General matters
Clauses 9, 45B, 48, 61, 81, 84, 85, 98, 186B, 187, 519 and 524
Issue: Support for amendments
Submission
(68 – Corporate Taxpayers Group)
Corporate Taxpayers Group is generally supportive of the proposed legislative changes.
Recommendation
That the submission be noted.
Issue: The ETS tax provisions should be put on hold
Submission
(62 – Minter Ellison Rudd Watts)
Given the review of the ETS by the Emissions Trading Scheme Review Select Committee, it may be preferable for the ETS tax provisions to be put on hold until the outcome of that review is known.
Comment
There are arguments both in favour of and against this submission. The principal supporting argument is that if an ETS is not proceeded with, this legislation will be unnecessary, and that if a substantially amended ETS is proceeded with, the legislation may require further amendment.
The main argument against the submission is that there is a likelihood that an ETS will be proceeded with. If it is, much of what is in the legislation is general in nature, and will continue to apply to whatever form the ETS takes. Accordingly, proceeding with the legislation in its current form gives taxpayers some degree of certainty, which is especially important in light of the next sector entry date under the current ETS of 1 January 2010. Any amendments which become necessary at a later stage can be made by subsequent legislation.
Also, it should be noted that the forestry part of the ETS already applies.
Recommendation
That the submission be declined.
Issue: Sale of free units which relate to a future year
Submission
(68A – Corporate Taxpayers Group)
If a non-forestry taxpayer sells free units in the current income year but those units relate to an emissions liability in a future year, the tax liability should be recognised in that future year, not the current year as the bill now provides.
Comment
The general objective in the tax treatment of emissions unit transactions is to have standard principles apply wherever possible, and provide specific rules only when the application of standard principles is unclear or gives an inappropriate result.
The application of standard accrual accounting principles to the receipt of free units would, in all probability, require the income to be recognised either on an accruals basis when the entitlement to receive those units is known, or possibly at a later date when those units are actually received. The tax rules proposed in this bill recognise that the concept underlying the receipt of those units is to compensate for increased costs or emissions liabilities in the future, and so defer the recognition of income until those costs accrue.
There is an exception to this rule when units are sold and the value of the units has not yet been recognised as described above – then, the income from their sale is recognised. As noted above, officials expect that for financial reporting purposes all of the income would be recognised at the point of sale. If, as accounting standards are developed, this turns out not to be the case, officials will revisit this issue.
We do not agree with the submission that the recognition of this income should be deferred to a later year. Following sale of the units, the taxpayer has converted a near-cash asset into a cash asset, and it is entirely appropriate to recognise that income in the year in which it arises.
Recommendation
That the submission be declined.
Issue: Reference to issue of free units
Submission
(Matter raised by officials)
The tax provisions should be amended to be consistent with the process set out in the Climate Change Response Act 2002.
Comment
A number of provisions use the expression “issue” to refer to the process by which a business receives a free allocation of units from government. However, the Climate Change Response Act 2002 describes the process as a “transfer” of emissions units. To avoid any confusion, the terminology used in tax provisions should be consistent with the Climate Change Response Act 2002.
Recommendation
That the submission be accepted.
Issue: Relationship between sections CX 51B and ED 1B is unclear
Submission
(62 – Minter Ellison Rudd Watts)
Section CX 51B should be amended to make it clear that income which arises under the valuation rules in section ED 1B is not excluded income.
Comment
Section CX 51B provides that any income which arises from the receipt of free emissions units is excluded income. Section ED 1B establishes rules for the timing of recognition of income in relation to these free units (essentially, as the costs for which that free allocation is intended to compensate arises). The intention is that these two provisions work together to ensure that no income arises when the units are first issued, but income is recognised later, on an appropriate accrual basis.
Following consideration, we recommend this issue be addressed by deleting section CX 51B and achieving the desired effect of no income arising on the issue of units by inserting a valuation rule which will initially value free units at nil.
