Parliament has passed under urgency two measures announced by the Government on 15 April to assist businesses dealing with the consequences of COVID-19. The measures are a loss carry-back regime (which will enable eligible businesses expecting to be in loss to obtain a refund of tax paid on prior year's profit) and a new power for Inland Revenue to vary administrative requirements and timeframes due to COVID-19 related disruptions.
Both these reforms are intended to be temporary, and Inland Revenue's variation power is specific to COVID-19 disruptions. But a permanent loss carry-back regime, as well as reforms to the criteria for carrying forward tax losses to future years (also announced on 15 April) will be developed over the coming months and should become law by early 2021.
Tax loss carry-back regime (temporary version now enacted)
A new tax loss carry-back regime will enable a firm to offset a loss in a particular tax year against a profit in a previous year, and receive a refund of the tax paid in the previous (profitable) year. As noted above, the new regime is being introduced in two stages:
- First, a temporary mechanism will allow businesses that anticipate a loss in either the 2019-20 year or the 2020-21 year to estimate the loss and use it to offset against taxable income in their previous year. This may entitle them to a refund of tax paid in the previous year. The temporary mechanism can be accessed by request via the Inland Revenue's website shortly following enactment.
- Second, permanent loss carry-back rules will be consulted on over the course of this year and legislation introduced and enacted by early 2021. Officials' guidance indicates that the permanent regime may be more traditional, such as not allowing a refund before the loss has been established and may have more integrity measures. The longer-term regime may provide for a one-year or two-year loss carry-back.
In relation to the temporary measures, there are certain limitations in scope that it is important to be aware of. For example:
- The measures permit losses to be carried back only to the immediately preceding year (ie, from the 2020-21 year to the 2019-20 year, or from the 2019-20 year to the 2018-19 year).
- Carry back of losses is subject to the company holding sufficient imputation credits in accordance with existing rules for obtaining tax refunds.
- For shareholder-employees of closely-held companies who receive salaries from the company (such that tax is, in effect, paid by the shareholder rather than the company), there is no provision to enable a net loss of the company in one year to be offset against net income of the shareholder in the previous year. The shareholder-employee may, however, be entitled to a refund of tax in certain circumstances where their salary is or will be reduced.
- For taxpayers with outbound investments in controlled foreign companies (CFCs) who are required to recognise attributed income under the CFC rules, the rules do not appear to permit carry back of an attributed CFC net loss in one year against attributed CFC income in the previous year. It may be that this issue will be addressed in the design of the permanent loss carry-back rule.
- The loss carry back will be subject to maintaining the 49% continuity of ownership requirement (currently applicable to the carry forward of tax losses) and (for grouping of carried-back losses) the 66% commonality of ownership requirement applicable to tax loss grouping.
- The 49% continuity of ownership requirement will limit the availability of the regime to companies that have been, or are in the process of being, sold or are raising new capital. It is hoped that the same-or-similar business test that is to be introduced as an alternative to the 49% continuity threshold for the carry forward of tax losses (see below), will also apply as an alternative to that test for the carry back of losses, at least once the permanent loss carry back rules are enacted.
Reform to tax loss carry-forward rules (expected to be enacted by early 2021)
As noted above, New Zealand law currently allows a company to carry-forward its tax losses to offset against profits in future years only if its shareholding remains the same, at least to the extent of 49%. This rule will be reformed to allow a company to carry-forward its tax losses even if its ownership has changed so long as its business remains "of a same or similar nature". The new test is expected to closely follow Australia's "same or similar business" test.
The details of the new test have yet to be finalised and amending legislation is not expected to be introduced for some months yet. But once enacted, the new test should apply from the current income year. This should allow companies needing to bring in new investors in the interim to do so while preserving their tax losses (in reliance on the same or similar business test) where losses would otherwise have been forfeited under the continuity of ownership test.
The reforms can also be expected to affect market standard documentation for business acquisitions. For example, if the parties agree commercially that the tax losses being sold have value and this is reflected in the purchase price, the purchaser will expect to have coverage for such tax losses under the tax indemnity. Existing New Zealand share sale agreements may not provide for this, given they will be drafted on the assumption that tax losses will be forfeited on sale of the shares in a company.
Flexibility to extend deadlines and timeframes (now enacted)
A new discretionary power will allow Inland Revenue to vary the application of a provision in an Inland Revenue Act by extending due dates and timeframes or by modifying procedural or administrative requirements. The power is intended to provide Inland Revenue with some flexibility to mitigate the effect of the Revenue Acts when compliance is impossible, impractical, or unreasonable in circumstances arising either from the imposition of COVID-19 response measures or as a consequence of COVID-19. The power will be time-limited for a period of 18 months. It is expected that the power could, for example, allow Inland Revenue to extend deadlines for filing tax returns and paying provisional and terminal tax.
The new variation power will supplement Inland Revenue's existing powers of care and management, which allow Inland Revenue flexibility in the way it administers and enforces tax laws, and allow it to determine that it will not pursue every tax liability owing under law. Inland Revenue recently released guidance under those powers (see https://www.ird.govt.nz/Updates/News-Folder/covid-19-novel-coronavirus-residence-issues) to the effect that it would not pursue tax liabilities resulting from individuals or companies being technically tax resident in New Zealand (the former based on the extent of their physical presence in New Zealand, the latter based on the exercise in New Zealand of management and directorial control) where that consequence resulted from relevant individuals being "stranded" in New Zealand due to "the present emergency". Inland Revenue also confirmed that "[i]f a person leaves New Zealand within a reasonable time after they are no longer practically restricted in travelling, then extra days, when the person was unable to leave, will be disregarded" when determining the length of their presence in New Zealand.
A mix of temporary measures and longer-term reforms
The latest reforms follow a series of announcements made in March and enacted under urgency on 25 March 2020 in the COVID-19 Response (Taxation and Social Assistance Urgent Measures) Act 2020. That earlier series of measures included:
- reinstating depreciation deductions for non-residential buildings;
- increasing the low-value asset write-off threshold from $500 to $5,000 if the item of property was acquired on or after 17 March 2020, with the threshold for items of property acquired on or after 17 March 2021 being $1,000; and
- bringing forward the application date for certain changes intended to broaden the eligibility criteria for a refund of an R&D tax credit to the 2019¬20 income year.
The fact that New Zealand's tax policy response to COVID-19 has included a mix of temporary measures and permanent reforms suggests the Government is looking to balance the need for immediate flexibility and support for business with the importance of maintaining a tax system underpinned by sound tax policy principles. The reforms affecting tax losses and increased deductions under the depreciation rules should also help to remove barriers to businesses bringing in new investors and investing in new long-term assets, both of which will be essential elements of the future economic recovery.
This article also appeared on International Tax Review.