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Thin capitalisation rules

It is now more important than ever for you to monitor your thin capitalisation
calculations, with the safe-harbour threshold reducing from 75% to 60% from the
2012 tax year.

The following short checklist of common errors and current issues should also
assist compliance:

1. Debts and assets must be valued in New Zealand dollars for the safe-
harbour calculation. Unexpected foreign exchange fluctuations, of the
nature seen in the current market, have the potential to cause
unanticipated breaches of the safe-harbour threshold. Currency
conversions are permissible at the spot rate on your measurement date(s)
or at the forward rate applicable on the first day of the year. These options
and exchange fluctuations need to be incorporated into your regular
reviews.
2. In a number of circumstances, the valuation of a financial arrangement for
tax purposes can vary significantly from the value of debt recorded for the
instrument in your financial statements. Its important that you understand
the implications of the relevant tax rules on your financial arrangements.
3. Assets are valued by reference to generally accepted accounting practice.
Companies adopt accounting policy changes for a wide range of reasons
and often these changes have no tax impact. However, where your
debt/asset ratio sits near the safe-harbour threshold, its important that the
personnel responsible for tax compliance keep abreast of accounting
policy changes, especially those relating to asset valuations.
4. The recent adoption of the International Financial Reporting Standards
("IFRS") provides additional safe-harbour headroom for some taxpayers
on the revaluation of property assets. For others, debt/asset ratios were
adversely impacted through asset impairment adjustments (for example,
intangible property impairments). To the extent that taxpayers opted into
the IFRS revaluation model on the upward market, the recent current
market devaluation of many assets could again result in unanticipated
breaches of the safe-harbour threshold. Be wary of any creative
accounting solutions, especially in respect of intangibles.
5. The thin capitalisation rules require consistent treatment for a number of
items such as controlling interests for grouping purposes and applicable
measurement dates. Its important that you are aware of previous
practices and elections made, particularly where there has been a change
in personnel preparing the calculations.
6. When you calculate your debt/asset ratio on a group basis, consideration
must be given to the impact of any movements in the group structure
during the year.
7. Non-resident withholding tax still applies to interest paid, even if a
deduction is not available under the thin capitalisation rules.
8. When your debt/asset ratio is near the safe-harbour threshold, a thin
capitalisation review based solely on management accounts will not be
sufficient. To be effective, a review must consider the rules applicable in
your specific circumstances, and in light of current market movements.

We are aware that asset revaluations in the Canterbury area following the
earthquakes may place pressure on some taxpayer thin capitalisation positions.
We recommend taxpayers experiencing such concerns talk to us at their earliest
convenience.

As a matter of routine, we do not deny interest deductions to taxpayers carrying


high debt levels that satisfy the thin capitalisation rules. However, where a loan
transaction would not have taken place in the open market, then the
commerciality of the financing arrangement between associated parties may be
called into question. In such extreme circumstances, serious consideration would
be given to call upon the general anti-avoidance provision.

Date published: 30 May 2012