Loss group contingent on group loss company satisfying its liabilities for deductible expenditure
Clause 15(2)
Submission
(Corporate Taxpayers Group)
We support the amendments as being reasonable in principle, subject to technical and drafting issues being resolved but do not agree the amendments are remedial in nature.
Comment
Officials note the submission supports that the amendments are reasonable in principle but cannot identify any drafting issues raised in the submission.
Technical points raised by the Group in relation to specific submissions are dealt with separately in this report.
The Corporate Taxpayers Group considers the amendments ought to have been more appropriately dealt with as a policy matter rather than an “other remedial matter” in the Commentary to the bill.
We consider that the proposed amendments are appropriately classified as remedial measures, as they correct an unintended consequence arising from earlier amendments.
Before the commencement of the Income Tax Act 2004, the Commissioner could amend past years’ assessments of a taxpayer to cancel the benefit from using past tax losses if the taxpayer’s liabilities for deductible expenditure were later discharged without full consideration, were remitted or had become unrecoverable or unenforceable through the lapse of time. This power to issue this amended assessment was not limited to the normal four-year time bar. This power also applied to the benefit of loss grouping in past years.
To achieve consistency with self-assessment, the rewrite of these provisions altered both the manner and timing of the adjustment to cancel the benefit of using past tax losses. The adjustment was treated as income in the year a taxpayer’s liabilities for deductible expenditure were later discharged without full consideration, were remitted or had become unrecoverable or unenforceable through the lapse of time. However, this policy change did not adequately address how this policy applied to past loss grouping.
The proposed amendments:
- correct this gap in the law arising from the 2004 Act change to the manner and timing of the adjustment; and
- do not involve a change in existing policy.
Recommendation
That the submission that the amendments are reasonable in principle be noted.
That the submission that the amendments are remedial in nature be declined.
Submission
(New Zealand Institute of Chartered Accountants)
We agree in principle with what the amendment is aiming to achieve.
Comment
Officials note the support for the amendments.
Recommendation
That the submission be noted.
Submissions
(Corporate Taxpayers Group, Deloitte, New Zealand Institute of Chartered Accountants)
Income should not be deemed to arise prior to amounts being remitted. (Corporate Taxpayers Group, Deloitte)
The proposals targeting companies leaving consolidated groups and voidable preference transactions seem to go too far and do not leave companies with many options when trying to refinance an insolvent company prior to a group profit company trying to exit a group. (Corporate Taxpayers Group, Deloitte)
The amendment results in an overreach when a company wishes to leaves a consolidated group. The profit company may be subject to a tax liability as a result of the financial position of other members of the consolidated group in certain situations merely because either the profit company or the loss company exits the group. (New Zealand Institute of Chartered Accountants)
Comment
These submissions relate to proposed section CG 2D, which applies in circumstances when the group loss company and group profit company are in the same group.
This approach addresses concerns raised in submissions on a consultation paper that an adjustment to cancel the benefit of past loss grouping should not apply if the group loss company and the group profit company are not in the same group of companies.
The proposed amendment is consistent with the general adjustment rule that cancels the benefit of using past tax losses if unpaid liabilities for past deductible expenditure (related to those past tax losses) became unrecoverable or unenforceable through the lapse of time. The proposed amendment in section CG 2D identifies that at the time loss grouping status is broken:
- if the group loss company is insolvent, there is a high risk that the liability will not be satisfied in full (that is, it is likely to be unrecoverable); and
- that risk will be known to the management of the group of companies.
Officials consider that as the unpaid liabilities have a high risk of being unrecoverable, it is appropriate to cancel the benefit of related past tax losses used under the loss grouping rules. It also ensures proposed section CG 2C cannot be easily avoided. Section CG 2C applies if the loss company is liquidated, struck off or otherwise removed from the register of companies.
Submitters also comment it is possible the group loss company may later satisfy its liabilities. We consider that, in most circumstances, it is unlikely that the insolvent group loss company would later satisfy its obligations for unpaid deductible expenditure.
Recommendation
That the submissions be declined.
Submission
(Corporate Taxpayers Group, Deloitte, Ernst & Young, New Zealand Institute of Chartered Accountants)
Subsections CG 2D(4), (5) are unnecessary and should be removed. (Corporate Taxpayers Group, Deloitte, Ernst & Young)
References to “transactions or arrangements” in proposed subsection CG 2D(4) introduce uncertainty into the rules. (New Zealand Institute of Chartered Accountants)
Comment
The reference to an arrangement was intended to take into account:
- guarantees given by other taxpayers that enable the insolvent group loss company to meet the solvency test;
- a release given by creditors of the group loss company from the obligation to pay the unsatisfied liability; or
- an agreement of composition with the group loss company’s creditors.
The policy concern is that funding provided to the group loss company to satisfy the solvency test should not subsequently be used to make an insolvent transaction. An insolvent transaction could subsequently be reclaimed by a liquidator of the group loss company. An example of payments that could be at risk are payments to satisfy outstanding accident compensation levies, or fringe benefit tax, both of which are normally deductible expenses for a company.
