AM I SUBJECT TO THE FINANCIAL ARRANGEMENT RULES?
The financial arrangement (“FA”) rules apply to income arising from debt, whether they be simple bank accounts, investment bonds, or foreign currency accounts.
To the extent that the FA rules apply, the taxpayer is required to spread income and deductions over the life of the FA via a prescribed methodology.
For many taxpayers, no spreading is required due to the application of the cash basis person exclusion from the FA rules. From 1 April 2009, the cash basis definition was extended to include all taxpayers. Prior to 1 April 2009 it only applied to natural persons.
To be a cash basis person, the total of all of the income received and all of the expenditure incurred in relation to all FAs that the taxpayer is a party to, must be $100,000 or less, or the total value of all the FAs to which the person is a party is $1 million or less at all times during the year. If either one of those criteria is met, then the taxpayer can be a cash basis person provided that the difference between the income calculated on a cash basis and on an accruals basis is $40,000 or less.
If the cash basis person definition is met, then the taxpayer simply returns income from the FA when that income has been received. If the person is not a cash basis person and the FA rules apply, then the taxpayer must apply a spreading method, which spreads the income and any deductions from the FA over the life of the FA. In its most common sense, this results in interest income being accrued to balance date and included in the taxpayers income tax return, even though that interest is yet to be received.
Even though the FA rules may not apply to a taxpayer due to the cash basis person concession, the taxpayer is still required to complete a base price adjustment (“BPA”) in the final year that the financial arrangement is held. Commonly, this is when a FA matures or when the FA is disposed of.
Where the BPA calculation gives rise to a positive amount, this is always income of the taxpayer. Where the BPA calculation gives rise to a negative amount, this amount may be allowed as a deduction for the person.
How it affects you
Given the wide application of the FA rules, it pays to be certain whether the rules will apply to you, or whether the cash basis person exclusion can be relied upon. Even when the cash basis person exclusion is relied upon, a BPA is required in the year that you no longer hold the FA. If you are uncertain as to the tax treatment of any investment income you receive, we suggest you contact your tax advisor to discuss this matter further.
TRANSITIONAL PERIOD FOR IMPUTATION CREDITS
With the reduction of the company tax rate to 28% for income years starting on or after 1 April 2011 it is a good opportunity to review what the imputation regime is all about and the impact of the tax rate change.
The imputation regime has the objective of eliminating double taxation on company profits. Under the imputation regime a company can attach imputation credits (tax credits) to dividends distributed to shareholders. The shareholder’s tax liability on the dividend is reduced to the extent of the imputation credits attached to the dividend. Dividends will generally also have resident withholding tax deducted from them at a rate of 3% to 5%. This effectively means that dividends are tax paid to 33%.
Generally the maximum imputation rate mirrors the company tax rate at the time the dividend is paid. This creates an issue when there is a reduction in the company tax rate, as tax has been paid at a higher rate than can be imputed. This would lead to double taxation for the shareholders of the company.
To remedy this issue a transitional period exists which provides an opportunity to impute dividends at 30% and utilise imputation credits created at 30% or 33% in income years up to and including the 2011 income year.
The transitional period runs from 1 April 2011 to 31 March 2013. During the transitional period a company is able to continue to impute dividends at the rate of 30% to utilise its 30% imputation credit account balance.
For many companies, the imputation credit balance will only relate to the 2009 and later income years as all 33% imputation credits were utilised during the previous transitional period (1 April 2008 to 31 March 2010).
For companies that are able, the payment of dividends during the transitional period will ensure that no double taxation occurs in relation to tax paid by the company in the 2009 to 2011 income years. Dividends paid will need to have resident withholding tax deducted, which does result in a cash cost to declare the dividend.
How it affects you
The availability of imputation credits has a real impact on the real tax rate for distributed company profits. If you are a shareholder in a company with significant imputation credits we suggest that you carefully consider the payment of dividends during the transitional period. The reduction in the top personal tax rate to 33% reduces the impact of any additional income tax payable on the dividend which may have discouraged the payment of dividends earlier.
POINTS OF INTEREST…
The Liberty Trust was registered as a charitable entity under the Charities Act and was confirmed as a charitable entity in the High Court that held that a trust operating a mortgage lending scheme in order to teach financial principles it proclaimed were derived from the Bible, had, as its main purpose, a charitable purpose. The Court found that the Trust was set-up to advance religion. The Court also found that the Trust’s activities existed for the public benefit.
The Supreme Court hearing of the Penny & Hooper case commenced last week. Our pick is that the Court of Appeal decision will be mostly upheld.
TO THE POINT…
“To shorten winter, borrow some money due in spring”