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Last Updated: 26 April 2020
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INTERNATIONAL TAX REFORM
FULL
IMPUTATION
PART 2
___________
REPORT OF
THE
CONSULTATIVE COMMITTEE
JULY 1988
Consultative Committee on
Full Imputation and International Tax
Reform
PO Box 3724
WELLINGTON
30 June
1988
Hon R O Douglas
Minister of Finance
Parliament
Buildings
Wellington
Dear Mr Douglas
On behalf of the
Consultative Committee on Full Imputation and International Tax Reform, I
enclose the final report of the Committee.
It covers matters which were
outstanding after our first two reports and expands on the details of the
regimes. The report is in
two volumes. The first volume outlines the Committee's
recommendations while the second contains the Committee's draft of the
legislation
covering both the international reforms and imputation.
When
the details of tax reforms are developed, it is inevitable that minor changes
need to be made to previous decisions and this
has proved to be the case here.
There are, however, no fundamental or significant changes. To a large extent,
the recommendations
in the present report merely cover the details necessary to
implement the regimes approved in response to our earlier reports.
As was
the case with our earlier reports, the recommendations in this report represent
the unanimous views of Committee members.
We have been very ably assisted
in the preparation of the draft legislation by Mr Graeme Smaill, Mr John Bassett
and Mr Paul MacKay.
The legislation has not been considered fully by officials
or by parliamentary counsel but we consider that it is sufficiently
well-developed
for wider circulation and comment from interested parties and for
introduction into the House.
The Committee is indebted to officials of the Treasury and Inland Revenue
Department for their assistance. In particular, we thank
Messrs Alex Duncan,
David White, Ken Heaton, Peter Goss, Ross Judge and Mrs Jenny Whyte of the
Treasury and Messrs Anthony Grace,
Michael Rigby, John Moreno and Ms Jane Tait
of the Inland Revenue Department.
Yours sincerely
Arthur Valabh
STATEMENT BY
Minister of Finance, Hon R O
Douglas
Minister of Revenue, Hon T A de Cleene
Introduction
This document is the final report of the
Consultative Committee on Full Imputation and International Tax Reform. It
contains the recommendations
of the Committee on the further detailed measures
required for the operation of the imputation and international tax regimes. The
draft legislation for these regimes is set out in a separate annex to the
Committee's report.
As noted by Mr Valabh in his covering letter, the
report involves a number of changes to the regimes developed by the Committee
and
presented in its first reports but nothing which could be described as
fundamental. These changes reflect the detail required to
implement the regimes
in accordance with the structure and principles already approved.
The Government supports the Committee's recommendations subject to some minor
changes and reservations on definitional matters as
highlighted further below.
An enormous amount of detail has had to be developed in a relatively short space
of time. We concur with
the Committee that the overall regime is now at a
sufficiently advanced stage for the legislation to be circulated. After being
introduced
to the House, the Bill will be referred to a Select Committee. There
will then be a final opportunity for submissions.
Imputation
The Government endorsed the Committee's
recommendations on imputation set out in its earlier report. There were
relatively few issues
that required further work. The Committee now makes
additional recommendations on the rules governing the allocation of imputation
credits, the inclusion of co-operative companies and producer boards within the
imputation regime, the treatment of returns of capital,
the carry forward of
unutilised imputation credits, the operation of the dividend withholding payment
system, and on consequential
changes to the definition of a dividend and to the
excess retention tax and deemed dividend provisions. All these recommendations
are supported subject to the following changes.
First, the Committee
recommends that distributions subject to the winding up distribution tax of 10
percent should not also be subject
to non-resident withholding tax. It had been
envisaged that the winding up distribution tax would be enacted along with the
imputation
and international tax reforms later in the year. The Government
considers that it would instead be preferable to enact this measure
as soon as
possible to facilitate the winding up process. Accordingly, the Government has
decided that the measure will be enacted
through the Taxation Reform (No.4)
Bill.
Secondly, the Committee has recommended that fringe benefits received by a
major shareholder/employee be subject to the FBT regime
rather than the current
deemed dividend provisions, in respect of fringe benefits other than loans with
effect from 1 April 1988,
and in respect of loans with effect from 1 October
1988. The Government agrees with the extension of the FBT regime but has decided
that the change apply to fringe benefits including loans with effect from 1
April 1988. It will give further consideration to the
details of the change to
take account of anti-avoidance rules which are being developed to strengthen the
provisional tax regime.
Consideration also needs to be given to the implications
for companies which wind up before the legislation extending the FBT is
passed.
In its earlier report the Committee recommended that the date for
the first withholding payment by companies, in respect of foreign-source
dividends received after 1 April 1988, be the 20th of the month following the
month in which the necessary legislation is passed.
Given the scheduled
enactment of the legislation later this year, the Government has decided that,
in order to provide greater certainty
for taxpayers, the date for the first
withholding payment will be 20 January 1989.
International Tax
The international tax regime recommended by the
Committee in its first report comprises a branch-equivalent (BE) regime, a
foreign
investment fund (FIF) regime, and a revised trust regime. The regimes
are designed to reduce the myriad opportunities for residents
to avoid or defer
New Zealand tax where they interpose foreign entities between themselves and
income-producing assets.
The legislation has been drafted to ensure that
the three regimes support one another and other recent tax reform. The
provisions
are necessarily detailed and are supported by a number of
anti-avoidance provisions. These should not be read down given the clear
objective of the reforms. The purpose of the BE regime is to tax on a current
basis New Zealand residents having economic or financial
interests, including
contingent interests, in the
income of any foreign company where five or fewer residents in any manner
whatsoever have a 50 percent or more interest in the company.
The purpose of the
FIF regime is also to tax residents on a current basis where they have interests
in, but do not control, foreign
entities in which they are able to accumulate
income and obtain taxation advantages. Such interests include policies with
foreign
life offices and superannuation funds. The revised trust regime supports
the BE and FIF regimes by generally taxing on a current
basis the foreign-source
trustee income of trusts having a New Zealand settlor, and taxing to New Zealand
resident beneficiaries
distributions from non-resident trustees.
We
highlight the following features:
– Aspects of BE Regime
Two important aspects here include the
measurement of interests and an additional transitional measure. The Committee
originally considered
that a resident's control and income interests be measured
on each day of the foreign company's accounting year. After further
consideration,
in light of the high compliance costs of daily measurement, the
Committee now recommends that a resident's control and income interests
be
measured at the end of each quarter in a year and that anti-avoidance measures
be adopted. In our view, this line strikes the
right balance between minimising
compliance costs and countering avoidance.
The Committee recommends that
in respect of existing investments taxpayers should have the option of applying
the BE regime before
the end of the transitional period so that losses during
that period may be accounted for in determining future BE income. In exercising
this option, however, taxpayers cannot bring in losses and not profits.
Accordingly, taxpayers will be entitled to elect, in respect
of all of their
income interests held on 17 December 1987 in all CFCs resident in countries not
on the transitional list, to apply
the BE regime for the accounting years of
such CFCs falling in whole or in part during the period 1 April 1988 to 31 March
1990.
The Government has also decided the composition of, and the nature of the
qualifications to, the permanent and transitional country
lists as discussed
below.
– Grey List
The costs of complying with the BE regime should
not exceed the revenue to be gained. For this reason, taxpayers with interests
in
CFCs resident in certain listed countries will not be subject to the regime.
However, if stated preferences are utilised the BE regime
will apply and income
will be computed on a simplified basis. This list of countries is called a grey
list.
Australia, Canada, France, Japan, the Federal Republic of Germany,
the United Kingdom, and the United States of America will be on
the grey list
(see Attachment A). The relevant considerations in deciding the list included:
the definition of taxable income, the
extent of any tax preferences, the level
of income tax rates, the efficiency of tax administration, and the extent of
protection
of the domestic tax base (including a comprehensive international tax
regime) in each country.
It might be argued in certain circumstances that
a taxpayer with an interest in a CFC in a grey-list country will be treated more
favourably than a taxpayer with a similar interest in a non-listed country.
However, favourable treatment in this context means only
that some taxpayers are
freed from additional income calculations; it does not necessarily mean that
there is any anomaly in terms
of tax liability. Rather than make all taxpayers
calculate their BE income, it is preferable to relieve at least some from
compliance
costs where there is little risk to revenue.
– Qualification of Grey List
The general qualification to the grey list
relates to business income derived by a CFC from outside the listed country in
which it
is resident which is not subject to tax in that country. Other forms of
income such as interest and dividends are also being considered
for
qualification. A general qualification rather
than a qualification by country is favoured at this stage. Should it be
necessary to introduce country qualifications they will have
prospective
effect.
– Transitional List of Low Tax Countries
Under the transition recommended by the
Committee, residents with interests acquired on or before 17 December 1987 in
companies resident
in countries other than low tax jurisdictions will be exempt
from the BE regime until 31 March 1990. The list of low tax jurisdictions
for
this purpose is contained in Attachment B. The list is an updated and more
detailed version of the illustrative list set out
in the Committee's earlier
report.
– Trusts
The Committee has recommended changes to the
trust regime set out in Part 1 of its report but these are of detail rather than
of principle.
The Committee continues to hold to the following
principles:
Transitional provisions apply where a resident settled
a trust on or before 17 December 1987.
In addition, the Government has decided that testamentary or inter vivos
trusts settled by a person who dies a resident of New Zealand,
should also be
subject to New Zealand tax on their foreign-source income where such trusts have
a. resident trustee. Although in
these cases there is no resident settlor in the
year trustee income is derived, the resident trustee provides a sufficient basis
for taxation.
With respect to the recommended taxation of distributions
from trusts, effective from 1 April 1988, the Government has decided to
modify
the treatment recommended by the Committee for foreign trusts (trusts which at
no time since 17 December 1987 have had a settlor
who is a New Zealand
resident). As recommended, distributions from the trustee income of such trusts
derived in income years commencing
after 1 April 1987, other than of corpus and
capital profits, would be assessable to a beneficiary at his or her marginal tax
rate
but other distributions from such trusts would be non-assessable. The
Government has decided that distributions of trustee income
of such trusts
derived in income years commencing on or before 1 April 1987 should also be
assessable to a beneficiary but at a flat
rate of 10 percent. This treatment is
consistent with the transitional provisions recommended by the Committee in
respect of trusts
settled before 17 December 1987 which are either wound up by
31 March 1989 or brought within the new settlor regime for the 1989
income
year.
Under the new trust regime recommended by the Committee, the
existing distinction between specified and non-specified trusts will
be removed
with effect from the income year commencing 1 April 1988 (the distinction was
originally made to limit the scope for income
splitting). Along with this
change, the Committee has recommended a widened definition of beneficiary income
to include income of
a trust which vests in a beneficiary, as well as income
paid to or applied for the benefit of a beneficiary within six months of
the end
of a trustee's income year. The Government wishes to consider further the
definition of beneficiary income.
– Residence Rules
The definitions of residence under the Income
Tax Act will be amended in order to reduce the scope for individuals and
companies to
manipulate their affairs to obtain taxation advantages. The new
definitions, building on existing concepts, make it easier for a
person to
become a resident of New Zealand and harder to become a non-resident, and they
more precisely define residence for companies.
In brief, if a person has
a permanent place of abode in New Zealand or is present here for at least 183
days in any year he or she
is resident, only ceasing to be so if absent for at
least 325 days in any year having during that time no permanent place of abode
here. A company will be resident in New Zealand if it is incorporated here or
has its head office or its centre of director control
or executive management
here. There will be no special rule for banking companies.
– Other Legislative Changes
To support the regime recommended by the
Committee, two other legislative changes are required. These will be made
through the Taxation
Reform (No.4) Bill.
The first change is to the low
income earner rebate. Despite the substantial reduction in the incentives for
income splitting as a
result of the flattening of the income tax scale, the
Government is concerned to reduce them even further. Accordingly, it has decided
to include beneficiary income in income which does not qualify for the low
income earner rebate.
The second change relates to the rate of taxation
of trustee income. The Committee has recommended a complete upgrading of the
taxation
of trusts including the removal of the distinction between specified
and non-specified trusts from 1 April 1988. The uniform treatment
of trustee
income is an integral part of the trust regime and hence of the overall
international regime since the BE, trust, and
FIF regimes are mutually
interlocking.
Accordingly, the trustee income of all trusts will be taxed at a rate of 35
percent or at the marginal composite rate scale for individuals
(whichever is
the higher) in the current year. From the 1989 income year, trustee income will
be taxed at the top marginal rate for
individuals (33 percent in that
year).
This change will mean that some trustee income will be subject to
a higher rate of tax than it would otherwise have been in the current
year. This
move towards a more uniform taxation of trustee income has been foreshadowed
both in terms of the rates as originally
set out in the No.4 Bill and the
Government's acceptance of the Committee's earlier recommendations on the reform
of the taxation
of trusts.
– Earlier Reservations
There were three issues on which Government
expressed reservations in response to the Committee's first report on
international tax
reform:
The Government maintains its reservation in (a)
and will be closely monitoring the FIF regime and strengthening it if necessary.
As
mentioned below, the reservations in (b) and (c) are removed in the light of
changes to the Committee's recommendations on trusts.
The Committee
recommends that where a trust settled on or before 17 December 1987 does not
wind up before 1 April 1988 or the settlor,
trustee or a beneficiary does not
pay a tax of 10 percent on the net assets of the trust at 31 March 1988,
distributions from the
trust would be treated as non-qualifying
distributions. This means that all such distributions (other than of corpus)
would be taxable to beneficiaries at a tax rate of 45
percent. The Government
considers that this measure provides a sufficient incentive for settlors in a
position to do so to wind up
such trusts or subject their foreign-source trustee
income to tax in New Zealand.
Under the non-qualifying distribution
provisions, distributions of capital profits would be taxed to a beneficiary.
Distributions
of capital profits which are not non-qualifying distributions
would be non-assessable. Capital profits would of course, in some cases,
continue to be taxable as trustee or beneficiary income. Capital profits of
trusts that are foreign investment funds would also be
taxable to residents. The
recommended taxation of distributions of capital profits from trusts is broadly
in line with existing treatment.
However, it will need to be reviewed in
considering the introduction of a capital gains tax.
Conclusion
The Government supports the recommendations of
the Consultative Committee subject to some relatively minor changes and
reservations.
The changes, as discussed, relate to:
As discussed, the
only points on which the Government reserves its position at this stage
concern:
The Government
has also decided that in order to provide greater certainty for taxpayers the
date for the first withholding payment
by companies, in respect of
foreign-source dividends received after 1 April 1988, will be 20 January
1989.
In addition to the legislation to implement the measures
recommended by the Committee, two other consequential legislative changes
are
required. One is the addition of beneficiary income to the list of income which
does not qualify for the low income earner rebate.
This is designed to counter
income splitting. The other change required is the rationalisation of the rate
of taxation of trustee
income. This is necessary given the removal of the
distinction between specified and non-specified trusts under the new trust
regime.
These changes together with the distribution winding up tax will be
implemented through the Taxation Reform (No.4) Bill.
The Government has
decided the composition of, and the nature of the qualifications to, the
permanent and transitional country lists
for the purposes of the BE regime. The
lists are set out in Attachments A and B to this statement.
Once again we
record our thanks to the Committee. It is to be commended for its report and for
its professional commitment to seeing
through an extremely difficult job.
Chaired by Mr Arthur Valabh, the Committee comprises Dr Robin Congreve, Mr
Stuart Hutchinson,
Dr Susan Lojkine, Professor John Prebble and Mr Tim
Robinson.
After being introduced to the House, the Bill giving effect to the imputation
and international tax reforms will be referred to a
Select Committee. There will
then be a final opportunity for submissions. We commend a close examination of
the Committee's report
and the draft legislation to all interested
parties.
Roger Douglas Trevor de Cleene
Minister of
Finance Minister of Revenue
ATTACHMENT A
PERMANENT LIST OF EXCLUDED COUNTRIES
Australia,
excluding the Territory of Norfolk Island;
Canada;
Federal
Republic of Germany;
French Republic, including the European and Overseas Departments, but
excluding the Overseas Territories;
Japan;
United Kingdom of Great
Britain and Northern Ireland;
United States of America, but excluding its
possessions and territories.
Notes
1. The Government
has considered the Consultative Committee's recommendations concerning the
listing of preferences and has decided
that initially it would be more
appropriate to list general features of tax systems which might be used to avoid
the BE regime rather
than listing specific preferences in relation to individual
countries listed above. However, the Government intends to monitor developments
in the seven listed countries. Once it is decided to list a particular
preference or feature, or amend a listing, the change will
apply
prospectively.
2. The legislation presented to Parliament will include
one general qualification which will apply to all of the above listed countries.
Interests in a CFC resident in a listed country will be subject to the BE regime
where a CFC derives certain forms of foreign source
income which are not subject
to income tax in the listed country of residence. At this stage, it has been
decided that the general
qualification will apply to foreign source "business"
income. Other forms of foreign source income, such as interest and dividends,
are being considered for inclusion in this general qualification too.
ATTACHMENT B
TRANSITIONAL LIST OF LOW TAX JURISDICTIONS OR
TERRITORIES
Andorra Isle of
Man
Angola Jamaica
Anguilla Jordan
Antigua and
Barbuda Kuwait
Bahamas Lebanon
Bahrain Liberia
Barbados Liechtenstein
Bermuda Luxembourg
British
Channel Islands Macau
British Virgin
Islands Madeira
Campione Maldives
Cayman Islands Marshall Islands
Cook
Islands Monaco
Costa Rica Montserrat
Cyprus Nauru
Djibouti Netherlands
Antilles and/or Aruba
Dominica Nevis
Ecuador New Caledonia
French
Polynesia Norfolk
Island
Greece Oman
Grenada Panama
Gibraltar Palau
Guatemala Puerto
Rico
Hong Kong Saint Helena
Saint Kitts Switzerland
Saint Lucia Turks and Caicos Islands
Saint
Vincent United Arab Emirates
San
Marino Uruguay
Seychelles Vanuatu
Solomon Islands Venezuela
Sri
Lanka
Belgium – companies which are regarded as Foreign Sales Corporations by the United States of America and which therefore qualify for reduced Belgian taxation
– companies approved under Royal Decree No 187 of 30 December 1982 as Co-ordination Centres (as defined by the original Royal Decree or by subsequent amending laws)
Brunei – companies deriving income from sources outside Brunei
Ireland – companies obtaining relief or exemption from tax under Part V of the Corporation Tax Act 1976 or section 43 of the Finance Act 1980 (profits from trading within Shannon Airport)
– companies obtaining relief or exemption from tax under Part IV of the Corporation Tax Act 1976 or section 42 of the Finance Act 1980 (profits from exporting certain goods)
– companies certified by the Minister of Finance to provide international financial services or to carry on any other activities in the Customs Dock area
Kenya – companies having income granted exemption from tax under paragraph 11 Schedule 1 of the Income Tax Act 1973
Malaysia – companies exempt from tax in relation to shipping
– companies subject to tax at 5 percent in relation to inward reinsurance
– companies deriving income from sources outside Malaysia
Netherlands – companies exempt from tax under the Decree for the Avoidance of Double Taxation 1985 for foreign source business profits
– companies which have obtained a participation exemption under article 13 of the Corporate Income Tax Act 1969 or under article 18 of the Corporate Income Tax Act 1969
– companies which are regarded as Foreign Sales Corporations by the United States of America and which therefore qualify for reduced Netherlands taxation
– companies which have obtained an advance ruling from the Ministry of Finance in relation to income earned with respect to intercompany loans
Philippines – companies which are regional headquarters companies
– companies which operate as an Offshore Banking Unit or a Foreign Currency Deposit Unit
– companies which receive interest on deposits with a Foreign Currency Deposit Unit, or other interest subject to reduced rates of tax under the National Internal Revenue Code
Singapore – companies subject to the concessionary rate of tax for insurance and reinsurance of risks outside Singapore
– companies which operate Asian Currency Units which have income -
– companies which are exempt from tax on the income of a shipping enterprise
– companies which derive any income to which section 43E of the Income Tax Act applies (headquarters companies)
– companies which are incorporated in Singapore but not managed and controlled from Singapore and which derive any income from sources outside Singapore
TABLE OF CONTENTS
Letter to the Minister of Finance
i
Statement by the Ministers of
Finance and Revenue iii
Table of Contents xx
CHAPTER 1 – INTRODUCTION 1
1.1 Purpose of This Report 1
1.2 Outline of the Report 2
1.3 "Grey List Exemption" 3
1.4 Compliance and Administration
7
1.5 Trust Transition
8
1.6 Credit Streaming
9
1.7 Draft Legislation
10
CHAPTER 2 – BRANCH-EQUIVALENT
REGIME
PART 1: DEFINITIONS 11
2.1
Introduction 11
2.2
Relationship of BE Regime to Existing Act 11
2.3 Definition of "Company" and "Trustee"
12
2.4 Residence: Individuals
13
2.5 Residence: Companies
16
2.6 Definition of "Nominee"
19
2.7 Definition of
"Associated Persons" 21
CHAPTER 3 – BRANCH-EQUIVALENT
REGIME
PART 2: DETERMINATION OF CONTROL
AND INCOME INTERESTS 26
3.1
Introduction 26
3.2 Definition
of Interests In a Company 26
3.3
Frequency of Measurement of Interests 30
3.4 Calculation of Control Interests
35
3.5 Calculation of Income
Interests 40
CHAPTER 4 – BRANCH EQUIVALENT
REGIME
PART 3: ATTRIBUTION AND COMPUTATION
OF BRANCH EQUIVALENT INCOME, LOSSES
AND FOREIGN TAX
CREDITS 46
4.1 Introduction 46
4.2 Attribution of Income and Losses
47
4.3 Adoption of CFC' s
Accounting Year 50
4.4 BE Income
Calculation 52
4.5 Foreign Tax
Credits 59
4.6 Attributed
Foreign Losses 65
4.7
Application of the Regime to CFCs Resident in a "Grey List" Country 68
4.8 Change of Residence of CFC or Taxpayers
69
4.9 Determination of
Residence 70
CHAPTER 5 –
FOREIGN INVESTMENT FUNDS 71
5.1 Introduction 71
5.2 Definitions 72
5.3 Calculation of FIF Income or Loss
73
5.4 Treatment of Losses
75
5.5 Entry and Exit Provisions
77
5.6 Conflict
Provisions 78
CHAPTER 6 – TRUSTS 79
6.1 Introduction 79
6.2 Existing Treatment of Trusts
80
6.3 Overview of Trust Regime
82
6.4 Definition of a Settlor
85
6.5 Trustee Income
87
6.6 Settlor Liability:
Superannuation Funds 91
6.7 Settlor
Liability: New Residents 92
6.8
Settlor Liability: Charitable Trusts 93
6.9 Beneficiary Income 94
6.10 Distributions From Qualifying
Trusts 97
6.11
Distributions From Foreign Trusts 98
6.12 Distributions From Trusts
Settled by New Residents 103
6.13 Non-Qualifying
Distributions 105
6.14
Financial Assistance to Trusts 107
6.15 Residence of a Beneficiary
109
CHAPTER 7 – DISCLOSURE
AND DEFAULT METHODS 111
7.1
Introduction 111
7.2 Disclosure: BE Regime
112
7.3 Disclosure: FIF Regime
115
7.4 Disclosure: Trusts
116
7.6 Default Methods
118
CHAPTER 8 – TRANSITION
120
8.1 Introduction
120
8.2 BE Regime Transition
120
8.3 Trust Transition
123
CHAPTER 9 – IMPUTATION AND
WITHHOLDING PAYMENT SYSTEMS 130
9.1 Introduction 130
9.2 Draft Legislation 130
9.3 Allocation Rules 131
9.4 Deemed Dividends: Allocation Rules
133
9.5 Producer Boards
134
9.6 Co-operative
Companies 139
9.7
Sharemilking Arrangements 140
9.8 Capital Distributions
141
9.9 Carry Forward of
Credits by a Company 143
9.10
Carry Forward of Unutilised Imputation Credits 145
9.11 Refunds of Dividend Withholding
Payment 146
9.12
Integration With BE Regime: Individuals 148
9.13 Group Investment Funds
149
CHAPTER 10 –
IMPUTATION: RELATED ISSUES 150
10.1 Introduction 150
10.2 Dividend Definition
150
10.3 Section 190
152
10.4 Section 197
153
10.4 Winding Up Distribution
Tax 154
10.5 Fringe Benefits
Received by "Major Shareholders" 155
10.6 Excess Retention Tax 156
CHAPTER 11 – SUMMARY AND
CONCLUSION 159
11.1
Introduction 159
11.2 BE Regime
159
11.3 FIF Regime
161
11.4 Trusts 162
11.5 Disclosure 164
11.6 Imputation and Withholding Payment
Systems 164
11.7 Summary of
Recommendations 164
11.8
Conclusion 191
Annex – Draft Legislation
CHAPTER 1 – INTRODUCTION
1.1 Purpose of This Report
1.1.1 The
Committee's recommendations on the main features of the international tax
reforms and the imputation scheme were outlined
in Part 1 of its Report on
International Tax Reform and its Report on Imputation. The Government's response
to these recommendations
was outlined in press statements issued jointly by you
and the Minister of Revenue. These were published with the Committee's reports.
