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Last Updated: 26 April 2020
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CONSULTATIVE DOCUMENT
ON
INTERNATIONAL TAX REFORM
DECEMBER 1987
PREFACE BY THE MINISTER OF FINANCE
Introduction
In
my Budget of 18 June 1987, I announced that the Government would be introducing
anti-tax haven measures. This move is necessary
to strengthen the tax system and
facilitate further tax reform. The resulting measures are set out in this
consultative document.
Reasons for the Measures
New Zealand residents are subject to tax on their
worldwide income. However, some residents, notably larger companies and wealthy
individuals, are avoiding tax on their foreign income, some of which is income
that is diverted from New Zealand. This places an
unfair tax burden on others
and undermines the integrity of the tax system. The Government is determined to
prevent the erosion of
the income tax base by cross-border transactions which
enable the deferral or complete avoidance of tax properly payable in New
Zealand.
The use of tax havens in particular has become widespread and has been
a drain on government revenue. This concern to protect the
tax base and to
preserve the integrity of the tax system underpins the measures.
Another
objective is to remove artificial incentives for taxpayers to invest offshore.
Offshore investment is generally to be welcomed,
but it should not be subsidised
by ordinary taxpayers. Existing tax provisions are encouraging greater offshore
investment than is
economically and socially desirable. Hence, the measures
attempt to ensure that investment and other decisions are based on commercial
merit rather than tax avoidance.
Evolution of the Measures
An overview of the proposed reforms was sketched
in Annex 4 of the 1987 Budget. It was stated then that the outline of the
proposed
regime was not definitive or complete. There were good reasons for
this.
First, anti-tax haven provisions are among the most complex in international
tax law and are typically subject to continual legislative
and administrative
refinement. The measures outlined in Annex 4 of the Budget have been modified to
better meet the Government's
reform objectives and to ensure that, as far as
possible, the measures themselves will not be vulnerable to
abuse.
Secondly, I indicated in the Budget that the anti-tax haven
measures would be the first step towards a comprehensive tax regime designed
to
combat international tax avoidance. Given the progress which has been made in
developing further aspects of that regime, this
first step will now be larger
than earlier envisaged. Thus, the complexion of the original proposals has been
altered significantly.
Main Elements of the Regime
In brief, the measures will tax New Zealand
residents on income derived from an interest in a non-resident company or trust.
Residents
have been able to divert income and accumulate it in such entities and
thereby avoid or defer New Zealand tax. Income which is already
taxed in New
Zealand as it is derived will not be subject to these measures. The main
elements of the proposed regime, including
changes to the original proposals,
are highlighted below.
Basis of Taxation
Under the original proposals, all taxpayers
required to report income earned through a non-resident company or trust would
have been
subject to New Zealand tax on a 'branch-equivalent' basis. An
alternative basis has now been introduced. Where residents are unable
to obtain
sufficient information to report on a branch-equivalent basis, tax will be
levied on the annual change in value of their
interests. This
'comparative-value' basis is a proxy for taxing the underlying income.
Control
There are now no detailed rules relating to the
control of a company. However, control can affect the amount of information a
taxpayer
can provide about the income of a company and may therefore affect
whether a taxpayer will be able to report income on a branch-equivalent
or a
comparative-value basis.
Nature of Income
The distinction between tainted and non-tainted
income has been eliminated. There are three related reasons for this: first, the
Government
has decided that it wishes to prevent as much tax avoidance and tax
deferral as it reasonably can, not just the worst and most visible
forms;
secondly, the distinction would produce uncertainty, and possibly unintended
consequences, as a result of inevitably arbitrary
definitions; and thirdly,
after further detailed consideration, the Government has decided that such a
distinction, which has no
economic basis, would be extremely difficult, if not
impossible, to enforce adequately.
Sources of Income
The distinction between low-tax and high-tax
countries has been eliminated. The new measures will apply to foreign income
earned through
any non-resident entity. Statutory rates of tax are an unreliable
indicator of the real impact of taxes given the myriad of possible
tax rules and
the degree of enforcement in other countries. This new approach removes the need
to make piecemeal and often inaccurate
distinctions between high-tax and low-tax
countries.
Exemption from Measures
A de minimis rule has been introduced. This rule
will exempt from the measures natural persons with small shareholdings in
non-resident
companies. Such a rule balances the need for reducing the avoidance
and deferral of tax against the need for effective compliance
and
administration.
Inset 2
Trusts
The measures that apply to trusts are essentially
of an anti-avoidance nature. As with companies, there will be no distinction
between
tainted and non-tainted income. The taxation of foreign income earned
through non-resident trusts will be consistent with that of
income earned
through non-resident companies.
Foreign Portfolio Dividends
Resident companies will be subject to tax on
foreign portfolio dividends (dividends from non-resident companies in which the
resident
has less than a 10 percent interest). This treatment is in line with
international norms. Resident individuals will continue to be
subject to tax on
all foreign dividends received. Appropriate double-tax relief will be
provided.
Effective Dates
The scope for tax avoidance during the period of
public consultation, prior to the application of the new tax law, means that the
effective implementation of the measures must necessarily entail an element of
retrospectivity. I announced in the Budget that the
measures to be enacted would
apply from the accounting years of the entities concerned commencing after 18
June 1987. However, given
the changes to the original proposals and the time
required for consultation and to enact legislation, as well as the need for
administrative
preparation, the effective date will be altered. This decision is
necessary in the circumstances. It should not be regarded as a
precedent.
As described in chapter 2, the measures will take effect from
17 December 1987 in respect of distributed income and from 1 April 1988
in
respect of undistributed income.
Role of the Measures in the Government's Tax Reform Programme
In proposing these measures, I would stress that
the purpose is not to increase the total tax burden on the community. It is to
spread
the tax burden more evenly and more fairly. To the extent that the tax
base is broadened and more people pay their fair share of
tax, rates of taxation
can be lowered.
The changes are an integral part of the Government's
continuing programme to improve the efficiency and equity of the tax system.
It
is overwhelmingly clear that the New Zealand tax base must be protected from
international tax avoidance; without a broader base,
further tax reform will be
prejudiced if not precluded. I am confident that the proposed changes to New
Zealand's international tax
regime will provide a solid platform for further tax
reform. In particular, the expected gains from the new international tax regime
have helped make possible the further major reform of the tax and benefit system
which I have recently announced. Reductions in tax
avoidance and lower rates of
tax go hand in hand.
Consultative Process
This is the fourth time the Government has
initiated a consultative process on a major taxation change. With the assistance
of the
business sector and members of the public, the previous consultations
resulted in significant improvements to the reform proposals.
The Government has
appreciated this participation and hopes that it will again be forthcoming in
the current consultative process.
In particular, the Government is grateful to
those who have agreed to serve on the Consultative Committee. It can be expected
to
complete its task in a thorough and professional manner.
The timetable
for implementation is tight. The period allowed for consultation and review
reflects the need to give adequate time
for interested parties to make
submissions and the need for timely decisions in order to
reduce uncertainty. The Government invites public consideration of the
proposals and welcomes comment on ways that may improve the
implementation,
operation and administration of the new measures.
Conclusion
The proposals outlined in this consultative
document provide the basis for a substantial strengthening of New Zealand's
international
tax provisions. The need for such upgrading is overdue. The
measures will reduce the problem of tax avoidance by residents diverting
New
Zealand income, and earning tax-favoured returns, through the use of offshore
entities. Resources will flow to areas where they
will generate the highest
return for the nation as a whole. There will be a greater compatibility between
private and national interests
in investment decisions. Such reform will
therefore contribute directly to creating a fairer and more prosperous
society.
I believe that the development of a sound and secure domestic
tax base is a prerequisite to further significant domestic tax reform.
I commend
a close scrutiny of this consultative document to those affected by the
measures, as well as to those interested in the
further reform of New Zealand's
tax system.
Roger Douglas
Minister of Finance
TABLE OF CONTENTS
PREFACE i
TABLE OF CONTENTS vii
CHAPTER 1 – INTRODUCTION
1.1 Purpose of the Consultative Document
1
1.2 Reasons for the Measures
1
1.3 Consultative
Committee 2
1.4 Terms of Reference
2
1.5 Submissions 3
1.6 Outline of the Document 4
1.7 Meaning of Terms Used 5
CHAPTER 2 – SUMMARY
2.1 Income Subject to the Measures
6
2.2
Branch-Equivalent Basis 7
2.3 Comparative-Value Basis
7
2.4 Distributions from
Non-Resident Companies and Trusts 8
2.5 Effective Dates 9
2.6 Disclosure and Administration
10
CHAPTER 3 – OBJECTIVES OF
THE REFORM MEASURES
3.1
Introduction 11
3.2 The Issues at a
Glance 11
3.3 Deficiencies in
Existing Law 12
3.4 Objectives
of Reform 13
3.5 Context of Reform
15
3.6 Impact of the Measures
17
3.7 Conclusion 19
CHAPTER 4 – INCOME SUBJECT TO THE
REFORM PROPOSALS
4.1 Scope of
Reform 20
4.2
Non-Resident Companies 21
4.3 Non-Resident Trusts 25
4.4 Bases for Reporting Income
27
CHAPTER 5 – REPORTING
INCOME ON A BRANCH-EQUIVALENT BASIS
5.1 Overview 28
5.2 Non-Resident Companies
29
5.3 Non-Resident Trusts
33
5.4 Election to Report Income
on Branch-Equivalent Basis 35
5.5 Changing from Branch-Equivalent to
Comparative-Value Basis 36
APPENDIX 5.1 Schematic Outline of Income
Attribution Rules 38
APPENDIX 5.2
Example of Attribution Rules in Operation 39
CHAPTER 6 – REPORTING INCOME ON A
COMPARATIVE-VALUE BASIS
6.1
Non-Resident Companies 40
6.2 Non-Resident Trusts 55
6.3 Beneficial Interests in
Discretionary Non-Resident Trusts 59
6.4 Changing from Comparative-Value to
Branch-Equivalent Basis 59
CHAPTER
7 – THE TAXATION OF DISTRIBUTIONS
7.1 Introduction 60
7.2 Foreign Dividends 60
7.3 Assessable Distributions
from Trusts 61
7.4 Relief for
Branch-Equivalent Taxes 62
7.5
Foreign Tax Credits 63
7.6 Disguised Distributions
64
CHAPTER 8 – DISCLOSURE
AND ADMINISTRATION
8.1
Introduction 65
8.2 Disclosure
65
8.3 Administration
67
GLOSSARY OF TERMS
68
CHAPTER 1 – INTRODUCTION
1.1 Purpose of the Consultative Document
The
Minister of Finance, the Hon R O Douglas, announced in the Budget of 18 June
1987 that the Government would introduce measures
to broaden the New Zealand tax
base and to limit international tax avoidance.
The purpose of this
consultative document is to set out the details of the structure and operation
of the proposed new measures so
that interested parties have an opportunity to
consider them and to submit their views and suggestions before final decisions
are
made.
The document focuses on the taxation of income earned by New
Zealand residents through offshore entities. The taxation of income earned
in
New Zealand by non-residents is not addressed.
1.2 Reasons for the Measures
The measures are
part of a major upgrading of New Zealand's international tax regime. They
reinforce the Government's drive to create
a fairer and more efficient tax
system. They seek to ensure that all residents of New Zealand pay their proper
share of tax.
Moreover, the measures will make possible other desirable
reforms. In particular, they will facilitate a reduction in income tax rates.
They will also stimulate efficient investment in New Zealand. In this way, the
measures will contribute to a better use of resources
and have a positive
influence on savings, investment and the creation of more productive and
permanent jobs for New Zealanders.
In summary, the measures are designed
to:
1.3 Consultative Committee
The
Government invites the public to make submissions on the matters set out in this
document. A Consultative Committee has been appointed
to receive and consider
submissions and to advise the Government on implementation.
The Committee
comprises:
Mr Arthur Valabh (Chairman), a tax partner and partner in charge of Deloitte, Haskins and Sells, Auckland;
Dr Robin Congreve, a tax consultant with Russell, McVeagh, McKenzie, Bartleet and Company, Auckland;
Mr Stuart Hutchinson, a tax partner with Simpson Grierson Butler White, Auckland;
Dr Susan Lojkine, a tax partner with McLeod Lojkine Associates, Auckland;
Professor John Prebble, a Wellington tax barrister and Dean of the Law Faculty at the Victoria University of Wellington; and
Mr Tim Robinson, an economist with Jarden and Company Limited,
Wellington.
