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Other policy matters

Annual income tax rates for 2013–14 tax year

The annual income tax rates for the 2013-14 tax year are the rates set out in schedule 1 of the Income Tax Act 2007, and are the same that applied for the 2012-13 tax year.

Application date

The provision applies for the 2013-14 tax year.

Further Canterbury earthquake-related amendments

Sections CZ 25, CZ 26, EE 1, EE 52, EZ 23B, EZ 23BB, EZ 70 to EZ 74 and FZ 7 of the Income Tax Act 2007

Amendments have been made to ensure existing Canterbury earthquake tax measures work as intended, in the context of the rebuilding activity now taking place in Canterbury.

Background

As a result of the Canterbury earthquakes, a number of changes to tax law were made in 2011 and 2012. These measures included deferring recognition of depreciation recovered in respect of certain assets (rollover relief), and rules to smooth the timing of income recognition for insurance proceeds received for damaged assets.

The policy objective behind the earthquake-related measures is to ensure the tax rules do not over-tax insurance proceeds or unnecessarily bring forward future tax liabilities for taxpayers affected by the earthquakes. A further objective has been to ensure that the tax rules do not produce unfair results and that they assist recovery and rebuilding in the Canterbury region.

Amendments have been made in response to further tax issues identified as the Canterbury recovery plans have developed and the rebuild has commenced. These largely relate to ensuring that the existing tax measures work as intended in the context of the rebuilding activity taking place in Canterbury, rather than with providing additional "special relief" measures.

Key features

There are two main amendments. The first extends the previous 2015-16 income year time limit for existing Canterbury-earthquake amendments by three years, to the end of the 2018-19 income year. The second amendment extends the existing rule providing tax relief to taxpayers for unexpected depreciation claw-back arising from earthquake-damaged assets to taxpayers who reinvest jointly with others to acquire replacement property.

A number of remedial amendments have also been made to the taxation of insurance proceeds, the revenue account property rollover relief (which is similar to depreciation rollover relief, but applies to buildings and land held on revenue account), and the special exemption for certain land disposals.

Detailed analysis

Insurance proceeds received for repairable assets

Section EE 52 specifies the amount of depreciation recovery income that a person has when they receive insurance proceeds for damage to a depreciable asset. An amendment has been made to section EE 52, to clarify that if damaged property is disposed of before the insurance proceeds are received, the proceeds will be treated as being derived immediately before the disposal. This is to remedy a gap in the earlier legislation. If a person receives insurance proceeds for a damaged building and the building is then sold, the owner is taxed on the insurance proceeds. However, before the amendment, if the damaged building was sold before the insurance proceeds were received by the owner, the proceeds were not taxable.

Application date

The amendment applies from 25 June 2013, the date the Supplementary Order Paper on further Canterbury earthquake tax measures was released.

Extension of time limit for Canterbury earthquake-related amendments

Amendments have been made to extend the 2015-16 income year time limit for Canterbury earthquake-related provisions by three years to the end of the 2018-19 income year. The following provisions are affected by this extension:

  • rollover relief for depreciation recovery income arising from insured damaged assets (section EZ 23B);
  • rollover relief for buildings and land on revenue account (section CZ 25);
  • timing rules for smoothing income and deductions/disposal losses when insurance proceeds are received for depreciable assets (sections EZ 23F and 23G repealed and re-enacted as sections EZ 73 and EZ 74) ;
  • the provision regarding assets that are uneconomic to repair (section EZ 23C repealed and re-enacted as section EZ 70);
  • the provision capping depreciation recovery income arising under section EE 52 (section EZ 23D repealed and re-enacted as section EZ 71);
  • the amendment to the "available for use" depreciation rule (section EZ 23E repealed and re-enacted as section EZ 72);
  • the provision allowing deduction of expenses when income-earning activity was temporarily interrupted (section DZ 20); and
  • the provision allowing adjustment to assets under thin-capitalisation rules (section FZ 7).

Application date

The amendments apply until the end of the 2018–19 income year.

Extension of relief from depreciation claw-back to persons who reinvest jointly

Many income-producing depreciable assets are insured. In these cases, the tax rules deem the assets to be sold for the value of any insurance proceeds received. If the insurance proceeds exceed an item's tax book value, any excess depreciation deductions allowed while the asset was in use are clawed back as income under section EE 48 (referred to as "depreciation recovery income").

A rule was introduced in 2011 (section EZ 23B) to allow the deferral of the claw-back of depreciation that ordinarily arises when insurance proceeds are received for items of depreciable property that have been irreparably damaged in a Canterbury earthquake. It works by rolling over the depreciation recovery income to reduce the acquisition cost of replacement depreciable property. The purpose of the rollover relief is to defer any unanticipated tax liability resulting from the destruction of insured depreciable assets in the earthquakes and to assist the rebuilding in Canterbury. The relief rule is designed on the basis that the person who owns the damaged asset is the same person who acquires replacement property.

An amendment has been made (section EZ 23BB) to extend relief from depreciation claw-back to taxpayers who reinvest jointly with other investors to acquire replacement property – this is because reinvestment in Canterbury is occurring through multiple owners pooling together to invest in large building complexes. Unlike section EZ 23B, the new rule does not involve rolling depreciation recovery income into the cost base of replacement property.

Under section EZ 23BB (1), relief is available when a person:

  • receives insurance proceeds for a depreciable asset (that is not depreciable intangible property or property for which the pool method is used);
  • that is damaged in a Canterbury earthquake, as that term is defined in section 4 of the Canterbury Earthquake Recovery Act 2011, and is irreparable (section EE 47(4)) or uneconomic to repair (section EZ 23C or section EZ 70);
  • has depreciation recovery income under section EE 48;
  • is not linked with replacement property under section EZ 23B;
  • has a voting interest in a company that will acquire replacement property or is the settlor of a trust which holds a voting interest in such a company; and
  • gives written notice to the Commissioner meeting the requirements of section EZ 23BB (10).

The replacement property must also meet certain criteria (subsection (6)), namely:

  • It must be of the same class or type as the damaged property with which it is linked.
  • It must be located in greater Christchurch, as that term is defined in section 4 of the Canterbury Earthquake Recovery Act, if the item is a building or commercial fit-out.

If the person meets these criteria, they should be able to defer recognising their depreciation recovery income until the earliest income year that:

  • the replacement property is sold by the joint investment company; or
  • they exit the joint investment company that they have a share in by reducing their voting interests in the entity or entering into liquidation or bankruptcy.

In addition, depreciation recovery income must be recognised if the income year is the 2018-19 income year and the joint investment company has not acquired the replacement property linked to the damaged property by the end of the income year.

The person's entitlement to defer their depreciation recovery income is related to their level of investment in replacement property, for consistency with the existing depreciation rollover relief provision (subsections (4) and (5)). This means the amount of depreciation recovery income that a person can defer is limited to their share of the cost of a replacement asset as a proportion of the original cost of their destroyed asset. The person's share of the cost of the replacement (referred to as the "fractional interest value") is determined using the formula:

  • person's fractional interest x replacement expenditure

The person's fractional interest is either the person's voting interest in the joint investment company or, if the voting interests are held through a trust, the fraction calculated by multiplying the voting interest in the owning company held by the trustee of a trust of which the person is a settlor by the proportion of the trust corpus that has been settled by the person (subsections (12) and (13)).