With three reservations, the Government accepted the Committee's recommendations
on the international reforms while those on imputation
were accepted in
full.
1.1.2 The purpose of this report is to outline the Committee's
recommendations on the outstanding issues relating to both sets of
reforms and
to present the Committee's draft of the legislation. We comment only on those
areas where we have found it necessary
to modify our original recommendations
and on issues which were left undecided in our earlier reports. In all other
respects, the
draft legislation implements the recommendations of the previous
reports.
1.1.3 The aim of this report is therefore to provide interested
parties, once you have made your decisions, with an explanation of
the policy
behind the draft legislation. The report is not intended as an exhaustive guide
to the draft legislation. It does not
restate all of the arguments or
conclusions reached in the Committee's first two reports. This report should
therefore be read in
conjunction with the earlier reports. We do, however,
elaborate our views on a number of the issues which have been raised in response
to our previous reports.
1.2 Outline of the Report
1.2.1 The report
is contained in two volumes. Our recommendations are presented in this volume.
The Committee's draft of the legislation
covering the international regimes, the
imputation and the withholding payment system and related reforms is contained
in a separate
volume which forms an annex to this report.
1.2.2 The
present chapter includes further comment on a number of issues which are central
to the Committee's recommendations. Chapters
2, 3 and 4 outline the Committee's
recommendations on the remaining details of the branch-equivalent ("BE") regime
to apply to certain
controlled foreign companies ("CFCs"). Chapter 5 discusses
the outstanding issues relating to the foreign investment fund ("FIF")
regime.
Trusts are dealt with in chapter 6, while disclosure and default provisions are
the subject of chapter 7. Transitional issues
relating to the international
reforms are considered in chapter 8.
1.2.3 Chapter 9 outlines the
Committee's views on the remaining issues concerning the imputation and
withholding payment regimes.
Consequential and related changes to other aspects
of the existing tax law are dealt with in chapter 10. Finally, chapter 11 draws
together all of the recommendations of the previous chapters and makes a number
of concluding remarks.
1.2.4 Annex 1 of the separate volume consists of
the Committee's draft of the legislation on the international tax reforms. Annex
2 in the same volume presents the Committee's draft of the legislation on
imputation, the withholding payment system and related
matters.
1.3 "Grey List Exemption"
1.3.1 Residents
are to be exempt from the BE regime in respect of interests in CFCs resident in
certain "grey list" countries unless
such a CFC utilises a listed significant
tax preference available in a grey list country. These countries are the United
States,
the United Kingdom, West Germany, Canada, Australia, France and Japan.
The list is referred to as "grey" because it may be qualified
by the listing of
certain significant tax preferences.
1.3.2 Since by far the bulk of
existing New Zealand investment overseas is in these countries, it is not
surprising that further elaboration
of the exact details of the operation of the
grey list exemption have been sought by tax practitioners and businesses. In
addition,
a number of criticisms have been made: that the list should be
expanded, perhaps to include all of the countries with which New Zealand
has a
tax treaty; that it should not be qualified by the listing of preferences; that
no criteria have been given for deciding what
preferences would be listed; that
there should be no "look through" of a CFC resident in a grey list country to
CFCs underneath it;
and that the compliance costs of the regime would be
unmanageable if it frequently applied to CFCs in grey list
countries.
1.3.3 These concerns to some extent reflect the uncertainty
that arises when tax reforms are developed during a consultative process.
Though
everyone would wish to see uncertainty minimised to the greatest extent
possible, some considerable uncertainty is inevitable
if the Government's reform
proposals are to be the subject of private sector input and consultation. The
trade off is that a better
result will usually emerge. It is not possible to
have consultation and certainty.
1.3.4 In Part 1 of our Report on
International Tax Reform, we said the list should include countries "which have
comprehensive
international tax rules including CFC regimes" (page 19 of our report). The
governing principle for listing a country is that, if
the BE regime were applied
in respect of CFCs resident in that country, it would be probable that the tax
credit allowed for tax
paid by a CFC resident there would be sufficient to
offset the New Zealand tax liability on that income. In other words, the
compliance
costs of the regime would be excessive in relation to any revenue
likely to be raised.
1.3.5 Whether or not the income tax paid by a CFC is
likely to be comparable to the tax that would be levied on its income under the
BE regime will depend on the definition of taxable income in its country of
residence (such as whether there are significant tax
preferences), income tax
rates, the efficiency of the tax administration and the extent to which the
domestic tax base is protected
from avoidance. The existence of comprehensive
international tax rules is relevant to the last factor, in particular. The tax
legislation
by itself may suggest that nominally high rates of tax will be
payable, but if there are international planning opportunities effective
rates
may be very different.
1.3.6 We consider that the existence of a CFC
regime is indicative of an income tax system and administration in respect of
which
it can reasonably be assumed that the effective tax rates on business
income in those countries do not depart substantially from
the statutory rates.
In addition, the CFC regime of the grey list country tends to support the New
Zealand BE regime where residents
hold interests in CFCs resident outside a grey
list country through intermediate companies resident in such a
country.
1.3.7 We do not consider that the list should be extended to
include all of New Zealand's tax treaty partners. The treaties are entered
into
to relieve double taxation, promote trade and advance our relationships with
other countries. They say nothing
about the robustness of the tax system of the treaty partner nor its
comparability with New Zealand's. That is not relevant to the
decision to
establish a treaty. Indeed, we have suggested that a number of our treaty
partners should be listed on the transitional
list of low tax
jurisdictions.
1.3.8 If the grey list is to serve its purpose, provision
must be included for its qualification by the listing of preferences. Until
recently, countries such as the United States and the United Kingdom gave
substantial tax preferences to a broad range of businesses.
If the list were
being considered, say, four years ago, it would have been necessary to either
exclude these two countries or to
designate the preferences that would trigger
the application of the BE regime. Because so much of New Zealand's investment is
in
these countries, the compliance costs of the BE regime will depend
importantly on whether a country is listed with preferences or
the country is
excluded from the list altogether. Listing with a qualification for certain
preferences is the more flexible approach
and the one which will have lower
compliance costs.
1.3.9 The general arguments for not preserving the
effect of tax preferences under the BE regime were set out in section 2.3 of our
previous report. The main counter argument is that the claw-back of tax
preferences will make foreign subsidiaries of New Zealand
companies
uncompetitive. In our view, this argument exaggerates the importance of tax
considerations in investment decisions. Factors
such as relative labour costs
and inflation rates, access to capital and raw materials and proximity to
markets will generally be
far more important determinants of international
competitiveness than relative tax burdens.
1.3.10 Nevertheless, one of
the objectives of the BE regime is to minimise the extent to which tax
influences the location of investment.
Over time, the regime will tend to
equalise the effective tax rates on the income of foreign and domestic
companies owned by New Zealand residents. The potential effect of a tax
preference on investment decisions should be the principal
criterion for
determining whether the preference should be listed. Developments in the tax
systems of the grey list countries will
need to be monitored by the Government.
If a country introduces a tax preference that is significant enough to attract
New Zealand
investment, the preference should be listed. A number of generous
preferences are to be or are currently being phased out in grey
list countries
but, because of their limited future, they are unlikely to influence investment
decisions.
1.3.11 Even if no preferences are listed, the possibility of
one being listed does introduce uncertainty. To minimise this, we recommend
that
the listing of a preference should have prospective application. Since an
existing or a newly established CFC in a grey list
country could take advantage
of a preference, it is not sufficient to restrict the effect of the listing of a
preference to CFCs
established after its introduction. Thus, we propose that, if
a preference is listed, the listing should not take effect until the
beginning
of the next income year.
1.3.12 We commented in our previous report on
the need for the New Zealand regime to "look through" CFCs resident in grey list
countries
to CFCs owned by them. If this were not done, New Zealand would not
have one CFC regime, but eight - those of the seven grey list
countries as well.
Residents could choose which of the eight was most favourable to them and
establish an intermediate CFC in the
relevant country which would own the
underlying CFC. It would be pointless to have such a system. As noted above, the
existence of
a CFC regime in the grey list countries is indicative only. The
complete exemption of a grey list CFC and all of its underlying interests
should
not turn on this factor.
1.3.13 Chapter 4 outlines the Committee's views
on how the BE regime should apply in respect of a CFC resident in a grey
list
country which does utilise a listed preference. We propose that the
computation of the BE income of the CFC for any accounting year
should be
simplified by taking it as the taxable income of the CFC for that year, measured
according to the tax laws of its country
of residence, adjusted for the effect
of the preference. This approach should significantly reduce compliance costs.
The major avenue
for minimising the compliance costs of the regime in respect of
grey list CFCs should be the listing of significant preferences only.
It may
well be that the best approach initially is to refrain from listing preferences
until the regime has been introduced and some
experience with its operation has
been gained.
1.4 Compliance and Administration
1.4.1 The grey
list exemption will remove most of New Zealand's offshore investment from the
regime. This will substantially reduce
the compliance and administrative costs
of the BE regime to the extent that it will affect relatively few taxpayers. The
Committee
has, however, been concerned to reduce as far as possible the
compliance costs of the regime where it will apply. In our previous
report, we
recommended that the BE regime should apply to a foreign company that is
controlled at any time during its accounting
year. In principle, this would
require taxpayers to compute their interests daily though, in practice, this
computation would obviously
be necessary only when a taxpayer's interest
changed. Nevertheless, the compliance and administrative costs of the scheme
will be
raised the more frequent the measurement of interests is
required.
1.4.2 For this reason, we recommend in chapter 3 that interests
in foreign companies for both control and income attribution purposes
be
measured on four days during the year -on the last day of each calendar quarter.
A consequence of this decision is the need to
have rules to deal with disposals
and
related acquisitions straddling a measurement day but, for taxpayers who do
not engage in such activity, the reduction to four measurement
days should
considerably simplify compliance.
1.4.3 The definition of an interest for
control and income attribution purposes is, of necessity, broad - we have
defined five categories
of interest in a company. For most normal share
structures, the five categories will, however, reduce to only one or two. Where
complicated
share structures and rights exist, greater computational
requirements will arise. Similarly, greater compliance costs will arise
where
there are relationships between companies which complicate the calculation of
indirect interests. These can be reduced by simplifying
corporate group
structures.
1.4.4 We mentioned in the previous section the Committee's
recommendation for a simplified basis of computing the BE income of a CFC
resident in a grey list country. This should considerably reduce the compliance
costs of the regime to the extent that it applies
to such companies.
1.5 Trust Transition
1.5.1 A
further issue which has attracted comment is the transition to apply to trusts
with non-resident trustees settled on or before
17 December 1987. Once again,
the concern is in part due to uncertainty since your earlier decision on the
transition was only provisional.
We discuss this matter further in chapter
8.
1.6 Credit Streaming
1.6.1 The
Committee proposed a number of provisions to reduce the streaming of imputation
and withholding credits. By streaming, we
mean the allocation of credits
disproportionately to taxpayers able to use them rather than to those, like
non-residents, who will
be unable to. Streaming would not be a concern if tax
revenue were not an issue, but since it is, rules are needed to minimise its
impact.
1.6.2 A related matter is whether New Zealand shareholders in
non-resident companies with New Zealand subsidiaries should be able
to receive
credits for any New Zealand tax paid by the subsidiaries. One mechanism to
achieve this would be to issue "stapled" shares
in the subsidiaries to the
resident shareholders.
1.6.3 The Committee considered this issue in its
report on imputation. Imputation cannot be considered in isolation from the
international
reforms. If non-resident companies could direct credits to their
resident shareholders through stapled stock and similar arrangements,
a
constraint on the adoption of a non-resident corporate structure in order to
avoid the international reforms would be removed.
Hence, we see the disallowance
of stapled stock arrangements as a quid pro quo for non-resident status and
relief from the international
reforms. We consider that this argument also
applies to companies which are already non-resident.
1.6.4 It has also
been suggested that, if stapled stock type arrangements were to be disallowed in
general, an exception should apply
for Australian companies, in particular, and
perhaps others. It is for the Government to consider whether a special
arrangement is
warranted with Australia. We would note, however, that a number
of New Zealand's tax treaties have non-discrimination articles and
most favoured
nation provisions which
might mean that a special arrangement could not be confined to only one of
our treaty partners.
1.7 Draft Legislation
1.7.1 The
Committee's draft of the legislation is contained in the annex to this report
which is presented in a separate volume. The
legislation has not been fully
considered by officials nor parliamentary counsel, but we consider that it is
sufficiently well-developed
to provide a considerable degree of certainty to tax
practitioners and businesses. Refinements to the legislation will, however,
be
needed. We understand that it will be considered by the Finance and Expenditure
Select Committee so that interested parties will
have an opportunity to comment
on it.
CHAPTER 2 – BRANCH-EQUIVALENT REGIME PART 1: DEFINITIONS
2.1 Introduction
2.1.1 Chapters
2, 3 and 4 outline the Committee's recommendations on the outstanding issues
relating to the branch-equivalent ("BE")
regime. The main elements of this
regime were outlined in Chapter 2 of Part 1 of the Committee's Report on
International Tax Reform.
For ease of reference to the draft legislation, the
issues are discussed in the order that they arise in the legislation. This
chapter
deals with the definitions which are central to the BE regime.
2.2 Relationship of BE Regime to Existing Act
2.2.1 The BE
and the Foreign Investment Fund ("FIF") regimes will represent substantial
additions to the existing Income Tax Act 1976
(the "Act") and, as a practical
convenience, are best located together in Part IV of the Act. Their particular
location is a minor
matter - we have proposed that they form new sections 245A,
245B, etc. The regimes do, however, require a number of definitions.
Definitions
which are intended to apply generally throughout the Act are contained within
section 2, while definitions which are
specific to particular sections are
usually included within those sections. The BE regime will apply when five or
fewer New Zealand
residents hold interests, either directly or through nominees
or associated persons (which include certain relatives and trustees),
which in
aggregate equal or exceed 50 percent of the shares, voting rights, etc, of a
foreign company. Thus, the definitions of residence,
nominee, associated person,
relative, trustee and company are critical to the effective operation of the
scheme.
2.2.2 For this reason, we have reviewed existing definitions in the Act in
order to consider their appropriateness for the purposes
of the BE regime. We
have proposed new definitions of a company, a trustee a resident which we
recommend apply generally throughout
the Act. Our proposed definitions of a
nominee, associated person and relative are, however, intended to apply only to
the international
regime. The main reason for this limitation is that these
definitions are pivotal to the operation of other sections of the Act as
well as
the sections that will form part of the international regime and should not be
amended for the purposes of those other sections
without careful consideration
of the consequences. In the time available, we have not been able to undertake
this task. There are,
however, a number of deficiencies in the existing
definitions and they should be reviewed at some stage. To this end, we have
included
in an appendix to the draft legislation new drafts of section 7, the
present section defining associated persons, and section 8,
the section dealing
with control of a company, which could be considered in this review. Special
definitions for particular sections
may still be required.
2.3 Definition of "Company" and "Trustee"
2.3.1 As noted
in the previous section, we recommend that the existing general definition of a
"company" in section 2 of the Act be
changed. It should be expanded to include
any entity with a legal personality or existence separate from those of its
members, which
is created by way of incorporation or otherwise whether in New
Zealand or elsewhere. This change is not fundamental but aims to more
clearly
include within the definition the variety of legal entities in overseas
jurisdictions that are equivalent to companies. We
understand that it is the
intention of the Inland Revenue Department to publish for the guidance of
taxpayers a list of the types
of non-resident entities it considers to be the
equivalent of companies under New Zealand law.
2.3.2 We also propose a minor amendment to the existing section 2 definition
of a trustee to make it clear that a reference to a trustee
of a trust means the
trustee only in his or her capacity as trustee of that trust and includes all
trustees of that trust.
Recommendation
2.3.3 Accordingly, the Committee recommends
that:
2.4 Residence: Individuals
2.4.1 The
BE regime will apply to residents in respect of interests in foreign companies
which are controlled by residents. Similarly,
the settlor regime for trusts will
apply to trusts which have a New Zealand resident settlor. Thus, the definitions
of residence
of an individual and of a company for tax purposes are key elements
of the regimes. Residents should not be able to cease temporarily
or regularly
to be resident in order to avoid the control test and income attribution under
the BE regime nor the settlor designation
under the trust regime. In addition,
residents should not be able to lose temporarily their residence status in order
to receive
a taxable distribution from a trust
or company without suffering New Zealand income tax.
2.4.2 The present
definitions are contained in section 241 of the Act. A natural person is deemed
to be resident in New Zealand if
he or she:
2.4.3 Where a person is absent from New Zealand
for a continuous period of not less than 365 days, the person is deemed not to
be
resident in New Zealand during that period except that, where a person has a
permanent place of abode in New Zealand at all times
during the period, he or
she may request to be treated as a resident.
2.4.4 For the purposes of
both 365 day tests, two or more periods are defined to be continuous if there
are not more than 28 days
between them and the intervening days do not exceed 56
days in that 365. In order to cease to be a New Zealand resident, a natural
person must therefore be absent from New Zealand for at least 309 (i.e 365 less
56) days of a 365 day period and not be present here
for any period exceeding 28
days. An absence of only 29 days is sufficient under the definition to break the
residence link where
the person in question does not have a permanent place of
abode in New Zealand.
2.4.5 A person who is not a New Zealand resident
can remain a non-resident by having a permanent place of abode outside of New
Zealand
and no permanent place of abode in New Zealand, irrespective of the time
they are in New Zealand. Thus, a New Zealand resident can
cease to be resident
here by disposing of any permanent place of abode in New Zealand and acquiring
a
permanent place of abode outside New Zealand.
2.4.6 In our view, the
permanent place of abode test needs to supplemented by a strengthened personal
presence test. As noted above,
the present test can be avoided by disposing of
one's permanent place of abode in New Zealand and spending 29 continuous days
out
of New Zealand or by maintaining a permanent place of abode outside New
Zealand. The continuous period concept in the existing personal
presence tests
adds little. We propose that they be simplified by determining residence
according to whether a person is present
or absent from New Zealand for a
certain number of days. Thus, we propose that a natural person be deemed to be a
New Zealand resident
if:
2.4.7 In addition, we propose that a natural
person who is a New Zealand resident may cease to be a resident only if:
2.4.8 The effect of these changes would be to make it
easier for a person to become a New Zealand resident and harder to cease to
be
one. We propose that the amendment come into effect from the commencement of the
1989 income year.
Recommendations
2.4.9 Accordingly, the Committee recommends
that the residence tests applying to natural persons be amended with effect from
the income
year commencing on 1 April 1988 so that:
2.5 Residence: Companies
2.5.1 Temporary
changes of residence by companies do not present the same problems under the
international regime as do those by individuals.
A company controlled by
residents which became a non-resident to avoid the control and income
attribution rules under the BE regime
would itself fall within the regime. The
present definition of the residence of a company is contained in section 241(2).
A company
is deemed to be resident in New Zealand if it:
An
exception applies to a "banking company" which is deemed to be resident only if
its centre of administrative management is in New
Zealand.
2.5.2 There
are two problems with this definition. The first is the ambiguity of the term
"centre of administrative management". The
Inland Revenue Department interprets
this to mean the place where the day to day administration of a company is
carried out. By contrast,
a number of tax practitioners consider that it means
the place where the highest (i.e board of director) level of decision-making
takes place. Many other countries use the term "place of central management and
control" to designate the place where the board of
directors
meets.
2.5.3 The second problem with the definition is the administrative
difficulty of applying a place of management test (whether central
or day to
day). To a large extent, the need for a CFC regime arises because of this
difficulty. The place of management test has,
however, much more economic
substance than the place of incorporation test. In addition, most of New
Zealand's double tax agreements
employ a management and control test to settle
the residence of a company resident within the jurisdiction of both treaty
partners.
Thus, a management and control test is an integral part of our tax law
since the treaty tests override the Income Tax Act provisions
where the two are
in conflict. For these reasons, we favour retaining a place of management test
of corporate residence.
2.5.4 To clarify the present definition, the
level of management on which it is intended that residence depend should be
spelt out
more precisely. To avoid altering substantively the present test, we
propose that the place of both the board and
executive levels of management be included and that the term "head office"
(where both levels of management would normally be located)
be retained. Thus, a
company would be resident in New Zealand if it:
For the purposes of the second
test, the substantive issue is whether control by directors is exercised in New
Zealand, irrespective
of whether board meetings are also occasionally held
outside New Zealand. We propose that the new residence definition apply with
effect from the present (i.e. 1989) income year.
2.5.5 We have asked the
Inland Revenue Department to investigate the origin of the special residence
rule applying to banking companies.
It dates from 1941 and was apparently
intended to permit banks incorporated in New Zealand for the purposes of issuing
banknotes
here to do so without being subject to tax on their worldwide income,
as would be the case if the place of incorporation test applied
to them. Since
this consideration is no longer relevant, we propose that the residence of a
banking company be determined under the
normal rules.
Recommendation
2.5.6 Accordingly, the Committee recommends
that the residence test for companies be amended with effect from the income
year commencing
on 1 April 1988 so that a company, including a banking
company, is resident in New Zealand if it:
2.6 Definition of "Nominee"
2.6.1 Since the
BE regime will apply whenever residents hold a certain threshold percentage of
the "control interests" (meaning generally
the various rights or powers of
ownership which when aggregated sufficiently enable a person to control a
company) in a foreign company,
there is an obvious incentive for a person to
disperse interests among nominees or associated persons. To counteract this,
interests
held by a nominee of a person must be deemed to be held by that
person. The treatment of interests held by associated persons is
referred to in
the next section.
2.6.2 The scope of the definition of nominee will
depend to some extent on its application. There are at present two definitions
of
nominee in the Act but they are both framed in relation to the sections to
which they apply. For example, they differ according to
the way in which
relatives are brought within the definition. In principle, it is not necessary
to deem relatives to be nominees
of a person but, in practice, where
it is likely certain relatives will be acting as nominees, it is reasonable
to shift the burden of proof on to the taxpayer to establish
that this is not
so.
2.6.3 For the purposes of the BE regime, the definition of nominee
needs to be framed in terms of the rights and powers which, if
a person held
them directly, would be taken into account in determining his or her control
interest. With respect to relatives, given
that the tax consequences for a
person of having someone else deemed to be his or her nominee may be
substantial, we propose that
only children under 18 years of age be deemed to be
nominees of a person unless the person can establish otherwise. In addition,
we
propose that a bare trustee (i.e. a trustee who holds property to the order of a
beneficiary) be included in the definition. (A
broader inclusion of relatives
and trustees is proposed for the definition of associated
persons.)
2.6.4 To support the definition, we propose that the definition
of a nominee include a person who has entered into an arrangement
or
understanding with another person with respect to the holding or exercising of
rights or powers in relation to foreign companies.
Recommendation
2.6.5 The Committee therefore recommends
that, for the purposes of the BE regime, a nominee of a person be defined to
include:
2.7 Definition of "Associated Persons"
2.7.1 A nominee
of a person is in effect that person's agent. The definition of associated
persons aims to embrace persons who are
not related as principal and agent but
who, because of their personal or economic relationship, can reasonably be
assumed to have
similar economic interests. For example, two companies owned by
the same shareholders may not be related as principal and nominee
but will
nevertheless have substantially similar if not identical economic interests.
They should therefore be treated as associated
persons.
2.7.2 In the
context of the BE regime, we propose that interests in foreign companies held by
associated persons be aggregated for
the purposes of the control test, but not
for the purposes of income attribution. The income attributed to any person
would depend
only on the interests that the person holds directly, through
nominees, or through other controlled foreign companies. (Interests
held by the
nominees of a person should be aggregated with that person's own direct and
indirect interests for the purposes of determining
both the control and income
interests of the person.)
2.7.3 The present Act contains a general
definition of associated persons in section 8. In brief, this section defines
associated
persons as any two companies which consist of substantially the same
shareholders or that are under the control of the same persons;
a person and a
company where that person owns 25 percent or more of the shares in the company;
two persons who are relatives; and
a person and a partnership where that
person is associated with a partner. This definition is not appropriate for
the purposes of the BE regime. First, the relationship
between two companies or
another person and a company needs to be extended and defined in terms of the
rights and powers to be taken
into account in determining control and income
interests under the BE regime. Secondly, the 25 percent ownership threshold
should
be raised to 50 percent for consistency with the control threshold under
the BE regime. Thirdly, the term relative means persons
connected within the
fourth degree of relationship (such as first cousins). This is too broad for the
purposes of the BE regime.
Fourthly, the present definition does not include
trust relationships.
2.7.4 Accordingly, we propose that, in relation to
the BE regime only, the term associated persons mean:
2.7.5 In addition,
two persons who habitually act in concert with respect to the holding or
exercising of interests in foreign companies
should be deemed to be associated
persons with respect to those interests.
