Can I carry forward my tax losses? Final guidance from Inland Revenue

Tax Alert - December 2022

By Vyshi Hariharan, Hamish Tait & Robin Kim

Inland Revenue has recently released, in final form, a new interpretation statement Loss carry-forward – continuity of business activities (the final statement). We have previously commented on an earlier draft of the statement (the draft statement). The final statement provides helpful guidance on how the main aspects of the business continuity test (BCT) apply.

Enacted nearly two years ago, the BCT relaxes New Zealand’s previously strict loss carry-forward rules for companies. Under the rules, losses are no longer forfeited where there is a breach in shareholder continuity, provided there is no major change in the nature of the company’s business activities; or if it is a major change, provided it is one of four “permitted changes."

In this article, we have briefly commented on the guidance included in the final statement and our observations in respect of matters not addressed by the statement - such as when Inland Revenue will seek to apply anti-avoidance rules.

What does the statement cover?

Consistent with previous drafts, the final statement includes helpful examples and expands guidance previously issued.

We have summarised the main changes and key additional guidance included in the final statement below.

  • Defining the nature of a company’s business activities

Taxpayers relying on the BCT will need to define their business activities as a first step.

The draft statement released in mid-2021 included detailed comments in relation to the level of granularity that taxpayers should apply to define business activities. Specifically, it stated that, rather than describing a business “very broadly” (e.g. agriculture), or “very narrowly” (e.g. merino sheep farming for fine wool), the business should be described “more narrowly” (e.g. sheep farming).

The final statement sets out more generalised guidance on the relevant factors to be considered in determining the “nature of a company’s business activities”, noting that this should be described with reference to:

- The core business processes
- The type of product or service produced or provided;
- Significant assets utilised and where relevant, significant suppliers or other inputs;
- Scale; and
- The main markets supplied to.

  • Groups of companies

The BCT deems a group of NZ resident companies that are part of the same group of companies at the time of a shareholder continuity breach (e.g. the acquisition of an entire corporate group) to be a single company for the purposes of assessing the nature of any future changes to business activities.

The final statement provides further guidance on how this should be applied in practice, including that intra-group activities/transactions are ignored for BCT purposes. For example, administrative services from a holding company to other companies within the same group are disregarded when considering whether there has been a major change, as are a holding company’s shares in its subsidiaries when determining the relevant assets.

Furthermore, the guidance notes that if a deemed single company produces/provides multiple products/services, a significant change in the relativities of these products/services can be considered to be a major change.

  • Major changes or cessations occurring part-way through an income year

The final statement provides guidance in relation to the impact of a major change that occurs part-way through an income year, noting that this does not prevent a tax loss from being carried forward and set off against income that arises in the part of the year prior to the major change, provided there are adequate financial statements calculating the company’s taxable income for that part of the income year. This position is consistent with the outcome where a shareholder continuity breach occurs part-way through an income year.

  • Decreases in scale, and/or discontinuation of existing products or services

A reduction in the scale of output or the discontinuation of existing products or services may be indicative of a major change in certain (but not all) circumstances. The statement helpfully includes examples that indicate the context in which such changes may or may not be considered a major change.

The BCT provides that certain major changes are “permitted” major changes. This includes:

a. Changes to increase the scale of a business; and
b. Changes in the type of products or services, if they are produced using mainly the same assets, or are closely connected with the old products/ services.

Where a reduction in the scale of output or the discontinuation of existing products or services is determined to be a major change in the context of the operations of a company (or group), the final statement notes that the changes would not be considered a permitted major change under (a) or (b) above.

  • Examples

The final statement helpfully includes new and expanded examples which cover a wide range of situations, including the application of the rules with respect to

- Ownership continuity breaches taking place prior to the 1 April 2020 application date (but still in the 2021 income year), e.g. early balance dates;
- Companies with intervening or a series of ownership continuity breaches and changes in the nature of business activities carried on;
- Where a major change occurs part-way through an income year;
- Determining the nature of business activities carried on by a deemed single company;
- Where major changes are in respect of technological advances that are not related to the business activities of the company;
- Start-ups and permitted major changes; and
- A diversified group of companies disposing of one of its businesses and whether this is a major change and if so, a permitted change.

Matters not covered in the final statement

  • Trade buyers and post-merger integration

It is common to see one company purchasing a competitor or related business, with a view to essentially absorbing it into the purchaser’s business. The purchaser may look to integrate a number of functions (e.g. back office, sales etc) from the target, either immediately or gradually over time as part of the integration process to achieve synergies.

Inland Revenue’s guidance includes a helpful example around outsourcing a manufacturing operation being a permitted major change, given it is made to increase efficiency (Example 8). Based on this example, it may be acceptable in some situations for a number of a target company’s functions to be outsourced – provided fundamentally the same business continues to be carried on. However, Inland Revenue’s guidance does not discuss whether or when any such changes might be a ‘bridge too far’, or what should be done (e.g. intercompany agreements, management fees) to support the outsourcing. Therefore, where the target has pre-completion tax losses, a purchaser will need to be wary of the extent to which any changes made could be a ‘major change’ and carefully consider the application of the rules before implementing post-acquisition integration measures.

  • Anti-avoidance rules

The BCT rules are buttressed by several specific anti-avoidance rules. The final statement does not provide any comment on what situations Inland Revenue might regard as being in breach of these rules.

  • Interaction with other tax rules

The statement does not comment on or provide examples that consider, whether the tax consolidated group rules or the amalgamation tax rules could impact on the application of the BCT.

How are we seeing taxpayers responding to the new rules?

  • Market practice / paying for losses

One of the big questions ahead of the introduction of the BCT was how purchasers in merger & acquisition (M&A) transactions would respond, including whether they would place value on targets with tax losses. Whether losses have value in specific scenarios varies depending on the purchaser and their circumstances. For example, the likely usage of losses (i.e. when will the losses start to shelter go-forward income), and the likelihood they will stay intact (depending on the purchaser’s plan for the business post-completion) is impacting on this.

  • Seeking certainty through rulings

Officials have engaged with taxpayers and advisers throughout the design of the rules and issued helpful guidance, including a number of practical examples. Where the application of the rules is not clear or taxpayers would like to have more certainty, it is also possible to seek binding and non-binding views in relation to the application of the rules. We understand that in most cases, these views are provided in relation to a targeted aspect of the rules.

  • Documenting the positions taken

The application of the BCT is ultimately a fact intensive, subjective analysis. Therefore, each company (or group of companies) must evaluate the relevant factors under the rules with reference to their own circumstances. We recommend documenting an initial snapshot of the business (with reference to the relevant factors noted in the guidance and the rules) and regularly monitoring and updating the documentation to track any changes in activities. This will ensure that positions taken can be supported with appropriate documentation and analysis. Businesses should also consider their internal processes so that appropriate consideration is given to the impact of the BCT prior to making changes.

Please get in touch with your usual Deloitte advisor if you would like to discuss this further or are relying on the BCT to carry forward tax losses. We can work with you to help with undertaking the required analysis, determine whether a binding or non-binding view should be sought, and document the results in an efficient way.

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