For example a person has depreciation recovery income of $4 million for a destroyed building which originally cost $5 million. The person reinvests with three other investors into a company which acquires a replacement building at a cost of $30 million by the end of the 2018-19 income year. The person owns a 10% share of the company. Therefore, their share of the cost (fractional interest value) is 10% of $30 million, that is, $3 million. The amount of depreciation recovery income they can obtain relief for is determined under subsection (4) as:

  1. zero, if the cost of the damaged property equals or is less than the total fractional interest values for other replacement interests acquired by the person before the replacement interest; or
  2. the amount calculated using the formula:

(limited replacement cost x excess) ÷ affected cost

"Limited replacement cost" is the lesser of:

  1. the fractional interest value determined under subsection (12); and
  2. the amount by which the cost of the damaged property exceeds the total amount of the fractional interest values of other replacement interests acquired by the person before the replacement interest.

"Excess" is the excess recovery for the affected class.

"Affected cost" is the total cost for the person of the damaged property.

Therefore, in the example above, the amount under subsection (4) is:

$3m x $5m ÷ $4m = $2.4m

$2.4 million is treated as "suspended recovery income" and a reduction in the amount of depreciation recovery income under subsection (3). If the person's share of the replacement asset cost is equal to or more than the cost of their destroyed asset, they would be entitled to treat the full amount of depreciation recovery income as suspended recovery income.

In the case where a person has purchased two or more replacement interests concurrently, an ordering rule applies, requiring the taxpayer to choose the order in which the interests are treated as being acquired (subsection (14)). A similar ordering rule has been introduced in section EZ 23B (subsection (11C)). This amendment has been made to ensure the formula applies correctly when two or more replacement items/interests are purchased at the same time.

Notice requirements

A person who wishes to elect to apply section EZ 23BB is required to give written notice in each year they choose to apply the new rule by the date on which the return of income is filed for that income year (subsection 10). Notice can also be given under section EZ 23B for previous years.

Subsection (11) specifies that a notice must provide details of:

  1. the items of damaged property and whether it is a building or grandparented structure, commercial fit-out or other depreciable property;
  2. replacement property that the damaged property was linked with under section EZ 23B in a previous income year;
  3. the person's voting interest in the company acquiring the replacement property or, where a trust is used to hold an interest in a joint investment company, the proportion of the trust corpus that the person has settled on the trust;
  4. the amount of expenditure by the joint investment company in the income year on replacement property;
  5. the amount of suspended recovery income at the end of the current year; and
  6. the amount of depreciation recovery income for the damaged property at the end of the current year.

Interaction with other provisions

A person who has elected into section EZ 23B for a previous income year and has not yet begun incurring expenditure on acquiring replacement property that they wish to link with their damaged property is eligible to elect to use section EZ 23BB (refer to section EZ 23B (11B)). Therefore, both persons who have never elected into section EZ 23B and taxpayers who have elected into section EZ 23B for a previous income year are able to apply section EZ 23BB. A person cannot link replacement property to the same affected property under both provisions concurrently.

Both sections EZ 23B and EZ 23BB override subpart EE.

Application date

The amendment applies from 4 September 2010.

Revenue account property rollover relief

Revenue account property (RAP) rollover relief was introduced in 2011. It is similar to the rollover relief for depreciable assets, but applies to relation to buildings and assets held on revenue account.

The purpose of the RAP rollover relief is to delay the tax that would arise on the disposal of the original RAP, until the eventual sale of the replacement RAP. The tax obligation is not removed altogether though; when the replacement RAP is eventually sold, the profit will be taxed at the time of sale.

RAP rollover relief allows for equivalently valued RAP to be purchased with the receipts from the original RAP by deferring the payment of the associated tax.

The three main situations and outcomes can be summarised as:

  1. The cost of replacement RAP is less than the disposal proceeds and less than the cost of the original RAP.
    In this situation no rollover relief will be due, because any liability arising on the sale of the original RAP can be met without affecting the ability to purchase replacement RAP.
  2. The cost of replacement RAP is equal to or more than the disposal proceeds, and more than the cost of the original RAP.
    In this situation all the proceeds are put towards the replacement RAP. Rollover relief can be claimed in full, and there is no pro-rata. The full amount of taxable income will be rolled over, and the go-forward value of the replacement RAP will be reduced accordingly.
  3. The cost of replacement RAP is less than the insurance proceeds but more than the cost of the original RAP.

If not all of the amount received from disposal of the original RAP is used to purchase replacement RAP, there is a pro rata approach to determine the amount that is to be rolled over, and that amount of the proceeds that are taxable immediately. This is achieved through the formula in section CZ 25.

Amendments have been made to this formula to clarify and simplify this pro-rata calculation.

Example of pro-rata formula
Income from disposal of original RAP         $7m       
Cost of original RAP (deductions)     ($3m)   
Excess recovery (section CZ 25(2)) $4m
Cost of new replacement RAP         $5m      

The disposal income from the original RAP of $7m exceeds the cost of the new RAP.

Therefore a pro-rata approach is needed to determine how much of the $4m profit (excess recovery) from this disposal will be taxed immediately, and how much will be rolled over (suspended) and reduce the tax cost of the replacement RAP going forward.

For the purposes of determining the amount of the suspended recovery income, and the value of the replacement property going forward, the expenditure on the replacement RAP ($5m) is reduced by an amount calculated as follows:

replacement RAP cost ÷ deductions for original RAP x excess of insurance proceeds over replacement RAP

= $5m ÷ $3m x $2m = $3.3m

The replacement RAP's cost base is reduced ($5m - $3.3m) to $1.7m.

The amount of the suspended recovery income immediately before the expenditure on the replacement RAP ($4m) is reduced by the same amount ($4m - $3.3m).

This leaves income taxable immediately of $0.67m.

In addition, the section has been amended to apply to disposal proceeds received from Crown acquisitions under sections 54 and 55 of the Canterbury Earthquake Recovery Act 2011 (compulsory acquisitions) as well as acquisitions under section 53 of that Act.

Application date

These amendments apply from 4 September 2010.

Disposal of buildings and land within 10 years of acquisition

Subpart CB of the Income Tax Act 2007 contains various provisions to ensure that the proceeds from land purchased with the intention or purpose of sale are taxable. Broadly speaking, a seller may also derive income from the disposal of land if it is disposed of within 10 years of purchase or within 10 years of improvements being made to the land, and the seller is, or is associated with, a person in the business of dealing in, developing or building on land.

Section CZ 26 contains an exemption to some of these rules in situations involving a Crown purchase of land made under the Canterbury Earthquake Recovery Act 2011. This means a person who accepts the Crown's offer of purchase will not be considered to derive income from the disposal of land. The exemption recognises that the particular circumstances of Christchurch may mean that it is not possible, nor in some cases desirable, for the owner to retain their property for the requisite 10-year period following acquisition or other event that triggers the 10-year rule.

Three key amendments have been made to the scope of this exemption.

The first amendment is to clarify that the exemption applies to Crown acquisitions under sections 54 and 55 of the Canterbury Earthquake Recovery Act 2011 (compulsory acquisitions) as well as acquisitions under section 53 of that Act.

The second amendment extends the exemption to income arising under section CB14. This section deals with income arising on disposal of land within 10 years of changes in zoning, planning permissions etc. when the profit from disposal is attributable to an increase in the value of the land caused by such changes.

The exemption did not originally apply to this type of income, because it was not considered relevant given the circumstances in Christchurch. However it is considered that changes to the re-zoning rules under recovery plans may mean that this section might apply to a small number of taxpayers, so the exemption has been extended accordingly.

The third amendment corrects a drafting error, and removes the exemption for income arising under section CB 11, which applies in situations when the owner has entered into a scheme to do non-minor development. The exemption does not apply to income under in this situation, because, once section CB 11 applies it is not time-limited to 10 years in relation to the date of disposal.