1.4 Terms of Reference
The Committee's
terms of reference are:
having regard to the Government's firm objective of eliminating the avoidance
and deferral of New Zealand tax on foreign income as
a means of broadening the
tax base and facilitating a reduction in income tax rates;
The Committee is to report to the Minister of
Finance by 31 March 1988.
1.5 Submissions
Submissions
should contain a brief summary of their main points and recommendations. They
should be typed in double space and be lodged
by 12 February 1988 with:
The Chairman
Consultative Committee on
Full Imputation and International Tax Reform
c/– The Treasury
PO Box 3724
WELLINGTON
Submissions received by the due date will be
acknowledged.
1.6 Outline of the Document
This Consultative
Document comprises eight chapters, as follows:
Chapter 1: This introductory chapter describes briefly the purpose of the document and the reasons for the proposed reforms. Members of the Consultative Committee, its terms of reference and submission procedures are detailed.
Chapter 2: This chapter summarises the main elements of the measures set out in this document for the reform of New Zealand's international tax provisions.
Chapter 3: This chapter discusses the importance of preventing international tax avoidance and strengthening international tax provisions. Existing problems and the consequences are highlighted. The objectives of tax reform, which have guided the measures proposed in this document, are presented.
Chapter 4: This chapter outlines the scope of the proposed measures. It indicates that taxpayers resident in New Zealand must include in their assessable income foreign income earned through non-resident companies or trusts on either a branch-equivalent or a comparative-value basis.
Chapter 5: This chapter discusses the branch-equivalent basis for the taxation of income subject to the measures. The determination of assessable income and how it will be attributed to resident taxpayers are described.
Chapter 6: This chapter discusses the comparative-value basis for the taxation of income subject to the measures. The annual change in value of a taxpayer's interest in a non-resident entity will be taxed as a proxy for tax on the underlying income.
Chapter 7: This chapter addresses the taxation of dividends from non-resident companies and distributions from non-resident trusts. Provisions for double-tax relief are described.
Chapter 8: This final chapter discusses disclosure and administrative
issues.
1.7 Meaning of Terms Used
A glossary of the
technical terms used is provided at the end of this document.
CHAPTER 2 – SUMMARY
2.1 Income Subject to the Measures
The
reforms described in this consultative document apply to foreign income derived
by residents of New Zealand from interests in
non-resident companies and
trusts.
An interest in a non-resident company will be defined in terms of
a resident's expected return of dividends from a non-resident company,
and will
also include such interests held indirectly through one or more non-resident
entities. A taxpayer's percentage interest
in the income of a non-resident
company will be the greater of the taxpayer's percentage entitlement to, or
entitlement to acquire
rights to, dividends or voting rights in relation to
distributions or changes to the company's constitutional rules.
A
taxpayer's percentage interest in the income of a non-resident trust is the
market value of the property contributed by the taxpayer
to the trust, directly
or indirectly, as a percentage of the market value of the net assets of the
trust. A New Zealand taxpayer
will be required to include in assessable income
his or her percentage interest in the income of a non-resident company or
trust.
Individuals who have interests in non-resident companies, where
those interests have a total market value of not more than $10,000
at all times
in a year, will not be subject to tax under this regime. Similarly exempt will
be individuals who have contributed property
with a market value of less than
$500 to non-resident trusts.
The amount of foreign income derived by a
resident of New Zealand from an interest in a non-resident company or trust will
be determined
on either a branch-equivalent basis or a comparative-value
basis.
Any losses from interests in non-resident companies may be used to offset
branch-equivalent or comparative-value income in respect
of interests in other
non-resident companies in the current year or may be carried forward to offset
such income in future years.
Any loss from an interest in a non-resident trust
may only be carried forward to offset future income from that trust. Losses may
not be used to offset other assessable income.
2.2 Branch-Equivalent Basis
The
branch-equivalent basis for reporting income may be used if the taxpayer has
sufficient information about the income of the non-resident
entity and elects to
adopt this basis.
New Zealand residents who elect to report income on a
branch-equivalent basis will include in assessable income their percentage
interest
in the income of any non-resident company or trust in which they have a
direct or indirect interest. For this purpose, the income
of a non-resident
company or trust must be computed in accordance with New Zealand tax law. In
addition, dividends received by a
non-resident company from another non-resident
company whose income is reported on a comparative-value basis must also be
included
in the recipient company's income. Distributions of income received by
a resident may be deducted, subject to certain limitations,
in calculating
branch-equivalent income. A taxpayer's percentage interest in the income of a
non-resident trust will not include
any amount which has become indefeasibly
vested in a beneficiary.
New Zealand residents who include in assessable
income for any year their percentage interest in the income of a non-resident
company
or trust computed on a branch-equivalent basis will be entitled to a
credit for their percentage interest in the foreign taxes paid
by the
non-resident company or trust in that year.
2.3 Comparative-Value Basis
Under
the comparative-value basis, a New Zealand taxpayer must include in his or her
assessable income each year any change in the
market value of a direct or
indirect interest in a non-resident company or trust. The market value
of
Inset 3
an interest in a non-resident company must be determined by reference to the
trading price of the interest if the price is available
and reliable. If not,
the market value must be determined in accordance with appropriate valuation
methods based on shareholders'
funds or net (after-tax) earnings. In certain
circumstances, taxpayers will be required to compute the change in value of an
interest
by reference to an imputed rate of return of five percent in excess of
the rate on five-year Government stock.
Where the proceeds of disposition
or the market value of an interest in a non-resident company exceed the last
reported value of the
interest by more than 30 percent and the interest has not
been valued by reference to trading prices, a post facto adjustment will
be made
to the taxpayer's tax liability for the preceding years to recoup any
tax-deferral benefits resulting from the undervaluation,
unless the taxpayer can
demonstrate that earlier market values were accurate.
The market value of
an interest in a non-resident trust will be the portion of the market value of
the net assets of the trust represented
by the settlor's percentage interest in
the trust. If, however, the market value of the assets of the trust cannot be
determined,
the imputed return method must be used to value the
interest.
2.4 Distributions from Non-Resident Companies and Trusts
Foreign
portfolio dividends received by resident companies (ie dividends from a
non-resident company in which a resident has less
than 10 percent of the paid-up
share capital) will be included in assessable income. A credit will be allowed
for any foreign withholding
taxes. Other dividends received by resident
companies from non-resident companies will continue to be exempt from company
tax. However,
recipient companies will be required to collect a withholding
payment on behalf of their shareholders. The withholding payment will
be
creditable to their resident shareholders (and refundable to
tax-exempt and non-resident shareholders) when dividends are paid by the
resident company. Similarly, any New Zealand tax paid by
resident companies
under the branch-equivalent basis will be creditable to resident shareholders
under the imputation scheme outlined
in the accompanying consultative
document.
Dividends received by individuals resident in New Zealand will
remain assessable, with a credit allowed for any foreign withholding
tax.
Distributions received by resident beneficiaries from non-resident
trusts will be included in assessable income except to the extent
that the
distribution is made out of the corpus of the trust. A credit will be allowed
for any foreign withholding taxes on the distributions.
2.5 Effective Dates
The various
aspects of the reform proposals set out in this consultative document will come
into effect as follows:
– for taxpayers electing to use the branch-equivalent basis, from 1 April 1988. Where a non-resident entity's accounting year straddles 1 April 1988, only the proportion of its income for the year attributable to the period after 1 April 1988 will be subject to tax under these measures;
– for taxpayers using the comparative-value basis, from 1 April 1988. Such taxpayers will be required to establish the market value on 1 April 1988 of their interest in non-resident companies and trusts. Thus, only increases and decreases in market value occurring after 1 April 1988 will be taken into account under these measures;
– for portfolio dividends received from non-resident companies, such dividends declared after the time of the Minister of Finance's statement on 17 December 1987. A dividend will be deemed to be received when it is declared by the payer company; and
– for distributions by non-resident trusts to resident beneficiaries, such distributions that become indefeasibly vested in a resident beneficiary after the time of the Minister of Finance's statement on 17 December 1987.
2.6 Disclosure and Administration
Taxpayers will
be required to disclose their interests in non-resident companies and trusts and
to provide all information necessary
to compute foreign income in accordance
with these measures. Taxpayers with interests in non-resident companies or
trusts will be
required to file a separate schedule for each such company or
trust with their annual return. Schedules will deal with the calculation
of the
income from such interests. Penalties will apply for failure to disclose the
necessary information.
A special unit of the Inland Revenue Department
will be established to ensure the efficient and fair administration of the
measures
proposed in this document.
CHAPTER 3 – OBJECTIVES OF THE REFORM MEASURES
3.1 Introduction
The
purpose of this chapter is to briefly outline the deficiencies in New Zealand's
existing international tax provisions and their
consequences; the objectives for
the reform of those provisions; why the reform proposals set out in this
consultative document have
been adopted and why they are more comprehensive than
those proposed in the June 1987 Budget; and to address issues relating to the
likely impact of the reforms.
3.2 The Issues at a Glance
The taxation of
income earned by residents through offshore entities is manifestly in need of
reform. New Zealand's existing international
tax provisions are unable to
counter the deferral or outright avoidance of New Zealand tax. The following
observations sum up the
problems.
There is blatant erosion of the tax
base. Many large companies and wealthy individuals resident in New Zealand
are avoiding and deferring New Zealand tax through a variety
of offshore
transactions. Such practices have become easy and routine.
The cost to
New Zealand of tax abuse is high and growing. As the level of deferral and
avoidance has become more widespread and the techniques more sophisticated, the
New Zealand tax base
has been seriously eroded. Such erosion amounts annually to
hundreds of millions of dollars in forgone tax revenue - which must be
raised
from other sources.
Offshore investment is taxed more favourably than
domestic investment. The exploitation of opportunities to defer or avoid New
Zealand tax has resulted in investment being directed offshore rather than
to
more productive uses in New Zealand. Tax considerations are driving investment
decisions. Consequently, the best use is not being
made of New Zealand's scarce
resources.
The cost is pervasive and ultimately borne by other New Zealanders.
The fiscal and economic cost of the deferral and avoidance of New Zealand tax
reduces the economic and social well-being of the nation.
In this sense, the tax
system imposes a greater burden on the community than is necessary. The impact
is adverse for jobs, growth
and living standards.
International tax
avoidance is unfair. The ability of some taxpayers to defer or avoid New
Zealand tax undermines perceptions about fairness and puts at risk the voluntary
compliance of taxpayers on which the integrity of the tax system
rests.
Desirable domestic reform is obstructed. A tax system that
is vulnerable to international tax deferral and avoidance reduces the prospects
for domestic tax reform. In particular,
lower and more uniform rates of income
tax are possible only if all taxpayers bear their fair share of tax.
3.3 Deficiencies in Existing Law
The
fundamental deficiency in the tax system, which is at the heart of the issues
identified above, is the lack of neutrality. In
principle, residents are subject
to New Zealand tax on their income derived from all sources - that is, their
worldwide income. In
practice, however, foreign income derived by residents is
often not subject to New Zealand tax. Whether it is depends on whether
the
income is realised directly or realised indirectly through the use of interposed
entities such as companies or trusts, and on
whether it is earned in a country
that levies high or low income taxes.
For example, residents of New
Zealand may conduct business outside New Zealand through branches or separately
incorporated subsidiaries.
Branches are not considered to be separate entities
and income derived by a foreign branch is included in the resident taxpayer's
assessable income as it is realised by the branch. However, because a company is
considered to be a legal and taxable entity separate
from its shareholders,
income derived by a non-resident company does not constitute income of the New
Zealand shareholders until
they receive dividends. Thus, New Zealand resident
individuals and companies can
defer New Zealand tax on foreign income simply by earning such income through
a non-resident company. Moreover, resident companies
may avoid New Zealand tax
entirely because the dividends they receive from non-resident companies are
exempt.
