Further IFRS amendments to the financial arrangements rules
2009 amendments reflect changes anticipated following the introduction of the original international financial reporting standards (IFRS) tax rules.
Sections EW 14, EW 15B, EW 15D to EW 15I, EW 21 to EW 23, EW 25B, EW 26, EW 29, EW 31, EZ 52BB and YA 1 of the Income Tax Act 2007; sections EW 15C to EW 15E, EW 21 to EW 23, EW 26, EW 29, EW 31 and OB 1 of the Income Tax Act 2004
The Taxation (Business Taxation and Remedial Matters) Act 2007 introduced changes to the taxation of income and expenditure on financial arrangements (the accrual rules) for taxpayers who have adopted new international financial reporting standards (IFRSs). It was anticipated that further changes to those rules would be required once the full consequences of the new IFRS were better understood. The amendments to the Income Tax Act 2004 and the Income Tax Act 2007 were largely introduced by Supplementary Order Paper. The first four bullet points below were included in the original bill. The amendments mostly reflect changes anticipated following introduction of the original IFRS tax rules.
- make IFRS GAAP (generally accepted accounting principles) operating leases which are financial arrangements for tax purposes subject to the compulsory yield to maturity (YTM) treatment for tax purposes;
- amend the anti-arbitrage provisions regarding the use of the Determination, expected value and modified fair value methods where IFRS hedging involving two financial arrangements occurs and the (IFRS financial reporting) fair value method is used for one of the financial arrangements in the hedging relationship;
- ensure that IFRS taxpayers who prepare financial statements in a functional currency other than New Zealand dollars are required to use New Zealand dollars for the four IFRS methods available for financial arrangements when filing the tax return;
- for Determinations G27 and G29, replace the use of Determination G9A with Determination G9C, both changes applying from the 2009-10 income year;
- introduce an option to allow the use of Determination G3 from the 2009-10 income year for New Zealand currency non-derivative financial arrangements;
- allow the retrospective use of Determination G3 from the 2008-09 income year for financial arrangements of entities which are subject to a creditor workout. This change implements the policy change announced by the Ministers of Finance and Revenue on 15 December 2008;
- allow IFRS early adopters who used the (IFRS financial reporting) fair value method in the 2005-06 income year to change to another method in either the 2006-07 or 2007-08 income years, with a base price adjustment being performed in the year of change;
- clarify the deductibility of interest capitalised in terms of NZ IAS 23 so that, unless it was otherwise dealt with in a return filed by 30 June 2009, the interest is deducted for tax purposes as it is incurred;
- reinstate on a retrospective basis the use of the pre-IFRS financial reporting method for those taxpayers who did not have to adopt IFRS GAAP;
- clarify that the use of the IFRS financial reporting method is based on the IFRS GAAP rules used in the taxpayer’s financial statements;
- allow taxpayers who use the (IFRS financial reporting) fair value method for financial arrangements which are held for the business of dealing in such arrangements not to adjust for impaired credit adjustments included in the IFRS GAAP financial reporting values;
- change the consistency requirements for group companies in respect of the expected value and modified fair value methods so that they do not apply to financial arrangements of group companies that do not have a business of a substantially similar nature to a business of another group company, unless the financial arrangement is with other members of the group. These provisions have also been amended to make it clear that there is both an election and a notification requirement to fulfil;
- correct an error for use of the base price adjustment in respect of non-integral fees and consideration; and
- provide for the use of the modified fair value method for taxpayers within an IFRS GAAP consolidated group in some circumstances, based on the hedge accounting adopted in the consolidated financial statements.
Except where otherwise stated, the amendments set out above all apply from the application date of the original legislation, being 1 April 2007 for the Income Tax Act 2004 and 1 April 2008 for the Income Tax Act 2007.
