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Special Determination S23: Transfer of acquired bad debts by a certain New Zealand company to another New Zealand company in the same consolidated group and the utilisation of a profit emerging basis by the transferee company

This determination may be cited as Special Determination S23: "Transfer of acquired bad debts by a certain New Zealand company to another New Zealand company in the same consolidated group and the utilisation of a profit emerging basis by the transferee company".

1. Explanation (which does not form part of the determination)

  1. This determination relates to the transfer of acquired bad debts from New Zealand Company Limited (NZC) to a newly incorporated company, New Zealand Company (2) Limited (NZC-2). NZC and NZC-2 are members of the same consolidated group at the time the acquired bad debts are transferred.
  2. NZC originally acquired for valuable consideration pools of unpaid loans and receivables, which may consist of a few hundred to a few thousand individual debts (ABDs).
  3. NZC can use the profit emerging method of returning income and expenditure pursuant to Special Determination S17: "Utilisation of a profit emerging basis for purchased debt ledgers by a certain New Zealand Company Limited".
  4. This determination also relates to the ability of NZC-2 to utilise a profit emerging basis for returning income and expenditure arising from ABDs that are either transferred from NZC (transferred ABDs) or acquired from a person other than NZC (third-party ABDs).
  5. NZC-2 acquires the ABDs at a deep discount to their face value. NZC-2 subsequently seeks to recover the overdue balances from debtors through various means.
  6. The acquisition of an individual ABD is done on the expectation that its recoveries will be in excess of the purchase price and the cost incurred in attempting collection. Some debts may not achieve any recovery and become uncollectable, and others may be partially collected. The volatility of cash collections may be attributed to such things as the nature of the underlying debt, its age and type, as well as external economic conditions and the effort applied.
  7. NZC-2 will apply NZ IFRS 9 to ABDs for financial reporting purposes.
  8. This determination provides that NZC-2's contribution to the assessable income and tax liability of the consolidated group for an income year will be based on actual collections reduced by the proportion of purchase cost allocated to that income year.

2. Reference

This determination is made under ss 90AC(1)(bb) and 90AC(1)(j) of the Tax Administration Act 1994.

3. Scope of determination

  1. This determination applies to the tax treatment by NZC of transferred ABDs, which were transferred to a member of the same consolidated group. NZC and the transferee company, NZC-2, were not members of the same consolidated group for the whole of the income year of transfer.
  2. The determination also applies to the tax treatment by NZC-2 of both transferred ABDs and third-party ABDs.
  3. ABDs are pools of unpaid loans and receivables. These pools may consist of a few hundred to a few thousand individual debts.
  4. NZC originally acquired the transferred ABDs at a deep discount to their face value on the expectation that its recoveries would be in excess of the purchase price and the cost incurred in attempting collection. NZC applied the profit emerging basis for the recognition of income and deduction of expenditure on the transferred ABDs pursuant to Special Determination S17: "Utilisation of a profit emerging basis for purchased debt ledgers by a certain New Zealand Company Limited".
  5. NZC-2 will apply NZ IFRS 9 to ABDs for financial reporting purposes.
  6. This determination is made subject to the following conditions:
    1. NZC-2 is satisfied on the basis of objective criteria that a period of no less than five years and no more than seven years is the appropriate period over which cashflows from a third-party ABD are to be forecast. This period is to be ascertained at the time of purchase of the ABD and must match the accounting spreading period for that ABD, and
    2. NZC-2 will not take a deduction for the acquisition cost of either a transferred ABD or a third-party ABD (or any part thereof) except as set out in this determination, and
    3. NZC-2 treats all underlying debts to which it becomes a party on the acquisition of either a transferred ABD or a third-party ABD (which would otherwise be excepted financial arrangements) as financial arrangements under s EW 8 of the Income Tax Act 2007.

4. Principle

  1. NZC will recognise all income and expenditure on the ABDs using a profit emerging basis for the part income year prior to forming the consolidated group in its separate return of income under s FM 14 of the Income Tax Act and ss 33 and 92 of the Tax Administration Act 1994.
  2. NZC will perform a base price adjustment pursuant to s EW 31, as modified by s FM 19, when the ABDs are transferred to NZC-2. The consideration for the transfer will be the tax book value of the ABDs on the date of transfer, pursuant to s FM 19(2).
  3. All underlying debts to which NZC-2 becomes a party on the acquisition of an ABD are either financial arrangements as defined in s EW 3 of the Income Tax Act 2007 or are treated as financial arrangements by NZC-2 under s EW 8 of the Income Tax Act 2007.
  4. This determination specifies that income and expenditure from an ABD for an income year is to be recognised by NZC-2 using a profit emerging method. This method takes into account actual cash flows less an apportionment of the cost of purchase.
  5. The apportionment of the purchase cost of a third-party ABD is based on the original forecasted recoveries for the income year as a proportion of the total original forecasted recoveries from the ABD over a period of no less than five years and no more than seven years.
  6. For transferred ABDs, NZC-2 will be allowed a deduction in the income years following the transfer for the amount apportioned to the relevant income year as set out in the original forecast for the ABD by NZC.
  7. Any cash collections on ABDs will be returned as income in the income year in which they are received.

5. Interpretation

In this determination (and the Explanation), unless the context otherwise requires:

  1. Words and expressions that are not defined elsewhere in the determination have the same meaning as in s YA 1 of the Income Tax Act 2007
  2. "NZ IFRS 9" means the New Zealand Equivalent to International Financial Reporting Standard 9 - Financial Instruments, or equivalent as updated or changed from time to time".