However, we agree that the use of “an arrangement” might cause uncertainty in the mergers and acquisitions market. To address the uncertainty, the provisions in section CG 2D(4), (5) should be aligned more closely with the insolvent transaction provisions under company law and omit the reference to “arrangement”. There appears to be a low risk that an arrangement would subsequently be used to fund an insolvent transaction. We do not consider that the two provisions otherwise create uncertainty.
Submitters comment that the general anti-avoidance provisions in the Income Tax Act 2007 could address the insolvent transaction concerns. We consider the policy for the proposed provisions address a specific issue relating to insolvent transactions, and this is preferable, for compliance and administration cost reasons, to leaving the matter to be addressed under the general anti-avoidance provisions.
Recommendation
That the submission that the provisions relating to voidable transactions be removed from the bill be declined, subject to officials’ comments.
Submission
(Ernst & Young)
The provisions of proposed sections CG 2C and CG 2D should not apply if a loss company is removed from the register of companies through formal amalgamation under the Companies Act 1993 or any equivalent Court order, whereby the liability to pay their relevant unpaid expenditure amounts pass to the on-going amalgamated company
Comment
Officials agree that, if the group loss company has been removed from the register by reason of amalgamation, proposed sections CG 2C should not apply. This is because the unsatisfied liabilities of the group loss company are assumed by the amalgamated company (the company remaining after the formal amalgamation).
However, as the liabilities have been assumed by the amalgamated company, proposed section CG 2D should apply to the amalgamated company. This ensures that the formal amalgamation process cannot be used as a means to avoid the assessment of income to the group profit company under proposed sections CG 2C and 2D (for example by amalgamation and then liquidating the amalgamated company).
Recommendation
That the submission be accepted, subject to officials’ comments.
Submission
(Ernst & Young)
Proposed sections CG 2C and 2D should be clarified as to whether or how the proposed rules might apply if loss companies have been part of a consolidated group for income tax purposes.
Comment
Officials agree that it would be helpful to clarify how the consolidated group rules are to interact with proposed sections CG 2C and 2D as that would assist in minimising compliance and administration costs.
Recommendation
That the submission be accepted.
Submission
(Ernst & Young)
The Commissioner of Inland Revenue should provide appropriate guidance for the application of proposed sections CG 2C and 2D in situations when loss companies have losses representing a combination of paid and unpaid expenditure and when they have apportioned losses to more than one group of company.
Comment
The recovery rules in proposed sections CG 2C and 2D modify the general recovery rule applying to taxpayers with unpaid liabilities (relating to an amount of deductible expenditure) that have been remitted or cancelled. This includes liabilities that have become unrecoverable or unenforceable through the lapse in time.
Under this general rule, there is no requirement to match or trace the unpaid liability for deductible expenditure and match those amounts to specific use of tax losses. Instead, the taxpayer is assessed for an amount of income equal to the relevant amount remitted or cancelled. Proposed sections CG 2C and 2D adopt the same approach for consistency and to maintain the integrity of the tax system.
We agree with the submission relating to apportionment. We consider that allocation of the recovery income arising under sections CG 2C and 2D should be explicit in the legislation. This will assist in minimising compliance and administration costs.
Recommendation
That the submission on paid and unpaid expenditure be declined.
That the submission on tax losses apportioned to more than one group company be accepted.
Submission
(Ernst & Young)
Exclusions for financial arrangements within proposed sections CG 2C and 2D should be clarified.
Comment
As drafted, proposed sections CG 2C and 2D make it clear that they do not apply to financial arrangements. For example, proposed sections CG 2C and 2D apply to unpaid liabilities for normal trade debts.
Recommendation
That the submission be declined.
Submission
(Ernst & Young, New Zealand Institute of Chartered Accountants)
The interaction of proposed sections CG 2C and 2D with sections IC 11 and IC 12 should be clarified. (Ernst & Young)
The effect of section IC 11 should be considered. (New Zealand Institute of Chartered Accountants)
Comment
Section IC 11 applies if the Commissioner amends an assessment to determine that the tax loss of a group loss company (for a tax year) is less than the total amounts made available and subtracted from net income of group profit companies. This section applies, for example, when the group loss company has taken a tax position on an expenditure that has not been accepted by the Commissioner.
Officials consider section IC 11 is not suitable for cancelling the benefit of past grouping of tax losses on remission or cancellation of unpaid liabilities for deductible expenditure of a group loss company because:
- section IC 11 results in retrospective amended assessments of the group companies. That approach was strongly opposed in submissions on a consultation paper;
- section IC 11 is subject to the time bar, preventing the Commissioner from cancelling the benefit of past tax losses if more than four years have passed since the last assessment.
However, we agree that it would be desirable to adopt an apportionment rule similar to the apportionment in section IC 11 to minimise compliance and administration costs.
We agree with the submission that proposed sections CG 2C and 2D should not apply to tax losses for which other provisions apply (such as section IC 12). We recommend that this be clarified.