The amendments in this Act primarily clarify or amend provisions in the original legislation, based on further submissions and discussions with taxpayers and advisors. There are also some new general initiatives in the Act, being:
- the use of the modified fair value method for taxpayers within an IFRS GAAP consolidated group in some circumstances, based on the hedge accounting adopted in the consolidated financial statements;
- introduction of the general use of Determination G3 from the 2009-10 income year for New Zealand currency non-derivative financial arrangements;
- changes to the consistency requirements for group companies in respect of the expected value and modified fair value methods, so that they do not apply to financial arrangements of group companies that do not have a business of a substantially similar nature to a business of another group company, unless the financial arrangement/s is/are with other members of the group; and
- making IFRS GAAP operating leases which are financial arrangements for tax purposes subject to the compulsory YTM treatment for tax purposes.
These are discussed, along with all the other changes mentioned above, in the following commentary.
A summary of the spreading methods available to taxpayers under the amended financial arrangement rules is presented in Figure 1. An earlier version of this flowchart was included in TIB Volume 20, No 3 April 2008.
Figure 1: New Financial arrangement spreading rules
IFRS GAAP operating leases which are financial arrangements for tax
Under the original legislation some financial arrangements for tax purposes were being classified as operating leases in IFRS GAAP financial statements. However, the IFRS tax methods available for such financial arrangements were not appropriate and, after consultation with taxpayers and advisors, these types of financial arrangements have been included in the compulsory use of the YTM method in section EW 15B of the Income Tax Act 2004 and section EW 15I of the Income Tax Act 2007.
Determination methods: inclusion of Determination G3 from the 2009-10 income year
The use of Determination G3 has been included in section EW 15E of the Income Tax Act 2007 for New Zealand currency non-derivative financial arrangements. Originally, it was considered that the IFRS financial reporting method would be the only method necessary for New Zealand currency non-derivative financial arrangements. However, after consideration and consultation, it is now considered that an alternative YTM method should be available for these financial arrangements.
Taxpayers will be able to use this method from 2009-10 by performing a base price adjustment or change of spreading method adjustment as appropriate. Section EZ 52B of the Income Tax Act 2007 provides a one-off opportunity for taxpayers to change to Determination G3 in the 2009-10 income year to further allow the reduction of volatility. The tenor of Determination G26 can be used in conjunction with Determination G3 where appropriate (see the discussion below relating to creditor workouts).
It should be noted that Determination G30 was withdrawn from use on 1 October 2009. This determination was introduced as an interim measure for use with certain New Zealand currency financial arrangements which were either held or issued by IFRS taxpayers who were in the business of lending money. It is understood that only a few taxpayers applied Determination G30 to eliminate volatility on applicable financial arrangements following the introduction of the original legislation. The revised rules available from the 2009-10 income year mean that this determination was no longer required.
Creditor workouts: use of Determination G3 from the 2008-09 income year
A “creditor workout” has been defined in section YA 1 of the Income Tax Act 2007. The use of Determination G3 is permitted in the 2008-09 and subsequent income years in section EZ 52B for financial arrangements which are subject to a creditor workout. These changes give effect to the policy change announced by the Ministers of Finance and Revenue on 15 December 2008.
It is intended that the legislation will apply to creditor workouts which are legally binding on the parties to the relevant financial arrangements, including those which are legally binding on the parties to the financial arrangements as a result of a workout effected through changes to a trust deed and a trustee.
For financial arrangements affected by these changes, changing the tax method to the use of Determinations G3 will be accomplished by performing a change of spreading method adjustment in the income year in which the method is changed. Determination G25 is also relevant here.
Inland Revenue has been made aware that the definition of “creditor workout” may not include some of the workouts which have been entered into and would qualify in terms of the policy objective announced by the Ministers in December 2008. Officials will discuss the situation with affected parties and any amending legislation necessary will be separately enacted on a retrospective basis.
It is also aware that some creditor workouts may involve a fixed-rate financial arrangement being rearranged as a floating rate financial arrangement. If the rearrangement causes a one-off fair value accounting gain for IFRS GAAP purposes, that amount can be spread on a YTM basis as per Determination G3, while the ongoing floating rate payments from that time in accordance with the tenor of Determination G26 will also form part of the YTM income/expenditure for those financial arrangements. Again, any amending legislation necessary will be separately enacted on a retrospective basis.
