Financial arrangements – agreements for the sale and purchase of property or services in foreign currency
Issue: Support for proposed changes
Clauses 60 to 67, 82 and 123
Submissions
(Deloitte, New Zealand Institute of Chartered Accountants, New Zealand Law Society, Corporate Taxpayers Group)
The submitters support changes to simplify the spreading methods used by taxpayers for the agreements. They particularly note the appropriateness of the changes for IFRS taxpayers while also noting that some further improvements could be included for non-IFRS taxpayers. The latter submissions are discussed below.
Recommendation
That the submissions be noted.
Issue: Lowest price clauses and interest explicitly included in agreements for non-IFRS taxpayers
Clauses 65 and 123
Submissions
(Deloitte, New Zealand Institute of Chartered Accountants, New Zealand Law Society, Corporate Taxpayers Group)
The elimination for tax of the lowest price clause mechanism to value the property or services in agreements and thereby not implicitly agree the amount of interest (if any) is not appropriate for non-IFRS taxpayers.
The imputation of interest into “12-month ASAPs” is also inappropriate when non-IFRS parties have not explicitly agreed interest.
Comment
The current rules for agreements for sale and purchase of property or services (ASAPs) is to value them at the lowest price the parties would have agreed, on the date the agreement was entered into, if payment had been required in full at the time the first right in the property was transferred or the services provided. This tax rule has resulted in the long-established practice of including “lowest price” clauses in commercial contracts for the sale and purchase of property or services in New Zealand. The lowest price tax mechanism also establishes if there is any interest in the agreement for tax, being the difference between the lowest price and the total consideration paid for the property or services. However, when the objective facts indicate that interest is disguised or capitalised, Inland Revenue may challenge the lowest price stated by the parties (Tax Information Bulletin Vol 3, No 3, October 1991 p8 sets out Inland Revenue’s position).
The submissions focus on the long established practice of including lowest price clauses in commercial contracts when there is no interest explicitly agreed in the contracts. They submit that this practice has worked well and has become widely accepted. Officials acknowledge these points but consider that the practice is not relevant when New Zealand taxpayers enter into contracts with non-residents.
However, officials consider that the genuine explicit agreement of interest in commercial contracts should not be overturned through the application (or non-application) of a tax rule. This will address the issues regarding lowest price clauses raised in the submissions.
Officials also consider that the imputation of interest for tax purposes is appropriate for “12-month ASAPs”, as included in the bill, in the absence of an explicit agreement of interest in commercial contracts.
Recommendation
That the submissions be accepted in part, subject of officials’ comments.
Issue: Definition of 12-month ASAP
Clause 123
Submission
(New Zealand Law Society)
The definition of “12-month ASAP” (applicable for non-IFRS taxpayers) should be amended to exclude ASAPs which incorporate certain deferral features (for example, an earn-out) but do not have the underlying features of a loan.
Comment
The concern is that an ASAP may become a 12-month ASAP because an “earn-out” payment (expressed as an adjustment to the purchase price) is made 12 months after completion of the transaction. The deferral of payment in such a case occurs because of uncertainty regarding the value of the business, not because there is some imputed interest component between the parties that ought to be recognised for tax purposes. Similar issues may arise with warranty payments that are expressed as an adjustment to the purchase price, or working capital adjustments that take more than 12 months to determine.
Officials agree that these payments should not result in interest income or expenditure when there is no interest explicitly agreed between the parties. Officials recommend that the definition of “12-month ASAP” in the bill be amended to exclude agreements which include these types of payments made more than 12 months after the rights date.
Recommendation
That the submission be accepted.
Issue: Definition of “foreign ASAP”
Clause 123
Submission
(New Zealand Law Society)
The definition of “foreign ASAP” should be clarified to confirm whether an ASAP will be a foreign ASAP when some part (but not all) of the consideration is denominated in a foreign currency.
Comment
Officials agree with the submission and recommend that the definition of “foreign ASAP” in the bill be amended to apply to foreign ASAPs where 50 percent or more of the consideration (measured at the time the ASAP is entered into) is in foreign currency. This rule will be based on using spot foreign currency rates at the time the ASAP is entered into.
Recommendation
That the submission be accepted.
Issue: Revenue account property/trading stock
Clause 66
Submission
(Ernst & Young)
Proposed section EW 33B should be amended to refer consistently to revenue account property for all taxpayers and foreign ASAP situations, rather than using that term in section EW 33B(1)(a)(i) but referring to trading stock in section EW 33B(2)(a).
Comment
The use of trading stock (along with depreciable property) in proposed section EW 33B(2)(a) for non-IFRS taxpayers was considered to be appropriate as those taxpayers would usually be hedging those types of sales and purchases in foreign currency. It was also considered appropriate to constrain the ability to use foreign currency hedging for tax for non-IFRS taxpayers to the most common transactions. It was considered that IFRS taxpayers would be hedging all types of revenue account property (including trading stock) and that the use of the IFRS accounting rules for tax for all those transactions was appropriate.