Recommendation
That the submission be declined, subject to officials’ comments.
Submission
(Russell McVeagh)
Sections CG 2 and 2D should be treated as coming into force and applying to all income years ending on or after the date upon which the bill is introduced.
Comment
Officials can see no policy reason why the proposed provisions should not apply from the date of introduction of the bill (22 November 2013). The proposed provisions apply if a group loss company with unpaid liabilities or past deductions has subsequently:
- been removed from the register or companies; or
- lost group status with a group profit company that received the benefit of past tax losses.
The long-standing policy is that the use of tax losses is contingent on the payment of liabilities for deductible expenditure. The proposed amendments are consistent with the general rule for all taxpayers that cancels the benefit of past tax losses if liabilities for past deductible expenditure are remitted or cancelled.
We also consider the amendments in sections CG 2C and 2D are significantly more constrained than the previous law, which permitted the Commissioner to amend assessments to cancel the benefit of past tax losses, without any time constraints, whether or not the group loss company or group profit company were in the same group of companies.
Recommendation
That the submission be declined, subject to officials’ comments.
Issue: Income derived in trust by public and local authorities
Clauses 25 and 26
Submission
(Ernst & Young)
The amendments to sections CW 38 and 39 are too restrictive and may prevent exemptions applying to income derived in trust for charitable or other exempt public purposes.
Comment
The exemption for income derived by a public authority or a local authority (sections CW 38 and 39) is not available for income derived by a trust for which a public authority or a local authority is the trustee. The policy of this exemption has never been related to the terms of the trust, as suggested by the submitter.
However, the amendment addresses an issue raised with the Commissioner relating to the trustee’s tax obligations for the beneficiary. As the income derived by the trustee is not exempt under section CW 38 or CW 39, we consider that the amendment clarifies, for the avoidance of doubt that:
- the exemption for income derived by a public authority or a public authority does not extend to income derived in the capacity as trustee that has not been distributed; and
- the trustee may take into account any exemption from income of the beneficiary for determining the trustee’s income tax obligations on that beneficiary income.
However income derived by a public authority or local authority as trustee may be exempt under other provisions of the Income Tax Act which may take into account the terms of the trust. We consider this amendment does not disturb these principles and that the submitter is raising issues that would require further analysis as part of the Government’s tax policy work programme.
Recommendation
That the submission be declined.
Submissions
(New Zealand Law Society, Tax Team, The Whyte Group)
The proposed amendments are unnecessary, as the current position in relation to trust income distributed as beneficiary income is clear. (New Zealand Law Society)
The amendments are ad hoc amendments that potentially exacerbate existing uncertainty in relation to the interpretation and application of the exclusions from the public and local authority exemptions for income derived “as a trustee”. (New Zealand Law Society, Tax Team)
If any amendments are made to the exclusions, they should only be made following a more comprehensive review of the underlying policy and intended scope of the exclusions. (New Zealand Law Society)
The amendment to section CW 39(3) should be removed from the bill. (The Whyte Group)
Comment
We consider the submission is seeking a review of the scope of the policy for the public and local authority exemptions which raises issues that would require further analysis as part of the Government’s tax policy work programme.
The long-standing policy is that the public and local authority exemptions do not extend to income that a public or local authority derives as a trustee. This is because income is derived in trust beneficially for the beneficiaries of the trust and not for the public or local authority.
The amendment clarifies, for the avoidance of doubt that if a public or local authority derives income as a trustee:
- whether the income derived and retained by the trustee is exempt income and is determined by whether other exempt income provisions in the Income Tax Act apply to the trustees and the trust, and not by the public or local authority exemptions; and
- income distributed as beneficiary income to a public or local authority is exempt income.
Recommendation
That the submissions be declined.
Issue: Spreading of income derived from land
Clauses 58 and 59
Submission
(New Zealand Institute of Chartered Accountants)
We support the amendment as a clarification to the current position.
Comment
Officials note the support for the amendment.
Recommendation
That the submission be noted.
Submission
(BDO Wellington Ltd, PricewaterhouseCoopers)
A taxpayer should be able to choose a shorter timeframe for the spreading of income rather than being locked into a statutory timeframe (set out in the amendment). (BDO Wellington Ltd)
A review should be undertaken regarding the timing of income and its allocation between income years. (PricewaterhouseCoopers)
Comment
The amendment clarifies that income is to be spread evenly over the time periods referred to in sections EI 7 and 8. This was the practice before the following drafting changes were made:
- in 2002 to give effect to formal self-assessment; and
- in rewriting those provisions into the Income Tax Act 2004.
The submission raises a policy question relating to a number of spreading provisions (both deduction and income) in the Income Tax Act 2007. These provisions are mainly concerned with:
- the primary sector; and
- certain intangibles (such as copyright, patents or leases).
Officials consider that, consistent with the objective of maintaining the integrity of the tax system, any review of the timeframes should consider all similar spreading rules which would require further analysis as part of the Government’s tax policy work programme.
Recommendation
That the submissions be declined.