Anti-arbitrage provisions in the Determinations, expected value and modified fair value methods
The policy intent for the use of these three methods is that they cannot be used for a financial arrangement which is either a hedge of another financial arrangement or being hedged by another financial arrangement under IFRS GAAP if the other financial arrangement is using the fair value method (included in the IFRS method and the IFRS financial reporting method in the Income Tax Act 2004 and the Income Tax Act 2007 respectively).
This policy is to prevent tax arbitrage where there is IFRS GAAP hedging occurring. This was considered necessary because, as a result of many submissions on the original legislation, the three methods were introduced to allow taxpayers to elect out of volatility for tax purposes which may have resulted from the use of the IFRS method and the IFRS financial reporting methods in the respective acts.
Otherwise, the three methods can be used for financial arrangements that are not in an IFRS GAAP hedging situation, or when both financial arrangements in an IFRS GAAP hedging situation use any of the three methods or the IFRS financial reporting method which is not the fair value method.
It proved difficult to draft the appropriate clause in sections EW 15D and EW 15E of the Income Tax Act 2004, and sections EW 15E to EW 15G of the Income Tax Act 2007 and taxpayers and the Inland Revenue became aware that the clauses inserted in the bill did not achieve the desired policy intent. There have been subsequent discussions with many taxpayers and advisors on the application of these sections and it has been Inland Revenue’s position that the clauses were to be amended to achieve the intended outcome as set out in the first paragraph of this item.
A table summarising the use of the various tax methods for financial arrangements (FAs) where IFRS GAAP hedging applies and does not apply is set out below.
| IFRS GAAP |
| FA 1 Tax |
| FA 2 Tax |
|(IFRS financial reporting) fair value method.||(IFRS financial reporting) fair value method.||Both must use (IFRS financial reporting) fair value method.|
|(IFRS financial reporting) not fair value, Determination, expected value or modified fair value methods.||(IFRS financial reporting) not fair value, Determination, expected value or modified fair value methods.||Both have to use a method that is not the (IFRS financial reporting) fair value method.|
| Non-IFRS |
|Any applicable method.||Any applicable method.||A full choice of tax methods is available for these FAs.|
During the course of the drafting process it became obvious that, for the anti-arbitrage provisions to work properly, it was also necessary to insert a new subclause in sections EW 15C of the Income Tax Act 2004 and section EW 15D of the Income Tax Act 2007 for the use of the IFRS financial reporting fair value method, in addition to amending the clauses relating to the anti-arbitrage provisions for the three methods above.
It has also been considered appropriate, as a result of submissions during the consultation stage of the bill, to include in the definition of “fair value method” in section OB 1 of the Income Tax Act 2004 and section YA 1 of the Income Tax Act 2007 reference to sections EW 15C and EW 15D respectively. This reference is not intended to change the meaning of the definition but merely to reinforce that the fair value method is a method included in those two sections, being the IFRS taxpayer method and the IFRS financial reporting method respectively.
It should also reinforce that the IFRS method/financial reporting fair value method does not include the modified fair value method, which is a separate method.
FRS early adopters who used the (IFRS method) fair value method in the 2005-06 income year
IFRS early adopters who filed their 2005-06 income year tax returns on the basis of using the (IFRS method) fair value method for financial arrangements have the choice of changing to another applicable method for those financial arrangements in either the 2006-07 or 2007-08 income years. They can make the change by performing a base price adjustment in the year they elect to change methods.
This transitional measure has been provided on the basis that the original legislation was not enacted until after early adopters were required to file their 2005-06 income year returns and were not fully aware of the final shape of the legislation. It is likely that very few taxpayers would be affected by this change.
Interest capitalised for IFRS GAAP
The policy on capitalised interest and other borrowing costs is that it is deductible when incurred for tax purposes. However, enactment of the 2007 tax legislation for IFRS created some doubt on this matter. There was no intention to change the longstanding policy as a result of the enactment of the original IFRS tax legislation.
