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Income Tax Act 2007

Recharacterisation of certain transactions - Hybrid and branch mismatches of deductions and income from multi-jurisdictional arrangements

FH 3: Payments under financial instruments producing deduction without income

You could also call this:

“Rules for claiming tax deductions on payments from certain financial arrangements”

This section talks about how the government handles payments made under certain financial agreements. It applies when you make a payment as part of a financial deal, and you want to claim it as a deduction on your taxes.

You can’t claim the deduction if:

  1. The payment is part of a planned arrangement or you’re connected to the person receiving the money.

  2. The country where the receiver lives doesn’t count the payment as regular income, but would if the payment was classified differently.

  3. The country does count it as income, but not at the right time, and the financial deal might last more than 3 years.

If these rules apply, you can’t claim the full deduction. The amount you can claim depends on how much tax the receiver pays on the payment in their country.

If the receiver later counts the payment as income at a different time, you might be able to claim the deduction then.

If you earn money from a financial deal where you can’t claim full deductions for your payments, some of your income from that deal might not be taxed.

The law also explains what counts as “ordinary income” in other countries. It’s income that’s taxed at the full rate and doesn’t get special tax breaks, except for credits for taxes already paid in other countries.

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View the original legislation for this page at https://legislation.govt.nz/act/public/1986/0120/latest/link.aspx?id=LMS65823.

Topics:
Money and consumer rights > Taxes
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“How to decide which rule applies when multiple rules could affect your tax deductions or income”

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FH 4: Receipts under financial instruments producing deduction without income, or

“Taxing payments from overseas that usually wouldn't be income”

Part F Recharacterisation of certain transactions
Hybrid and branch mismatches of deductions and income from multi-jurisdictional arrangements

FH 3Payments under financial instruments producing deduction without income

  1. This section applies when a person (the payer) is a party to a financial instrument (the payment instrument) under which the person makes a payment and—

  2. the person incurs in an income year an amount that relates to the payment instrument and does not arise from a fluctuation in the value of a currency; and
    1. the amount of expenditure incurred in the income year (the incurred amount) relating to the payment instrument is allowed as a deduction for the payer in the absence of this section and sections FH 5 and FH 7 to FH 11; and
      1. the taxation law of a country or territory outside New Zealand (the payee jurisdiction) treats the payment, when made, as being received by a person or other entity (the payee) in the payee jurisdiction; and
        1. the payment instrument is or is part of a structured arrangement or the payer is related to the payee when the expenditure is incurred; and
          1. the tax treatment by the payee jurisdiction of the payment meets the requirements of subsection (2) or (3).

            1. The tax treatment of a payment under the payment instrument meets the requirements of this subsection if—

            2. no country or territory recognises an amount of the payment (the unrecognised amount) as giving rise to ordinary income of the payee under subsection (9); and
              1. the unrecognised amount would be recognised by the taxation law of the payee jurisdiction as giving rise to ordinary income of the payee under subsection (9) if the classification of the payment or payment instrument were varied and the payee had the usual tax status for a person or entity of the payee’s class.

                1. The tax treatment of a payment under the payment instrument meets the requirements of this subsection if—

                2. an amount of the payment is recognised as giving rise to ordinary income of the payee under subsection (9); and
                  1. the amount is recognised with a timing that does not meet the requirements of subsection (6); and
                    1. the duration of the financial instrument, including extensions contemplated by the financial instrument, may be more than 3 years.

                      1. The payer is denied a deduction for expenditure incurred under the financial instrument equal to the greater of zero and the amount calculated using the formula—

                        incurred amount × (1 − payee tax ÷ ordinary tax).

                        Where:

                        • In the formula in subsection (4),—

                        • incurred amount is the amount of the expenditure incurred by the payer relating to the payment instrument and the payee:
                          1. payee tax is the total of amounts—
                            1. calculated by multiplying the amount of the payment that is recognised by the payee jurisdiction as ordinary income arising from the payment received by the payee with a timing that meets the requirements of subsection (6) by the rate of tax imposed by the taxation law of the payee jurisdiction on the class of income that the payee is recognised as receiving:
                              1. of income tax imposed by a country or territory outside New Zealand on a person (the CFC payee) other than the payee, on an amount of income corresponding to attributed CFC income relating to the payment and attributed to the CFC payee with a timing that meets the requirements of subsection (6) plus the amount of any credit for withholding tax on the payment taken into account in determining the amount of income tax imposed:
                              2. ordinary tax is the amount calculated by multiplying the amount of the income arising from the payment received by the payee by the rate of tax imposed by the taxation law of the payee jurisdiction on ordinary income under subsection (9) received by the payee.

                                1. The timing of the recognition by a tax jurisdiction of an amount meets the requirements of this subsection if the amount is, or is reasonably expected to be, recognised as being derived—

                                2. over a period of time during which the amount can reasonably be treated as accruing:
                                  1. in an accounting period beginning within 24 months of the end of the income year to which a deduction of the payer for the incurred expenditure would be attributed.

                                    1. If an amount of the payment for which a deduction has been denied under subsection (4) is recognised as income of the payee derived at a time not meeting the requirements of subsection (6), the payer is allowed a deduction, when the amount is recognised, equal to the denied deduction.

                                    2. If a payer that derives income (the affected income) in an income year from a financial instrument would, as a consequence of unrecognised amounts under subsection (2) of payments, be denied by subsection (4) a deduction for a fraction (the affected fraction) of expenditure incurred by the payer in the income year under the financial instrument, an amount of the payer’s affected income, calculated by multiplying the affected income by the affected fraction, is excluded income of the payer.

                                    3. An amount of income is ordinary income under this subsection for a country or territory and a person or entity if the income is—

                                    4. taxed by the country or territory at the full marginal rate of the person or other entity for the income from financial instruments; and
                                      1. not eligible for an exemption, exclusion, credit, or tax relief, under the laws of the country or territory, other than a credit or tax relief for a withholding tax or similar tax imposed on the amount of the income by the laws of another country or territory.

                                        Notes
                                        • Section FH 3: inserted, on , by section 35(1) (and see section 35(2) and (3) for application) of the Taxation (Neutralising Base Erosion and Profit Shifting) Act 2018 (2018 No 16).
                                        • Section FH 3(2)(a): amended (with effect on 1 July 2018), on , by section 67(1) (and see section 67(3) for application) of the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021 (2021 No 8).
                                        • Section FH 3(2)(b): amended (with effect on 1 July 2018), on , by section 67(2) (and see section 67(3) for application) of the Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Act 2021 (2021 No 8).
                                        • Section FH 3(5)(b)(i): amended (with effect on 1 July 2018), on , by section 195(1) (and see section 195(2) for application) of the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 (2019 No 5).