Application dates

The first two amendments apply from 4 September 2010.

The third amendment applies from 27 February 2014, being the date of Royal assent. This is to protect taxpayers who may already have used the exemption in relation to income arising under section CB 11.

Working for Families Tax Credits

Sections GB 44, MA 8, MB 1, MB 4, MB 7, MB 8, MB 9, MC 6, MD 1, MD 2, MD 11, MD 12, MD 13 and MD 16 of the Income Tax Act 2007

Amendments have been made to clarify and improve the Working for Families (WFF) tax credit provisions to ensure they operate as intended. The amendments are consistent with the policy behind previous amendments, including the broadening of the definition of "family scheme income" to prevent people structuring their income to inflate their entitlements.

Key features

There are a number of specific changes to the WFF tax credit provisions as follows:

  • Sections MD 1, MD 2 and MD 16 have been amended to ensure that the formula for calculating the family credit abatement produces the correct result in all cases, when it relates to a family that receives a parental tax credit in a lump sum for a child born within 56 days of the end of the tax year.
  • Section MB 4 provides that income attributable to shares in a close company held by dependent children will be included in family scheme income. This addresses a situation where a person could reduce their income by allocating shares in a close company to their dependent children. It also clarifies how dividends from close companies are treated and aligns the provision's wording with section MB 7.
  • Section MB 7 ensures that, when calculating family scheme income, the attribution of trust income takes into account only settlors who were alive in the income year. It also aligns the provision's wording and structure with section MB 4 on how company income is attributed to a trustee.
  • Sections MA 8 and MB 1 clarify that family scheme income is based on a person's net income and is further adjusted as provided by subpart MB.
  • Section GB 44, the anti-avoidance provision, has been clarified to ensure that all arrangements that have a purpose of favourably affecting an entitlement to WWF tax credits are covered by the provision.
  • Section MD 12 clarifies the days when a person is entitled to a parental tax credit by reference to the criteria in section MD 11.
  • The reference to "fortnightly instalments" has been removed from section MD 13 and regulation 8 of the Health Entitlement Cards Regulations 1993, as instalments can be paid weekly as well as fortnightly.
  • Reference to a market value circumstance in determining a proportion of shareholding in a company has been removed from sections MB 4, MB 7, MB 8 and MB 9.
  • Sections in the Tax Administration Act 1994 and the Health Entitlement Cards Regulations 1993 have been updated to refer to "family scheme income" rather than "net income", to reflect the changes in sections MA 8 and MB 1.
  • The list of defined terms in section MC 6 has been updated.

Background

WFF tax credits are provided to the principal caregiver of dependent children based, among other things, on their level of family scheme income for a tax year. The tax credits are abated when family scheme income exceeds $36,350 and are abated at the rate of 21.25 cents per dollar. The tax credits can be received as a lump sum at the end of the tax year or in weekly or fortnightly instalments throughout the year.

The WFF tax credits are:

  • Family tax credit − for principal caregivers of dependent children.
  • In-work tax credit − for principal caregivers of dependent children who are not receiving an income-tested benefit and who meet the full-time earner requirements.
  • Parental tax credit − for principal caregivers of a newborn child who are not receiving a social assistance payment and not receiving paid parental leave.
  • Minimum family tax credit − for principal caregivers of dependent children who meet the full-time earner requirement and do not receive income from certain sources such as an income-tested benefit.

The provisions have been amended a number of times over the last decade including as part of the rewrite of the Income Tax Act. The names of WFF tax credits and some criteria were amended in 2004. The parental tax credit abatement formula was introduced in 2007 (with effect from 1 April 2008). The definition of family scheme income was broadened as part of Budget 2010, with effect from 1 April 2011. This included a new provision for attributing the income of a trust and trust-owned companies to the settlors of a trust.

Detailed analysis

Calculation of parental tax credit and abatement

The parental tax credit is a payment covering the first eight weeks (56 days) after a child is born (the parental entitlement period). Section MD 11 indicates that a person is entitled to the parental tax credit if they meet the requirements in section MC 2, and for any day within the parental entitlement period they or their spouse are not in receipt of a social assistance payment. They must also not receive paid parental leave for that child. Section MD 12 calculates the amount of parental tax credit and has been amended to clarify that the number of days a person qualifies for a parental tax credit is based on the days a person meets the entitlement criteria in section MD 11.

The maximum amount a person is entitled to is then abated by family scheme income using the main abatement formula in section MD 13.

If a principal caregiver has a child born within the last 56 days of the tax year, and receives the parental tax credit as a lump sum in the tax year the child is born, there is an additional abatement calculation reflecting the fact that part of the parental entitlement period falls in the next tax year. For example, for a child born on 1 March, the main abatement formula would calculate abatement for the month of March only but the parental tax credit is based on entitlement for the period 1 March to 25 April. The formula in section MD 16 is required to calculate abatement for the period 1 April to 25 April in this situation.

The formula in section MD 16 has been replaced to clarify how it operates when calculating an additional abatement. It also improves how the formula works in very unusual circumstances. The formula calculates additional abatement for the parental tax credit based on the rate of abatement that applied on the last day of the last entitlement period in the tax year the child was born. If there was no entitlement period in the tax year the child was born, the rate of abatement is based on the first day of the first entitlement period in the following tax year.

Family scheme income of major shareholders in close companies

Section MB 4 has been replaced with an expanded formula and additional definitions. The previous formula determined the amount that was included in family scheme income when a person was a major shareholder in a close company on the last day of the company's balance date for financial purposes. The amount was based on the proportion of the company's income for the accounting year that reflects the person's proportional holding of company shares, and reduced to reflect dividends paid.

A major shareholder is someone who owns or controls, directly or indirectly, at least 10 percent of the shares in a close company. While a major shareholder includes a person who controls, including indirectly, at least 10 percent of the shares, the formula in section MB 4 only refers to shares held by the person. When shares are held by a dependent child of a principal caregiver or dependent child of their spouse, the previous formula would attribute the relative share of the income of the company to the dependent child. Section MB 11 includes resident passive income derived by a dependent child in family scheme income, including dividends received from a close company, but not attributed income under section MB 4.

The replacement formula continues to apply only when a person is a major shareholder in a close company on the last day of the company's income year. (The company's balance date is replaced with the company's income year to reflect current drafting styles and wording in section MB 7.) A person who is a major shareholder in a close company will be unable to reduce their attributed income under section MB 4 by transferring ownership of the shares to their dependent child, or dependent child of their spouse, while still retaining control of the shares.

The income attributed under section MB 4 is the greater of zero or the amount given by the formula. This clarifies that the result under section MB 4 cannot be a negative amount (in situations when dividends exceed attributed income).

The formula allocates the amount of company income, less total dividends paid by the company, to shareholders based on their proportional holding. Dividends are deducted from the amount of company income as dividends received are already included in family scheme income through section MB 1 (net income of a person) or section MB 11 (resident passive income of a dependent child). Similarly, dividends paid to other shareholders would reduce the amount of income retained in the company and therefore the income potentially available to the principal caregiver.

The proportion of shares for a person is based on the number of shares held directly and the number of shares attributed to them. Attributed shares are shares held by a dependent child of the person or the person's spouse, and they are shared among the relevant number of major shareholders connected to the dependent child. Reference to shareholding is to the percentage of voting interest. Reference to a market value interest under a market value circumstance has been removed from section MB 4, as well as sections MB 7, MB 8 and MB 9.

