New Zealand Thin Capitalisation Rules, 2012

According to regulation of New Zealand Inland Revenue Department, it is now more important than ever for you to monitor your thin capitalisation calculations, with the safe-harbour threshold reducing from 75% to 60% from the 2012 tax year.

The following short checklist of common errors and current issues should also assist compliance:

  • Debts and assets must be valued in New Zealand dollars for the safe-harbour calculation. Unexpected foreign exchange fluctuations, of the nature seen in the current market, have the potential to cause unanticipated breaches of the safe-harbour threshold. Currency conversions are permissible at the spot rate on your measurement date(s) or at the forward rate applicable on the first day of the year. These options and exchange fluctuations need to be incorporated into your regular reviews.
  • In a number of circumstances, the valuation of a financial arrangement for tax purposes can vary significantly from the value of debt recorded for the instrument in your financial statements. It’s important that you understand the implications of the relevant tax rules on your financial arrangements.
  • Assets are valued by reference to generally accepted accounting practice. Companies adopt accounting policy changes for a wide range of reasons and often these changes have no tax impact. However, where your debt/asset ratio sits near the safe-harbour threshold, it’s important that the personnel responsible for tax compliance keep abreast of accounting policy changes, especially those relating to asset valuations.
  • The recent adoption of the International Financial Reporting Standards (“IFRS”) provides additional safe-harbour headroom for some taxpayers on the revaluation of property assets. For others, debt/asset ratios were adversely impacted through asset impairment adjustments (for example, intangible property impairments). To the extent that taxpayers opted into the IFRS revaluation model on the upward market, the recent current market devaluation of many assets could again result in unanticipated breaches of the safe-harbour threshold. Be wary of any creative accounting solutions, especially in respect of intangibles.
  • The thin capitalisation rules require consistent treatment for a number of items such as controlling interests for grouping purposes and applicable measurement dates. It’s important that you are aware of previous practices and elections made, particularly where there has been a change in personnel preparing the calculations.
  • When you calculate your debt/asset ratio on a group basis, consideration must be given to the impact of any movements in the group structure during the year.
  • Non-resident withholding tax still applies to interest paid, even if a deduction is not available under the thin capitalisation rules.
  •  When your debt/asset ratio is near the safe-harbour threshold, a thin capitalisation review based solely on management accounts will not be sufficient. To be effective, a review must consider the rules applicable in your specific circumstances, and in light of current market movements.

As a matter of routine, Inland Revenue Department does not deny interest deduction to taxpayers carrying high debt levels that satisfy the thin capitalisation rules. However, where a loan transaction would not have taken place in the open market, then the commerciality of the financing arrangement between associated parties may be called into question. In such extreme circumstances, serious consideration would be given to call upon the general anti-avoidance provision.

November 14th, 2011