1. TAX WORKING GROUP SESSION 3

The Tax Working Group met for the third session on 16 September 2009. The session dealt with tax broadening and revenue raising opportunities to compensate the tax base for the effects of major Government fiscal reforms. Such reforms include the restated objective to align the corporate income and trust tax rates at 30% expected in the near future.

• The Group considered the following matters:
• Capital Gains Taxes;
• Land Taxes; and
• Other revenue raising options including the risk-free return method (RFRM), treatment of depreciation, environmental taxes, estate taxes, and additional resources for Inland Revenue.

Capital Gains Taxes (CGT)

The Group considered two possible capital gains tax design options for New Zealand:

• A hybrid model that taxes listed shares and unit trusts on an accruals basis, and imposes a RFRM tax on other assets; and

• A realisation-based CGT on all realty, and to allow capital losses to be offset against gains.

The Group estimate revenue of $1.5 billion per year from a realisation-based CGT on property (excluding owner occupied property), at current personal income tax rates, and that is expected to substantially offset the cost of alignment of other rates at 30%.

The accrual-based CGT has not been adopted by other countries due to practical difficulties involved and the effect on the integrity of the tax system. The Group felt the problems might be avoided in some instances by having clear definitions and avoidance provisions.

Land Taxes

The immobility of land is the main benefit of basing a tax purely on land. The group agree that it is critical that if a land tax is introduced the same rate should apply across all land types. The taxable land base (excluding government-owned and conservation land) is estimated around $460 billion, and a rate of 0.1% would raise $460 million per year. The tax base is new and unrelated to taxable income, and like CGT, taxes an area that is currently untaxed to most taxpayers. A comprehensive land tax is likely to be easier to implement, comply with and administer than a CGT.

There are two main concerns with a land tax:

• if levied at a high rate (say 1%), it will cause a fall in land values, which could mean that people with highly-geared properties could end up with negative equity. The lower the rate applied to land values, the lower would be the fall in land values, and the liquidity cash-flow problems caused for taxpayers would be less acute; and

• there are equity concerns that the tax will be incurred by the wealth of only those who had wealth in one particular form (i.e., land).

Other base broadening and revenue raising options:

Risk Free Return Method (RFRM)

The Group discussed the possibility of applying an RFRM tax to rental property as recent data shows that tax revenue from the approximately $200 billion rental property sector is negative and has trended downward since the introduction of the 39% tax rate in 2000. The Group agreed that there are efficiency and equity problems with the current tax system in the rental property sector. Under an RFRM tax, rents from land would not be taxed, and other expenses relating to the investment would not be deductible, but a risk-free rate of return would be applied to the net equity in the property, and included in taxable income. The Group generally agreed that the option to establish an RFRM on rental property depends on whether a CGT is adopted. If CGT is not the preferred option, then the RFRM for rental properties is an option worth considering.

Depreciation on Buildings

Doubts were expressed on whether or not rental housing and commercial buildings do depreciate. A question was raised as to whether there should be any depreciation deductions for buildings. Allowing depreciation on buildings costs about $1.3 billion in forgone tax. It was noted, however, that some buildings, for example, industrial buildings, will in fact depreciate. Officials noted that the UK allows depreciation deductions for industrial but not other buildings.

No Offset for Rental Losses

The Group considered ring-fencing rental losses and preclusion of offset against other income. Officials noted that previous ring-fencing regimes have proven reasonably easy to circumvent. It was also noted that the lack of tax attributable to rental investments is not limited to properties that are funded by debt.
CGT for Building Owners that Claim Depreciation
A proposal for base broadening is to require building owners that claim depreciation to pay tax on any gains made when the building is sold. A possible variation to this would be to allow depreciation only against those buildings which reduce in value, such as industrial buildings.

Other Revenue Raising Options

Other revenue raising options discussed included:

• Removing the depreciation loading on new assets - estimated at $0.5 billion in 2013.

• Removing the KiwiSaver tax exemption for employer contributions - estimated revenue of about $170 million per annum.

