Chapter 1 - Background
1.1 Debt remission is the extinguishing of a debtor’s liability by operation of law or forgiveness by the creditor.
1.2 This issues paper discusses proposed changes to the tax consequences of certain related parties debt remission when the debtor (the borrower) and the creditor (the lender) are either group companies, or when an owner or owners of a company or a partnership remit debt. These people or entities are referred to in this paper as “related parties”.
1.3 In particular, this paper considers debt remission in situations when there is no change of ownership of the debtor, or the net wealth of the “owner”. A debt remission within a wholly owned group of companies is a very common example of this. The company that advanced the loan (the creditor) suffers a loss, while the other company that borrowed the money (the debtor) has a corresponding gain but overall, there is no change in ownership of the companies, or in the owners’ wealth.
1.4 Under present tax law, debt remission in these circumstances produces taxable income to the debtor, but usually no tax deduction is available to the creditor. Until recently, this asymmetric tax outcome was commonly avoided by the debtor issuing equity to the creditor to “satisfy” the debt obligation.
1.5 However, an interpretation by Inland Revenue has indicated that these debt capitalisations may sometimes be considered to be tax avoidance and if so they are taxed as a debt remission. (See the Appendix.)
1.6 As well as the group company scenario, other relevant scenarios seemingly subject to the debt remission rules (either directly or potentially via the anti-avoidance analysis and reconstruction) include:
- debt remission between an overseas parent and its wholly owned New Zealand subsidiary; and
- shareholder or partner debt advanced to a company or partnership (which term includes look-through companies and limited partnerships), where the debt is remitted pro-rata to ownership.
1.7 The Government has agreed, subject to confirmation following this consultation, to the following core proposal:
there should be no debt remission income for the debtor when the debtor and the creditor are in the New Zealand tax base, including controlled foreign company (CFC) debtors; and
- they are members of the same wholly owned group of companies;
- the debtor is a company or partnership; and
- all of the relevant debt remitted is owed to shareholders or partners in the debtor; and
- if we presume that if the debt remitted was instead capitalised, there would be no dilution of ownership of the debtor following the remission and all owners’ proportionate ownership in the debtor is unchanged.
1.8 Again, subject to confirmation after consultation, the Government has agreed that the core proposal apply from the commencement of the 2006–07 tax year.
Inland Revenue’s operational approach
1.9 Given the decision made by the Government, Inland Revenue will not, pending the outcome of the policy process, be devoting resources to determine whether there is any debt remission income arising in the situations described at paragraph 1.7.
Outstanding policy issue – inbound investment
1.10 When the owner/creditor is a non-resident, the use of related-party inbound debt is a key BEPS (base erosion and profit shifting) concern. Continuing to tax debt remission in this case may dissuade non-residents from over-gearing to begin with. On the other hand, leaving the present tax outcomes in place could also dissuade non-residents from reducing gearing levels.
1.11 Officials’ current conclusion for inbound investment is that more work is needed, and this work is ongoing. However, submissions on this are welcome.
1.12 A number of second-tier technical issues have also been identified. These are discussed in this paper.
1.13 We believe that the core proposal has no fiscal effect as debt remission income in the past did not arise because taxpayers used debt capitalisation instead.
1.14 Submissions on this paper should be made by 14 April 2015 and can be addressed to:
C/- Deputy Commissioner
Policy and Strategy
Inland Revenue Department
P O Box 2198
Or email: [email protected] with “Debt remission” in the subject line.
1.15 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their publication. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider there is any part of it that should properly be withheld under the Act should clearly indicate this.