Tax Administration (Financial Statements) Order 2014

From 1 April 2014, companies including "look-through companies" that do not prepare financial reports to a higher authoritative accounting standard will be required under section 21B of the Tax Administration Act 1994, to prepare financial reports to a minimum standard as set out in the Tax Administration (Financial Statements) Order 2014 unless otherwise exempted from doing so.

Application date

The new regulation applies for income years commencing 1 April 2014 and later, with a deferral for the disclosures connected with associated persons' transactions to the 2015 tax year.

Background

The start of the Financial Reporting Act 2013 on 1 April 2014 removed for a large number of companies the obligation to prepare general purpose financial reports.

When decisions were made by the Government to reform the financial reporting regulatory framework for companies, it was also decided that these companies should continue to prepare financial reports for tax purposes, but to a lesser and minimum special-purpose level (special-purpose financial reports). For medium-sized companies that previously complied with the general-purpose financial reporting requirements, significant compliance cost savings are anticipated.

The Tax Administration Act 1994 has been amended by the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act 2014 and sets a framework so that by way of Orders in Council, the minimum financial requirements can be specified for companies and other taxpayers (when specified). A fuller description about the legislative changes made to the Tax Administration Act 1994 can be found in the commentary on the new legislation in this Tax Information Bulletin.

Overview of the Tax Administration (Financial Statements) Order 2014

Application of the minimum requirements to companies and look-through companies

All companies including look-through companies, except those expressly exempted, will be required to prepare special-purpose financial reports to a level specified by the regulation. The circumstances when companies are not required to prepare financial reports are discussed below.

"Company" is defined as having the same meaning as in section YA 1 of the Income Tax Act 2007, which includes bodies corporate and other entities that have a legal existence separate from that of their members. This includes subsidiaries of companies that prepare general-purpose consolidated financial reports.

The regulation also provides that the minimum requirements also apply to "look-through companies" as defined in the Income Tax Act 2007, unless they are otherwise exempt because the look-through company is inactive or its activities are small-scale. Look-through companies that prepare financial reports using a higher authoritative accounting standard are also exempted from preparing special-purpose reports.

Companies exempted from preparing financial reports

Section 21B of the Tax Administration Act 1994 removes the obligation to prepare special purpose reports if the company prepares financial statements to a higher authoritative accounting standard or is required to prepare according to a standard specified by another enactment, for example - companies that are subject to the Companies Act 1993 or Charities Act 2005.

In addition, recognising the costs connected with preparing financial reports, the regulation also exempts:

• companies, that are not part of a group of companies, whose activities are small-scale (both income and expenditure do not exceed $30,000 during an income year); and
• companies that are non-active companies.

The term "non-active companies" is defined by reference to section 43A of the Tax Administration Act 1994. An election under section 43A removes the obligation to file a return of income for certain companies when, for example, the company has derived no income or deemed income and has no deductions. An explanation of the non-active company rules can be found in Tax Information Bulletin Vol 6, No 12 (May 1995), page 28.

Definitions

For the most part, the definitions used in the regulation are defined in the context of the Inland Revenue Acts. An exception applies to terms used to describe accounting principles - clause 4(2) refers - and includes:

• accrual accounting
• assets
• double-entry
• expenditure
• historical cost
• income
• intangible property
• liabilities
• net assets.

The terms above are to be defined according to their accounting context.

Minimum requirements

Clause 8 and the Schedule to the regulation prescribe the minimum requirements for preparing financial statements. The minimum requirements are directed at the preparation of special-purpose financial statements. The requirements are, for the most part, principles based, although some disclosures and valuation methods are specified. The new regulation sets out the following minimum requirements for preparing financial reports under the headings:

• Form of the financial reports - Companies are required to prepare a balance sheet and a profit and loss statement.
• Principles with which statements must comply - Financial reports must be prepared using double-entry accrual accounting concepts.
• Valuation - Disclosed values should generally be based on tax values (values that comply with the Inland Revenue Acts). In most instances this will correspond with historical cost, but not always. Historical cost or market values can be used if this is more appropriate. For example, entertainment expenses should be recorded using historical cost, with the add-back detailed in the book-to-tax reconciliation. The valuation method used should be included in the accounting policies disclosure.
• Statement of accounting policies - A description of the policies used by the company in preparing the financial reports must be included.
• Matters the statements must show - Comparatives are required, but in years that special-purpose financial reports are first adopted they need not be restated, so long as resulting movements in shareholders' funds are disclosed.
• How matters must be shown - Amounts showing interest and dividends received must be grossed up for RWT and dividends should be grossed up for imputation credits, to the extent the dividend is taxable and the imputation credits can be used. However, the imputation credit gross-up can be disclosed in the book-to-tax reconciliation if the preparer of the financial reports prefers.
• Schedule - The schedule to the regulation sets out the matters that must be disclosed. Clause 1 prescribes matters that must be shown for income years starting from 1 April 2014. Clause 2 prescribes additional information for certain transactions with certain associated persons and applies to tax years starting from 1 April 2015. These clauses are discussed in more detail below.

The schedule

Clause 1 specifies, under three headings, a number of disclosures:

• The first heading deals with reconciliations and fixed or depreciable assets - where a difference arises between a company's accounting profit and taxable income for an income year, a reconciliation of the two figures is required. Companies are also required to prepare a detailed tax schedule of fixed assets and depreciable property.
• The second heading deals with disclosures specific to certain taxpayers. The regulation specifies particular disclosures for companies involved in forestry (the tax-carrying cost of timber) or that deal with livestock (class by class details of sales, purchases and on-hand).
• The third heading requires the financial reports to show items on forms prescribed under section 35 of the Tax Administration Act 1994. This is a reference in the IR 10 prescribed form. However, any reconciliation from the IR 10 back to the financial reports will be undertaken by Inland Revenue in the first instance. This is because it is accepted that good detailed financial reporting may be prepared on a divisional basis and this practice may mean that the financial report does not directly reconcile with the disclosures in the IR 10. A good example of this is a dairy farm's financial reports which are likely to have a milk account, cattle account and sundry income, all of which will have components of "gross income".

Clause 2 applies to tax years from 1 April 2015 and deals with matters connected with certain associated persons' transactions, within the meaning of the term "associated person" in subpart YB of the Income Tax Act 2007.

Clause 2(3)(a) requires matters connected with transactions with non-companies (for example, individuals and trusts) and non-resident companies to be disclosed if the transaction relates to:

• interest expense incurred in respect of any loan;
• amounts paid in the nature of outbound loans or other advances;
• expenses incurred for services, including wages and salaries, management fees and other payment for services;
• expenses incurred in respect of rentals or leases of land and other assets;
• expenses incurred to acquire or use intangible property including royalty payments.

Clause 2(3)(b) also requires a reconciliation of any movements in shareholders' equity and loans or other advances to (and from) the company's shareholders or other owners and persons associated with the company.

Relationship with authoritative financial reporting standards and other frameworks

The Income Tax Act 2007 makes reference in a number of places to financial reporting standards (New Zealand International Accounting Standards) when determining values for income, expenditure or loss. Examples of this include research and development expenditure and the financial arrangement rules. Preparers of financial reports may choose to use higher quality reporting standards for segments of their financial reports when appropriate so long as Inland Revenue's minimum requirements are disclosed. Also, preparers are free to use frameworks that have more detailed disclosures, such as the New Zealand Institute of Chartered Accountants' (NZICA) special-purpose framework, which is in the process of being finalised. It is anticipated that compliance with NZICA's special-purpose framework will also mean compliance with minimum requirements set out in the regulation.

Tax Administration (Financial Statements) Order 2014 LI 2014/69