Good news for businesses with new shareholders
Tax Alert - March 2021
By Robyn Walker
One thing the COVID-19 crisis has highlighted is that businesses will often need new capital in order to grow and innovate… or to survive a one in one-hundred year pandemic. Likewise, in some cases, businesses of all sizes may need new shareholders for a variety of reasons. If a company being sold or raising capital has tax losses, the introduction of new shareholders has long caused a tax headache. This is because tax losses are currently only able to be carried forward to offset future profits if 49% shareholder continuity has been maintained. The reason for this rule has been to prevent “loss trading”, where a profitable business could acquire a business with considerable losses for a low price and use this to shield its profits from tax.
In response to this perennial problem, in April 2020 the Ministers of Finance and Revenue announced that New Zealand would be supplementing its existing tax loss carry forward rules with a new “same or similar business test” with effect from the commencement of the 2020/21 income year (generally 1 April 2020). Since that time, Officials have been working with a private sector reference group to develop the regime. As a member of that Group, it was an extremely productive and well-run process, and the result has been a development of a regime which will be a great benefit, particularly to start-ups who need more capital to grow.
Some high-level details of the proposed regime have now been publicly released, which we summarise below.
What is the proposal?
When this proposal was originally announced, the plan was to model our new rule on something Australia does; their rules essentially say you can carry forward tax losses if the business is the same or substantially the same (i.e. similar) both at the time the losses were incurred and when the losses are used. After examining the Australian approach and comparing it to what other countries do, it was decided to adopt a slightly different (and better) approach. A same or similar business test has limitations because it’s necessary to continuously prove that the business satisfies the test, which can be onerous. Instead the approach proposed is a “major change test” which will allow losses to be carried forward unless there is a major change in the nature of the company’s business activities, having regard to the assets used (other than land) and other relevant factors.
There are certain things which will not be a “major change”, for example companies will be able to make changes to increase efficiency, increase scale, keep pace with technology, or rationalising the companies product or service range, including adding new items produced using the same, or largely the same, assets of the company. Whether a change is major or not really comes down to the facts and circumstances of each individual case.
The test will apply to tax losses incurred from the 2013/14 income years onwards and to shareholder continuity breaches in the 2020/21 and later income years. Once a company has had a breach in shareholder continuity, in order to carry forward tax losses the business can’t have had a “major change” until the earlier of when the losses are utilised or the end of five years after the ownership change (subject to some exclusions).
Buffalo and Reindeer Yoghurt Limited (BARY) has been running a yoghurt manufacturing and sales business for some time, however in recent years it has begun to run at a tax loss. As at 1 April 2020, BARY has tax losses of $5million. To help remedy this, BARY approaches a well-known chef and yoghurt-maker, Claire, to help run the business. In March 2021 Claire agrees to bring her considerable intellectual property to the business in return for a sixty percent ownership share. Claire comes into the business and helps turn its fortunes around by developing new recipes and changing some product offerings. For example, reindeer yoghurt is dropped as a product line as it is unprofitable, and a new cashew yoghurt is introduced to appeal to the growing market of customers following a plant-based diet. BARY uses all the same manufacturing assets both before and after the shareholding change. BARY is able to carry forward its tax losses despite 49% shareholder continuity not being maintained. BARY incurs a further $1million tax loss in the year ended 31 March 2021; but then goes on to make $1million of taxable income in the 2022 year, $2million in the 2023 year and $3million in the 2023 year. Because at the end of the 2023 year BARY has used all of its tax losses, it no longer needs to satisfy the major change test.
Are there any complications?
With most things associated with tax, there will be complexities which businesses looking to benefit from these rules will need to understand. However, as a general comment, the complexity comes about to prevent taxpayers manipulating income and expenses to exploit the rules; so businesses operating within the spirit of the rules should have no issues.
Some points to note are:
- The rules will contain a purpose statement to help taxpayers apply the rules. The stated policy purpose is “to remove an impediment to sensible business reorganisations while preventing loss trading.
- The rules won’t apply to mineral mining companies as they have a separate tax regime.
- Dormant companies cannot apply the rules.
- There will be anti-injection rules to stop income from being added to the company and an anti-cost transfer rule to stop costs being removed from the company artificially.
- A business will not be able to apply the rules if the business has had a “major change” in the two years prior to the change in shareholding.
- The rules will apply differently for finance companies.
The next steps are that legislation will be added to the Taxation (Annual Rates for 2020-21, Feasibility Expenditure, and Remedial Matters) Bill as a supplementary order paper in the second half of March. While these changes will not be going through the usual full “generic tax policy process” and public consultation, the changes are taxpayer favourable and remove an impediment to growth and innovation which should be applauded (despite the non-standard process adopted).
What else is happening with losses ?
Readers may recall that at the time the Government announced these loss carry forward rules, it also announced that it would introduce a temporary loss carry back regime which would then be replaced by a permanent loss carry back regime. The temporary loss carry back regime has been in place since April 2020, you can read more about those rules here. At a recent tax conference the Minister of Revenue advised that at this stage the Government will not be immediately implementing a permanent loss carry back regime.
March 2021 Tax Alert contents
- What are the tax obligations which come with claiming COVID-19 Government support?
- The tax cost of your fringe benefits is about to increase
- The new 39% tax rate puts tax structuring back into the spotlight – why it may be time to talk about tax avoidance
- Good news for businesses with new shareholders