Recommendations
2.7.6 Accordingly, the Committee recommends
that, in relation to the BE regime only, the term associated persons
mean:
or, being a person associated with the settlor of the trust, could derive a benefit from it (except where the trust is for the benefit of employees only and the person, or an associated person, does not manage or control the affairs of the trust);
CHAPTER 3 – BRANCH-EQUIVALENT REGIME PART 2: DETERMINATION OF CONTROL AND INCOME INTERESTS
3.1 Introduction
3.1.1 The
BE regime will apply when five or fewer residents control 50 percent or more of
the rights or powers of ownership which
when aggregated sufficiently enable
those residents to control a company. A person's proportionate share of the
total of such rights
or powers will be referred to as his or her "control
interest" for the purposes of the control test and his or her "income interest"
for the purposes of income attribution. Depending on whether interests are held
directly or indirectly through companies or associated
persons, a person's
control interest may be different from his or her income
interest.
3.1.2 The objective of this chapter is to set out the
Committee's recommendations on the determination of control and income
interests.
These matters are dealt with in sections 245B to 245G of the
accompanying draft legislation.
3.2 Definition of Interests In a Company
3.2.1 The
attributes of a company which are critical for the purposes of calculating
control and income interests are the rights or
powers which give the holders the
ability to receive or control the disposition of the company's income or
capital. In general, these
rights or powers attach to shares and are held by the
shareholders of the company. Different classes of shares may, however, have
a
wide variety of rights attached to them so that it is not sufficient to focus on
the percentage of the shares held by a person.
Thus, control and income
interests in a foreign
company need to be defined in terms of:
3.2.2 The
ownership of or an entitlement to acquire any one of these things in relation to
a foreign company will be referred to as
an "interest" in the company. Thus, the
list above specifies five categories of interest. A foreign company should be
deemed to be
a controlled foreign company (CFC) when five or fewer residents,
directly or indirectly, own or are entitled to acquire 50 percent
or more of any
category of interest. The meaning of "directly or indirectly" is outlined in the
next section. For example, if five
or fewer residents own 50 percent of the
voting rights in relation to the distributions of a foreign company, it should
be a CFC.
3.2.3 The income attributed to any resident having an
interest
in a CFC will, however, depend on that person's income interest in the CFC.
The definition of an income interest is explained further
in section
3.5.
3.2.4 In determining how voting rights are held, those of directors
to decide distributions, such as interim dividends, should be
excluded. These
are exercised by directors acting in their capacity as directors under an
authority delegated by shareholders in
terms of the articles of the
company.
3.2.5 The calculation of an interest under category d would
require taxpayers to decide how the income of a company would be allocated
if it
were distributed as a dividend on a particular day. Certain shares, such as
preference shares, may be entitled only to a fixed
rate of dividend payable on
specified days during the year. To accommodate these types of share, category d
interests need to be
measured on the basis that all of the foreign company's
income for the accounting year is distributed as a dividend on the last day
of
the accounting year and all interests held on a measurement day are treated as
if they were held on the last day of the accounting
year.
3.2.6 In some
circumstances, the percentage of the income or the net assets of a company that
a person could acquire may differ from
the percentage of its paid up capital,
nominal capital or votes that he or she may hold. For example, minority
shareholders of private
companies may have no rights, or the powers given to a
majority shareholder, directors or managers may be such that the shareholders
who control the company could cause to be distributed to them or for their
benefit a disproportionate share of the income or assets
of a company. In cases
such as this, the income interest of a person or group holding a control
interest of more than 50 percent
should be taken as 100 percent.
Recommendation
3.2.7 Accordingly, the Committee recommends
that residents' control and income interests in foreign companies be
defined in terms of:
3.3 Frequency of Measurement of Interests
3.3.1 The
objective of the BE regime is to tax residents on the income of certain CFCs
that remains undistributed from one year to
the next. Thus, the regime needs to
determine which residents hold interests in a CFC from one year to the next.
This requires the
determination of the interests held by residents at least once
a year. There are, however, several problems with a single annual
measurement of
interests. First, there would obviously be an incentive for residents to avoid
holding interests on that particular
day. To counter this incentive, rules would
be required to catch "bed and breakfast" transactions whereby interests were
disposed
of prior to the measurement day and reacquired after that day. Where a
right of repurchase existed, the disposal would not be effective
since the
measurement of a control interest will require taxpayers to take into account
interests that they are entitled to acquire.
In addition, a provision would be
needed to counteract temporary changes in the aggregate interests of a CFC in
any category of interest
(e.g. by the issue and cancellation of shares around
the measurement day). Both of these types of rule would be needed if measurement
of interests takes place on only a number of specified days during the year. A
single measurement day would, however, put more pressure
on the rules than more
frequent measurement.
3.3.2 Secondly, a single measurement day would
enable taxpayers in some cases to avoid the regime by holding companies for the
interval
between measurement days - that is, up to 364 days but not the
measurement day. Income could thus be accumulated in a CFC which might
then be
sold to a non-resident prior to the measurement day for a gain that reflected
the accumulated income. The longer the period
between measurement days, the
greater the scope for such activity. Thirdly, a single measurement day may be
unfair on taxpayers who
hold interests for
short periods that included the measurement day, since their proportionate
share of the income of the CFC for the whole of the year
would be attributed to
them. In principle, the anticipated tax liability could be taken into account in
the purchase price of the
interest.
3.3.3 At the other extreme,
measurement of interests could be required on each day of the foreign company's
accounting year. This
was the approach we favoured in our earlier report and is
the method adopted in the United States and Canadian CFC regimes for the
purposes of determining control. The major disadvantage of this option is the
compliance cost involved. In practice, residents would
not need to compute
interests daily, but they would need to do so for each day on which there was a
change in their own interests,
those of associated persons or in indirect
interests held through CFCs and for each day on which there was a change in the
aggregate
of any category of interest in the relevant foreign company. The
compliance costs could thus be onerous where taxpayers had complex
holdings of
interests and where the aggregate interests in the foreign company changed
relatively frequently, such as may be the
case for listed companies (which, for
example, may regularly issue shares to finance acquisitions). While the
compliance burden of
this approach to measuring control interests may be
acceptable under the United States and Canadian regimes, which are directed
mainly
at "passive" investment income, they could be excessive under the New
Zealand regime which is targeted more widely.
3.3.4 The choice of the
interval between the measurement of interests needs to weigh up the compliance
costs of more frequent measurement
on the one hand and, on the other hand, the
possible reduction in the effectiveness and fairness of the regime if
measurement is
relatively infrequent. The Committee favours a compromise of
requiring measurement four times a year at the end of each calendar
quarter. A
resident having a control or an income interest on a measurement day would then
be deemed to have
held the interest on every day of the previous quarter. If no interest were
held on a measurement day, the resident would be deemed
not to have held a
control or income interest at any time during that previous
quarter.
3.3.5 As noted above, a trade off for less than daily
measurement is the necessity to have provisions to counteract bed and breakfast
transactions and temporary changes in the aggregate interests in a foreign
company. In essence, the bed and breakfast provision would
deem a person who had
disposed of an interest in a CFC before a measurement day which had the effect
of reducing his or her attributed
income not to have disposed of it to the
extent that an interest in the CFC was acquired within a certain period, which
we propose
be 183 days, after the date of the disposal. A parallel rule would
apply where a person temporarily increased an interest before
a measurement day
which had the effect of increasing an attributed loss.
3.3.6 A person's
attributed income will depend, first, on whether a foreign company in which he
or she holds an interest is a CFC
and, secondly, on his or her income interests
in the foreign company if it is a CFC. As discussed further below, whether a
foreign
company is a CFC will depend on the interests held by residents, their
associated persons and CFCs in which they have a direct or
indirect interest.
Thus, a disposal and acquisition around a measurement day by any of these
parties will affect the control interest
of the person. This means that it is
necessary to draw the bed and breakfast provision widely, so that it applies not
just where
one person reduces and subsequently increases an interest in a
foreign company, but also where such a reduction occurs and any other
party
connected with the person whose interests affect that person's control interest
subsequently acquires an interest. The provision
should not, however, apply
where a disposal or acquisition is made by one person and an opposite
transaction is made by another person
whose control interests do not affect the
other's control
interests.
3.3.7 The rule to reverse the effect of temporary changes
in the aggregate interests in a CFC would deem the change not to have occurred
to the extent to which it is reversed within a certain period, which we propose
be 365 days. Where the provision applies, it would
require residents to
determine their interests on each measurement day in the period on the basis of
the deemed aggregate interests.
3.3.8 The effect of these rules is to
ignore for interest measurement purposes changes in interests in foreign
companies which have
the effect of defeating the intent and application of the
BE regime. A remaining problem is the acquisition and disposal of interests
within a period between successive measurement days. This would have the effect
of converting what would be income under the BE regime
to a gain. The principal
provision dealing with the taxation of such gains is section 65(2)(e). This
taxes gains on the disposal
of personal property (which includes
shares):
"if the business of the taxpayer comprises dealing in such property, or if the property was acquired for the purposes of selling or otherwise disposing of it, and all profits or gains derived from the carrying on or carrying out of any undertaking or scheme entered into or devised for the purpose of making a profit".
3.3.9 In practice, this section has proved difficult to administer
because, for example, of the need for the Department to establish
the taxpayer's
purpose of acquiring property at the time of its acquisition. In addition, the
section cannot be successfully administered
without sufficient disclosure by
taxpayers. With adequate disclosure, however, we consider that this provision
will be more effective
in taxing gains on the disposal of interests in foreign
companies in the circumstances
outlined in the previous paragraph since, in many instances, the substantive
purpose of the acquisition of such interests will be
to dispose of them at a
gain.
3.3.10 To reinforce the need for disclosure, we propose that
residents who have a control interest in a foreign company at any time
during
its accounting year equal to or higher than 10 percent should be required to
disclose the interests they hold in the company
on its balance date and any
disposals of interests in the company made during its accounting year.
Similarly, where a resident has
a control interest of 10 percent or more in a
CFC at any time during its accounting year and that CFC has a control interest
of 10
percent or more in another foreign company, the resident should be
required to disclose the interests in that foreign company held
by the CFC on
its balance date and any disposals of such interests the CFC has made during its
accounting year.
3.3.11 The circumvention of the BE regime by the
disposal of shares for a capital gain can be addressed comprehensively only by
the
general inclusion of capital gains within the income tax system. The income
tax system will always be vulnerable if taxable income
can be converted, in one
way or another, into an exempt capital gain. Accordingly, we commented on the
need for the inclusion of
capital gains within the income tax base in our two
previous reports.
Recommendations
3.3.12 The Committee therefore recommends
that:
paragraph 3.2.7 on the last day of each calendar quarter;
3.4 Calculation of Control Interests
3.4.1 We
referred in chapter 2 to the need to aggregate interests held by residents
through nominees, associated persons and other
controlled companies in order to
counteract the incentive for the dispersion of interests aimed at avoiding the
control test. Interests
held by a person directly will be referred to as "direct
control interests". Those held indirectly through CFCs will be referred
to as
"indirect control interests".
A person's total or aggregate control interest in each category of interest
listed in paragraph 3.2.1 should be calculated by aggregating
the person's
direct and indirect control interests in that category and those of associated
persons. Any person's interest in any
category should include interests held by
nominees.
3.4.2 The calculation of indirect interests requires the
attribution to New Zealand residents of the direct control interests of CFCs
and
their associated persons (hereafter together referred to as "qualified control
interests"). We propose that, where one CFC is
controlled by a second CFC, the
qualified control interests of the first CFC be attributed to the second CFC.
The resulting qualified
control interests deemed to be held by the second CFC
should then be deemed to be held by the persons who control that CFC. This
tier
by tier or step by step attribution process means that the interests being
attributed at each stage are direct control interests
only.
3.4.3 As a
general principle, we propose that such interests be attributed to the smallest
group of residents who have a control interest
of 50 percent or greater and,
where there is more than one such group, to the group with the highest aggregate
control interest.
In particular, we propose that:
the qualified control interests held by the CFC be attributed to the group with the highest aggregate control interest in the CFC;
3.4.4 In summary, a
resident's control interest in any category of interest would be the sum of the
direct and indirect interests
of the person and associated persons. A foreign
company would be deemed to be a CFC if there is any category of interest in
which
the aggregate control interests of five or fewer residents equals or
exceeds 50 percent.
3.4.5 The control interests of two persons who are
associated would each be included in the control interest of the other so that,
when interests are aggregated for the purposes of determining whether a foreign
company is a CFC, multiple counting of control interests
may arise. It is
therefore necessary to have a general proviso to the effect that any person's
(including a CFC's) direct control
interests shall be counted only once for the
purpose of determining whether a foreign company is a CFC.
3.4.6 Another
source of potential double counting is the inclusion, for the purposes of
determining control interests, of interests
which a person holds and those which
another person is entitled to acquire. Where one person holds an interest in a
foreign company
and another person is entitled to acquire that interest and both
are in the same group of 5 or fewer persons
for the purposes of determining whether the foreign company is a CFC, the
interest would be double counted. We have therefore included
in the draft
legislation a provision which would avoid this type of double
counting.
3.4.7 It is necessary to base the control test on the aggregate
interests of a small number of persons, though the particular number
is
arbitrary, because the larger the group, the smaller each person's respective
interest will be and the less likely it is that
they will have sufficient
incentive or opportunity to concert their actions in order to control a company.
Where, however, the directors
of a company control it, the size of the group is
irrelevant. We therefore propose that a foreign company in which the New Zealand
resident directors (or their nominees) have an aggregate control interest of 50
percent or more be included in the definition of
a CFC, irrespective of the
number of such directors.
3.4.8 It is important to note that the
calculation of a person's control interest in a foreign company requires the
person to include
interests which he or she is contingently or absolutely
entitled to acquire in the future. Thus, interests which a person could acquire
under an option to buy shares or an option to acquire such an option must be
taken into account. Similarly, interests which a person
would acquire if another
person exercised an option to sell such interests to them need to be taken into
account where the terms
of the agreement are such that the exercise of the
option is a matter of course. Hence, so-called "shot-gun provisions" in a
buy-sell
agreement requiring a purchaser to buy shares in certain circumstances
must be taken into account. In addition, a right or entitlement
to acquire
shares or voting rights given to a creditor in terms of a debt instrument needs
to be taken into account.
3.4.9 Instances have arisen in other
jurisdictions where a parent company has tried to avoid having direct control of
a
foreign subsidiary by issuing shares in the subsidiary to the parent's own
shareholders. In order that the subsidiary's shares are
not traded separately
from those of the parent, they are "stapled" to the former. To accommodate this
possibility, we propose that,
where shares in a foreign company (the "stapled"
company) can ordinarily be transferred only in conjunction with the shares of a
New Zealand resident company or a controlled foreign company, shares in the
stapled company should be deemed to be held by the New
Zealand resident company
or the controlled foreign company. This is simpler than the alternative
provision, discussed in our previous
report, of treating the stapled company as
an associated person of the parent company.
Recommendations
3.4.10 Accordingly the Committee recommends
that:
3.5 Calculation of Income Interests
3.5.1 As noted
above, the interests in a foreign company to be taken into account in
determining the income to be attributed to a
person under the BE regime can be
referred to as his or her "income interest" in the foreign company. We propose
three differences
between the determination of control and income
interests.
3.5.2 First, while it is necessary for the purposes of the
control test to take into account interests held by associated persons,
this
should not be the case for income attribution
purposes. The income interest of a resident should depend only on his or her
direct and indirect interests, including those of nominees,
and not those of
associated persons. Where both parties are residents, income attributable to any
interests they hold will be taxable
in their hands. Thus, there is an important
distinction between nominees and associated persons.
3.5.3 Secondly, we
propose that the circumstances in which an entitlement to acquire an interest in
a foreign company gives rise to
an income interest be more circumscribed than we
propose for control purposes. A person who is entitled to acquire an interest in
a foreign company will have a control interest in that company, but it will not
always be appropriate to attribute income to that
person. For example, the
interest to be acquired may be held by another resident and income would be
attributed to that resident.
In addition, entitlements may not be exercised.
This will generally be the case if the consideration payable to exercise the
entitlement
exceeds the market value of the interest to be acquired. Conversely,
where a resident is entitled to acquire an interest in a foreign
company at less
than its market value, it is reasonable to assume that the entitlement will be
exercised. The resident should then
have an income interest in that company.
Similarly, an income interest should arise if a resident is entitled to acquire
an interest
held by another person who has received financial assistance from
the resident to acquire that interest.
3.5.4 In view of these
considerations, we propose that an entitlement to acquire an interest in a
foreign company give rise to an
income interest whenever the consideration
payable to exercise the entitlement is less than the market value of the
interest to be
acquired or when a person who is entitled to acquire an interest
has given any form of financial assistance, such as a loan, cancellation
or
reduction of a debt, guarantee or other form of indemnity, to the person who
holds the interest for the purposes of acquiring
or holding that interest.
3.5.5 In addition, it is necessary to support these provisions by a general
anti-avoidance measure the effect of which would be to
deem a person to hold an
interest which he or she is entitled to acquire if the holding of that
entitlement has the effect of defeating
the intent and application of these
provisions. Such a provision clearly needs to be supported by full disclosure.
Entitlements to
acquire interests in foreign companies are to be taken into
account for control purposes and therefore must be disclosed. Where a
person's
income interest in a foreign company is significantly less than his or her
control interest, the Commissioner should require
a reconciliation of the
two.
3.5.6 Thirdly, indirect income interests (i.e. those held through
CFCs) need to be calculated differently from indirect control interests.
As
explained in the previous section, for control purposes it is necessary to deem
all of the interests held by a CFC in a foreign
company to be interests of the
controlling shareholders of the CFC. The income of the underlying company would,
however, normally
be distributed to its shareholders in proportion to their
interests in it. Thus, a 51 percent shareholder, even though controlling
a
company, would normally expect to receive only 51 percent of the income of the
company, not 100 percent (although, as noted in
section 3.2.6, in some
circumstances, shareholders should have 100 percent of the income attributed to
them). It is therefore necessary
to compute a person's income interest in a CFC
held through another CFC by multiplying the person's direct income interest (and
that
of any nominees) in the first CFC by that CFC's direct income interest in
the second CFC, and so on.
3.5.7 The direct and indirect interests of a
person in a CFC will be measured on each of the measurement days falling within
the accounting
year of the CFC. It will be necessary for the person to
determine, for each of those measurement days, his or
her direct and indirect income interests in each category of interest. The
person's income interest for any quarter should then be
taken as the highest of
the five categories of income interest of the person on the last day of the
quarter. In other words, the
person would be deemed to have held that highest
interest on each day of the preceding quarter.
3.5.8 The calculation of
income interests will in most cases be a good deal simpler than the previous
paragraph might suggest. In
most companies, the rights of members by virtue of
share ownership to vote, to share in dividends, to participate in winding up and
so on do not vary from share to share, except where there are shares carrying a
fixed dividend entitlement only. Thus, generally
speaking, a shareholder will
not need to examine his or her shares category by category to determine what
percentage of rights he
or she has in each case. In closely held companies, on
the other hand, where a variety of share categories is more common, there
is
relatively little change in shareholding from year to year. Moreover, where a
company is closely held, a New Zealand shareholder
should not find the task of
checking his or her income interest excessively onerous.
3.5.9 In order
to determine a person's income interest with respect to a CFC and an accounting
year, his or her income interests in
each quarter, calculated as outlined in the
previous paragraphs, should be averaged over the year. The resulting income
interest
represents an average interest of the person in the CFC for that year.
This interest would be the basis of calculating the income
to be attributed to
the person in respect of that CFC and that accounting year. An equivalent rule
is needed for short or long accounting
periods arising from changes in balance
dates or residence.
3.5.10 On page 85 of out first report, we indicated
that we were considering an anti-avoidance rule aimed at situations where five
or fewer taxpayers structured their affairs to achieve an
income interest in a foreign company of more than 50 percent but a control
interest of less than a 50 percent. On further examination,
we consider that
such an arrangement is possible only where the taxpayers hold interests in the
company through a non-controlled
company. This would mean that the group may not
exercise control over the disposition of the underlying company's income and
assets.
We therefore consider that special provision for this situation is not
needed. The definition of associated persons and of a nominee
should be
sufficient to deal with circumstances where there is any understanding or
arrangement between the group and the non-controlled
foreign company to act in
concert.
Recommendations
3.5.11 Accordingly, the Committee recommends
that:
the purpose of acquiring or holding that interest; or
CHAPTER 4 – BRANCH EQUIVALENT REGIME: PART 3 – ATTRIBUTION AND COMPUTATION OF BRANCH EQUIVALENT INCOME, LOSSES AND FOREIGN TAX CREDITS
4.1 Introduction
4.1.1 Residents
with an income interest of 10 percent or more in a CFC will be required to
compute the income or loss to be attributed
to them in respect of that CFC. This
will depend on their income interest in the CFC and the BE income or loss of the
CFC. BE income
and losses will generally be calculated according to New Zealand
tax law though, as outlined in section 4.4 below, a number of departures
from
domestic law are required. Where the CFC is resident in a grey list country, its
resident shareholders will be exempt from the
regime unless the company utilises
one or more of what the Committee considers, as discussed in chapter 1, should
be a very limited
list of significant tax preferences. Where such a CFC does
utilise a listed preference, we propose that a much simplified basis of
computing the BE income or loss of the company should apply.
4.1.2 Where
residents have an amount of attributed income or loss in respect of any
accounting year of a CFC, they will be able to
claim a credit for their
proportionate share of the foreign tax paid by the CFC in that year. We propose
that provision be made for
the carry forward of excess foreign tax credits. We
also propose that BE losses be "ring-fenced" on a jurisdictional
basis.
4.1.3 The broad outline of these provisions was decided in
response to the Committee's first report. This chapter outlines our
recommendations
on the remaining details of the attribution and computation of
BE income and losses, the operation of the
grey list exemption, the calculation of foreign tax credits and a number of
related issues. The corresponding parts of the draft legislation
are sections
245E to 245N.
4.2 Attribution of Income and Losses
4.2.1 In Annex
2 of our earlier report, we indicated that we favoured an exemption for persons
with income interests in a CFC of less
than 10 percent. Though such residents
would need to compute their control and income interests on each of the four
measurement days
during a year in order to determine that their income interests
fell below the 10 percent threshold, they would not have to incur
the possibly
much more substantial costs of computing the BE income of the CFC and their
proportionate share of the foreign tax paid
by it. An alternative would be to
have an exemption for residents with BE income below a certain threshold but
this would be self-defeating
from the point of view of minimising compliance
costs since the residents would first have to compute BE income before
determining
whether they were exempt. Hence, the Committee continues to favour
an exemption for residents who have an income interest of less
than 10 percent.
In order to prevent residents from fragmenting their income interests among
associated persons, for the purposes
of this exemption only, a person's income
interests should include those of associated persons.
4.2.2 Where a
resident, together with associated persons, has an income interest in a CFC
which is above the 10 percent threshold,
an amount of income or loss will be
attributed to the person. The attributed income or loss in respect of any
accounting year of
the CFC should be calculated by multiplying the resident's
income interest in the CFC for that year by the BE income or loss of the
CFC for
that year.
4.2.3 As explained in chapter 3, the definition of an
interest in a foreign company needs to be wide in order to cover the variety
of instruments or arrangements which a resident could
use to control and
accumulate income in such a company. The consequence of such a wide definition
is, however, that an attributed
loss may arise where a person has no economic or
financial loss. For example, a person may have an option to acquire shares in a
foreign company which, because it makes a loss, is not exercised. The economic
or financial loss of the person is limited to the
amount he or she paid for the
option. No part of the loss of the company should be attributed to the person.
Similarly, where a person
owns shares in a company which makes a loss, but the
person has an option to require another person to purchase the shares at a
certain
price, the economic or financial loss of the person is restricted by the
option.
4.2.4 A general response to this issue would be to have a wash-up
on disposal of an interest to the effect that the cumulative attributed
income
or loss of a person in relation to any income interest would be limited to the
overall gain or loss he or she realises on
the disposal of the interest. This
type of provision could be considered as a complement to the general taxation of
capital gains.
4.2.5 For the present, we propose that an attributed loss
of a resident not be recognised where the person suffers little or no economic
or financial loss. In applying this provision, it would be necessary to have
regard to such things as the extent to which an attributed
loss is due to a
right to acquire an interest in a CFC with a BE loss and to the extent to which
interests in a CFC with a BE loss
could be disposed of under an option to
require another person to purchase them.
4.2.6 A further consequence of
the way in which we have defined an interest is that it is possible that the
aggregate income interests
of residents may exceed 100 percent. For example, one
resident may own 100 percent of the voting rights of
a foreign company while another holds 100 percent of the dividend rights,
though such an outcome would be unusual. Where it does occur,
more than 100
percent of the BE income or loss of a CFC could be attributed to residents. To
avoid this possibility, we propose that,
where the income interests of 10
percent or more of residents in a CFC in any accounting year when aggregated
would otherwise exceed
100 percent, the income interest of each resident be
apportioned downward so that the aggregate income interest does not exceed 100
percent.
Recommendations
4.2.7 The Committee therefore recommends
that:
4.3 Adoption of CFC's Accounting Year
4.3.1 In Annex 2
of our previous report, we considered that residents should bring to account any
attributed income or loss of a CFC
in the income year corresponding to the
accounting year of the CFC pursuant to section 15 of the Act. Thus, for example,
if a CFC
had a balance date between 1 April and 30 September, any attributed
income of residents in respect of that CFC would be brought to
account in the
income year ending on the preceding 31 March. The advantage of this rule is that
it is the same as that applying domestically.
