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BeeGee
02-07-2010, 05:53 AM
This is currently a hot topic with accountants preparing end of year returns , and as I understand it, losses on bonds like Babcock and Brown are deductable, but those on preference shares in for example south canterbury finance are not. There is one other requirement. You have to be in the business of investing in bonds. This is what my question is about. How do you define being in the business.

peat
02-07-2010, 06:59 AM
read this and then search around the Income Tax Act legislation
http://www.ird.govt.nz/ecommerce-tax/onlinetrading.html

Snapper
02-07-2010, 09:56 AM
As far as I'm aware (and I'm not an accountant) losses on bond sales are tax deductible as they are on income account not capital account (therefore any gains on sale are taxable). One exception to this is when losses are caused by declines in the other party's creditworthiness - an excerpt from the IRD is below

If you sell or transfer a financial arrangement for a consideration influenced by:
the decline of the other person’s creditworthiness
an increase in the possibility that the other person may default
an event that occurred which reduced or cancelled the other person’s obligations
under the financial arrangement
treat the financial arrangement as having received all amounts that would be payable if
the consideration were not influenced by these factors. This does not apply if your business
includes the holding or dealing in financial arrangements of that class and you were not
associated to the other party to the arrangement.

Aaron
21-07-2010, 04:23 PM
This is currently a hot topic with accountants preparing end of year returns , and as I understand it, losses on bonds like Babcock and Brown are deductable, but those on preference shares in for example south canterbury finance are not. There is one other requirement. You have to be in the business of investing in bonds. This is what my question is about. How do you define being in the business.
Your question regarding the bond trader/dealer definition would not be clear cut but obviously you would need to show the buying and selling of a number of debt instruments rather than holding to maturity.

The other question of gains or losses on bonds/debentures/loans (I will call them bonds) is an interesting question most of which I would have thought would be pretty straight forward.

The following is only my opinion based on some brief reading so don't rely on it as I now have as many questions as answers and am not clear on this at all.

Bonds are "financial arrangements" and are affected by the financial arrangement rules.
Shares are an "excepted financial arrangement" and this I would assume includes preference shares so shares are not included in the financial arrangement rules.
The financial arrangement rules allow individuals who earn less than $100,000 interest per year and have bonds (financial arrangements) of less than $1million to calculate financial arrangements on a "cash basis" otherwise income needs to be spread over the life of the financial arrangement.(Which it is in most cases with regular interest payments)
Assuming most people are on a cash basis the only real issue is the base price adjustment required when a financial arrangement (bond) matures/is sold.
If you receive your initial capital back plus interest the base price adjustment should be zero.
If the face value of your bonds decreases due to interest rate rises and you sell at a loss you have a deductible loss and you have income if the face value rises.
If the bond face value decreases because a debtor is in financial difficulties (I assume this includes a credit rating downgrade) you can’t claim the loss (unless you are a bond dealer/trader) but if you buy junk bonds cheap and their creditworthiness improves or they mature with full repayment I guess you would be expected to pay tax on any increase in the face value. This seems unfair if I have things correctly.

The legislation talks about “disposal” of a financial arrangement. Does disposal include where a financial arrangement is held to maturity and only so many cents in the dollar are recovered. Would holding to maturity generate an expenditure/loss for tax purposes?

Type in “finance companies” on the IRD website and you get the IRD view on losses from “secured debenture stock” they discuss a “loss of capital” being not deductible but I thought the financial arrangement rules to which the debentures apply disregard any distinction between capital and revenue amounts. The IR3K indicates income or loss and only mentions financial arrangements “sold’ or “transferred” not if they are held to maturity in the cases where value changes due to debtor’s financial difficulties.

Could someone point me to the thread that may have already discussed this if there is one or perhaps clarify the issue of whether a gain or loss in the face value of a bond is income or expense for income tax purposes. I find the whole issue confusing especially when you apply it to finance company debentures.

Snoopy
21-07-2010, 05:14 PM
There is one other requirement. You have to be in the business of investing in bonds. This is what my question is about. How do you define being in the business.

The answer from an NZ Tax perspective, the one that applied when I made a small loss on some bonds I had held for around 9 years after they matured, is that the capital loss on maturity was treated as a one hit loss in my income tax for that year. Now if you buy a bond on the secondary market not at coupon rate (implies a loss or gain when bond matures), that the potential loss/gain has to be amortised across the years remaining in the life of that bond. In either case, you are treated as a 'bond trader' whether you really are just a short term trader or a long term holder. IOW, if you exist and hold bonds you are defined as being 'in the business' of bond trading.

