Applying the thin capitalisation rules to active FIFs

(Clauses 44, 45(1), 45(2), 46(3), 47(4)) and 56)

Summary of proposed amendments

The Bill modifies the thin capitalisation rules that apply to investors with CFCs so that these also apply to investors in FIFs that use the attributable FIF income method (i.e. active income exemption) or the section EX 35 Australian exemption. In the absence of such rules there could be an incentive for businesses to reduce their taxable income by stacking additional debt against their New Zealand operations when in fact they are using these funds to equity finance their exempt offshore investments.

Application date

The proposed changes would apply to income years beginning on or after 1 July 2011.

Key features

Amendments are proposed to the thin capitalisation rules so that investors using the attributable FIF income method, or that use the exemption for FIFs resident in Australia, are subject to the same thin capitalisation rules that currently apply to investors in CFCs.

More specifically, the amendments to outbound thin capitalisation rules would apply to New Zealand residents with CFCs or with FIFs for which they use the attributable FIF income method or New Zealand residents that use the section EX 35 exemption for FIFs resident in Australia. Assets from these entities will be included in the worldwide group assets but not in the New Zealand group’s assets for the purposes of determining if the New Zealand group’s debt to asset ratio is below 110% of the worldwide ratio (in which case there is no denial of interest deductions).

Background

One fiscal risk with the active income exemption is that it can create an incentive for businesses to reduce their taxable income by stacking additional debt against their New Zealand operations when in fact they are using these funds to equity finance their exempt offshore investments. This concern was addressed for CFCs through the use of thin capitalisation rules which limit the amount of New Zealand debt to 75% of the investor’s New Zealand assets. A similar risk arises in respect of investors in FIFs that use the active income exemption. The Bill amends the thin capitalisation rules so that they also apply to investors in FIFs that use the active income exemption or the Australian exemption.