Exemption from the outbound rules

(Clause 47(2))

Summary of proposed amendment

Section FE 5(1B)(b) provides an exemption from the thin capitalisation rules for excess debt outbound companies if total interest deductions for the New Zealand group do not exceed $250,000. This exemption is rendered effectively redundant by section FE 6(3)(ac)(ii) which reduces to zero the deductions subject to apportionment under the rules where the finance costs of an outbound entity do not exceed $1 million. Accordingly, it is proposed that section FE 5(1B)(b) is repealed.

Application date

Income years beginning on or after 1 July 2011.

Detailed analysis

Section FE 51B(b) and section FE 6(3)(ac)(ii) provide overlapping exemptions from the thin capitalisation rules for excess debt outbound companies. Because the threshold for the latter exemption is more generous, section FE 51B(b) is now largely redundant and ought to be repealed.

There are some minor differences in scope between section FE 5(1B)(b) and section FE 6(3)(ac)(ii), as noted below. It is not considered that these differences affect the case for a simple repeal of section FE 5(1B)(b).

Section FE 5(1B)(b) sets the $250,000 exemption threshold based on interest deductions under sections DB 6 to DB 8, whereas the $1 million threshold in section FE 6(3)(ac)(ii) also takes account of “FRD” (basically, fixed-rate dividends: see section FE 6(3)(ab)). In this regard, section FE 6(3)(ac)(ii) is less generous than section FE 5(1B)(b) and it is possible that, where fixed-rate equity is used in place of ordinary debt, the latter may provide an exemption where the former does not. However, since the thin capitalisation rules now extend to cover FRD, the approach taken in section FE 6(3)(ac)(ii) is appropriate. Again, this supports the conclusion that section FE 5(1B)(b) can be repealed.

The $250,000 exemption under section FE 5(1B)(b) is not available when the New Zealand group includes an entity with an income interest in a CFC that is deriving rent from land in the CFC’s local jurisdiction. There is no equivalent exclusion from the $1 million exemption under section FE 6(3)(ab), which means that this rule will seldom bite in practice.