Tax Watch: Edition 3, May 2017

Changes to related party debt remission rules

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Changes to related party debt remission rules

Changes to the debt remission rules now mean that debt remission income will generally not arise where debt is capitalised within an “economic group”.

Inland Revenue’s previous interpretation overruled

Corporates converting debt to equity to clean up their balance sheets has been standard practice for many years.  That it could amount to tax avoidance was a shock.  Inland Revenue nevertheless reaffirmed its view in Question We’ve Been Asked QB 15/01.

The new law overrules this interpretation.  It ensures debt remission income does not arise in the case where there is no change to the net wealth of the economic group or dilution of ownership. Instead, the debt will be regarded as fully repaid.

The new debt remission rule is welcome.  It remedies the current asymmetric tax outcome that can arise when debt is remitted within economic groups.

The problem can occur where the creditor is denied a bad debt deduction for the loan principal, but the debtor is treated as having debt remission income for the amount remitted.

Meaning of “economic group”

The term “economic group” can include:

  • Members of the same wholly owned group of companies, or
  • Situations where the debtor is a company or partnership, and:
    • all of the debt remitted is owed to shareholders or partners of the debtor, and
    • the debt remitted is held and remitted pro-rata to ownership.

Backdated application but no reassessments

The new rule is backdated to apply to the 2008-09 and later income years.  However, no reassessments will be permitted in relation to tax positions taken before the 2015-16 income year which are inconsistent with the new rule.