, there should be "adequate accounts" from both the loss company and the profit company, the standard for which requires a sufficiency of detail of the assessable income and the allowable deductions of the company, in respect of part of the income year, materially the same as the level of reporting necessary for the preparation of end of year accounts;
      
      
   4. Where the loss company is reassessed (having its loss reduced below the level in the election) and as a consequence is not entitled to offset the amount elected, then (i) where there is only one available profit company the Commissioner will, usually after consultation with the company's agent, simply assess or reassess the profit company in accordance with s89C(k) of the Tax Administration Act 1994, or (ii) where there is more than one profit company capable of sharing the loss the election may be altered;
      
      
   5. Where the loss company is reassessed and as a consequence has additional losses to offset, a further election can be made in respect of those additional losses if this can be done within the statutory time period for making elections or within such further time as the Commissioner may allow;
      
      
   6. Where a profit company is reassessed and as a consequence has additional profit that could be the subject of an offset, a further election can be made by the loss company in respect of the additional profit within the statutory time period or within such further time as the Commissioner may allow;
      
      
   7. Where a profit company is reassessed and as a consequence has reduced profits (below the level of losses available), the election is valid up to the amount of the reduced profits; and
      
      
   8. Generally an election and any subsequent election must be made by 31 March in the year following the year of offset. A late election can be accepted at the discretion of the Commissioner.
      
      
7. The legislation is in section IG 2 of the Income Tax Act 2004. The section states the circumstances in which losses may be offset.

Background

8. Inland Revenue has hitherto had no published practice on loss offset elections. This SPS is necessary to ensure that consistent decisions are made when loss offset elections are received by Inland Revenue.
   
   
9. A Standard Practice Statement sets out what the Commissioner considers should be the standard or normal practice in the situations that it covers.

Standard Practice

Prerequisites

10. Before a loss offset can proceed the following factors must be present.

Net loss company

11. There must be a company with a net loss for an income year or a net loss carried forward. The loss company must also have 49% continuity of ownership from the time the loss is incurred until the loss is offset.
    
    
12. The loss company must be incorporated in New Zealand or be carrying on business in New Zealand through a fixed establishment in New Zealand.
    
    
13. The loss company must not be a dual resident company ie the company, though resident in New Zealand must not:
    
    
    • be treated under a double tax agreement as not being resident in New Zealand for the purposes of the double tax agreement; or
      
      
    • be liable for income tax in another country by reason of domicile, residence or place of incorporation; section IG 2(11).

Profit company or companies

14. There must be one or more profit companies in the same group of companies as the loss company. All companies involved must be in the same group of companies for the whole continuity period. Whether or not two companies form a group of companies is outside the scope of this SPS.

Amount of loss

15. The amount of loss to be offset cannot exceed the taxable income of the elected profit company or the total taxable income of all the elected profit companies (section IG 2(2)(f)) and neither may the amount of loss to be offset exceed the net loss of the loss company (section IG 2(2)(b)).

A specific amount

16. An election should refer to an amount that is capable of identification as a specific dollar amount. The amount must be fixed by the election in a manner which binds the electing company, but need not be quantified in the notice of election. That is, a formula may be used where it could be known at the time of the election what the result of applying that formula would be. For example, the election might provide that the loss to be offset is to be such amount as would reduce the profit company's taxable income to nil.

Example 1

In a group consisting of two companies, it is found, once its accounts have been prepared, that company A has a tax loss of $10,000. It is anticipated that Company B will be in profit and that the amount of the taxable profit will be about $2,000, ie less than the amount of Company A's loss. Company B's accounts, however, have still to be prepared as the accountants are waiting on further information from their clients. That information will be arriving in a few days. There is still time to file an election and the question is whether Company A can now elect to offset some of its loss up to the amount of the profit company's profit by using a formula, which formula will simply be that the amount to be offset will be the amount of Company B's profit.