• Estate or Inheritance Taxes - these were ruled out because of mobility effects with the absence of these taxes in Australia, and the issue of double taxation.

• A Cashflow Tax - this will be considered in more detail in the next Tax Working Group session.

The Group also looked at the possibility of increasing funding available to the IRD to enforce the tax system, and to increase audit activity. The Group agreed that it should be pursued and should be considered in the final report.

2. NEW ZEALAND EMISSIONS TRADING SCHEME (NZETS) – AN OVERVIEW

 

The New Zealand Emissions Trading Scheme (NZETS) came into force on 26 September 2008 with the enactment of the Climate Change Response Act 2002.
The key purpose of the NZETS is to enable New Zealand to comply with its international obligations under the Kyoto Protocol and the United Nations Framework Convention on Climate Change while providing certainty for economic growth, equity, and flexibility to respond to possible changes in the post-2012 international framework.
Emissions trading is a market-based approach for achieving environmental objectives where emissions units are traded between participants. In effect, those emitting greenhouse gases have to pay for increases in emissions and are rewarded for decreases.

Under the Kyoto Protocol, New Zealand is obliged to return emissions to 1990 levels during the first commitment period (2008 to 2012), or take responsibility for the difference through international offsetting.

In respect of each sector covered by the NZETS, there are a number of participants. Each participant must calculate the emissions from their activities and surrender to the government an emission unit for each tonne of greenhouse gas emissions (measured in tonnes of CO2 equivalent) for which they are responsible. There are various types of units that participants can use to meet their obligations under the emissions trading scheme.

The primary unit of trade for the New Zealand emissions trading scheme is the New Zealand unit (NZU). The NZU is a unit issued and allocated by the government under the scheme. One NZU corresponds to one tonne of CO2 emissions.

Under the NZETS, different sectors start to have obligations under the scheme at different times. The forestry sector has an obligation to surrender units in respect of relevant emissions from 1 January 2008. Under the current legislation, further sectors will enter the scheme as follows:

• the stationary energy and industrial processes sectors will have obligations to surrender units in respect of their emissions from 1 January 2010;

• participants in the liquid fossil fuels sector will have obligations to surrender units in respect of emissions from 1 January 2011;

• participants in the waste, agriculture, and synthetic gases sectors will have obligations to surrender units in respect of emissions from 1 January 2013.

A sector is said to have entered the NZETS from a certain date where it has obligations to surrender units in respect of emissions from that date.

As well as imposing an obligation on participants whose activities are covered by the scheme, the NZETS provides for allocation of units to certain participants. Introducing an emissions trading scheme will impact on certain parts of the New Zealand economy and society more than others. Allocation is a means of providing assistance or compensation to strongly affected parties.

There are two main reasons for providing assistance to firms. One is to provide compensation where the introduction of a carbon price has reduced the value of assets. The other is to protect the competitiveness of firms, particularly those that are emissions-intensive and trade-exposed as these firms are unable to pass the carbon cost on to consumers.

The appropriate method of allocation will depend on the reason for providing it. Under the current NZETS, allocation has been provided in relation to pre-1990 forest land to compensate land owners for the loss in value of their land as a result of the costs imposed by the NZETS. A similar equity rationale applies in the case of allocation to the fishing sector. In respect of other sectors, the purpose of allocation is to avoid the loss of industries that would not have occurred if our competitors had adopted equivalent emissions pricing. The detail of how units are to be allocated to these persons will be set out in the relevant allocation plan for that sector. No allocation plans have yet been finalised.

There is concern that the NZETS as currently designed may not meet the objectives, given the currently weak state of the economy and the recent developments in the Australian Carbon Pollution Reduction Scheme (CPRS).

There is a need to ensure that there is a smooth transition for industry into the NZETS in order for it to adjust to the scheme while coping with the current economic recession. There is also a need to ensure that the levels of assistance (in the form of free allocation) are appropriate and key sectors of the economy do not experience undue competitive impacts as a result of the NZETS. Finally, there is a need to provide business with some certainty regarding the future of the NZETS and the levels of emissions reductions that New Zealand will be committed to meeting in the long term.

