Understanding Non-BAU Transactions

and Tax Implications

The term "BAU," or "business as usual," serves as a benchmark for assessing whether transactions are typical or unusual. While standard operations often follow predictable patterns, non-BAU transactions—such as insurance payouts, large asset purchases, fines, or penalties—require special attention to determine their tax treatment.

A recent Technical Decision Summary (TDS 24/12) from Inland Revenue highlights a case involving non-BAU transactions. Two companies received lump sum compensation payments from a third party for damage to their intellectual property (IP), specifically licenses for commercialising certain products. The settlement was based on the discounted value of future income streams that would have been generated if the licenses had not been damaged.

Under New Zealand's income tax legislation, income is typically taxable, including specific items like rental income and broader categories like business-derived income unless it is capital in nature. A key principle from case law is that payments intended to replace lost profits may inherit the tax attributes of the lost profits, potentially making them taxable.

However, in this case, the compensation, though calculated based on lost cashflows, was not treated as taxable. The focus was on the nature of the damage to the IP rights, which was significant but not complete destruction. The agreement between the companies and the third party explicitly stated that the payment was for the damage to the IP rights.

The significant reduction in market participation and the loss of earning capacity from the asset were pivotal. Importantly, the compensatory payment was considered a one-off rather than a regular or recurring income stream.

This case illustrates that while business-derived amounts are generally taxable, non-BAU situations may warrant a closer look. If you encounter such a transaction, it’s essential to pause and evaluate its tax treatment carefully. Consulting your advisor early, especially when drafting agreements or written communications, is crucial, as these documents can influence the final tax outcome.