Other remedial matters

• Spreading of income for income derived from land
• Mixed-use assets – remedial amendments
• Loss grouping contingent on group loss company satisfying its liabilities for deductible expenditure
• Remitted amounts on discharge from bankruptcy
• Serious hardship
• Unacceptable tax position
• Clarification of new due date for payment of tax
• References to loss attributing qualifying companies
• Working for Families tax credits
• Child support remedials
• Tax Administration Act 1994: cross-references to sections 108 and 109
• Trusts that are local and public authorities
   

SPREADING OF INCOME FOR INCOME DERIVED FROM LAND

(Clauses 58 and 59)

Summary of proposed amendment

Sections EI 7 and EI 8 are being amended to ensure that if a taxpayer chooses to apply these sections to income derived in the 2015–16 or a later income year, the income is spread evenly over the period of time referred to in those sections.

Transitional provisions apply to income derived before the 2015–16 income year if the taxpayer has previously chosen to apply either section EI 7 or section EI 8. The transitional provisions apply to that unallocated income as follows:

• If the period of time referred to in those sections has not expired before the start of the 2015–16 income year, that unallocated income is spread evenly over the number of years remaining in that period, beginning with the 2015–16 income year.
• If the period of time referred to in those sections has expired before the start of the 2015–16 income year, that unallocated income is allocated to the 2015–16 income year.

Application dates

The amendment applies to income derived in the 2015–16 and later income years if the taxpayer chooses to apply either section EI 7 or section EI 8.

The transitional provisions apply to income derived before the start of the 2015–16 income year if the taxpayer has previously chosen to apply either section EI 7 or section EI 8.

Background

Sections EI 7 and EI 8 of the Income Tax Act 2007 provide relief to taxpayers who derived income from land, either:

• in the nature of fines, premiums or from a payment of goodwill on the grant of a lease (section EI 7); or
• as a result of a compulsory disposal of land to the Crown (section EI 8).

Before self-assessment legislation enacted in 2001, the corresponding provisions to sections EI 7 and EI 8 in the Income Tax Act 1994 required taxpayers to follow the Commissioner’s practice and spread that income evenly over the number of years referred to in the relevant sections (sections EB 2 and EN 4 of the Income Tax Act 1994).

Following the enactment of self-assessment legislation and subsequent rewriting of the two provisions into the Income Tax Act 2004, consistent with the self-assessment process, it became arguable that the Commissioner’s discretion was replaced with a choice for taxpayers for the spreading of the income. That choice did not require the income to be spread on an even basis. However, the Commissioner’s practice has generally been followed.

The proposed amendments to sections EI 7 and EI 8 serve to clarify that the income is to be spread on an even basis over the years referred to in both of those sections.

Detailed analysis

The policy for sections EI 7 and EI 8 is to provide relief for taxpayers who derived income from land in certain circumstances. The relief granted is to permit the taxpayers to spread the income evenly across the current and certain future income years instead of returning the income in the year it is derived. This relief applies to income derived either:

• in the nature of fines, premiums or from a payment of goodwill on the grant of a lease (section EI 7, Income Tax Act 2007); or
• from a compulsory disposal of land to the Crown (section EI 8, Income Tax Act 2007).

The amendments to sections EI 7 and EI 8 of the 2007 Act clarify that the taxpayer may choose between allocating income to which the sections apply on the default basis (section BD 3 of the Income Tax Act 2007 refers), or allocate the income to the number of years referred to in sections EI 7 or EI 8, as appropriate.

If the taxpayer chooses to spread the income forwards:

• income derived from land for payments in the nature of fines, premiums or goodwill on the grant of a lease is allocated evenly over the income year the income is derived in and the five immediately succeeding income years; and
• income derived from a compulsory disposal of land to the Crown is allocated evenly over the income year the income is derived in and the three immediately succeeding income years.

Both of these amendments apply to income derived in the 2015–16 income year and later income years.

Transitional issues

The amendments to sections EI 7 and EI 8 apply to income derived from and including the 2015–16 income year. Therefore, it is necessary to ensure that all income derived before the 2015–16 income year that has not been fully allocated at the end of the 2014–15 income year is:

• allocated evenly to income years from 2015–16 onward, while ensuring that the income spread does not exceed the time period referred to in sections EI 7 or EI 8; and
• if the period of time referred to in the relevant provision has expired before the start of the 2015–16 income year, to allocate that remaining amount of income to the 2015–16 income year.

Transitional provisions apply to sections EI 7 and EI 8 for income derived before the beginning of the 2015–16 income year for which:

• the taxpayer has chosen to apply section EI 7 or section EI 8 (as appropriate); and
• all of that income has not been allocated to an income year before the beginning of the 2015–16 income year.

MIXED-USE ASSETS – REMEDIAL AMENDMENTS

(Clauses 47, 48 and 49)

Summary of proposed amendments

The bill proposes several minor remedial changes to the mixed-use asset rules in subpart DG and section DZ 21 of the Income Tax Act 2007.

Application date

An amendment to the mixed-use asset associated persons rule and amendments to legislative examples apply for the 2013–14 and later income years (that is, the beginning of the mixed-use asset regime).

An amendment to the depreciation rollover relief provision applies generally for the
2013–14 and later income years. However, the amendment does not apply in relation to an asset when a shareholder who acquires the asset disposes of it before the date of the bill’s introduction.

Key features

The proposed amendments fall into three categories and are all consistent with the original policy intent of the rules:

• an amendment to the mixed-use asset specific associated persons rule in section DG 6;
• minor corrections to several examples in the legislation; and
• an amendment to the depreciation rollover relief provision that applies when a company distributes its mixed-use asset to one or more shareholders in the 2013–14 income year. The amendment is to ensure that depreciation recovery income is ultimately crystallised if the shareholder sells the asset for more than its adjusted tax value (taking into account depreciation claimed by the company).

Background

The mixed-use asset rules were introduced as new subpart DG and related provisions by the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013.

The rules generally apply from the 2013–14 income year to prevent excess deductions where an asset is used partly for business and partly for private purposes.