If the foreign taxes are lower than those in New Zealand,
taxpayers can enjoy tax deferral advantages by realising income through
a
non-resident company or trust instead of directly. The income will not be taxed
in New Zealand until repatriated and will not be
taxed even then in the case of
dividends received by a resident company.
The deferral or avoidance of
New Zealand tax on foreign income earned through non-resident companies and
trusts is unacceptable. It
constitutes an incentive for foreign investment by
New Zealand residents in countries with tax rates lower than those of New
Zealand.
It encourages the diversion of New Zealand income to non-resident
companies and trusts. It benefits mainly large companies and wealthy
individuals. More generally, it undermines the integrity of the tax system by
permitting the New Zealand tax base to be easily eroded.
3.4 Objectives of Reform
The two major
objectives guiding the Government's reform of the tax system are efficiency and
equity. The best way to improve the
efficiency and equity of New Zealand's tax
system is to broaden the tax base and lower income tax rates. A comprehensive
base with
lower and more uniform rates will encourage investment decisions to be
based on commercial rather than tax considerations. It will
remove artificial
incentives for taxpayers to invest offshore. Lower rates will serve to encourage
all types of investment, business
and income-earning activity. Lower tax rates
are possible only if the tax base is broadened and avoidance is curtailed.
New Zealand's international tax regime should generally reflect the same
principles of efficiency and equity embodied in the domestic
tax system. In
particular, the taxation of foreign income should reinforce the taxation of
domestic-source income and prevent the
erosion of the domestic tax base by
international tax avoidance. Reform of New Zealand's international tax regime
therefore requires
measures which will ensure that all New Zealand residents are
subject to tax on their worldwide income as it is earned.
More
particularly, the objectives of the reform proposals contained in this
consultative document are to ensure, as far as possible,
that:
3.5 Context of Reform
The thrust of the
reform proposals in this consultative document is the elimination of the
avoidance and deferral of New Zealand tax
on all foreign income derived by
residents of New Zealand through non-resident companies and trusts.
Consequently, these reforms
differ in some important respects from those
originally proposed.
The proposals outlined in the 18 June 1987 Budget
were essentially anti-avoidance rules. They were directed primarily at the use
of
trusts and companies established in tax havens to earn passive investment
income and limited types of business income. They applied
only to non-resident
companies controlled by, and trusts settled by, residents of New
Zealand.
The proposals were modelled on anti-tax haven measures currently
in effect in several capital-exporting countries. Such measures may
be effective
in limiting the use of tax haven companies and trusts to defer and avoid
domestic tax, but they are narrow in scope,
arbitrary and complex. They deal
only with the worst forms of tax avoidance. They do not deal with the
fundamental problem of the
deferral of domestic tax on foreign income earned
through non-resident companies and trusts.
The Government has decided a
broadening of the tax base with respect to foreign income is required to permit
cuts in the rates of
income tax applicable to both individuals and companies.
Accordingly, the task is to eliminate the avoidance and deferral of New
Zealand
tax on foreign income earned by residents of New Zealand through non-resident
companies or trusts. Where a New Zealand resident
has an interest in a
non-resident company and can provide sufficient information about the company,
the resident's share of the foreign
income will be taxed as if it were derived
from a foreign branch. Where the resident is unable to provide sufficient
information,
New Zealand tax will be levied annually on the change in value of
the interest. A similar approach will be adopted with respect to
non-resident
trusts to which New
Zealand residents contribute property. Further, there will be several
consequential changes to the tax treatment of dividends received
by New Zealand
residents from non-resident companies and distributions received by New Zealand
resident beneficiaries from non-resident
trusts.
This approach has
several advantages over the more limited anti-avoidance approach adopted by some
countries. For example, under the
measures proposed in this document it will be
unnecessary to determine when a non-resident company is controlled by New
Zealand residents;
to distinguish between tainted and other income; or to
determine whether a non-resident company is resident in a tax haven.
The
new approach will significantly limit opportunities for international tax
avoidance and protect the domestic tax base. Since the
foreign income of
non-resident companies will be subject to New Zealand tax currently, there will
be little reason for New Zealand
residents to divert income (whether in the form
of transfer pricing, fees for services, royalties or interest) from New Zealand
to
a non-resident company.
Under the reform proposals, if a New Zealand
resident has an interest in a non-resident company or trust, in many cases that
interest
will be treated, in effect, as if it were a foreign branch. Since the
tax treatment of foreign branches is relatively straightforward,
the reform
proposals are simple in concept and should not involve undue legislative
complexity. The alternative basis for taxing
foreign income, the
comparative-value basis, will require such interests to be valued each
year.
The Government recognises that no other country has to date
eliminated the deferral of domestic tax on foreign income earned through
non-resident companies and trusts as completely as these measures propose.
Nevertheless, they are fully justifiable as part of the
Government's broad tax
reform initiatives to expand the tax base and lower income tax rates.
3.6 Impact of the Measures
In developing the
proposed reforms, the Government has considered their effect on new investment,
on New Zealand firms operating offshore,
on foreign countries, and on the
existing investment of residents.
3.6.1 New Investment
The key impact of the proposed measures on new
investment will be to remove artificial incentives for taxpayers to invest in
low-tax
jurisdictions, and to restore incentives for investment to flow to areas
where it will provide the greatest returns for the nation
as a whole. This is
consistent with directing New Zealand's resources to their most profitable
uses.
At present, however, some offshore investment by residents has a
lower pre-tax return than alternative investment in New Zealand.
Such investment
is made because it has a higher post-tax return as a result of the avoidance or
deferral of New Zealand tax. This
is clearly an undesirable effect of the
current law which the proposed measures will remedy. A likely consequence is
more productive
investment by New Zealand residents, both domestically and
offshore, and a relative increase in domestic investment by residents.
3.6.2 New Zealand Business Offshore
It is sometimes contended that New Zealand
businesses offshore should not be required to pay as much tax as they would in
New Zealand
to enable them to compete more readily in foreign markets. This
contention carries little weight. A resident taxpayer should not
pay less New
Zealand tax simply as a result of investing offshore in a particular legal form
(ie a non-resident company or trust).
The implicit subsidy in the
existing tax system for foreign investment in countries with tax rates lower
than those of New Zealand
is inefficient and inequitable. The proposed reforms
will eliminate this aspect of our tax system.
Much offshore investment is not primarily tax-motivated. New Zealand
companies are attracted to invest offshore for such reasons as
proximity to
markets, availability of natural resources, access to particular goods and
services, and the like. The proposed measures
will have little impact on these
investments where they yield high pre-tax returns. The measures will, however,
adversely affect
offshore investments that have been made primarily for tax
reasons.
3.6.3 Other Countries
Some countries may be adversely affected by New
Zealand's moves to counter the avoidance and deferral of domestic tax by its
residents.
For example, if a foreign country provides significant corporate tax
concessions in order to attract investment, those concessions
may be less
effective in eliciting investment from New Zealand as a result of the proposed
reforms. Where foreign taxes are very
low, reductions in the foreign tax of a
company owned by New Zealand residents will simply be replaced by the domestic
tax payable
on such income according to the rules proposed in this
document.
However, there will be some benefits for foreign countries
arising from New Zealand's tax reforms. For example, the lowering of the
New
Zealand company tax rate will mean that the return which non-residents can
obtain from investment in New Zealand will increase.
The anti-avoidance measures
will also make it more difficult for non-residents to enter into tax avoidance
arrangements via New Zealand
to exploit the tax systems of their own or other
foreign countries.
3.6.4 Existing Investment
The effective date of the reform proposals for
undistributed income is 1 April 1988, which provides taxpayers with a reasonable
opportunity
to reorganise their affairs if necessary. Although there may be
costs for some investors who have entered into arrangements which
cannot be
altered, the Government has decided that no special relief can be justified. All
tax policy changes
create winners and losers, as do economic policy changes in general. New
Zealand is currently undergoing a period of substantial and
necessary economic
adjustment. The long-term benefits of economic reform will be shared by all New
Zealanders.
3.7 Conclusion
Significant reform
of New Zealand's international tax provisions is urgently required. Such reform
is a key element in the Government's
overall programme of tax reform. In
particular, the ability of the tax system to afford lower rates of income tax
depends in large
measure on a comprehensive tax base, and international tax
reform is essential to ensure that all New Zealand residents pay tax on
their
worldwide income.
The measures proposed in this consultative document
will strengthen New Zealand's international tax regime against widespread tax
avoidance techniques and arrest the erosion of the domestic tax base. At the
same time, the new measures will reduce the bias in
the tax system in favour of
foreign investment by New Zealand residents. The nature of the problems involved
suggests, however, that
results will not be achieved through any single set of
initiatives. Rather, results will depend on a continuing reform of tax
provisions
on a broad front. The overriding concern must be to ensure that New
Zealand's tax system adjusts as necessary, so that the nation
secures the
maximum benefit possible from international investment and income flows. The
measures proposed in this document are compatible
with this longer-term
direction.
Inset 4
CHAPTER 4 – INCOME SUBJECT TO THE REFORM MEASURES
4.1 Scope of Reform
The
purpose of these reforms is to tax New Zealand residents on income as it accrues
to their benefit through their direct interest
in a non-resident company or
trust and through their interest held indirectly through that non-resident
entity in other non-resident
entities. Two requirements must therefore be met
before income will be subject to the rules:
Once these requirements have been met, a New Zealand
resident will be required to include in assessable income his or her percentage
interest in the income of the non-resident company or trust. Whether a person is
a New Zealand resident for the purposes of these
measures will be determined
according to the normal tax residence provisions in section 241 of the Income
Tax Act. However, there
will be one special rule. An individual who has been
resident in New Zealand for a cumulative period of less than 24 months in the
immediately preceding 15 years will not be a resident for the purposes of these
measures. Thus, individuals who work in New Zealand
on a temporary basis will
not be taxed on their interest in non-resident companies or trusts.
The
new regime will apply only to income earned through non-resident companies or
trusts. These are separate taxable entities under
New Zealand law and may be
used to avoid or defer New Zealand tax. Income derived by New Zealand
residents through foreign branches or partnerships, which are not separate
taxable entities under New Zealand tax law, will not be
affected since such
income is already subject to current taxation in New Zealand. Income derived
directly by New Zealand residents
from foreign property, whether tangible (such
as land) or intangible (such as debt instruments), is also excluded since it is
already
subject to taxation in New Zealand as it is earned.
This chapter
elaborates on the types of non-resident entities that will be subject to the
rules. It deals first with companies and
then with trusts.
4.2 Non-Resident Companies
The
forthcoming legislation will apply to income earned through the following
"non-resident companies":
The existing residence rules in the Income Tax Act will
apply to determine the residence of companies. For the guidance of taxpayers,
a
list of common non-resident entities that will be treated as companies for the
purpose of this legislation will be issued by the
Commissioner of Inland
Revenue.
4.2.1 Percentage Interest in a Non-Resident Company
This regime will require the measurement of a
New Zealand resident's true economic stake in a non-resident company. This is
best measured
by the ability of a resident to extract income from the company.
As proposed in the consultative document on full imputation, the
definition of
dividends for
income tax purposes is to be widened to include all types of distributions,
with the exception of certain returns of paid-up share
capital. Thus, a New
Zealand resident's interest in a non-resident company will be defined in terms
of his or her expected return
of dividends from the company. It is clearly not
feasible to give the Commissioner of Inland Revenue a discretion to decide what
is a resident's ability to extract dividends from a non-resident company on a
case by case basis. The rule should ideally be clear
and objective so that
taxpayers know in advance the tax consequences of investing in non-resident
companies. Furthermore, it is not
sufficient to define an interest in a
non-resident company only in terms of current rights, or future entitlements, to
dividends.
In order to prevent avoidance, it is also necessary to measure a
resident's current and future entitlement to voting rights in relation
to the
distribution policy of the non-resident company.
Therefore, a taxpayer's
"percentage interest" in a non-resident company will be defined as the greatest
of:
A taxpayer's percentage interest will be determined at
the end of the non-resident company's accounting year.
An interest in a non-resident company will include an interest held
indirectly through interests in other non-resident companies or
trusts. A
taxpayer's percentage interest in a lower-tier non-resident company will be
determined by multiplying the taxpayer's interest
in the first-tier non-resident
company by that company's percentage interest in the lower-tier company. This
determination must be
made for all levels in a chain of ownership of
non-resident companies (see sections 5.2.1 and 5.2.2 and Appendices 5.1 and 5.2
for
further details).
