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Inland Revenue

Tax Policy

Chapter 4 - Technical issues

Tax losses

4.1 In general, tax losses should not be affected by related party debt remission under this paper’s core proposal. These losses presumably result from third-party trading and should be treated as being genuine for the purposes of this paper’s proposals.

4.2 Losses arising from related party interest income and associated bad debt write-offs is an exception, and is dealt with below.

Accrued interest

4.3 The outcomes from these proposals should be, in the domestic context, symmetrical. If the related party creditor has taken a bad debt deduction for an “interest” accrual, the outcome may not be symmetrical.

4.4 Borders seem to complicate this analysis – this discussion presumes that all parties are New Zealand-resident.

4.5 New Zealand has no general or specific rules under which a creditor who takes a bad debt deduction has to notify the debtor. However, it might be reasonable to presume that an associated person debtor could be expected to have knowledge about any bad debt deduction for “interest” that the creditor takes. Example 15 provides a likely scenario.

Example 15

Parent Co has made a zero coupon loan to its wholly owned Sub Co. After a couple of years, the subsidiary is either insolvent, or very close to being insolvent.

Parent Co takes an annual bad debt deduction for its financial arrangement “interest” income. Sub Co continues to accrue its financial arrangement “interest” expense, which increases its overall tax losses and annually offsets these losses to another company in the group.

Economically, the group has two available deductions – the bad debt write off, and the “interest” deduction, facilitated by the group tax loss offset. Against this there is one strand of income – being the “interest” income of parent company/creditor.

4.6 The outcome described in Example 15 is available under present law and, anecdotally, is being used in some circumstances. Theoretically, the advantage is cancelled eventually when the BPA is done because the “interest” deduction of the subsidiary/debtor is reversed. Any reversal could be in the distant future as the timing of the BPA is controlled by the related parties. Further, if the debtor is eventually liquidated, the reversal will not be effective as no taxation will be paid.

4.7 Even if the advantage is merely timing, it is not a tenable policy outcome.

4.8 A possible policy solution would be to disallow a bad debt deduction for associated persons interest receivable. This is because the debtor will likely be taking a deduction for the accrual of interest. This would mean that the tax outcome is symmetric when the actual interest deduction is being used.

4.9 This symmetric outcome is important, as a net deduction could potentially be grouped and utilised within the wider group even if the debtor is not in a position to obtain any benefit from the deduction due to a net loss position. However, the disallowance of the creditor’s bad debt deduction should not be dependent on this as it would be difficult to know whether the debtor would be able to utilise the deduction in a later year (by carrying the net loss forward) or by grouping the loss with the creditor or another company in a later year.

4.10 A significant advantage of this solution is that it can apply in non-corporate scenarios such as shareholder or partner creditor to company or partnership debtor.

4.11 A disadvantage is that when the debtor cannot utilise the interest deduction, the tax result becomes asymmetric, to the detriment of taxpayers. In this situation the debtor and the creditor themselves may be able to avoid this outcome by amending the terms of the loan to make it interest-free. Submissions on this point are welcome.

4.12 It has been suggested that section DB 31(5) deals with this situation. If so, this section would need to be further clarified in the context of these proposals as its current scope seems too narrow.

4.13 More complex solutions may be available but simplicity has its advantages.

Transitional rule

4.14 The amendment suggested above would only apply prospectively. We may also need to consider past situations when the creditor has taken bad debt deductions for interest accruals when those deductions have not been matched by reversals of expenses by the debtor. This issue will be further considered after the receipt of submissions.

Debt parking

4.15 The Income Tax Act 2007 has several references to “debt parking”, as follows:

  • The core debt parking rule:
    • section EW 29(8) – BPA forced where debt sold at a discount to associate of debtor;
    • section EW 43 – debt sold at a discount to associate of debtor; and
    • section EW 49 – debt sold at a discount to associate of debtor.
  • The consolidated group debt remission rules are in section FM 8(3)(b).

4.16 The core debt parking rule provides that if a debt is acquired by a person associated with the creditor for less than 80 percent of the market value of the debt, calculated as if it is not distressed, then there is an immediate BPA, and the value of the debt is reset. The difference between the acquisition cost and the debtor’s carrying value is income to the debtor, and the debt is reset to the acquisition cost in the debtor’s books.

4.17 The consolidated group rule provides that intra-consolidated group debt remission is ignored if the debt has always been inside the consolidated group (that is, it cannot have been acquired off a non-consolidated group creditor).

4.18 To ensure that the proposed amendments deal adequately with debt parking issues, the present consolidated group debt parking rule would need to be extended to cover all debt that is affected by the proposals in this issues paper.

Certain dividends

4.19 As noted in Chapter 2, a debt remission from a company to a shareholder causes a dividend which is not subject to the debt remission rules, but rather is a taxable dividend. This overrides the wholly owned group dividend exemption. We consider the principles of this dividend exemption should apply and there should be neither debt remission income nor any taxable dividend income within a wholly owned group of companies.

4.20 However, in other ownership situations an upstream debt remission is conceptually a transfer of wealth and should continue to be regarded as a dividend.


4.21 Presently, when amalgamations take place between a debtor and a creditor, regard must be had to solvency, and when the debtor is insolvent and unable to meet their obligations, a BPA is performed which results in the debtor having debt remission income. When the companies involved are members of a wholly owned group of companies, this paper’s core proposal makes this amalgamations rule redundant and an appropriate consequential amendment would need to be made.