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Weekly Comment 20 October 2017

1. The Taxation (Annual Rates for 2016-17, Closely Held Companies, and Remedial Matters) Act 2017 (“the Closely Held Companies Act”) received the Royal assent on 30 March 2017. There are a number of changes affecting various parts of the Income Tax Act 2007 and the Goods and Services Tax Act 1985.

2. This week I complete looking at the changes affecting look-through companies (“LTCs”). In the following weeks, I look at the qualifying companies continuity of ownership requirement, and other changes affecting closely held companies generally.

Self-remission of LTC debts

3. New rules relating to the tax treatment of debts that are “self-remitted” apply for income years beginning on or after 1 April 2011.

4. New s. DB 11(1B) permits a deduction for “self-remission” as follows: 5. To briefly recap, when a financial arrangement terminates under the rules in s. EW 29, a base price adjustment (“BPA”) must be calculated using the formula in s. EW 31. That formula commences by deducting what is paid by the person (which, in the case of a creditor would be the sum advanced and, in the case of a debtor of an unpaid debt, zero), from what is paid to the person (which, in the case of a creditor would be zero and, in the case of the debtor, the amount advanced). This calculation- i.e. the BPA - would, therefore, end up being negative for an unpaid creditor.

6. A person with a with a negative BPA is allowed a deduction for interest under ss. DB 6 to DB 8, and under s. DB 11 if the rules permit.

7. However, a further item in the BPA formula would eliminate the negative result if the creditor has “remitted” the amount advanced – i.e. excused the debtor from repaying the amount.

8. In addition, if a financial arrangement is disposed of for a consideration less than market value due to a decline in the debtor’s creditworthiness or because the debtor’s obligations have been reduced or cancelled, a creditor is deemed to have been paid the market value under s. EW 39, thereby eliminating a negative consideration for the purposes of the BPA.

9. For the debtor, the BPA results in income if a debt is unpaid, as explained in paragraph 5 above. Where a LTC owner is both a creditor (due to having advanced an amount to the LTC) and a debtor (because of the attribution of the LTC’s debt to the owner), the above rules result in an unfair amount of taxation. This is because the owner as debtor has income, whereas the owner as creditor is denied an equivalent deduction.

10. This is remedied under the new rules in s. DB 11(1B), s. EW 31(11) and s. EW 39(4). A deduction is permitted to the creditor/lender for “self-remission” by:

1. Allowing a deduction for a negative BPA resulting from “self-remission” under s. DB 11(1B);


2. Excluding “a remission that is self-remission” from being “remission” for the purposes of the add-back in the BPA formula under a replacement definition of ‘remission” in s. EW 31(11); and


3. Subtracting the amount of “self-remission” from market value for the purposes of calculating the BPA upon disposal of a financial arrangement, under new s. EW 39(4).

11. For an interest-free loan in New Zealand currency repayable on demand, which would be an excepted financial for the creditor/lender under s. EW 5(10) and to which, therefore, the above amendments would not apply, an amendment to s. EW 8 allows “a person to treat as financial arrangements … any excepted financial arrangement to which the person is a party that is described in s. EW 5(10)”.

What is “self-remission”

12. Under a new definition in s. YA 1, “self-remission” means, for a person:

1. For the purposes of the BPA formula in s. EW 31(11), a remission amount for a financial arrangement under which, and to the extent to which, because of the operation of s. HB 1 (the LTC rules) or s. HG 2 (the limited partnership rules), the person is also liable as debtor in their capacity of owner or partner;


2. For the purposes of determining market value upon disposal of a financial arrangement under s. EW 39(4), the amount by which the consideration for the disposal of a financial arrangement is affected by a factor described in s. EW 39(1)(d), to the extent to which:
   
   
   1. The disposal occurs upon cessation of a LTC or dissolution of a partnership under s. HB 4(3) or (6) or s. HG 4; and
   
   
   2. Immediately before the disposal, the person is also liable as debtor in their capacity of owner or partner because of the operation of s. HB 1 or s. HG 2.

13. Paragraph (a) if the above definition means that a shareholder or partner of a LTC or partnership will have a negative base price adjustment in their capacity as a creditor that neutralises out any income attributed to them as debtor in their capacity as owner or partner.

14. An example is provided on page 43 of Tax Information Bulletin, Vol. 29, No. 5, June 2017 (“the TIB Item”) of a LTC with 2 owners with equal 50% ownership interests, Shareholder A, who has lent $100 to the LTC, and Shareholder B who has not lent the LTC any money. Shareholder A subsequently remits the $100 debt it owes to the LTC: 15. An example is provided on page 44 of the TIB Item of how the amendment allowing subtraction of the amount of “self-remission” from market value for the purposes of calculating the BPA upon disposal of a financial arrangement, under new s. EW 39(4) will work. It is noted on page 43 of the TIB Item that for a LTC, this can occur upon permanent cessation, capital reduction, or revocation of LTC status. For partnerships this can occur on sale of partnership interests by a partner or upon dissolution of a partnership: Amendment to ensure LTC owners are taxed on LTC debts forgiven by third parties

16. Section HB 4 contains the general provisions relating to disposals of LTCs. A new s. HB 4(7) provides that the market value of an owner’s interest in a financial arrangement as debtor must take into account the amount of any adjustment for credit impairment.

17. It is stated on page 44 of the TIB Item that this ensures the debt remission rules work as intended so that when a debtor sells their interest in a financial arrangement that they will not be able to repay in full, they are treated the same as if the amount they are unable to repay was remitted. The new rule is explained on page 44 of the TIB Item as follows: 18. An example is also provided on page 44 of the TIB Item as follows: 19. This rule applies from 1 April 2011 (i.e. from the inception of the LTC tax regime). However, to avoid reopening past returns, any additional income and associated penalties and interest from those earlier years is brought to account in 2017–18 income returns by way of a new transitional rule in s. HZ 8.

20. The formula in s. HZ 8 requires taxpayers to revisit all past LTC disposals involving financial arrangements and apply the new rule to calculate revised income under a revised BPA. This is referred to as the “retrospective amount”.

21. This “retrospective amount” is then compared to the actual income returned on disposals of financial arrangements before the 2017-18 income year, referred to as “current income”.

22. The difference between the “retrospective amount” and the “current amount” will be income in the 2017-18 income year.