Use of Money Interest Rates to increase again

With market interest rates continuing to increase, the government has issued an Order in Council to increase Inland Revenue Use of Money Interest Rates.

From 17 January 2023, the new rates will be:

• Underpayments: 9.21%
• Overpayments: 2.31%

This is the highest that Use of Money Interest Rates have been since 2015.

Inland Revenue’s harsh draft “Questions We’ve Been Asked” on Foreign Investment Funds

On 14 December, Inland Revenue released a draft “Questions We’ve Been Asked” on Foreign Investment Funds (FIFs). Ordinarily for trusts and individuals, for ownership of foreign shares of less than 10%, unless the foreign investments are exempt, the taxpayer has the option of using:

• The “Fair Dividend Rate” (FDR) method, which calculates FIF income as 5% of the opening market value of a portfolio of investments; or
• The “Comparative Value” (CV) method, which broadly calculates FIF income based on the realised and unrealised economic movement of the investment over the relevant income year. If there is an economic loss, then the result is nil FIF income

Under this new document, Inland Revenue provides its view on whether a taxpayer has a choice of calculation methods for FIF income when they:

• File a late income tax return; or
• Make a voluntary disclosure

Inland Revenue concludes that taxpayers cease to have the choice between FDR and CV under those circumstances, and instead must apply the FDR method or, if it is not available, the cost method (which calculates FIF income as 5% of the cost price of investments). This is a particularly harsh consequence in years where markets are generally down (for example, the current year).

Inland Revenue’s logic is based on FDR being the default method and, unless the taxpayer files their income tax return on time, they are considered to have chosen the default FDR method. Filing on time means by 7 July or the following 31 March if they are linked to a tax agent such as Baker Tilly Staples Rodway.

Comment

We are concerned with the reach of this Questions We’ve Been Asked. Previous commentary on the FIF rules gave no indication that a return needed to be filed on time for a choice of FIF method to be available. Indeed, the Income Tax Act usually specifies when elections are required to be made by the filing date. An example of this is loss transfers, where the Act specifically states the Commissioner must be notified of the loss transfer election by the extended return due date.

We are particularly concerned that this interpretation could be applied to other situations where a taxpayer has a choice of options (e.g. financial arrangement rules or tax depreciation rules) not currently cut off by the return due date.

This interpretation might discourage voluntary compliance, as it prevents taxpayers filing voluntary disclosures from having a choice of FIF method and therefore being subject to the FDR method. The FDR method sees income arise even when an investment portfolio might lose value in a given year. In our experience, taxpayers who need to file voluntary disclosures in relation to FIF income do so because they were ignorant of the rules and as soon as they find out about these rules want to ensure they are in compliance. This is especially common for people who have either returned to New Zealand after some years overseas or who have immigrated to New Zealand.

Finally, we are concerned about the timing of the release of the draft Questions We’ve Been Asked. It is common for government departments to release items that they want to go under the radar in the month of December and given past experience with controversial Questions We’ve Been Asked; we wonder if Inland Revenue is trying to avoid an outcry.

If you wish to make a submission on this matter, comment is open until 10 February 2023, and we will be making a submission. If you have any queries about this, or the tax impact of holding foreign investments more broadly, please contact your Baker Tilly Staples Rodway advisor.

Shareholder loan interest deductions 

On 13 December, Inland Revenue released a Questions We’ve Been Asked on whether interest can be deducted on shareholder loan accounts where the specific amount is not known until after balance date.

Inland Revenue has concluded that a close company can deduct interest on shareholder loan accounts if there is a legal obligation to pay the interest based on a previously agreed formula or method. The obligation and method must arise and have been determined by balance date, even if the interest has not been calculated at balance date.

The method must be certain and cannot simply be a guess. Examples provided in the Questions We’ve Been Asked include:

• Terms of an agreement that provides a method of calculating the interest
• A bank rate at a given date
• Interest rates used in previous years

Documents that can be used to evidence the obligation and method chosen can include:

• Written agreements
• Meeting minutes
• Directors’ resolutions
• Correspondence with shareholders

The financial arrangements rules might change the timing of the deduction.

Comment

This Questions We’ve Been Asked emphasises the need for i’s to be dotted and t’s to be crossed when it comes to related party transactions. Most businesses that have some sort of shareholder loan account will have a logical basis for calculating interest (a common example being the FBT interest rate) and so will simply need to evidence this in an appropriate document, such as a shareholder loan agreement. If your business has a shareholder loan account and does not have documentation in place, then we recommend discussing this further with your Baker Tilly Staples Rodway advisor.