Many capital structures are designed to take
advantage of tax provisions. It is not unreasonable to expect that these
structures will
be altered to reflect the new tax provisions. However, the
adoption of the rule outlined above may cause difficulties for some taxpayers
who currently hold certain classes of shares in non-resident companies. A period
of adjustment will therefore be provided before
the regime comes into effect. In
this period, taxpayers may wish to reconsider their interests in companies with
complicated capital
structures or, if they control the non-resident company, to
adjust the way in which they invest in the company so that they obtain
the
desired level of risk, return and control, taking into account the definition of
"percentage interest" in this regime.
The following are examples of
instruments to which the rights taken into account in determining a taxpayer's
percentage interest in
a non-resident company may attach:
Convertible debt in a non-resident company is debt
which converts automatically, or at the option of the holder or issuer of the
debt,
into equity in the company. Convertible debt instruments have the
characteristics of both equity and debt. Any change in the market
value of
convertible debt reflects changes in market yields on debt and changes in the
market value of the potential equity rights
represented by the instrument. The
debt portion of such instruments is currently taxable under the provisions of
section 64B to 64M
of the Income Tax Act. The forthcoming legislation will
ensure that a taxpayer is not taxed twice on income derived from convertible
debt instruments.
Where a nominee of a resident holds an interest in a
non-resident company, the interest shall be deemed to be held by the resident.
The existing definitions of "nominee" in the Income Tax Act will be reviewed to
ensure that they are satisfactory for the purposes
of this regime.
4.2.2 De Minimis Rule
Where the market value of an individual's
aggregate direct interests in non-resident companies, at all times in the
individual's income
year, does not exceed $10,000, the individual will be exempt
from reporting his or her income from those non-resident companies under
the
branch-equivalent or comparative-value basis. Market value will be determined
according to the valuation rules set out in section
6.1.2.
4.3 Non-Resident Trusts
The
measures will also apply to non-resident trusts. To eliminate any possible
ambiguity in the present law, a trust will be deemed
to be resident in New
Zealand for tax purposes if any trustee of the trust is resident in New Zealand
at the end of the accounting
year of the trust. The existing residence rules in
section 241 of the Income Tax Act will apply to determine the residence of a
trustee.
A non-resident trust will thus be a trust that does not have any
trustee resident in New Zealand at the end of the accounting year
of the trust.
The measures will apply to inter vivos and testamentary trusts, irrespective of
whether they are specified or non-specified
trusts pursuant to the Income Tax
Act.
4.3.1 Interest in a Non-Resident Trust
Non-resident trusts may be used to avoid New
Zealand tax where the non-resident trustee or trustees accumulate trustee income
and
it is not also derived by New Zealand resident beneficiaries entitled, or
deemed to be entitled, in possession to the receipt of
it (this is the
definition of beneficiaries' income in section 227 of the Income Tax Act). In
many cases it will not be possible
to ascertain, at the end of a trust's
accounting year, whether there are any resident beneficiaries, or, if there are,
their respective
shares of the trust income. Consequently, it is often not
feasible to tax resident beneficiaries on their share of the trust income
of
non-resident trusts.
In order to achieve the objectives of these reform measures with regard to
non-resident trusts, any person resident in New Zealand
(referred to as a
"resident settlor") who has contributed property by way of gift, including a
transfer of property for inadequate
consideration, to a non-resident trust will
be considered to have an interest in the non-resident trust until such time
as:
The value of a contribution to a non-resident trust will be
the difference between the market value of the property transferred to
the trust
and the market value of any consideration given by the trust. Special rules will
be necessary in relation to any financial
assistance given to non-resident
trusts, whether given directly or indirectly, and whether by means of a loan,
guarantee, the provision
of security or otherwise. The definition of a "resident
settlor" will include residents who make indirect contributions to non-resident
trusts through resident or non-resident interposed entities such as trusts,
companies or financial institutions, or through non-resident
individuals. A
resident will also be considered to have an interest in any non-resident trust
to which a non-resident trust or a
non-resident company in which the taxpayer
has an interest contributes property. This determination must be made for all
levels of
entities in a chain of ownership irrespective of whether the income of
the higher-tier entity is being reported on a branch-equivalent
or
comparative-value basis. A resident settlor with an interest in a non-resident
trust will also be deemed to have an interest in
any non-resident company in
which that trust has an interest.
4.3.2 Percentage Interest in a Non-Resident Trust
The rules for determining a resident settlor's
percentage interest in a non-resident trust are set out in section 5.3.2.
4.3.3 De Minimis Rule
An individual will be exempt from the proposed
resident settlor rules if the market value of all contributions made by him or
her
to non-resident trusts at any time is less than $500. For this purpose, the
market value of each contribution must be determined
at the time of the
contribution.
4.3.4 Beneficiaries
New Zealand-resident beneficiaries of
non-resident trusts must include in their assessable income trust income
distributed to them
or which becomes vested indefeasibly in them in accordance
with the rules set out in section 7.3.1.
New Zealand residents who
purchase a beneficial interest in a discretionary non-resident trust will be
taxed on such an interest on
the comparative-value basis (see section
6.3).
4.4 Bases for Reporting Income
Once it is
determined that a New Zealand resident has an interest in a non-resident company
or trust, then the amount of the entity's
income that has accrued to the benefit
of the New Zealand resident must be calculated in accordance with the
"branch-equivalent"
basis or the "comparative-value" basis.
The next two
chapters explain in more detail the branch-equivalent and the comparative-value
bases of determining income to which
the reform measures outlined in this
document apply.
CHAPTER 5 – REPORTING INCOME ON A BRANCH-EQUIVALENT BASIS
5.1 Overview
New
Zealand residents who elect to have the income they derive through a
non-resident company or trust taxed on a branch-equivalent
basis will be taxed
on their percentage interest in the entity at the end of the entity's accounting
year multiplied by the income
of the entity. The branch-equivalent basis
operates in almost the same manner as the present treatment of foreign branches.
It commences
with a calculation of the non-resident entity's income as measured
by New Zealand tax rules. The New Zealand resident's percentage
interest in such
income is then included in the resident's assessable income. A non-resident
company's losses attributed to a New
Zealand taxpayer may be offset only against
the taxpayer's branch-equivalent or comparative-value income from other
non-resident
companies. Losses attributable to a settlor's interest in a
non-resident trust must be carried forward to be offset against future
income
from the settlor's interest in that trust.
The tax liability resulting
from the taxation of branch-equivalent basis income is reduced by the taxpayer's
percentage interest in
foreign taxes paid by the non-resident entity deriving
the income. Where distributions to New Zealand residents from the non-resident
entity are taxable in New Zealand, relief for previous New Zealand taxes paid is
provided by permitting such distributions to be
deducted from branch-equivalent
income to the extent of the branch-equivalent income reported in the year of
distribution. The New
Zealand tax liability will be reduced by any foreign
withholding taxes levied on the distributed income. Branch-equivalent income
will be reported in New Zealand dollars using a close-of-trading spot exchange
rate on the last day of the relevant accounting year
of the non-resident
entity.
5.2 Non-Resident Companies
5.2.1 Measurement of Branch-Equivalent Basis Income
New
Zealand taxpayers reporting income from a non-resident company on a
branch-equivalent basis will include in assessable income
their percentage in
the company's income at the end of the company's accounting year. This applies
to non-resident companies in which
a New Zealand taxpayer has a direct or an
indirect interest. The income of each such company will be calculated according
to New
Zealand tax rules with one exception. Where dividends are paid by a
non-resident company whose income is being reported by the taxpayer
on a
comparative-value basis to another non-resident company, they shall be included
in the assessable income of the recipient company.
It is necessary to include
the latter dividends in the net income of the recipient company because their
payment will reduce the
market value of the taxpayer's interest in the
dividend-paying company (for an illustration of this point, see Appendix 5.2
where
the income of Company E is reported on a comparative-value
basis).
When computing his or her share of branch-equivalent income, a
taxpayer may deduct dividends received (gross of foreign withholding
taxes) from
the non-resident company. Such dividends are deductible against the income of
the non-resident company in the accounting
year in which they are paid, to the
extent of the branch-equivalent income earned in that year. This ensures that
income from which
dividends are paid is not subject to New Zealand tax twice.
Should the deduction of dividends result in a branch-equivalent loss
being
computed, such a loss may be offset against branch-equivalent or
comparative-value income earned through other non-resident
companies, whether in
a current or future income year of a taxpayer.
5.2.2 Calculating a Taxpayer's Percentage Interest in the Income of a Non-Resident Company
The portion of a non-resident company's income
included in the income of a resident New Zealand taxpayer will be the amount of
such
income multiplied by the taxpayer's percentage interest in the non-resident
company at the end of company's accounting year (see
section 4.2.1 for a
description of how to calculate a percentage interest in a company). Similarly,
where a taxpayer elects to report
on a branch-equivalent basis the income of a
non-resident company in which he or she has an indirect interest, the portion of
that
company's income to be included in the taxpayer's income is the company's
income multiplied by the taxpayer's percentage interest
in the company. In this
situation, the taxpayer's percentage interest will be determined by multiplying
the taxpayer's percentage
interest in the first-tier non-resident company by
that company's percentage interest in the lower-tier non-resident entity, and
so
on.
There is an exception to the income allocation rules, however, where
a taxpayer can establish that 100 percent of the income of a
non-resident
company is included in the income of New Zealand taxpayers. (It should be noted
that tax-exempt entities are not taxpayers.)
The purpose of this exception is to
prevent more than 100 percent of the branch-equivalent basis income of a
non-resident company
being taxed where there is no prospect of avoidance or
deferral. It is possible for more than 100 percent of the income of a
non-resident
company to be taxable under these rules because the determination
of a taxpayer's percentage interest is based on the greatest of
the taxpayer's
entitlement, or entitlement to acquire, rights to dividends and voting rights in
relation to distributions and changes
to the company's constitutional rules. To
qualify for the exception, any one New Zealand resident with an interest in the
non-resident
company must provide the Inland Revenue Department (IRD) with the
following information: the branch-equivalent basis income of the
non-resident
company, the names and IRD tax numbers of all of the resident taxpayers with
interests in the company, and the allocation
of
100 percent of the branch-equivalent income. If this exception applies, the
resident shareholders may allocate the branch-equivalent
income among themselves
on any reasonable basis.
Taxpayers who acquire an interest in a
non-resident company during the company's accounting year will be required to
include in their
assessable income their percentage interest in the pro-rata
portion of the company's income attributable to the period after acquisition.
Taxpayers who dispose of their interests during the company's accounting year
will be required to include in their assessable income
the pro-rata portion of
the company's income attributable to the period before disposition. If the
taxpayer lacks sufficient information
to pro-rate the company's income in this
way, tax will be levied on a comparative-value basis for the part-year from the
beginning
of the company's accounting year to the time of disposition. The
valuation rules set out in chapter 6 will be used to determine the
comparative-value income to be taxed.
A New Zealand resident's share of
the income of a non-resident company for a particular year will be included in
the resident's assessable
income for his or her income year in which the
non-resident company's accounting year ends. For example, if a company has a
balance
date of 30 September and a New Zealand resident a balance date of 31
March, the New Zealand resident will report his or her share
of the non-resident
company's income for the year ended 30 September on his or her return for the
year ended 31 March of the following
year.
A non-resident company's
losses attributed to a New Zealand taxpayer may be used to offset the taxpayer's
branch-equivalent or comparative-value
income from other non-resident companies.
Where the taxpayer is a company within a group of companies (as defined in
section 191
of the Income Tax Act), these losses may be transferred to other
companies in the group for offset against comparative-value or branch-equivalent
income.
5.2.3 Credit for Foreign Taxes
A taxpayer's tax liability arising from income
reported on a branch-equivalent basis will be reduced by his or her percentage
interest
in the foreign taxes paid by the non-resident company deriving the
income. A taxpayer's percentage interest in foreign taxes paid
by a non-resident
company will be the foreign taxes paid by the company multiplied by the
taxpayer's percentage interest in the company.