Family scheme income of settlors of a trust

Section MB 7 attributes income when a person is a settlor of a trust. Under this section the income of the trust (and trust-owned companies) is allocated in equal portions to the settlors of the trust when calculating family scheme income. A settlor is a person who, at any time, transfers value to the trust or for the benefit of the trust (with some exceptions). Under the previous rules, settlors could include people who had gifted property to the trust and since died. The formula has been amended so that the attribution of income takes into account only settlors who are alive during the income year. This includes people who were alive for only part of the income year, including the person for whom family scheme income is being calculated.

Section MB 7 has been amended to align with the wording and structure of section MB 4 in relation to the attribution of company income to the shareholding trustee. This includes clarifying that income is the greater of zero or the amount of the formula, reference to shareholding by voting interest and the revised structure of the formula in section MB 7(5).

Arrangements involving tax credits for families

Previously, section GB 44 referred to a person (a claimant) entering into an arrangement and the Commissioner's ability to reduce the claimant's tax credit. It was unclear from the wording whether the section would cover an arrangement entered into by a spouse of a principal caregiver, if the principal caregiver was not a party to the arrangement, yet benefited from an increased entitlement to WFF tax credits. For example, a spouse is a major shareholder in a close company and the principal caregiver is not, and the spouse enters into an arrangement with the company to reduce the amount of family scheme income attributed to them in that year. The amended drafting of the section is more closely aligned with the style of other anti-avoidance provisions.

Definition of "family scheme income"

Both the change in section MA 8 and the change in section MB 1(1) highlight that a person's entitlement to a WFF tax credit is based on a person's family scheme income. Furthermore, family scheme income is based on a person's net income (calculated under section BC 4) and adjusted as provided by subpart MB. This replaces the previous wording in section MB 1(1) which referred to entitlement being based on "the net income (the family scheme income)". The previous wording was unclear and the amendment is intended to clarify that family scheme income includes net income. Changes have also been made to sections in the Tax Administration Act and the Health Entitlement Cards Regulations 1993 to refer to "family scheme income" rather than "net income".

Application dates

The amendments will generally apply for the 2014−15 and later tax years, with some applying from the date of Royal assent, being 27 February 2014.

Below market interest rate loans under IFRS

Sections EW 15D and EZ 69 of the Income Tax Act 2007

In some situations, the International Financial Reporting Standards (IFRS) accounting rules require a special treatment for interest-free and reduced-interest loans. This can involve the recognition of a one-off adjustment to the value of the loan and notional payments or receipts of interest. These adjustments do not reflect actual payments made between parties, but rather are bookkeeping adjustments with no economic substance.

Amendments to section EW 15D clarify that these bookkeeping adjustments do not have a tax effect. The amendment confirms that positive adjustments are not taxable and negative adjustments are not deductible.

The amendments apply only to loans that begin with below market interest rates. They will not affect the treatment of loans that subsequently pay below market interest (for example, because of movements in market interest rates). Loans that pay no explicit interest but involve increasing repayment amounts as a substitute for interest (for example, deep-discount bonds) are also not affected by the amendment.

New section EZ 64 is a transitional provision that requires a taxpayer who has been claiming deductions for these bookkeeping adjustments or paying tax on them to perform a change of spreading method adjustment in their 2014-15 income year. This adjustment will, in effect, reverse the taxpayer's earlier deductions or tax payments.

Example  

A Co, an IFRS and accrual-basis taxpayer, receives a two-year interest-free loan of $100,000 from an unrelated party.

Under IFRS, A Co will be required to adjust the book value of the loan when it is first received based on its present value. For simplicity, say this adjustment moves the loan's value to $90,000. The $10,000 difference will be credited to its income statement. IFRS also requires A Co to increase the loan's value each year through a debit in its income statement so its book value returns to $100,000 on termination. Again for simplicity, say this debit is $5,000 each year.

The new rules mean that the $10,000 difference credited to the income statement is not income and the $5,000 debited to the income statement is not expenditure under section EW 15D.

Application date

The changes apply from the beginning of the 2014-15 income year.

Over-crediting of imputation credits in excess of FIF taxation

Sections CV 19 and LE 8B of the Income Tax Act 2007

Amendments have been made to the Income Tax Act 2007 to address a mismatch arising under the tax rules in relation to imputed dividends paid by Australian companies under the trans-Tasman imputation rules. This mismatch arose because imputation credits are calculated on the basis of the dividend paid but income tax arises only on the foreign investment fund (FIF) income.

New section LE 8B limits the amount of the tax credit to the shareholder receiving the imputed dividend to the amount of imputation credits they would have if the imputation credits were calculated on the basis of the shareholder's FIF income from that company.

Background

The trans-Tasman imputation rules permit an Australian company to operate an imputation credit account (ICA). An Australian ICA company that has paid New Zealand tax can attach imputation credits to dividends paid to New Zealand shareholders. Wholly owned Australian and New Zealand companies can also form a trans-Tasman imputation group. New Zealand tax paid by a member of the group will generate imputation credits that can be distributed to a New Zealand shareholder. The amount of imputation credits that a particular shareholder receives is determined with reference to the actual dividend paid by the company. In the domestic context, this works as intended.

However, an issue arises when a New Zealand resident shareholder receives a dividend with imputation credits attached that is paid from a closely held Australian company. The New Zealand resident's investment in that company will generally be an attributing interest under the FIF rules. Under the FIF rules, a New Zealand resident is taxed only on the deemed FIF income; the actual dividend is disregarded (refer to section EX 59(2)).

A mismatch therefore arises, with imputation credits being calculated on the actual dividend paid but income tax arising only on the FIF income. If the dividend is of greater value than the amount of FIF income, the shareholder will receive excess imputation credits under section LE 1(4B), which they can use against the tax on their other income, such as salary and wage income. This is inconsistent with the policy intent.

Key features

New section LE 8B limits the amount of the tax credit to the shareholder receiving an imputed dividend from an Australian company to the amount of imputation credits they would have if the imputation credits were calculated on the basis of the resident's FIF income from that company. The section applies only if the dividend amount exceeds the amount of FIF income.

The amount of imputation credits is calculated using the formula: imputation ratio x FIF income, where the imputation ratio is that given under section OB 60, with a maximum imputation ratio of 0.28/0.72, as specified in section OB 60(5).

In addition, a new section CV 19 has been added to ensure that the shareholder's tax liability is calculated correctly in relation to the FIF income and imputation credits by providing that a person's income includes the amount of imputation credits under new section LE 8B. In the absence of section CV 19, a shareholder subject to section LE 8B would be under-taxed on their FIF income.

Example  

A New Zealand-resident trustee shareholder in an unlisted Australian company receives a $500,000 dividend with $200,000 of imputation credits attached. The shareholder is treated as having an attributing interest in a FIF. Under the FIF rules, the person is taxed on $11,000 of FIF income and the dividend is disregarded.

Applying new section LE 8B, the shareholder is allowed a credit for the lesser of the imputation credits actually received ($200,000) and the imputation ratio x FIF income.

The imputation ratio under section OB 60(3) is: credit attached ÷ net dividend paid = $200,000 ÷ $500,000 = 0.4.

As 0.4 is greater than the maximum permitted ratio under section OB 60(5) of 0.28 ÷ 0.72, the shareholder is treated as having the maximum imputation ratio as set out in section OB 60(5):

Imputation ratio x FIF income = 0.28 ÷ 0.72 x $11,000 = $4278. Accordingly, the shareholder's tax credit is limited to $4,278.

Therefore, the shareholder is taxed as follows:

FIF income     $11,000    
Imputation credits*   $4,278
Taxable amount       $15,278      
Tax (@ 33%) $5,042
Less imputation credits         $4,278       
Tax payable   $764
*Per section CV 19  

Application date

The amendments apply from 1 April 2014.

