Richard's tax updates: June/July

Richard has had over 30 years’ experience with New Zealand and International taxation. His team provide services including:

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Below are articles from Richard’s weekly email ‘A Week in Review’ over the last month. You can sign up for his ‘A Week in Review’ newsletter here and get the updates weekly, directly to your inbox.

Further COV determinations issued

IR has certainly become trigger-happy with its new administrative flexibility powers, last week issuing three further COV Determinations:

  • Determination COV 20/03: ‘Variation of the application of s 15D(2) Goods and Services Tax Act 1985 to extend time to make an application to change GST taxable period’ – this variation provides additional time for a person who may wish to elect to change from a six monthly filing period to one monthly filing (primarily due to Covid-19 and the need to obtain GST refunds earlier than otherwise) from 1st April 2020. Usually the legislation provides that an election to change filing periods takes effect from the end of the taxable period during which the change election is made to IR – so a person wishing to change to monthly filing from 1st April 2020, would need to have filed their election no later than 31st March 2020. COV 20/03 however extends the election filing date to 30th June 2020. Note that the determination only applies to those changing to a monthly filing period from 1st April 2020, and requires them to remain a monthly filer until at least 30th September 2020.
  • Determination COV 20/04: ‘Variation in relation to s DB 31 Income Tax Act 2007 to extend time for writing off bad debts’ – this variation extends the time period for cementing 2020 bad debt deductions. Usually a person has to both determine that a debt is ‘bad’, and then physically write-off the amount in their books, prior to the end of the relevant income year, in order to claim a tax deduction for the bad debt in that relevant income year. So for the 2020 income year, this action should have been undertaken pre 31st March 2020. COV 20/04 extends this date to 30th June 2020, provided that the person can show that they did not write off their debt as bad by the end of the 2020 income year as a result of the impacts of Covid-19, and that they have taken into account only information that was relevant at the end of their 2020 income year.
  • Determination COV 20/05: ‘Variation in relation to s RP 17B(4) of the Income Tax Act 2007 to extend time for tax pooling transfers’ – this variation extends the present 75 day transfer request period to 365 days with respect to the 2019 income year. A person wishing to use a tax pooling intermediary in respect of their 2019 income year (to satisfy provisional/terminal tax obligations or UOMI on either) would usually have had to have made their transfer request no later than 75 days post their terminal tax due date (21st June 2020 for those with
  • tax agents EOT). COV 20/05 extends that date until 7th April 2021, provided that the transfer relates to a contract the person has with the tax pooling intermediary that is in place on or before 21 July 2020 to purchase tax pooling funds, and in the period between January 2020 and July 2020 the taxpayer’s business must have experienced (or for June and July 2020 be expected to experience) a significant decline in actual (or predicted) revenue which means that in respect of the 2019 tax year the taxpayer was either:

(a) unable to satisfy their existing commercial contract with a tax pooling intermediary; or,

(b) was, prior to this variation, not able to enter into a commercial contract with a tax pooling intermediary; and that decline in actual or predicted revenue is related to Covid-19.

You should note that COV 20/05 contains no set definition of the term ‘a significant decline in actual (or predicted) revenue’ – so there is no 30% or 40% revenue decline threshold for example as there was to ensure eligibility to claim the wage subsidy.

Anti-avoidance IS for temporary loss carry-back regime

IR has issued Interpretation Statement IS 20/03 ‘Income tax — sections GB 3B and GB 4 of the Income Tax Act 2007 — temporary loss carry-back regime’, to counter you gamers out there who already had your thinking caps on as to how the new temporary loss carry-back regime rules could be utilised to obtain unintended advantages to those contemplated by Parliament when the rules were drafted.

Commonly referred to now as the ‘parliamentary contemplation test’ under the general anti-avoidance provision in section BG 1 as set out by the Supreme Court in Ben Nevis Forestry Ventures Ltd v CIR [2008] NZSC 115, the test targets arrangements that in legal substance satisfy the requirements of a particular provision or regime, but when viewed in a commercial and realistic way, make use of (or circumvent) the provision or regime in a manner that is inconsistent with the provision or regime’s purpose.

