The FA rules can apply when the financial arrangement involves a deferral of the payment of consideration. Examples include:
- a loan to buy a rental property
- a US Treasury bond
- a foreign currency bank account.
The rules disregard distinctions between capital and revenue amounts. They can require income and expenses to be spread over the term of the arrangement and usually require a wash-up calculation called a base price adjustment (BPA) to be made at the end.
There are several methods for spreading income and expenses which can or cannot be used depending on the circumstances.
The rules can be complex and you may need the assistance of a tax professional.
When the FA rules do not apply
The rules usually do not apply to non-resident taxpayers and transitional tax residents.
They also do not apply to the calculation of:
- resident passive income such as interest paid by a New Zealand bank to a New Zealand tax resident
- non-resident passive income such as interest paid by a New Zealand bank to a non-resident
- use of money interest paid to or by Inland Revenue.
Cash basis persons do not have to use methods for spreading income and expenses
Taxpayers who are cash basis persons do not have to use a spreading method and can report income or expenses on a cash basis. They still usually must do the BPA.
A cash basis person is a person who either:
- has income and expenditure from all financial arrangements on an accrual basis under $100,000 and the difference between this and a cash basis is less than $40,000
- has total financial assets and liabilities less than $1 million and the difference between income using a spreading method and the cash basis is less than $40,000.
'Total' means you add items together ignoring signs. For example, if you have assets of $500,000 and debts of $600,000 you have a total of $1.1 million and are over the threshold for assets and liabilities.
The $40,000 threshold is particularly relevant in the case of foreign currencies. Large movements in the exchange rate or smaller movements on large amounts can result in going over the threshold.
Cash basis persons return income on a cash basis during the term of an arrangement and perform a BPA when it ends. For example, if you earn interest from a foreign bank account, you would return the interest as you received it converted into New Zealand dollars. When you closed the bank account, you would need to account for movements in exchange rates.
For further information, refer to Interpretation Statement (IS) 22/05.
Excepted financial arrangements are taxed differently
The rules do not apply to excepted financial arrangements.
The Income Tax Act lists arrangements which are excluded from the FA rules. You can, however, choose for the rules to apply.
Examples include:
- shares
- loans in a foreign currency for a private or domestic reason
- variable principal debt instruments such as an overdraft or current account in a foreign currency where the balance does not exceed $50,000 at any time in a year
- cryptoassets (except those economically equivalent to debt arrangements).
As mentioned, most financial arrangements held by transitional tax residents will be excepted financial arrangements.
Excepted financial arrangements often have their own tax rules or the general rules apply.
Base price adjustments are usually required at the end of the arrangement
As noted, when a financial arrangement ends, you must do a BPA whether or not you're a cash basis person.
The BPA takes into account all consideration given and received during the arrangement. If the calculation is positive, this is income. If the result is negative, the deductability depends on the normal rules.
As noted, large currency fluctuations or smaller fluctuations on large amounts may give rise to unexpected income where the financial arrangement is not in New Zealand dollars.