A problem with this approach,
however, is that where a CFC's balance date falls after that of the resident
taxpayer (it could be
up to one year later), the taxpayer would have obvious
difficulty calculating the BE income or loss of the CFC in the time required
to
file a tax return for the year and little if any information on which to base
his or her provisional tax payments.
4.3.2 The alternative rule would be
to require attributed income and losses to be allocated to the income year in
which the balance
date of the CFC falls. This would mean that the balance date
of the CFC could never be later than that of its resident shareholders,
thus
reducing the compliance problem of computing BE income or losses. For this
reason, we now favour this approach.
4.3.3 As a general rule, we propose
that residents be required to compute their control and income interests in a
CFC and its BE income
or loss based on the accounting year of the CFC. Where the
accounting year of the CFC changes, the Commissioner's approval of the
use of
the new accounting year for the purposes of the BE regime should be required.
Since New Zealand has no jurisdiction over non-residents,
it is not practicable
to require the CFC itself to obtain the Commissioner's consent to the
change.
4.3.4 In determining whether to give his consent to the use of a new balance
date by residents, the Commissioner could consider such
factors as a change of
ownership of the CFC, the requirements of the tax law of the country of
residence of the CFC and the balance
dates of any other companies in the same
group as the foreign company. Where the Commissioner declines to give his
consent, residents
would be required to continue to compute their control
interests, income interests and the BE income or loss of the CFC on the basis
of
its old accounting year. To avoid unnecessary complexity, the Commissioner's
decision should apply to all residents with an interest
in the foreign
company.
4.3.5 Where a CFC changes its balance date to a later date and
the Commissioner consents to residents using the new accounting year,
residents
would compute the BE income of the company for the long accounting period but,
to avoid incentives for balance date changes
in order to defer attributed
income, the corresponding attributed income should be brought to account in the
income year in which
the old balance date falls.
4.3.6 Since it would be
possible to avoid seeking the Commissioner's consent to a balance date change by
instead acquiring a new company
with the desired balance date, consideration may
need to be given to strengthening the Commissioner's powers such that he could
require
taxpayers to compute the BE income of a CFC on the basis of an
accounting year different from that of the CFC.
Recommendations:
4.3.7 Accordingly, the Committee
recommends that:
4.4 BE Income Calculation
4.4.1 In Annex 2 of
our first report, we outlined our views on the general approach that should be
adopted for the calculation of
BE income or losses. As a general rule, the BE
income or loss of a CFC should be calculated as if it were a New Zealand
resident.
A number of departures from domestic law are, however, required:
its cost less the sum of the depreciation deductions allowed under the BE regime. The maximum amount of depreciation recovered would then be the aggregate of the depreciation deductions allowed in computing BE income;
sections 188 and 191 should not apply since, as explained in section 4.6, residents will be able, subject to certain restrictions, to carry forward and group attributed losses. There would be double counting if losses were also able to be carried forward and grouped in the computation of BE income;
not apply, except where the income of a CFC consists of a reinsurance premium paid by a New Zealand insurance company which has been denied a deduction for the premium by virtue of section 208(1)(b);
4.4.2 The above modifications
also have implications for the computation of the income of foreign branches of
New Zealand resident
companies. We therefore recommend that consideration be
given to requiring the income of foreign branches to be computed on the same
basis as the BE income of CFCs.
4.5 Foreign Tax Credits
4.5.1 Residents
with income interests in CFCs (together with those of associated persons) in
excess of the 10 percent threshold will
be assessed on their pro rata share of
the BE income of the CFC and will receive a pro rata credit for the income tax
paid by that
company. It is therefore necessary to have provisions for
determining how the tax credit is to be calculated.
4.5.2 New Zealand,
like most countries, currently allows residents a credit for foreign taxes paid
on foreign-source income up to
the amount of New Zealand tax that is payable on
that income. This is provided for under section 293 of the Act. The most
important
application of this section is to foreign-source income earned by
resident companies through foreign branches. A branch is not a
separate legal
entity so its income is amalgamated with that of its parent company for New
Zealand tax purposes. The company is then
able to claim a credit for the foreign
tax paid by the branch.
4.5.3 The general approach of the BE regime, as
the name suggests, is to treat CFCs in the same way as branches. The foreign tax
credit
provisions applying to the BE regime should therefore be based as far as
possible on the existing provisions. Section 293 is, however,
rudimentary. While
it may suffice when, as at present, it has limited application, it will not do
so for the much more significant
purposes of the BE regime. We therefore propose
modifications to the section 293 provisions for the purpose of the BE regime.
These
modifications could apply equally to branches, suggesting that section 293
should itself be amended.
4.5.4 The first issue to consider is the
definition of the
foreign taxes which can be credited. Under the present section, creditable
income tax is any tax which, in the opinion of the Commissioner
is of
"substantially the same nature" as New Zealand income tax. This definition has
some ambiguity but most tax practitioners consider
that it includes income taxes
levied by central, state or local governments, provided that they are of
substantially the same nature
as New Zealand income tax. The Department takes
the view that only federal level income taxes are creditable. To clarify the
issue,
a legislative amendment is necessary. We propose that, for the purpose of
the BE regime, any income or withholding tax paid by a
CFC be creditable. Since
a CFC may pay New Zealand income tax if it has New Zealand-source income, such
tax should also be creditable
under the BE regime.
4.5.5 In some cases, a
CFC may earn income which is not subject to tax in either the jurisdiction in
which it is derived or the jurisdiction
in which the CFC is resident. The income
tax paid by the CFC on its taxable income would then be credited towards the
resident's
income tax payable on the total BE income of the company, including
that which is exempt to the CFC. This would permit income tax
paid in one
jurisdiction to relieve New Zealand income tax on income which was exempt in
another. We therefore propose that the proportion
of the total income tax paid
by a CFC that is creditable under the BE regime be the proportion of its total
income that is taxable
in its country of residence or the country of source of
the income.
4.5.6 A resident's proportionate share of the total
creditable income tax paid by a CFC in any accounting year should equal the
proportion
that the resident's attributed income or loss in that year in
relation to that CFC makes up of the BE income or loss of the CFC in
that year.
This should be found by multiplying the person's income interest in the CFC by
the total amount of the creditable income
tax it has paid. Where residents with
income interests in a CFC of 10 percent or more have an aggregate income
interest in that CFC
of more than 100 percent, the tax
credit allowed to each person would be scaled down according to the rule
outlined in section 4.2.
4.5.7 As noted above, section 293 currently
limits the maximum credit allowed in respect of any foreign income to the New
Zealand
income tax payable on the income. We consider that it is necessary to
have an equivalent provision in the BE regime since foreign
tax could otherwise
be used to offset New Zealand income tax payable on New Zealand-source
income.
4.5.8 As a result of this limitation, the credit allowed to
residents will sometimes exceed the New Zealand income tax payable on
their
attributed income. The question therefore arises of whether residents should be
able to offset excess tax credits in respect
of one CFC against their New
Zealand tax payable on attributed income derived from another CFC. The CD
proposed that credits should
be limited on an entity by entity basis and a
source by source basis. That is, residents would be required to separate out the
taxable
income (measured under New Zealand rules) of each CFC according to the
jurisdiction in which the income was sourced, determine the
foreign tax paid by
the CFC in respect of each category and the New Zealand tax payable on each
category. This approach would therefore
be complicated. In addition, the dual
limitation would not be effective where the New Zealand resident controllers of
more than one
CFC could shift income between CFCs. The scope for such shifting
will be greatest when the CFCs are in the same jurisdiction.
4.5.9 An
alternative approach advocated in submissions would be to have a global
computation of attributed income and foreign tax
credits. This would, however,
allow the tax paid by a CFC in a high tax jurisdiction to offset New Zealand tax
payable on attributed
income derived through CFCs in low tax jurisdictions.
Thus, the income of tax haven companies, which could include income diverted
from New Zealand, could be sheltered by foreign tax paid by a CFC in a high tax
jurisdiction. This would not be
consistent with the anti-avoidance objective of the international
reforms.
4.5.10 The Committee favours an intermediate approach of a
country by country limitation. That is, residents would be able to aggregate
the
attributed income or loss they derive from CFCs which are resident in the same
jurisdiction. Similarly, they would aggregate
allowable foreign tax credits in
respect of those CFCs. The resulting aggregate foreign tax credit would be able
to be credited towards
the New Zealand tax payable on the resident's aggregate
attributed income derived in that jurisdiction, with the maximum credit equal
to
the New Zealand tax payable. This approach recognises that scope exists for
shifting income between companies in the same jurisdiction
but, as far as it is
possible to do so, avoids allowing residents to use tax paid in high tax
jurisdictions to shelter income in
low tax jurisdictions. In addition, we note
that a country by country limitation is consistent with the existing rules in
section
293.
4.5.11 A further issue is the extent to which excess tax
credits with respect to any jurisdiction should be able to be carried forward
or
backward. Excess foreign tax credits could arise because New Zealand and the
foreign country calculate taxable income differently
or because the New Zealand
tax rates differ from those in the other country. We consider that an adjustment
to take account of differing
tax rates is not necessary for the purposes of the
BE regime as long as the maximum allowable credit in any year is limited to the
New Zealand tax payable on attributed income derived in that
year.
4.5.12 The main argument for allowing excess credits to be carried
into another income year is to smooth out the effect of income
measurement
differences. For example, under our accrual rules, interest income is accrued
over the term of the instrument. If another
country taxes interest only on
receipt, there may be no foreign tax payable in a particular year because
no interest is received, and hence no foreign tax credit, whereas a New
Zealand resident would be taxed under the BE regime on accrued
interest. When
the interest is received, it would be taxable in the other jurisdiction but,
provided that it had been accrued correctly,
no income would be derived under
the New Zealand rules. Thus, both New Zealand tax and foreign tax would be
payable on the same income
and no foreign tax credit would be allowed because
the foreign and the New Zealand taxable income would fall into different years.
To avoid such consequences, we propose that excess credits of a resident with
respect to an interest in a CFC should be able to be
carried forward for credit
against the New Zealand tax payable on attributed income of the resident in
future income years derived
in respect of that CFC or other CFCs resident in the
same jurisdiction. In principle, carry back might also be allowed but we do
not
favour it because of the administrative difficulties of reopening past
assessments.
4.5.13 For consistency with our proposed treatment of
losses, which is discussed in more detail in the next section, we propose that
the carry forward of a credit by a company should be subject to a 40 percent
continuity of shareholding test equivalent to that in
section 188, the company
loss carry forward provision. For the same reason, we recommend that credits be
able to be transferred between
the companies in a group of companies. Transfer
of losses by way of subvention payments has no parallel in the case of foreign
tax
credits. Thus, we propose that the grouping of credits be permitted only in
the case of specified groups (i.e those with 100 percent
common shareholding),
subject to provisions equivalent to those in section 191.
4.5.14 Finally,
we note that a double taxation problem may arise when a company falls within
both the BE regime and the CFC regime
of another country. For example, a New
Zealand resident may own a United Kingdom ("UK") company which in turn owns a
company in Cyprus.
The UK company may incur a tax liability under the UK's CFC
regime in respect of the Cyprus company. The New
Zealand BE regime would attribute a New Zealand tax liability to the New
Zealand resident in respect of the Cyprus company but credit
would not be
allowed for the UK tax paid by the UK company since it was not paid by the
Cyprus company. To avoid double taxation
in these circumstances, we propose that
foreign income tax paid by a CFC in respect of income attributable to another
CFC be deemed
to be paid by the latter.
Recommendations
4.5.15 Accordingly, the Committee recommends
that:
income tax payable in any future income year on attributed income in respect of CFCs resident in that jurisdiction;
4.6 Attributed Foreign Losses
4.6.1 In
the domestic context, the New Zealand tax system is based on a global
computation of income. That is, residents amalgamate
their profits and losses
from all their activities and are taxed on the basis of the net result. There
are two reasons to depart
from this global treatment in the context of the BE
regime. First, a BE profit is not equivalent to a domestic profit as far as the
consequences for tax revenue are concerned because of the allowance of a foreign
tax credit. New Zealand will collect revenue on
the BE profits of CFCs only to
the extent
that the foreign tax credit allowed is less than the New Zealand tax payable
on the profits. For this reason, a BE loss should also
be treated differently
from a domestic loss. The regime would be asymmetric if it permitted attributed
losses to be aggregated with
domestic income but then allowed a credit for
foreign tax paid by a CFC once a resident had attributed income. Thus, one of
the consequences
of allowing a credit for income taxes paid by a CFC is the need
to restrict the offset of attributed losses against domestic
income.
4.6.2 Secondly, unrestricted offset of BE losses would give rise
to problems where New Zealand residents were able to acquire losses
in foreign
companies. We referred earlier to the need for a special provision to counter
this, but such provisions can never be fully
effective.
4.6.3 For these
reasons, we consider that attributed losses under the BE regime should not be
able to be offset against other taxable
income. At the same time, we recognise
that loss ring-fencing is seldom very effective, particularly in the absence of
interjurisdictional
allocation rules. Taxpayers invariably find ways to mitigate
its effect. Nevertheless, unrestricted offset of BE losses against domestic
income could not be justified.
4.6.4 The Committee proposes that
taxpayers be able to aggregate attributed income and losses from income
interests in CFCs resident
in the same jurisdiction. As noted in the previous
section, the rationale for not permitting grouping of attributed income and
losses
derived in different jurisdictions is that this would permit income
accumulated in low tax jurisdictions to be sheltered by losses
derived in high
tax jurisdictions. This would not be consistent with the basic anti-avoidance
objective of the regime.
4.6.5 Where a taxpayer's aggregate attributed
income for a
jurisdiction is a loss, we propose that it be able to be carried forward for
offset against future attributed income derived from
income interests in CFCs
resident in that jurisdiction. Where the taxpayer is a company, the carry
forward of an attributed loss
should be subject to provisions equivalent to
those in section 188. In addition, as for tax credits, we propose that companies
in
the same specified group that have income interests in two or more CFCs in
the same jurisdiction should be able to aggregate their
attributed income and
losses in respect of those interests, subject to provisions equivalent to those
in section 191.
Recommendations
4.6.6 Accordingly, the Committee recommends
that:
4.7 Application of the Regime to CFCs Resident in a "Grey List" Country
4.7.1 The BE
regime will not apply to a CFC resident in "grey list" countries (i.e the United
States, United Kingdom, West Germany,
Japan, France, Canada and Australia)
unless the CFC utilises a specified significant tax preference. Where such a CFC
did utilise
a listed preference, we recommended in our first report that its
resident controllers should be required to adjust the taxable income
of the CFC,
measured according to the tax law of its country of residence, for the effect of
the preference. If the foreign tax paid
by the CFC as a percentage of the
adjusted taxable income equalled or exceeded the New Zealand company rate, the
CFC would remain
exempt from the regime.
4.7.2 The application of the
regime in these circumstances can now be spelt out in more detail. We consider
that the best approach
is to adopt a simplified computation of BE income
whenever a CFC resident in a grey list country utilises a listed significant
preference
in a particular income year. In such cases, the BE income of the CFC
would equal its taxable income in that year computed according
to the tax law of
its country of residence before taking into account any losses incurred by the
CFC in other years or losses incurred
by any other company, adjusted for the
effect of the listed preference.
4.7.3 The adding back of any losses
incurred by the CFC or any other company is necessary in part for consistency
with the way in
which the BE regime will apply outside of the grey list
countries and in part to prevent possible double counting of losses, once
in the
computation of the BE income of a grey list CFC and again as an attributed loss
in the hands of resident taxpayers.
4.7.4 In all other respects, the BE regime would apply to grey list CFCs in
the same way as for other CFCs. Where a grey list CFC
fell into the regime by
virtue of utilising a significant preference, no New Zealand tax would be
payable on its BE income to the
extent that it paid income tax at least equal to
the New Zealand tax that would be payable on its income. Thus, the allowance of
a tax credit has the same effect as the rate test outlined in paragraph
4.7.1.
Recommendation
4.7.5 The Committee therefore recommends
that where a CFC resident in a grey list country utilises a listed significant
preference
in any accounting year, the BE regime apply as for CFCs resident in
other jurisdictions except that the BE income or loss of the
CFC be computed as
its taxable income or loss for that year, measured according to the tax law of
its country of residence (before taking into account any losses of the
CFC incurred in other years or losses incurred by any other company), adjusted
for the effect of the listed preference.
4.8 Change of Residence of CFC or Taxpayers
4.8.1 Provisions
are required to deal with changes of residence of foreign companies and New
Zealand residents. For example, where
a resident company ceases to be resident,
it should be deemed to have an accounting period that commences on the day on
which it
ceases to be resident so that, if it falls into the BE regime as a
result of its change of residence, an accounting period with respect
to the
computation of BE income is defined. These rules are therefore necessary for the
mechanics of the BE regime.
4.8.2 The compliance costs of computing BE
income for a short accounting period required as a result of a change of
residence may be excessive. Thus, residents should have the option of pro
rating the income derived by the CFC in its actual accounting
year.
4.9 Determination of Residence
4.9.1 A
number of provisions of the proposed regime depend on the residence of a
company. For example, we have proposed that the carry
forward of losses and
excess tax credits be limited on a jurisdictional basis. In addition, the
transitional provisions are related
to the fiscal residence of a foreign
company. This means that it is necessary to have provisions for determining
unambiguously the
residence of a foreign company.
4.9.2 The fiscal
residence of a company will normally be the jurisdiction in which it is liable
for tax. Where a company is resident
in two or more jurisdictions, it should be
regarded as being resident in the jurisdiction which the New Zealand residence
rules would
assign it to. If this still does not prescribe a single residence to
the company, the country in which most of its assets are located
should be its
fiscal residence. Where none of these rules settles the residence of a company,
there is no option but to let the Commissioner
decide.
CHAPTER 5 – FOREIGN INVESTMENT FUNDS
5.1 Introduction
5.1.1 The
foreign investment fund regime is to apply to interests in offshore investment
vehicles which fall outside the BE regime
but nevertheless confer tax advantages
on residents because of a favourable tax treatment in the country of residence
of the fund.
An investment fund in the form of a unit trust domiciled in a tax
haven is a typical example of such an entity. By accumulating rather
than
distributing most of its income, the fund can convert income such as interest
and dividends into a capital gain to the investor,
which can be realised either
by sale through a stock exchange or by repurchase by the fund or its
managers.
5.1.2 We defined a foreign investment fund in our previous
report as any entity:
5.1.3 The taxable income derived by a New Zealand
resident from an interest in a foreign investment fund in any income year is to
be calculated as the increase in the market value of the
interest over the income year, plus any distributions receivable by the
resident.
5.1.4 This chapter outlines the Committee's recommendations on
the remaining issues which need to be decided in order to implement
the foreign
investment fund ("FIF") regime. The relevant section in the draft legislation is
section 245O.
5.2 Definitions
5.2.1 The
definition of a FIF in the draft legislation follows closely the one outlined
above with the following changes. Instead
of referring to an "entity", the
definition lists the types of entities which could be FIFs, namely, a foreign
company, a foreign
unit trust and a foreign superannuation fund ( which together
can be referred to as "foreign entities"). Although a unit trust is
deemed to be
a company by section 211 of the Income Tax Act, we have expressly referred to
unit trusts to emphasise their inclusion
in the FIF definition. We propose that
the new definition of "superannuation fund" to be added to section 2 as a result
of the current
review of the tax treatment of superannuation also apply for the
purposes of the FIF definition.
5.2.2 The explicit inclusion of unit
trusts and superannuation funds in the definition recognises that some countries
give favourable
tax treatment to such entities. A parallel change is therefore
needed to the second leg of the definition, which requires a person
to have
regard to the jurisdiction in which the entity is resident, requiring a person
to also have regard to be concessionary tax
regimes applying within that
jurisdiction.
5.2.3 An interest in a FIF is defined in the same way as a
direct income interest in a foreign company for the purposes of the BE
regime.
As explained in chapter 3, income interests are defined in terms of the things
that a shareholder of a company, or a person
entitled to acquire shares, would
hold. A person
may, however, have rights to the income of a foreign entity by holding a life
insurance or superannuation policy issued by that entity.
Consequently, life
insurance or superannuation policies must be added to the definition of an
interest in a foreign entity for the
purposes of the FIF regime. Such an
interest will, however, be taxable under the regime only if the foreign entity
that issued the
policy falls within the definition of a
FIF.
5.2.4 Constructive ownership rules are not needed in this regime
since there is no control test, nor do we propose a minimum interest
threshold
before the regime applies. Given that the market value of an interest in a FIF
will reflect the value of the FIF's direct
and indirect interests, it is
necessary to focus on direct interests only.
Recommendation
5.2.5 Accordingly, the Committee recommends
that the foreign investment fund regime apply to interests in foreign companies,
foreign
unit trusts and foreign superannuation funds that fall within the
definition of a foreign investment fund and that the definition
of an interest
in a foreign investment fund include policies of life insurance or
superannuation issued by a foreign investment fund.
5.3 Calculation of FIF Income or Loss
5.3.1 The
income or loss in any income year that a person derives from an interest in a
FIF is to be measured by the change in value
of the interest over the year.
Taking into account purchases and sales within a year, the taxable income or
loss of a person holding
an interest in a FIF in any income year can be defined
as:
(a + b) − (c + d)
where a = the market value of the interest held at the end of the income year;
b = the market value of all distributions and any other consideration receivable by the person in that income year with respect to that FIF, including any consideration resulting from any disposal of an interest during the income year;
c = the market value of the interest held at the end of the previous income year; and
d = the market value of any consideration paid by the person for the
acquisition of an interest during the year.
This definition is
essentially the same as the one that you approved in response to our
recommendation in Part 1 of our Report on
International Tax
Reform.
5.3.2 The term "b" in the above formula is defined to include
within FIF income all distributions of a FIF. All such distributions,
whether of
income or capital, need to be included within the definition since any
distribution will reduce the end of year market
value of a FIF interest.
Furthermore, distributions should be taxed in the year they become receivable,
rather than the year that
they are received, since the corresponding reduction
in the market value of a FIF interest resulting from a distribution will be
taken into account on an accrual basis. Finally, all distributions must be
included, whether they are in cash or otherwise and whether
or not they are
received directly or are credited in account or are otherwise dealt with in the
interest or on behalf of the person.
5.4 Treatment of Losses
5.4.1 FIFs have
been defined so that it can be reasonably assumed that the change in the market
value of an interest in a FIF over
an income year will reflect the change in the
market value of its net assets over the year. The growth in a FIF's net assets
over
a year will in turn depend on its income for that year, reduced by any tax
paid and by any amount distributed to interest holders
during the year. Thus,
FIF income or losses will be measured net of any income tax paid by the fund.
This means that it is not appropriate
to allow interest holders a credit, or a
deduction, for any income tax paid by a FIF.
5.4.2 By contrast, a tax
credit is to be allowed under the BE regime. We recommended in respect of the BE
regime that attributed income
and losses of a person under the regime should not
be amalgamated except where they are derived in respect of interests in CFCs
resident
in the same jurisdiction. Residents would otherwise be able to use
credits for tax paid by a CFC in a high tax jurisdiction to offset
a New Zealand
tax liability in respect of an interest in a CFC resident in a low tax
jurisdiction. This consideration is not relevant
under the FIF regime since
credits will not be given. We therefore propose that residents should be able to
aggregate their FIF income
and losses derived in any income year, irrespective
of the residence of the FIF.
5.4.3 In order to ensure that residents are
not double taxed on FIF income, once as it is reflected in an increase in the
market value
of an interest and again on distribution, it is necessary to allow
FIF losses to be deductible. The regime should not, however, permit
residents to
claim a deduction for a FIF loss of income and/or capital accumulated or
contributed prior to the introduction of the
regime. It is therefore necessary
to limit the FIF loss that can be deducted by a resident in any income year to
the amount of the
FIF income, if any, derived by the resident in that year or an
earlier income year with respect
to any FIF. Thus, where a FIF loss derived by a resident in any income year
exceeds his or her FIF income for that year, the excess
loss should be able to
be deducted from other income of the resident derived in that year to the extent
that the excess loss was
less than the cumulative FIF income of the resident
derived in earlier income years, less the amount of any such excess losses set
off against other income in those earlier years. The effect of this rule is that
a FIF loss could be deducted only to the extent
to which a person has previously
or will currently be taxed on FIF income.
5.4.4 To the extent that a FIF
loss cannot be deducted in the year that it is derived, it should be carried
forward for offset against
FIF income derived in subsequent years. Where the
taxpayer is a company, such a loss carry forward should be subject to a 40
percent
shareholding continuity test, as we have recommended in the case of BE
losses. Similarly, FIF income and losses should be able to
be amalgamated within
a specified group of companies resident in New Zealand, subject to provisions
comparable to those applying
to the grouping of losses under section
191.