When new section IZ 8 was introduced into the Income Tax Act 2007 to establish the temporary loss carry-back regime, introduced in tandem were specific anti-avoidance rules contained in sections GB 3B and GB 4. IS 20/03 provides commentary as to how IR will apply those specific provisions, where:

  • a company share is ‘subject to an arrangement’ (which includes ‘an arrangement directly or indirectly altering rights attached to the shares’);
  • the arrangement ‘allows’ the relevant company ‘to meet the requirements’ of the temporary loss carry-back regime; and,
  • a ‘purpose’ of the arrangement is ‘to defeat the intent and application’ of the regime.

In simple terms IR are concerned with the 49% and 66% shareholding continuity requirements, where taxpayers may enter into arrangements to ensure continuity is not breached ‘on paper’, thereby still enabling them to take advantage of a loss carry-back, whereas ‘off paper’ there has been a breach – for example new investor required to inject cash due to Covid-19, will take a 60% shareholding in respect of that injection, puts the cash into the company now, but share transfer deferred until post end of relevant loss year.

I would suggest that ultimately IS 20/03 may only have a one year application period if the proposed changes to the loss continuity rules do proceed to come into effect from 1st April 2020 – move to a ‘same or similar business’ test as opposed to the existing 49% ownership continuity requirements.

QWBA on Healthy Homes standard costs

IR has issued QB 20/01, a question we’ve been asked on whether owners of existing residential rental properties can claim deductions for costs incurred in complying with the new Healthy Homes (‘HH’) standards.

IR’s view is that there are four potential scenarios where the costs are likely to be on revenue account and therefore fully deductible in the year incurred:

  1. repairing items that would otherwise meet the standards if operational or in a reasonable condition – so the building already has a heat pump for example that would satisfy HH standards if it actually worked, then the cost to get it working should be on revenue account;
  2. minor additions or alterations not involving repairs that do not change the character of the building;
  3. replacing items on a like-for-like basis in the future where they have previously been treated as part of the building – so while the initial spend may have been on capital account (installing the smoke alarms that are deemed to be on capital account due to changing the character of the building), the subsequent replacement of the item likely to be r&m; and,
  4. record-keeping and providing information in tenancy agreements – so paying a property manager to provide a HH compliance report or services for example.

Otherwise the costs are likely to be capital in nature, particularly where the work involved:

  • results in the reconstruction, replacement or renewal of the whole asset or substantially the whole asset; or,
  • goes over and above making good wear and tear, i.e. is not a repair, and changes the character of the asset.

Naturally, the use of the term ‘asset’ in the aforementioned paragraphs, requires identifying the relevant asset, and IR’s 3 step test can be used as guidance in this regard:

Step 1: Determine whether the item is in some way attached or connected to the building. If so, go to step two. If not, the item will be a separate asset.

Step 2: Determine whether the item is an integral part of the residential rental property such that a residential rental property would be considered incomplete or unable to function without the item. If so, the item will be part of the residential rental building. If not, go to step 3.

Step 3: Determine whether the item is built-in or attached or connected to the building in such a way that it is part of the ‘fabric’ of the building. If so, the item will be part of the residential rental building. If not, the item will be a separate asset.

In respect of the present topic, HH expenditure, IR’s view is that step one is almost always met, step two will be met in most cases, and step three is sometimes applicable.

A few other comments of note:

  • replacements using modern materials are not necessarily capital in nature;
  • expenditure that is part of an overall project may be capital in nature – IR’s view you cannot break one project down into its revenue and capital items – if capital expenditure exists, then all costs are on capital account for that project; and,
  • do not overlook the low-value asset rule, particularly when until 17th March 2021, the threshold is $5,000. So immediate write-off still for costs that would otherwise have been on capital account.

QB 20/01 ends with a commentary on the various types of likely HH expenditure, and IR’s views on the treatment of each.

Covid-19 legislation guidance

IR has now published guidance on the legislative changes introduced via the passing of two recent tax Bills – the Covid-19 Response (Taxation and Other Regulatory Urgent Measures) Act 2020 (No. 10 of 2020) enacted on 30 April 2020 and the Covid-19 Response (Further Management Measures) Legislation Act 2020 (No. 13 of 2020) enacted on 15 May 2020.