Recommendation
That the submission be accepted, as described above.
Issue: Revenue account treatment of free units
Submission
(68A – Corporate Taxpayers Group)
If, in the future, units are allocated on the basis of the diminution of the value of the taxpayer’s assets, those emissions units should be treated as being received on capital account.
Comment
The bill treats all allocations of emissions units as being on revenue account except for allocations made to pre-1990 foresters. This is on the basis that allocations other than those made to pre-1990 foresters are made to compensate businesses for either their emissions liabilities, or the cost increases they face as a result of the introduction of the ETS (such as increased power prices).
As noted, there is an exception for pre-1990 foresters. The allocation of units to foresters is to compensate for the fall in value of their land, rather than their potential emissions unit liability. Pre-1990 forestry is unusual in that allocations of units are made to businesses which only suffer an impact on the asset value, and cost increases only in relation to a capital transaction (deforestation is a fundamental change in the nature of the business and so would be on capital account under ordinary principles). Accordingly, this allocation of units is appropriately treated as being on capital account. This capital treatment extends to the purchase of further emissions units to satisfy a liability to surrender.
If emission units are in the future allocated by reference to the impact of the ETS on asset values, then capital treatment should be considered. However, in most instances, allocation of units will be to businesses which suffer cost increases – for example, a business which owns an industrial plant which emits CO2 and so gives rise to an emissions liability when surrendered. Cost increases will be on revenue account, and so treating the allocation of units as being on revenue account is appropriate.
Recommendation
That the submission be noted for future consideration if the government does issue units for dimunition of asset values.
Issue: Cost of emissions units valued under section ED 1B(3)(a)
Submission
(35 – PricewaterhouseCoopers)
The definition of “cost” should be modified to include the cost of emissions units valued under section ED 1B(3)(a).
Comment
Section ED 1B(3)(a) states that the cost of emissions units which are recognised as having accrued to the business is their market value at the end of the year. This feeds into section CB 36 correctly. However, “cost” is defined in section YA 1 without any cross-reference to the cost concepts in section ED 1B.
We agree this is potentially confusing. We propose that section ED 1B should instead define “value” for certain emissions units, and that section CB 36 and other sections where this issue arises refer to cost or value, for those emissions units for which a value is prescribed.
Recommendation
That the submission be accepted, with the issue being addressed as described above.
Issue: Surrender of emissions units valued under section ED 1B(3)(b)
Submission
(35 – PricewaterhouseCoopers)
The surrender of a unit which is given a zero cost by section ED 1B(3)(b) will not give rise to any income. An amendment should be made to ensure that income does arise.
Comment
Section ED 1B(3)(b) provides that a unit which has been transferred by government to compensate for an emissions liability or increased cost which has not yet arisen has a market value of nil. As the submission points out, the current drafting of section CB 36 means that if such a unit was surrendered, its receipt would never be taxable.
We agree that such a unit should be deemed to be disposed of for its market value when surrendered, and recommend that proposed section CB 36 be amended. We note that the same problem arises with section ED 1B(2)(a), which also values emissions units at zero.
Recommendation
That the submission be accepted.
Issue: Year-end valuation for free units
Submission
(68A – Corporate Taxpayers Group)
Free units should be brought into account at an average value, rather than the emissions year-end value, to avoid any price spikes.
Comment
Free units received by non-forestry taxpayers are brought into account at the end of the year at which the relevant increased costs or emissions liability accrues. The value brought into account is the market value at the end of the relevant income year.
Because the market value used is the market value at the end of the income year, which will vary amongst different taxpayers, we do not think price spikes are as likely as the submission suggests. If any price spikes do occur, they are likely to be around the time emitters are required to surrender units to the government, which is not aligned to any income year (or the emissions year). The ability of New Zealand businesses to surrender emissions units purchased on the international markets, as well as New Zealand units should mean that price spikes do not arise – it is unlikely that the New Zealand surrender timetable will have any effect on international markets.
