New Zealand’s Thin Capitalisation Rules and the Adoption of International Financial Reporting Standards in New Zealand

In response to Australia’s decision to adopt international financial reporting standards (IFRSs) from 2005, New Zealand has subsequently decided to follow. New Zealand reporting entities are required to adopt IFRSs from 2007 with the option of early adoption from 2005. As New Zealand is one of many jurisdictions where different rules are employed to determine income for financial reporting and tax purposes, it would seem to a casual observer that the adoption of IFRSs in New Zealand is unlikely to have any income tax implications for New Zealand companies. This is not entirely correct. There are links between financial reporting standards and the determination of taxable income under New Zealand income tax law in respect of certain matters. One such area is the application of the New Zealand thin capitalisation rules in subpart FG of the Income Tax Act 2004. The rules rely upon values taken from a taxpayer’s financial statements to determine the taxpayer’s debt percentage and consequently the extent to which a deduction for interest expense will be apportioned. Therefore the adoption of IFRSs in New Zealand potentially could affect a taxpayer’s New Zealand tax liability if the thin capitalisation rules have application. This paper seeks to examine the changes in IFRS and their impact on the New Zealand thin capitalisation provisions. In particular it will examine the changes in the IFRS Standards concerning the measurement and valuation of assets and the effect on the safe harbour provisions. In addition, the paper will consider the implications for tax advisers and their clients in complying with the new standards and the transitional issues involved

New Zealand’s Thin Capitalisation Rules and the Adoption of International Financial Reporting Standards in New Zealand

In response to Australia’s decision to adopt international financial reporting standards (IFRSs) from 2005, New Zealand has subsequently decided to follow. New Zealand reporting entities are required to adopt IFRSs from 2007 with the option of early adoption from 2005. As New Zealand is one of many jurisdictions where different rules are employed to determine income for financial reporting and tax purposes, it would seem to a casual observer that the adoption of IFRSs in New Zealand is unlikely to have any income tax implications for New Zealand companies. This is not entirely correct. There are links between financial reporting standards and the determination of taxable income under New Zealand income tax law in respect of certain matters. One such area is the application of the New Zealand thin capitalisation rules in subpart FG of the Income Tax Act 2004. The rules rely upon values taken from a taxpayer’s financial statements to determine the taxpayer’s debt percentage and consequently the extent to which a deduction for interest expense will be apportioned. Therefore the adoption of IFRSs in New Zealand potentially could affect a taxpayer’s New Zealand tax liability if the thin capitalisation rules have application. This paper seeks to examine the changes in IFRS and their impact on the New Zealand thin capitalisation provisions. In particular it will examine the changes in the IFRS Standards concerning the measurement and valuation of assets and the effect on the safe harbour provisions. In addition, the paper will consider the implications for tax advisers and their clients in complying with the new standards and the transitional issues involved