The answer is that this is permissible because:

• the notice will be given in time;
  
  
• the amount will be subsequently identified as a specific dollar amount;
  
  
• it does not matter that (even if the accounting firm could commit staff to the finalisation of the accounts) the profit cannot be ascertained with finality at the time of the notice;
  
  
• the information will be in the accountants' hands shortly and so the profit will be identifiable at a time close to the notice. It could even be said that the profit is presently identifiable if the information is somewhere within Company B; and
  
  
• the amount to be offset is already fixed in that it is controlled by the formula.

The election

17. An election to offset the loss must be made by the loss company in writing. The loss company can give notice of the election by:
    • completing the appropriate boxes in a return; or
      
      
    • completing the appropriate boxes in an e-filed return; or
      
      
    • sending either manually or electronically a notice of election in writing (either with the return or separately).

18. The details to be provided by completing the appropriate boxes in the income tax return for companies are as follows:
    • where it is a loss company's return that is being prepared, the IRD numbers of the profit companies and the amounts being offset to each of them, and
      
      
    • where it is a profit company's return that is being prepared, the IRD numbers of the loss company or companies that are offsetting losses to it and the amount being offset from the loss company or, if there is more than one loss company, the amount being offset from each of them. If a loss company makes more than one valid election to the same profit company it may simply enter the total amount and record it in the return as one transaction.
19. A written Notice of Election can be filed outside the loss company return. There is not a prescribed form to be used but the Notice must be signed by an officer or an agent of the company, although where it is filed electronically by a recognised tax agent it will be assumed that the agent has authority to make the election on the loss company's behalf. In this case where a more formal Notice is filed, it would be helpful if separate copies were provided for each of the returns of the companies affected by the election. The Notice should contain the information required above at paragraph 18, ie:
    • the total amount of the loss or losses to be offset,
      
      
    • the name and IRD number of the loss company that is offsetting losses and the amount being offset from the loss company or, if there is more than one loss company, their names and numbers and the amount being offset from each of them, and
      
      
    • the names and IRD numbers of the profit company or companies and the amount being offset to each of them and from which company or companies.

Late elections and extensions of time for filing them

20. An election must generally be made by 31 March in the year following the year of offset (that is, in the year to 31 March in respect of which the offset is elected). A late election can however be accepted at the Commissioner's discretion; section IG 2(3). The purpose of the loss offset provisions is to allow those companies that incur losses to utilise those losses even where different entities are involved, so that there is similarity in the tax treatment of a group of companies, each carrying on separate enterprises, as against a single company that carries on the same enterprises in separate divisions. A case need not be exceptional for the discretion to be exercised favourably. In exercising this discretion the following factors will be considered:
    • the timing of the late application/election to offset a loss: generally, the longer the delay, the potential risk to the Revenue in terms of subsequent audit. Also the effect of a loss offset means that the loss company's assessment must be increased to reflect the reduced loss remaining and this can only be done within four years from the end of the income year in which its return is filed, or within such further time where the company waives the time bar under section 108B of the Tax Administration Act 1994;
      
      
    • the reason for the delay and its correlation to the length of the delay;
      
      
    • the circumstances which have changed after the election date;
      
      
    • the circumstances surrounding the failure to provide a notice within time;
      
      
    • whether the circumstances were beyond the applicant company's control;
      
      
    • any public interest considerations, to ensure the integrity of the tax system is protected. This would mean that the profit and loss company would be treated fairly in that any decision to allow or not allow an extension of time would be in accord with the way other companies in a like position would be treated;
      
      
    • prejudice to any party (the Commissioner, the loss company and the profit company) from the exercise or non-exercise of the discretion;
      
      
    • whether there have been reassessments made by the Commissioner, giving rise to possible further elections; and
      
      
    • any other matters relevant to the merits of the application.

Example 2

A reason for the delay could be that the Commissioner has made an adjustment increasing a profit company's income as a result of an avoidance scheme, evasion or fraud. This factor would weigh against the favourable exercise of the discretion where the profit company then (later than the correct date) seeks to access losses elsewhere from within the group. It could be said that the delay in requesting the compensating election is directly attributable to the actions of the loss company or parties with which it is associated. In cases of illegality the Commissioner will not readily assist the taxpayer to utilise losses.

