Are you a CBP?

I appreciate it is everyone’s favourite topic – the financial arrangement or ‘FA’ rules – and consequently, you will all be overjoyed to hear that IR has released a draft interpretation statement titled ‘Cash basis persons under the financial arrangements rules’, with a reference of PUB00396.

The purpose of the latest IS draft is to explain when a person can account for income and expenditure from FA’s on a cash basis instead of an accrual basis, and to provide some clarity around the adjustment that must usually be made when a person ceases to be a cash basis person and must account for their FA’s using the accrual basis.

You may or may not recall an IS released in 2020 titled IS 20/07 ‘Income tax – Application of the financial arrangements rules to foreign currency loans used to finance foreign residential rental property.’ That document explained who qualified as a CBP, but did not expand on the adjustment calculations required, which the present statement looks to do.

I expect that most of you already understand the difference between cash basis and accrual basis when dealing with the FA rules. Accounting on a cash basis is arguably the simpler of the two methodologies, where the income/expenditure relating to the FA is accounted for during the life of the arrangement, based on when an amount is received or paid. Under an accrual basis, however, an appropriate spreading methodology must be used.

Now to qualify as a CBP, you must not hold FA’s which exceed the following thresholds:

  • NZD$100,000 for the income and expenditure threshold (s EW 57(1)); or,
     
  • NZD$1 million for the financial arrangement threshold (s EW 57(2)); and,
     
  • NZD$40,000 for the deferral threshold (s EW 57(3)). 

It should be noted here that you only have to satisfy one of the first two tests, and not both tests, to qualify as a CBP. In other words, if for example the total income/expense (absolute number) for all of the person’s FA’s for the income year was $60,000, but they held $3,000,000 of FA’s, then the person could use the cash basis for accounting purposes, provided they also satisfied the $40,000 deferral threshold. Unfortunately, it is this latter threshold which is quite often overlooked or its basis of calculation is misunderstood.

And just remember when undertaking your first two threshold calculations, that it is an absolute number – so you add the two numbers together (income/expense) or (asset/liability), you do not subtract one from the other to obtain a net amount.

Once the person has qualified as a CBP, there are then two potential adjustment calculations which could be triggered each income year (so annual reviews must be undertaken). A base price or BPA is triggered when the FA either matures or comes to an end, and a cash basis adjustment is triggered when the person loses their CBP status for whatever reason.

PUB00396 contains a number of detailed examples which in my view are well worth a look, to understand exactly how the rules operate in practical scenarios.

Finally of important note is a comment on the application of the $40,000 deferral threshold. You have to perform the calculation over the entire period that the FA has existed – so from the income year in which the FA commenced, through until the income year you are reviewing a person’s CBP status – so it is not a single-year calculation. Due to the complexity of the calculation that may be required, therefore (or simply the likely time period for which the FA may exist), there is an option to elect to use the accruals basis to calculate annual FA income/expense, even though the person may qualify as a CBP. However, once you make an election to use a spreading method, that method must then be used for:

  • all financial arrangements you are a party to at the time of making the election; and,
     
  • all financial arrangements you enter into after the income year in which you make the election.

You can subsequently revoke the election by giving notice to IR with a return of income within the prescribed timeframe, however, the revocation only applies to all FA’s entered into after the income year in which you give the notice, and you must continue to use a spreading method for those arrangements covered by the election even though you may qualify to be a CBP.   

Should you wish to make a comment on the draft IS, the deadline is July 15th.

Contributing Advisors