Group offsetting New Zealand Company Tax Losses – Some Valuable Lessons
New Zealand tax law contains a detailed set of rules that allow companies that incur tax losses to share and transfer those losses for the benefit of other profit-making entities within the same tax group. Supplementary tax practice rules also apply from the Inland Revenue Department (“IRD”) – refer to SPS 17/03 (IRD’s Standard Practice Statement, effective, 14 December 2017).
Many of these rules are permissive, yet in my experience many companies, and practitioners, fail to maximise the advantages that are available, or just get it wrong. Optimising available choices to reduce the corporate tax bill, and related cash outflows, is quite simply a ‘no-brainer’.
This article highlights some of the Valuable Lessons and Options that are available, and includes:
- Loss offset methods – automatic transfer election, or subvention payment?
- What is an eligible New Zealand loss offset group? Less than 100% wholly owned companies, and, resident and non-resident companies, and, part year entities;
- Advantages with making subvention payment loss offsets;
- How to properly effect a transfer of tax losses?
- Some traps, tips, and lessons.
Loss offset methods – automatic transfer election, or subvention payment?
NZ tax law provides for two methods to offset losses within an eligible group of companies.
One involves an automatic offset of the loss against the net taxable income of a profit company (by means of an election lodged by the loss company with the IRD). In this method, the loss company can use its current year losses, or, it can use prior year losses that it has carried forward legitimately.
The second method involves what is termed as a ‘subvention payment’, whereby the profit company makes a payment to the loss company to bear or share in that company’s loss. This subvention payment is by agreement between the parties, and can be any amount not exceeding the amount of the losses that are transferred.
A common approach is to use a combination of these methods, with the subvention payment set at the 28% corporate tax rate (as if the profit company is discharging its tax on its offset profits), and with the 72% balance offset by automatic transfer.
|Profit Coy net income||$500,000|
|Loss Coy net losses||($600,000)|
|Subvention Payment from Profit Coy to Loss Coy fixed at 28% of the $500,000 losses transferred||-140,000||+140,000||A subvention payment is actually paid and reduces Profit Coy’s net income, while also reducing Loss Coy’s losses|
|Automatic loss offset election||-360,000||+360,000||This is by ‘election’ of the Loss Coy lodged with the IRD|
|Net outcome from losses offset||$Nil income||($100,000)||Profit Coy’s profit is extinguished|
|Losses available to carry forward to future years by Loss Coy||($100,000)||So long as both entities remain in the same group, the residual unutilised losses may be used in future years against Loss Coy’s own profits, or, be transferred from Loss Coy to Profit Coy.|
This loss offset practice combining both of the available loss transfer methods is a conventional practice, however, variations are allowable that may yield commercial benefits to the entities (see below).
What is an eligible New Zealand loss offset group?
The loss company and the profit company must essentially be common owned as to at least 66%. NZ tax law contains detailed ownership measurement rules, and these must be examined, however common share / stock ownership rights most typically give rise to common ownership. The two entities may be parent / subsidiary, or sister companies.
The loss company may also be a foreign company with a NZ branch business , (but cannot be a company that is dual resident in New Zealand and another country as this invokes specific anti-avoidance measures around double-dipping losses). Advantages exist for foreign loss companies under the subvention payment offset method (refer on).
Prior year losses in the loss company are subject to NZ ownership continuity rules of at least 49% continuous ownership from the time of the loss to the time of offset. Should ownership in the companies breach this continuity threshold, the loss offset rules do contain provisions allowing part-year loss offsets that enable losses carried forward and incurred up to the time of a significant ownership change to be utilised by way of existing group offset. Similar part year apportionment rules allow new companies acquired into a group to offset post-acquisition losses to the acquiring group, or, post-acquisition profits of newly acquired companies to be loss relieved.
Advantages with making subvention payment loss offsets
Subvention payments within NZ’s group loss offset regime can yield advantages for organisations. Because subvention payments can be made at any amounts including dollar-for-dollar of the loss offset amount, this facilitates the transfer of value from one entity to another without adverse tax consequences. The transaction is also not a dividend.
Full dollar-for-dollar subvention payments may be used as funding support for loss companies. Alternatively, subvention payments may be satisfied by offsetting debts of the loss company from past advances made by the profit company (or other group members).
In the example above, Profit Coy is able to make a subvention payment of up to a maximum of $500,000 to the Loss Coy to effect the transfer of $500,000 losses.
Foreign group companies, with NZ loss operations can benefit from full subvention payments. In this scenario, losses incurred within a NZ operation of a foreign company can be transferred to a NZ profit company that is a subsidiary of the foreign group (the two entities both form members of the same NZ group). Group loss offsets in this scenario can occur through the NZ profit company making full subvention payments to the loss company NZ branch (up to the actual amount of the losses being grouped). In turn, the NZ branch (loss company) can repatriate the proceeds of the subvention payment out of NZ to the combined entities’ foreign owners free of any NZ withholding taxes.
How to properly effect a transfer of tax losses?
Procedural requirements to properly effect a valid loss offset election must be adhered to. In short, the loss company must file its election to offset losses to group company(ies) within the permitted timeframes. Typically, this can be completed with the income tax return, or by separate letter request. The deadline is no later than 31 March following the end of the company’s year of offset, or, if allowed within the IRD’s discretion such further time by extension.
Subvention payments must be made within the same timeframe – no later than 31 March following the year of loss offset.
Where amended assessments are made by the IRD, or either company amends their taxable income or loss, such changes will impact on the loss offset election lodged. The IRD will consider the impact of such changes and decide on how revised elections may be made.