On reflection officials agree that the proposed section for non-IFRS taxpayers should apply to all revenue account property. We also consider that the section should also apply to services (as it already does for IFRS taxpayers). However, use of the hedging provisions by non-IFRS taxpayers should continue to be subject to a once only irrevocable election (in writing) to apply the section. This is appropriate for non-IFRS taxpayers because, unlike IFRS taxpayers, they will not usually be using a proscribed hedging treatment in the financial accounts for these transactions. Because of the vast range of small to medium-sized taxpayers in this category, it is appropriate they be required to make a conscious act to be able to use the hedging rules.
Recommendation
That the submission be accepted.
Issue: Transitional provisions
Clause 82
Submission
(Ernst & Young)
The requirement that taxpayers should have filed returns in accordance with the proposed sections EZ 70 or EZ 71 as the case may be, for “every earlier income year” as well as for the 2013–14 income year, should be deleted.
Comment
The submission says, given the uncertainty, confusion and numerous amendments which have been made to the financial arrangement rules, it is unreasonable to restrict application of the proposed transitional provisions to taxpayers who may have filed all previous year returns in accordance with provisions which are only now in the process of being articulated and enacted.
The proposed changes to the tax rules for foreign ASAPs are the first changes to these rules since they were enacted in 1999. There have been changes to other parts of the tax rules for financial arrangements since then. The proposed changes will simplify the current treatment of these financial arrangements considerably and are generally welcomed by taxpayers.
During consultation with taxpayers and their advisers over the past few years over possible changes to the rules for these arrangements, it became clear there is a substantial degree of non-compliance with the technicalities of the rules. It is considered necessary to retrospectively endorse this technical non-compliance when it has been in accordance with what the new rules require. We understand from discussions with a number of taxpayers and their advisers that the proposals in the bill for endorsing the past years are appropriate.
However, it is necessary to apply this to every year of the term of a financial arrangement as the technically incorrect methods applied should have been applied for all years. It is not appropriate to retrospectively endorse positions when taxpayers have switched between various (technically non-compliant) methods for the same financial arrangements during their terms.
It is appropriate to amend the proposed sections to endorse positions taken when the treatment was originally technically non-compliant but has been changed to technically compliant. This will apply to the treatment of all a taxpayer’s foreign ASAPs for the relevant years.
Recommendation
That the submission be accepted in part.
Issue: Deposits/payments for progress made
Clause 123
Submission
(Ernst & Young)
Clarification is needed as to when deposits or other instalments would not be regarded as “payments for progress made” and thus excluded from treatment as prepayments in the definition of “12-month ASAP”.
Comment
The submission is concerned about relatively small deposits paid at or very close to the commencement of a contract which may not be regarded as “payments for progress made”. These contracts may have payments for progress made subsequent to any initial deposit.
Officials agree there is good reason to exclude small deposits paid at the beginning of contracts from creating a 12-month ASAP under the proposed rules. Officials recommend that the bill be amended to exclude deposits aggregating no more than 10 percent of the total consideration to be paid for the property or services and paid within the first three months of entering into the contract from being treated as prepayments for the definition of a 12-month ASAP.
Recommendation
That the submission be accepted.
Issue: Sale and purchase of services
Clause 123
Submission
(Ernst & Young)
The proposed definitions of “12-month ASAP” and “rights date” should be clarified in relation to agreements for sale and purchase of services.
Comment
The submitter is concerned the proposed definition (of “rights date”) is not appropriate in relation to the provision of services, particularly if they are provided on many dates or over a continuous period.
The proposed definition uses the same words used in an existing definition of “right” which has been part of the financial arrangements rules since they were introduced. Officials have not been provided with any actual examples of issues regarding the valuation of services using the existing definition of “right”.
In the absence of known widespread problems, and given that the words used in the definition of “rights date” (and therefore also in “12-month ASAP”) are already used in the legislation, officials consider no action should be necessary at this time.
Recommendation
That the submission be declined.
Issue: Consistency requirements
Clause 60
Submission
(KPMG, New Zealand Institute of Chartered Accountants)
The consistency requirements in subpart EW require taxpayers to use the same spreading method every income year for financial arrangements that are the same or similar. The bill does not amend the consistency requirement to allow taxpayers to use the IFRS method for new foreign currency ASAPs if they are currently applying Determination G29 to other “same or similar” ASAPs entered into before the application of these new rules.
Comment
Officials agree that the consistency rules should be amended as submitted, to allow for the proposed changes.
Recommendation
That the submission be accepted.
Issue: Interest-free loans
Clause 60
Submission
(KPMG)
Another bill contains an amendment to the IFRS spreading method in section EW 15D to ensure that holders of interest-free or low interest loans cannot claim deductions for interest imputed under IFRS that has not been economically incurred. It is not clear whether a foreign currency ASAP could also fall within the scope of the low-interest loan proposals. The policy intention should be clarified. This could be achieved by defining the terms “interest-free loan” and “low-interest loan” so that they exclude foreign currency ASAPs (if this is the intention).