A number of problems have been identified with the NZETS, which the current government has committed to addressing. The issues fall into two categories;

• Economic Impacts – This includes concerns that the scheme could have large initial impacts on businesses given the current economic climate and that, in the longer term, it could result in the loss of key industries that are exposed to a carbon price ahead of international competitors. A key initiative since the development of the current NZETS is the Australian CPRS. The proposed CPRS will provide greater assistance to emissions-intensive, trade-exposed (EITE) industries than the NZETS. This could disadvantage New Zealand firms that compete in markets with Australian firms.

• Implementation Timeframes – There are some implementation dates in the Act which will be difficult to achieve as there is not enough time for allocation plans to be developed and for the sectors to prepare to enter the NZETS. The most pressing is the entry date of the Stationary Energy and Industrial Processes (SEIP) sectors which will begin to accrue obligations under the NZETS from 1 January 2010.

Accordingly, the decision was made to review the NZETS and consider alternative options. Those considered:

• Make amendments to the NZETS and change implementation dates. The option is to leave the majority of the NZETS as it is currently legislated, and change the entry date for the Stationary Energy and Industrial Processes (SEIP) sectors.

• Abolish the NZETS. Under this option, the New Zealand government would meet its commitments under the Kyoto Protocol by purchasing emissions credits from international markets.

• Replace the NZETS with a carbon tax. Carbon tax is an alternative price-based mechanism to an emissions trading scheme and is a realistic option.

• Delay the entry dates of all sectors other than forestry until 1 January 2013. Under this option, all sectors would enter the NZETS on 1 January 2013, other than the forestry sector. The entry date for the forestry sector would remain at 1 January 2008.

Subsequently the Government pursued the option to amend the NZETS and pushed through the Climate Change Response (Moderated Emissions Trading) Amendment Bill.

3. CLIMATE CHANGE RESPONSE (MODERATED EMISSIONS TRADING) AMENDMENT BILL

The Climate Change Response (Moderated Emissions Trading) Amendment Bill passed its second and third reading on 25 November 2009.
The main changes are as follows:

• shift the commencement of unit-surrender obligations for the liquid fossil fuels, stationary energy, and industrial processes sectors to 1 July 2010;

• provide for a transitional phase to operate from 1 July 2010 to 31 December 2012 during which:

− participants in the liquid fossil fuels, stationary energy, and industrial proces ses sectors are only required to surrender one eligible unit for every two tonnes of CO2 emitted and have an option to pay $25 in lieu of surrendering a unit in satisfaction of unit-surrender obligations; and
− the export of New Zealand units from the New Zealand Emissions Trading Scheme (NZETS) is prohibited, with the exception that the prohibition will not apply to the export of forestry-related New Zealand units;

• participants in the forestry sector are required to surrender one eligible unit for every tonne of CO2 emitted and have the option to pay $25 in lieu of surrendering a unit in satisfaction of unit surrender obligations;

• provide for free allocation of New Zealand units to emissions-intensive, trade-exposed industry on an intensity basis, with eligibility thresholds and phase-out rates for free allocation set at levels to reduce trans-Tasman competitiveness risks;

• delay the commencement of unit-surrender obligations for the agriculture sector until 1 January 2015;

• provide for free allocation of New Zealand units to the agriculture sector on an intensity basis;

• set the point of obligation for the agriculture sector at the processor level initially, with flexibility to move the point of obligation to the farm level in the future;

• increase free allocation of New Zealand units to the fishing sector to 90% of 2005 emissions levels for 1 July 2010 to 31 December 2012;

• provide power to make regulations for the setting of emissions reduction targets. The Bill sets a domestic target for New Zealand of a 50% reduction of net greenhouse gases from the 1990 levels by 2050, and that will be set through regulation.

4. FORESTRY & THE CLIMATE CHANGE RESPONSE (MODERATION EMISSIONS TRADING) AMENDMENT BILL

Only minor changes will be made to the treatment of forestry under the modified NZETS:

• emissions liabilities from the pre-1990 and post-1989 forestry sectors will be covered by the $25 fixed price option that accrue before 1 January 2013;

• the reduced 1:2 core obligation will not apply to either pre-1990 or post-1989 forests. This mitigates the risk that a short-term reduction in price could drive short-term deforestation, causing an increase in emissions;

• the forestry allocation plan process will be continued.

