The Financial Reporting Act 2013 will slash the cost of preparing general purpose financial statements for most small to medium-sized companies.
Other changes will impose stronger requirements on certain overseas ‘multinationals’ and extend reporting obligations of some financial market participants.
The new Act, which is expected to come into effect on 1 April 2014, replaces one of the clumsiest pieces of legislation in the corporate statute book.
This Brief Counsel highlights the more important features of the new regime. For fuller detail, see this summary table.
Predecessor Act a dog
The Financial Reporting Act 1993 was originally intended to apply only to public issuers but all companies were added at a very late stage before enactment without sufficient regard to the excessive compliance burden the Act’s provisions would create for smaller, non-public issuers.
Although the Act was subsequently amended several times, the concessions were targeted to very small “exempt companies” and “non-active companies” and failed to provide any meaningful relief for small-to-medium-sized businesses.
The new Act comprehensively restates and rationalises the obligations applying to companies, overseas companies, limited partnerships, and other forms of business organisation.
Summary of key requirements
Some of the most significant improvements will apply to companies that are not involved in the financial markets.
Preparation of financial statements
The requirement to prepare general purpose financial statements is much more targeted, and will be limited to:
large overseas companies and large subsidiaries of overseas companies that carry on business in New Zealand2
companies with 10 or more shareholders, unless the shareholders opt out by a 95% resolution, and
companies with fewer than 10 shareholders, where shareholders holding at least 5% of the voting shares opt in.
Audit requirements for general purpose financial statements have been limited to the same companies as above, but large companies can opt out by a 95% shareholder resolution.
A company with subsidiaries needs only to prepare group financial statements, rather than the parent having also to prepare its own separate general purpose financial statements.
The obligation to register financial statements is limited to:
large overseas companies
large companies where, in broad terms, 25% or more of the shares are overseas owned.
The requirements for entities participating in the financial markets (referred to as “FMC reporting entities”3) have been tightened. Each FMC reporting entity must prepare financial statements (or group financial statements, if it has any subsidiaries) and those financial statements must be audited and registered.
The deadline for registration has been accelerated to four months after balance date (currently five months to prepare, plus 20 working days to register).
Consistent with the main focus of the Financial Markets Conduct Act 2013 (FMCA), the primary recourse for a failure in defective financial statements will be civil action against both the reporting entity and its directors under the general enforcement provisions set out in Part 8 of the FMCA. Pecuniary penalties can run as high as $1 million for the directors and $5 million for the entity.
Criminal liability will be limited to directors who knowingly prepare false and misleading financial statements, but will expose errant directors to criminal penalty of up to five years imprisonment and/or a fine of up to $500,000.
Accordingly, the spectacle of directors having to appear in District Court for a strict liability offence – as occurred with the Feltex directors – will no long apply to FMC reporting entities. However, it will continue to apply for those entities that are required to prepare financial statements outside the FMCA.
At a late stage of the Parliamentary process, the Government decided to cut by two thirds the “large” threshold for “overseas companies” and subsidiaries of “overseas companies” (generally, a body corporate incorporated outside New Zealand).
The Cabinet papers explain that this decision was made to respond to:
concerns “about high profile multinational companies that are paying almost no tax anywhere in the world by treaty shopping and transferring profits to low-tax jurisdictions”, and
a G20 approved OECD action plan on “base erosion and profit shifting”.
The concern was that, if the Bill had proceeded in the manner originally proposed, it would be too late to dial-back the relaxed obligations on overseas companies because of the implications under international treaties.
The additional compliance costs have been estimated at somewhere between $2 million (100 companies at $20,000 an audit) and $12 million (300 companies at $40,000 an audit) of the approximately 6,000 overseas companies currently subject to reporting obligations. Officials have conceded that it might have been possible to reduce some of these additional costs, but that time constraints prevented them from being able to properly consider the matter.
However, relief may still be available as there is a mechanism in the new Act for overseas companies to seek an exemption where they can establish an appropriate rationale, including where financial statements prepared under their local laws effectively satisfy the New Zealand requirements.
Although the new Act removes the requirement for many “small” companies to prepare general purpose financial statements, the Tax Administration Act 1994 is being amended to empower the IRD to specify requirements for “small” companies to prepare more limited special purpose financial statements for taxation purposes, with other business organisations to be consulted on next year.
Chapman Tripp comments
The 2013 Act is a vast improvement on the 1993 Act and, in combination with the greatly simplified regime for income tax, is expected to result in significant cost savings for small and medium sized enterprises, as long as they do not seek funding from the financial markets.
Strangely, the Government has deferred application of the new Act to the accounting period beginning on or after 1 April 2014. For example, for entities with a 31 March balance date, this will delay the benefits of the new regime to the financial reporting year ending 31 March 2015. For 30 June balance date entities, the full benefit of the reforms will not be available until 30 June 2015.
New provisions being inserted into the FMCA will extend the regime’s application to persons required to obtain a licence under Part 6 of the FMCA. At present, some of these market participants do not need to publicly file their audited financial statements or, in some cases, obtain an audit at all.
Consideration on whether large trusts (which are not charities) will need to prepare or have audited financial statements has been deferred but may be addressed in the context of the Law Commission’s work on trust law reform.
But large partnerships and some other forms of business organisation which were exempt will now be required to prepare financial statements. Chapman Tripp which - as a large partnership - will be affected by this change, welcomes it.