Example 3

A late election is filed on 10 April after 31 March of the year following the year of offset. It is accompanied by a request for an extension of time of ten days. The reasons given for requesting the extension are that although the loss company's return had been prepared and filed sometime previously, there were numerous profit companies in the group the preparation of whose returns was time consuming. Their returns were filed on time (some actually on 31 March) but due to pressure of work the question of offsetting the loss company's losses was overlooked. Early in April this omission came to the agent's attention and a decision was made about how the offset should be made. The election was then filed without delay. Inland Revenue considered the request and granted it.

Further elections

21. Once a loss company has made an election it cannot withdraw that election or change any part of that election. It is final and irrevocable (see the concluding words of section IG 2(2)). However further elections can be made in some cases – a loss company is not limited to a single election in respect of only one profit company.

Part year losses

22. It is possible to offset a part year loss (section IG 2(4)). This requires:
    • the loss company and profit companies to have continuity of shareholding for the relevant period, ie the period that the loss to be offset is attributable to;
      
      
    • the provision of adequate accounts for the loss company that are fairly and reasonably attributable to the relevant period;
      
      
    • the provision of adequate accounts for all profit companies that again are fairly and reasonably attributable to the relevant period;
      
      
    • that these accounts contain sufficient information to show they are accurate for the relevant period. The standard for "adequate accounts" requires a sufficiency of detail of the assessable income and the allowable deductions of a company, in respect of part of the income year, that is materially the same as the level of reporting necessary for the preparation of end-of-year accounts adjusted for tax purposes. The Commissioner's view is that this requires accounts prepared in accordance with generally accepted accounting practice adjusted for the purposes of income tax legislation, eg to reflect assessable income or deductible expense, at the level required under the Financial Reporting Act 1994. (This does not require the preparation of notes to the accounts and disclosure statements.) The part-year accounts will of necessity be different from full-year accounts due to different ratios, denominators, etc.; and
      
      
    • a valid election.
23. Where a company has a loss of continuity part way through a month and its accounting system balances and reports at the end of the month, subject to backing out significant transactions pre or post the loss of continuity, Inland Revenue will accept the use of the end of month balance sheet numbers for determining provision balances. Inland Revenue will accept pro-rata allocation of the month's income and expenditure to determine the pre and post continuity change profit or loss.
    
    
24. In some cases it may be difficult to prepare part year accounts to the level of detail set out above, particularly in circumstances where there has been a significant lapse of time from the part year. In these circumstances, taxpayers may discuss their individual positions with Inland Revenue and depending on the facts agree to a different approach being taken.

Reassessments

25. In some cases Inland Revenue may reassess a profit or loss company resulting in increased or reduced profits or losses respectively. As a consequence there may be a need for further or fresh elections or the original election may be altered. There are four situations that may be brought about by reassessments. These are:
    • The available loss is reduced below the amount originally elected to be offset.
      
      
    • The available loss is increased.
      
      
    • The profit company has additional profit that could be the subject of an offset.
      
      
    • The profit company has reduced profits below the level of the amount of the loss offset.

Reduced loss

26. Where the loss company is reassessed (having its loss reduced below the level in the election) and as a consequence is not entitled to offset the amount elected then:
    
    
    1. where there is only one profit company then the Commissioner will, usually after consultation with the company or its agent, simply assess or reassess the profit company in accordance with sections 89C(k) and 113 of the Tax Administration Act 1994. No further election is necessary as the assessment of the profit company will reflect the reduced loss available to be offset; and
       
       
    2. where there is more than one profit company the election may be altered in accordance with subsection (7).
       
       
27. Where there is more than one profit company the loss company may elect how that reduced loss is to be allocated to the profit companies pursuant to section IG 2(7)(c). If the loss company does not make this subsequent election within six months or within such further time as the Commissioner may allow, the reduced loss is allocated proportionately to the profit companies.

