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Inland Revenue

Tax Policy

Appendix - Summary of the current legislation

New Zealand’s thin capitalisation rules limit the tax deductions that may be taken for interest expenditure. There are specific rules for foreign investors, New Zealanders investing abroad, and for registered banks. These rules are summarised in the following sections. The summary is intended to convey the broad thrust of the rules to put the rest of this document in context, but does not discuss the detail of the rules.

Foreign investors (“inbound” rules)

The inbound rules apply to non-residents directly earning New Zealand income, to New Zealand resident companies controlled by a single non-resident, and to certain resident trustees. They prevent large amounts of debt being concentrated in the New Zealand operations of a foreign-controlled multinational. For example, they might prevent a foreign parent from allocating external debt to New Zealand when it is properly attributable to overseas assets and operations.

To work out if any interest deductions that would normally be available are denied, a person subject to the rules must work out the debt-to-asset ratios of their New Zealand group and their worldwide group.

The New Zealand group is, crudely speaking, all the operations of the investor in New Zealand. Similarly, the worldwide group is the worldwide operations of the investor.

No deductions are denied if:

  • the New Zealand group’s debt-to-asset ratio is 110% or less of the worldwide group’s ratio; or
  • the New Zealand group’s debt-to-asset ratio is 60% or less.

The intuition for the first condition (the “110% safe harbour”) is that if the New Zealand group of a multinational is no more indebted than the worldwide group, the debt in New Zealand is a rough but convenient proxy for the group’s external debt that is really attributable to New Zealand operations.

The second condition (the “60% safe harbour”) is provided to reduce compliance costs. Many companies will have debt-to-asset ratios that are significantly lower than 60% for commercial reasons. Those companies need not undertake worldwide group calculations to justify their debt levels.

If neither condition is met, interest deductions will be reduced to the extent they relate to debt above the highest of the 60% (absolute) or 110% (relative) thresholds.

The inbound rules are the main focus of this document.

New Zealanders investing abroad (“outbound” rules)

The outbound rules apply to any resident with a controlling interest in a foreign company and to some residents with non-controlling but significant interests in foreign companies. If a person is subject to the inbound rules, the inbound rules take precedence.

The outbound rules prevent a New Zealand-based multinational from concentrating large amounts of debt in New Zealand. For example, they might prevent a New Zealand parent from allocating debt to New Zealand when it is properly attributable to the assets and operations of a foreign subsidiary.

The process for working out whether or not interest is denied is almost the same as it is for the inbound rules. In the normal case, a person considers their debt-to-asset percentages and interest is denied to the extent that:

  • the New Zealand group’s debt-to-asset ratio exceeds 110% of the worldwide group’s ratio; and
  • the New Zealand group’s debt-to-asset ratio is 75% or more.

An alternative set of conditions, based on interest-coverage ratios, may be used in limited circumstances, and there are some exceptions to the rules for smaller businesses.

Registered banks

These rules apply, as the name suggests, to registered banks operating in New Zealand.

They require that banks have a minimum level of non-deductible capital – essentially equity – for tax purposes. If the bank’s debt levels are too high, and so equity levels are too low, interest on the excessive portion is denied.

The rules for registered banks override both the inbound and the outbound rules. They are not affected by the changes in this document.