Thin capitalisation - concession for groups with low interest deductions

2011 legislation makes it clear that concessions for low interest deduction groups relate to the interest deductions of the NZ group of a taxpayer.

Section FE 6 of the Income Tax Act 2007

Section FE 6, which includes a concession for groups of companies with low deductions for interest paid, has been amended to ensure it works as intended.

Analysis

The Taxation (International Taxation, Life Insurance and Remedial Matters) Act 2009 widened the thin capitalisation rules in subpart FE to include New Zealand groups with investments in controlled foreign companies.

The wider rules included a concession for groups with deductible interest expenses of less than $2,000,000. If the expenses were less than $1,000,000 the thin capitalisation rules effectively did not apply at all. If the expenses were between $1,000,000 and $2,000,000 the thin capitalisation rules had limited effect.

The intention was always that when applying the concession, the relevant limits would be deductible interest expenses of the relevant group rather than the expenses of an individual taxpayer within the group. However, this was not reflected in the legislation as originally enacted.

Sub-paragraphs FE 6(3)(ac)(ii) to (iv) have been amended to make it clear that the concession relates to the interest deductions of the New Zealand group of a taxpayer.

Example

There are two members in the New Zealand group, X Co and Y Co. X Co has a "total deduction" amount under section FE 6(3)(a) of $0.7 million and Y Co has a total deduction amount of $0.5 million.

The group finance cost is $1.2 million. Since this is between $1 million and $2 million, subparagraph (iii) applies. $800,000 is the amount by which $2 million exceeds the group finance cost.

For X Co, the ratio of the member finance cost to the group finance cost is $0.7m ÷ 1.2m = 7/12. The amount "adjust" in the formula in section FE 6(2) is therefore 7/12 x $800,000 = $466,667. For Y Co, "adjust" is $333,333.

Application date

The amendments apply from the date of introduction of the Taxation (Tax Administration and Remedial Matters) Bill, being 23 November 2010.