The emission units from pre and post 1990 forest land can be traded on international markets for the period to 1 January 2013. The $25 fixed price option is in line with the expected international price, so the sector faces the same incentive to reduce emissions as under the current scheme. It will provide a modest benefit to forest owners wishing to deforest during the Commitment Period through greater price certainty. The forestry sector has been excluded from the reduced 1:2 core obligation so there will not be the incentive to deforest or seek to convert land for the short term reduction in price offered to other industries. Forestry will be excluded from the concession.

The pre-1990 forest sector will also receive a full allocation of units during the transition phase as the free allocation represents compensation for the long-term reduction in land values faced by the sector.

Post-1989 forest land is currently able to be deforested under the NZETS. In contrast to the rest of the economy, owners of those forests benefit from a higher price on carbon. Reduction of expected returns to forestry or high levels of uncertainty among investors could reduce investment in new plantings and participation of existing post-1989 foresters in the ETS. In order to provide some certainty for investment decisions, the banking and exporting of emission units will be permitted for both the pre-1990 and post-1989 forestry sectors during the transition phase. The risk of arbitrage from allowing exports during the transition phase is considered to be low as the level of deforestation for pre-1990 forests is not expected to be significant. Allowing exports for post-1989 foresters will ensure that the sector receives the full economic incentive for new investment.

5. TAXATION (INTERNATIONAL TAXATION, LIFE INSURANCE AND REMEDIAL MATTERS) ACT 2009

The Taxation (International Taxation, Life Insurance and Remedial Matters) A

ct 2009 received royal assent and became law on 6 October 2009. The Act contains a number of major tax reforms and numerous technical amendments which are outlined in our September Newsletter.

The date of the royal assent has added significance for provisions in the Act that apply from that date. Some of the main provisions that apply from the date of the royal assent are:

• new associated persons definitions that apply for the purposes of determining the assessability of gains from the sale of land. Land acquired on or after 6 October 2009 and (where relevant) land on which improvements are begun on or after 6 October 2009 will be subject to the new associated persons definitions;

• amendments to the tax pooling rules apply from 6 October 2009;

• payroll giving;

• GST changes relating to the Emission Trading Scheme.

• Tax Pooling

The Act amends the tax pooling rules to extend the availability of tax pooling to include reassessments of all tax types, and not limit the application to only provisional tax.

The amendments provide for the use of tax pooling in the following situations:

• Amendment of any assessment by the Commissioner for any reason;

• Determination of provisional tax made by the Commissioner;

• Assessment of tax through the Commissioner’s acceptance of a Notice of Proposed Adjustment;

• Assessment by taxpayer voluntary disclosure; and

• Assessment through resolution of a dispute with the Commissioner.

The amendments are intended to cover situations where there is uncertainty on the amount of tax resulting from a dispute, reassessment or voluntary disclosure. It is not intended that they apply to assessments where there is certainty of the amount of tax to pay.

Taxpayers must access the tax pool within 60 days of the Notice of Assessment or 60 days after the dispute is resolved, as appropriate.

Payroll Giving

The voluntary payroll-giving scheme will take effect from 7 January 2010. The scheme provides a tax credit for gifts of money that are deducted from an employee’s pay through his or her employer’s payroll. Employees receive an immediate reduction in tax by way of the tax credit each pay-period, eliminating the need to collect and keep receipts to claim the tax relief on gifts of money at the end of the year. To participate in the payroll-giving scheme, the recipient organisation, such as a charity or school, must be a donee organisation.

The legislation only provides for the tax administration of the scheme. It does not prescribe the nature of the arrangements or relationships between employers, employees and donee organisations, or how the schemes should be set up in the workplace.

The scheme operates in addition to the current end-of-year donation tax credit claim system. Therefore, employees who do not or are unable to give through a payroll-giving scheme can still claim tax benefits on their donations through the existing end-of-year refund process.