This calculation is subject to
the exception described in section 5.2.2 where 100 percent of the income of a
non-resident company
is included in the income of New Zealand taxpayers. If a
taxpayer's percentage interest in the branch-equivalent income of a non-resident
company is reduced pursuant to that exception, then the taxpayer's percentage
interest of the foreign taxes paid by the company must
be reduced
correspondingly.
The conditions and limitations that apply to foreign tax
credits in Part VIII of the Income Tax Act will be amended to ensure that
they
are appropriate for these measures. Foreign tax credits will be limited to the
amount of New Zealand tax payable on the income
of each non-resident entity.
Foreign tax credits will also be limited to the amount of New Zealand tax which
would have been payable
on the income sourced in each jurisdiction. Carry-back
and carry-forward for foreign taxes that cannot be used in the current year
will
be allowed to the extent permitted under current law to deal with timing
differences between foreign and New Zealand tax law.
Foreign taxes which will
qualify for the foreign tax credit regime are income and company taxes which are
of substantially the same
nature as New Zealand income tax whether levied by the
federal, state or provincial government in any foreign jurisdiction on the
income of the non-resident entity. A credit will also be permitted for New
Zealand taxes paid by a non-resident company on New Zealand-source
income.
Foreign withholding taxes levied on distributed income will also be
creditable.
Taxes paid by non-resident companies in which a New Zealand
resident has an indirect interest will also be creditable. The same formula
used
to determine a taxpayer's percentage interest in an entity's income will be used
to calculate the taxpayer's percentage interest
in the foreign taxes paid by the
entity.
The operation of the rules for calculating a taxpayer's entitlement to
foreign taxes paid by non-resident companies is illustrated
in Appendix
5.2.
5.3 Non-Resident Trusts
As
explained in section 4.3, a resident settlor will be assessed on income
attributable to his or her interest in a non-resident trust.
The
branch-equivalent reporting system applies to settlors with interests in
non-resident trusts in much the same manner as it applies
to resident
shareholders with interests in non-resident companies.
5.3.1 Measurement of Branch-Equivalent Basis Income
On the branch-equivalent basis, the income of a
non-resident trust must be measured in accordance with New Zealand tax rules, in
the
same way as the income of a non-resident company (see section 5.2.1). Where,
however, a non-resident trust receives dividends from
a non-resident company
whose income is reported on a branch-equivalent basis by the resident settlor of
the trust, such dividends
will be excluded from the trust's income. Where a
non-resident trust receives dividends from a non-resident company whose income
is reported on a comparative-value basis by the resident settlor of the trust,
the dividends will be included in the trust's income
in accordance with New
Zealand law.
Trustee income of a non-resident trust will be defined as
the net assessable income of the trust, computed in accordance with New
Zealand
tax law as modified above, less distributions to the extent of the
branch-equivalent income reported in the year of distribution,
and less amounts
that have vested indefeasibly in beneficiaries (except beneficiaries which are
non-resident trusts and companies).
Under current law, trustee income excludes
only income that is also derived by a beneficiary entitled, or deemed to be
entitled, in possession to the receipt thereof. That definition will be
amended in relation to non-resident trusts to make it clear
that income in which
a beneficiary has an indefeasibly vested interest will be deducted from the net
assessable trustee income, whether
or not the beneficiary is entitled to enforce
immediate payment of the income. Whether trustee income vests indefeasibly in a
beneficiary
will be determined in accordance with New Zealand law. For example,
if, under foreign law, income is deemed to vest in the registrar
of trusts or
some other government official until it is distributed by trustees, the income
will nevertheless be considered trustee
income for New Zealand income tax
purposes.
5.3.2 Calculating a Taxpayer's Percentage Interest in the Income of a Non-Resident Trust
Resident settlors will include in their
assessable income the portion of the trustee income of a non-resident trust
equal to the trustee
income multiplied by their percentage interest in the
trust. The percentage interest of a resident settlor in a non-resident trust
will be calculated as the percentage that the market value of the property
contributed to the trust by the settlor, determined at
the time of the
contribution, is of the market value of the trust's net assets, also determined
at the time of the settlor's contribution.
Once the interest is established, it
will remain constant until another contribution is made to the trust. Thus, for
example, if
A and B each contribute $100 to a trust each will have a 50 percent
interest in the trust. If the trust assets double in value from
$200 to $400, at
which time C contributes $400 to the trust, A and B will each have a 25 percent
interest in the trust while C will
have a 50 percent interest in the trust. The
recalculation of settlors' respective interests in a trust will be made only at
the
end of a trust's accounting year and will apply to attribute income to
settlors for the next trust accounting year.
Where a non-resident trust
in which a New Zealand taxpayer has an interest contributes property to another
non-resident trust, the
taxpayer's percentage interest in the second trust will
be determined by multiplying his or her
percentage interest in the first trust by that trust's percentage interest in
the other non-resident trust, and so on. Resident settlors
will be taxed on
their share of the income of each non-resident trust separately from their other
New Zealand income. This is consistent
with the way trustee income is taxed in
the hands of New Zealand resident trustees.
Trust losses attributable to
a settlor's interest in a non-resident trust must be carried forward to be
offset against future income
from the settlor's interest in that trust. Since
beneficiaries will never have an interest in trust losses, the entire amount of
a loss will, in effect, be treated as a trustee loss. Without a carry-forward
rule, the attribution system would be open to abuse,
since trustees could ensure
that beneficiaries had indefeasibly vested interests in any trust income while
passing losses on to the
settlor for tax purposes.
5.3.3 Credit for Foreign and New Zealand Taxes
If a non-resident trustee provides a resident
settlor with information about foreign taxes paid on trustee income (or New
Zealand
taxes on New Zealand-source income), the settlor will be entitled to
claim a tax credit equal to the taxes paid on trustee income
multiplied by the
settlor's percentage interest in the trust. The calculation and attribution of
tax credits available to resident
settlors who report income attributed to their
interests in non-resident trusts on a branch-equivalent basis is made by
reference
to the same rules applicable to shareholders in non-resident companies
who report income on a branch-equivalent basis.
5.4 Election to Report on Branch-Equivalent Basis
Taxpayers who
qualify to report income from a non-resident entity on a branch-equivalent basis
must file an election with the IRD
office to which they send their annual tax
returns. A copy will be sent by IRD to the special IRD tax unit. A separate
election must
be made in respect of each
non-resident entity which the taxpayer wishes to report on a
branch-equivalent basis. Thus, the taxpayer may choose to report the
income of
one non-resident entity on a branch-equivalent basis and another on a
comparative-value basis.
The taxpayer will be required to inform the
Commissioner of Inland Revenue of the accounting year used by the non-resident
entity.
Any subsequent change in the entity's balance date must be communicated
to the Commissioner and approved by him as a basis for continuing
to use the
branch-equivalent method. If the Commissioner does not give his consent, the
taxpayer will be required to report income
from the entity using the
comparative-value basis. The mechanics of changing the basis of reporting income
are described in section
5.5.
Elections to use the branch-equivalent
basis reporting system filed before 1 April 1988 will be effective from 1 April
1988. Elections
filed after 1 April 1988 will be effective from the first
accounting year of the non-resident entity commencing after the date on
which
the election is filed.
Branch-equivalent taxpayers must be able to
provide the Commissioner with information similar to that which taxpayers
reporting on
an actual branch basis are required to provide. The Inland Revenue
Department will make available details of the information required
for filing
and auditing purposes. A special requirement for taxpayers reporting income on a
branch-equivalent basis will be that
they must be able to provide the
Commissioner, on request, with a copy of the financial accounts of the
non-resident company or trust
and a copy of its foreign tax returns. Any
information in a foreign language must be accompanied by an English translation
(see the
discussion of the disclosure requirements in chapter 8).
5.5 Changing from Branch-Equivalent to Comparative-Value Basis
Taxpayers may
change the basis of reporting income from a non-resident entity if they notify
the Commissioner of Inland Revenue at
least one month before the beginning of
the next accounting year of the entity. The change in the
basis of reporting will become effective from the beginning of the next
accounting year of the entity.
A taxpayer changing from branch-equivalent
to comparative-value reporting will be required to compute the value of his or
her interest
in the entity on the date the change becomes effective (referred to
as the "effective date"). The value of an interest will be computed
on this date
in accordance with the rules set out in chapter 6.
The value of the
interest computed on the effective date will be deemed as the opening value of
the interest at the beginning of the
taxpayer's income year. This value will be
compared with the value of the interest at the end of the taxpayer's income year
for the
purposes of computing income using the comparative-value basis. The
taxpayer will be required to report income from the entity for
the accounting
year up to the effective date on a branch-equivalent basis.
Where a
taxpayer has elected to report income on a branch-equivalent basis and it is not
possible for whatever reason to compute branch-equivalent
income up to the
effective date, income from the beginning to the end of the entity's accounting
year must be calculated using an
imputed return method. For the purposes of
applying an imputed return method, the value of the interest on the first day of
the non-resident
entity's accounting year will be computed as the market value
of the taxpayer's interest on the last day of the entity's accounting
year
discounted by the annual imputed return rate on a straight-line basis. This rule
will apply where taxpayers cannot compute branch-equivalent
income in any
accounting year of a non-resident company and where they have not given prior
notice of their intention to compute
income on a comparative-value basis.
APPENDIX 5.1
SCHEMATIC OUTLINE
OF THE INCOME ATTRIBUTION ROLES
APPENDIX 5.2
EXAMPLE OF
ATTRIBUTION RULES IN OPERATION
Resident Non-Resident
Companies
Company
|
Income (1)
|
Foreign
Taxes |
NZCo's
Interest (2) |
Attributed to NZCo
|
|
---|---|---|---|---|---|
Income (3)
|
Tax Credit (4)
|
||||
|
($)
|
($)
|
(%)
|
($)
|
($)
|
A
|
300
|
50
|
80
|
240
|
40
|
B
|
−400
|
NIL
|
56
|
−224 (5)
|
NIL
|
C
|
500 (6)
|
100
|
34
|
170
|
34
|
D
|
600
|
200
|
17
|
102
|
31 (7)
|
E
|
700 (8)
|
150
|
13
|
91
|
N/A (9)
|
F
|
N/A (10)
|
N/A
|
N/A
|
N/A
|
N/A
|
(Figures rounded; amounts in New Zealand dollars)
Notes
CHAPTER 6 – REPORTING INCOME ON A COMPARATIVE-VALUE BASIS
6.1 Non-Resident Companies
6.1.1 Overview
Under
the comparative-value basis, a taxpayers includes in his or her income for a
year any change in the market value of an interest
in a non-resident company.
The change in value will be calculated by comparing the market value of the
taxpayer's interest in a company
at the end of the taxpayer's income year and
the value of that interest at the beginning of the year. Where market values
cannot
be determined by reference to the traded price of an interest, the market
value of a taxpayer's interest in a non-resident company
will be determined at
the end of the company's accounting year.
Subject to provisions to
prevent avoidance, where an interest in a non-resident company is acquired
during a year, the amount included
in assessable income will be the difference
between the cost of the interest and its market value at the end of the year.
Similarly,
where an interest is disposed of during a year, the amount included
in assessable income will be the difference between the market
value at the
beginning of the year and the proceeds of disposition.
In general,
taxpayers will be required to value interests in non-resident companies by
reference to the traded prices of the interests,
if such prices are available
and provide a reliable indication of market value. Otherwise, taxpayers will be
required to compute
the market value of their interests in accordance with
appropriate valuation techniques. Where the traded price of an interest is
unavailable or unreliable and the compliance costs of establishing market values
by any other methods are excessive, the taxpayer
may use an imputed rate of return method of valuation to determine the value
of the interest. Where the Commissioner of Inland Revenue
is not satisfied that
the values reported by a taxpayer accurately reflect market values, he may use
the imputed-return method to
determine the market value of the taxpayer's
interest.
Where the market value of an interest has not been determined
by reference to the traded price of the interest, and the market value
of an
interest at the end of a taxpayer's income year or the proceeds of disposition
exceed the last-reported value by more than
30 percent, a post facto adjustment
will be made to recoup any tax-deferral benefits which the taxpayer has enjoyed,
unless the taxpayer
is able to demonstrate the accuracy of the previously
reported market value.
