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Inland Revenue

Tax Policy

Chapter 5 – Other matters

5.1 This chapter discusses five additional proposed changes to our thin capitalisation rules. They are:

  • a de minimis for the inbound thin capitalisation rules
  • a special rule for infrastructure projects that are controlled by a single non-resident
  • reducing the ability for companies owned by a group of non-residents to use related-party debt
  • removing the ability to use asset valuations for the thin capitalisation rules that differ from those reported in a firm’s financial accounts
  • removing the ability to measure assets and debts on the final day of a firm’s income year; and
  • a minor remedial relating to the changes made in the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014

5.2 This chapter also discusses the application dates for all of the proposals in this paper.

De minimis for the inbound thin capitalisation rules

5.3 Thin capitalisation regimes can be fairly complex. Accordingly, many countries provide an exemption for companies with little interest expense, on the basis that they present a low BEPS risk. The OECD’s final report on Action 4 also raises the possibility of a de minimis on this ground.[21]

5.4 New Zealand does not currently have a de minimis in its inbound thin capitalisation rules, but does have one in its outbound rules (of $1 million of interest deductions).[22]

Proposal: De minimis for companies with little interest expense and third-party debt

5.5 We recognise that some type of de minimis is appropriate for companies that pose little BEPS risk. We therefore propose extending the existing de minimis in the outbound rules so that it applies to inbound entities as well, provided none of the entity’s debt is owner-linked debt.[23] The de minimis would operate exactly as it does for outbound entities (for example, phasing out between $1m and $2m of interest deductions).

5.6 Our proposed de minimis is restricted to firms with only third-party debt because firms with owner-linked debt carry a higher BEPS risk compared to firms with only third-party debt. This is because there are no commercial constraints that limit the amount of owner-linked debt an entity can take on.

Infrastructure projects controlled by single non-residents

5.7 The OECD’s final report on Action 4[24] discusses an exemption for specific third-party loans, provided on non-recourse terms, used to fund infrastructure projects. This exemption recognises that such funding presents little risk of BEPS.

5.8 New Zealand’s rules do not feature such an exemption. Nevertheless, when a New Zealand entity is owned by a group of non-residents (none of which has a controlling interest in their own right), the entity is unrestricted in how much third-party debt it can take on (provided that debt is not guaranteed by its owners). In practice, this operates more or less like the exemption discussed by the OECD.

5.9 In contrast, New Zealand entities controlled by a single non-resident do face restrictions on how much third-party debt they can take on. In general this restriction is well-placed: it prevents multinationals from allocating a disproportionate amount of their worldwide debt in New Zealand.

5.10 However, in some situations – when all of a New Zealand investment’s financing is from third-party lenders who are lending on a limited recourse basis, there is limited ability for debt to be over-allocated to the investment because of the limited recourse nature of the loan. In addition, third-party debt provided on limited recourse terms will, by definition, be no more than a commercial level of debt.

5.11 At the same time, we are aware that the worldwide group debt test is not particularly effective in relation to multinationals involved in constructing new assets, such as infrastructure. This is because such projects generally start with high debt levels that reduce over time. However, the worldwide group debt test only allows the New Zealand subsidiary to have slightly more than its average worldwide debt level – which may be insufficiently low for a new project.

Proposal: carve-out for infrastructure projects with third-party funding

5.12 Because of these two factors, we propose adopting the exemption discussed in the OECD’s final report. The restrictions to accessing the exemption discussed below are taken from that report. Under this proposal, a firm will be able to exceed the 60 per cent safe harbour if:

  • The firm has been established for a project to provide, upgrade, operate and or/maintain assets for at least 10 years, and the assets cannot be disposed of at the discretion of the entity;
  • The project has been established at the request of the New Zealand Government, a Government department or a local/regional council.
  • The loan is not owner-linked debt, so that the lender is a third-party and only has recourse to and a charge over the assets and income streams of the specific project;
  • The loan or loans made to the entity do not exceed the value or estimated value of the assets once constructed unless additional investment is made to maintain or increase their value. Subject to minimal and incidental lending to a third party (such as a bank deposit), none of the funds should be on-lent.
  • The entity, the interest expense, and project assets, and the income arising from the project assets must all arise or be incurred in New Zealand. Where the project assets are held in a permanent establishment, the exclusion applies only to the extent that the income arising from the project is subject to tax in New Zealand.