Increased loss

28. Where the loss company is reassessed and as a consequence has additional losses to offset, a further election can be made in respect of those additional losses. The first election cannot be altered at all. The further election must meet all the criteria set out above for an election, for example it must be on time, state the specific amount to be offset, and name the profit company or companies.

Increased profit

29. Where a profit company is reassessed and as a consequence has additional profits that could be the subject of an offset, a further election can be made by the loss company in respect of the additional profits within the statutory time period (set out in subsection IG 2(3)). This election must meet all the criteria set out above.

Reduced profit

30. Where a profit company is reassessed and as a consequence has reduced profits (below the level of the loss offset), the election remains valid up to the reduced amount of the profit. The "unused" offset loss remains to the credit of the loss company.
    
    
31. Accordingly a fresh notice of election need not be filed.

Late filing

32. These elections that are necessitated by reassessments should be made within the time allowed (subsection (3)), i.e. by the 31 March in the year following the year of offset or within six months of the date upon which notice is given to the loss company of the determination of the reduced amount of the net loss.
    
    
33. A late election can be accepted at the Commissioner's discretion. In exercising this discretion, the factors set out above at paragraph 20 will be considered, ie the merits of the application, the circumstances surrounding the failure to elect within time (including the fact that the reassessment may have occurred after the time for making elections had expired), the explanation for the delay, the length of the delay, compliance costs and fairness as between the taxpayer and the treatment of other taxpayers in a like position, are factors that will be taken into account. Late offset elections filed after a reassessment (whether as a result of a voluntary disclosure or not) would be allowed in most cases. However if, for example, there is an issue of evasion or tax avoidance then that factor would be taken into account in deciding whether to exercise the discretion to allow the late election.

Requests to amend assessments

34. After an election has been made there may be changes to the assessments of the loss company or profit company which impact on the loss offset resulting in the situations covered in the immediately preceding paragraphs. Where there are any consequential impacts on the loss offset election and a further election needs to be made or the election needs to be revised, the taxpayer companies may need to consider whether section 113 of the Tax Administration Act 1994 (including Inland Revenue's practice in respect of section 113) allows those changes to be implemented. In this regard SPS INV-510 Requests to amend assessments (published in Tax Information Bulletin Vol 14, No 8 (August 2002)), which sets out the circumstances when the Commissioner may amend assessments to ensure correctness, is relevant in considering whether the election should be approved.
    
    
35. It will be the Commissioner's practice having approved a further election where the loss company's loss or the profit company's profit is increased or reduced, to implement it, i.e. once a further election has been approved then the resulting amendments to assessments will also be made. Generally an amended assessment will not be agreed where the taxpayer has previously had the opportunity to offset known losses, and has failed, for whatever reason, to do so.
    
    

This Standard Practice Statement is signed on 16th December 2005.

Graham Tubb
National Manager, Technical Standards

Other pages in: General statements

• SPS 08/04 - Elections to change a balance date
• SPS 08/03 Income Tax Act 2007 - Penalties and interest arising from unintended legislative changes
• SPS 05/08 - Section 17 Notices (July 2005)
• SPS 07/05 - Transfer of depreciable property between associated persons - section EE 33 of the Income Tax Act 2004 (September 07)
• SPS 07/04 - Discretions to be exercised by the Commissioner of Inland Revenue under the KiwiSaver Act 2006 (July 07)
• SPS 05/09- Income equalisation deposits and refunds (October 2005)
• SPS 05/07 - Non-disclosure right for tax advice documents (July 2005)
• SPS 05/02 - Income Tax Act 2004 - Penalties and interest arising from unintended legislative changes (Jun 05)
• SPS 05/06 - Non-standard balance dates for managed funds and "as agent" returns (May 05)
• SPS 05/05 - Retrospective adjustments to salaries paid to shareholder-employees (May 05)
• GNL-430 Retention of business records by electronic means (Dec 03)
• GNL-420 Six-monthly GST return threshold (Dec 01)
• GNL-170 Release of information (Sep 01)

Date published: 24 Jan 2006

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