The report is intended to provide timely assistance to employers, employees, donee organisations and their advisors in understanding the tax mechanism for delivering tax credits for payroll donations. It also offers some guidance on how to set up a payroll-giving arrangement based on overseas experience and the current limited New Zealand experience using an after-tax payroll-giving scheme.

GST Changes relating to the Emission Trading Scheme

The legislation made a number of changes to provisions in the Goods and Services Tax Act 1985 that deal with the GST consequences of allocating and trading in emissions units. In effect all supplies of emission units and supplies of services made in exchange for units before 1 January 2009 are taxable supplies and GST is determined at the standard tax fraction, and all supplies of emission units after 1 January 2009 (including transfer of units from the government or other supplier, and surrender of emission units) are taxable supplies but zero rated. There are variations to the rule for voluntary units and transactions involving the government outside of the Emissions Trading Scheme.

This change takes effect from 1 April 2010.

6. STUDENT LOAN SCHEME (REPAYMENT BONUS) AMENDMENT BILL

The Student Loan Scheme (Repayment Bonus) Amendment Bill passed its final stages under urgency in Parliament on 17 September 2009. The Bill amends the Student Loan Scheme Act 1992 by providing a bonus of 10% on any payments in a tax year exceeding the borrower’s compulsory repayment obligation for that tax year by $500 or more. It aims to encourage borrowers to repay more than the compulsory minimum amount so that they pay off their student loans sooner. A secondary aim is to reduce the cost of the student loan scheme to the Government.

7. TAXATION (CONSEQUENTIAL RATE ALIGNMENT AND REMEDIAL MATTERS) BILL

The Finance and Expenditure Committee reported back to Parliament on the Taxation (Consequential Rate Alignment and Remedial Matters) Bill on 5 November 2009. The content of the bill is outlined in our September Newsletter. The main feature of the Bill is the alignment of resident withholding tax (RWT) rates on interest paid to individuals, to bring them into line with recent changes to personal tax rates. The new rates for individuals will be 12.5%, 21%, 33% and 38%, depending on their income. The Bill also introduces a new default rate of 38% for people who do not elect an RWT rate with their bank and aligns the tax rates on portfolio investment entities (PIEs) with the new personal tax rates of 12.5%, 21% and 30%.

8. ELIGIBLE RELOCATION EXPENSES

The Commissioner released Determination DET 09/04: Eligible Relocation Expenses on 28 October 2009. The determination applies to relocation expenses incurred in respect of the 2002/03 and subsequent income years.

The Determination states that all reimbursements by an employer for work related relocation costs incurred by or on behalf of an employee will be deemed non-assessable income to the employee subject to compliance with requirements set out in the Act.

The Determination provides a list of eligible relocation expenses. The expense must be on that list and comply with the following criteria:

• The reimbursement must be no more than the actual cost incurred by or on behalf of the employee on an expense that the IRD list as an eligible relocation expense.

• The reimbursement must only be for relocation costs incurred up to the tax year following the relocation.

• The relocation is a move from the employee’s residential location because it is not within a reasonable daily travel distance from the workplace as a result of either the employee taking up new employment or taking up new duties at a new location with the same employer or continuing the current position but at a new location.

The employer is entitled to a tax deduction for the cost on the basis of general permission contained in the Income Tax Act. The expenditure would have to have been incurred in the course of carrying on a business for the purposes of deriving assessable income.

The rules apply to employer/employee relationships including shareholder employment.

9. GST CHANGES AHEAD

The Government is proposing significant GST changes that include the introduction of a Domestic Reverse Charge (DRC) on certain transactions and reforms to the rules governing input tax deductions and change-in-use adjustments.

Domestic Reverse Charge

The DRC proposals are intended to reduce revenue risk to the Government, remove GST cash flow disadvantages for businesses and prevent unexpected GST liabilities from arising. There is a fundamental change to how GST works as it shifts the obligation to account for GST from the supplier to the recipient. The recipient accounts for the output tax on the transaction and then recovers the GST in accordance with their normal GST recovery entitlement.