Accordingly, we think the methodology currently proposed is robust.
Recommendation
That the submission be declined.
Issue: Operation of section ED 1B
Submission
(62 – Minter Ellison Rudd Watts)
Section ED 1B is complex and there are a number of concerns with it. These include:
- confusion between the valuation of a single emissions unit and the valuation of a pool of emissions units;
- the definitions in the formula are circular and contain reference to some terms which are not defined; and
- the formula gives a negative result if some emissions have already been sold, which should not be the case.
Comment
Officials agree that this provision is complex. In relation to the specific matters raised:
- We agree that there is one instance in which a singular concept is used rather than a plural one, and agree that this should be amended.
- We agree that one expression is not defined, and this should be corrected.
- We agree that the formula can produce a negative result when more units have been sold than need to be recognised as income, but disagree that this is the wrong outcome. The words preceding the formula state that any negative number is to be treated as zero. A zero result simply means that a sufficient number of units have already been brought into the income calculation by virtue of being sold, and no further units are required to be recognised at that time.
Recommendation
That the submission be accepted in part.
Issue: Valuation of excess units held
Submission
(68A – Corporate Taxpayers Group)
Taxpayers who hold units at year-end which have fallen in value since acquisition, should be able to value those units at the lower of cost or market value.
Comment
The valuation methodology currently provided for emission units which have been purchased is the cost basis.
An alternative approach would have been to value these units at market value, which would allow taxpayers to take losses when values fall, but recognise increases when values rise (financial arrangements model). Because the majority of taxpayers will hold units for compliance purposes rather than speculative purposes, the decision was taken following consultation that for simplicity and compliance-cost purposes, a cost basis method of valuation should be used.
We note that the submission requests that cost be written down to a lower market value, but there is no suggestion that if market value increases above cost, the increase be recognised as income.
Recommendation
That the submission be declined.
Issue: Surrender of a post-1989 forest land unit to meet a pre-1990 forest liability
Submission
(35 – PricewaterhouseCoopers)
Income ought to arise when a post-1989 forest land unit is surrendered to meet a pre-1990 forest liability.
Comment
Post-1989 forestry is generally on revenue account, and pre-1990 forestry is generally on capital account. Forestry is also taxed on a cash basis. Units received in relation to post-1989 forestry give rise to a tax liability when they are sold.
The current provisions would result in no income arising if post-1989 units were surrendered to meet a pre-1990 forestry liability. The same issue will arise if post-1989 units are surrendered for any other liability.
This is inconsistent with the treatment of their sale, and we agree that amendment is required.
Recommendation
That the submission be accepted, and the amendment apply to the surrender of a post-1989 forest land unit in relation to any emissions liability which is not a post-1989 forest liability.
Issue: Incorrect reference to “deforestation” in section CB 36(4)
Submission
(Matter raised by officials)
This subsection refers to the liability to surrender emissions units on the “deforestation” of post-1989 forest land, but in fact the liability arises on harvest, fire, wind-throw or other carbon loss. A more general expression should be substituted.
Recommendation
That the submission be accepted.
Issue: Interest deductibility should be available for companies that derive exempt ETS income
Submission
(35 – PricewaterhouseCoopers)
The general provisions dealing with interest deductibility should be amended to include companies that derive exempt income from the disposal of pre-1990 forest land units.
Comment
This issue arises because the sale of pre-1990 forestry units is treated by the proposed legislation as giving rise to exempt income – consistent with the general treatment of post-1990 forestry as being on capital account. Under existing general provisions, most companies are entitled to a deduction for interest paid regardless of the nature of their business or the underlying purpose of the borrowing. However, when a company derives exempt income, the interest deduction is available only when the exempt income falls into one of three specified categories. The disposal of pre-1990 forest land units is not one of those specified categories.
However, adding pre-1990 forestry to the specified categories for exempt income would not deal with the position of sole traders, who would still be denied a deduction for interest.
