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Inland Revenue

Tax Policy

Chapter 7 - Generally accepted accounting practice – GAAP

7.1 The Income Tax Act 2004 uses “generally accepted accounting practice” (GAAP) repeatedly. It is defined in section OB 1 as the definition in section 3 of the Financial Reporting Act 1993.[16] This definition has not changed as a result of IFRS, so it does not need to be amended.

7.2 What constitutes GAAP, however, will change as a result of the adoption of IFRS. For example, internally generated goodwill will no longer be recognised, thereby reducing reported total assets. On the other hand, IFRS requires the recognition of derivative assets and liabilities at their fair values and deferred tax assets/liabilities that were previously not recognised. It is therefore likely that IFRS will have a mixed impact on the balance sheet items.

7.3 In our view, the changes brought about by IFRS should automatically be incorporated into the tax legislation where the concept of GAAP is relied upon. In these circumstances, the use of GAAP in the tax legislation is ambulatory – meaning that its definition in tax law will change in accordance with changes in GAAP’s constituent parts. Therefore no changes to tax legislation are suggested.

The use of GAAP in tax legislation and IFRS

7.4 A number of tax consequences may arise as a result of IFRS because financial items reported for financial reporting purposes under GAAP are used in tax legislation.

7.5 An example of tax consequences that could arise from the adoption of IFRS is in the application of thin capitalisation rules.[17] Thin capitalisation rules limit interest deductions that some taxpayers can claim for taxation purposes if their debt level exceeds a certain level. The maximum amount of allowable debt under these thin capitalisation rules is determined with reference to an asset base calculated under GAAP. As such, the adoption of IFRS is likely to affect the maximum amount of interest that will be allowed for these entities.

7.6 Other areas where GAAP has been used in the tax legislation include the following:

  • The calculation of deemed underlying foreign tax credits and underlying foreign tax credits rely on a tracking account balance and after-income tax earnings that are calculated on the basis of GAAP.
  • Section CB 27 recognises an excess amount paid when assuming employment income obligations under a sale of business in line with GAAP.
  • The deferred deduction rule in section GC 29 requires the total deductions, assessable income and cost of property of a group of persons that may be involved in arrangements where money is not at risk to be calculated on a consolidated basis by eliminating intra-group balances in accordance with GAAP.
  • Taxpayers may use the accounting profits method to calculate their foreign investment fund income under section EX 40 if the net after-tax accounting profits or losses of the fund are calculated under GAAP.
  • When private insurers maintain reserves for claims relating to events covered by the Accident Insurance Act 1998, section EZ 27 recognises the difference between the closing value and opening value of the reserve as income or deduction, provided that the reserve is calculated having regard to GAAP, generally accepted actuarial practice and the present value of expected future payments.
  • Section CD 41 requires the un-repatriated income balance, calculated using total shareholders’ funds in accordance with GAAP, of a controlled foreign company to be non-negative.
  • “Controlled petroleum mining company”, “controlled petroleum mining holding company”, “controlled petroleum mining trust” and “controlled petroleum mining holding trust” are all defined in section OB 1 using net assets as specified in the entities’ account prepared under GAAP.
  • Sections DP 10 and DB 22 allow certain costs of timber and specified minerals to be deducted when the amount is treated as a cost by the taxpayer under GAAP for financial reporting purposes.

7.7 No legislative changes to these areas appear to be necessary because of the ambulatory nature of the use of GAAP in tax legislation. Even so, submissions are invited from taxpayers on specific areas where the adoption of IFRS may create unexpected tax consequences. Legislative changes to deal with these consequences may then be considered.


16 Financial statements and group financial statements comply with GAAP only if they comply with applicable financial reporting standards, and in relation to matters for which no provision is made in applicable financial reporting standards and that are not subject to any applicable rule of law, accounting policies that (i) are appropriate to the circumstances of the reporting entity; and (ii) have authoritative support within the accounting profession in New Zealand.

17 Different thin capitalisation rules apply to foreign controlled entities in general, New Zealand banking groups and conduit relief companies. The concept of “generally accepted accounting practice” is used in these rules in various ways to determine the maximum allowable debt or minimum capital requirement (for New Zealand banking groups).