The DRC would apply to all transactions between GST-registered businesses involving:

• land;

• going concerns; and

• supplies of goods and services with a GST-exclusive value of $50 million or more.

The advantage of the DRC for businesses entering into high-value transactions is that it would eliminate any potential GST cashflow cost and remove the potential uncertainty associated with zero-rated going concern sales. It would also protect the Inland Revenue against GST issues and timing differences in accounting for GST.

Input Tax Deductions and Change-in-use Adjustments

The Government proposes significant changes to the rules for determining input tax deductions and change-in-use adjustments. The changes are intended to address the uncertainty and complexity in the current rules and to align the New Zealand approach more closely with the Australian approach.

The proposed changes allow businesses to claim GST when they first acquire the goods or services irrespective of whether or not the goods and services are acquired for the principal purpose of making taxable supplies. The deduction would be based on the intended taxable use of the goods and services. Businesses would need to estimate the intended taxable use on a fair and reasonable basis using available records, previous experience with similar assets and business plans.

Annual adjustments to the upfront deduction would be made if the initial intended taxable use changed by more than 5%. If the actual taxable use is less than the intended taxable use additional GST would be payable and vice versa.

Calculating Change-in-use Adjustments

Adjustments are made annually in the first taxable period corresponding to a taxpayer’s balance date that is at least 12 months after the date the goods and services were acquired. Where businesses acquire goods and services shortly after balance date, it may take close to two years for the first adjustment entitlement to arise. This does not compare favourably with the flexibility of the current adjustment rules that allow adjustments in each return period (or annually).

No adjustments are required where either the goods and services have a value of $1,000 or less, the business only makes minor exempt supplies or the change in taxable use is 5% or less.

There is no limit on the number of annual adjustments required in relation to land regardless of its value.

Disposal of Assets

New rules are also proposed for the sale or disposal of assets that have been subject to change of use adjustments.

Concurrent Usage of Assets

The Government will introduce specific apportionment rules to cover assets used concurrently for taxable and non-taxable purposes (e.g. a residential property leased and advertised for sale at the same time). The effect of the proposals is to require the vendor to pay additional output tax from the sale proceeds to reflect the temporary exempt use of the asset.

Transitional Issues

The new rules would apply to assets acquired after the date of enactment.

CLIENT QUERIES – TAX

10. TAX DEDUCTIBITY OF LOSS IN VALUE OF INTEREST BEARING INVESTMENTS

RESPONSE

Notes and/or debentures are financial arrangements, and are generally treated and taxed in accordance with the Financial Arrangement Rules contained in the Income Tax Act rather than the more general provisions contained elsewhere in the Act.

A person that owns a debt instrument governed by the financial arrangement rules is allowed a deduction for a bad debt where the debt has been written off in the relevant income year, and they are not associated to the person who owes them the money, and carry on a business that includes dealing or holding financial arrangements that are the same or similar to the financial arrangements in question.

A person is in the business of holding or dealing in financial arrangements if the activity is a profession, trade, manufacture or undertaking carried on for pecuniary profit. A business is a continuous and regular activity with a motive to profit and has a certain level of organisation. There is a technical issue that appears not to allow a deduction for the failed investment but by referring to the previous Income Tax Act and an anomaly in the redraft of that Act it is arguable that a deduction should be allowed where the notes are held as part of a business activity that includes dealing in notes or similar investments.

A more conservative fall back position would be to wait for the investment to cease to exist and then perform a base price adjustment to determine available tax relief. A base price adjustment calculates all amounts received less all payments under a financial arrangement, including accrued amounts, and if a negative amount, in most cases there will be a tax deduction. The deduction is limited to the equivalent of any amounts of assessable income received in earlier years.

11. DEDUCTIBILITY OF TRAVEL AND ACCOMMODATION EXPENSES

QUESTION

Can out of town temporary rental accommodation provided to a shareholder employee be treated as a deductible expense to a company, and not be assessable to the employee?