Accordingly, section EW 15C of the Income Tax Act 2004 and section EW 15D of the Income tax Act 2007 have been amended so that interest that has been capitalised in the IFRS GAAP financial statements is deducted for tax when it is incurred, which will be the same income year as it is capitalised for IFRS GAAP. However, if a taxpayer has taken the position of not deducting interest which has been capitalised for IFRS GAAP in a tax return filed before 30 June 2009, that position will be grandparented.
Pre-IFRS GAAP financial reporting method
The original 2007 IFRS legislation repealed the section allowing the use of pre-IFRS GAAP financial reporting methods as a method available for tax. For taxpayers who had adopted IFRS financial reporting, the repeal was understandable as the new IFRS tax rules specifically include methods based on IFRS financial reporting. However, its wider repeal failed to recognise that IFRS is not compulsory for all preparers of GAAP financial statements.
Sections EW 21 of the Income Tax Act 2004 and the Income Tax Act 2007 have therefore both been reinstated as they were previously, including consequential amendments to other relevant sections. These sections apply from the dates of the original IFRS legislation and are available to non-IFRS GAAP adopters for any income year since those application dates.
IFRS financial reporting method - clarification
Section EW 15B of the Income Tax Act 2004 and section EW15B of the Income Tax Act 2007 did not specify whether the allocation of an amount for tax must be the amount shown in a taxpayer’s financial statements or whether an allocation can be made by applying an accounting methodology available under IFRS but not used by the taxpayer.
The policy intent is that the taxpayer must be actually using the allocation method in its financial statements for it to be able to use it for tax purposes. It is not intended for a taxpayer to use any allocation method which IFRS accounting may generally permit without actually using the method for its own financial statements. It should be noted that the policy is based on considerations such as simplicity, ease of compliance and that the financial statements are almost certainly audited.
The sections have been amended to provide greater clarity.
Impaired credit adjustments for financial arrangements using the IFRS financial reporting fair value method - dealers
Section EW 15C of the Income Tax Act 2004 and section EW 15D of the Income tax Act 2007 required taxpayers using the (IFRS financial reporting) fair value method to identify and adjust for credit impairments to financial arrangements accounted for at fair value.
Before the original IFRS legislation, dealers were permitted to use the mark to market value method with no adjustment for credit impairments.
It was subsequently submitted that the IFRS tax legislation changed the previous policy for dealers who now use the (IFRS financial reporting) fair value method, by making them identify and adjust for credit impairments to non-derivative financial arrangements.
This change restores the earlier position that existed for dealers before the original IFRS tax legislation, with retrospective effect.
Financial arrangements held by non-New Zealand functional currency taxpayers
An IFRS GAAP taxpayer can apply any relevant method of the four IFRS methods available under the IFRS tax legislation to financial arrangements denominated in a functional currency other than New Zealand dollars.
It was submitted at the consultation stage of the bill that there should be a rule requiring non-New Zealand dollar functional currency entities that apply IFRS GAAP to use New Zealand dollars, regardless of which of the four methods specified in section EW 15C(1) is adopted.
Section EW15B of the Income tax Act 2004 and section EW 15B of the Income Tax Act 2007 have both been amended to ensure that, when a taxpayer is using a non-New Zealand dollars functional currency for IFRS GAAP, the four IFRS tax methods are applied using New Zealand dollars.
Methodology for calculating taxable income on swaps: Determination G9A
Direct use of Determination G9A was denied in the original IFRS legislation. However, it was overlooked that Determination G27 included use of Determination G9A in some circumstances, and amendments eliminate that use via Determination G27 to ensure consistency with the original policy.
The original policy intent is considered to be still valid, to reduce volatility caused by the use of spot exchange rates unless the taxpayer is using the IFRS financial reporting method which accounts for volatility.
It is also considered that the other methods available in the legislation will allow taxpayers sufficient choice to reduce volatility for tax purposes in hedge situations.
However, it was agreed that the application dates as proposed were not equitable and that affected taxpayers should be given the choice of applying them from the next income year. As originally proposed, they would have been retrospective to the 2006 tax year if an IFRS early adopter taxpayer chose to use the new IFRS tax rules from 2006.