Comment
The submission is correct that it is not the intention that interest-free and low-interest loans are included in the proposals for foreign currency ASAPs. The two proposals are separate. Officials consider that the proposals for interest-free and low-interest loans stand alone and need no further clarification. The term “interest-free loan” is used in various other parts of income tax legislation and is not defined for any of those purposes. As a result, it is not considered necessary to add further text to income tax legislation. The point will be noted in the Tax Information Bulletin which will follow enactment of the legislation.
Recommendation
That the submission be declined.
Issue: Appropriate spreading methods for foreign currency ASAPs
Clauses 60 to 67, 82 and 123
Submission
(KPMG)
The Act and the bill should be reviewed and appropriate amendments made to ensure that taxpayers have appropriate spreading methods to apply.
Comment
The submission suggests that when a foreign currency ASAP does not meet the application criteria for the yield-to-maturity method it is difficult to apply a spreading method that meets the purpose of the financial arrangements rules. This results in the allocation of an inappropriate amount of income/expenditure to each income year.
While officials appreciate that sometimes it is difficult to achieve an appropriate allocation of income or expenditure in some situations, it is not an issue of major significance to warrant an immediate review of the Act. Officials are also aware of various disputes and discussions with taxpayers where it has been relatively easy to apply an appropriate spreading method using existing legislation and the underlying purposes of the financial arrangements rules.
Recommendation
That the submission be declined.
Issue: Use of spot rates to convert foreign currency payments
Clause 66
Submission
(Deloitte)
The use of spot rates to convert foreign currency amounts to New Zealand currency in proposed section EW 33C needs to be clarified. Also, proposed subsections EW 32(2C) and (2D) include redundant wording being, “section EW 33C applies if the consideration is in a foreign currency”, as the provisions only apply to foreign currency transactions in the first instance.
Comment
Officials accept that the use of spot rates could be clarified. The intention is to allow some flexibility in the use of spot rates to cater for a variety of factual circumstances which can apply. Officials recommend that the use of spot rates be amended to make it clear that spot rates to be used are the spot rates on the dates payments are made during an income year. When payments are made after the end of an income year, the spot rates used can be the actual spot rates for payments made within 93 days of the end of the income year or the spot rate at the end of the income year.
The redundant words in proposed section EW 33C will be addressed.
Recommendation
That the submission be accepted.
Issue: Elections by non-IFRS taxpayers to use foreign currency hedging
Clause 66
Submission
(New Zealand Institute of Chartered Accountants)
Separate elections should not be required (by non-IFRS taxpayers) to include in the value of property certain forward foreign exchange contracts which hedge the foreign currency arrangements.
Comment
The bill proposes that a once only irrevocable election is made in writing to apply the proposed section to all financial arrangements for the property. The form and timing of the election is considered quite clear from the wording of the proposed section.
It is considered appropriate to include this requirement for non-IFRS taxpayers to enable them to use hedging for foreign currency ASAPs because they will not usually be using hedging for accounting purposes. IFRS taxpayers can only apply hedging to foreign currency ASAPs which are subject to designated hedging under IFRS accounting. The application of designated hedge accounting under IFRS is a rigorous exercise and its use will be compulsory for tax. It is considered appropriate that non-IFRS taxpayers be required to consciously elect to use hedging for tax and to be on a similar footing to IFRS taxpayers.
Recommendation
That the submission be declined.
Issue: Future and discounted valuing
Clause 65
Submission
(Deloitte)
Proposed section EW 32(2C) requires a non-IFRS taxpayer to determine in respect of a foreign ASAP that is more than 12 months: “the future value, or the discounted value, or a combination of both the future and discounted values, on the rights date”. What is required is uncertain. This wording should be clarified and clear, worked examples should be provided in a commentary.
Comment
The words in proposed section EW 32(2C) are the same as those used in an existing subsection of section EW 32. There are examples of the use of the future value, or the discounted value, or a combination of both the future and discounted values in existing determinations. These existing provisions and examples will be referred to in a Tax Information Bulletin following enactment.
Recommendation
That the submission be noted.
Issue: Life financial reinsurance contracts which may be foreign ASAPs
Clause 60
Submission
(Matter raised by officials)
Life financial reinsurance contracts are subject to specific provisions in the Income Tax Act 2007. Where such contracts come within the definition of foreign ASAPs it is proposed that section EW 15D (the IFRS financial reporting method) is not able to be applied and the existing section EW 15I spreading method continues to apply.
Comment
Officials consider that the current and proposed IFRS accounting treatment may result in the spreading of income and expenditure on these contracts which does not reflect the underlying purposes of the financial arrangement rules. As a result, it is considered that the existing spreading treatment of such contracts under section EW 15I should be retained.
Recommendation
That the submission be accepted.