Businesses and financial institutions are working under increasingly pressured and uncertain circumstances to achieve economic stability and relief from the impact of the COVID-19 pandemic. It is important that both lenders and borrowers consider the tax outcomes of any funding or restructuring arrangements that they enter during this time. Although these transactions are usually entered into with good intentions, they often will not survive scrutiny by the Inland Revenue Department (IRD).
Insights
Borrowers may be attracted to the potential of transferring debt to a related party (for example a sister company) in exchange for no, or a nominal, payment to the lender rather than having the debt written off and having tax to pay on debt remission income. However, this type of transaction will give rise to questions of tax avoidance. A debt transfer may result in the lender being able to avoid having to perform a base price adjustment. However, lenders should consider the extent to which they can take to take a deduction for both capitalised interest payments and principal repayments under the financial arrangements rules, following the transfer of a debt to another party.
The desire to restructure existing arrangements to ensure the survival of a business by making an equity investment in that business (such as by issuing convertible notes for a debt that the lender may not otherwise recoup) is understandable. However, this can affect the ability of the borrower to access losses or imputation credits (new rules around losses for small and medium enterprises are expected to be introduced in draft legislation by the end of April), the legal relationship between the parties and, the ability to write off bad debts owed by the borrower to the lender.
Related party transactions can cause a party to be tainted by the activities of other parties to the transaction. They may also have the appearance or effect that the transaction is not independent or at arms'-length. IRD considers that this can be indicative of tax avoidance.
Buddle Findlay's reflections
Restructuring or entering into new funding arrangements is necessary in times of crisis. These decisions are often made in haste. However, they can give rise to unexpected tax outcomes, particularly where the tax results of a transaction were not considered before it was entered into.
When times are good and people have a lot of income, they often engage in tax planning and tend to seek advice on the outcomes of their transactions. Ironically, it is when times are bad and people are trying to protect their business or help their borrowers and when they have no income, that tax becomes an afterthought. Some of the worst outcomes in tax cases have resulted from situations not where there was income, but where there was none.
Final Thoughts
Even in these financially distressing times, it is important that you protect yourself, or your clients, by structuring financial transactions so that they comply with the applicable tax laws.
We know things are moving fast and you do not have time to wait for lengthy opinions on the tax effects of funding arrangements that you may be looking at entering into or restructuring. Our tax team are here to provide quick and practical answers on your individual circumstances.
This article was written by Tony Wilkinson, Fiona Heiford, Maria Clezy and Stacey Naylor. If you would like any further information or advice on this subject please contact our National Tax Team.