We think the best way to resolve this issue is to instead treat the sale of emission units awarded in relation to pre-1990 forestry as giving rise to excluded, rather than exempt, income. There is no restriction on the deduction of interest expenditure by taxpayers that earn excluded income.
Recommendation
That the submission be accepted.
Issue: Deduction in relation to forest emissions liabilities
Submission
(35 – PricewaterhouseCoopers)
The legislation should be amended to make it clear that taxpayers cannot claim a deduction for accrued emissions liabilities related to forests.
Comment
The intention of the legislation is that emissions transactions for foresters are dealt with on a cash basis, consistent with other forestry income and expenditure. Deductions should accrue to post-1989 foresters and pre-1990 foresters who hold the land on revenue account when they acquire replacement units or surrender units (or are implicitly given by the non-recognition of income from the award of free units).
Deductions should not be recognised on an accrual basis in the way they are in the non-forestry sector, and we agree that there is value in making this clear in the legislation.
Recommendation
That the submission be accepted.
Issue: Use of expression “paragraphs” may be confusing
Submission
(Matter raised by officials)
The expression “paragraphs” in section ED 1(5B) should be clarified.
Comment
Section ED 1(5B) divides emissions units into different pools for valuation purposes. It states that emissions units may not be pooled with emissions units described in another paragraph. These paragraphs contain sub-paragraphs. There is a risk that some readers will not appreciate the difference between paragraphs and sub-paragraphs, and find the section confusing.
Recommendation
That the submission be accepted.
Issue: Eligibility for a deduction for emissions liability accruals should be set out in statute
Submission
(62 – Minter Ellison Rudd Watts)
Officials have stated that a deduction for accruing liabilities will be available under existing law. However, it is not clear that this is the case, and the legislation should be amended to expressly provide for this deduction.
Comment
The submission correctly states that a deduction cannot be claimed for a provision, only for a liability which has economically accrued at balance date.
In our view it is clear that a properly calculated amount for an emissions liability at the end of an income year is deductible, even when the requirement to surrender the relevant emissions units arises in a subsequent year. The liability arises under statute, and it is certain that it will arise. In CIR v Mitsubishi Motors Limited, the Privy Council upheld the taxpayer’s claim to deduct a provision for warranty defects, on the basis that the cars had already been sold with the latent warranty defects in them, and noted that at balance date those defects were an existing fact and not a future contingency.
Recommendation
That the submission be declined.
Issue: Method for calculating emissions liability accruals should be set out in legislation
Submission
(35 – PricewaterhouseCoopers)
Officials have explained that the accrual calculation for an emissions liability for a non-forestry user will be calculated by reference to the cost of units on hand, the market value of units which have been awarded by government, and a reasonable estimate of the cost of units to be acquired post-balance date. This approach is a reasonable one but it is not set out anywhere in legislation, as it should be.
Comment
The method for valuing the accrued liabilities is in accordance with our understanding of standard accounting and tax practice. Our view is that further explicit guidance is unnecessary.
Recommendation
That the submission be declined.
Issue: Identifying the cost of units held in excess of accrued liabilities
Submission
(35 – PricewaterhouseCoopers)
The legislation should prescribe the valuation method to be applied when units are acquired in excess of those required to satisfy accrued liabilities.
Comment
The legislation provides that emissions units are to be valued using either first-in first-out or the weighted average cost method. Provided one of these methods is used in a consistent way across the taxpayer’s entire stock of emissions units, we do not see that any problem should arise.
Recommendation
That the submission be declined.
Issue: Application of anti-avoidance provisions
Submission
(62 – Minter Ellison Rudd Watts)
Section GC 4B should be clarified to ensure that it is not applied when a market value is difficult to ascertain, or when fixed-price forward contracts are entered into by unrelated parties.
Comment
The proposed legislation defines emissions units as trading stock. This means that section GC 4B is no longer required, and the standard trading stock rule, section GC 1, can apply.