Mixed-use asset specific associated person rule

The concept of association is key to the mixed-use asset rules. Section DG 6 modifies the general associated persons rules. Specifically, section DG 6(a) deems a shareholder who holds 5 percent or more of the shares in a company to be associated with that company. It was intended to remove this provision from the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Bill at the Finance and Expenditure Committee stage, however it was not removed before enactment. Accordingly, this bill proposes removing section DG 6(a) with application for the 2013–14 and later income years. Section DG 6(b), which deems a shareholder to be associated with a company if the person's share in the company gives them a right to use a mixed-use asset owned by the company, will remain.

Corrections

Several examples in the legislation contain minor errors that need to be corrected. These are summarised below with the proposed corrections bolded for emphasis.

Section	Example and correction	Why correction is needed
DG 11	Example Holiday Home Ltd holds a holiday home with a rateable value of $200,000. The company has debt of $40,000, with associated interest expenditure of $4,000. Since the debt value is less than the asset value, all the interest expenditure must be apportioned (section DG 11(3)). Boat Ltd has a charter boat whose adjusted tax value cost is $60,000. The company has debt of $100,000, with associated interest expenditure of $10,000. Since the debt value is more than the asset value, the company must apportion interest expenditure of $6,000 (section DG 11(4)-(6)). The formula is $10,000 × ($60,000/$100,000) = $6,000.	Under section DG 11(8)(b), the appropriate “asset value” for property other than land is its adjusted tax value, not its cost.
DG 16	Example David has a city apartment with a rateable value of $300,000. He rents out the apartment and also uses it privately. He receives market rate rental of $4,000 from non-associates, and $6,000 from associates. David's total allowable expenditure, under sections DG 7, DG 8 and DG 11, is $15,000. The income from associates is exempt under section CW 8B, and is ignored. David therefore has asset income of $4,000 and deductions of $15,000, giving rise to an excess of expenditure over income of $11,000. Since David's income from non-associates is less than 2% of the apartment's rateable value, the excess expenditure of $11,000 $5,000 is denied as a deduction. The amount denied may be allocated to a later income year under section DG 17.	The excess expenditure in this example is $11,000 not $5,000. The proposed amendment also provides additional explanation of the calculations to assist readers.
DG 17	Example, continued from section DG 16 In the following income year, David derives $10,000 from renting his city apartment at market rates to a non-associate. David's total allowable expenditure, under sections DG 7, DG 8, and DG 11, is $8,000. He also has expenditure of $11,000 $5,000 quarantined from the previous income year. David is able to deduct $2,000 of that quarantined expenditure. The remaining $9,000 $3,000 continues to be quarantined and may be allowed as a deduction for in a later income year.	Carry-through from correction of section DG 16.
DG 18	Example Aircraft Ltd owns an aircraft to which the rules in this subpart apply; the income derived from the asset in the current year is less than 2% of the cost of the aircraft. The company has calculated an outstanding profit balance of $12,000 after the application of section DG 16. Aircraft is 100% owned by Parent Ltd, which has apportioned interest expenditure of $5,000 calculated under section DG 12. Parent has 2 equal shareholders, Alisa who has apportioned interest expenditure of $8,000, and Hamish who has apportioned interest expenditure of $1,000, both calculated under section DG 14. Parent must apply section DG 18 first, and is not required to quarantine any of its interest expenditure; the outstanding profit balance is reduced to $7,000 ($12,000 – $5,000). Alisa’s and Hamish’s share of the outstanding profit balance is $3,500 each ($7,000 $7,500 x 50%). Alisa must quarantine $4,500 of interest expenditure ($8,000 – $3,500); Hamish is not required to quarantine any interest expenditure.	Correction of numeric error.
DG 19	Example, continued from section DG 18 In the following income year, Aircraft has calculated an outstanding profit balance of $16,000 after the application of section DG 18. Section DG 19 does not apply to Parent or Hamish Alisa because they have no previously quarantined interest expenditure. However, the section does apply to Alisa Hamish because she he has $4,500 of quarantined interest expenditure from the previous year. Alisa’s Hamish’s current year apportioned interest expenditure is $7,000, calculated under section DG 14, and her his share of the outstanding profit balance is $8,000 ($16,000 x 50%). Alisa Hamish is allowed a deduction for $1,000 of previously quarantined expenditure ($8,000 – $7,000). His Her remaining quarantined expenditure is $3,500 ($4,500 – $1,000).	Correction of names.
DZ 21	Example On 31 March BoatCo has a boat with an acquisition cost of $85,000. on 31 March 2013 which The boat meets the various requirements set out in subpart DG. All the shares in BoatCo are owned by Michelle. The boat has a market value of $75,000, and an adjusted tax value of $55,000. BoatCo transfers the boat to Michelle without payment (which is treated as a dividend of $75,000). For depreciation purposes, BoatCo is treated as disposing of the boat for $55,000, and Michelle is treated as acquiring it for $55,000 $85,000, and having been allowed a deduction of $30,000 for depreciation loss in past income years.	Amendments to ensure the example is consistent with the change to section DZ 21 in the bill.

Depreciation recovery income for assets transferred in the 2013–14 income year under section DZ 21

There is a one year transitional period (2013–14 income year) in which companies that own mixed-use assets can transfer those assets to their shareholders without triggering depreciation recovery income (this is referred to as “rollover relief”). The rollover relief provision is contained in section DZ 21. Section DZ 21(2) treats the transfer as if it were a disposal and acquisition for an amount equal to the adjusted tax value of the asset on the date of the transfer.

This means that there is no depreciation recovery income to the company when it transfers the asset to its shareholder(s) because the consideration deemed to have been received is the same as the asset’s adjusted tax value.

If the shareholder later sells the asset for more than its adjusted tax value, the policy intention is that depreciation recovery income will be crystallised at this point. To ensure this policy objective is achieved the bill proposes to treat the shareholder as stepping into the shoes of the company for depreciation purposes – that is, by having:

• acquired the asset on the date on which the company acquired it for an amount equal to the amount the company paid to acquire it;
• used the asset for the purposes for which the company used it;
• used the depreciation method used by the company in relation to the asset; and
• been allowed a deduction for an amount of depreciation loss that the company has been allowed since the company’s acquisition of the asset.

As well as including all depreciation deductions the company has previously been allowed in the depreciation recovery calculation, this amendment also ensures that any change in use or depreciation method by the shareholder is captured and the shareholder has the correct depreciation cost base.

