Other policy matters

TREATMENT OF SHORT-TERM AGREEMENTS FOR SALE AND PURCHASE UNDER THE FINANCIAL ARRANGEMENTS RULES

(Clause 33B)

Summary of proposed amendment

New section EW 32B adjusts the amount of consideration (payment) that a vendor or purchaser of a short-term agreement for sale and purchase may take into account for the purposes of applying the financial arrangements rules, if they elect to treat the agreement as a financial arrangement.

This means the taxpayer will not be able to claim a deduction under the financial arrangements rules for amounts that are payments for capital or goodwill – for example, the cost of acquiring a contract to provide services or any losses on disposal of such a contract.

Application date

The amendment will apply for a short-term agreement for sale and purchase that a taxpayer elects to treat as a financial arrangement unless the election occurs before 27 September 2012 or the taxpayer has obtained a binding ruling or determination on the tax treatment of the agreement under subpart EW before 27 September 2012.

Key features

An amendment is being made to adjust the amount of consideration that a vendor or purchaser of a short-term agreement for sale and purchase may take into account for the purposes of applying the financial arrangements rules, if they elect to treat the agreement as a financial arrangement.

The amount of consideration that can be taken into account for spreading or undertaking a base price calculation will be limited to debts outstanding under the short-term agreement for sale and purchase. This means taxpayers will not be able to claim a deduction under the financial arrangements rules for either the cost of acquiring the agreement or any losses on disposal of the agreement.

Background

The purpose behind the financial arrangements rules in the Income Tax Act is to account for the income or expenditure on a financial arrangement (the “interest” component) over the term of the arrangement.

The problem under the current financial arrangements rules is that it is possible for taxpayers to receive a deduction for the goodwill component of certain contracts when they are purchased. The rules also allow a deduction for a loss on the sale of onerous contracts.

The manner in which this can be achieved is through electing to treat a short-term agreement for sale and purchase (ordinarily, an excepted financial arrangement under section EW 5(22)) as a financial arrangement under section EW 8.

The following example illustrates the problem:

A company acquires the assets of another company, which includes profitable contracts for the provision of certain future services. The purchase price for the contracts is $5 million, being the present value of estimated future profits from providing services under the contract. Electing that the service contracts be financial arrangements and then applying the financial arrangements rules, a tax deduction of $5 million is available to the purchaser over the life of the contracts, resulting in tax savings of $1.4 million. If the contracts were treated as excepted financial arrangements (as conceptually they should be) the general deductibility rules would treat the amounts as capital (non-deductible) expenditure, just as the sale proceeds to the vendor would usually be capital and therefore non-taxable.

The rationale behind allowing a taxpayer to elect to treat a short-term agreement for sale and purchase as a financial arrangement was to reduce compliance costs by allowing any short-term debt under the agreement to be treated for tax purposes as it is for accounting purposes. The rule was never intended to allow taxpayers to convert what would otherwise be capital sums into deductible amounts.

Accordingly, it is proposed that an amendment be made to the financial arrangements rules to prevent this outcome.

KIWIRAIL

(Clauses 12B, 34B, 57(1B), 57(19C)-(19D), 57(23B), 57(25B-25E), 57B, 74(2)-(3) and 94B)

Summary of proposed amendments

In June 2012 the KiwiRail group announced a restructure of its balance sheet, to reflect a standard commercial valuation approach. Under the new structure, a new state owned enterprise will own and operate the rail and Interislander businesses under the existing KiwiRail brand. Crown land held for rail purposes will be retained by the New Zealand Railways Corporation and made available for use by KiwiRail.

Supplementary Order Paper No. 167 contains several technical amendments to support this restructure, to ensure that the restructure does not impose additional tax liabilities, and to provide for the tax position of the new State Owned Enterprise going forward.

Application date

The amendments will apply from 31 December 2012, being the date of the restructure.