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Taxation (International Investment and Remedial Matters) Act 2012 : Exemption from the outbound rules – changes to legislation and thin capitalisation rules.

Section FE 5(1B)(b) of the Income Tax 2007 (repealed)

Under the previous rules, section FE 5(1B)(b) provided an exemption from the thin capitalisation rules for excess debt outbound companies if total interest deductions for the New Zealand group did not exceed $250,000. This exemption was rendered effectively redundant by section FE 6(3)(ac)(ii) which reduces to zero the deductions subject to apportionment under the rules if the finance costs of an outbound entity do not exceed $1 million. Accordingly, section FE 5(1B)(b) has been repealed.

Application date

The change applies to income years beginning on or after 1 July 2011.

Detailed analysis

Section FE 5(1B)(b) and section FE 6(3)(ac)(ii) provided overlapping exemptions from the thin capitalisation rules for excess debt outbound companies. Because the threshold for the latter exemption is more generous, section FE 51B(b) became largely redundant and has been repealed.

There are some minor differences in scope between section FE 5(1B)(b) and section FE 6(3)(ac)(ii), as noted below.

Section FE 5(1B)(b) set the $250,000 exemption threshold based on interest deductions under sections DB 6 to DB 8, whereas the $1 million threshold in section FE 6(3)(ac)(ii) also takes account of fixed-rate dividends (see section FE 6(3)(ab)). In this regard, section FE 6(3)(ac)(ii) is less generous than section FE 5(1B)(b) was, and it is possible that, where fixed-rate equity is used in place of ordinary debt, the latter may have provided an exemption where the former does not. However, since the thin capitalisation rules now extend to cover fixed-rate dividends, the approach taken in section FE 6(3)(ac)(ii) is appropriate.

The $250,000 exemption under section FE 5(1B)(b) was not available when the New Zealand group included an entity with an income interest in a CFC that was deriving rent from land in the CFC's local jurisdiction. There is no equivalent exclusion from the $1 million exemption under section FE 6(3)(ab).