The method for computing foreign income under the
comparative-value basis is summarised in the following formula:
Y = (E + S) − (B + P)
where:
Y = annual accrued gain or loss in respect of an interest in a non-resident company.
E = market value of the interest at the end of the taxpayer's income year.
S = proceeds from the disposition of all or part of the interest in the non-resident company during the taxpayer's income year.
B = market value of the interest at the beginning of the taxpayer's income year (this will be the market value of the interest at the end of the immediately preceding year).
P = the cost of any interest acquired by the taxpayer in the non-resident company during the income year.
All amounts must be calculated in New Zealand dollars in accordance with the
rules for converting foreign currency denominated values
contained in section
6.1.2.
The annual accrued gain or loss from interests in non-resident
companies must be calculated separately for each non-resident company
in which a
taxpayer has an interest. Any losses so calculated may be used to offset
branch-equivalent or comparative-value income
in respect of interests in other
non-resident companies in the current year or may be carried forward to offset
such income in future
years. Such losses may not be used to offset a taxpayer's
other assessable income. However, where the taxpayer is a company within
a group
of companies (as defined in section 191 of the Income Tax Act), these losses may
be transferred to other companies in the
group for offset against
branch-equivalent or comparative-value income.
6.1.2 Market Value of an Interest in a Non-Resident Company
The market value of an interest in a
non-resident company is the highest price obtainable for the interest in a
transaction between
non-associated persons who are under no compulsion to buy or
sell and who have full knowledge of all the relevant facts.
Methods that
may be used to determine the market value of an interest in a non-resident
company are outlined below.
a Valuation by Reference to Traded Price
The best indication of the market value of an
interest in a non-resident company will be the observable traded price of the
interest.
Where an interest is traded on a public exchange, its market value
will be determined by reference to the reported traded price of
the interest
computed on the following basis:
– where buy and sell offers are recorded on the exchange for the five working days prior to the end of the taxpayer's income year (referred to as the taxpayer's balance date), market value is the average of the close-of-trading prices recorded during that period;
– where for any day within the five day period no transactions in the interest are recorded, the market value shall be the mid-point of the close-of-trading buy and sell offers reported; and
– where neither buy nor sell offers are recorded during the last five trading days prior to the taxpayer's balance date, market value is the average of the mid-point of buy and sell offers reported in the most recent three days of the 30 working days immediately preceding the taxpayer's balance date.
Interests in unit trusts that are not traded but are
redeemable at call or upon notice by the unit holder at prices set by the trust
fund managers may be valued by reference to the most recently quoted redemption
price in the 30 days immediately preceding a taxpayer's
balance date. The
redemption price may be a daily, weekly, or monthly price quoted in accordance
with procedures adopted by the managers
of the unit trust.
The market
value of an interest in a non-resident company determined on the basis of its
traded price or redemption price must be
computed in New Zealand dollars using
the close-of-trading spot exchange rate on the balance date of the taxpayer.
Taxpayers will
be required to disclose the name of the public exchange and the
dates of the traded prices used to establish the market value of
their interest
(disclosure requirements are discussed further in Chapter 8).
b Other Valuation Methods
Where traded prices are not available, or do not
provide a reliable indication of the market value of a taxpayer's interest in a
non-resident
company, the market value of the interest must be determined in
accordance with other valuation methods provided that they conform
to
commercially acceptable valuation methods.
Under these valuation methods, the market value of an interest in a
non-resident company will reflect:
Other
valuation methods or variants of the above methods may be employed provided that
they conform with commercially acceptable valuation
methods.
Where
interests in a non-resident company are not traded on a public exchange, but
that company's assets can be valued by reference
to traded prices, the market
value of an interest in the first company should be determined by reference to
the traded prices of
its assets.
If the market value of an interest can
be determined by reference to traded prices, it will be valued at the end of the
taxpayer's
income year. If the market value of an interest is determined on some
basis other than the traded price of the interest, it will
be computed at the
end of the non-resident company's accounting year. The market value of the
interest at the end of the taxpayer's
income year will be considered to be the
value computed on the last day of the non-resident company's previous accounting
year. However,
if the last day of the non-resident company's accounting year is
before 1 April 1988, taxpayers will be required to value their interest
as at 1
April 1988.
The market value of an interest in a non-resident company determined at the
end of the company's accounting year must be converted
to New Zealand dollars
using the close-of-trading spot exchange rate on the last day of the company's
accounting year.
c Valuation by Reference to an Imputed Return
Where the traded price of an interest is
unavailable or unreliable and the compliance costs of establishing market values
by any other
methods are excessive, the taxpayer may compute the value of the
interest at the end of an income year by an imputed return method.
This will be
based on a rate of return equal to a yield of 5 percent above the yield on
five-year New Zealand Government stock. The
annual imputed rate applicable to
this method will be published each year by the Inland Revenue
Department.
A taxpayer will compute the value of an end-of-year interest
on an imputed-return basis by multiplying the opening value of the interest
by
the appropriate imputed rate and adding the result to the opening value. The
same calculation is done for interests acquired during
the taxpayer's income
year except that the imputed return is pro-rated to reflect the portion of the
taxpayer's income year during
which the asset is owned.
When a taxpayer
uses the imputed return method for calculating comparative-value income, he or
she may deduct from the value of the
interest at the end of the income year any
dividend received from the non-resident company during the income year. This
provision
for dividends paid is only necessary where an end-of-year value is
determined using the imputed-return method. The market value of
an interest
computed on any other basis will reflect any dividends paid by a non-resident
company.
Once taxpayers have an end-of-year interest in a non-resident
company computed on an imputed-return basis they will not be able to
alter the
basis upon which the interest can be valued for a further period of four income
years. This
provision is necessary so that taxpayers cannot choose the method of
valuation each year depending on whether income computed by reference
to the
actual market value of the interest or the imputed-return method results in
lower assessable income.
At the end of a five-year period, if the
taxpayer wishes to continue to use the imputed return method, he or she will be
required
to compute the market value of his or her interest on the basis of the
rules set out in section 6.1.2(a) or (b) above. When a taxpayer
changes at the
end of a five-year period from the imputed-return method to any other method of
valuing an interest, the market value
of the interest at the beginning of the
year must be equal to its market value under the imputed-return method at the
end of the
previous income year. Where a taxpayer changes from another method of
valuation to an imputed-return method, the imputed-return method
will be applied
to the market value of the interest at the beginning of the taxpayer's income
year. In the case of valuations which
are not based on traded prices, the value
of an interest at the beginning of a taxpayer's income year is deemed to be the
market
value at the end of the last accounting year of the non-resident company.
The imputed return will be pro-rated to reflect the portion
of the taxpayer's
income year represented by the period between the end of the non-resident
company's accounting year and the taxpayer's
balance date.
d Market Value of an Interest on the Date of Commencement of these Rules
The date of the implementation of these rules is
1 April 1988. The market value of an interest in a non-resident company at the
beginning
of the first income year this regime applies will be the market value
of the interest on that date. This ensures that only accrued
gains and losses
derived after 1 April 1988 will be included in the assessable income of a
taxpayer.
6.1.3 Proceeds of Disposition of an Interest in a Non-Resident Company
When a taxpayer disposes of an interest in a
non-resident company, the taxpayer must include in his or her assessable income
the difference
between the market value of the interest at the beginning of the
year and the proceeds of disposition. The determination of the time
of
disposition of an interest is dealt with in section 6.1.6.
A special rule
is necessary where a taxpayer has valued his or her interest at the end of a
non-resident company's accounting year
pursuant to the rules set out in section
6.1.2(b) and the interest is disposed of after the end of the non-resident
company's accounting
year. The amount included in the taxpayer's income will be
the difference between the proceeds of disposition and the deemed market
value
of the interest at the beginning of the taxpayer's income year.
a Arm's-Length Dispositions
Proceeds of disposition will be defined to
include all amounts received or receivable in consideration for the interest.
Proceeds
will be valued in New Zealand dollars using the close-of-trading spot
exchange rate applicable on the date of disposition of the
interest.
b Dispositions Not at Market Value
A taxpayer who disposes of an interest in a
non-resident company by way of testamentary or inter vivos gift, or for less
than its
market value, will be deemed to have received proceeds of disposition
equal to the market value of the interest at the time of the
disposition. As a
result of this deemed disposition at market value, the taxpayer will be required
to include in assessable income
any change in the market value of the interest
from the last time it was valued for the purposes of these rules.
6.1.4 Acquisition of an Interest in a Non-Resident Company
When a taxpayer acquires an interest in a
non-resident company, the market value of the interest is added to the market
value of the
taxpayer's interest in that company, if any, at the beginning of
the income year for purposes of computing his or her annual accrued
gain or loss
pursuant to the formula set out in section 6.1.1 above. An interest acquired
during a taxpayer's income year may be
taken into account in this manner
provided it is acquired on or before the actual date when the value of the
interest at the end
of the taxpayer's income year is determined.
For
example, if the market value of the taxpayer's interest at the end of the year
is determined by reference to the traded price
of the interest, any interests
acquired during the taxpayer's income year will be taken into account (the value
of an interest computed
by reference to traded prices being determined at the
end of the taxpayer's income year). This includes interests acquired during
an
income year when the taxpayer switches from a method of valuation based on the
accounting year of the non-resident company to
a method based on the traded
price of the interest. If the market value is determined at the end of the
non-resident company's accounting
year, only those interests acquired by the
taxpayer prior to the end of the non-resident company's accounting year (on
which date
the interest is valued) may be taken into account. Interests acquired
after the end of the non-resident company's accounting year
will be taken into
account in determining the value of the interest in the taxpayer's next income
year.
a Arm's Length Acquisitions
The market value of an interest acquired by a
taxpayer in an arm's length transaction will be the cost of the interest to the
taxpayer.
b Acquisitions Not at Market Value
Taxpayers who acquire an interest in a
non-resident company by way of
testamentary or inter vivos gift or for more than market value, will be
deemed to have acquired the interest at a cost equal to its
market value at the
time of the acquisition.
This provision will ensure that the value of a
gift is not subject to income tax under these rules. However, any subsequent
increase
in the market value of the interest will be taxable. This deeming
provision complements a similar provision described in section
6.1.3(b) which
deems the donor of an interest in a non-resident company to have disposed of the
interest for its market value at
the time of the gift.
The rules for
computing the market value of interests in non-resident companies acquired by
gift or for excessive consideration will
be identical to those set out in
section 6.1.2. The determination of the time of acquisition of an interest is
dealt with in section
6.1.6.
The cost of acquisitions in a non-resident
company will also be defined to include disguised acquisitions. For example,
property transferred
to, or services performed for a company directly or
indirectly by a taxpayer or an associated person of the taxpayer will be deemed
to be an acquisition of an interest in the company by the taxpayer. The cost of
the interest acquired would be the difference between
the market value of the
property transferred or service performed and the market value of the
consideration received in respect of
the service or property.
6.1.5 The Post Facto Adjustment
The post facto adjustment is an adjustment to a
taxpayer's tax liability on income computed on a comparative-value basis where
the
annual accrued gain for the preceding year has been significantly
under-estimated. The adjustment is designed to counteract taxpayers
gaining an
advantage from the deferral of New Zealand tax by under-reporting the market
value of an interest. By removing the advantage
of deferral, this adjustment
will also encourage taxpayers to value interests in non-resident companies as
accurately as possible.
A post facto adjustment will be required when the proceeds of disposition of
an interest in a non-resident company or the market value
of the interest at the
end of the taxpayer's income year plus any dividends received exceeds the market
value of the interest at
the end of the immediately-preceding income year by
more than 30 percent. However, such an adjustment will not be required if the
taxpayer has valued his or her interest at the end of the immediately-preceding
income year by reference to traded prices, or can
demonstrate the accuracy of
the previously reported value, or can demonstrate the accuracy of the previously
reported value.