 

LOSS GROUPING CONTINGENT ON GROUP LOSS COMPANY SATISFYING ITS LIABILITIES FOR DEDUCTIBLE EXPENDITURE

(Clauses 14, and 15(2), (3))

Summary of proposed amendment

Changes are being made to the loss grouping rules to correct an unintended consequence of the rewrite of the Income Tax Acts. The bill proposes a number of amendments to confirm the correct policy intent.

Key features

Section CG 2 no longer applies to a group loss company if:

• the group loss company has previously made a tax loss available to another company in the same group of companies under the loss grouping rules; and
• the group loss company in the same group of companies as the group profit company has unsatisfied liabilities for deductible expenditure included in those past tax losses made available under the loss grouping rules; and
• the group loss company in the same group of companies is liquidated; or
• either the group profit company or the group loss company has left the group and for both cases, the group loss company is insolvent, in receivership or in liquidation at that time.

Instead, new sections CG 2C and CG 2D will apply in these circumstances. These amendments confirm the long standing policy that the grouping of tax under the loss grouping rules is contingent on the group loss company fully satisfying its liabilities relating to past deductible expenditure included in the group loss company’s tax losses. If the sections apply, the group profit company derives income equal to the amount of certain unsatisfied liabilities of the group loss company.

New section CG 2C will apply if the group loss company has been struck off the register of companies.

New section CG 2D will apply if the profit company and the group loss company are no longer part of the same group of companies and:

• the group profit company has received the benefit of group tax losses from the group loss company; and
• at the time either company leaves the group, the group loss company is insolvent, in receivership or has been placed in liquidation (but not yet struck off the register of companies).

Application date

New sections CG 2C and CG 2D will apply from the date of introduction of the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill.

Background

Since the enactment of section 191(7B) of the Income Tax Act 1976, the grouping of tax losses has been contingent on the group loss company fully satisfying its liabilities for deductible expenditure included in its tax losses made available to another company in the same group of companies.

This policy was given effect in the Income Tax Act 1994 by the interaction of sections CE 4, IE 1(4) and IG 2(9) which permitted the Commissioner to amend an assessment of a group profit company to reduce the amount of grouped tax losses to the extent the group loss company had not satisfied all liabilities giving rise to deductions included in the grouped tax losses. The effect of the interaction of the predecessors of these three rules was confirmed by the Court of Appeal in the case of Hotdip Galvanisers (Christchurch) Ltd v CIR (1999) 19 NZTC 15,337.

These three provisions from the Income Tax Act 1994 were rewritten into section CG 2 of the Income Tax Act 2004, and included a policy change relating to the timing of the recovery of amounts relating to remitted or cancelled debts for past deductible expenditure. Section CG 2 was re-enacted unamended into the Income Tax Act 2007.

Under current section CG 2, a remitted or cancelled debt for past deductible expenditure is treated as income derived in the year the debt is remitted (for example, on the company being struck off or liquidated). This policy change was to better align the adjustment (for remitted or cancelled liabilities relating to past deductible expenditure) with self-assessment by eliminating the need to amend past assessments.

However, this policy change has also resulted in in an unintended consequence for the loss grouping rules. The unintended consequence is that section CG 2 does not give effect to the policy that the benefit of the loss grouping rules is contingent upon the group loss company fully satisfying its liabilities for past deductible expenditure included in its tax losses.

Detailed analysis

Reduction in benefit of group tax losses under the Income Tax Act 1994

The interaction of sections IG 2(9), IE 1(4) and CE 4 of the Income Tax Act 1994 permitted the Commissioner to amend an assessment of a group profit company to reduce the amount of losses made available under the loss grouping rules. This amended assessment of a group profit company could be made for any income year – it was not limited by the four-year time bar that normally applies to income tax assessments. However, the reduction in the benefit of grouped tax losses was limited to the amount of remitted or cancelled debts of the group loss company.

The decision of Hotdip Galvanisers (Christchurch) Ltd v CIR (1999) 19 NZTC 15,337, the Court of Appeal confirmed that, under the 1976 Act’s corresponding provision to section IG 2(9) of the 1994 Act:

• the Commissioner was entitled to amend an assessment of a group profit company in a group that received the benefit of tax losses from a group loss company, if the group loss company’s deductible expenditure forming part of the loss offsets was remitted or cancelled; and
• the provision did not require the Commissioner to first re-assess the group loss company for the remission adjustment; and
• the Commissioner was not limited by the four-year time bar that normally applies to income tax assessments.

Policy change in Income Tax Act 2004

In rewriting sections CE 4 and IE 1(4)(d) of the Income Tax Act 1994 into section CG 2 of the Income Tax 2004, it was considered desirable to place the timing of the effect of the remission on a basis consistent with self-assessment. This policy change resulted in the timing the effect of the remission on the income tax liability to the year of remission in contrast to the amendment of previous years’ assessments under the former law.

Under the 2004 Act and the 2007 Act, remitted or cancelled debts for past deductible expenditure are treated as income derived in the year the debt is remitted (for example, on the company being struck off or liquidated).

Unintended consequence

The remission income rule in the 2004 and 2007 Acts applies only to the taxpayer that had incurred the debt. While this rule technically applies to a group loss company that has been liquidated, it has no consequence for a company that has been struck off the register of companies. A company struck off the register does not exist, and no valid assessment for tax on income arising under section CG 2 can be made (absent the company being restored to the register).

Under current law, section CG 2 does not apply to a group profit company if a group loss company cannot be assessed for remission income. This has resulted in the unintended consequence that there is no longer a legislative provision to reduce the benefit of past grouped tax losses from group profit companies if debts of the group loss company are remitted or cancelled.

The new sections CG 2C and CG 2D give effect to the policy that the retention of the benefits of loss grouping is contingent on the group loss company:

• fully satisfying its liabilities for deductible expenditure included in a net loss; and
• that net loss has been included in a tax loss subsequently made available under the loss grouping rules to another company in the same group of companies.

Group loss company going into liquidation

Section CG 2C applies to a group profit company in a group of companies if:

• the group profit company has received the benefit of tax losses under the loss grouping rules from a group loss company in the same group of companies;
• the group loss company is removed from the register of companies (and not subsequently restored to the register);
• the group profit company and the group loss company are in the same group of companies immediately prior to the removal of the group loss company from the register of companies;
• at the time the company is removed from the register of companies, the group loss company has unsatisfied liabilities for past deductible expenditure relating to tax losses made available to the group profit company under the loss grouping rules; and
• the removal of the group loss company from the register of companies occurs after the tax loss has been made available to another company under the loss grouping rules.