Recipients of charitable or other public benefit gifts

Schedule 32 of the Income Tax Act 2007

The following organisations have been granted donee status from the 2014-15 income year:

  • Kailakuri Health Care Project – New Zealand Link
  • Marama Global – Education
  • Marama Global – Health.

Background

New Zealand-based charities who apply some or all of their funds for overseas purposes and who want donors to receive tax benefits in connection with any donations received, are required to be named as a donee organisation on the list of recipient of charitable or other public benefit gifts in schedule 32 of the Income Tax Act 2007.

Donee status entitles individual donors to a tax credit of 33⅓ percent of the monetary amount donated to these organisations, up to the level of their taxable income. Companies and Māori authorities are eligible for a deduction for monetary donations up to the level of their net income.

Application date

The change applies from the 2014-15 and later income years.

Financial reporting for companies and other taxpayers

Sections 17, 21B, 21C and 22 of the Taxation Administration Act 1994

The Tax Administration Act 1994 has been amended as part of the Government's reform of the financial reporting regulatory framework for companies. The amendments to the Tax Administration Act 1994 imposes, unless otherwise exempted, a general requirement for companies to prepare financial reports that meet certain minimum requirements as prescribed by Order in Council.

These changes (collectively referred to here as "the new sections") are a small part of much wider reforms to financial reporting and auditing that are currently being put in place.

Details of an associated Order in Council made under the new sections are published in the appropriate section of this Tax Information Bulletin (Vol 26, No 4 (May 2014)).

Background

From 1 April 2014, under the rewritten Financial Reporting Act 2013, most companies will have no obligation to prepare financial reports. The new sections require all companies, unless specifically exempted, to continue to prepare financial reports, but under the auspices of Inland Revenue. Further, these financial reports will, at a minimum, be special purpose reports.

Key features

New sections 21B and 21C of the Tax Administration Act 1994 set up a framework that:

  • requires companies that do not prepare general purpose financial reports to prepare special purpose financial reports unless they are specifically exempted;
  • can be used to require non-corporate taxpayers to prepare financial statements; and
  • allows the minimum requirements to be specified.

Supporting amendments have been made to sections 17 and 22 of the Tax Administration Act 1994.

New section 21B of the Tax Administration Act 1994 provides that companies must prepare financial reports unless they are:

  • by way of other legislation required to prepare financial reports; or
  • they are specifically exempted by way of Order in Council.

This section also provides that other classes of taxpayer may be required to prepare financial reports by way of Order in Council. The minimum requirements to which the financial reports should be prepared must be specified in the relevant Order in Council.

New section 21C of the Tax Administration Act 1994 provides the mechanism that authorises the Orders in Council. In particular, before recommending the making of an Order, the Minister of Revenue must consult with professional accounting bodies.

Consequentially, section 17(2) of the Tax Administration Act 1994 which requires companies to produce financial reports on request has been repealed as it is redundant, and section 22 of the Tax Administration Act 1994 which concerns the keeping of records has been amended to include reference to the financial reports.

Application date

The new sections apply from 27 February 2014, the date the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act 2014 received Royal assent. In practice, as discussed elsewhere in this Tax Information Bulletin (Vol 26, No 4 (May 2014)), the effective date is years commencing 1 April 2014 and later.

Bad debt deductions for holders of debt – compliance change

Section DB 31 of the Income Tax Act 2007

The law has been amended to make it easier for taxpayers to take bad debt deductions in certain situations. These are when the taxpayer would ordinarily be entitled to them on the cessation of a financial arrangement, but for technical compliance issues. The amount of deductions that can be taken has not changed. For instance, there is no intended change to the tax treatment of capitalised interest (interest which has been added to the original capital). This interest has always been, and continues to be, treated as being paid to the investor and reinvested.

Background

One function of the bad debt write-off rules is to ensure that taxpayers are not taxed on amounts which may have been derived and included in assessable income, but are never actually received. If deductions for bad debts were not allowed, taxpayers would pay too much income tax because they would be assessed on income which substantively was not received.

There is a required process for taking bad debt deductions for debts owing under a financial arrangement. Generally, they must be written off as a bad debt before the financial arrangement ends (for instance, by liquidation). This means that if a creditor fails to take a bad debt deduction before that time, the deduction cannot be taken later.

Previously, where a debtor went into liquidation or bankruptcy the creditor could take a bad debt deduction only if the debt was written off as bad in the same income year, and before the liquidation or bankruptcy took place. This requirement was considered unnecessarily onerous for certain creditors (for example, "mum and dad" investors in failed finance companies who had returned income from the debt but never received the income). It meant they would need up-to-date knowledge of the financial state of the debtor in order to take the bad debt deduction in time. In some situations, creditors are not informed of upcoming liquidations or bankruptcies unless they regularly check the companies register or public listings for updates on the financial status of the debtor.

The same strict write-off criteria applied to creditors when the debtor company entered into a composition with them. A composition with creditors is a deed or agreement where the debtor is released from making all remaining payments (for example, when the creditor agrees to accept 70 cents for every dollar owed by the debtor). Where a debtor has entered into a composition with its creditors, the creditors could take a bad debt deduction only if the debt was written off as bad in the same income year and before the composition took place. Again, the write-off requirement was considered unnecessarily onerous for creditors because the timeframe to write off the debt can be short (the period between being informed of the financial difficulties of the debtor and the composition itself).

Creditors, in both the above situations, who failed to write off the bad debt in time would have a tax obligation in respect of accrual income they never received, or income from the base price adjustment that was never written off. This result was considered unfair and resulted in unnecessary complexity.

Key features

The law has been amended so that deductions can be taken for bad debts, not only after they have been written off as bad, but in two additional situations:

  • if the debt has been remitted by law (new section DB 31(1)(a)(ii)); and
  • if a debtor company has entered into a composition with its creditors in relation to the debt (new section DB 31(1)(a)(iii)).

Detailed analysis

The concern with the previous rules was that taxpayers who were holders of financial arrangements could only take bad debt deductions when the debt had been correctly written off as bad. There are no legislative criteria for writing off a debt as bad, however it must be written off in accordance with the accounting and record-keeping systems maintained by the taxpayer. Whether or not a debt is bad is a question of fact and depends on the prospects of recovery. A debt is adjudged as "bad" when a reasonably prudent commercial person would conclude that there is no reasonable likelihood that the debt will be paid.

Under the previous rules, a taxpayer was required to write off a debt as bad before the financial arrangement came to an end and a base price adjustment1 (BPA) was performed. If the taxpayer failed to do so they would not be able to take a bad debt deduction later. This would not be the right policy outcome if the person had derived income under the BPA calculation or in a prior income year.

Under the new rules, bad debt deductions are also allowed in two additional situations - first, if the debt has been remitted by law (section DB 31(1)(a)(ii)), and secondly, if a debtor company has entered into a composition with its creditors in relation to the debt (section DB 31(1)(a)(iii)). Deductions in these situations must be taken in the year that the BPA is performed.

The requirement that the debt be "bad" before any deduction can be taken is unchanged. However, the requirement to write off a debt as bad before the financial arrangement comes to an end and a BPA is performed is considered unnecessary in the two situations listed above. In these situations it is clear that the debt is bad, and it is not always possible for the creditor to write off the debt as bad.