The taxpayer (or the Inland Revenue Department where it
has undertaken a revaluation of a taxpayer's interest) will determine an
adjusted
tax liability in accordance with the following steps:
Step 1: compute the amount which determines whether the post facto adjustment is triggered:
a + b − c − d
where:
a = proceeds of disposition and/or on the market value at the end of the taxpayer's income year; and
b = dividends paid by the non-resident company in the income year in respect of which the post facto adjustment applies and received by the taxpayer or by a non-resident company or trust in respect of which the taxpayer reports income on a branch-equivalent basis;
c = reported market value at the end of the immediately preceding income year; and
d = the cost of an interest acquired by the taxpayer during the income year.
Step 2: if the amount computed in step 1 is greater than 30 percent of the reported market value at the end of the immediately preceding income year, the post facto adjustment must be undertaken. The amount subject to adjustment is that computed in step 1, less an amount equal to 30 percent of the reported market value at the end of the immediately preceding income year. This amount is referred to as the post facto adjustment balance (PFAB).
Step 3: if the taxpayer is a resident individual or a company portfolio investor with less than 10 percent of the paid up capital of the non-resident company, the dividends and gains in the value of the interest are both assessable. A single post facto adjustment calculation will suffice. If, on the other hand, the taxpayer is a resident company which is not a portfolio investor, the dividends are exempt but the company will be required to collect a withholding payment at a rate equal to the personal tax rate. The taxpayer will therefore need to apportion the PFAB between that part attributable to the gain in the value of the interest and that part attributable to dividends. The portion of the PFAB attributable to the gain in the value of the interest is referred to as the income adjustment balance (IAB) and the remainder is referred to as the dividend adjustment balance (DAB). The PFAB will be allocated first to the IAB with any remainder being allocated to the DAB. A separate post facto adjustment will be required for each balance. The adjustment to the IAB will be taxed at the company tax rate. The adjustment to the DAB will be subject to a withholding payment at the personal tax rate.
Step 4: spread the amount subject to the post facto adjustment computed in step 3 evenly across the lesser of:
– the period over which the interest was held subsequent to 1 April 1988; or
– the period since the market value of the interest was last valued by reference to traded prices.
The shortfall will be spread on the basis of each complete month of the relevant period.
Step 5: calculate the increased annual tax liability (or the adjusted withholding payment) for each income year the interest was held during the relevant period described in step 4;
Step 6: determine the total adjusted tax liability or withholding payment amount. This will be the cumulative amount of increased tax or withholding payment recomputed for previous income years calculated on a year-on-year compounding basis using interest rates for each year published by the Inland Revenue Department applicable to tax in dispute. The interest levied to adjust tax payable or withholding payments to current values will not be deductible.
Step 7: where the post facto adjustment applies to the income adjustment balance (the IAB) compute net tax to pay on total assessable income by adding the tax payable on income that has been subject to the post facto adjustment to tax payable on other income (that is, tax on other assessable income excluding the amount subject to the post facto adjustment). Where the post facto adjustment applies to the dividend adjustment balance (DAB), compute the withholding payment due by adding the withholding payment on dividends that have been subject to the post facto adjustment to withholding payments due on other dividends received (that is, payments due on dividends received excluding the dividends subject to the post facto adjustment).
EXAMPLE:
A corporate taxpayer X sells a 20 percent interest in non-resident company Y for $435,000 on 30 September 1990. The reported value of the interest at the end of the taxpayer's previous income year (31 March 1990) was $360,000. During the income year to 31 March 1991, the taxpayer received $73,000 in dividends from company Y. The taxpayer originally purchased the interest in company Y on 1 June 1985.
Step 1: Compute the amount which determines whether the post facto adjustment is triggered:
= proceeds of disposition + dividends received − reported value at end of previous year.
= $435,000 + $73,000 − $360,000
= $148,000
Step 2: Compare the amount computed in step 1 to the reported market value at the end of the previous income year:
= $148,000 = 41%
$360,000
Therefore post facto adjustment is activated.
Compute the amount subject to the post facto adjustment:
= $148,000 minus an amount equal to 30 percent of reported market value at end of previous income year.
= $148,000 – $108,000
= $40,000
In this example, the PFAB (ie $40,000) is less than the gain in the value of the interest in the company, $75,000 (ie $435,000 minus $360,000). Thus, the PFAB is only allocated to the IAB. The DAB is zero. If, on the other hand, the PFAB were $85,000 which exceeded the gain in the value of the interest in the company (viz $75,000), the remainder (ie $10,000) would be allocated to the DAB.
Step 4: Spread the IAB subject to the post facto adjustment across the period the interest was held from 1 April 1988.
Complete Months
|
||
---|---|---|
2 complete income years 1988–89 to 1989–90
|
24
|
|
6 months in 1990-91 income year
|
6
|
|
Total
|
30
|
|
Shortfall per
month = $40,000
30
= $1,333,33
Step 5: Recomputation of tax liability
Year End 31/3
|
Adjusted Annual Income
|
Adjusted Annual
Tax @ 30% (say) |
Annual Tax Int. Rate (say)
|
Adjusted Tax at Start
of year |
Adjusted by Int. Rate
|
Plus Adjusted Tax for Year
|
Equals Year-End Tax Liability
|
---|---|---|---|---|---|---|---|
|
$
|
$
|
%
|
$
|
$
|
$
|
$
|
1989
|
16,000
|
4,800
|
15
|
0
|
0
|
4,800
|
4,800(1)
|
1990
|
16,000
|
4,800
|
13
|
4,800
|
5,424(2)
|
4,800
|
10,224(3)
|
1991
|
8,000
|
2,400
|
10
|
10,224
|
10,724(4)
|
2,400
|
13,124
|
(6 months)
Notes
(1) This figure is the underpaid tax for the 1989 income year.
(2) This is the underpaid tax for 1989 compounded up by the tax in dispute rate for the 1990 income year.
(3) This is equal to $5,424 plus the underpaid tax for the 1990 income year (ie $4,800).
(4) For six months @ 10% p.a.
Figures rounded to nearest dollar
for illustrative purposes.
Step 6: Adjusted Tax Liability on the income adjustment balance (IAB) subject to post facto adjustment = $13,124
6.1.6 Time of Acquisition or Disposition of an Interest in a Non-Resident Company
In general, a taxpayer will be considered to
have acquired an interest in a non-resident company when the taxpayer acquires
legal
title in the interest from the seller. Similarly, a taxpayer will be
considered to have disposed of an interest in a non-resident
company when title
in the interest passes to the purchaser.
6.2 Non-Resident Trusts
6.2.1 Overview
The
comparative-value basis of reporting foreign income will apply to resident
settlors who are deemed to hold an interest in a non-resident
trust pursuant to
the rules set out in section 4.3.1 and who do not qualify for, or choose not to
use, the branch-equivalent basis
(see section 5.3).
The measurement of
the annual accrued gain or loss in an interest in a non-resident trust will be
similar to the measurement of the
annual accrued gain or loss in an interest in
a non-resident company. The annual accrued gain or loss in respect of a
taxpayer's
interest in a non-resident trust is the difference between the market
value of the interest at the end of the taxpayer's income year
and its market
value at the beginning of the income year.
The method for computing annual accrued gains or losses is summarised in the
following formula:
Y = E − (B + P)
where:
Y = annual accrued gain or loss in respect of an interest held by a New Zealand resident settlor in a non-resident trust.
E = market value of a settlor's interest in a non-resident trust at the end of the settlor's income year. This will be deemed to be the market value at the end of the non-resident trust's accounting year.
B = market value of a settlor's interest in a non-resident trust at the beginning of the settlor's income year.
P = market value of contributions to the non-resident trust by the settlor
during the trust's accounting year.
All amounts must be calculated in New
Zealand dollars in accordance with the procedures set out in section
6.2.2(b).
Losses from an interest in a non-resident trust must be carried
forward and will offset only comparative-value or branch-equivalent
income from
the trust in future years.
6.2.2 Valuation of a Settlor's Interest in a Non-Resident Trust
a Market Value of an Interest at the End of a Taxpayer's Income Year
The market value of an
interest in a non-resident trust will be determined at the end of the trust's
accounting year and that amount
will be the market
value of the interest at the end of the taxpayer's income year (the
taxpayer's balance date). The market value of an interest at the
beginning of
any income year will be the market value of the interest reported on the last
day of the taxpayer's immediately preceding
income year.
The market value
of an interest in a non-resident trust will be computed by multiplying the
market value of the net assets of the
trust (being assets of the trust that are
not indefeasibly vested in beneficiaries, less the trust's liabilities) as at
the end of
the trust's accounting year by the settlor's interest in the trust,
determined in accordance with the rules in section 5.3.2. The
market value of an
interest must be reported in New Zealand dollars converted at the
close-of-trading spot exchange rate on the last
day of the non-resident trust's
accounting year.
b Valuing an Interest Using the Imputed Return Method
If a resident settlor has insufficient access to
the financial information of a non-resident trust to compute the market value of
an interest in the trust by reference to the net assets of the trust, the market
value will be the market value of the interest at
the beginning of the settlor's
income year in New Zealand dollars adjusted by an imputed return. As for valuing
interests in non-resident
companies, the imputed rate of return will be equal to
a rate 5 percent above the yield on five-year New Zealand Government stock.
The
annual imputed rate applicable will be the same as that applying to the
valuation of interests in non-resident companies. The
same calculation will be
made for contributions to a non-resident trust during the taxpayer's income year
except that the imputed
return will be pro-rated.
Once the market value
of a settlor's interest in a non-resident trust has been determined on an
imputed-return basis, it must continue
to be valued on that basis for a further
period of four income years. When taxpayers move from the imputed-return method
to the net
assets method of valuing an interest, the market value of their
interest at the beginning of the year must be equal to its market
value under
the imputed-return method. When taxpayers move from the net assets method of
valuation to the imputed return method,
the imputed-return method will be
applied to the market value of the interest at the end of the last accounting
year of the non-resident
trust.
c Market Value of an Interest in a Non-Resident Trust on the Date of Commencement of These Rules
Settlors of non-resident trusts who adopt the
comparative-value method of reporting income will be required to value their
interests
as at 1 April 1988, the date of implementation of the
regime.
Where a taxpayer is unable to compute the market value of an
interest in a non-resident trust by reference to the market value of
the net
assets of the trust, the market value of the interest will be computed as the
market value, at the time of the contribution,
of all property contributed to
the trust to 31 March 1988 adjusted on a year-on-year compounding basis by the
annual interest rate
published for each income year by the Inland Revenue
Department.
6.2.3 Valuation of Property Contributed to a Non-Resident Trust
Property contributed to a non-resident trust by
a resident settlor during an income year must be valued at market value.
Procedures
for valuing gifts and transfers for inadequate consideration will be
the same as those set out in section 6.1.4(b).
Whenever additional
property is contributed to a trust, it will be necessary to recompute the
settlor's interest in the trust pursuant
to the rules set out in section
5.3.2.
Where the value of a settlor's interest at the end of his or her
income year is computed by reference to the net assets of the non-resident
trust, only contributions made prior to the end of the trust's accounting year
(on which date the interest is valued) may be taken
into account. Otherwise,
gifted property contributed during a taxpayer's income year may be taken into
account in determining the
market value of an interest at the beginning and end
of the taxpayer's income year.
6.2.4 Post Facto Adjustment
A post facto adjustment to a settlor's tax
liability for prior income years will be triggered where the market value of a
settlor's
interest in a non-resident trust at the end of any income year exceeds
the reported value of the interest at the end of the immediately
preceding
income year by more than 30 percent. A post facto adjustment may be triggered by
the taxpayer or as a result of a revaluation
of the settlor's interest by the
Inland Revenue Department.
The post facto adjustment will be identical to
that in respect of interest in non-resident companies. The post facto adjustment
is
described in greater detail in section 6.1.5.
6.3 Beneficial Interests in Discretionary Non-Resident Trusts
Taxpayers
who acquire through purchase a beneficial interest in a discretionary
non-resident trust will be taxed on such an interest
on the same basis as any
interest held by resident settlors described in section 6.2. The opening value
of an interest in the non-resident
trust will be the cost of the interest or
market value if this is greater.
6.4 Changing from Comparative-Value to Branch-Equivalent Basis Reporting.
A taxpayer may
only change the basis of reporting income earned through a non-resident company
or trust from the comparative-value
basis to the branch-equivalent basis from
the beginning of a non-resident entity's accounting year. The taxpayer must
notify the
Commissioner of Inland Revenue of the change before the beginning of
the accounting year in respect of which the change is to be
effective. The
Commissioner may require taxpayers to continue to use the comparative-value
basis where their access to the financial
information of the foreign entity is
insufficient to permit branch-equivalent basis reporting.