On removal from the register of companies, there is no longer a company in existence to meet those unpaid unsatisfied debts. In the absence of this amendment section, section CG 2 would treat the group loss company as deriving income equal to the amount of the unsatisfied liability for prior deductible expenditure, but no valid assessment could be made for income tax on this income without restoring the company to the register.

Therefore, section CG 2 does not apply and instead section CG 2C will apply. The section treats the group profit company as deriving income equal to the remitted or cancelled liability (due to the operation of the Companies Act 1993) for deductible expenditure incurred by the group loss company. That income is treated as derived on the day the group loss company is removed from the register of companies.

The amendment in section CG 2C ensures that the 2007 Act will have the same effect as the interaction of sections CE 4, IE 4 and IG 2(9) of the Income Tax Act 1994, provided that the group loss company and the group profit company are in the same group of companies immediately prior to the group loss company being removed from the register of companies.

New section CG 2C will not apply to a debt arising under a financial arrangement, consistent with section CE 4 of the Income Tax Act 1994.

Group loss company or group profit company leaving the group

A number of commercial considerations mitigate against section CG 2C applying to a group profit company if the group profit company and the group loss company are not in the same group of companies when the group loss company is removed from the register of companies.

These considerations include:

• The management of the affairs of the group loss company would differ from the management of the affairs of the group profit company. A decision to remove the group loss company from the register of companies by the new owners need not consider the implications for that group profit company given they are no longer part of the same group of companies.
• A tax obligation for a company arising from the liquidation of a group loss company that is no longer part of the same group as the group profit company (and beyond the management of the group’s affairs) can impact adversely on the group profit company’s balance sheet, and also potentially affect existing financing arrangements.

However, if a group loss company is insolvent, when either it or a group profit company exits the group, it can be assumed that management would be aware at that time:

• if an insolvent group loss company has not satisfied its debts giving rise to tax losses transferred under the loss grouping rules; and
• there is a strong risk that the insolvent loss group company might not subsequently satisfy its debt obligations for past deductible expenditure included in the tax losses of the group loss company.

Under new section CG 2D the profit company must forfeit the benefit of past grouped tax losses to the extent the insolvent loss group company has unsatisfied liabilities for past deductible expenditure. However, if the group loss company satisfies its unpaid debts for past deductible expenditure before the exit time without giving a preference to one creditor over another, section CG 2D would not apply.

New section CG 2D will not apply to a debt arising under a financial arrangement, consistent with section CE 4 of the Income Tax Act 1994.

Voidable preference

Under new section CG 2D, either the profit company will forfeit some or all of the benefit of past grouped tax losses or the group loss company will repay the relevant debts.

However, because solvency is measured at a point in time, an issue arises under the voidable preference rules in the Companies Act 1993. It is possible for a payment by the group loss company to satisfy an unpaid liability for past deductible expenditure to be a voidable preference under the Companies Act 1993. If the payment is a voidable transaction (a creditor is repaid in preference to other creditors), a liquidator could recover the payment, resulting in the liability being reinstated.

The Commissioner has the discretion to ignore payments of the group loss company if those payments could constitute a voidable transaction under the Companies Act 1993. If the Commissioner exercises this discretion, an amended assessment will be made for the group profit company for income derived under new section CG 2D.

 

REMITTED AMOUNTS ON DISCHARGE FROM BANKRUPTCY

(Clauses 14 and 15(1))

Summary of proposed amendment

This amendment provides that section CG 2 will not apply to a bankrupt on discharge from bankruptcy. At present, section CG 2 of the Income Tax Act 2007 applies to a person discharged from bankruptcy and can result in a discharged bankrupt deriving assessable income on the full amount of remitted debts on discharge (remission income). This conflicts with the “fresh start” principles of insolvency law on discharge from bankruptcy.

New section CG 2B applies to a person discharged from bankruptcy. This new provision provides for remission income sufficient to reduce the benefit of past deductions to the extent liabilities incurred for those deductions are remitted or cancelled. Instead of section CG 2 applying to debts remitted on discharge from bankruptcy, new section CG 2B will apply to limit the remission income from those debts to the lesser of:

• the total amount of debt remitted on discharge from bankruptcy that relates to past deductible expenditure; and
• the bankrupt’s loss balance at the end of the tax year preceding the discharge from bankruptcy after taking into account any reduction in the loss balance made by the Commissioner under section 177C of the Tax Administration Act 1994.

Application date

The amendment applies from the commencement of the amending Act.

Background

On 3 October 2011, the Minister of Revenue issued a press release calling for submissions on some remedial items. One of those remedial items related to the Commissioner’s powers, under section 177C of the Tax Administration Act 1994, relating to a taxpayer in bankruptcy, to:

• write off uncollectible amounts of tax owing by the bankrupt; and
• make related consequential adjustments to the taxpayer’s tax losses carried forward (“the loss balance”).

Submissions on this remedial item raised two issues relating to the remission of most debts when a bankrupt is discharged from bankruptcy:

• Insolvency law remits most debts of a bankrupt at the time of discharge. One issue was whether it was appropriate for section CG 2 to recover all of the past deductions (as remission income of the taxpayer) if debts incurred for those past deductions:
  a) remained unpaid on the taxpayer being adjudged bankrupt; and
  b) were subsequently remitted on discharge from bankruptcy.
• It was unclear whether remission income under section CG 2 is taken into account in the calculation of the bankrupt’s taxable income before or after being discharged from bankruptcy. This uncertainty potentially impacts on the Commissioner’s powers to write off remission income arising on discharge from bankruptcy against a loss balance of the bankrupt.

Detailed analysis

Section CG 2 of the Income Tax Act 2007 was re-enacted without change from the Income Tax Act 2004. Section CG 2 of the Income Tax Act 2004 corresponded to sections CE 4 and IE 1(4)(d) of the Income Tax Act 1994.

Section CG 2 applies to a person:

• who has been allowed a deduction for an amount the person is liable to pay;
• that liability is later remitted or cancelled (but not if the remission or cancellation is a dividend); and
• the financial arrangement rules do not require a base price adjustment to be made for that remission or cancellation.

The potential application of section CG 2 to a bankrupt on discharge from bankruptcy is an unintended consequence arising from a policy change made in rewriting section CE 4 of the Income Tax Act 1994. This policy change related to the timing of income from debt remissions to make the operation of the debt remission rule more consistent with self-assessment principles.

