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 (TDS 24/12) 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, such as rental income, and then more broadly, amounts that are income under ordinary concepts. In addition, 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 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.
In a positive outcome for the taxpayer, the fact that the 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 their IP rights which was permanently damaged (but not destroyed) and that damage was significant or substantial. The companies and the third party expressly agreed that the payment was in respect of that damage.
The damage had significantly reduced the companies’ ability to participate in the market in which they would otherwise have been able to participate, and the companies had effectively lost earning capacity from their asset. The nature of the compensatory payment was one-off rather than regular or recurrent.
This case demonstrates that 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 pausing and 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 and therefore crucial that they are correct.
