BAU is a phrase that is used to describe “business as usual”. It is a good barometer of whether anything strange or unusual has occurred or whether things have been BAU. Invariably, non BAU transactions will occur: an insurance payout, a large asset purchase, a fine or a penalty. This then leads to the question of what the tax treatment is of that non-BAU transaction.
A non-BAU type transaction was the subject of a recent Technical Decision Summary released by Inland Revenue. Two companies received lump sum compensation payments from a third party for damage to intellectual property (IP). The IP was held in the form of licenses to commercialise certain products. The settlement amount was based on discounting the future income streams that were otherwise expected if the licenses had not been damaged.
New Zealand’s income tax legislation captures ‘specific items’ as taxable, and then more broadly, amounts that are income under ‘ordinary concepts’, and importantly in this case, ‘income derived from a business’ is taxable, unless it is capital in nature.
One principle that has developed through case law is that where an ‘amount introduced’ is intended to replace lost profits, then the payment takes on the attributes of the amount it was designed to replace and could therefore be taxable. One frustration with this approach is that the value attributable to most capital assets is ‘a function’ of the income to be derived from them.
Positively for ‘the taxpayer’, the fact that such compensation was calculated based on lost cashflows was ‘not determinative’. Instead, the focus was placed on the fact the settlement payment was for the damage to specific IP rights which were permanently damaged (but not destroyed) wherein that damage was significant or substantial. In this case the companies and the third party expressly agreed that the nature of the compensatory payment was one-off rather than regular or recurrent.
Therefor although it is routine to treat amounts derived by a business as taxable, that may not always be the case. If a non-BAU situation has arisen it is worth asking the question ‘how should this transaction be treated?’.
It may also be worth asking your advisor early in the process, particularly if agreements or communications are being put in writing, because those statements may become ‘determinative’ in the eyes and statutes of IRD.