Typically, the loss offset amount is a stated fixed amount. Sometimes this may not be possible (eg., delays in the profit company tax calculation), however the IRD will accept an election that refers to an amount that is capable of identification as a specific amount. IRD’s SPS 17/03 gives an example of an election that the tax loss to be offset is such amount as would reduce the profit company’s net income to nil.
Subvention payments can be by payment in cash, its equivalent, or by certain accounting entries. Accounting entries must cause a genuine crediting in the payee loss company’s account, or set off of a pre-existing obligation (eg., loan advance funding by the profit company).
Some traps, tips, and lessons
Loss transfer risks to profit company – preserving tax credits
I have observed serious blunders by corporates and practitioners alike with loss transfers mishandled and resulting in the forfeiture of valuable tax credits. Because loss election transfers are irrevocable, traps exist where elections are made ahead of finalising the standalone corporate tax position of the profit company. Where the net income of the profit company is identified, it is also imperative that the final tax liability is calculated that takes into account all available non-refundable tax credits, particularly foreign tax credits as these will be forfeited with no benefit where all it’s profits are loss offset.
Negative impact on profit company’s imputation credit balance
Where a profit company pays less or no tax because it benefits from group loss transfers, a mis-match will arise between its reserves (retained earnings) and its imputation credit balance. From a wider economic group perspective this mis-match is fair since the overall consolidated reserves are netted off, however on a standalone basis the profit company mis-match will impair its ability to pay dividends that carry full tax credits from imputation.
This lack of imputation tax credits is a timing trade-off since shareholders will suffer tax on deriving dividends (withholding taxes for foreign shareholders), given no tax outflow at the parent profit company.
Achieving an equitable outcome where minority interests exist
Losses can be transferred between companies that are less than 100% commonly owned, since an eligible group need only comprise shareholding commonality of 66%.
Where a JV exists, or simply spread shareholdings, but with one majority shareholder with at least 66% ownership, then loss offsets trigger issues of equity between the stakeholders.
In the above scenario, the jointly owned loss company is surrendering its losses to the majority shareholder group (via its profit subsidiary). Should this loss transfer be by automatic loss transfer, or, by combination with a subvention payment payable by the profit company to the jointly held loss company? The losses transferred will be utilised to the benefit of the majority shareholder, while the joint loss company will forfeit any future value for the losses transferred (that is, future profits of the joint loss company will bear tax at 28% without any carry forward loss shelter).
A range of factors will influence this determination, for example, the future profit projections (and timings) of the jointly held loss company; the distribution policy of the company and its shareholders; the tax status of the shareholders (individual vs corporate vs resident or foreign, etc). Further questions arise, whether any subvention payment should be at the 28% tax rate, or a lower or higher rate? Arguably, the shareholders are ‘invested’ in the subvention payment at their respective 70% / 30% interests.
In this scenario, the jointly owned company is in profit (rather than losses), with the majority shareholder’s subsidiary in losses, and so a group loss offset will result in the majority shareholder surrendering its losses in favour of the jointly owned company, and minority shareholder (to the extent of its 30% interest).
The factors noted above will need to be considered again, albeit with ‘flipped’ perspective given the changed profit and loss entities and ownership. As raised earlier (Negative impact on profit company’s imputation credit balance), the minority shareholder will likely be mindful of any adverse impact on the ability of the jointly held company to distribute dividends with imputation tax credits attached.
Agreements to share in losses by subvention payments
The subvention payment method requires that the loss company ‘agree’ with the profit company that the profit company shall bear its tax losses in return for a payment, and so this wording is often embodied in an annual Subvention Payment and Loss Offset Agreement between the parties. However, this agreement need not be in writing, and therefore corporate pragmatics may be best served by adopting a generic agreement among a number of group companies that provides for the sharing of losses if and when they should occur, at such amounts as determined at the time, but not exceeding the loss transfer amount.
Adherence to the election process
As canvassed earlier, it is important that companies follow and adhere to the statutory requirements to ensure valid loss transfer elections are made, including late elections and extensions of time.
Accounting for tax loss transfers
The accounting treatment of tax loss transfers is not specifically addressed in NZ IAS 12. A useful reference to guidelines on the financial accounting treatment of tax loss transfers and subvention payments can be found in Audit New Zealand’s publication https://auditnz.govt.nz/publications-resources/tax/tax-loss-transfers
From the above, it can be seen that there are many factors at play when it comes to maximising your tax position when dealing with group loss transfers. Some specific options that are unique to NZ tax law are available, and essential planning and compliance checks should be examined closely to optimise your position.
CAVEAT: While the above commentary provides insights and tips, as always, every scenario carries its own facts and circumstances that will influence the position variously, and therefore it is imperative that you seek specific advice to your own situation.
Director, ACUMEN Limited
 It is noted that wholly owned NZ companies my ‘elect’ treatment as a Consolidated Group which is a specific regime that treats all entities simply as one company with tax consolidation of all income and expenditure. Pro’s and con’s do exist with electing to enter this consolidation regime which should be reviewed carefully.
 Referred to as a company with a fixed establishment in NZ
 In the absence of such loss grouping, the profit company would ordinarily pay taxes, thus generating imputation credits with which it could impute an outflow dividend and avoid any dividend withholding taxes.
 These arise on income that is sourced from outside NZ and subject to withholding or source taxation abroad
 In practice, dividend paying companies are required to apply resident withholding taxes to unimputed dividends, which reduce the cash dividend receipt to individual shareholders.
 Limited provisions exist for the transfer of available imputation tax credits around members of the group to alleviate this mis-match between company reserves and available imputation credits.
 NZ Equivalent to International Accounting Standard 12 – Income Taxes