6. Method

Profit emerging method

The profit emerging method is illustrated in the following formula:

AI = AC - (PC x OF)
TECC


Where:

  • AI  = assessable income of an ABD for an income year
    AC = actual cash collected from the ABD during the income year
    PC = purchase costs of ABD
    OF = original cash forecasted to be collected during the income year
    TECC = total expected cash to be collected over the spreading period, forecast at date of purchase

Once the cost of the ABD is fully amortised, cash collected after the spreading period will be treated as derived in the income year in which it is received.

Base price adjustment calculation

The base price adjustment calculation arising upon the transfer of ABDs from NZC to NZC-2, members of the same consolidated group at the date of transfer (but not for the whole income year), is illustrated in the following formula:

  • BPA = C - I + E + AR

Where:

  • C = Consideration
    • = total cash collected + consideration for transfer - purchase cost
  • Consideration for transfer = PC - D - (F x 336 / 366)
  • PC = purchase costs of ABD
  • D = total deductions allowed in prior income years for the ABD
  • F = NZC's original forecast deduction for the ABD for the whole of the 2012 income year, expressed as PC x OF / TECC
  • I = income
  • E = expenditure
  • AR = amounts remitted

7. Example

This example illustrates the application of the method (set out in this determination) for determining the income and expenditure attributable to a transferred ABD in each income year. Balance date is 30 June.

This example uses the following parameters.

Purchase date 1 July 2009
ABD purchase cost (PC) 1,000,000
Forecast cash collection (OF)  
Year 1 1,068,000
Year 2 582,000
Year 3 274,000
Year 4 58,000
Year 5 18,000
Total expected cash collected over five years (TECC) 2,000,000
Actual cash collection  
Year 1 1,106,000
Year 2 600,000
Year 3 293,000
Year 4 88,000
Year 5 20,800
Year 6 6,800
Year 7 500


Appendix 1. Schedule of expected assessable income from ABD) for NZC at purchase date on 1 July 2009

Taxable income 2010 2011 2012 2013 2014 2015 2016 Total
Original forecast cash (OF) 1,068,000 582,000 274,000 58,000 18,000 0 0 2,000,000
Actual cash (AC) 1,106,000 600,000 293,000 88,000 20,800 6,800 500 2,115,100
                 
Actual cash (AC) 1,106,000 600,000 293,000 88,000 20,800 6,800 500 2,115,100
Less (PC x OF / TECC) 534,000 291,000 137,000 29,000 9,000 0 0 1,000,000
Equals assessable income (AI) 572,000 309,000 156,000 59,000 11,800 6,800 500 1,115,100

Appendix 2. NZC and NZC-2 form consolidated group commencing 30 May 2012

Taxable income of NZC for pre-consolidation period 1 July 2011 to 29 May 2012 (inclusive)

AC = 267,383 (for this example the amount is based on 334 days divided by 366 days, NZC must use actual cash collected)

(PC x OF / TECC) x 334 / 366 days = 125,022

Taxable income NZC 2010 2011 2012 2013 2014 2015 2016 Total
Original forecast cash (OF) 1,068,000 582,000 274,000 58,000 18,000 0 0 2,000,000
Actual cash (AC) 1,106,000 600,000 267,383 0 0 0 0 1,973,383
                 
Actual cash (AC) 1,106,000 600,000 267,383 0 0 0 0 1,973,383
Less (PC x OF / TECC) 534,000 291,000 125,022 0 0 0 0 950,022
Equals assessable income (AI) 572,000 309,000 142,361 0 0 0 0 1,023,361

Appendix 3. PDLs transferred from NZC to NZC-2 on 1 June 2012

Base price adjustment to be calculated by NZC on 1 June 2012 (for two days since consolidated group formed)

BPA = C - I + E + AR = (1,974,984 + 49,229 - 1,000,000) - 1,973,383 + 950,022 + 0

BPA = 852

Where:

  • AC = 1,601 (for this example the amount is based on 2/366 days, actual cash collected to be used by NZC)
  • (PC x OF / TECC) x 2 / 366 days = 749
  • Consideration for transfer = 1,000,000 - (825,000 + (137,000 x 336 / 366)) = 49,229

Appendix 4. Taxable income of NZC-2 from 1 June 2012

For 2012 income year ended 30 June 2012:

  • AC = 24,016 (for this example the amount is based on 30/366 days; actual cash collected to be used by NZC-2)
  • (PC x OF / TECC) x 30 / 366 days = 11,229
Taxable income NZC-2 2010 2011 2012 2013 2014 2015 2016 Total
Original forecast cash (OF) 1,068,000 582,000 274,000 58,000 18,000 0 0 2,000,000
Actual cash (AC) 0 0 24,016 88,000 20,800 6,800 500 140,116
                 
Actual cash (AC) 0 0 24,016 88,000 20,800 6,800 500 140,116
Less (PC x OF / TECC) 0 0 11,229 29,000 9,000 0 0 49,229
Equals assessable income (AI) 0 0 12,787 59,000 11,800 6,800 500 90,887

Summary

NZC 2012 assessable income = 142,361 (to be returned in separate tax return)
Consolidated Group 2012 assessable income = 13,639  
  = 852 (NZC) + 12,787 (NZC-2)  

Reconciliation

Total assessable income for 2012 income year = 156,000

Total estimated assessable income for 2012 = 156,000
(Originally forecast by NZC when ABDs acquired)

This determination is signed by me on the 9th day of November 2012.

Howard Davis

Director (Taxpayer Rulings)