Update on debt remission proposals
Tax Alert - October 2015
On 3 September 2015, Revenue Minister Todd McClay announced that Cabinet has approved finalised proposals to address the situation where debt remission income arises and the debtor and creditor are in the same wholly owned NZ group of companies.
Currently the financial arrangement rules create an asymmetrical outcome for debt remission in the context of wholly-owned NZ group companies - i.e. that debt remission income arises to the borrower for the amount remitted, while the related-party lender is denied a deduction for the bad debt. This issue has driven parties to resort to capitalising the debt rather than forgive the debt (which Inland Revenue has recently deemed to be tax avoidance).
Officials acknowledged that this issue was driving debt capitalisation and released an issues paper in February 2015. At this time the Government agreed to a core proposal that, in the context of a wholly owned NZ group scenario, debt remission income should not arise.
It has now been confirmed that there will be no debt remission income for the debtor when the debtor and creditor are in the New Zealand tax base, which includes controlled foreign companies, and:
- they are members of the same wholly owned group of companies; or
- the debtor is a company or partnership and:
- all of the relevant debt is owed to shareholders or partners in the debtor; and
- if we presume that the debt remitted was instead capitalised, there would be no dilution of ownership of the debtor following the remission and all owners’ proportionate ownership of the debtor is unchanged.
The rationale is that when the two parties are within the same wholly-owned group, the wealth of the group as a whole is not altered by the debt remission and the tax outcome should reflect that. The outcome does mean that as an alternative to debt remission, debt capitalisation in these particular scenarios can continue without avoidance being alleged.
However the original proposal did not deal with a creditor that was non-resident. Officials wanted to do more work on what the policy answer should be where the owner/creditor is non-resident because the use of related-party inbound debt is a key BEPS (Base Erosion and Profit Shifting) concern. Officials have now concluded their review of this issue and it is therefore an extremely welcome announcement that Cabinet have approved that the core proposal should extend to inbound debt.
The amending legislation is expected to be introduced in early 2016 with retrospective application from 1 April 2006. To provide further certainty, a technical information sheet contains early detail of the proposals to be included in the draft legislation.
October 2015 Tax Alert