Recommendations
5.4.5 Accordingly, the Committee
recommends that:
earlier income years, less the sum of any excess losses set off against other income in those earlier years pursuant to this provision;
5.5 Entry and Exit Provisions
5.5.1 Occasions
will arise when an interest in a FIF will fall within or cease to be within the
regime without an acquisition or disposal
at market value occurring at the same
time. This will happen when:
interest in a CFC of not less than 10 percent, or vice versa.
In such
cases, the interest should be deemed to be acquired or disposed of, as the case
may be, for its market value on the relevant
day.
Recommendations
5.5.2 Accordingly, the Committee
recommends that a deemed acquisition or disposal at market value occur
when:
5.6 Conflict Provisions
5.6.1 As
decided previously, where an interest in a foreign company would give rise to
attributed income under both the BE and FIF
regimes, the BE regime will apply.
This is provided for in section 245P of the draft legislation. The exemption
from the BE regime
for income interests of less than 10 percent does not,
however, apply to the FIF regime. Thus, persons holding income interests in
a
CFC of less than 10 percent may fall within the FIF regime if the CFC is a
FIF.
CHAPTER 6 – TRUSTS
6.1 Introduction
6.1.1 In
many circumstances, trusts can substitute for CFCs or FIFs. Hence, it is
necessary to support the BE and FIF regimes with
a regime applying to trusts. We
referred to the trust regime in our first report as "the settlor regime" because
it will bring within
the tax net the foreign-source trustee income of trusts
which have one or more New Zealand resident settlors. This trustee income
is now
not subject to tax in New Zealand where the trust has non-resident
trustees.
6.1.2 A further deficiency with the current rules is the
ambiguity about the tax treatment of distributions from non-resident trustees
to
New Zealand beneficiaries. This was discussed in the Consultative Document
released in December and we have drafted legislation
to deal explicitly with
this type of income. The present rules also attempt to deal, though not very
effectively, with the use of
trusts for income splitting. With the recent
considerable flattening of personal income tax rates, the need for such
provisions has
lessened. We have therefore taken the opportunity to recommend
changes to the existing tax legislation applying to trusts. The result
is a new
regime for trusts which would apply to domestic trusts as well as to overseas
trusts with New Zealand connections.
6.1.3 This chapter outlines the new
regime. Transitional issues relating to the treatment of settlements in
existence on or before
17 December 1987 are dealt with in chapter 8.
6.2 Existing Treatment of Trusts
6.2.1 The
present tax treatment of trusts is dealt with primarily in sections 226 to 233
of the Income Tax Act 1976. Section 226 currently
distinguishes between
"specified" and "non-specified" trusts. Broadly speaking, non-specified trusts
include trusts created by will
or on an intestacy and inter-vivos trusts created
before 19 July 1968. Specified trusts are inter-vivos trusts created on or after
that date. The distinction was brought into existence by an amendment to the
Land and Income Tax Act 1954 following the 1968 Budget.
The difference between
the two types of trust is purely a matter of tax treatment of the income derived
by their trustees and beneficiaries.
It is not founded in any jurisprudential
distinction between trusts of different kinds.
6.2.2 The policy behind
the distinction was an effort to frustrate income splitting by means of trusts
which was thought to have become
particularly prevalent in the 1960's. The
benefits of income splitting achieved by taxpayers were enhanced by the steeply
progressive
income tax scales that prevailed at that time and that remained in
force until relatively recently. The effect of this policy is
that, broadly
speaking, income of a specified trust is taxed at a higher rate than income of a
non-specified trust.
6.2.3 The current law further distinguishes between
trusts or, more precisely, between different streams of trust income, according
to whether income is accumulated by trustees or distributed to beneficiaries
and, if the latter, according to whether the distribution
is pursuant to a
discretion vested in the trustee or to a provision of the trust that fixes the
rights of a beneficiary to income.
Finally, a distinction is drawn in some
circumstances according to whether the beneficiary is an infant or an adult.
6.2.4 Income accumulated by a trustee is taxed in the hands of the trustee at
the rates that would apply if the trustee were an individual
and had no other
income. For specified trusts, there is a minimum rate of 35 percent, reflecting
the 1968 policy of harsher treatment
for these trusts.
6.2.5 When a
trustee does not accumulate income but instead it is derived in trust for a
beneficiary "entitled in possession" to the
income, it is taxable to that
beneficiary. This rule works well enough in the case of adults. If income vests
in them by virtue of
the provisions of a trust or by virtue of the exercise of a
discretion by the trustee, they are entitled in possession to that income
because they can call on the trustee to pay it over. This is not the case with
infants (nor with persons who lack full legal capacity
for other reasons, such
as unsoundness of mind) since an infant is not entitled to the possession of
income.
6.2.6 Thus, where, in the exercise of a discretion by a trustee,
income is paid to or applied for the benefit of a beneficiary by
a "bona fide
transaction" which places the income beyond the possession and control of the
trustee, the beneficiary is deemed to
be entitled in possession to the income so
long as the payment or application is made within six months of the end of the
income
year in which the income is derived. The six month rule enables a trustee
to calculate the trust's income for the relevant year before
applying the money
for the benefit of a beneficiary.
6.2.7 An additional condition applies
in the case of a specified trust or an infant beneficiary. In that case, where
the income comes
within the possession or under the control of the trustee or is
used for the purposes of a business carried on by the trustee, it
is reassessed
to the trustee instead of the beneficiary. This rule is part of the harsher
regime for specified trusts mentioned in
paragraph 6.2.4.
6.2.8 The precise effect of the "bona fide transaction" requirement is not
certain. In many cases this requirement poses few problems
because income is
employed to meet current needs of the beneficiary. In other cases, trustees go
to some lengths to ensure that there
has been something that qualifies as a
payment or an application. A common technique is for the trustee to establish a
sub-settlement
for the benefit of the beneficiary and for income to be
channelled to that sub-settlement. The second requirement outlined in paragraph
6.2.6 in many cases is also able to be avoided, albeit at some cost in the
establishment of sub-settlements and other planning devices.
6.2.9 In the
case of fixed trusts other than specified trusts, income that vests in an infant
beneficiary is also deemed to be income
to which the beneficiary is entitled in
possession.
6.2.10 In view of the ineffectiveness of the
specified/non-specified trust distinction in countering income splitting and of
the substantial
flattening of the personal income tax scale, the Committee
considers that the distinction should be removed. In addition, because
the
settlor regime supersedes the current trust provisions to some extent it is
simpler to replace all of sections 226 to 233 by
new provisions which cover both
wholly domestic trusts and trusts with foreign elements.
Recommendation
6.2.11 Accordingly, the Committee recommends
that the present distinction between specified and non-specified trusts in
sections 226
to 233 of the Act be removed from 1 April 1988.
6.3 Overview of Trust Regime
6.3.1 The major
difference between the existing tax treatment of trusts and the proposed new
regime is that the latter brings within
the New Zealand tax net the trustee
income of trusts with
non-resident trustees which have a New Zealand resident settlor. Such income
has previously not been subject to tax in New Zealand
except where it has a New
Zealand source. As explained in Part 1 of our report, the new regime recognises
that the economic substance
of a trust may differ from its legal appearance. A
settlor may have substantial influence over the trustee, usually on an informal
basis though there may be specific provision in the trust deed so that, in
practice if not in law, a settlor may be able to wind
up a trust and influence
or control the disposition of its property.
6.3.2 If this assumption does
not accord with the circumstances of a particular trust, then in future New
Zealand residents can settle
trusts on resident trustees and divest themselves
of any liability for tax on trustee income. If they wish to use non-resident
trustees,
they must be prepared to have the trustee's liability for New Zealand
tax on trustee income fall back on them should the trustee
default. We recognise
that this choice may not be available in respect of trusts that were settled
before 17 December 1987 and so
have recommended that the settlor in these
circumstances not be liable for tax on trustee income. A number of transitional
provisions
relating to these trust are outlined in chapter 8.
6.3.3 Thus,
under the new regime, the foreign-source trustee income of any trust will be
taxable in New Zealand where, at any time
in an income year, a settlor of the
trust is resident in New Zealand. Trustee income is income derived by a trustee
of a trust in
any year that is not beneficiary income of any beneficiary of the
trust. The tax treatment of trustee income is discussed in section
6.5. We refer
to a trust in respect of which trustee income has been taxable in New Zealand in
every income year since its settlement
as a "qualifying trust". The liability
for the tax on trustee income will fall on the trustee. Where there is no
resident trustee,
the New Zealand resident settlor will be liable as agent of
the trustee. In effect, the settlor is treated as the "taxpayer of last
resort"
in respect of trustee income.
6.3.4 We propose that settlors of trusts that are charitable trusts or
superannuation funds not be liable for tax on trustee income
as agents of the
trustees. In addition, we propose that, where a trust is settled by a new
resident before he or she becomes resident
in New Zealand, the settlor should
not be liable for tax on trustee income provided that the settlor has not been
resident in New
Zealand at any time after 17 December 1987. These provisions are
outlined in sections 6.6 to 6.8. We propose, however, that a new
resident in the
above circumstances should be able to elect to become liable for tax on trustee
income. Similarly, a trustee of a
trust which has a settlor who is no longer
resident or who has died should be able to elect to continue to pay tax on
foreign-source
trustee income so that the trust retains it status as a
qualifying trust.
6.3.5 The income derived by a trustee of a trust in any
income year is either "trustee income" or "beneficiary income". Beneficiary
income is, broadly, that part of the income derived by the trustee in any income
year which vests in or is distributed to a beneficiary
in the same year. Section
6.9 sets out the proposed treatment of such income. A beneficiary may also
receive distributions from a
trust other than beneficiary income. Such
distributions could consist of income received by a beneficiary after the income
year in
which it is derived by the trustee or distributions from current or
prior year gains that are not taxable income. Any payment, benefit,
property or
other consideration derived by a beneficiary from a trust, including beneficiary
income, will be referred to as a "distribution".
The draft legislation refers to
the taxable portion of such a distribution as a "taxable distribution". The
taxation of distributions
is discussed in sections 6.10 to 6.12.
6.3.6 As
noted above, trusts in respect of which trustee income has been subject to tax
in New Zealand in all income years since their
establishment will be called
"qualifying trusts". We use the term "qualifying" since we propose that
distributions
from such trusts, other than beneficiary income, should qualify as
non-assessable income in the hands of beneficiaries.
6.3.7 A second
category of trust will be called a "foreign trust". We define a foreign trust as
a trust that has not had a settlor
who is or was a resident of New Zealand at
any time after 17 December 1987. We propose that distributions of the trustee
income of
these trusts derived by the trustee in accounting years commencing on
or after 1 April 1988 and any beneficiary income derived by
a beneficiary of
such a trust be taxable in New Zealand but other distributions be
non-assessable. These proposals are discussed
in section
6.11.
6.3.8 Distributions, other than beneficiary income, which are made
by the trustee of a trust that is neither a qualifying trust nor
a foreign trust
will be referred to as "non-qualifying distributions". This term is not used in
the draft legislation but, for convenience
of exposition, we have employed it in
this report. For example, distributions from trusts in respect of which trustee
income has
not been subject to tax in New Zealand in all income years since
their settlement, other than foreign trusts, will be non-qualifying
distributions. Since non-qualifying distributions may consist of income which
has never been taxed in New Zealand and may not have
been taxed in any other
jurisdiction, they should not be non-assessable in the hands of beneficiaries.
Our proposals in relation
to these distributions are outlined in section
6.13.
6.3.9 The distinction between qualifying, foreign and other trusts
is therefore an important determinant of the way in which we propose
that
distributions from trusts should be taxed.
6.4 Definition of a Settlor
6.4.1 A
cornerstone of the regime is the definition of a settlor. This is dealt with in
section 226 of the draft legislation. There
are several legs to the
definition:
or she nominates, as a beneficiary, the resident is deemed to be a settlor;
6.4.2 The above
definition of a settlor elaborates for the purposes of the draft legislation the
very wide definition of a settlor
and a settlement recommended in our previous
report.
6.5 Trustee Income
6.5.1 As
mentioned above, "trustee income" means income derived by a trustee of a trust
in any income year that is not beneficiary
income of any beneficiary of the
trust. Where trustee income is derived in New Zealand, the trustee, whether
resident or not, will
be liable for tax in New Zealand on the
income.
6.5.2 The settlor regime brings into the New Zealand tax net
trustee income which is derived outside New Zealand in any income year
if the
trust has a settlor who is resident in New Zealand at any time during the year.
Thus, where there is a resident settlor, both
New Zealand- and foreign-source
trustee income will be assessable in New Zealand.
6.5.3 As the Committee
recognised in Part 1 of its report, where trustee income is to be subject to New
Zealand taxation, the best
course is to tax it in the hands of the trustee as if
he or she were a resident. It is the trustee who derives the income and it
is to
the trustee that one should look in the first instance for the resultant tax.
Consequently, in the case of a trust where there
is a New Zealand resident
settlor at any time during the income year, the primary liability for income tax
should
fall on the trustee.
6.5.4 As discussed in our previous report, where
there may be difficulties in enforcing the trustee's liability for tax on
non-New
Zealand source income, it is necessary to make the resident settlor
liable for tax on trustee income as agent for the trustee. Such
difficulties may
obviously arise where a trust has no resident trustees. If a trustee is
resident, the Department can pursue the
trustee through the legal process and
has recourse to the trustee's assets. Where, however, the trustee is a shell
company with no
tangible assets in New Zealand, problems of enforcement may
still occur. We therefore propose that the settlor of a trust not be
liable for
tax on trustee income if the trustee is resident in New Zealand and is a natural
person, a trustee company within the
meaning of the Trustee Act
1956.
6.5.5 In other cases, the settlor of a trust will be liable as
agent of the trustee for tax on the trustee income of the trust. This
liability
will not, however, arise if the trust was settled on or before 17 December 1987
unless the settlor elects to be so liable.
We propose a number of other
exemptions in respect of superannuation funds, new residents and charitable
trusts which are discussed
in sections 6.6, 6.7 and 6.8.
6.5.6 In
summary, foreign-source trustee income will be liable for tax in New Zealand in
any income year in which the trust has a
settlor who is resident in New Zealand.
The primary liability for the tax will fall on the trustee. Where the trust was
settled after
17 December 1987, a liability for tax on trustee income, in the
event of the default of the trustee, will also fall on a resident
settlor except
in certain circumstances. We propose that these circumstances be that:
6.5.7 Where there is more than one resident settlor, the
simplest treatment is to make them jointly and severally liable for the tax
as
agents of the trustee. The use of the term "agent" brings into play all the
provisions of the Income Tax Act in respect of agency
liability. One of these is
that an agent has a right of indemnity from his principal, in this case the
trustee. Thus, for mechanical
collection purposes, and to fit in with the
existing pattern of the Act, it is appropriate to give the settlor the status of
agent.
This approach should not, however, obscure the policy considerations that
make it appropriate for a New Zealand resident settlor
to be treated, in effect,
as a "taxpayer of last resort" in respect of the trustee income of a
trust.
6.5.8 Circumstances will arise where, though there is no New
Zealand tax liability in respect of foreign-source trustee income because
there
is no resident settlor, a settlor or trustee would prefer that a trust be a
qualifying trust so that distributions of the trust
(apart from beneficiary
income) are non-assessable. For example, a settlor who is emigrating may wish to
continue to have all of
the trustee income of a trust taxed in New Zealand. For
similar reasons, the trustee of a testamentary trust or an inter-vivos trust
following the death of a resident settlor may wish to retain a qualifying trust
status. Accordingly, we propose that a settlor or
trustee of a
trust be permitted to elect to make foreign-source trustee income of the
trust liable for tax in New Zealand in any income year, even
though there may be
no settlor of the trust resident in New Zealand in that year, by submitting a
return of such income by the due
date.
6.5.9 At present the trustee
income of specified trusts is taxed at a rate of 35 percent and the trustee
income of non-specified trusts
at the ordinary marginal tax rates applying to
individuals. Since we have recommended in paragraph 6.2.11 that the distinction
between
specified and non-specified trusts should be abandoned, we consider that
there should be a uniform rate of tax in respect of trustee
income with effect
from 1 April 1988.
Recommendations
6.5.10 Accordingly,
the Committee recommends that:
return of such income by the due date; and
6.6 Settlor liability: Superannuation Funds
6.6.1 A
contributor to a superannuation fund falls within the definition of a settlor
where the fund is constituted as a trust. Where,
however, the superannuation
fund is resident in New Zealand, a separate tax regime is to apply to the
taxation of the trustee income
of the fund. This regime is the subject of a
separate consultative process and supersedes entirely the trust regime which
falls within
our ambit. Consequently, our proposals for the taxation of trusts
do not apply where the trust is a resident superannuation
fund.
6.6.2 Where a superannuation fund is a non-resident, our
understanding is that the regime under consideration in the separate
consultative
process would not apply. We would not, however, propose to tax a
resident contributor to a non-resident superannuation fund on the
worldwide
trustee income of a non-resident superannuation fund. Thus, a contributor who is
technically a settlor of a superannuation
fund should never be liable for tax on
the trustee income of the fund.
6.6.3 The only liability that would fall
on a contributor would arise if the superannuation fund were a non-resident fund
that fell
within the definition of a foreign investment fund. As outlined in
chapter 5, residents with interests in superannuation funds that
are FIFs should
be taxed on the income derived from such interests under the FIF regime.
6.6.4 We therefore propose that a person who makes a settlement on a trust
that is a superannuation fund, as the term is to be defined
for the purposes of
the new tax regime for superannuation funds, should not be liable for tax on the
trustee income of the trust
irrespective of the residence of the trustee. This
exemption would apply, for example, to contributions made to a superannuation
fund by an employee or an employer, including those made by a CFC.
Recommendation
6.6.5 The Committee therefore recommends
that a person who makes a settlement on a trust that is a superannuation fund,
as that term
is to be defined for the purposes of the new tax regime for
superannuation, not be liable for tax on the trustee income of the
trust.
6.7 Settlor Liability: New Residents
6.7.1 An
immigrant who settles a trust before becoming resident in New Zealand is in a
position similar to a settlor of a trust in
existence on 17 December 1987,
provided that the immigrant has not previously been resident in New Zealand
since 17 December 1987.
Thus, we consider that a similar relief from liability
for tax on trustee income is warranted in such cases. In particular, we consider
that, where a person who has never previously been resident in New Zealand after
17 December 1987 becomes resident in New Zealand
after that date and has settled
a trust before becoming resident, that person should not be liable as agent of
the trustee for tax
on the trustee income of the trust.
Recommendation
6.7.2 The Committee therefore recommends
that persons who become resident in New Zealand after 17 December 1987 who have
settled a
trust before becoming resident not be liable for tax on trustee
income in respect of that trust, provided that they have not previously been
resident in New Zealand since
17 December 1987.
6.8 Settlor Liability: Charitable Trusts
6.8.1 Trustees
of charitable trusts are currently exempt from tax in New Zealand by virtue of
sections 61(26) and 61(27) of the Act.
The Government has announced its
intention to review the tax exempt status of charitable trusts, but this is
outside the brief of
the Committee. Given that the trustee income of resident
trustees of charitable trusts is exempt from tax in New Zealand, a person
making
a donation to a charitable trust (who would be a settlor under our definition)
should not be liable for tax on the trustee
income of the trust. Even if the
trustee income of charitable trusts were taxable in New Zealand, it would not be
appropriate to
make resident settlors liable for tax on the worldwide trustee
income of non-resident charitable trusts. Thus, we propose that the
new regime
for the taxation of trustee income should not apply to a person who makes a
settlement on a charitable trust. For this
purpose, we propose that a charitable
trust be defined taking into account the terms of section 61(27). If, however,
the definition
in this section is changed as a result of the current review, it
may be necessary to amend our proposed definition.
Recommendations
6.8.2 Accordingly, the Committee recommends
that a person who makes a settlement on a charitable trust not be liable for tax
on the
trustee income of the trust.
6.9 Beneficiary Income
6.9.1 As
outlined in section 6.3, the receipts of a beneficiary of a trust arise from two
sources:
6.9.2 Beneficiary income, as noted in section 6.2, is
currently defined as income derived by a trustee in any income year to which
a
beneficiary of the trust is entitled in possession in that year. In the light of
the Committee's conclusion in section 6.2 that
the specified/non-specified trust
distinction should be dropped, we propose that beneficiary income be defined
more widely as income
derived by a trustee in any income year which:
whether or not
the beneficiary is an infant or is subject to any other legal incapacity.
6.9.3 This definition would remove the conditions that must be satisfied
under current law in respect of specified trusts and infant
beneficiaries and
those of unsound mind. The effect would be to tax in beneficiaries' hands income
that the current law attempts
to tax to the trustee. We recommend, however, that
trustees should continue to be liable for tax on beneficiary income as agents
for the beneficiaries, as is now the case.
6.9.4 Where beneficiary income
has been subject to tax in another jurisdiction in the hands of the trustee, the
beneficiary (and the
trustee as agent for the beneficiary) should receive a
credit against the New Zealand income tax liability on the income for any
foreign income or withholding tax paid by the trustee. In order that a
disproportionate amount of the foreign tax paid by the trustee
is not credited
to a beneficiary, the credit allowed to the beneficiary should be equal to the
proportion of the total foreign tax
paid by the trustee that the beneficiary
income bears to the total income derived by the trustee in that income
year.
6.9.5 Where a trustee fails to meet an obligation for tax on
beneficiary income and the beneficiary is a New Zealand resident, the
liability
will fall on the beneficiary. Where a beneficiary is a non-resident, the trustee
will be liable, as agent of the beneficiary,
for tax in New Zealand on
beneficiary income only if that income has a New Zealand source. The rate of tax
will depend on whether
the income is ordinary income or non-resident withholding
income. In either case, the settlor should have no liability for tax on
beneficiary income.
6.9.6 The definition of a distribution needs to be
wide enough to encompass indirect distributions to a resident beneficiary. For
example, a taxable distribution paid through a tax-exempt or non-taxable third
party who received the distribution from a trustee
on the understanding that it
was to be paid to or enjoyed by a beneficiary in a tax-free or lightly-taxed
form should retain its
character as a trust distribution.
Other types of indirect distributions from a trustee include gifts, a loan, a
release or abandonment of a debt and a disposition of
property that purports to
be a settlement on a non-qualifying or foreign trust for the benefit of the New
Zealand resident or an
associated person.
6.9.7 The enforcement of tax on
such an extended definition of a trust distribution must rely to a large extent
on disclosure. Failure
by a beneficiary to disclose an indirect distribution
would, however, constitute a failure to disclose assessable income and would
be
subject to the penalties applicable to tax evasion.
Recommendations
6.9.8 Accordingly, the Committee recommends
that:
whether or not the beneficiary is an infant or is subject to any other legal incapacity;
in that income year that the beneficiary income of the beneficiary bears to the total income derived by the trustee in that income year;
6.10 Distributions From Qualifying Trusts
6.10.1 As
explained previously, the expression "taxable distribution" in relation to a
trust refers to a distribution received by
a beneficiary, other than beneficiary
income, that we propose should be taxable. The taxation of trusts has never
involved double
taxation such as occurred under the classical system of company
taxation. Where income has been taxed to the trustee and then distributed
to a
beneficiary, it has not constituted assessable income in the hands of the
beneficiary.
6.10.2 Accordingly, we propose that distributions, other
than beneficiary income, from qualifying trusts, which are trusts in respect
of
which the trustee income has been subject to tax in New Zealand in all income
years since settlement of the trust, be non-assessable
in the hands of
beneficiaries. Thus, there would be no taxable distributions from a qualifying
trust, other than distributions which
represent beneficiary income.
Recommendation
6.10.3 Accordingly, the Committee recommends
that all distributions from the trustee of a qualifying trust (other than
beneficiary
income) be non-assessable in the hands of resident
beneficiaries.
6.11 Distributions From Foreign Trusts
6.11.1 "Foreign
trust" is the term we have employed in our draft legislation to describe trusts
settled by persons who at no time
after 17 December 1987 have been residents of
New Zealand. These trusts came within the definition of a non-resident trust in
Part
1 of our report but the latter term is now superseded. Foreign trusts have
no connection with New Zealand apart from the residence
here of a potential
beneficiary. We therefore concluded in our previous report that distributions of
accumulated income from such
trusts should be taxable in New Zealand with a
credit for any foreign taxes paid by trustees but that distributions of capital
profits
and corpus should be exempt in the hands of
beneficiaries.
6.11.2 As noted in section 6.9, the income of a resident
beneficiary from a trust arise from two sources - beneficiary income and
distributions of trust accumulations received by a beneficiary in an income year
after the year in which it is derived by the trustee,
or distributions from
current year gains of the trust that do not represent taxable income.
Beneficiary income in respect of a foreign
trust should be taxable according to
the provisions outlined in section 6.9.
6.11.3 It is generally believed
that the present law does not tax distributions (as distinct from beneficiary
income) from foreign
trusts. For this reason, we propose that distributions from
foreign trusts of trustee income derived by a trustee in income years
commencing
on or before 1 April 1987 should remain exempt. Distributions of trustee income
of a foreign trust derived in income years
commencing after 1 April 1987 should,
however, be taxable to resident beneficiaries.
