New Zealand Introduces New Tax Loss Carry-Forward Rules

New Zealand has recently introduced tax loss carry-forward (“TLCF”) rules which apply from the start of the 2021 income year. These new rules are a positive development in that, in certain circumstances tax losses in a New Zealand company can survive a change in ownership, bringing New Zealand’s tax law in line with the position in Australia. The new rules also mean that tax losses in a New Zealand company are potentially valuable to a purchaser and can increase the value of that company in a transaction.

Previous shareholder continuity requirement

Prior to the introduction of the TLCF rules, a New Zealand company with tax losses would forfeit its tax losses where there was a change in the ultimate shareholders of more than 49%. In practice, this meant that most corporate acquisitions, including an offshore corporate acquisition of a group with New Zealand subsidiaries, would result in a complete forfeiture of New Zealand tax losses.

The new tax loss carry- forward rules and the Business Continuity Test

The new TLCF rules have been introduced as a pro-business initiative and to enable a purchaser of a New Zealand company to be able to use tax losses following an acquisition and offset those tax losses against future taxable profits.

The main requirement of the TLCF rules is that the New Zealand company must satisfy the business continuity test (“BCT”). Broadly, this means that following a more than 49% change in the ultimate shareholders, there must not be a major change to the nature of the business activities conducted by the company during the period in which those carried forward tax losses are utilised.

What constitutes a 'major change' requires a factual assessment of the business carried on, including the type or category of product or service provided, before the ownership change compared with the period in which the tax losses are used. Recent draft guidance from New Zealand Inland Revenue has provided useful examples of how the BCT will be applied and what will constitute a major change. Examples include a bakery that changes the types of products it sells, and a bookstore that transforms into a bookstore and café. In most cases, the guidance confirms that these types of examples will not be regarded as a major change.

In addition, the TLCF rules include four permitted circumstances where a 'major change' will be acceptable and will not result in the forfeiture of tax losses. Those permitted major changes are broadly:

• Changes made to increase the efficiency of a business activity;
• Changes made to keep up to date with advances in technology;
• Changes caused by an increase in the scale of a business activity; and
• Changes caused by a change in the type of products or services produced or provided.

Limitations on the new rules

The new TLCF rules do however contain a number of specific requirements that are aimed at limiting their application in certain circumstances.

First, the new rules do not apply to tax losses arising in the 2013/14 and earlier income tax years. This limitation is primarily to prevent very old tax losses, including those that arose during the global financial crisis, being available under the new rules.

Second, the loss company must not have become dormant in the period before the change in ownership. This limitation is largely aimed at preventing a company with no value being acquired purely for its tax losses.

Third, there is an anti-injection rule which, broadly, prevents income in an acquiring group being diverted into an acquired loss company.

Fourth, there is a specific limitation directed at a company that makes pre-emptive changes to its business before the change in ownership. The concern here is that a company with tax losses could change the nature of its business, prior to a sale so as to defeat the purpose of the BCT, and to align the business of the tax loss company with that of an acquiring company.

Fifth, there are specific rules in relation to limiting the application of the new rules where the losses arise as a result of bad debts.

Each of these five limitations are directed at relatively narrow situations and are not expected to reduce the overall benefits of the TLCF rules.

Valuing tax losses in a transaction

New Zealand's TLCF rules are deliberately generous. One of the stated aims of the Inland Revenue when designing these rules was that they wanted to ensure that shareholders of a New Zealand company with tax losses would be able to get value for those tax losses in a transaction.

The difficult question then becomes, how do you value tax losses in a transaction. A buyer of a company will generally not want to pay the cash equivalent value of the tax losses, partly because:

• there is some uncertainty as to whether and when a buyer will get the benefit of those tax losses;
• there is some work required by a buyer to claim the tax losses; and
• a warranty and indemnity insurer will generally not provide cover for the availability of tax losses after a transaction.

As a result, in a transaction it becomes necessary to negotiate the extent to which tax losses will be paid for. In our experience, a typical middle ground is for a buyer to pay a percentage of the cash equivalent value of the tax losses (say, 60%) and defer payment of that additional consideration for the shares until such time that the company is able to use those tax losses to reduce future tax paid in the New Zealand company.

Summary

The introduction of New Zealand's TLCF rules is a positive development and should mean that tax losses in a New Zealand company will have some value.

However, these new rules require careful consideration, and a number of limitations apply. Specialist tax advice should be obtained during a transaction to ensure that the value of tax losses in a New Zealand company can be realised by both a buyer and a seller.