The other legislative criteria for taking deductions have not changed. Bad debt deductions can be claimed for income amounts (under section DB 31(2)) and amounts owing (under section DB 31(3)), provided the criteria in those subsections are met. For instance, one criteria is that deductions under section DB 31(3) can only be taken if the person carries on a business for the purpose of deriving assessable income that includes dealing in or holding financial arrangements that are the same as, or similar to, the financial arrangement.

As noted above, the amount of deductions that can be taken has not changed. This means, for example, that there is no change to the tax treatment of capitalised interest (interest which has been paid by being added to the original capital). This interest has always been, and continues to be, treated as being paid to the investor and reinvested. Cash basis and accruals taxpayers will have derived the interest for tax. They may be allowed a bad debt deduction under section DB 31(3) as a dealer or holder of financial arrangements for the amount if it becomes a bad debt.

For clarification, bad debt deductions can be claimed in the two situations, outlined under "Key features" above, by taxpayers who are on an accruals basis and those who are on a cash basis.

The law has been amended to allow deductions where certain BPA events occur (under section EW 29(10) and (11) but with certain limitations). The remaining BPA events have intentionally been excluded. This means that when a financial arrangement comes to an end due to one of the other BPA events in section EW 29, the write-off requirements in section DB 31(1)(a)(i) must be met before a bad debt deduction can be taken. The rationale for this is that when one of the other BPA events takes place, it is not necessarily clear that a debt is bad, so requiring that the debt be written off will ensure that bad debt deductions can only be taken where the debt is actually bad. Subparagraph DB 31(1)(a)(i) is previously what was paragraph DB 31(1)(a) before the law change. It should be noted that the requirements for writing off a bad debt have not changed under subsection (i) as a result of the restructured section.

Remissions of law

Remissions by law under section DB 31(1)(a)(ii) are when the debtor is released from making all remaining payments under the Insolvency Act 2006 (excluding Part 5, subparts 1 and 2 of that Act), or under the Companies Act 1993, or under the laws of a country or territory other than New Zealand. Remissions that take place under Part 5, subparts 1 and 2 of the Insolvency Act 2006 relate to compositions during bankruptcy and proposals. These are excluded from the new rules because creditors of individuals who enter into proposals or compositions during bankruptcy are considered to have sufficient notice of the upcoming bad debt and be sufficiently aware of the write-off rules. In comparison, compositions by debtor companies can affect a wider range of people (such as "mum and dad" investors in finance companies) who are less likely to have the knowledge to write off the debt as bad in time.

Compositions with creditors

Under section DB 31(1)(a)(iii), bad debt deductions can be taken when a debtor company enters into a composition with its creditors, and when the creditors are required to perform a BPA. This change does not extend to non-company debtors, and is consistent with the exclusions to bankruptcy as described under the "remissions of law" section above.

Example 1  

On 1 April 2010, Mr Smith invests $5,000 in a finance company for five years with $500 interest payable per year. He is a cash basis holder and does not carry on a business of dealing in or holding financial arrangements. The debt is repayable in full on 31 March 2015. Mr Smith receives interest payments for the first three years and returns those amounts as income on a cash basis. In September 2013 the finance company faces financial difficulty and Mr Smith does not receive any further funds from the company i.e., the $5,000 investment and interest of $1,000 for the last two years. The company is liquidated in November 2014. On liquidation of the finance company, Mr Smith must perform a base price adjustment (BPA). Assume that the interest from year 5 is owing in full at the time the BPA is performed.

Mr Smith's BPA will be:

BPA: Consideration - income + expenditure + amount remitted

= (1,500 - 5,000) - 1,500 + 0 + 6,000

= 1,000

The positive BPA result is treated as income of Mr Smith in the 2015 income year under sections EW 31(3) and CC 3.

Tax treatment under the previous rules

To ensure Mr Smith is taxed only on his economic income, he must have taken a bad debt deduction for the $1,000 before the liquidation process was complete. If he failed to do so, he would have had to pay tax on income which was not economically received.

Tax treatment under the new rules

Mr Smith will be able to take a bad debt deduction for $1,000 under section DB 31(2) (and allowed by section DB 31(1)(a)(ii)) in the year that the BPA is performed – the 2015 income year – even if the debt is not written off as bad.

Note that under both the previous and new rules, if the interest in years 1 to 3 had been compounded instead of being paid out to Mr Smith, for tax purposes this interest is treated as having been paid and reinvested.

This means that upon reinvestment the amount is treated as being part of the principal amount. If the entire debt (including this compounded interest) later goes bad, the ordinary tax rules will apply – that is, the investor would only be able to take a bad debt deduction for the compounded amount if they hold or deal in the same or similar financial arrangements, and the requirements of subsection DB 31(3) are met.

 

Example 2  

On 1 April 2010, Mrs Jones invests $10,000 in a finance company for five years with $800 interest payable per year. The debt is repayable in full on 31 March 2015. Mrs Jones is an accruals taxpayer and does not carry on a business of dealing in or holding financial arrangements. She receives an interest payment for the first year, but does not receive any interest repayments after that. As an accruals taxpayer she must return $800 interest per year irrespective of whether it is in fact received. In July 2014 the finance company faces financial difficulty and is liquidated in November 2014. Mrs Jones does not receive any further funds from the company. On liquidation of the finance company Mrs Jones must perform a base price adjustment (BPA). Assume that the interest from year 5 is owing in full at the time the BPA is performed.

Mrs Jones' BPA will be:

BPA: Consideration - income + expenditure + amount remitted

= (800 - 10,000) - 3,200 + 0 + 13,200

= 800

Note the 3,200 income figure represents income returned in earlier years 1 to 4, and the 13,200 amount remitted figure represents all amounts remitted ($10,000 + interest not received in years 2 to 5).

The positive BPA result is treated as income of Mrs Jones in the 2015 income year under sections EW 31(3) and CC 3. This amount represents the interest income from the final year and because it was not received a deduction should be allowed to offset the income. In addition, Mrs Jones returned accrual income in years 2, 3 and 4 that was never received and for which a deduction should be allowed.

Tax treatment under the previous rules

Under the previous rules, to ensure Mrs Jones is taxed only on her economic income, she must have taken a bad debt deduction for years 2, 3 and 4's accrual income only in the year in which they were written off, and she must have taken a bad debt deduction for the $800 BPA income before the liquidation process was complete. If she failed to do so, she would have had to ultimately pay tax on income which was not economically received.

Tax treatment under the new rules

Under the new rules, Mrs Jones will be able to take a bad debt deduction for $3,200 ($800 BPA income and $2,400 accrual income from earlier years returned but never received) under section DB 31(2). This deduction will be taken in the year that the BPA is performed (the 2015 income year) even if the debt is not written off as bad.

Note: If Mrs Jones carried on a business of dealing in or holding financial arrangements, under the new rules she could either take a bad debt deduction for the entire $13,200 under amended section DB 31(3), or $10,000 under section DB 31(3) and $3,200 under section DB 31(2).

Application date

The changes apply to the 2008-09 and later income years.

Bad debt deductions for holders of debt – base maintenance change

Sections CZ 27 and DB 31 of the Income Tax Act 2007

The law has been amended to align the tax rules with the policy settings for taking bad debt deductions, by limiting bad debt deductions that can be taken by dealers and holders of debt to the economic cost of the debt.

Background

Under the previous rules, taxpayers who dealt in or held the same or similar financial arrangements could theoretically take bad debt deductions for amounts owing even when they did not suffer an economic loss. This was not consistent with the policy intent.