6.11.4 As proposed in our
previous report, we recommend that distributions from a foreign trust of capital
profits, whenever derived,
or corpus should remain exempt. As is the case in
the
domestic context with respect to companies, when capital distributions are
subject to more favourable tax treatment than income distributions,
there is
pressure to convert the latter to the former. An anti-avoidance rule is
therefore necessary to prevent trustees generating
contrived capital profits
that could be channelled to New Zealand resident beneficiaries. Hence, we
propose that a provision similar
to that in section 4 relating to distributions
of capital profits by companies be included to the effect that capital gains
realised
in transactions directly or indirectly with associated persons would be
treated as a taxable distribution.
6.11.5 As we have indicated previously
but, for clarity, note again, the income derived by a trustee in any income year
will consist
of taxable income (referred to in the draft legislation as
"income") and non-taxable income (which is referred to as "capital gain"
or
"capital profit"). The taxable income will be either trustee income or, where it
vests in or is paid or applied for the benefit
of a beneficiary, beneficiary
income. Thus, a distribution made to a beneficiary in any income year of income
derived by the trustee
in that year will be either beneficiary income or a
non-assessable profit or gain. Distributions to beneficiaries of income derived
in an earlier year will consist of either trustee income or capital profit or
gain derived by the trustee in that year. To distinguish
among these various
sources, an ordering rule is necessary.
6.11.6 We propose that a
distribution made to a beneficiary in any income year be deemed to be made first
from the taxable income
derived by the trustee in that year. Thus, to the extent
that the taxable income of the trustee absorbed the distribution it would
constitute beneficiary income of the beneficiary. Where distributions made in
any income year exceeded the taxable income derived
by the trustee in that year,
the excess distribution should be deemed to be made first from any capital gains
or profits derived
by the trustee in that year. To the extent that
a distribution in any income year exceeded both the taxable income and
capital gain or profit derived by the trustee in that year,
the excess should be
deemed to be made from the trustee income of the trust derived in the previous
income year not previously deemed
to have been distributed pursuant to these
rules. Any balance of the distribution exceeding the trustee income of the trust
should
be deemed to be made from any capital gain or profit derived by the
trustee in that previous year not previously deemed to have been
allocated, and
so on. The last amount deemed to be distributed would be the corpus of the
trust.
6.11.7 The corpus of a trust should be defined as any property
settled on the trust by natural persons valued at its market value
at the time
of settlement. Corpus should, however, exclude:
6.11.8 Where the ordering rule deems a
distribution to be beneficiary income, it would be taxed to a resident
beneficiary in the same
way as beneficiary income derived from other trusts. The
beneficiary would receive a credit for any foreign income or withholding
tax or
New Zealand income tax paid by the trustee on the income.
6.11.9 Distributions other than beneficiary income are derived either from
untaxed income of the trustee derived in the same year
as the year of the
distribution or of such income or trustee income derived in earlier years.
Whenever a beneficiary receives a distribution
from trustee income of an earlier
year, some deferral benefit is obtained. Because of this, we propose that where
a distribution
received by beneficiary is deemed to be made from trustee income
derived by the trustee, no credit be given to a beneficiary for
any tax paid by
a trustee on the income. We do, however, propose that withholding taxes should
be creditable. The amount of the withholding
credit should be the proportion of
withholding tax paid in respect of the distribution that the taxable
distribution bears to the
total distribution received by the
beneficiary.
6.11.10 Whether a distribution is deemed to be beneficiary
income or a taxable distribution, it should be taxed at the marginal tax
rate of
the beneficiary.
6.11.11 The ordering rule outlined above would require
the trustee on behalf of the beneficiary to determine the deemed source of
all
of the distributions made to any beneficiaries, not just those resident in New
Zealand. A beneficiary should be required to provide
sufficient information with
a return of income to establish that the appropriate portion of a distribution
has been included as assessable
income and to establish the basis upon which any
credit for foreign tax has been allocated. Where this information cannot be
provided
or is insufficient, all of the distribution should be taxable in the
hands of the beneficiary.
Recommendations
6.11.12 Accordingly, the Committee
recommends that, with effect from 1 April 1988:
the fact that it is diverted to the trust; and
6.12 Distribution From Trusts Settled by New Residents
6.12.1 In
section 6.7, we referred to a person who becomes resident in New Zealand after
17 December 1987 who had not previously been
resident here after that date as a
"new resident". We recommended that such a person should not be liable for tax
on the trustee
income of any trust settled before he or she became resident.
This does not affect the liability of the trustee - the trustee is
liable for
tax on all of the trustee income of the trust, wherever it is derived, from the
time at which the settlor becomes resident.
6.12.2 A trust settled by a
new resident before he or she becomes resident has the status of a foreign
trust. We propose
that distributions from such a trust which are attributable to income years
prior to the person becoming resident should continue
to be treated as
distributions from a foreign trust. The provisions for attributing distributions
to particular sources were outlined
in the previous section.
6.12.3 Once
the new resident settlor becomes resident, the trustee of the trust will be
liable for tax in New Zealand on the foreign-
and New Zealand-source trustee
income of the trust derived in or after the income year in which the settlor
becomes resident. The
settlor could also elect to be liable for tax on such
income, pursuant to recommendation c in paragraph 6.5.10. Provided that the
liability for tax on trustee income is met by either the trustee or the settlor
in every income year after the settlor becomes resident,
distributions from the
trust attributable to those income years should be treated as distributions from
a qualifying trust.
Recommendation
6.12.4 Accordingly, the Committee recommends
that where a trust is settled by a new resident before the person becomes
resident in
New Zealand and the trustee or the settlor of the trust meets the
New Zealand tax liability for tax on the foreign- and New Zealand-source
trustee
income of the trust in every income year after the settlor becomes
resident:
6.13 Non-Qualifying Distributions
6.13.1 By
"non-qualifying distributions", we mean distributions, other than beneficiary
income, that are not distributions from either
qualifying trusts or foreign
trusts. In general, these are distributions from trusts in respect of which
trustee income has not been
subject to New Zealand tax in all years subsequent
to their establishment but that have had a settlor who is or was a New Zealand
resident at any time subsequent to 17 December 1987. For example, the settlor of
the trust may in some years be resident in New Zealand
and in other years not.
In addition, distributions from a trust settled by a resident on a non-resident
trustee before 17 December
1987 would be non-qualifying distributions unless the
trust is converted to a qualifying trust pursuant to the recommendations
outlined
in chapter 8. Similarly, those from a testamentary trust (or an
inter-vivos trust following the death of a resident settlor) in relation
to
which the trustee does not elect to be subject to tax in New Zealand on the
foreign-source trustee income of the trust would be
non-qualifying
distributions.
6.13.2 In your press statement with the Minister of
Revenue that accompanied our first report, you indicated that all distributions
after 1 April 1988, except distributions of corpus, from trusts that had been
settled by New Zealand residents but that do not come
within the settlor regime
would be taxable. In the terminology we have now adopted, a trust which comes
within the settlor regime
would be a qualifying trust. Accordingly, we propose
that all non-qualifying distributions (other than beneficiary income) received
by New Zealand residents be taxable with the exception of distributions of the
corpus of the trust.
6.13.3 You also proposed that such distributions
should be taxable with an interest charge to offset the benefit to the
recipient of the deferral of tax. As explained further in chapter 8, we
consider that an interest charge would be unduly complex if
it were to be other
than arbitrary. As a simpler alternative, we propose that the deferral advantage
enjoyed by a beneficiary in
relation to a non-qualifying distribution be reduced
by taxing such distributions at a higher rate. We recommend that the rate be
45
percent. For comparison with the effect of an interest charge, this rate would
result in a tax impost on a distribution that would
equate with the tax that
would be payable if the distribution were assumed to be income derived by the
trustee over a period of five
years immediately preceding its receipt by the
beneficiary and interest were charged on the outstanding tax at a compound rate
of
16 percent.
6.13.4 In addition, we propose that a credit should be
permitted for foreign withholding taxes paid on non-qualifying distributions
but
not for income taxes paid by the trustee. The amount of withholding tax allowed
as a credit should be the proportion of the total
withholding tax paid on the
distribution that the taxable distribution (which would be the entire amount of
the distribution other
than that part deemed to be corpus according to the
ordering rule outlined in section 6.11) bears to the total distribution received
by the beneficiary.
6.13.5 In order that fictional distributions are not
counted, such as settlements of sub-trusts, distributions of trust accumulations
by a trustee to another trust or distributions over which the trustee retains
control should be deemed not to have been made for
the purposes of applying the
ordering rule. Where a beneficiary cannot provide satisfactory records to
support the allocation of
a portion of a distribution to corpus in accordance
with the procedures set out in the previous paragraph, all of the distribution
should be treated as a taxable distribution.
6.13.6 Non-qualifying distributions would also arise where the trustee or a
new resident settlor of a trust settled before the settlor
became resident here
does not meet the New Zealand tax liability on the trustee income of the trust
in respect of income years after
the settlor becomes resident. All of the
distributions of the trust, other than beneficiary income, would be treated as
non-qualifying
distributions.
Recommendations
6.13.7 Accordingly, the Committee recommends
that:
6.14 Financial Assistance to Trusts
6.14.1 In
our previous report, we proposed that a resident settlor of a trust settled
before 17 December 1987 who did not elect to
be subject to tax on trustee income
should be liable for tax on income that would be deemed to be derived in respect
of any financial
assistance the settlor had provided to the trustee of the
trust. This was proposed as a quid pro quo for not being liable for tax
on the
trustee income. The same
argument applies wherever a settlor of a trust is resident here but the trust
is such that distributions from it would be non-qualifying
distributions. This
would be the case, for example, if a settlor or trustee of a trust settled after
17 December failed to meet the
New Zealand tax liability on the trustee income
of the trust. Similarly, it would be the case where a new resident settlor
failed
to meet the obligation to pay tax on the trustee income of a trust
settled before the person became resident here.
6.14.2 Accordingly, we
propose that, where a distribution from a trust would be a non-qualifying
distribution and:
Recommendation
6.14.3 Accordingly, the Committee recommends
that, where a distribution from a trust would be a non-qualifying distribution
and:
6.15 Residence of a Beneficiary
6.15.1 One of
the consequences of a sharp distinction between taxable and exempt distributions
is that, where an otherwise taxable
distribution is large enough, there would be
an incentive for the intended recipient beneficiary to become a non-resident in
order
to receive the distribution. The Committee's proposed changes to the
definition of residence of a natural person would make it considerably
more
difficult for a resident to cease to be resident. Nevertheless, we consider that
a further provision is needed to the effect
that, where a resident ceases to be
a
resident and within 5 years again becomes a resident, any taxable
distributions received by the person during the period in which
he or she was a
non-resident from a trust, other than a qualifying trust, should be assessable
in the income year in which the person
commences to be resident again.
Recommendation
6.15.2 The Committee therefore recommends
that where a resident ceases to be a resident and within 5 years again becomes a
resident,
any taxable distributions received by the person during the period in
which he or she was not a resident, other than distributions
from a qualifying
trust, be assessable in the income year in which the person commences to be
resident.
CHAPTER 7 – DISCLOSURE AND DEFAULT METHODS
7.1 Introduction
7.1.1 The
BE, FIF and trust regimes will be amongst the provisions of the Income Tax Act
which are the most difficult for the Inland
Revenue Department to administer.
This is in part because of their relative complexity and in part because much of
the information
the Department will need to administer them will be found
offshore and often in countries with which New Zealand has no tax treaty
and
hence no exchange of information agreement. Thus, in the first instance, the
administration of the reforms will depend critically
on the information which
taxpayers provide to the Department. It follows that the information disclosure
requirements, far from being
a minor aspect, are central to the effective
administration of the regimes. Considerable care needs to be given in deciding
what
information taxpayers should be required to disclose.
7.1.2 This is
important not only for administration but also for satisfactory compliance with
the regimes. Voluntary compliance is
encouraged if taxpayers are required to
disclose relevant information and if there are substantial penalties for
non-disclosure.
Disclosure needs, however, to be selective. Too much information
may hinder administration and compliance as effectively as too
little.
7.1.3 We commented briefly on the importance of the disclosure of
information and appropriate penalties for non-disclosure in our
first report.
This chapter outlines the Committee's views in more detail. We also comment on
the way in which alternative assessment
provisions might operate where there is
non-disclosure or insufficient information to apply the BE, FIF or trust
regimes. You announced
in the Government
Economic Statement that the penalty provisions of the Act are to be reviewed
and in the light of this we make no further comment on
penalties. Special
penalties for these regimes are not needed - the general provisions of the Act,
strengthened as necessary, should
be sufficient.
7.1.4 Section 245R of
the draft legislation provides the Commissioner with a general power to require
the disclosure of sufficient
information to establish the nature of any interest
a taxpayer has in a foreign entity, whether or not the entity is a CFC or a FIF,
and to compute the taxpayer's attributed foreign income or loss. The disclosure
requirements in relation to trusts are provided for
in section 231 of the draft
legislation.
7.2 Disclosure: BE Regime
7.2.1 In
general, residents should be required to disclose their direct control interests
in foreign companies and the direct control
interests held by associated
persons. Where a resident does not personally hold a direct interest in a CFC,
he or she should not
be required to disclose the interests held by associates
unless they are non-resident.
7.2.2 In order to avoid requiring taxpayers
to disclose interests in companies which are unlikely to be either CFCs or FIFs,
exemptions
from this general rule will be needed. For example, an exemption from
any disclosure requirement could be given for minor interests
in listed
companies resident in grey list countries. Limiting the scope of any general
disclosure provision in this manner would
avoid duplication since disclosure of
interests in such companies is required for the return of
dividends.
7.2.3 Where a resident has a direct control interest in a CFC,
his or her income interest in the CFC needs to be computed
and disclosed. In addition, the person needs to disclose indirect interests
held through that CFC or an associate of the CFC. Where
an underlying foreign
company becomes a CFC by virtue of the indirect control provisions, residents
need to disclose their income
interests in the underlying
CFC.
7.2.4 Direct control interests held by persons in the capacity of a
nominee should also be disclosed, though disclosure of such interests
should
also have been made by the principal. The nominee definition includes a person
who, pursuant to an arrangement or understanding
or otherwise, holds powers or
rights on behalf of another person. The starting point in applying a provision
such as this is to ask
taxpayers to disclose such arrangements or
understandings.
7.2.5 In addition to the disclosure of control interests
held on any measurement day, disclosure should also be required of dispositions
and changes in the capital structure of a CFC to support the "bed and breakfast"
rules described in section 3.3 of chapter 3. The
information disclosed would
also assist in the application of section 65(2)(e) of the Act. Thus, taxpayers
would be required to disclose
(except where an exemption from disclosure
applied):
7.2.6 As discussed in chapter 3, residents who have a control interest of 10
percent or more in a foreign company, whether a CFC or
not, at any time during
its accounting year should be required to disclose:
Where appropriate, the disclosure requirements should
apply to interests held, acquired or disposed of by persons associated with
the
taxpayer.
7.2.7 Where a person has an income interest of 10 percent or
more in a CFC, the person should be required to provide a copy of the
accounts
of the CFC; details of the adjustments to accounting profit to arrive at the BE
income of the CFC; the dividends received
by the CFC; and the basis for
calculating the person's attributed income or loss and tax credit claimed with
respect to that CFC.
A separate disclosure should be required in respect of each
CFC in which a taxpayer has an interest in order to ensure compliance
with the
jurisdictional loss and tax credit limitation rules.
7.2.8 Where the
aggregate income interests in a CFC of persons resident in New Zealand who hold
income interests of 10 per cent or
more in the CFC exceeds 100 percent, the
names of persons who have those income interests should be disclosed to
ensure that no more than 100 percent of an income interest in a CFC is taken
into account in attributing BE income or BE losses.
7.2.9 A number of
provisions of the draft legislation relate to arrangements or understandings
between taxpayers. These cannot be
effective unless the Department requires
taxpayers, as a first step, to disclose the existence of such arrangements and
understandings.
Furthermore, as noted in chapter 3, taxpayers should be required
to reconcile significant differences between their control and income
interests
in a CFC.
Recommendation
7.2.10 Accordingly, the Committee recommends
that the Commissioner be given a general power to require the disclosure of
sufficient
information to establish the nature of any interest a taxpayer has in
a foreign entity, whether or not the entity is a CFC, and to
compute the
taxpayer's attributed foreign income or loss.
7.3 Disclosure: FIF Regime
7.3.1 Interests
disclosed under the provisions outlined above will include interests in FIFs
that are companies. Where a company is
resident or domiciled in a tax haven, it
may be a FIF. Thus, taxpayers should be required to disclose interests held in
tax haven
entities and to compute their FIF income or loss. In order to
determine whether a foreign company or a unit trust is a FIF, a taxpayer
will
need to consider the nature of the assets of the company, its residence for tax
purposes, whether it receives a concessionary
tax treatment in that country and
its distribution policy. In some cases, it will be obvious that a foreign
company will be a FIF
and, in order to reduce compliance costs, the Commissioner
could publish a list of such entities.
7.3.2 In addition, taxpayers should be required to disclose life insurance
and superannuation policies issued by foreign companies
or superannuation funds.
Depending on their characteristics, some such policies will be interests in a
FIF.
7.3.3 The basis upon which a taxpayer values an interest in a FIF
should be disclosed and copies of any financial reports or equivalent
information in respect of the FIF should accompany an income return. Section
245R of the draft legislation gives the Commissioner
sufficient power to obtain
the necessary information.
7.4 Disclosure: Trusts
7.4.1 The
primary liability for tax on trustee income will fall on the trustee. Where a
trustee is a resident, he or she should be
required to disclose the name and
address of the settlor of the trust and the names and addresses of beneficiaries
who receive distributions
or beneficiary income. Residents who have settled
trusts on resident or non-resident trustees after 1 April 1988 should also be
required
to disclose the settlements and the name and address of the trustee(s).
As outlined in chapter 6, the definition of a settlor and
a settlement are both
very broad.
7.4.2 Where a non-resident trustee fails to file a return or
meet an obligation to pay New Zealand tax on trustee income, the resident
settlor will be liable for the tax. In this event, the resident settlor should
be required to provide the accounts of the trust and
details of the calculation
of its taxable income.
7.4.3 Settlors of trusts in existence on 1 April
1988 that were settled prior to 17 December 1987 should be required to disclose
the
settlement and the nature of any financial assistance outstanding to the
trustees of the trust. In addition, they should disclose
whether they have
elected to have the trust
treated as a "qualifying trust".
7.4.4 Beneficiaries should be
required to disclose sufficient information to establish the appropriate basis
for the taxation of any
property or income of a trust that vests to them in any
income year. Where such property or income represents beneficiary income
or
non-assessable or taxable distributions, the names and addresses of trustees of
the trust should be provided. Sufficient information
should also be required to
support:
7.4.5 Where a person receives income from a trust, the
Commissioner's existing powers of disclosure are sufficient. An additional
general power of disclosure is required to permit the Commissioner to require
disclosure from settlors. A provision to this effect
is contained in section 231
of the draft legislation.
Recommendation
7.4.6 Accordingly, the Committee recommends
that provision be included in the legislation to permit the Commissioner to
require disclosure
of information from residents who are settlors of trusts in
existence on or after 1 April 1988.
7.5 Default Methods
7.5.1 Cases
may arise where taxpayers are unable to obtain the information necessary to
apply the BE regime. Alternatively, taxpayers
may fail to disclose information
requested by the Commissioner. The information necessary to apply the FIF regime
will generally
be much less than that required under the BE regime though
circumstances may occur where market values of interests in FIFs may not
be
available from published data or from the fund itself. It will then be necessary
to estimate market values or, where this is not
feasible due to insufficient
information, both the taxpayer and the Commissioner will need to resort to
alternatives.
7.5.2 Where the primary basis of computing income could be
applied by the taxpayer, failure to apply it would constitute evasion.
As
discussed, the disclosure provisions and associated penalties will encourage
compliance. Nevertheless, the alternative methods
should not produce a more
favourable outcome.
7.5.3 The draft legislation contains a non-exhaustive
list of methods that the Commissioner could apply to determine the income or
loss of a taxpayer in respect of an interest in a CFC or FIF. In particular, the
Commissioner could make an assessment of income
or loss by:
is an amount of income, applying a presumed compound rate of increase of not
less than 10 percent;
7.5.4 A default provision has also been included in the
draft legislation to apply to the calculation of trustee income.
Recommendation
7.5.5 Accordingly, the Committee recommends
that provision be included in the legislation for the calculation of the income
or loss
of a taxpayer where the taxpayer is unable to obtain sufficient
information or where there is failure to disclose information.
CHAPTER 8 – TRANSITION
8.1 Introduction
8.1.1 The
transitional provisions applying to the international reforms were largely
decided in response to Part 1 of our report.
We propose one additional provision
with respect to the BE regime and comment further on the trust transition where
you reserved
your decision. These issues are dealt with in this
chapter.
8.1.2 No transitional provisions are to apply to the FIF regime
which came into effect on 1 April 1988. This means that residents
with interests
in a FIF on 1 April 1988 will need to establish the market value of their
interests on that date.
8.2 BE Regime Transition
8.2.1 The
transitional arrangements approved for the BE regime provide that:
It is possible for a company to have no fiscal residence. Consequently, in
order to establish that a CFC is not resident in a country
on the transitional
list, it is necessary to require taxpayers to establish that the CFC is resident
in a country not on the list.
8.2.2 One of the consequences of the BE
regime is that, where any provision of the tax law of the country of residence
of a CFC has
the effect of reducing the income tax it pays in that country, the
tax credit allowed to New Zealand residents will also be reduced,
thereby
increasing the amount of New Zealand tax payable. This is the intended result
since a central objective of the regime is
to levy New Zealand tax on income
which has borne less tax than would be levied under New Zealand law. Tax losses
of a CFC, incurred
in a past income year or by another company in the same
group, which are available under the tax law of its country of residence
for
offset against its current year income, are an example of such a
provision.
8.2.3 Many submissions argued that the benefit of past tax
losses in particular (i.e. those incurred by a foreign company before it
becomes
a CFC or before the BE regime applies to it) should not be "clawed back" under
the BE regime. In the Committee's view, it
is difficult to distinguish the
effect of a CFC's past tax losses from the effect of other provisions of the tax
law of its country
of residence. If the BE regime were never to offset the
effect of a tax benefit available to a CFC, it would be necessary to define
BE
income as the taxable income of the CFC measured according to the law of its
country of residence. The BE regime would then have
an impact only where another
country had a company tax rate lower than New Zealand's. Thus, we consider that
no special provision
should be included to preserve the effect of past tax
losses of a CFC. Once the BE regime applies in respect of a CFC, attributed
losses will be able to be carried forward by resident taxpayers so that it is
not necessary to adjust the BE income for tax losses
carried
forward by a CFC. The attribution of BE losses to New Zealand resident
taxpayers is explained in chapter 4.
8.2.4 While residents can take these
considerations into account in making future investment decisions, they cannot
do so in respect
of existing investments except by disposing of them. We
therefore propose an additional transitional measure to the ones proposed
in
Part 1 of our report. We propose that taxpayers with income interests held on 17
December 1987 in CFCs resident in a country other
than those on the transitional
list should be able to elect to bring those interests within the BE regime for
the accounting years
of such CFCs falling (in whole or in part) during the
period commencing on 1 April 1988 and ending on 31 March 1990. Taxpayers should
not, however, be able to bring in only losses and not profits. The election
should therefore be available only if a taxpayer chooses
to bring in all of his
or her interests held on 17 December 1987 that would give rise to attributed
income or losses under the BE
regime from 1 April 1990.
8.2.5 The
election should be made by taxpayers in their 1991 income year return. The
aggregate attributed loss of the taxpayer for
the period from 1 April 1988 to 1
April 1990 would be brought to account in the 1991 income year. The measure
should not, however,
enable taxpayers to increase an attributed loss over what
it would have been in the absence of this transitional provision. For the
purposes of calculating the attributed loss of a taxpayer in each of the
transitional years, the taxpayer's income interest on any
measurement day should
be taken as the lesser of his or her income interest on that day and the income
interest held at 17 December
1987. Any attributed income in one of those years
should, however, be calculated according to the rules set out in chapters 3 and
4.
Recommendations
8.2.6 Accordingly, the Committee recommends
that:
8.3 Trust Transition
8.3.1 As
outlined in chapter 6, residents who settle a trust on or before 17 December
1987 are not to be liable for tax on the trustee
income of the trust as agent of
the trustee. This does not affect the trustee's liability - the trustee, whether
resident or not,
will be liable for tax on trustee income in any income year in
which there is a settlor resident in New Zealand. Where a settlement
is made
after 17 December 1987, the settlor will not be liable as agent of the trustee
if the trustee is a resident natural person
or trustee
company.