The guidance document covers:

  • The new temporary loss carry-back regime
  • IR’s new administrative flexibility powers
  • The small business cashflow scheme; and,
  • The rules to ensure those New Zealanders stranded overseas who are receiving social benefits and pension equivalent payments are taxed as if they were back in NZ.

Some take-outs from the guidance:

Loss carry-backs

  • A temporary measure applying to losses incurred in either the 2019–20 or 2020–21 income years (although Government intention to develop permanent rules to apply from the 2021–22 tax year).
  • You generally access the rules by changing your estimated provisional tax (assuming the profit year tax return not filed yet), and deadline for re-estimating provisional tax now extended to the date the tax return is due or filed, whichever is the earlier. If tax return for profit year already filed, then you request a reassessment and refund due to the loss carry-back.
  • Almost all taxpayer types eligible to carry back losses.
  • Be conservative with your loss estimates (you can estimate multiple times) as standard late payment use-of-money interest applies if the loss carry-back is overestimated, and use of the UOMI new relief provisions are not available in loss carry-back scenarios.
  • Ownership continuity (maintaining 49% / 66% throughout continuity period), grouping (must offset all current year profits first), and imputation rules (must have sufficient credits available for refunds) also apply.
  • Loss carry-back enables provisional tax already paid to be refunded, and rules extend to shareholder-employees who may have paid provisional tax on the basis that they would receive a shareholder salary from the company which is not in fact paid because the company’s pre-salary income is offset by a loss carry-back – both parties need to opt-in to the regime in this scenario.
  • Carry-back loss restricted where you’ve made charitable donations in the taxable income year, to the amount of taxable income reduced by the amount of charitable donations. This restriction will not apply to a company however, as it does not receive a tax credit but a deduction for a charitable donation.
  • If you owe a debt on other tax types, IR will not apply any of the refund arising from the loss carry-back to satisfy these tax debts.

Administrative flexibility

A temporary discretionary power IR may use to provide flexibility for due dates, deadlines, time periods, timeframes or procedural and administrative requirements for taxpayers who are affected by Covid-19, making compliance with current tax obligations impossible, impractical, or unreasonable.

To date (as far as I am aware at least), the following COV determinations have been issued:

  1. COV 20/01: variation to s HB 13(3)(b) of the Income Tax Act 2007 – LTC elections.
  2. COV 20/02: variation to s EI 1 of the Income Tax Act 2007 – Spreading of timber income.
  3. COV 20/03: variation of the application of s 15D(2) Goods and Services Tax Act 1985 to extend time to make an application to change GST taxable period.
  4. COV 20/04: variation in relation to s DB 31 Income Tax Act 2007 to extend time for writing off bad debts.
  5. COV 20/05: variation in relation to s RP 17B(4) of the Income Tax Act 2007 to extend time for tax pooling transfers.
  6. COV 20/06: variation in relation to s EI 1 of the Income Tax Act 2007 (supplement to COV 20/02).

Small business cashflow scheme

  • Section DF1(1)(cb) added to ensure that business expenditure funded by loan not subject to the restrictions on deductibility that apply to expenditure financed by certain government grants and loans – so normal deductibility rules apply.
  • Amendment to section EW 45 to ensure that if conversion to a grant occurs this does not trigger debt forgiveness income under the financial arrangement rules.
  • Section MB 13 amended to ensure that loan amounts are not counted as family scheme income for Working for Families purposes.
     
  • The definition of exempt interest in section YA 1 amended to ensure that interest payments made under the SBCS will not be subject to resident withholding tax.

FBT prescribed interest rate changed

The FBT prescribed interest rate has been reduced from 5.26% to 4.50% for the quarter commencing 1st July 2020.

QWBA on LTC debt remission

This ‘questions we’ve been asked’ looks to answer the question as to whether a look-through company will derive debt remission income when a close friend / family member of the shareholders forgives a loan made to the LTC.