Effect of law under the Income Tax Act 1994

Before the enactment of the Income Tax Act 2004, a debt remission of this nature would have resulted in the Commissioner amending the income tax assessment for the tax year in which the deduction was incurred (section CE 4 of the Income Tax Act 1994). This amended assessment could be made for any income year – it was not limited by the four-year time-bar that normally applies to the amendment of income tax assessments. However, the amount of the amended assessment to reduce past tax losses was limited to the amount of remitted or cancelled debts of the bankrupt.

Under the Income Tax Act 1994, an amended assessment of the income tax liability for an earlier income year by the Commissioner would have resulted in either:

• a reduction in the person’s loss balance at the end of that earlier tax year; or
• an increased income tax liability being assessed for that earlier tax year.

Policy change in Income Tax Act 2004

In rewriting section CE 4 of the Income Tax Act 1994 as section CG 2 of the Income Tax 2004, it was considered desirable to place the timing of the effect of the remission on a basis consistent with self-assessment. This policy change resulted in the timing the effect of the remission in the year of remission in contrast to the amendment of previous years’ assessments under the former law.

Amendment to section CG 2, and new section CG 2B

The application of section CG 2 to a bankrupt on discharge from bankruptcy conflicts with the “fresh start” policy of insolvency law for a discharged bankrupt. The amendment to section CG 2 ensures that it does not apply on discharge from bankruptcy. Instead, the new section CG 2B is to apply to a person discharged from bankruptcy.

If a person discharged from bankruptcy does not have a loss balance at the end of the tax year preceding the year in which the discharge occurs, that person will not have remission income under either of section CG 2 or section CG 2B.

If a person discharged from bankruptcy has a loss balance at the end of the tax year preceding the year in which the discharge occurs, section CG 2 does not apply but section CG 2B applies to provide that the person has income equal to the lesser of:

• the total amount of debts remitted which relate to past deductions; and
• the person’s loss balance at the end of the tax year preceding the year of discharge (after taking into account any reduction in that loss balance by the Commissioner under section 177C of the Tax Administration Act 1994).

Income derived under section CG 2B is treated as derived on the first day of the income year in which the person is discharged from bankruptcy. This income is included in the calculation of the person’s taxable income for the year of discharge:

• effectively reducing the benefit of the loss balance of the taxpayer brought forward from the previous year; and
• ensuring that a discharged bankrupt does not have an income tax liability for debts discharged in bankruptcy.

 

SERIOUS HARDSHIP

(Clauses 128(4) and 153 to 157)

Summary of proposed amendments

Amendments are made being made to allow the Commissioner, in appropriate circumstances, to bankrupt taxpayers, who are in serious hardship and to ensure the reasons why the debt arose is not a factor in determining whether the taxpayer is in serious hardship. These amendments ensure that the legislation is consistent with Inland Revenue’s current operational practice.

Application date

The amendments will apply from the date of enactment.

Key features

The bill will clarify the meaning of “serious hardship” and ensure that factors that give rise to the taxpayer not being able to pay the outstanding tax are not taken into account when determining whether or not the taxpayer is in serious hardship.

The bill also clarifies that the Commissioner of Inland Revenue can, in appropriate circumstances, bankrupt taxpayers, when they are in serious hardship.

Background

In 2003, the debt and hardship rules were introduced. Under the rules the Commissioner must maximise the recovery of outstanding tax from a taxpayer and deal with cases in an efficient manner. However, the Commissioner may not recover to the extent that recovery is an inefficient use of the Commissioner’s resources or it would place a taxpayer, who is a natural person (individual), in serious hardship.

The rules provide incentives for taxpayers who are having problems paying their tax to contact Inland Revenue and discuss the options available to them. The best option is always payment of the full amount on or before the due date. If that is not possible, taxpayers can enter an instalment arrangement and pay the debt off over time. If the debt cannot be paid off over time, the Commissioner has a discretion under which she can write off tax. In addition, the Commissioner must write off the tax that is not collected if the taxpayer is bankrupted, liquidated or their estate has been distributed. The Commissioner’s practice is to bankrupt taxpayers who cannot pay in appropriate circumstances – for example, when it is considered the write-off would have an adverse effect on taxpayers’ perceptions of the integrity of the tax system.

Following a review of the legislation, an alternative view of the rules has been raised which has two related implications.

The first implication is that bankruptcy is a recovery action and at the point that any further recovery action would cause serious hardship, bankruptcy, along with any other recovery action, is prohibited. Therefore, the Commissioner could not bankrupt a taxpayer when the taxpayer is facing serious hardship.

Inland Revenue’s current view is that bankruptcy does not place or cause a taxpayer to be in serious hardship. This is consistent with the policy intent; the Official Assignee takes over the bankrupt’s affairs and ensures they do not suffer serious hardship.

The second implication arises from the additional view that in determining whether a taxpayer is in serious hardship, Inland Revenue must first consider how the debt arose. For example, if the taxpayer’s debt arose from the taxpayer enjoying goods of an expensive nature, the taxpayer would not be in serious hardship and Inland Revenue could recover the debt.

This view is at odds with the way in which Inland Revenue applies the debt and hardship rules and can result in adverse outcomes for taxpayers. The view is also inconsistent with the policy intention of the rules which is to protect taxpayers from being placed in serious hardship as a result of recovery actions taken by Inland Revenue.

Inland Revenue’s current approach is that when a taxpayer applies for financial relief, Inland Revenue determines whether the taxpayer can pay the debt, or whether paying part or all of the debt would place the taxpayer in serious hardship. The cause of the outstanding tax is not taken into account in determining serious hardship as the alternative would require. If paying the debt would place the taxpayer in serious hardship, Inland Revenue then considers how best to deal with the debt, and in some cases writes off the debt. In some cases the taxpayer would be bankrupted and in other cases the debt would remain. In deciding which action to take, Inland Revenue will at this step consider how the debt arose and the need to maintain the integrity of the tax system.

 

UNACCEPTABLE TAX POSITION

(Clause 146)

Summary of proposed amendment

An amendment to the unacceptable tax position penalty will clarify that the penalty does not apply to shortfalls that arise in respect of GST and withholding-type taxes. That is, the unacceptable tax position penalty will only apply to income tax shortfalls. The amendment clarifies an amendment made in 2007.