For example, if a taxpayer purchased a debt at a discount, under the previous rules they may have been able to take a bad debt deduction for the full face value of the debt even though they only suffered an economic loss equal to the discounted purchase price. While the base price adjustment2 (BPA) would square up any excess deductions taken, the purchaser would still benefit from a timing advantage (and potentially a permanent advantage if a BPA was never performed). This timing advantage arose because the bad debt deduction for an amount greater than the purchase price could be taken well before income from the BPA is recognised, presenting a risk to the revenue base.

Key features

The tax rules have been amended so that when a creditor's business includes dealing in or holding the same or similar financial arrangements, they can only take bad debt deductions for their economic loss - that is, they can only take bad debt deductions for amounts owing up to the consideration they have provided and any income they have returned for tax purposes. This change is achieved by subsection DB 31(4B).

Two further amendments support this underlying change:

  • Limited recourse arrangements - When a taxpayer is party to a debt that a limited recourse arrangement relates to, they will only be able to take a bad debt deduction for the money at risk. This is an anti-avoidance measure to ensure that section DB 31(4B) cannot be circumvented by funding the acquisition of a financial arrangement by using a limited recourse arrangement.
  • Claw-back for prior bad debt deductions - New section CZ 27 is a claw-back rule that requires taxpayers who have taken bad debt deductions greater than their economic loss to return the excess deductions as income in their return for the 2014-15 year. This rule will ensure taxpayers are in the correct tax position, consistent with the policy intent. There is no concern for financial arrangements that have ended before the 2014-15 year, as the BPA would have been performed and squared-up any excess deductions taken.

Detailed analysis

The change that ensures bad debt deductions are limited to their economic cost is achieved by new subsection DB 31(4B).

Some submissions made at the select committee stage of the bill questioned if the correct economic result will be achieved under the new rules when the consideration paid for a debt is less than the face value. The policy intent is that a bad debt deduction should not exceed the economic cost of the debt to the taxpayer. However, it is recognised that the operation of the BPA for the debt may result in assessable income for taxpayers for which a deduction is required. The policy intent is that under the amended legislation, bad debt deductions for these income amounts are taken under subsection DB 31(2), and bad debt deductions for other amounts not received are taken under subsection DB 31(3) (limited by subsection DB 31(4B), to the consideration paid for acquiring the debt). This is illustrated by the example below:

Example 1 Application of section DB 31(3) and (4B)

A debt with a face value of $5m is acquired for $1m by Company G who is a dealer in the same or similar financial arrangements. Company G does not receive any income from the debtor and the entire $5m debt is eventually remitted by law. Company G has suffered an economic loss of $1m.

On remission, Company G performs a BPA as follows:

BPA: consideration - income + expenditure + amount remitted

= (0 - $1m) - $0 + $0 + $5m

= $4m income

Under the new rules, bad debt deductions are intended to be taken as follows:

  • $1m under subsection DB 31(3) (limited by section DB 31(4B)) – being a deduction for the amount not received by a dealer in financial arrangements, but limited to the consideration paid for acquiring the debt; and
  • $4m under subsection DB 31(2) – being a deduction for an income amount (the BPA income) not received.

Limited recourse arrangements – an anti-avoidance measure

New subsections DB 31(4C)-(4E) are provisions that are intended to ensure dealers and holders can only take bad debt deductions for the money at risk.

The definition of "limited recourse arrangement" is contained in subsection DB 31(5B) and is intended to capture arrangements that are used to fund the underlying financial arrangement (for which a bad debt deduction is being sought). To illustrate, an example of a limited recourse arrangement is set out below:

Example 2 Limited recourse arrangement

Co B (a holder of the same or similar financial arrangements) lends money to Co A. Under this debt arrangement, Co B lends Co A $1,000 repayable in 5 years with $100 interest payable per year. Co B only funds $200 of the amount lent and borrows the remaining $800 from Co C. Under the arrangement with Co C, Co B is only required to repay the $800 and interest to Co C to the extent that Co A pays these amounts to Co B.

Amounts received from Co A will be split on a proportional 80:20 basis (Co C:Co B). Assume Co B is an accruals-basis taxpayer.

Bad debt deductions for holders of debt

Read the long description for this image

In the absence of rules for limited recourse arrangements, if Co A failed to repay the $1,000 to Co B, even with new subsection DB 31(4B), it would be possible for Co B to take a bad debt deduction for the full $1,000 even though it has only suffered an economic loss of $200. The new limited recourse arrangement rules are intended to ensure that prior to the BPA for the limited recourse arrangement Co B can only take a bad debt deduction up to $200 (under section DB 31(4C)). If Co B was able to take a deduction for more than $200, it would receive an unintended advantage.

Limited recourse arrangements may take a variety of forms and the drafting is intentionally broad to capture a wide range of possible arrangements.

Subsection DB 31(4C) is intended to ensure that, prior to the BPA of the limited recourse arrangement, dealers and holders of the same/similar financial arrangements can only take bad debt deductions under section DB 31(3) for the money at risk. Subsections DB 31(4D) and (4E) are intended to ensure that when a BPA for the limited recourse arrangement is performed, dealers and holders of the same/similar financial arrangements are allowed a deduction for amounts owing under the debt for which deductions have not been taken under subsections DB 31(2) or (3).3

Example 3 All interest received when due, $80 received during the liquidation of Co A, accruals-basis taxpayer

In example 2, assume that Co A paid Co B all interest amounts when they fell due. Co A was put into liquidation and only $80 of the remaining $1,000 repayable was received during the liquidation of Co A. On a proportional 80:20 basis (Co C:Co B) Co B uses the amounts received from Co A to pay Co C under the limited recourse arrangement. This means Co C receives a total of $400 from interest payments, and Co B retains the remaining $100. Co C also receives $64 of the other $80 received, and Co B retains the remaining $16. In this case Co B has suffered a cash loss of $84 from both arrangements overall. It is assumed that the BPAs for both arrangements take place in the same year.

Debt

From Co B's perspective, the cashflow under the debt is a loss of $420 ($580 received - $1,000 lent). Co B's overall tax position should reflect this.

The BPA for the debt (between Co A and Co B) is:

BPA: Consideration - income + expenditure + amount remitted

= (580 - 1,000) - 400 + 0 + 920

= 100

Tax position:

The BPA performed under the debt arrangement will result in $100 of income for Co B. This amount represents interest received in the last year.

Co B was required to return $400 interest income received from Co A in years 1 to 4.

To align the tax position with the cashflow position (the loss of $420), a deduction of $920 is required.

In this example it is assumed that deductions were not taken under section DB 31(3) (limited by section DB 31(4C)) in a year prior to the BPA being performed. However, a deduction can be taken under subsection DB 31(3) (limited by subsection DB 31(4C)) for $120 in the year of the BPA. This is calculated as $920 (being the amount owing) - $800 (being the consideration paid to Co B under the limited recourse arrangement).

The law, as enacted, allows a deduction to be taken under section DB 31(4D) for $336 when the BPA for the limited recourse arrangement is performed. This is calculated as consideration paid to Co B under the limited recourse arrangement (800) - consideration paid by Co B under the limited recourse arrangement (400 interest + 64 other amounts). This is not the intended policy result.4

Limited recourse arrangement

From Co B's perspective, the cashflow under the limited recourse arrangement is a gain of $336 ($800 received - $464 paid). Co B's overall tax position should reflect this.

The BPA for the limited recourse arrangement (between Co B and Co C) is:

BPA: Consideration - income + expenditure + amount remitted

= (800 - 464) - 0 + 320 + 0

= 656

Tax position:

The BPA performed under the limited recourse arrangement will result in $656 of income for Co B.

Deductions of $320 for interest paid to Co A in prior years would be allowed under section DB 7 ($80 each year for years 1 to 4).