QB 20/02 responds with a ‘no’ as section EW 46C will prevent the LTC from deriving debt remission income where all of the shareholders and the close friend / family members have natural love and affection for each other. In this regard, IR will generally accept that the shareholders and the close friend / family members have natural love and affection for each other.

Note that a similar exception applies to partnerships (s EW 46C(1)(d)), and while QB 20/02 only applies to LTC’s, the conclusions reached in the QWBA are also relevant to partnerships where the creditor of the partnership and all of the partners have natural love and affection for each other.

In essence, the LTC shareholder and the close friend/family members will be treated as a single creditor group. Once this is achieved, then on the basis that the proportional debt ratio (the percentage the debt bears to the total amounts of debt owed by the LTC that are forgiven at the same time) equals the proportional ownership ratio (the creditor’s percentage of the total effective look-through interests in the LTC), no debt remission income will arise.

In this respect, be mindful therefore that a particular LTC shareholder may still have deemed remission income, if they are outside of the single creditor group (as economically they are now better off as a result of the creditor forgiving the loan).

US LLC binding rulings on FTC’s

IR has finalised its five binding rulings, which each provide commentary on when a foreign tax credit may be claimable by a New Zealand investor who has invested in a US LLC.

A US LLC is treated as a partnership for US federal tax purposes, meaning it is the individual members of the US LLC who are responsible for filing their own US federal income tax returns and paying the US income taxes assessed on their respective shares of the LLC income (in practice however, I have found that where non-resident investors are involved, US advisors will often recommend that the LLC elects to pay taxes as a US corporation – so the binding rulings might not be so relevant to your client therefore).

The binding rulings cover the scenarios where an individual investor holds FIF’s of $50k or less (usually therefore just subject to paying tax on dividends); a FIF investment where FDR and the like used to compute annual income; an attributed FIF investment; a CFC investment; and dividends derived from the LLC which is either a non-attributing active foreign investment fund or a controlled foreign corporation.

Filing date extension

Covid-19 Variation 20/07: ‘Variation in relation to s 70C of the Tax Administration Act 1994 to extend deadline for filing statements in relation to R&D loss tax credits’, has been issued. The notice applies to loss-making companies who have undertaken eligible R&D activities during the income year and wish to cash out the related tax losses. Companies that wish to take advantage of the cash out must make an electronic application accompanying the income tax return for the relevant income year.

In this regard, the deadline for filing the 2019 income year application was 31st March 2020 (for those taxpayers with extension of time arrangements). COV 20/07 now extends the 2019 due date to 31st August 2020.

As always, the variation is subject to the condition that it applies only to taxpayers for whom the impacts of Covid-19 response measures or the consequences of Covid-19 had a material impact on them not meeting the filing deadline.

Overseas hunters – IR’s GST guidance documents

If you have any client’s involved in hunting activities, either overseas person’s coming to New Zealand to hunt, or NZ suppliers of hunting outfits, hunting guide services or taxidermist services, then IR’s latest publication may be of interest to you.

Released in this regard are Interpretation Statement IS 20/02, ‘Goods and services tax — supplies by New Zealand hunting outfitters and taxidermists to overseas hunters’, which includes a series of three fact sheets, and an accompanying Commissioner’s Statement, CS 20/20. The three fact sheets are titled:

  1. IS 20/02 Fact sheet 1: GST
    Supplies by New Zealand hunting outfitters or guides to overseas hunters.
  2. IS 20/02 Fact sheet 2: GST
    Supplies by New Zealand taxidermists to overseas hunters and New Zealand outfitters
  3. IS 20/02 Fact sheet 3: GST
    Overseas hunters in New Zealand for big game-guided hunting.

CS 20/02 is titled ‘Trophy hunting and the GST treatment of the ‘trophy fee’’ and was released to advise what IR’s operational approach to IS 20/02 will be.

IS 20/02 recognises that the overseas hunter usually receives two separate GST supplies from a hunting outfitter:

  • A single composite supply of a hunting experience in New Zealand (standard GST rated)
  • A supply of souvenir animal parts or a hunting souvenir (GST zero-rated export – often referred to as the ‘trophy fee’).

