Deductibility of use-of-money interest

Deductibility of use-of-money interest

Sections DB 3B, EF 4, EF 5 and EF 6 of the Income Tax Act 2007; section DB 3B of the Income Tax 2004; section DB 2 of the Income Tax 1994; and section 184AA of the Tax Administration Act 1994

The amendments clarify that use-of-money interest (UOMI) payable to Inland Revenue is deductible for tax purposes and the deduction is made in the year the UOMI is paid.

Background

The penalty and interest rules have applied since the 1997-98 income year. The policy intention of the interest rules was that interest paid on overpayments of tax would be taxable, and interest charged on underpayments of tax would be deductible under the normal income tax rules. This approach provided consistency with the treatment of interest generally, removed the need to convert rates to after-tax rates and distinguished between penalties and interest. Furthermore, the discussion documents released before the introduction of the rules noted interest would be deemed to be interest on money lent for the purposes of determining whether a deduction was available under the Income Tax Act. This was, however, never specified in the legislation.

Over time questions were raised as to whether UOMI was in fact deductible. This led to a number of taxpayers seeking case-specific rulings from Inland Revenue on this issue. There appeared to be some inconsistency over whether interest is deductible for companies and individuals. Generally companies were automatically entitled to deduct interest, but other taxpayers (specifically individuals) needed to satisfy a nexus with assessable income requirement - meaning that interest may not have been deductible. This inconsistency arose as a result of a lack of clarity over what Parliament's intention was on the nexus requirement and resulted in calls for legislative clarity on the deductibility of UOMI.

Key features

The amendments clarify that UOMI is deductible for tax purposes. The amendments ensure consistency, in particular between companies (for whom interest was typically always deductible) and individuals. The amendment also ensures symmetry in treatment for tax purposes so that UOMI is both taxable and deductible.

The provisions setting out which period the deduction is allocated to have also been amended. Previously the UOMI deduction was allocated to the same year to which the tax liability relates, the following year or to the income year following the income year in which the Commissioner issues the notice of amended assessment. This meant that if there was a dispute involving court proceedings which was eventually resolved in the Commissioner's favour, the previous rules could inappropriately allocate the deduction to a year many years earlier than the year in which the interest is paid. The previous rules could also inappropriately allocate the deduction to the year of assessment in cases when the taxpayer simply failed to pay any relevant tax and the UOMI may not be paid until much later (if at all).

The timing provisions have been amended to provide for the deduction of UOMI in the year in which the UOMI is paid. This approach provides taxpayers with certainty on this issue and deals appropriately with the problematic cases described previously. Importantly, a paid approach is also consistent with the timing of assessability, that is, UOMI is assessable in the year the Commissioner pays the interest.

The amending provisions override the capital limitation, the employment limitation and the private limitation. This means the provision is consistent with section DB 3 (which allows for the deduction of expenditure incurred in calculating or determining tax liabilities).

Under section RM 2 of the Income Tax Act 2007, the Commissioner may refund tax if the four-year period for the amendment of an assessment has not ended. The four-year period can be extended to eight years in certain circumstances, for example, if the refund arises from a clear mistake or simple oversight of the taxpayer. These amendments apply retrospectively from the 1997-98 income year (the start of the UOMI rules). Therefore the time limitations on the Commissioner refunding tax do not apply to prevent these amendments being effective.

Application dates

The amendments clarifying the deductibility of UOMI apply retrospectively from the 1997-98 income year (the start of the UOMI rules) for taxpayers who have claimed deductions for UOMI in returns filed or notices of proposed adjustment issued before the date of introduction of the amending legislation, that is 24 November 2010. These amendments also apply generally to the 2010-11 and later income years.

The amendments to the timing provisions for UOMI deductions apply for the 2011-12 and later income years.