SNOOPY

Snoopy
21-07-2010, 05:26 PM
, losses on bonds like Babcock and Brown are deductable,

If the bond issuer has gone into liquidation, before the bond has matured, I am not sure if you can claim an immediate loss. It may not be sufficient to declare to the IRD your bond is worthless because it is untradable. The bond will be under the control of a receiver in Australia. The receiver will be sorting through assets, and it may be there is some return that finds itself back into the hands of those bondholders still holding at the time of receivership. The whole receivership process may have to run its course before a bond is declared 'dead' for tax purposes. You may need to contact the Australian Tax Office to determine the tax status of those Babcock & Brown bonds.

SNOOPY

Aaron
28-01-2011, 09:36 AM
Its been a while, just thought I would add that in my opinion a cash basis person who only invests and holds bonds to maturity without buying or selling on the secondary market would not be considered a bond trader and would not get to claim a loss of capital on their finance company bonds.
That said you could put amost anything in your income tax return and it is unlikley IRD will ever audit you.

Snoopy
14-02-2011, 01:50 PM
Its been a while, just thought I would add that in my opinion a cash basis person who only invests and holds bonds to maturity without buying or selling on the secondary market would not be considered a bond trader and would not get to claim a loss of capital on their finance company bonds.


You will have to do better than your opinion Aaron. From the point of view of someone who has actually held bonds, I can assure you they are dealt with on the income account. So capital losses are deductible and capital gains are taxable for everyone. Barring some law change in the last 2-3 years that I am unaware of, your opinion is 180 degrees wrong in a general sense, and is in fact misinformation.

SNOOPY

Aaron
23-02-2011, 06:04 PM
http://www.ird.govt.nz/news-updates/like-to-know-losses-from-finance-co-invests.html

Aaron
23-02-2011, 06:17 PM
That is the IRD's view.

I tried to be pretty specific and my comment #7 doesn't relate to BeeGee's initial question as I don't have enough information to give him an opinion.
I was being specific in comment #7 because I don't think you can make general opinions as though the same rules apply to everyone. It would depend on each individuals situation. I am not saying your wrong but your view would not be correct in all situations.
Cash Basis Holders who invest in an initial bond offer and hold to maturity not purchasing or selling on the secondary market would be hard pressed to call themselves bond traders.
Snapper above also points to Section EW39 of the Income Tax Act 2007 which would apply to people who are not bond traders.
If you check out the IRD link and the legislation get back to me if you still disagree and point out what your own "opinion" is based on.

I am not entirely sure what being 180 degrees wrong means but assuming 180 degrees is half wrong I would suggest your critisism of my comment would be the full 360 degrees and I would suggest your critisism of my statement#7 is not misinformation but total crap.

That said I do respect your views on this site and have enjoyed your comments on investing. It is probably because you are so well respected on this site that I felt the need to respond.

Snoopy
23-02-2011, 08:03 PM
If you check out the IRD link and the legislation get back to me if you still disagree and point out what your own "opinion" is based on.


Form IR3G, p35 'Sale or Maturity of Financial Arrangements'. "Total gains and losses from the financial arrangment are brought to account. This applies in every case - you don't have to be in the business of buying or selling financial arrangements, or have bought them for the purpose of resale, as you would with shares."

SNOOPY

Snoopy
23-02-2011, 08:15 PM
http://www.ird.govt.nz/news-updates/like-to-know-losses-from-finance-co-invests.html

Thanks for the reference Aaron. Interesting, I wish you had put it up the first time. Potentially claiming 100% capital bond losses on a company that has gone bust is a different abnormal situation. That is perhaps why IRD put out your referenced bulletin?

SNOOPY

Aaron
24-02-2011, 07:17 AM
Sorry I only bothered to learn how to insert the link after I got riled by your critisism. If you go from pg 35 of the IR3G and use the IR3K to make your calculations you will see a note on the back about a decline in creditworthiness affecting the calculation.

I suppose you could argue that the finance companies without a rating from a recognised credit rating agency had no creditworthiness at any stage so the losses weren't due to an actual decline in their creditworthiness.