The latter supply in this respect, usually involves a consideration paid by the overseas hunter for the opportunity to hunt and kill a particular breed and quality of animal in New Zealand. It is IR’s view that this portion of the trophy fee should be a standard rated supply for GST. Consequently, an apportionment issue arises for the NZ supplier.

CS 20/02 attempts to the assist the NZ supplier with the apportionment issue, by establishing some standard apportionment percentages for trophy hunting animals in NZ.

The percentages are intended to recognise the increasing value to the hunter of souvenir animal parts and hunting souvenirs as the quality and ‘uniqueness’ of the trophy animal increases. Outfitters may use these percentages to apportion their trophy fees when they export souvenir animal parts or hunting souvenirs, and those valuations will be accepted by the Commissioner.

Applying CS 20/02 is optional, and is therefore not required to be followed by the hunting outfitter, however as with any departure from following published IR rates or percentages, the supplier will need to ensure they retain sufficient evidence of their calculation methodologies, particularly if they are looking to zero-rate a higher portion of the trophy fee, than the IR guidance percentages.

Finance lease definition variation

IR has released COV 20/08: Variation in relation to the definition of ‘finance lease’ in s YA 1 of the Income Tax Act 2007.

In essence the variation is intended to prevent a re-characterisation of an operating lease to a finance lease (so no longer immediate write-off for the lease payment, instead recognising a fixed asset purchase subject to depreciation deductions instead), due to the lease having extended beyond 75% of the estimated useful life of the asset, due to Covid-19 related issues.

The variation operates as follows:

‘The time period of ‘more than 75% of the asset’s estimated useful life’ referred to in paragraph (b) of the definition of ‘finance lease’ in s YA 1 of the Income Tax Act 2007 is extended to ‘more than 75% of the asset’s estimated useful life plus an additional 18 months’ where the term of the lease is extended between 14 February 2020 and 30 November 2020.’

This variation applies from 17 March 2020 to 30 November 2020.

For COV 20/08 to apply, the lease must have been entered into before 14 February 2020, the lease term must not have been more than 75% of the estimated useful life when the lease was entered into, and:

  • The lessee must have been prevented or discouraged from returning the lease asset at scheduled maturity; or,
  • The lessee’s business must have experienced a significant decline in actual or predicted revenue related to Covid-19, which had the consequence that the lessee had difficulty in satisfying their existing lease agreement.

Other elements of COV 20/08 are:

  • A lessor and lessee are not required to adopt the same treatment of the lease asset as both parties can make their own decision about whether they rely on the variation.
  • Taxpayers do not need to take the same approach to all leases they have entered into for the same class of lease asset.
  • The variation applies to leases that are extended between 14 February 2020 and 30 November 2020 and is not limited to leases where the lease term would otherwise have ended during that period.

Accounting for your foreign rental income

I suspect most of you have had at one time or another, clients with investment rental properties located in overseas jurisdictions, with foreign bank and loan accounts attached to those properties, the annual transactions of which you then have to convert into $NZD, in order to prepare the clients New Zealand income tax returns.

In case you were not aware of the legislative niceties, section YF 1 of the ITA07 requires you to undertake the requisite foreign currency conversion, using the close of trading spot exchange rate on each day a transaction occurs, with an alternative to use a mid-month (15th day) close of trading spot exchange rate average, where either the Commissioner or a specific provision in the Act allows it.

Further, section YF 1(5) permits the Commissioner to issue general conversion rates and calculation methods approved by her for use in defined circumstances, and last week we saw the issue of a determination – FX 20/01: “Approval — foreign residential rental property amounts — currency conversion”.

FX 20/01 allows the conversion of income and expenses using either a monthly or an annual method, meaning that you can total a relevant month or an entire income year, and use a monthly average rate or average annual rate accordingly. The determination, also referred to as the Approval, also explains what exchange rates to use if you are using either the monthly or annual method.

Used of FX 20/01 is entirely optional, simply being a compliance cost reduction tool.