5.13 If a firm uses this exemption, any debt that does not qualify (such as shareholder loans) would not be deductible. The third-party debt of the firm is a reasonable measure of a commercial level of debt. As such, it does not seem appropriate to allow the firm to claim deductions on any additional debt, since one of the objectives of the thin capitalisation rules is to ensure firms can claim interest deductions on no more than a commercial amount.

5.14 Indeed, since these projects tend to have high levels of third-party debt, allowing additional shareholder debt would mean that shareholders could invest in the firm almost entirely through debt. Say, for example, total allowable debt is 110 per cent of the firm’s third-party debt. In this case, if a project was funded with 90 per cent third-party debt, its shareholders could make 90 per cent of their investment by way of debt without facing interest denial (and only 10 per cent through equity).

5.15 This exemption will apply only to entities controlled by a single non-resident. A similar exemption already applies (in effect) where an entity is controlled by a group of non-residents.

5.16 We are interested in submissions on this proposal, such as whether the restrictions above, taken from the OECD’s report on interest limitation rules, are reasonable.

5.17 We note that one of the restrictions is that the infrastructure project has been established at the request of the Government or other public body. We are not aware of any projects that would qualify for this exemption other than those established at the request of the Government or other public body – however, we would consider removing the exemption if submitters provide private sector examples where this rule could otherwise apply.

Example 8

Infrastructure Co is building a road that will be worth $100m in New Zealand at the request of the Government.

Infrastructure Co has borrowed $80m from Bank on non-recourse terms to fund the construction of the road. The remaining $20m of funding is from Infrastructure Co’s shareholders, who have advanced $15m of equity and $5m of debt.

The loan from Bank Co is not owner-linked debt and is on non-recourse terms, so meets the relevant conditions of this exemption. Infrastructure Co and the road project also meets all the other required conditions.

Infrastructure Co is able to exceed the 60 per cent safe harbour without facing interest denial in relation to its loan from Bank Co. However, the $5m of shareholder debt does not qualify for the exemption. All of the interest on the shareholder debt would not be deductible.

Firms controlled by non-residents acting together: related-party debt

5.18 A firm controlled by a group of non-residents acting together is able to have total debt equal to 110 per cent of its third-party debt.[25] This means, in effect, shareholders of firms with high levels of third-party debt are able to invest in New Zealand predominately through debt. As illustrated in paragraph 5.14, a project funded with 90 per cent third-party debt could have nine per cent shareholder debt and only one per cent equity without breaching thin capitalisation limits.

5.19 Allowing this additional shareholder debt is inconsistent with the objective of ensuring firms can claim deductions only for a commercial level of debt, since the third-party debt of a firm is a reasonable measure of a commercial debt level.

Proposal: restrict the use of related-party debt

5.20 We propose to amend the rules for firms controlled by a group of non-residents acting together. If such a firm exceeds the 60 per cent safe harbour, any owner-linked debt will be non-deductible.

5.21 This aligns with the proposal for infrastructure projects with third-party funding discussed above.

5.22 These rules for firms controlled by non-residents acting together have only just come into effect. Companies controlled by a group of non-residents may have recently restructured their borrowing to include some level of related-party debt, on the reasonable expectation that the newly introduced rules would remain unchanged for some time.

5.23 As such, we propose that this rule apply only on a prospective basis. Financing arrangements entered into before the application date of the proposals in this document (the first income year after the enactment of the legislation) will not be subject to this rule.

Asset valuations

5.24 In general, the thin capitalisation rules are based on the value of a company’s assets as reported in its financial statements. However, under sections FE 16(1)(b) and FE 16(1)(e), a company is able to use the net current value of the assets as an alternative to its financial statement values, or a combination of the financial statement values and net current values, provided that would be allowable under GAAP.

