This determination may be cited as "Special Determination S17: Utilisation of a Profit Emerging Basis for Acquired Bad Debts by a Certain New Zealand Company Limited".
1. Explanation
(Note that the explanation does not form part of the determination.)
(1) This determination relates to the ability of New Zealand Company Limited (NZC) to utilise a profit emerging basis for returning income and expenditure arising from the acquisition and collection of a portfolio of distressed debts acquired at a deep discount.
(2) NZC acquires for valuable consideration pools of unpaid loans and receivables, which may consist of a few hundred to a few thousand individual debts (ABDs).
(3) NZC acquires the ABDs at a deep discount to their face value. NZC subsequently seeks to recover the overdue balances from debtors through various means.
(4) The acquisition of an individual ABD is done on the expectation that its recoveries will be in excess of the purchase price and the cost incurred in attempting collection. Some debts may not achieve any recovery and become uncollectable, and others may be partially collected. The volatility of cash collections may be attributed to such things as the nature of the underlying debt, its age and type, as well as external economic conditions and the effort applied.
(5) NZC previously applied IAS 39 to ABDs for financial reporting purposes. From (and including) the financial year ended
30 June 2010, NZC will apply AASB 9 to ABDs for financial reporting purposes.
(6) This determination provides that NZC’s tax liability for an income year will be based on actual collections reduced by the proportion of purchase cost allocated to that income year.
2. Reference
This determination is made under section 90AC(1)(bb) of the Tax Administration Act 1994.
3. Scope of determination
(1) This determination applies to the tax treatment of ABDs acquired by New Zealand Company Limited (NZC).
(2) ABDs are pools of unpaid loans and receivables. These pools may consist of a few hundred to a few thousand individual debts.
(3) NZC acquires the ABDs at a deep discount to their face value on the expectation that its recoveries will be in excess of the purchase price and the cost incurred in attempting collection.
(4) NZC previously applied IAS 39 to ABDs for financial reporting purposes. From (and including) the financial year ended
30 June 2010, NZC will apply AASB 9 to ABDs for financial reporting purposes.
(5) NZC will apply the spreading method adjustment formula in section EW 27 of the Income Tax Act 2007 to any financial arrangements (forming part of an ABD) to which it was a party at the end of the financial year ended 30 June 2009.
(6) This determination is made subject to the following conditions:
(i) NZC is satisfied on the basis of objective criteria that five years is the appropriate period over which cashflows from an ABD are to be forecast; and
(ii) NZC will not take a deduction for the acquisition cost of an ABD (or any part thereof) except as set out in this determination; and
(iii) NZC continues to treat all underlying debts to which it becomes a party on the acquisition of an ABD (which would otherwise be excepted financial arrangements) as financial arrangements under section EW 8 of the Income Tax Act 2007.
4. Principle
(1) All underlying debts to which NZC becomes a party on the acquisition of an ABD are either financial arrangements as defined in section EW 3 of the Income Tax Act 2007, or are treated as financial arrangements by NZC under section EW 8 of the Income Tax Act 2007.
(2) This determination specifies that income and expenditure from an ABD for an income year is recognised using a profit emerging method. This method takes into account actual cash flows less an apportionment of the cost of purchase.
(3) The apportionment of the purchase cost of an ABD is based on the original forecasted recoveries for the income year as a proportion of the total original forecasted recoveries from the ABD over a five-year period.
(4) Any cash collections will be returned as income in the income year in which they are received.
5. Interpretation
In this determination (and the Explanation), unless the context otherwise requires:
Words and expressions used (which have not been defined elsewhere within the determination) have the same meaning as in section YA 1 of the Income Tax Act 2007.
IAS 39 means International Accounting Standard 39 (Financial instruments: recognition and measurement), issued by the International Accounting Standards Board.
AASB 9 means Australian Accounting Standard AASB 9 (Financial instruments), issued by the Australian Accounting Standards Board.
6. Method
The profit emerging method is illustrated in the following formula:
AI = AC - (PC x OF)
TECC
AI = assessable income of an ABD for an income year
AC = actual cash collected from the ABD during the income year
PC = purchase costs of ABD
OF = original forecast cash to be collected during the income year
TECC = total expected cash to be collected over five years, forecast at date of purchase
Once the cost of the ABD is fully amortised, cash collected after the five-year period will be treated as derived in the income year in which it is received.
7. Example
This example illustrates the application of the method (set out in this determination) for determining the income and expenditure attributable to an ABD in each income year.
This example proceeds on the following parameters:
Purchase date 1 July 2006
ABD purchase cost (PC) 1,000,000
Forecast cash collection (OF)
Year 1 1,068,000
Year 2 582,000
Year 3 274,000
Year 4 58,000
Year 5 18,000
Total expected cash collected over five years (TECC) 2,000,000
Actual cash collection (AC)
Year 1 1,106,000
Year 2 600,000
Year 3 293,000
Year 4 88,000
Year 5 20,800
Year 6 6,800
Year 7 500
Taxable income 2007 2008 2009 2010 2011 2012 2013 Total
Original forecast cash (OF) 1,068,000 582,000 274,000 58,000 18,000 0 0 2,000,000
Actual cash (AC) 1,106,000 600,000 293,000 88,000 20,800 6,800 500 2,115,100
Actual cash (AC) 1,106,000 600,000 293,000 88,000 20,800 6,800 500 2,115,100
Less (PC x OF/TECC) 534,000 291,000 137,000 29,000 9,000 0 0 1,000,000
Equals assessable income (AI) 572,000 309,000 156,000 59,000 11,800 6,800 500 1,115,100
This determination is signed by me on the 17th day of December 2010.
HOWARD DAVIS, Director (Taxpayer Rulings).