Extension of small business cashflow (loan) scheme

Originally the scheme was to have an application period of only 30 days (12th May to 12th June), however the Government has now extended the application period until the end of the year – 31st December 2020.

The announcement of the extension did not include any changes to the existing terms and conditions attached to the SBCS, being:

  • If you repay the loan fully within 12 months, then it is interest-free.
     
  • Otherwise the interest rate is 3%, from the date of drawdown, for a maximum term of five years.
  • There are no repayments required for the first two years.
  • Businesses employing 50 or fewer staff, who were eligible for the original wage subsidy, are eligible to apply for the one-off loan (there are common owned group limitations).
  • The loan amount is $10,000 plus $1,800 per equivalent full-time employee (divide the total amount of the wage subsidy you were entitled to claim by $7,029 to compute number of FTE’s), up to a maximum amount of $100,000.

Applications are still to be made via myIR and cannot be made by an agent on behalf of the applicant. A New Zealand business number (NZBN) must also be provided at the time of applying.

Election date of GST ratio method extended

Covid-19 has resulted in IR issuing another due date extension under their new administrative flexibility powers.

This time the extension is with respect to taxpayers who had wished to elect into the GST ratio method for calculating provisional tax payments for the 2021 income year, and due to Covid-19 were unable to file their elections pre 31st March 2020 (section RC 15 requires the requisite election to be notified to IR pre the start of the relevant income year).

The extension applies until 19th August 2020 or the day before the start of the taxpayer’s relevant 2021 income year (whichever is the later), and IR will then give taxpayers ten working days to make the provisional tax payment once they have been notified of their GST ratio, where if the required payments are made within that time frame, any penalties and interest will be remitted.

Foreign residential rental property IS’s finalised

In late April, my AWIR alluded to IR’s closure of the public consultation process, with respect to three draft items focussed on ownership of foreign residential rental properties.

Interpretation Statements IS 20/06 and IS 20/07 (along with the approval item above) have now been issue by IR as the finalisation of those draft items.

IS 20/06 – ‘Tax issues arising from owning foreign residential rental property’, as my earlier commentary outlined, is very generalised in its nature, in essence only identifying ‘consideration issues’ and then referring you to numerous other IR interpretation statements to actually find the answer you are looking for.

IS 20/07 – ‘Application of the financial arrangements rules to foreign currency loans used to finance foreign residential rental property’, is however more detailed in its content, considering for income tax purposes, the application of the financial arrangements (‘FA’) rules to foreign currency loans used to finance overseas rental property. The document discusses first, the two potential, although unlikely, excepted financial arrangement scenarios which would then negate your clients having to consider the application of the FA rules. The document then moves into a discussion outlining the cash-basis persons test (and calculations in this regard), followed with commentary as to how those non-cash basis persons should apply Determination G9A to determine their annual FA income/expenditure, and concluding with a discussion on the Base Price Adjustment and its calculation methodology.

Child support penalty changes in the wind

A recent SOP added to the Child Support Amendment Bill, proposes changes to child support incremental penalties and to simplify the penalty write-off provisions.

With respect to incremental penalties, it is proposed that these would no longer be charged on child support amounts not paid on time, with the amendment applying from 1st April 2021. So, in this regard, incremental penalties will not be applied to any new debt arising on or after 1st April 2021, and with respect to existing unpaid amounts due before 1st April 2021. Those penalties imposed before 1st April 2021 will remain.

The proposal to simplify the write-off provisions, would facilitate the write-off of any penalties imposed from 1st April 2021, when:

  • there was a reasonable cause for the late payment;
  • the late payment was due to the failure of another person to make a deduction;
  • the late payment was due to an honest mistake by the liable parent;
  • an error was made by IR;
  • a person is in serious hardship;
  • it is an inefficient use of IR’s resources to collect the penalty; and,
  • the receiving carer has uplifted the debt, or waived the right to the payment, to which the penalty relates, and a write-off would be fair and reasonable.

To ensure parents who are charged penalties on or before 31st March 2021 are not worse off under the new rules, a “fair and reasonable” penalty write-off provision would be retained that would only be used to write-off penalties charged on or before 31st March 2021.

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