Officials do not have any concerns around units having a value which is difficult to ascertain. It is likely that the New Zealand market will develop sufficiently for prices to be readily ascertainable. If it does not, then units which are internationally recognised will have readily ascertainable prices on world markets. New Zealand units can be valued by reference to equivalent Kyoto units. In any event, a price which is reached between unrelated parties and in the absence of any other circumstances influencing price will, by definition, be a market value.
We also do not have any concerns around the use of forward contracts. If this was an issue, it would already be a known concern for forward contracts for shares, which are also trading stock for some taxpayers.
Recommendation
That the submission be declined.
Issue: “Replacement forest land emissions unit” definition – application to surrender
Submission
(Matter raised by officials)
The definition should be amended to make it clear that it does not apply when post-1989 forest land emissions units are disposed of by surrender.
Comment
The purpose of the definition of replacement forest land emissions is to allow an immediate deduction where emissions units are purchased to replace post-1989 forestry units previously sold. The definition should not apply where units are purchased following the surrender of post-1989 forestry units, as it presently does.
Recommendation
That the submission be accepted.
Issue: “Replacement forest land emissions unit” definition – application to certain pre-1990 forest land transactions
Submission
(35 – PricewaterhouseCoopers)
The “replacement forest land emissions unit” definition should be extended to apply when pre-1990 forest land is held on revenue account.
Comment
The definition of “replacement forest land emissions unit” is part of the mechanism which ensures that a person who sells a post-1989 forest land unit (which will be taxable) and then purchases a replacement unit is entitled to a deduction for that subsequent purchase. This is consistent with the cash-basis treatment of forestry.
While pre-1990 forestry land is generally considered to be on capital account, the legislation acknowledges that some pre-1990 forestry land could be on revenue account (such as when it is held by a land developer).
The drafting in the bill presently ensures that a deduction will be available when the deforestation liability for pre-1990 land held on revenue account is met. No deduction is available when units which replace those previously sold are acquired.
While this treatment differs from the cash basis treatment provided to post-1989 foresters, we think that this difference is appropriate as someone who holds pre-1990 forest land on revenue account is holding it for a non-forestry purpose, and so ought not to be entitled to use the cash basis.
Recommendation
That the submission be declined.
Issue: Operation of “replacement forest land emissions unit” definition
Submission
(62 – Minter Ellison Rudd Watts)
The definition appears to allow a deduction to be available for a replacement forest land emissions unit only once all other units disposed of by the taxpayer have been replaced. It should be amended.
Comment
The definition is certainly not intended to have the meaning suggested by this submission. However, it does include some wording which may cause confusion and is probably unnecessary, so we agree that it should be amended.
Recommendation
That the submission be accepted.
Issue: Certain definitions should be simplified
Submission
(62 – Minter Ellison Rudd Watts, matter raised by officials)
Certain definitions are complex in their construction and should be replaced with simpler cross-references to the Climate Change Response Act 2002.
Comment
The bill was introduced in July 2008 before enactment of the recent amendments to the Climate Change Response Act 2002 in September 2008. Because a bill cannot refer to another bill (as its enactment is uncertain), certain definitions had to be constructed in a way which did not refer to the proposed amendments to the Climate Change Response Act 2002, so are more complicated than now required.
Recommendation
That the submission be accepted.
Issue: Forestry income tax provisions introduced by the Emissions Trading Act
Submission
(Matter raised by officials)
The amendments made by the Emissions Trading Act to the Income Tax Act 2007 are superseded by the amendments in the current bill, and should be repealed.
Comment
The Emissions Trading Act made amendments to the Income Tax Act 2004 and the Income Tax Act 2007 dealing with the application of the ETS to the forestry sector.
The provisions in the 2007 Act will be superseded by the provisions in the current bill, so those existing 2007 Act provisions should be repealed. This bill does not amend the 2004 Act, so those provisions ought to remain.
Recommendation
That the submission be accepted.