27 September 2012
Dunne: Govt tightens financial arrangements rules
Revenue Minister Peter Dunne said today that the Government will move swiftly to tighten the rules relating to financial arrangements.
Mr Dunne said the current rules have a loophole that can allow an unfair tax deduction for what are, in real terms, capital amounts.
“The rules allow taxpayers to elect to treat short-term agreements for the sale and purchase of property or services as financial arrangements to minimise compliance costs,” he said.
“However, an unintended consequence has come to light, meaning it is possible to claim a deduction for either the cost of acquiring agreements or any losses on disposal of those agreements by electing financial arrangement treatment.
“It was never the intention of the rules to allow a deduction in this fashion for what is a capital amount,” Mr Dunne said.
The amendment will apply retrospectively from the beginning of the 2008/09 income year, being the date that the current Income Tax Act came into force.
He said that the legislation will be retrospective because of the length of time some financial arrangements can cover and to prevent exploitation of the loophole over the remaining term of an arrangement.
A savings provision will be available for taxpayers who have filed a tax return making an election and taxpayers who have obtained a binding ruling (including a determination) on the tax treatment of financial arrangements under the election rule, before the date of this announcement.
Mr Dunne said it was important for the Government to address this issue.
“Failing to act will leave our tax system vulnerable. At a time when the Government is seeking to reduce national debt, it is more important than ever that we all pay our fair share of tax,” he said.
The amendment will be included in the next available tax bill.
A draft of the proposed legislation is available on Inland Revenue’s tax policy website at www.taxpolicy.ird.govt.nz
Mark Stewart | Press Secretary | Office of Hon Peter Dunne
Cell +64 21 243 6985
Questions and Answers
What will change?
An amendment will be made to the treatment of short-term agreements for the sale and purchase of property or services under the financial arrangements rules.
Where a vendor or purchaser of a short-term agreement for sale and purchase elects to treat the agreement as a financial arrangement, the amount of consideration that will be taken into account for the purposes of spreading or undertaking a base price adjustment will be limited to debts outstanding under the agreement. This will mean that the taxpayer will not be able to claim a deduction under the financial arrangements rules for either the cost of acquiring the agreement or any losses on disposal of the agreement.
Why is the change being made?
The current rules allow taxpayers to take advantage of a loophole in the law to obtain a tax deduction for what are in-substance capital amounts. This is because taxpayers can elect to treat a short-term agreement for the sale and purchase of property or services (ordinarily, an excepted financial arrangement) as a financial arrangement.
The result is that it is possible to claim a deduction for either the cost of acquiring such an agreement or any loss on disposal of an agreement by electing financial arrangement treatment. This was never the intention of the rules which were aimed at reducing compliance costs by allowing any short term debt under the agreement to be treated for tax purposes as it is for accounting purposes. The agreement itself should be on capital account.
An example will help to illustrate the problem:
A company acquires the assets of another company, which includes profitable contracts for the provision of certain services. The purchase price for the contracts is $5 million. Electing that the service contracts be financial arrangements and then applying the financial arrangements rules, a tax deduction of $5 million is available to the purchaser over the life of the contracts, resulting in tax savings of $1.4 million. If the contracts were treated as excepted financial arrangements (as conceptually they should be) the general deductibility rules would treat the amounts as capital (non-deductible) expenditure, just as the income to the vendor would be capital and therefore non-assessable.
Does the amendment have a fiscal impact?
The amendment will not count fiscally as it is largely a preventative measure. However, officials consider there could be a significant revenue cost if no amendment were made.
There will be a savings provision for taxpayers who have taken a position on the basis of treating a short-term agreement for the sale and purchase of services as a financial arrangement before the date that the change is announced.
When will the change apply?
The amendment applies from the start of the 2008-09 income year (which aligns with the date that the current Income Tax Act came into force).
However, there is a saving provision for taxpayers who have filed a tax return making an election and taxpayers who have obtained a binding ruling (including a determination) on the tax treatment of financial arrangements under the election rule, before the date of Ministerial announcement.
Why is it necessary for the amendment to apply from a date that is before the announcement of the Government’s decision to amend the law?
There is a high hurdle for tax legislation to be applied retrospectively.
In this particular case, the Government is concerned about the possibility that past transactions might be post-facto re-characterised with a potentially significant fiscal effect. This is because of the length of time that some financial arrangements can cover and to prevent exploitation of that loophole over the remaining term of an arrangement.