8.3.2 While residents who settled trusts on or before 17
December 1987 are to be relieved of liability as a settlor, an alternative
transitional arrangement is to apply to them. This
was one of the areas in the Committee's first report where you reserved your
decision. The Committee recommended that, in respect
of settlements by residents
on non-resident trustees in existence on 17 December 1987, distributions of
income made on or before
31 March 1989 should be subject to a final tax at a
rate of 10 percent and distributions of capital profits and corpus should be
non-assessable provided that either the trust is wound up on or before
that date or the settlor elects to be subject to the settlor regime from that
date
(i.e. the settlor elects to be liable for tax on the trustee income of the
trust). In the terminology of this report and the draft
legislation, the settlor
regime means the qualifying trust regime.
8.3.3 We recommended that, if
neither of these options were taken up and:
8.3.4 In response to these recommendations, you announced
in your press statement with the Minister of Revenue that:
"At this stage, the Government considers that from 1 April 1989 resident trusts [i.e. those with resident settlors] should be taxed according to the settlor regime, except where the settlor can demonstrate that there is manifest good reason for such an exception and it can be shown that either the trust is subject to tax in a high tax jurisdiction or the imposition of the settlor regime would cause undue hardship to the settlor."
8.3.5 The main problem with this approach is the administrative burden
such a discretion would place on the Inland Revenue Department.
Most settlors
would be expected to apply for the exemption and the Department would need to
decide in each case whether there was
"manifest good reason" and either undue
hardship or that a trust was subject to tax in a high tax jurisdiction. It is
difficult to
decide what criteria could be used to establish "manifest good
reason". A trustee of a trust would no doubt verify that a settlor
who was not a
beneficiary had no right to the income or assets of the trust, since this is the
legal position. The undue hardship
test does not add to the general discretion
of the Commissioner to waive tax in the case
of hardship. The substantive operative test would therefore be whether the
trustee was subject to tax in a high tax jurisdiction.
8.3.6 Though this
is a feasible test, it would bring within the regime settlors who have no way of
altering their settlor status and
who could therefore suffer a considerable
additional tax liability which could not have been anticipated. Our proposed
transition
aimed to avoid this outcome.
8.3.7 To offset partially the
deferral advantage of remaining outside the settlor regime, we proposed that
distributions from a pre-17
December 1987 settlement should be subject to an
interest charge in the hands of resident beneficiaries. Interest would be
charged
from the later of the 1988 income year or the year in which the income
distributed was derived. The notional tax that would have
been paid on the
distributed income in the year that the income was derived would then be
computed and carried forward at a prescribed
interest rate to the year in which
the distribution was made. An interest charge would therefore be complicated in
practice, especially
when the principal purpose of the provision is to encourage
such trusts to either wind up or come within the qualifying trust regime.
A
simpler incentive should suffice.
8.3.8 A trust that was settled by a
resident on or before 17 December 1987 would be a qualifying trust only if the
trustee had paid
New Zealand income tax on the foreign- and New Zealand-source
trustee income of the trust in every income year since its settlement.
This
would generally not be the case if the trust earned foreign-source income and
had no resident trustees. If there is a resident
trustee, then tax would
generally have been paid on all of the trustee income of the
trust.
8.3.9 As outlined in chapter 6, where a trust settled by a
resident on or before 17 December 1987 is not a qualifying
trust, we propose that all distributions from the trust, other than
distributions of corpus, should be assessable at a rate of 45
percent and no
credit should be given for any tax paid by the trustee other than withholding
tax. We also proposed in chapter 6 that
a resident settlor of such a trust
should be assessed on income deemed to be derived in respect of any financial
assistance outstanding
to the trustee. We consider that the treatment of
distributions from pre-17 December 1987 settlements by residents as
non-qualifying
distributions and the taxation of income deemed to be earned on
any financial assistance given to the trustee adequately offsets
the advantage
that the persons connected with the trust derive by virtue of its trustee income
not being subject to tax in New Zealand.
8.3.10 Nevertheless, the thrust
of our previous recommendations was that the transitional measures should
encourage the wind up of
trusts settled on or before 17 December 1987. To this
end, you agreed that distributions (other than distributions of capital profits
or corpus) from trusts that were settled on or before 17 December 1987 are to be
subject to a final tax at a rate of 10 percent provided
that all of the property
of the trust is distributed before 1 April 1989. Such distributions are
therefore not to be included in
the assessable income of the recipient. The
definition of corpus for this purpose was discussed in section
6.11.
8.3.11 In addition, a beneficiary, settlor or trustee of a trust
that was settled on or before 17 December 1987 is to have the option
of
converting the trust into a qualifying trust. In our previous report, we
recommended that the conversion should be effected by
the settlor electing to be
liable for tax on the trustee income of the trust. We have, however, recommended
in this report that all
distributions from a qualifying trust should be
non-assessable. A trust could therefore be converted to a qualifying trust and
then
wound up free of tax. This would not be consistent with the treatment
outlined in the previous paragraph for trusts that wind up
before 1 April
1989.
8.3.12 Accordingly, for greater consistency but also to encourage the wind up
of trusts rather than their conversion to qualifying
trusts, we propose that, in
order for a trust to become a qualifying trust, a 10 percent tax should apply to
the value of the net
assets of the trust as at 31 March 1988. New Zealand income
tax would then be deemed to have been paid on the trustee income of the
trust in
the income years ending before 31 March 1988. Where the value of the net assets
of a trust exceed its corpus and any capital
profits, this provision would
result in a heavier tax impost than would be the case if the trust were wound up
before 31 March 1989.
We consider that this is appropriate so that there is a
bias towards wind up. Since the relevant legislation will not be passed until
later this year, we recommend that the last date for payment of the 10 percent
tax be 7 February 1989.
8.3.13 Our proposals duplicate to some extent
decisions that were made in response to our earlier report but, for the sake of
completeness,
we gather them together in the following recommendation.
Recommendation
8.3.14 Accordingly, the Committee recommends
that:
1987 is not a qualifying trust or a foreign trust and a beneficiary, settlor or trustee of the trust pays to the Commissioner no later than 7 February 1989 an amount equal to 10 percent of the net assets of the trust as at 31 March 1988, New Zealand income tax be deemed to have been paid on the trustee income of the trust in prior income years.
CHAPTER 9 – IMPUTATION AND WITHHOLDING PAYMENT SYSTEMS
9.1 Introduction
9.1.1 The
main features and many of the details of the imputation and withholding payment
systems were outlined in the Committee's
first report which you accepted in
full. Thus, compared with the international tax regimes, few issues remain to be
decided in respect
of the imputation and withholding payment systems. Chapters 9
and 10 outline the Committee's recommendations on the remaining issues.
This
chapter deals with the imputation and withholding payment regimes. Consequential
changes to other parts of the Act are discussed
in chapter 10.
9.2 Draft Legislation
9.2.1 Like
the international regime, the imputation and withholding payment regimes will
result in major additions to the existing
Income Tax Act. For ease of reference,
each regime is best dealt with in a separate part of the Act. There is no
particular significance
to the location of these parts but we propose that the
imputation legislation make up a new Part XIIA of the Act (immediately following
Part XII, which deals with the provisional tax system), the withholding payment
legislation a new Part XIIB and the branch equivalent
tax account ("BETA")
provisions a new part XIIC.
9.2.2 Within each part, the main sets of
provisions are those concerning the operation of the imputation credit account
("ICA"), the
withholding payment account ("WPA") and BETA respectively; the
penalty tax provisions which apply when a company does not comply
with the
credit allocation rules; the provisions necessary to allow shareholders to
utilise the
credits; the anti-avoidance provisions; and, lastly, a number of transitional
arrangements.
9.2.3 In addition, a number of consequential changes are
necessary to other sections of the Act. For example, we propose a new definition
of a dividend and amendments to excess retention tax and the deemed dividend
provisions. These are outlined in chapter 10.
9.3 Allocation Rules
9.3.1 The
provisions concerning the operation of the imputation system by companies are
contained in sections 394B to 394H of the
draft legislation. The central feature
of the scheme is the ICA. Each company will be required to operate an ICA since
the balance
in this account will determine the amount of credits that the
company can allocate to its shareholders in any income year.
9.3.2 The
allocation of credits by a company will be subject to the allocation rules
proposed in our previous report which are designed
to ensure that credits are
apportioned across dividends and bonus issues made to all shareholders, rather
than directed selectively
to certain groups of shareholders. The principal
requirement is that a company must maintain the same credit ratio (i.e. ratio of
credit to the value of a dividend or taxable bonus share) for all dividends paid
in any income year unless it makes a statutory declaration
that a ratio change
is not part of an arrangement to confer a taxation advantage on a group of
shareholders. In our first report,
we proposed that such declarations should be
made at least 21 days in advance of the first distribution at the changed ratio
but
we now recommend that they should be able to be made at any time before the
dividend is declared.
9.3.3 Where a company does not comply in any income
year with
the requirement outlined in the previous paragraph, all the dividends
(including taxable bonus shares) it pays in that year will be
deemed to have
been credited at the highest credit ratio applied by the company during the
year. The corresponding aggregate credit
deemed to have been allocated will be
debited to the ICA of the company.
9.3.4 In addition, in order to ensure
that the credit allocated to a dividend is not disproportionate to the amount of
the dividend,
the maximum ratio of imputation and withholding credit to dividend
will be limited to the ratio of 28:72, based on the company tax
rate of 28
percent. Where a company exceeds this ratio, it is necessary to impose some
penalty. This was not dealt with in our earlier
report. We therefore propose
that, where the credit ratio of a dividend applied by a company exceeds the
maximum ratio, the excess
credit should not be allowed to shareholders, nor
should it be included in the definition of a dividend. If the credit is an
aggregate
of an imputation credit and a withholding credit, the excess to be
disallowed should be deemed to be, first, withholding credit and,
secondly,
imputation credit.
Recommendation
9.3.5 Accordingly, the Committee recommends
that:
9.4 Deemed Dividends: Allocation Rules
9.4.1 Under
the present Act, a number of types of payment or benefit given to the
shareholders of certain companies are deemed to
be dividends. As discussed in
chapter 10, we consider that these provisions should be retained. Deemed
dividends would, however,
cause complications in the application of the
allocation rules. First, the application of the deemed dividend provisions is
uncertain.
Thus, a payment or benefit given to a shareholder of a company may
not be deemed to be a dividend until some time after the end of
the income year
in which it is paid or conferred. Since the deemed dividend would not have been
credited, it would trigger an additional
allocation debit to the ICA of the
company in a previous income year. Secondly, the quantification of the value of
a deemed dividend
is also uncertain under the present rules. Where the
Commissioner's assessment differed from the taxpayer's, a breach of the credit
allocation rules may result, once again triggering an allocation
debit.
9.4.2 In view of these uncertainties, we consider that it is
impractical to require companies to allocate credits to deemed dividends
in the
same way as for cash dividends. As discussed in chapter 10, benefits previously
deemed as dividends provided to "major shareholders"
who are employees are to be
brought within the fringe benefit regime. Consideration could be given to
bringing all non-cash benefits
provided to shareholders within the fringe
benefit regime. In the interim, we propose that deemed dividends be excluded
from the
allocation rules where they arise in respect of benefits given to
shareholders by way of the sale of company property to a shareholder
at an
inadequate consideration (presently dealt with under section 4(l)(b)); the
purchase of property from a shareholder by a company
for excessive consideration
(a new provision); loans to shareholders other than bona fide loans at
commercial interest rates; non-deductible
expenditure enjoyed by proprietary
company shareholders and associates; and excessive remuneration to
directors or shareholders of proprietary companies, or their
relatives.
9.4.3 A separate category of deemed dividends is interest on
debentures or convertible notes which fall within sections 192, 195 or
196 of
the Act. These need to be treated in the same way as ordinary dividends for the
purposes of the allocation rules.
Recommendation
9.4.3 Accordingly, the Committee recommends
that deemed dividends be excluded from the allocation rules where they arise in
respect
of benefits given to shareholders by way of the sale of company property
to a shareholder at an inadequate consideration; the purchase
of property from a
shareholder by a company for excessive consideration; loans to shareholders
other than bone fide loans at commercial
interest rates; non-deductible
expenditure enjoyed by proprietary company shareholders and associates; and
excessive remuneration
to directors or shareholders of proprietary companies, or
their relatives.
9.5 Producer Boards
9.5.1 Co-operative
companies and the producer boards (which are to lose their tax exempt status
from the beginning of the 1989 income
year) are to be included within the
imputation system. The boards are created by statute and do not have a
shareholding structure
on which dividends and credit allocations could be based.
They do, however, act on behalf of producers who can be regarded as their
owners
in an economic if not a legal sense. It is therefore appropriate to impute any
income tax paid by boards to their respective
producers.
9.5.2 The
boards' operations take one of two principal forms:
9.5.3 In both cases, the return to a
producer takes the form of higher product prices as a result of the boards'
direct or indirect
involvement in price-smoothing, marketing and other forms of
representation. Product payments or levies therefore provide an appropriate
basis on which the boards could allocate credits to producers. Individual
producers will receive product payments and/or pay levies
at various times of
the year. It is therefore necessary to aggregate product payments or levies over
the income year and to base
the credits subsequently allocated to each producer
on the aggregate annual product payments received or aggregate levies paid by
the producer during the year. Where credits are allocated on the basis of
product payments, the proportion of the aggregate credit
allocated to each
producer in any income year would equal the proportion that the producer's
product payment made up of the of the
total product payments made by the board
in the previous year (as the actual allocation could not be made until after the
end of
the year of production). Alternatively, the allocation could be on the
basis of the value of product supplied during the production
year, rather than
on the payments made. An equivalent proportional allocation rule would apply
where credits were allocated on the
basis of levies. In either case, no credits
could be allocated until after the end of the first year of operation of the
scheme.
9.5.4 In practice, the Dairy Board buys produce from dairy companies who in
turn purchase milk from their farmer suppliers. Thus,
payments for produce pass
from the Board to the companies and from the companies to farmers. For the
purposes of the credit allocation
rule outlined in the previous paragraph, each
company can be regarded as a producer with respect to the
Board.
9.5.5 Companies incorporated under the Companies Act will be able
to allocate credits to either dividends or taxable bonus issues. In our view,
the producer boards should have the option
of distributing cash dividends as a
means of allocating credits to their producers. The boards presently do not have
any statutory
authority to pay dividends so that the characterisation of a
payment to a producer as a dividend would occur only in respect of its
income
tax treatment. Where a board is authorised to make a payment to a producer, for
example, in consideration for product purchased,
it would elect to make all or
part of the payment non-deductible for tax purposes. The amount of the payment
to be treated as a dividend
should be calculated on the basis that the dividend
were fully credited. For tax purposes only, the non-deductible payment would
then be treated as a fully credited dividend. The dividend would be assessable
to a producer in the same way as any other dividend,
but the producer would be
able to use the attached credit to offset the tax payable. The additional tax
payable by a board therefore
results in an equal tax saving to its producers.
The mechanism to give effect to this election will be included in an amendment
to
section 199 which is currently being drafted by the Inland Revenue
Department. We have anticipated this amendment in our draft
legislation.
9.5.6 In order that cash flow considerations do not
constrain a company's ability to allocate credits to its shareholders, companies
will be able to allocate credits to taxable bonus issues. These will be taxed in
the same way as dividends in the hands of shareholders.
The boards do not at
present have share capital so that a bonus issue allocation mechanism cannot
be
used. It is, however, desirable that the boards have a mechanism for
allocating credits without having to pay out cash dividends.
Hence, we propose
that they should be able to allocate credits to notional dividends. As proposed
for cash dividends paid by a board,
the amount of a notional dividend should be
computed by assuming that it is fully credited. In other words, the allocation
of a credit
of 28 cents would require the declaration of a notional dividend of
72 cents. Producers would be taxed on the sum of the notional
dividend and the
credit in the same way as if the dividends were actual dividends. Where a
producer member is a company, the notional
dividend would not be assessable but
the credit would be added to its ICA or WPA.
9.5.7 This credit allocation
mechanism is equivalent to allocating credits to taxable bonus shares. In the
latter case, the amount
capitalised by way of the taxable bonus issue is added
to the paid-up capital of the company. The distribution of capital will be
subject to marshalling rules which are outlined in section 9.8. The boards do
not, however, have a share capital so that a return
of capital cannot be made in
substitution for dividends. Thus, we propose that the boards be able to maintain
a record of notional
capital for tax purposes. The amount allocated to notional
capital would equal the amount of notional dividends declared by the board,
net
of any credits. Actual cash payments sourced from notional capital would be
exempt in the hands of the recipient producers.
9.5.8 The boards should
also be able to operate a withholding payment account (WPA) in order that
credits for withholding payments
made can be passed through to producers and a
branch equivalent tax account (BETA) in order to relieve any double taxation of
the
income of a CFC in which a board has an income interest of 10 percent or
more.
Recommendations
9.5.9 Accordingly, the Committee recommends
that:
9.6 Co-operative Companies
9.6.1 A
number of co-operatives are in a similar position to the producer boards in that
the return they provide to their members
is in the form of reduced input prices
or higher output prices rather than dividends. Co-operative companies do,
however, have issued
share capital and may pay dividends to members. The number
of shares held may, however, be unimportant since the return members obtain
usually depends primarily on their transactions with the co-operative rather
than their shareholdings. We therefore propose that
co-operative companies be
treated in much the same way as we have recommended for the producer boards.
Thus, they would have the
option of electing to make a payment to members
non-deductible to the co-operative for tax purposes in which case it would be
treated
as a dividend. Credits could then be allocated to the dividend. In the
event that cash dividends were not available, the notional
dividend allocation
mechanism outlined for the producer boards could be used. In either case, the
credits would be allocated to members
on the basis of their transactions with
the co-operative.
9.6.2 Since some co-operative companies do, however,
have a share capital and pay dividends, they should be also be able to allocate
credits to dividends or taxable bonus shares in the same way as other
companies.
9.6.3 The present section 199 applies not only to co-operative
companies but more generally to "mutual associations". An association
is widely
defined as "any body or association of persons, whether incorporated or not".
The Committee is uncertain of the nature
of any unincorporated mutual
associations and of their tax treatment. We therefore refrain from making any
recommendations on the
way they should be treated under imputation. Our
recommendations therefore apply only to co-operative companies.
Recommendation
9.6.4 The Committee therefore recommends
that co-operative companies be treated in the same way as the producer boards
for the purposes
of imputation except that they also have the option available
to other companies of allocating credits to dividends or taxable bonus
shares.
9.7 Sharemilking Arrangements
9.7.1 One
of the issues outstanding from our first report was whether a special
arrangement was needed for sharemilkers who receive
product payments through
members of co-operatives though they themselves are not members. This would be
the case under some sharemilking
agreements. Where payments by a dairy company
for milk supplied are made directly to a sharemilker and the land-owner,
dividends
and attached credits paid on the basis of product supplied should be
paid directly to both persons on the same basis that payments
for milk supplied
would be made. In other words, the sharemilker should receive dividends from the
co-operative even though he may
not be a shareholder.
9.7.2 Where some
other contractual arrangement exists, we would be reluctant to prescribe a
general remedy. The parties involved can
be expected to amend their contractual
arrangements if they wish to. Where both the sharemilker and the land-owner are
members of
the co-operative, each would receive dividends and credits directly
from the co-operative.
Recommendation
9.7.3 Accordingly, the Committee recommends
that, where payments by a dairy company for milk supplied are made directly to a
sharemilker
and the land-owner, dividends or bonus shares and attached credits
paid on the basis of product supplied should be paid directly
to both persons on
the same basis that payments for milk supplied would be made.
9.8 Capital Distributions
9.8.1 The
CD proposed that all distributions should be taxable, other than distributions
of paid-up capital (including share premiums
paid) made on the winding up of a
company or on the redemption of shares. You agreed that this proposal should be
amended by retaining
the present exemption of distributions of capital profits
on winding up.
9.8.2 The remaining issue is the treatment of a return of
capital other than on winding up. In principle, a return of capital should
not
be taxed if it is merely a return of the capital paid in on the subscription of
shares. If it were to be taxed, equity would
be treated very differently from
debt and instruments such as redeemable shares would not be viable. A return of
capital should not,
however, be a substitute for dividends and, pending solution
of this problem, the Committee reserved its position on this issue in
paragraph
2.6.4 of its earlier report.
9.8.3 It is conceivable that a company might
issue shares, either of the same class or of separate classes, which are to be
redeemed
at regular intervals in the future. The redemptions would then be made
instead of dividends. For example, if a company with a single
class of shares
redeems a certain percentage of every shareholder's holding each year, the
resulting capital payments should be treated
as dividends. Similarly, if a
company issues a certain class of shares to its shareholders and then redeems
them on a pro rata basis
over a period of years, the return of capital should be
treated as a dividend.
9.8.4 While providing for circumstances where a
return of capital is made in substitution for a dividend, the legislation should
give
companies as much flexibility as possible to issue
redeemable shares. We therefore propose that a return of capital made on the
redemption of shares, other than on winding up, should
be treated as capital,
and hence non-assessable, provided that:
9.8.5 In addition to returning capital on the
redemption of shares, capital may be returned pursuant to reductions in the par
or nominal
value of shares. Such partial redemptions will, however, invariably
be made on a pro rata basis and hence on the same basis that
dividends would be
paid. For this reason, we propose that a distribution made on a partial
reduction of the nominal or par value
of shares not be treated as a return of
capital but be treated as a dividend. We also propose that debentures which fall
within sections
192 or 195 of the Act which are issued after 30 September 1988
be treated as shares for the purposes of these rules.
9.8.6 Our proposals
are significantly different from those proposed in the CD so that it is
reasonable that taxpayers have some notice
of them. The implementation date of
the proposals should also be integrated with the change to the tax treatment of
bonus shares
which is to come into effect on 1 October 1988. We therefore
propose that they come into effect on 1 October 1988.
Recommendation
9.8.7 Accordingly, the Committee recommends
that, with effect from 1 October 1988, a return of capital made by a company on
the redemption
of shares (including debentures issued on or after 1 October 1988
which come within sections 192 or 195 of the Act), other than on
winding up, be
exempt from tax in the hands of the recipient provided that:
9.9 Carry Forward of Credits by a Company
9.9.1 In our
first report, we referred to the need for anti-streaming provisions to ensure
that the revenue cost of the imputation
regime is not different from that
envisaged by the Government. The allocation rules and anti-stapling provisions
have this objective.
In paragraph 2.4.8 of our earlier report, we referred to
the possible need for a specific anti-avoidance rule buttressed by disclosure
requirements to counteract temporary transfers of interests aimed at avoiding
the allocation rules. The effect of the allocation
rules would also
be avoided by the accumulation of credits within companies which were then
sold.
9.9.2 To limit the opportunity for such credit trapping and sale,
we recommend in chapter 10 that excess retention tax be retained.
This measure
by itself is, however, not sufficient since, for example, the New Zealand
holding company of a non-resident is not liable
for ERT.
9.9.3 To
supplement ERT with respect to companies owned by residents and as a measure
effective in relation to non-residents, the
Committee proposes that a 75 percent
commonality of interests be required (using the same tests already used in
section 188 of the
Act with respect to the carry forward of losses, but extended
to include fixed dividend shares) for a company to be able to carry
forward the
credit balance of its ICA, WPA or BETA. In the event that the 75 percent
commonality is lost, a debit would arise in
the relevant account equal to the
credit balance of the account on the date that the required degree of
commonality is lost. This
measure will reduce trafficking in credits and is
consistent with the integration principles underlying a full imputation
system.
9.9.4 The compliance costs of a shareholding commonality rule are
undoubtedly highest for listed companies because of normal trading
of shares and
the need to trace shareholdings through interposed companies. Moreover, listed
companies and their subsidiaries are
unlikely to be used as credit traps since
their shareholders will generally be residents who are able to utilise the
credits. Hence,
we propose that there be an exception to the proposed
commonality rule for companies listed on the New Zealand stock exchange and
their wholly-owned subsidiaries.
Recommendation
9.9.5 Accordingly, the Committee recommends
that a 75 percent commonality of shareholding (using the tests presently
contained in section 188 of the Act but extended to include fixed dividend
shares) be required for a company, other than a company
listed on the New
Zealand stock exchange or a wholly-owned subsidiary of such a company, to be
able to carry forward the credit balance
of its ICA, WPA or BETA.
9.10 Carry Forward of Unutilised Imputation Credits
9.10.1 Taxpayers
in tax loss would be unable to utilise imputation credits (which are referred to
in the draft legislation as "tax
credits") so, in response to the Committee's
recommendation, you agreed that they should be able to gross up the amount of
any credit
by dividing by a tax rate of 28 percent and adding the resulting
amount to the amount of the tax loss to be carried forward. This
was the
mechanism that could at present be most easily accommodated within the
Department's existing administrative and EDP systems.
A better system would be
to carry forward the amount of the unutilised credit but, according to the
Department, it would be unable
to implement this in the next year or
so.
9.10.2 Since a system based on converting an unutilised credit to a
loss carry forward is feasible, there seems no reason why it should
not extend
to all taxpayers. This would reduce the incentive for arbitrage amongst
taxpayers aimed at utilising what would otherwise
be wasted credits. Thus, we
propose that all resident taxpayers, other than companies, be able to convert
any imputation credits
in excess of their tax liability in any income year,
after taking into account all other tax reliefs, into a tax loss to be carried
forward, where the amount of the loss is calculated as the amount of the
unutilised credit divided by 0.28.