Officials also noted that Determination G29 allows the use of Determination G9A in some situations and that for IFRS taxpayers this is also inappropriate in terms of the original policy. This alternative has also been removed for IFRS taxpayers.
Sections EW 14E and EW 15H of the Income Tax Act 2007 have been amended to effect these changes, with application from the 2009-10 income year. A change of spreading method adjustment may be necessary in that year.
Consistency requirements for groups of companies: expected value and modified fair value methods
The original IFRS legislation for these two methods included a consistency requirement which could have been interpreted as an election requirement. Section EW 15E of the Income Tax Act 2004 and sections EW 15F and EW 15G of the Income Tax Act 2007 have been amended to ensure that it is both an election condition and a consistency requirement, as originally intended.
Also, submissions were received about the general application of the consistency requirements for groups of companies’ using these two methods for financial arrangements.
As a result, the application of the consistency requirements for groups of companies and those two methods has been relaxed, and sections EW 15E of the Income Tax Act 2004 and sections EW 15F and EW 15G of the Income Tax Act 2007 have been amended.
The resulting changes mean that the consistency requirements for the two methods do not apply to a company in a group of companies which does not have a business of a substantially similar nature to another company in the group, and the relevant financial arrangements are not with associated persons. However, if the arrangements are with associated persons, the two methods can be used by a company in a group of companies if the associated persons also use the same method for those arrangements (following the requirements in the legislation prescribing the use of those methods). This is illustrated in the following example.
It is noted that there is no intention to change the consistency requirements applying to a taxpayer in a group of companies for either the use of tax methods for the same/similar financial arrangements or for financial arrangements over time (i.e. from year to year) by the changes regarding group companies described above.
Base price adjustment: non-integral fees
The definition of “consideration” was changed by the original IFRS legislation in respect of “non-integral fees” for IFRS GAAP. The change was made for non-integral fees paid by a taxpayer but it should also have been made for non-integral fees paid to a taxpayer. This has been corrected by changes to sections EW 31 of the Income Tax Act 2004 and the Income Tax Act 2007.
Modified fair value method: IFRS GAAP hedging achieved only in the consolidated financial statements
The original IFRS legislation did not provide an acceptable method for eliminating volatility of income/expenditure for financial arrangements in an individual company’s tax return where IFRS GAAP cashflow hedge accounting cannot be applied at an individual company level but is applied at an IFRS GAAP consolidated level. The hedge accounting in this situation therefore does not appear in the IFRS GAAP financial statements of any individual group company.
In practice the situation will arise where one company in a wholly owned group has a financial arrangement with a non-associated person which is hedged by a financial arrangement entered into by another group company, again with a non-associated person. These financial arrangements would be “related” for purposes of the legislation.
Where this occurs one of the individual companies in the group will have fair value amounts for financial arrangements in its profit and loss account which will produce volatility and may be unacceptable for tax purposes. However, when these amounts are offset for IFRS GAAP accounting by hedging entries at the consolidated level, an acceptable accounting result is achieved. This is achieved by removing the IFRS GAAP volatility in the individual company’s profit and loss account to equity reserve accounts at the consolidated level.
It must be emphasised that, in these limited situations, the affected taxpayers only want to achieve a position where volatility at the individual company level is removed for tax purposes, as it is for IFRS GAAP at the consolidated level. It should also be noted that, without an amendment, the issue is still relevant when individual companies file as part of a tax “consolidated” group in terms of tax legislation.
Where a taxpayer in a wholly owned group uses the modified fair value method in this manner, all members of the wholly owned group must use the modified fair value method for financial arrangements which have amounts allocated to equity reserves either in the taxpayer’s accounts or at the consolidated level.
Section EW 15G of the Income Tax Act 2007 has therefore been amended to achieve this outcome of removing the volatility in an individual company’s tax return which is otherwise removed for IFRS GAAP only at the consolidated level with application from the 2008-09 income year.