This gives the correct tax result for Co B under the limited recourse arrangement as the tax position ($656 income - $320 deductions) aligns with the cashflow ($336 gain).

We note that section BD 4(5) allocates deductions to income years so their total does not exceed the amount of the expenditure or loss.

 

Example 4 No interest received when due, $80 received during the liquidation of Co A, accruals-basis taxpayer

This example further illustrates the intended application of the new rules including new section DB 31(4D).

In example 2, assume that Co A did not pay Co B any of the interest amounts when they fell due. Also assume that Co A was put into liquidation and Co B received $80 during the liquidation of Co A. On a proportional 80:20 basis (Co C:Co B) Co B uses the amount received from Co A to pay Co C under the limited recourse arrangement. In this case Co B has suffered a cash loss of $184 from both arrangements overall. It is assumed that the BPAs for both instruments take place in the same year.

Debt

From Co B's perspective, the cashflow under the debt is a loss of $920 ($80 received - $1,000 lent). Co B's overall tax position should reflect this.

The BPA for the debt (between Co A and Co B) is:

BPA: Consideration - income + expenditure + amount remitted

= (80 - 1,000) - 400 + 0 + 1,420

= 100

Tax position:

The BPA performed under the debt arrangement will result in $100 of income for Co B. This amount represents interest income not received in year 5 and a deduction can be taken under subsection DB 31(2).

Co B was required to return $400 interest income for interest payable by Co A in previous years. The $80 that was received during the liquidation of Co A is attributed to the earliest amount of unpaid interest (in year 1). A deduction for the interest amounts that were returned but not received in years 1 to 4 (that is, $320) can be taken under subsection DB 31(2).

To align the tax position with the cashflow position (the loss of $920), a further deduction of $1,000 is required.

In this example it is assumed that deductions were not taken under section DB 31(3) (limited by section DB 31(4C)) in a year prior to the BPA being performed. However, a deduction can be taken under section DB 31(3) (limited by section DB 31(4C)) for $620 in the year of the BPA. This is calculated as $1,420 (being the amount owing) – $800 (being the consideration paid to Co B under the limited recourse arrangement).

The law, as enacted, allows a deduction to be taken under section DB 31(4D) for $736 when the BPA for the limited recourse arrangement is performed. This is calculated as $800 (being the consideration paid to Co B under the limited recourse arrangement) – $64 (being the consideration paid by Co B under the limited recourse arrangement). As covered in footnote 7, this is not the intended policy result.5

Limited recourse arrangement

From Co B's perspective, the cashflow under the limited recourse arrangement is a gain of $736 ($800 received – $64 paid). Co B's overall tax position should reflect this.

The BPA for the limited recourse arrangement (between Co B and Co C) is:

BPA: Consideration - income + expenditure + amount remitted

= (800 - 64) - 0 + 320 + 0

= 1,056

Tax position:

The BPA performed under the limited recourse arrangement will result in $1,056 of income for Co B.

Deductions of $320 for interest paid to Co A in prior years would be allowed under section DB 7 ($80 each year for years 1 to 4).

This gives the correct tax result for Co B under the limited recourse arrangement as the tax position ($1,056 income - $320 deductions) aligns with the cashflow ($736 gain).

We note that section BD 4(5) allocates deductions to income years so their total does not exceed the amount of the expenditure or loss.

Claw-back for prior bad debt deductions

The new rules have been introduced to align the law with the policy intent. It was never intended that bad debt deductions be taken for more than the economic loss. New section CZ 27 has therefore been introduced to rectify this by clawing back any excess bad debt deductions taken in prior years.

The rules apply to a taxpayer who has taken an excess bad debt deduction before 20 May 2013. An excess bad debt deduction is one that would not have been allowed under new subsections DB 31(4B), (4C) and (5B). If a taxpayer took an excess bad debt deduction under a financial arrangement before 20 May 2013, and if that financial arrangement is still in existence in the 2014-15 income year, the taxpayer is treated as receiving an amount of income equal to the amount of the excess bad debt deduction.

The claw-back rule in section CZ 27 only applies if a BPA has not already been calculated in the 2014-15 or earlier income year. This is because the BPA will have captured excess deductions, and result in an income amount for the taxpayer.

There is a "savings" provision for taxpayers who, on 20 May 2013, were already involved in the disputes process in relation to the prior bad debt deduction. For these taxpayers, section CZ 27 will not apply.

Application dates

The changes apply from 20 May 2013, the date of introduction of the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill.

The claw-back rule requires taxpayers who have taken excess deductions to return those amounts as income in the 2014-15 year. The effect of this rule is that it is retrospective for financial arrangements that are in existence in the 2014-15 year, subject to a "savings" provision for taxpayers who are involved in assessments that are subject to the tax disputes process.

Child support

Sections 2, 9, 12, 19A, 38, 39, 40, 43, 46, 52, 53, 62, 63 and schedule 3 of the Child Support Amendment Act 2013

Sections 3A, 276 and schedule 1 of the Child Support Act 1991

The Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act 2014 makes technical changes to child support and also inserts provisions to delay most changes made by the Child Support Amendment Act 2013. There are also some consequential amendments to the Child Support Act 1991.

Key features

The relevant provisions change the date at which most provisions in the Child Support Amendment Act 2013 come into force. They also make consequential amendments to the Child Support Act 1991. In particular, some provisions originally intended to come into force on 1 April 2014 will now come into force on 1 April 2015 and some changes originally intended to come into force on 1 April 2015 will now come into force on 1 April 2016. The consequential amendments to the Child Support Act 1991 are to various transitional provisions that were inserted by the Child Support Amendment Act 2013 with effect from 17 April 2013.

The other specific change to the Child Support Amendment Act 2013 is the insertion of section 19A which amends section 89F(1)(a)(i) of the Child Support Act and clarifies that a paying parent who is a hospital patient is exempt from paying child support even if they are in receipt of income from investments earned before their hospitalisation. This approach is consistent with allowing a paying parent to take care of their needs for the period they are in hospital. This amendment, and a similar amendment to the exemption for prisoners, continues to come into force from 1 April 2014.

Application dates

Part 1 of the Child Support Amendment Act 2013 applies from 1 April 2015. Part 2 applies from 1 April 2016.

1A wash-up calculation that is performed when the financial arrangement comes to an end.

2 A wash-up calculation performed when the financial arrangement comes to an end; shortened to "BPA".

3 As currently drafted, the application of subsections DB 31(4C)-(4E) may not give the intended result and legislative amendments are expected to be made in a later tax bill. Amendments may need to be made so that dealers and holders of the same or similar financial arrangements are allowed a deduction for amounts owing under the debt in the year the BPA for the limited recourse arrangement is performed, other than amounts for which deductions have been taken under subsections DB 31(2) or (3). The application date of any amendment is likely to be 20 May 2013 (the same application date for the other base maintenance changes).

4If the law is amended as outlined in footnote 3, it is anticipated that in the year the BPA for the limited recourse arrangement is performed, Co B should be allowed to take a deduction for amounts owing under the debt other than amounts for which deductions have not been taken under subsections DB 31(2) or (3).
Total amounts owing under the debt - section DB 31(2) deductions - section DB 31(3) deductions
= 920 - 0 - 120
= 800

5 If the law is amended as proposed in footnote 3, it is expected that at the time the BPA of the limited recourse arrangement is performed, Co B should be allowed to take a deduction for amounts owing under the debt other than amounts for which deductions have not been taken under subsections DB 31(2) or (3).
Total amounts owing under the debt - section DB 31(2) deductions - section DB 31(3) deductions
= 1,420 - 500 - 620
= 300