Application date

The amendment applies retrospectively to tax positions taken on or after 1 April 2008 (the application date of the 2007 amendment).

Key features

The amendment clarifies that the tax types listed in section RA 1 of the Income Tax 2007 are removed from the scope of the unacceptable tax position shortfall penalty so that the penalty will apply only to tax positions relating to income tax.

Background

A tax shortfall is the difference between a taxpayer’s correct tax liability calculated under the legislation and the position a taxpayer took in their tax return. There are five categories of shortfall penalty – ranging from not taking reasonable care (when the penalty is 20 percent of the tax shortfall) to evasion or a similar act (when the penalty is 150 percent of the tax shortfall). The appropriate penalty is assessed when a required standard is breached – for example, if the taxpayer does not take reasonable care, the penalty for not taking reasonable care is assessed.

One of the shortfall penalties is the unacceptable tax position penalty. An “unacceptable tax position” is a tax position that, if viewed objectively, fails to meet the standard of being “about as likely as not to be correct”. This does not mean that the taxpayer’s tax position must be the better view or be more than likely the correct view, but rather that the position is “about as likely as not to be correct”.

The aim of the shortfall penalty is to encourage taxpayers to take tax positions that are correct in terms of the law. A taxpayer is liable to pay a shortfall penalty of 20% if the taxpayer takes an unacceptable tax position in relation to income tax, and the tax shortfall arising from the taxpayer’s tax position is more than both:

• $50,000; and
• 1 percent of the taxpayer’s total tax figure for the relevant return period.

A change to the legislation in 2003 meant the unacceptable tax position penalty potentially applied to all tax shortfalls over the thresholds, including cases when the tax shortfall arose from a mistake in the facts or when an unacceptable tax position was taken and immediately corrected. Taxpayers and tax agents noted that the penalty was having an adverse effect on taxpayer behaviour, resulting in taxpayers being less inclined to make voluntary disclosures. In 2006 a short-term solution was put in place which gave Inland Revenue a discretion not to impose the penalty in specific circumstances.

In 2007 the discretion was repealed, the threshold for imposition of the penalty was increased and the scope of the penalty was limited to income tax – that is, the penalty was no longer to be imposed on GST or withholding tax shortfalls. At the same time, the reduction given for voluntary disclosures made before a taxpayer is notified of a pending audit or investigation when the shortfall arose from the taxpayer not taking reasonable care, or from an unacceptable tax position, increased from 75% to 100%.

Following a review of the legislation it has been determined that the 2007 amendment does not achieve the desired policy outcome. The 2007 amendment inserted the words “in relation to income tax” in section 141B of the Tax Administration Act 1994. However, section RA 2 of the Income Tax Act 2007 deems the tax types listed in section RA 1 to be income tax and therefore subject to the unacceptable tax position penalty. These taxes include PAYE, fringe benefit tax and non-resident withholding tax.

The intention of the 2007 amendment was clear and taxpayers expected that following the amendment the unacceptable tax position penalty would only apply to tax shortfalls that arose in annual income tax returns. Inland Revenue’s practice to date has been to apply the penalty only to tax shortfalls that arise in annual income tax returns.

 

CLARIFICATION OF NEW DUE DATE FOR PAYMENT OF TAX

(Clause 149)

Summary of proposed amendment

Amendments clarify that a new due date is not set when the Commissioner makes a systems-generated default assessment, and that when a taxpayer files a return following a systems-generated default assessment, a new due date is set for the resulting tax liability.

Application date

The amendment will apply retrospectively from 6 October 2009 (which was the application date of the 2009 amendment).

Key features

The bill proposes a clarification to section 142A of the Tax Administration Act 1994 to ensure that a new due date is not set when the Commissioner makes a systems generated default assessment. The bill will also clarify that when a taxpayer files a return following a systems generated default assessment, a new due date is set for the resulting tax liability.

Background

If the Commissioner makes an assessment or amends and increases an assessment, a new due date is set for the tax assessed. Before an amendment in 2007 a new due date was only required when the Commissioner increased an assessment. This had the effect of creating an incentive for taxpayers who considered they did not have a tax liability to file a “nil return”. This meant that if the Commissioner determined at a later date that the taxpayer did have a tax liability, a new due date would be set for the tax assessed by the Commissioner. In the absence of the “nil return”, the taxpayer would be liable for use-of-money interest and late payment penalties from the original due date and, when the taxpayer had breached a required standard of behaviour, shortfall penalties.

There was a concern that the penalty rules were discouraging taxpayers from complying voluntarily with their tax obligations, as the imposition of both use-of-money interest and late payment penalties overly penalised taxpayers. Also, the application of late payment penalties when the taxpayer considered they did not have a tax liability could be seen as inappropriate. In some cases the late payment penalty was effectively being used as a penalty for the taxpayer not filing their return on time.

In 2007 an amendment was made under which Inland Revenue is required to set a new due date when it makes an assessment or increases an assessment. In 2009 the provision was again amended. The aim of this amendment was to remove the requirement to set a new due date when Inland Revenue makes a systems-generated default assessment.

More recently, concerns have been raised that the 2009 amendment does not achieve the desired policy outcome. In particular, it has been found that when a taxpayer files a return following a default assessment, a new due date is only set when the tax assessed by the taxpayer is more than the default assessment and the new due date only applies to the difference.

This is contrary to the policy intent which is that the late payment penalty is a penalty imposed when the taxpayer knows they have a tax liability and they do not pay on time. Default assessments are made by the Commissioner under section 106 of the Tax Administration Act 1994. There are a number of different circumstances when the Commissioner can issue a default assessment, for example, when a return has not been made or following an audit or investigation when the Commissioner is not satisfied with the return filed by the taxpayer.

The 2009 amendment which removed the requirement to set a new due date when Inland Revenue makes a default assessment was aimed at systems-generated default assessments, assessments generated by Inland Revenue’s FIRST system to encourage the taxpayer to file an outstanding return. It was not aimed at assessments made by the Commissioner following an audit. It was considered appropriate to impose late payment penalties from the original due date because in the case of systems-generated default assessments the assessment is issued because there is a concern about the taxpayer’s non-compliance.