Recommendation
9.10.3 Accordingly, we recommend that that
all resident taxpayers, other than companies, be able to convert any imputation
credits
in excess of their tax liability in any income year into a tax loss to
be carried forward, with the amount of the loss calculated
as the total amount
of the unutilised credit divided by 0.28.
9.11 Refunds of Dividend Withholding Payment
9.11.1 The
dividend withholding payment will be levied on dividends received on or after 1
April 1988 by resident companies from non-resident
companies. The amount of the
payment is intended to approximate the income tax that a non-corporate
shareholder would pay on a dividend
from a non-resident company if the dividend
passed directly to the person. Where the eventual recipient shareholder would
not incur
such a liability, such as a non-resident or tax-exempt shareholder, or
where the amount withheld exceeds a resident shareholder's
tax liability, the
excess is to be refunded.
9.11.2 The withholding payment is to be paid
quarterly. The Government Economic Statement proposed that refunds to
non-resident companies
be made by the resident company paying the dividend. In
our first report, we proposed that the payer company should offset the refund
paid to a non-resident against its withholding payment liability for the quarter
in which the refund was made. If the refund paid
exceeded the liability, the
excess would be refunded by the Department. Refunds to tax-exempt shareholders
were to be made quarterly
by the Department. In our report, we proposed that
excess withholding credits should also be refunded to other resident taxpayers
at the end of the year in the same way as refunds of other tax.
9.11.3 We
have given further consideration to the refund
mechanism. A problem with the proposed system is that the Department
would be required to make reimbursing refunds to companies and
refunds to
tax-exempt shareholders before it had assessed withholding payment liabilities
to verify, where necessary, that the withholding
payment to be refunded had
indeed been paid. One approach would be to have quarterly assessments but this
would raise significantly
the administrative and compliance costs involved. A
more efficient system from an administrative point of view is to have annual
assessments and annual refunds for all shareholders.
9.11.4 If an annual
refund system were adopted, resident companies would face an unreasonable cash
flow burden if they had to make
not only the original withholding payment and
pay that to the Department, but also refunds to non-resident shareholders that
would
be reimbursed only after the end of the year. We therefore consider that
refunds to non-residents should be made by the Department
on an end of year
basis on application by a non-resident.
9.11.5 Withholding payment
collected on behalf of non-resident shareholders can be viewed as an advance
payment of some or all of
their non-resident withholding tax (NRWT) liability on
dividends paid. Thus, the withholding credit allocated to a dividend paid
to a
non-resident should be credited towards the NRWT payable on the dividend. Where
the withholding credit was less than the NRWT
payable, the payer company would
be obliged to deduct the balance of the NRWT and pay it over to the Department
as under the present
system. Conversely, where the withholding credit exceeded
the NRWT payable, the non-resident would claim a refund of the excess by
making
an application to the Department after the end of the income year in which the
dividend was paid. Finally, if the withholding
credit equalled the NRWT
liability, no further payment or refund would be required.
9.11.6 The
application for a refund by a non-resident or any
other shareholder would need to be supported by the dividend statement
supplied by the payer company. The draft legislation details
the information
that we propose be required to be included in the statement.
Recommendation
9.11.7 Accordingly, the Committee recommends
that:
9.12 Integration With BE Regime: Individuals
9.12.1 In
our previous report, we recommended that individuals, like companies, should be
able to operate a branch equivalent tax
account ("BETA") for the purposes of
avoiding double taxation of the income of a CFC, once as attributed income under
the BE regime
and again as a dividend when the income is distributed. The BETA
would record the amount of tax paid by a person on attributed foreign
income.
The person could then offset tax payable on a dividend received from a CFC to
the extent of the credit balance in the account.
The computation of the tax
payable on attributed income and the withholding payment liability on a dividend
is straightforward for
a company because of the flat rate of company and
withholding tax. It is, however, more complicated for non-corporate taxpayers
because
of the
progressive rate scale.
9.12.2 The objective of avoiding double
taxation in the case of non-corporate taxpayers can be achieved more simply by
recording in
BETA the amount of attributed income the person has derived, rather
than the tax paid on such income. A dividend received from a
CFC would then be
non-assessable to the extent of the credit balance in the account. We therefore
recommend this approach instead
of that proposed in our previous report.
Recommendation
9.12.3 Accordingly, the Committee recommends
that, where a non-corporate taxpayer elects to establish a branch equivalent tax
account,
the amounts to be credited to the account be the attributed income
derived by the person under the BE regime.
9.13 Group Investment Funds
9.13.1 Section
211A of the Act deals with group investment funds. The income of such funds is
divided into two categories with "category
A" income taxed as if it were derived
by a company. The "category" B income of a fund is taxed as if it were derived
by a trustee.
A distribution of after-tax category A income is treated as
dividend. As the trustees of such funds are taxed in the same way as
companies
in relation to category A income, it is appropriate that they be permitted to
impute tax on distributions of category A
income as if they were companies. The
draft legislation gives effect to this.
CHAPTER 10 – IMPUTATION: RELATED ISSUES
10.1 Introduction
10.1.1 This
chapter outlines the Committee's recommendations on sundry other issues raised
by the imputation reforms, including the
definition of a dividend, the
amendments to the fringe benefit tax regime and excess retention tax.
10.2 Dividend Definition
10.2.1 In
paragraph 4.7.1 of our earlier report, we advised that we were considering
amendments to the section 4 definition of a dividend.
One possibility was the
extension of the ambit of the present section 4(2) dealing with proprietary
company dividends, to all companies.
The desirability of doing so, however, is
due more to the weaknesses of the proprietary company definition rather than to
any perceived
avoidance policies of non-proprietary companies. In section 10.6,
we suggest that the proprietary company definition requires review
and, pending
that review, we do not propose that the present section 4(2) ambit be
broadened.
10.2.2 One deficiency of the existing dividend definition is
that the provision of benefits to shareholders other than by way of
distributions
or dispositions are not clearly within the definition. As benefits
can be conferred upon shareholders in this way, we propose to
include as
dividends the making available of any company property for the benefit of any
shareholder if in the opinion of the Commissioner
the making available of the
property is virtually a distribution of an amount which, if distributed other
than in the course of winding-up
of the company, would be a dividend. We also
propose to extend
the dividend definition to include any excessive consideration provided
by a company upon the acquisition of property from a shareholder.
The taxable
value of the dividend in the first case would be the amount by which the value
of the benefit or property acquired by
a shareholder exceeds any consideration
provided by the shareholder. In the second case, the taxable value of the
dividend would
be the amount by which the consideration provided by the company
exceeds the market value of the property acquired by the
company.
10.2.3 Since these changes would extend the existing definition
of a dividend, it is reasonable that taxpayers should have some notice
of them
before they come into effect. Accordingly, the Committee proposes that they take
effect from 1 October 1988.
10.2.4 At present, section 4(2) deems to be a
dividend any expenditure incurred by a proprietary company for the benefit of a
shareholder,
spouse of the shareholder, trust under which the shareholder or his
or her spouse is a beneficiary or any other person associated
with the
shareholder. In order that we do not restrict the definition of a dividend with
respect to a proprietary company, we propose
that the extended definition of a
dividend outlined in the previous paragraph apply where the person acquiring or
disposing of the
property in question is an associate of a shareholder of a
proprietary company. By "associate", we mean any of the persons listed
in the
present section 4(2).
10.2.5 The CD proposed a definition of the term
"paid up capital" meaning capital which could be returned free of tax upon
winding-up
or redemption. In our draft definition of dividend, we have adopted
an alternative to this. A new section 4 defines widely the types
of transactions
which are initially considered to be dividends. A new section 4A contains
exclusions from the section 4 net, so that
no definition of "paid up capital" is
required. Since our redrafted definition, apart from
the changes proposed in paragraph 10.2.2 (which we suggest come into
effect from 1 October 1988), merely attempts to state more clearly
the present
definition, we consider that it should come into effect from the commencement of
the present income year.
Recommendation
10.2.6 The Committee therefore recommends
that the definition of a dividend be extended with effect from 1 October 1988 to
include,
with respect to any person who is a shareholder of a company or, where
the company is a proprietary company, an associate of a shareholder:
10.3 Section 190
10.3.1 Section
190 of the Act permits the Commissioner to disallow a deduction to a proprietary
company for remuneration paid to a
director, a shareholder or a relative of
those persons if the remuneration is considered unreasonably high. The
disallowed amount
is deemed to be a dividend paid to the recipient. Such
arrangements may appear more attractive in the light of the Committee's
recommendation
that, due to uncertainties in the application of the deemed
dividend provisions, such dividends be excluded from the credit allocation
rules. Hence, the Committee proposes that section 190
be retained in amended form.
10.3.2 The proviso to section 190 has
the effect that the section does not apply where the recipient of the
remuneration is an adult
employed substantially full time in the business of the
company and participating in its administration and management, and the
remuneration
is not influenced by the fact that the recipient is a relative of a
shareholder or director. Because of the ease with which the proviso
can be
invoked and the possibility of streaming arrangements being entered into, the
Committee proposes that, with effect from the
commencement of the 1990 income
year, the proviso exemption be limited to persons who are residents. This would
have the dual effect
of limiting the use of remuneration as a means of avoiding
the allocation rules and reinforcing one of the few interjurisdictional
allocation rules presently in the Act.
Recommendation
10.3.3 Accordingly, the Committee recommends
that the proviso to section 190 be amended, with effect from the commencement of
the
1990 income year, to limit its application to resident recipients of
remuneration.
10.4 Section 197
10.4.1 Section
197 relates to distributions of trading stock to shareholders as such, with
distributions treated as a sale by the
company and a purchase by the shareholder
at market value. Section 197(3) makes it clear that the Commissioner's ability
to deem
the distribution to be a dividend under section 4 is not derogated by
the deemed sale treatment under section 197(2).
10.4.2 The Consultative
Document proposed the repeal of section 197 from the commencement of the 1989
income year. In our first report,
we advised we were still considering this
issue. The objective of the Act in regard to such distributions
of trading stock is to place the company and the shareholder in the same
position as each would be had the trading stock been sold
to a third party and
the profit distributed as a dividend.
10.4.3 Merely to treat the
distribution as a dividend without deeming the distribution to be a sale does
not achieve this result,
as it leaves the company with a deduction by way of a
lower closing stock figure. Hence it is necessary to deem the distribution
to be
a sale and for this reason we recommend the retention of section 197.
Recommendation
10.3.5 The Committee recommends that section
197 be retained.
10.4 Winding Up Distribution Tax
10.4.1 Winding
up distribution tax ("WUDT") is designed to encourage the winding-up of
companies which have ceased trading by levying
tax at a concessional rate on
taxable reserves distributed before 1 April 1989 in the course of and for the
purpose of winding up.
Winding up for this purpose includes a dissolution
procedure provided for in section 335A of the Companies Act 1955. In our earlier
report, we proposed that this should be a final tax. This means that
non-resident withholding tax should not be levied
on such distributions to
non-residents, nor should any withholding payment be levied on such
distributions received by companies
upon the winding up of a non-resident
company.
Recommendation
10.4.2 The Committee recommends that
distributions which have been subject to the winding up distribution tax not be
liable for either
non-resident withholding tax or dividend withholding
payment.
10.5 Fringe Benefits Received by "Major Shareholders"
10.5.1 The
CD proposed that as from 1 April 1988 fringe benefits provided by a company to
any shareholder/employee should be subject
to fringe benefit tax. Fringe
benefits received by "major shareholders" of private companies had previously
been treated as dividends
and were excluded from the fringe benefit tax
regime.
10.5.2 The Committee accepts that retention of the major/minor
shareholder employee distinction for FBT purposes is now redundant.
We have
become aware that, as we did not comment on this proposal in our first report,
there is an expectation amongst many taxpayers
and their advisers that we did
not support the CD proposal. As this expectation can be attributed to an
omission on our part to comment
explicitly in our earlier report, we believe
that a delay in the implementation date of the proposal is justified in respect
of some
but not all fringe benefits.
10.5.3 Most benefits, with the
exception of loans at concessional rates, to major shareholders who are also
employees are currently
subject to a deemed dividend provision. In respect of
such fringe benefits other than loans, we believe that taxpayers will not be
prejudiced by a 1 April 1988 commencement date as proposed in the
CD.
10.5.4 The existing provision applicable to loans at concessional
rates to major shareholders who are also employees is not a very
effective
provision so that bringing such loans into the fringe benefit regime will be a
substantial change of treatment. Ideally
such change should have a prospective
application date. Due to the confusion over whether the CD proposal was to be
implemented,
we propose that the application of FBT to concessional rate loans
to major shareholders who are
also employees be postponed to 1 October 1988. Such loans should remain
subject to the deemed dividend provision before that date.
Recommendation
10.5.5 Accordingly, the Committee recommends
that fringe benefits received by any shareholder who is an employee be subject
to the
FBT regime rather than the current deemed dividend
provisions:
10.6 Excess Retention Tax
10.6.1 The
CD at paragraph 6.6 proposed the repeal of excess retention tax ("ERT") with
effect from the commencement of the 1989 year.
The CD noted that ERT has two
objectives under the classical company tax system - first, to ensure that
non-corporate taxpayers cannot
defer personal tax liability on dividend income
by holding shares through a company and, secondly, to reinforce the classical
company
tax system by requiring a minimum distribution of income each year. The
CD suggested that, with the introduction of imputation,the
reinforcement of the
classical tax system was no longer relevant. In addition, it argued that there
will be no incentive for a company
to retain dividends which bear imputation
credits and that, while privately controlled investment companies may still be
used to
defer shareholder tax liability on dividends without credits, that
opportunity exists for all companies, not just privately controlled
investment
companies.
10.6.2 In our first imputation report, we noted at paragraph 2.4.8 that it
might be necessary to retain ERT in order to ensure that
credits are utilised by
individual shareholders rather than held in a company which, together with the
credits, is then sold. We
believe that there would be a considerable incentive
for credits to be trapped for this purpose. While our proposal, discussed in
section 10.7, for a 75 percent commonality provision for carry-forward of
credits goes some way to limit credit trap and sale opportunities,
we believe it
should be supplemented by retention of ERT. This will also limit the deferral
opportunities such companies would provide
in respect of uncredited
dividends.
10.6.3 We noted in our first report that the ERT provisions
have had little impact since the abolition of bonus issue tax and that
they
would need strengthening if ERT were to be retained. Accordingly, we recommend
that non-taxable bonus issues made after 30 September
1988 be excluded from the
calculation of dividends distributed by a privately controlled investment
company for ERT purposes.
10.6.4 The Committee and the Inland Revenue
Department have reservations about the effectiveness of the current definition
of "privately
controlled investment company" given the ease with which the
definition of "proprietary company" may be avoided. This should be reviewed
by
the Department.
10.6.5 The Department has proposed that the current
exemption from ERT for companies not having share capital should be repealed.
We
are not aware of the reason for the original exemption and, in the absence of
any compelling reason for its retention, we recommend
the repeal of the
exemption with effect from the commencement of the 1990 income year.
Recommendation
10.6.2 The Committee recommends
that:
CHAPTER 11 – SUMMARY AND CONCLUSION
11.1 Introduction
11.1.1 This
chapter briefly summarises the main elements of the BE, FIF and trust regimes
and draws together all of the Committee's
recommendations and some concluding
remarks.
11.2 BE Regime
11.2.1 The BE
regime recommended by the Committee is set out in chapters 2, 3 and 4 and
follows closely that outlined in our first
report. The regime will apply when
five or fewer New Zealand residents hold interests, either directly or
indirectly, or through
nominees or associated persons, which add up to 50
percent or more of the rights or powers of ownership of a foreign company. The
rules for determining whether a company is controlled are necessarily wide in
scope. The rules for attributing the income of a controlled
foreign company
(CFC) to individual residents are more circumscribed. Income or loss will be
calculated according to New Zealand
tax rules, with some necessary
modifications.
11.2.2 Residents with an income interest of 10 percent or
more in a CFC will be required to compute their share of its income or loss,
which is then attributed to them with a credit for the corresponding share of
the foreign tax paid by the CFC. Residents would be
able to aggregate their
attributed income or loss, and the foreign tax credits, in respect of CFCs
resident in the same jurisdiction.
We propose that excess tax credits should be
able to be carried forward. The New Zealand shareholders of a CFC resident in a
grey-list
country (Australia, Canada, France, Japan, West Germany, United
Kingdom, United States) will be exempt from the regime unless the
CFC utilises a
significant tax
preference. Where such a preference is used, the Committee recommends a
simplified basis of income calculation.
11.2.3 In our first report, we
suggested that a foreign company should be a CFC if it was controlled by 5 or
fewer residents on any
day of its accounting year. After further consideration,
in light of the high compliance costs of monitoring control interests which
in
some cases could change, if not daily, relatively frequently, the Committee now
recommends that a resident's control and income
interests be measured on the
last day of the calendar quarters that fall in the accounting year of a CFC. A
foreign company would
be a CFC if 5 or fewer residents have an aggregate control
interest of 50 percent or more on any of the quarterly measurement days.
This
change necessitates more elaborate anti-avoidance measures than would be
necessary if control and income interests on every
day in the year were taken
into account. A remaining problem is the circumvention of the BE regime by the
disposal of shares for
a capital gain, but this can be addressed comprehensively
only by the general inclusion of capital gains within the income tax
base.
11.2.4 With respect to the grey list countries, the Committee
recommends that only significant tax preferences should be listed and
that it
would be best not to list specific preferences until there has been some
experience with the BE regime. The fundamental criterion
for listing a
preference should be that it is significant enough to attract New Zealand
investment. Where a preference is listed,
the listing should have prospective
application.
11.2.5 We proposed a number of transitional provisions in
our first report. The principal provision is the exclusion from the BE regime
for a two year period (ie until 1 April 1990) of interests in CFCs, resident in
countries other than listed low tax jurisdictions,
that were acquired by
taxpayers on or before 17 December 1987. We recommend one further
transitional
measure in this report whereby residents with interests in CFCs on 17
December 1987 could elect to apply the regime for the two year
period from 1
April 1988 until 31 March 1990 so that losses generated in that period would be
available at the commencement of the
regime on 1 April 1990 for offset against
attributed income derived in the same jurisdiction.
11.3 Foreign Investment Fund (FIF) Regime
11.3.1 The
FIF regime is set out in chapter 5 and section 245O of the draft legislation.
The regime buttresses both the BE regime
where tax deferral benefits do not
depend on control and the proposed regime for superannuation where residents
invest in foreign
superannuation funds. It does this by taxing New Zealand
residents on the income they derive through foreign companies, foreign unit
trusts, or foreign superannuation funds ("foreign entities") which provide New
Zealand residents with significant tax advantages.
11.3.2 The Committee
has defined a FIF as any foreign entity which derives its income or value
primarily or substantially from holding
or trading portfolio investments in
shares, investments in debt instruments, real property, commodities, etc, where
the effect of
the fiscal residence, the tax treatment applying to the entity in
its country of residence and the distribution policy of the entity
is to reduce
the tax payable on the income of the entity to a level significantly below what
it would have been had the income been
taxed in New Zealand as it was
derived.
11.3.3 We define an interest in a FIF in a similar way to an
income interest under the BE regime, but this is extended to include
life
insurance or superannuation policies issued by a foreign entity. FIF income or
loss is determined by reference to the change
in value of the interest in the
entity. We propose that there should be no credit for any foreign tax paid by
the FIF because attributed
FIF income or loss is effectively net of foreign tax.
Attributed FIF income and losses of a taxpayer
should, however, be able to be aggregated without limitation and, in
addition, attributed FIF losses should be able to be offset against
other income
up to the extent of the past attributed FIF income returned by the
taxpayer.
11.4 Trusts
11.4.1 The trust
regime recommended by the Committee is described in chapter 6 and is set out in
Part F of the draft legislation.
We propose a number of changes from the regime
recommended in our first report but these are of form rather than of substance.
The
basic principles underlying the proposed regime can be summarised as
follows:
11.4.2 We use the term "qualifying trust" to denote a
trust in respect of which trustee income has been subject to tax in New Zealand
in all income years since its settlement. Distributions from these trusts should
be non-assessable to beneficiaries. "Foreign trusts",
on the other hand, are
trusts which have had, at no time after 17 December 1987, a settlor who is a New
Zealand resident. We recommend
that distributions from the trustee income of
these trusts derived in income years commencing after 1 April 1987 should be
assessable
to a beneficiary, at his or her marginal tax rate, but other
distributions from such trusts be exempt.
11.4.3 "Non-qualifying
distributions" are distributions from trusts which are not qualifying or foreign
trusts. We propose that these
distributions, other than of the corpus of the
trust, should be assessable to a beneficiary at a tax rate of 45 percent with no
credit
for any foreign tax, except withholding tax, paid by a trustee. The
higher rate is intended as a proxy for an interest charge on
tax deemed to have
been deferred in respect of such distributions.
11.4.4 The Committee
proposes that transitional provisions apply in respect of trusts settled by
residents before 17 December 1987.
These are that:
subject to a final tax of 10 percent;
11.5 Disclosure
11.5.1 Disclosure
of relevant information, with penalties for non-disclosure, and default methods
where the taxpayer is not able to
comply are critical to the effective operation
of the regime. We outline our views on disclosure in chapter 7.
11.6 Imputation and Withholding Payment Systems
11.6.1 Our
recommendations relating to the imputation and withholding payment systems cover
details of the regimes which were left
unsettled in our earlier report or which
have emerged in the drafting of the legislation. There are no changes of
substance or policy
involved.
11.7 Summary of Recommendations
11.7.1 In
summary, the Committee recommends that:
Definition of "Company" and "Trustee"
Residence: Individuals
Residence: Companies
Definition of "Nominee"
Definition of Associated Persons
presently defined in section 7; or
of the trust);
Definition of Interests In a Company
would be beneficially entitled to receive or to have dealt with in his or
her interest or behalf if it were distributed; and
Frequency of Measurement of Interests
any disposals of such interests made during its accounting year and where a
resident has a control interest of 10 percent or more
in a CFC at any time
during its accounting year, the taxpayer be required to disclose the equivalent
information in respect of the
CFC;
Calculation of Control Interests
Calculation of Income Interests
effect of defeating the intent and application of the BE regime;
Attribution of Income and Losses
percent, the income interest of each resident be apportioned downward so
that the aggregate income interest equals 100 percent;
Adoption of CFC's Accounting Year
Foreign Tax Credits
taxable in its country of residence or the country of source of the
income;
Attributed Foreign Losses
Application of BE Regime to CFCs Resident in "Grey List" Country
measured according to the tax law of its country of residence (before taking
into account any losses of the CFC incurred in other
years or losses incurred by
any other company), adjusted for the effect of the listed preference;
Definition of Foreign Investment Fund
Treatment of FIF Losses
the same income year, it be carried forward for offset against FIF income
derived in future income years;
Entry and Exit From FIF Regime
Trusts
Trustee Income
Settlor Liability: Superannuation Funds
Settlor Liability: New Residents
Settlor Liability: Charitable Trusts
Beneficiary Income
whether or not the beneficiary is an infant or is subject to any other legal
incapacity;
Distributions From Qualifying Trusts
Distributions From Foreign Trusts
be made first from the most recent income year of the trustee and, with
respect to any income year, first, from taxable income derived
by the trustee in
that income year and, secondly, from non-taxable gains derived in that
year;
Distributions From Trusts Settled By New Residents
Non-Qualifying Distributions
Financial Assistance to Trusts
Residence of a Beneficiary
qualifying trust, be assessable in the income year in which the person
commences to be resident;
Disclosure: BE Regime
Disclosure : Trusts
Default Methods
BE Regime Transition
the period 1 April 1988 to 31 March 1990;
Trust Transition
Allocation Rules
Deemed Dividends: Allocation Rules
Producer Boards
producers by way of cash and/or notional dividends be made only once in each
income year;
Co-operative Companies
Sharemilking Arrangements
Capital Distributions
Carry Forward of Credits by a Company
Carry Forward of Unutilised Imputation Credits
Refunds of Dividend Withholding Payment
Integration With BE Regime: Individuals
Definition of Dividend
company or, where the company is a proprietary company, an associate of a
shareholder:
Section 190
Section 197
Winding Up Distribution Tax
Fringe Benefits Received by "Major Shareholders"
Excess Retention Tax
11.8 Conclusion
11.8.1 The
Committee's recommendations outlined above are incorporated in the draft
legislation contained in the accompanying annex.
Further refinement of the draft
will be needed as it is examined by parliamentary counsel and officials.
Interested parties will
then have an opportunity to comment at the select
committee stage. The experience of other countries
has been that CFC regimes need relatively frequent amendment to meet changing
business practices and no doubt that will be the case
with the New Zealand
regime. The increasing internationalisation of businesses and financial markets
also makes it inevitable that
tax legislation will become more complex, though
this will affect only a small number of taxpayers.
11.8.2 The real test
of the draft legislation will, however, come as it is applied. It is impossible
to anticipate all of the circumstances
that may arise. We are, however,
confident that the basic framework of the regimes, as embodied in the draft
legislation, is sound.
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