5.25 This valuation method was originally provided as it was considered that valuation methods for financial reporting purposes are likely to have been adopted for non-tax reasons.[26] However, while this may be the case, we consider that the valuation method chosen for financial reporting purposes will be the one that most fairly represents the value of a company’s assets. It therefore seems appropriate to require the resulting asset valuations to be adopted for thin capitalisation purposes.

5.26 Moreover, asset valuations reported in financial statements are subject to a reasonable level of scrutiny – they will be reviewed by auditors and its directors, as both may face repercussions if the values are found to have been materially misstated. This is not the case with asset valuations adopted solely for thin capitalisation purposes.

Proposal: remove net current valuation method

5.27 We therefore propose to remove the net current valuation method from the list of available asset valuation methods.

Measurement date for assets and liabilities

5.28 Taxpayers currently can choose one of three methods for valuing their assets and liabilities. Taxpayers can use:

  • their value on the last day of the taxpayer’s income year;
  • the average of their values at the end of each quarter of the income year; or
  • the average of their value at the end of every day in the income year.

5.29 The first method, valuing assets and liabilities on the last day of the income year, is clearly the simplest approach. However, there is the potential for taxpayers to breach the thin capitalisation debt limits for up to one year without facing any interest denial. Provided a taxpayer repays a loan or converts it to equity on or before its balance date, they can have any amount of debt without facing interest denial. This is one of the problems with an asset based thin capitalisation rule identified by the OECD.

5.30 The thin capitalisation rules do feature a specific anti-abuse rule (section FE 11) that requires temporary changes in asset or liability values to be ignored. However, this section does not apply to one-off events, such as a company borrowing large amounts at the beginning of the year and repaying it all at the end.

Proposal: Allowing only average valuation methods

5.31 We propose to remove the first asset valuation method, so that assets and liabilities can only be valued based on the average values at the end of every quarter or at the end of every day. This would ensure that the rules apply effectively to a loan that was entered into and repaid within a year.

Remedial change: trusts and owner-linked debt

5.32 The 2014 changes to the thin capitalisation rules introduced section FE 18(3B), which sets out the meaning of owner-linked debt in the context of both companies and trusts settled by non-residents.

5.33 Paragraph (c) provides that, in order for a financial arrangement to be counted as owner-linked debt, the owner must have ownership interests in a member of the group of companies of five per cent or more. This rule is intended to reduce compliance costs.

5.34 This test makes sense when the New Zealand entity is a company. However, the current legislation does not specify how the rule should work in relation to trusts as settlements on a trust do not convey ownership interests in the trust or entities owned by the trust.


5.35 We propose amending section FE 18(3B) to ensure it operates clearly in relation to trusts. That is, in addition to the requirements of FE 18(3B)(a), (b) and (d), in order for a financial arrangement to be counted as owner-linked debt:

  • the owner must have a direct ownership interests in a member of the group of five per cent or more; or
  • the owner must have made five perccent or more (by value) of the settlements on the trust.

Application date for all proposals

5.36 If these proposals are implemented, we generally propose that they apply from the first income year beginning after enactment of the legislation.

5.37 We expect that most foreign-owned firms will not face interest denial because of these proposals. This is because most foreign-owned firms either have low levels of debt, use only third-party debt, or both.

5.38 That said, some firms will face denial unless the firms change their mix of debt and equity funding. We consider this delayed application should give companies sufficient time to rearrange their affairs, so do not propose any special transitional measures.

5.39 The exception to this approach is the grandparenting of existing arrangements for the firms owned by non-residents acting together discussed in this chapter.


21 OECD 2015, op. cit, p. 35.

22 The de minimis then phases out between $1m and $2m of interest deductions.

23 Broadly speaking, owner-linked debt is debt from a person with an ownership interest in the entity or debt that is guaranteed by such a person. It is defined in section FE 18(3B).

24 OECD 2015, op. cit, p. 39.

25 Strictly, 110 per cent of its debt that is not owner-linked debt.

26 Inland Revenue Tax Information Bulletin: Volume Seven, No. 11 (March 1996).