RESPONSE

In Case G57 the taxpayer was employed in the city in which he lived. In addition he carried on a business, operating a mussel farm, some distance from that city. While carrying on his mussel farming activities the taxpayer stayed at a guest-house providing meals and accommodation. The guest-house charged a single tariff making no distinction between the cost of meals or accommodation.

The Court found although the taxpayer’s purpose in staying at the guest-house was to put himself in a position to tend to his mussel farming activities for the production of assessable income, the expenditure was not incurred in gaining or producing the income from the farm, nor was it necessarily incurred in carrying on the business of the mussel farm.

The costs should be deductible to the company as an employment/business expense. However, unless a very narrow set of circumstances exist, the provision of accommodation to the shareholder-employee is considered to be employment income and the market value of the benefit forms part of the employee’s remuneration. The only time such accommodation would be tax free to the employee would be if the company’s business was based in a town or city that was geographically distant from the out of town location and previous to moving, the shareholder-employee was based in the town or city in which the company’s business is based and attended work there, and the shareholder-employee maintains a home (eg spouse and family) in that town or city for the entire period that they are working out of town.

RECENT CASES

12. WESTPAC BANKING CORPORATION v CIR

In a sequel to the High Court’s decision in BNZ Investments v CIR, released in July this year, a different Judge of the High Court has issued his decision in respect of similar issues involving Westpac. The Court reached largely the same conclusion as had been reached in the BNZ Investments case, but for different reasons in some respects. Our September Newsletter outlined the BNZ Investment case.

Background

Westpac subsidiaries had entered into ten cross-border sale and repurchase (or “repo”) transactions with UK and US counterparties. One of these transactions was subject to a favourable binding ruling from Inland Revenue. Inland Revenue, however, subsequently challenged the remaining nine transactions.

The transactions all followed the same basic structure usually seen in cross-border repo financings: a Westpac subsidiary purchased from a US or UK counterparty interests in a non-resident special purpose entity, and agreed to sell-back those interests to the counterparty or an entity related to the counterparty at a future date. In addition, Westpac paid a guarantee procurement fee (“GPF”) to the repurchase counterparty, for it to procure from its parent company, a guarantee of its repurchase obligation.
The income from the transactions was not taxable, and Westpac treated the costs associated with the transactions as deductible. The case considered two categories of costs, the funding costs and the GPF.

IRD

The Commissioner accepted that the funding costs were deductible under the specific deductibility provisions, but contended that that was not the case for the GPF. Inland Revenue also contended that deductions for both the GPF and the funding costs should be disallowed on the basis each transaction was a tax avoidance arrangement.

Westpac

Westpac advanced two grounds for the GPF being deductible under the deductibility provisions. The first was that the GPF was expenditure under a financial arrangement, and as such was deemed to be interest expenditure, automatically deductible for a company. The second ground was that the GPF was incurred in deriving gross income which arose when the Westpac subsidiary disposed of the relevant repurchased interests.

The High Court Decision

The Court held that the interests acquired under the repo were held on capital account, and that the GPF was not deductible in terms of the accruals rules provisions. The GPF was not paid to the guarantor, and was not in consideration for the guarantee.

The Court also held that even the presence of a genuine commercial purpose for the transactions did not preclude a finding that there was also a purpose or effect of tax avoidance. In relation to the GPF, he found that, even if it had been an allowable deduction, it “did not serve an objectively ascertainable business purpose” and was a “contrivance” to allow Westpac to claim a deduction. Like in the BNZ Investments case, the lack of an underlying prospect of profitability (absent the tax benefits) pointed to a lack of commercial or business justification.

13. NEWS ABOUT THE OFFICE

Staff

We welcome Sharon Brodie who joined us in November from Deloittes, Wellington. Sharon is in her final year of study to become a Chartered Accountant and is a welcomed addition to the accounting division.

Christmas Hours

We will be closing 3.00pm Tuesday 22 Dec 2009 and reopening again 8.30am Wednesday 13 Jan 2010.

Should you require urgent advice during the closure period please email: margaret@woodwalton.co.nz

The Partners and staff wish you a wonderful holiday season.