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New Zealand: NZ Inland Revenue releases GAAR guidance


Tim Stewart

The Inland Revenue has issued a final statement (Income tax: scenarios on tax avoidance) which considers whether New Zealand's general anti-avoidance rule (GAAR) would apply to three instances. The final statement follows the release in May 2014 of a draft statement. The GAAR and the draft statement were considered in an article in the September issue of International Tax Review (see "NZ Inland Revenue releases draft GAAR guidance", August 29 2014). As explained in that article, when determining whether an arrangement is a tax avoidance arrangement and therefore subject to the GAAR, Inland Revenue applies a parliamentary contemplation test. Under this test, the question is: "Does the arrangement, viewed in a commercially and economically realistic way, use (or circumvent) the relevant [specific] provisions in a manner that is consistent with parliament's purpose?" If not, the arrangement will be a tax avoidance arrangement unless the tax avoidance is "merely incidental" to some other purpose or effect.

Of the four fact scenarios discussed in the draft statement, two (the scenario involving shareholder debt, and the scenario involving debt capitalisation) are especially relevant to international and corporate tax planning. Inland Revenue's approach to those two scenarios has changed in the final statement.

Scenario – substituting debentures

In this scenario, a company owned equally by two shareholders is funded in part by shareholder debt that is issued in proportion to the ordinary shareholdings. Under New Zealand law, debentures issued to shareholders by reference to the amount of their shareholding are substituting debentures, and so are deemed to be equity for tax purposes, unless the debentures are convertible into shares. The debt in the scenario is convertible at the option of the company, and so falls within the exception to the substituting debenture rule (which would otherwise apply to deem the debt to be equity for tax purposes).

In the draft statement, Inland Revenue concluded that the GAAR would potentially apply to override the application of the convertible debenture exception to the substituting debenture rule. Inland Revenue has changed its position in the final statement, concluding that the GAAR would not apply in this instance. Inland Revenue's change in approach is to be welcomed, although its practical impact will be limited, as the substituting debenture rule will be repealed with effect from April 1 2015.

Scenario – debt capitalisation

The second scenario of particular relevance to international and corporate tax planning was the debt capitalisation scenario: A company has a $700 liability under a shareholder loan, but assets of only $200. The company and the shareholder agree that the shareholder will subscribe for $500 in shares in the company and the company will use the subscription proceeds to repay $500 to the shareholder. The two payments are set-off such that no cash changes hands. Had the shareholder instead forgiven $500 of the loan, the company would have had taxable income of $500 under the financial arrangements rules.

In the draft statement, Inland Revenue concluded that the GAAR would potentially apply in this situation. This conclusion would however exacerbate a design flaw in the underlying provisions. The underlying provisions mean that if debt owing between two associated companies is forgiven, the borrower derives income of the amount forgiven while the lender is denied a deduction. This scenario has been removed from the final statement and Inland Revenue is considering legislative amendments to address the asymmetrical outcome that presently arises. While Inland Revenue has said that it will recommend amendments to resolve the issue where both lender and borrower are New Zealand tax residents, it is currently unclear to what extent the amendments will apply to cross-border related party debt, and what Inland Revenue's final position will be on the application of the GAAR to arrangements not covered by the legislative amendments.

Tim Stewart (

Russell McVeagh

Tel: +64 4 819 7527


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