 

REFERENCES TO LOSS ATTRIBUTING QUALIFYING COMPANIES

(Clauses 147 and 148)

Summary of proposed amendment

In 2010 the loss attributing qualifying company rules were repealed and the look-through company rules introduced. The promoter penalty legislation still refers to “loss attributing qualifying companies” when it should refer to “look-through companies”.

The bill proposes that the references in the promoter (section 141EB) penalty legislation which refer to loss attributing qualifying companies be updated to refer to look-through companies, and the penalty relief provision for loss attributing qualifying companies be repealed.

Application date

The amendments will apply from 1 April 2011 (the date from which the look-through company rules apply).

 

WORKING FOR FAMILIES TAX CREDITS

(Clauses 114 to 116)

Summary of proposed amendments

Additional items are proposed to be added to the list of payments that are excluded from the definition of family scheme income in relation to the Working for Families scheme (WFF) under section MB 13(2) of the Income Tax Act 2007. These items are windfall gains or payments of a capital nature. The change reflects that WFF is income-tested but not asset-tested.

There are also two remedial changes to clarify wording and correct errors in section MB 1(5C) relating to depreciation losses in earlier years, and section MB 7B(2) concerning employment benefits.

Application dates

The amendments to section MB 13(2) apply for the 2015–16 and later income years.
The amendments to section MB 1(5C) apply from 1 April 2011.
The amendments to section MB 7B(2) apply from 1 April 2014.

Key features

Changes to the rules in subpart MB of the Income Tax Act 2007 describing the definition of family scheme income are proposed. The main change will add the following items to the list of payments that are excluded from the “other payments” rule in section MB 13:

• repayment of a loan;
• repayment of a mistaken or misdirected payment;
• refund of a payment (including tax, student loan and child support refunds resulting from an overpayment);
• payment from the person’s ownership of an investment activity or business, where it is received on capital account, and the payment is not a loan and is not a payment by a trustee;
• payment of an inheritance from a deceased person’s estate;
• money won from gambling or a New Zealand lottery.

The other changes in subpart MB will:

• correct a cross-reference error in section MB 1(5C)
• amend section MB 1(5C) to cover depreciation loss for a building in an investment activity, to mirror earlier changes made to section MB 3 to ignore net losses from investment activities; and
• correct a drafting error in section MB 7B(2)(b) to refer to a “benefit” instead of a “fringe benefit”.

Background

WFF tax credits are provided to the principal caregiver of dependent children based, among other things, on their level of family scheme income for a tax year. The tax credits are abated when family scheme income exceeds $36,350 at a rate of 21.25 cents per dollar. Families that choose instalment payments of tax credits throughout the year are required to estimate their family scheme income and are subject to an end-of-year reconciliation. Alternatively, families can apply for an end-of-year lump sum payment.

The family scheme income provisions have been amended a number of times over the last decade, including as part of the rewrite of the Income Tax Act. The definition of “family scheme income” was broadened as part of Budget 2010, with effect from 1 April 2011. This included a new provision for other payments a family may receive to replace lost income or to meet their usual living expenses. The broader definition is intended to improve the fairness and integrity of Working for Families tax credits by, for example, countering arrangements that have the effect of inflating entitlements beyond what people’s true economic circumstances justify.

In 2012 the Government agreed that employer-provided vouchers and other short-term charge facilities should also be included in family scheme income. This change comes into effect from 1 April 2014.

The definition of “family scheme income” is also used, with some adjustments, for determining eligibility for some people applying for student allowances and the community services card. The income definition will also be the basis for assessing child support in the future. A similar definition is used for student loan repayments.

Detailed analysis

Current sections MB 1 to MB 12 list specific amounts that are included in family scheme income. Section MB 13(1) includes other payments in the definition of family scheme income where the payment is paid or provided to the person from any source and used by the person to:

• replace lost or diminished income of the person or the person’s family; or
• meet usual living expenses of the person or the person’s family.

Current section MB 13(1) is broadly drafted. Section MB 13(2) then excludes payments from MB 13(1) where the payment is not intended to form part of family scheme income. An example is when a payment is already included in family scheme income under sections MB 1 to MB 12, or when it is a government payment and treated as exempt income for tax and welfare purposes.

The WFF tax credits are income-tested on family income. While it has a broad definition of income, it is not the policy intent for the tax credit to be asset-tested. For example, the use of money or cash assets from a person’s bank account for usual living expenses is not intended to be included in family scheme income, whereas interest earned on savings is included. Similarly, the family scheme income definition is not intended to capture the realisation of assets into cash, other than the extent to which it is assessable income under the Income Tax Act. Section MB 13(2)(b) excludes a payment where it is the proceeds of the disposal of property and not assessable income of the person disposing of the property. This is intended to prevent, for example, the proceeds from the sale of a car, when the proceeds are used to meet usual living expenses, from being included in family scheme income. The exception is when sales proceeds are assessable income for that person.

There are payments not covered by section MB 13(2)(b) but which are similar in nature to capital or they relate to a change in how assets are held or realised which should be excluded. It has also not been the policy intention to include windfall gains in family scheme income, to the extent that they are not assessable income for the person. For families who estimate their family scheme income upfront, it would not be possible to accurately estimate windfall gains, leading to end-of-year debts. It is also unlikely that the family would rely on windfall gains to meet the family’s usual living expenses.

The proposed list of items to be excluded under section MB 13(2) can be technically caught by the wording of section MB 13(1) but do not come within the policy intent of that provision. They are:

• Repayment of a loan – this covers the repayment of the principal of the loan. Interest payable on the loan is assessable income and is already included in family scheme income under another provision.
• Repayment of a mistaken or misdirected payment – this is not additional money for the person or their family.
• Refund of a payment (including tax, student loan and child support refunds resulting from an overpayment).
• Payment of an inheritance from a deceased person’s estate.
• Money won from gambling or a New Zealand lottery – these windfall gains are not intended to be caught by the “other payments” rule.

The bill also proposes to include in the list of excluded items a payment from the person’s ownership of an investment activity or business, where it is received on capital account, and the payment is not a loan and is not a payment by a trustee.

Dividends, shareholder salary, interest, or rent from a business or investment activity are not received on capital account and are already included under other provisions in subsection MB. A payment from a person’s investment or business received on capital account is equivalent to the withdrawal of funds from a savings account and should likewise not be included in family scheme income. The person and their family are not “better off” from receiving the payment, rather they are converting their assets into cash. Often the payment on capital account will be referred to as drawings, although some drawings may be a loan or income that has been incorrectly labelled. A loan from a business or investment to the person will be excluded under section MB 13(2)(a) if it is on the basis of ordinary commercial terms and conditions.