CHAPTER 7 – THE TAXATION OF DISTRIBUTIONS
7.1 Introduction
To
this point, this consultative document has outlined the treatment of foreign
income earned by residents through non-resident companies
and trusts that will
be taxable on a current basis in New Zealand. This chapter outlines the proposed
treatment of distributed income
in residents' hands, whether in the form of
dividends from non-resident companies or distributions from non-resident
trusts.
7.2 Foreign Dividends
7.2.1 Dividends Received by Companies
All
foreign dividends received by resident companies will continue to be exempt from
tax with the exception of portfolio dividends.
However, companies receiving
non-portfolio dividends will be required to collect a withholding payment on
behalf of shareholders.
Foreign portfolio dividends received by companies
resident in New Zealand after the time of the Minister of Finance's Statement on
17 December 1987 will be included in assessable income. A credit will be allowed
for foreign withholding taxes paid in respect of
such dividends. Portfolio
dividends will be defined as dividends received from a non-resident company in
which the recipient company
owns less than 10 percent of the paid-up share
capital at the time that the dividends are received. A dividend will be deemed
to
be received when it is declared by the payer company.
7.2.2 Dividends Received by Individuals
Foreign dividends received by individuals who
are residents of New Zealand will continue to be included in assessable income.
Foreign
withholding taxes levied on such dividends will continue to be
creditable against a resident's New Zealand tax liability.
7.3 Assessable Distributions from Trusts
It
is necessary to amend existing income tax rules with respect to distributions by
non-resident trusts to beneficiaries who are residents
of New Zealand. These
amendments will make it clear that all distributions will be taxable in the
hands of beneficiaries resident
in New Zealand with the exception of
distributions made from the capital of the trust.
7.3.1 Definition of a Distribution
In order to minimise opportunities for deferral
of New Zealand tax, beneficiaries' income in respect of distributions received
from
non-resident trusts will be defined to include any amount which vests
indefeasibly in a beneficiary, whether or not the beneficiary
is entitled to
enforce immediate payment of the amount. This definition of beneficiaries'
income is consistent with the definition
of trustee income of a non-resident
trust set out in section 5.3.2 which excludes any income that vests indefeasibly
in beneficiaries
of the trust. This definition will be restricted to
distributions from non-resident trusts. However, the extension of the definition
to distributions from resident trusts will be considered in due
course.
Distributions out of the capital of the trust will not be
included in assessable income. For the purpose of these rules, distributions
will be deemed to be made out of trust income unless the beneficiary can show
that it represents distributions of the capital of
the trust.
These rules will apply to distributions received and amounts that vest
indefeasibly in beneficiaries after the time of the Minister
of Finance's
Statement on 17 December 1987.
7.3.2 Non-Resident Trusts That Became Resident Trusts
An opportunity to avoid New Zealand tax on
distributions exists when a non-resident trust with accumulated funds appoints a
resident
trustee, thereby becoming a resident trust. Distributions from the
accumulated funds of the trust to beneficiaries in New Zealand
would not be
subject to New Zealand tax.
Therefore, when a non-resident trust becomes
a resident trust, the resident trustee will be assessable on the market value of
the
trust assets reduced by the value of the capital of the trust, being the
original capital and any subsequent contributions, at historical
cost.
7.4 Relief for Branch-Equivalent Taxes
As noted in
section 5.2.1, relief for New Zealand tax is available for dividends or
distributions paid from income that has been reported
by a taxpayer on a
branch-equivalent basis. This is provided by permitting a deduction for
dividends or distributions to the extent
that branch-equivalent income is earned
in the year of distribution.
There will be no provision for relief from
New Zealand tax for dividends or distributions from income that has been
reported by a
taxpayer on a comparative-value basis. This is because the payment
of such dividends or distributions will reduce the value of a
resident's
interest in the non-resident company, thereby reducing the resident's income
measured on a comparative-value basis.
7.5 Foreign Tax Credit
7.5.1 Dividends from Non-Resident Companies
Tax
credits will be provided for foreign withholding taxes paid on portfolio
dividends received by resident companies and dividends
received by resident
individuals in accordance with the provisions in Part VIII of the Income Tax
Act.
Foreign non-portfolio dividends, while exempt in the hands of
resident companies, will be assessable when distributed to individual
shareholders. Certain foreign withholding taxes on dividends received by a
resident company will be added to the company's imputation
credit account and
thereby flow through to individual shareholders. This is explained in greater
detail in the consultative document
on full imputation.
7.5.2 Distributions from Non-Resident Trusts
Foreign withholding taxes paid on assessable
distributions received by resident beneficiaries from non-resident trusts will
be creditable
against New Zealand tax payable on such
distributions.
Section 293 of the Income Tax Act currently permits a
credit to be claimed against New Zealand tax payable by a beneficiary for
foreign
income taxes and withholding taxes paid in respect of the beneficiaries'
income. This section will be amended to provide a tax credit
for foreign
withholding taxes only.
The credit for foreign withholding taxes paid on
distributions to resident beneficiaries will be subject to conditions and
limitations
similar to those under the provisions of Part VIII of the Income Tax
Act.
Where both exempt and assessable distributions are received, foreign
withholding tax must be apportioned between them on a pro-rata
basis.
7.6 Disguised Distributions
Dividends
from non-resident companies or distributions from non-resident trusts received
by a resident will be broadly defined to
include benefits received directly or
indirectly by the resident. Such benefits must be reported at market
value.
Examples of benefits considered to be distributions or dividends
include those enjoyed pursuant to loans to a resident shareholder
or beneficiary
at non-market interest rates, or property transferred or services performed for
consideration that differs from market
value. The value of the benefit in such
circumstances will be the difference between market value of the arrangement and
the actual
value of any consideration paid or received by the resident
shareholder or beneficiary to or from the non-resident entity.
CHAPTER 8 – DISCLOSURE AND ADMINISTRATION
8.1 Introduction
Taxpayers
will be required to disclose their interests in non-resident companies and
trusts and to provide all information necessary
to compute foreign income in
accordance with these measures. Taxpayers with interests in such entities will
be required to file a
separate schedule for each entity with their annual income
tax return. Penalties will apply for failure to disclose the necessary
information. To assist in the efficient and fair administration of the new
measures, a special unit of the Inland Revenue Department
will be
established.
8.2 Disclosure
Each income year
taxpayers will be required to disclose whether they:
– had an interest, as defined in section 4.2.1 of this document, in a non-resident company;
– had an interest, as defined in section 4.3.1 of this document, in a non-resident trust;
– received a dividend from a non-resident company; and
– received a distribution from a non-resident trust or whether income in such a trust became vested indefeasibly in them.
A separate
schedule for each non-resident company or non-resident trust in which the
taxpayer has an interest must be filed with the
annual income tax return.
Individuals will not be required to complete such schedules where the total
value of all interests in non-resident
companies does not exceed $10,000 at all
times in the income year or where the total value of all contributions to
non-resident trusts
does not exceed $500 at all times in the income year.
The information to be disclosed on the schedule will include:
– the name, address and other basic details of the entity;
– the taxpayer's percentage interest in the entity;
– a return of income computed on either a branch-equivalent or comparative-value basis;
– the computation of New Zealand tax liability on dividends or distributions;
– recomputed tax liability where the post facto adjustment is triggered; and
– any change in the balance date of the entity during the income year.
A taxpayer reporting income on a branch-equivalent
basis will be required to include with the return the annual balance sheet and
profit and loss statement for the non-resident trust or company. In addition,
the taxpayer must have available in New Zealand, for
inspection by Inland
Revenue Department on request, a copy of the entity's financial accounts
(audited if available) and of its tax
return filed with the foreign tax
authorities.
A taxpayer reporting income on the comparative-value basis
must provide sufficient information to support the basis of valuation used
and
the change in value reported. Where relevant, this will include such details as
the name of the exchange on which the interest
is traded, the dates on which
traded prices have been used to value the interest, and the volume of shares
traded.
All information required to be disclosed by taxpayers under these
measures must be in English or be accompanied by an English
translation.
Substantial penalties will apply for non-disclosure or
inadequate disclosure.
8.3 Administration
Taxpayers
will continue to file their income tax returns at IRD district offices. The
processing of disclosure returns will be centralised
in a special unit of the
Department. The unit will be staffed by personnel specialising in the monitoring
of income earned by residents
under this regime.
Such centralisation will
facilitate investigation and the cross-checking of returns and hence their
consistent treatment. Comprehensive
auditing will also be possible.
The
Government will ensure that the necessary resources are committed to enable the
international tax regime to be effectively monitored
and enforced.
GLOSSARY OF TERMS
Accounting
year – the 12-month period ending with the taxpayer's balance
date.
Associated persons – individuals and companies
associated within the meaning of section 8 of the Income Tax
Act.
Branch-equivalent basis – the method for determining a
taxpayer's income from an interest in a non-resident company or trust where the
taxpayer has
sufficient information to calculate the income of the company or
trust in accordance with New Zealand tax rules.
Comparative-value
basis – the method for determining the annual increase or decrease in
the market value of an interest in a non-resident company or
trust.
Dividend Adjustment Balance (DAB) – the amount of
non-portfolio dividends that will be subject to the post facto
adjustment.
Distribution from a non-resident trust – any
amount which vests indefeasibly in a beneficiary.
Imputation Credit
Account – an account to be established by companies to record the
amount of imputation credits available for allocation to
shareholders.
Imputed return method – the determination of
the market value of an interest in a non-resident company or trust assuming that
the value grew at a
rate equal to a prescribed interest rate.
Income
Adjustment Balance (IAB) – that part of the accrued gain in the value
of an interest that will be subject to the post facto adjustment.
Income year – the year ending 31 March. For example, the year
ending 31 March 1988 is referred to as the 1988 income year. Income year
is
defined in section 2 of the Income Tax Act 1976.
Interest in a
non-resident trust – the proportion of the market value of the net
assets of the trust attributable to a resident settlor's
contribution.
Interest in a non-resident company – an
entitlement to, or entitlement to acquire, rights to dividends or voting power
in relation to distributions and changes
to a company's constitutional
rules.
Market value – the highest price obtainable in a
transaction between non-associated persons who are under no compulsion to buy or
sell and
who have knowledge of the relevant facts.
Non-Resident
company – a company this is not subject to tax in New Zealand on its
foreign income.
Non-resident entity – a company or trust
resident outside New Zealand.
Non-resident trust – a trust
which has no trustees resident in New Zealand at the end of its accounting
year.
Proceeds of disposition – all amounts received or
receivable on the disposition of an interest in a non-resident company or
trust.
Portfolio dividends – dividends received by a company
from another company in which the first company owns less than 10 percent of the
paid-up
share capital.
Post facto adjustment – an adjustment
to a taxpayer's tax for previous years during which an interest in a
non-resident company was owned where the
proceeds of disposition of the interest
or its market value significantly exceeded the last reported value of the
interest.
Post Facto Adjustment Balance (PFAB) – the amount of accrued
gain in the value of an interest in a non-resident entity and the amount of
non-portfolio dividends
that will be subject to the post facto adjustment. (The
post facto adjustment balance is the sum of the dividend adjustment balance
and
the income adjustment balance.)
Resident settlor – any
person resident in New Zealand who has contributed property, directly or
indirectly, to a non-resident trust.
Tax avoidance – the
minimisation of tax liability by legal means. The term describes practices which
are contrary to the intent of, and exploit
loopholes in, the tax
law.
Tax base – the base on which tax is levied, which in
New Zealand includes income and expenditure.
Tax deferral –
the practice of delaying the payment of tax without penalty. For example, where
income is taxed as received and not as it
accrues, deferral is possible. A tax
system which allows deferral provides certain taxpayers, in effect, with an
interest-free loan.
Tax haven – a country which imposes
little or no tax, or is otherwise attractive for tax reasons, relative to
another country.
V. R. WARD, GOVERNMENT PRINTER, WELLINGTON, NEW ZEALAND—1987
79967G
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