 

CHILD SUPPORT REMEDIALS

(Clauses 181 to 191)

Summary of proposed amendments

A number of changes are proposed to ensure the policy objectives of the child support reform are achieved. The changes clarify wording, correct errors, make further consequential changes and make minor improvements to simplify the child support scheme.

Application date

The majority of the amendments will apply from 1 April 2014.

One amendment will apply from the day of Royal assent.

Background

Under the Child Support Amendment Act 2013 a number of changes were made concerning child support terms – for example, the “custodial parent” of the qualifying child is now referred to as the “receiving carer”.

The Child Support Amendment Act will also amend, from 1 April 2014, the way a formula assessment of child support is determined and make improvements to the operation of the child support scheme. The amendments include:

• decreasing the threshold for recognised shared care;
• the Commissioner determining who is a liable parent and who is a receiving carer of the qualifying child based on the income and care details of both parents;
• defining who is a non-parent receiving carer;
• changes to how income is measured and estimated for assessment purposes; and
• how child support is distributed.

Key features

The bill proposes the following additional remedial changes to the Child Support Act 1991:

• removing the definition of “election period” in the interpretation section as it has been replaced by a new definition in new section 40AA;
• clarifying in new section 9(1)(c) that a beneficiary is not required to apply for child support if they are already a receiving carer;
• clarify that notices of election in new section 40(1) cannot be given after the end of the child support year to which the election relates;
• correcting the ordering of provisions in new section 44 relating to the end-of-year reconciliation of an estimate of income to ensure the correct policy outcome is achieved;
• consequential changes to section 65 in light of the new rules for determining liable parents and receiving carers, and to prevent a voluntary agreement and a formula assessment for a child being in force simultaneously;
• repealing new section 92(3A) as the provision is no longer required;
• amending section 98 to align with new section 32 on the method for distributing the minimum annual amount of child support when there is more than one receiving carer;
• ensure that a non-parent receiving carer who has been granted a Sole Parent Support payment under the Social Security Act 1964 cannot waiver the right to collect child support from a liable parent; and
• further consequential amendments reflecting the changes in child support terminology.

 

TAX ADMINISTRATION ACT 1994: CROSS-REFERENCES TO SECTIONS 108 AND 109

(Clauses 135 to 145)

Summary of proposed amendment

Sections 93(2)(b), 94(2)(b), (c), 95(2)(b), 97(3)(a), 97B(3)(a), 98(2)(a), 98B(3)(a), 99(2)(a), (b), 100(3)(b), 101(2)(a) and 101B(2)(a) are being amended to confirm that:

• the Commissioner cannot amend an earlier assessment made under any of those provisions outside the time-bar period; and
• section 109 applies in relation to these provisions.

These amendments correct cross-referencing to sections 108 and 109 of the Tax Administration Act 1994.

Application date

The amendments will apply from 1 October 1996.

Background

In a recent court decision (Vinelight Nominees Limited v CIR [2012] NZHC 3306), Peters J identified a remedial issue within section 99 of the Tax Administration Act 1994, concerning the relationship of section 99 to section 108 of the Tax Administration Act 1994. Peters J stated:

[100] There is an obvious difficulty with s 99(2)(a), because s 108(1) does not include the words “income tax for any year”.

The judge’s comments in the Vinelight decision highlight a technical problem that the time bar may not apply to resident withholding tax (RWT) assessments. The words identified by Peters J, “income tax for any income year”, were repealed in 1996 as part of the reforms of the disputes resolution legislation. Section 99 of the Tax Administration Act 1994 was not updated at that time to reflect the new wording in section 108(1). The same cross-referencing problem arises in a number of provisions from section 93 to section 101B of the Tax Administration Act 1994.

Similar drafting issues arise from the use of the term “taxpayer” in a number of provisions from section 93 to section 101B of the Tax Administration Act 1994 that refer to section 109 of the Tax Administration Act 1994. This is because the term “taxpayer” no longer appears in section 109.

Section 99 of the Tax Administration Act 1994 enables the Commissioner to assess a person for RWT if the Commissioner considers that person has not paid the correct amount of RWT. Under the RWT rules, a person paying resident withholding income is required to withhold RWT and pay to the Commissioner the amount of RWT withheld on a periodic basis.

The reference in section 99(2) of the Tax Administration Act 1994 to section 108(1) of the Tax Administration Act 1994 is necessary to ensure that the Commissioner cannot amend an earlier RWT assessment outside the time-bar period. Peters J’s comments in the Vinelight decision highlight a technical problem that the time bar may not apply to RWT assessments.

Section 108(1) imposes a time limit (time bar) on the Commissioner’s power to amend an earlier assessment of income tax. That time-bar period is four years after the end of the tax year in which the earlier assessment was made.

Section 109 of the Tax Administration Act 1994 provides that disputable decisions are treated as correct unless a challenge is lodged against that decision, but the provision no longer uses the word “taxpayer”. Disputable decisions include assessments by the Commissioner and most decisions of the Commissioner in relation to the application of a tax law to a taxpayer’s circumstances.

Again, this drafting issue results from these provisions not being updated correctly in 1996 to reflect the amended wording in section 109.

 

TRUSTS THAT ARE LOCAL AND PUBLIC AUTHORITIES

(Clauses 25 and 26)

Summary of proposed amendment

Amendments to section CW 38 and CW 39 clarify that an amount derived by a trustee for a local authority or a public authority constituted as a trust:

• does not enjoy the exempt income status under sections CW 38 or CW 39 if that amount is retained and included in trustee income of the trustee; and
• is exempt income if that amount is distributed to a beneficiary that itself is exempt from income tax in relation to that distribution.

Application date

The amendment applies from the commencement of the amending Act.

Background

The Income Tax Act 2007 currently exempts from tax any amount derived by a local authority and a public authority other than “an amount received in trust”. The exact meaning of these words is unclear and their interpretation has caused difficulty for taxpayers and Inland Revenue.

The policy is that this exemption should not extend to amounts that a local authority receives as a trustee. However, if the trustee receives an amount (other than as trustee for a beneficiary which itself enjoys exempt income status).