Chapter 4 – Branch Equivalent Regime Part 3: Attribution and Computation of Branch Equivalent Income, Losses and Foreign Tax Credits
4.2 Attribution of Income and Losses
4.3 Adoption of CFC' s Accounting Year
4.4 BE Income Calculation
4.5 Foreign Tax Credits
4.6 Attributed Foreign Losses
4.7 Application of the Regime to CFCs Resident in a "Grey List" Country
4.8 Change of Residence of CFC or Taxpayers
4.9 Determination of Residence
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.
4.2.1 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.
4.2.7 The Committee therefore recommends that:
a residents be exempt from the BE regime in respect of a CFC and an accounting year of the CFC where their income interest in the CFC for that year and that of any associated persons is less than 10 percent;
b the attributed income or loss of a resident with respect to a CFC and any accounting year of the CFC 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
c an attributed loss of a resident not be recognised where the resident suffers little or no economic or financial loss; and
d where the aggregate income interests of 10 percent or more of residents in a CFC in any accounting year would otherwise exceed 100 percent, the income interest of each resident be apportioned downward so that the aggregate income interest equals 100 percent.
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.
4.3.7 Accordingly, the Committee recommends that:
a residents be required to report attributed income in respect of a CFC in any accounting year in the income year in which the balance date of the CFC falls;
b where a foreign company changes its balance date, residents be required to obtain the Commissioner's consent to compute their control interests, income interests and attributed income or loss in respect of that company on the basis of its new accounting year and the Commissioner's decision apply to all residents with interests in the company;
c where a CFC changes its balance date to a later date and the Commissioner consents to the residents using the new accounting year, any attributed income of a resident for the resulting long accounting period be brought to account in the income year in which the old balance date falls.
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:
a rules are needed to determine the opening value of the depreciable assets and trading stock of a CFC in the year it first comes within the regime. As discussed previously, we propose that residents have the option of using the values used by the CFC for tax purposes in its own jurisdiction (provided that they are not higher than market value or the values that would apply had the CFC been at all times a New Zealand resident). Having elected either option, the taxpayer should be required to value all of the depreciable assets and trading stock of the CFC on that basis;
b the acquisition price of financial arrangements in the initial year should be, at the option of the taxpayer, the market value of the arrangement or its adjusted base price (being its original acquisition price, plus the amount of interest which has accrued since acquisition or issue, less the the sum of all consideration paid, in the case of an issuer, or received in the case of a holder);
c the BE income or loss of a CFC should be computed in the currency which the CFC uses for financial reporting purposes or, if there is no such reporting, the currency of the country in which the CFC is resident. We propose that the foreign currency annual income or loss then be converted into New Zealand dollars at an average of the mid-month New Zealand dollar/foreign currency spot exchange rates for the months falling within the reporting period;
d a number of sections contain incentives relating to the encouragement of investment in New Zealand, most of which are now being phased out, which should not apply for the purposes of computing BE income or losses;
e other sections have references to the carrying on of a business in New Zealand. In order that they can apply to the computation of BE income or losses, where applicable, the business carried on by a CFC needs to be deemed to be carried on in New Zealand;
f dividends received by resident companies from non-resident companies after 1 April 1988 are to be subject to the withholding payment regime. It is therefore necessary to tax or subject to the withholding payment dividends received by a CFC. Dividends received by one CFC from another should, however, be exempt in order to avoid multiple taxation. We therefore propose that, in determining the BE income or loss of a CFC with respect to any resident taxpayer, dividends received by the CFC be taxable, other than dividends which are received from another CFC in respect of which the taxpayer has an income interest of 10 percent or more. One consequence of this provision is that the BE income or loss of a CFC may differ for different taxpayers according to whether the CFC has received dividends from another CFC in which some but not all of its resident controllers also have an income interest;
g section 67, the section dealing with profits on land transactions, gives rise to an assessable profit where a taxpayer disposes of land and, at the time of acquiring the land, the taxpayer or an associated person was a dealer in land, a land developer or a builder. We consider that, for the purposes of the BE regime, the assessable income of a CFC should not be affected by the activities of associated persons who are not New Zealand residents. A similar provision exists in section 191(4A). If this section applied to a CFC, it could bring within the BE income of the CFC profits or gains derived by other companies in the same group. We consider that neither section should apply to the extent that the activities of associated persons of a CFC who are not New Zealand residents would give rise to income which would be assessable to the CFC;
h a number of sections refer to other New Zealand statutes (e.g. the Bankruptcy Act 1908 and the Companies Act 1955). These sections should apply as if such references were references to equivalent legislation in the country of residence of the CFC;
i section 117 of the Act deals with the recovery of excess depreciation on the disposal of an asset. The amount of depreciation recovered is equal to the lesser of the sum of the depreciation deductions allowed over the life of the asset and the difference between its written down value and its cost price. For the purposes of applying this rule, the written down value of an asset should be deemed to be 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;
j section 129 is the section dealing with the recovery of interest on money borrowed to acquire or develop land which is sold within 10 years of its purchase. The section now applies only to land not used in the primary sector. In order that the section applies to interest on money borrowed by a CFC, it is necessary that the interest expense of a CFC which is deducted in computing the BE income of the CFC be treated as if it were a deduction allowed to the CFC;
k any value added tax in an overseas country should be accounted for in the same way as GST in New Zealand, as determined by section 140B;
l where a taxpayer finances expenditure by way of a Government grant or subsidy, a deduction for the expenditure is not permitted. Where the expenditure relates to a depreciable asset, the depreciable value of the asset for tax purposes is reduced by the amount of the grant or subsidy. We propose that a comparable treatment apply to grants or subsidies received by a CFC from other governments. Where a subsidy or grant does not relate to deductible or depreciable expenditure, we propose that it should be treated as assessable income for the purposes of computing BE income;
m the loss carry forward and grouping rules in 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;
n in paragraph m above, we proposed that the BE income or loss of a CFC should be calculated without taking into account the BE income or loss of any other company. A CFC with a loss in its country of residence may, however, transfer the loss to a related company under grouping provisions similar to those in section 191. For example, the transfer may be effected by way of a subvention payment made to the CFC by another company. The effect would then be to increase the income tax paid by the CFC in future years. This would in turn increase the foreign tax credit that residents could claim under the BE regime. We therefore propose that any gain of a CFC which arises as a result of the transfer of a loss to another company should be included as assessable income under the BE regime;
o section 208(1)(a) of the Act currently exempts from tax underwriting profits of an insurance company derived from insurance business carried on out of New Zealand. Section 208(1)(b) denies a deduction for reinsurance premiums paid out of New Zealand. In order that the CFC regime extends to so-called "captive" insurance companies (i.e. one that insures the risks of its parent in New Zealand and/or associated persons), the exemption in section 208(1)(a) should 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);
p sections 214A to 222 deal with the taxation of mineral and petroleum mining. Legislation implementing a new petroleum mining regime is currently before the House. A number of the provisions of the new regime are linked to the holding or relinquishment of prospecting or mining licences issued by the Ministry of Energy. It is not possible to specify parallel licences that might exist overseas. Hence, we have included a general provision in the draft legislation requiring that these sections apply with any necessary modifications for the purposes of computing BE income; and
q the specified lease provisions should not apply to any leases entered into by the CFC before the first day of the accounting period in which it becomes a CFC, not being a day before 1 April 1988.
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.
4.5.1 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.
4.5.15 Accordingly, the Committee recommends that:
a subject to recommendation b, income and withholding tax paid by a CFC be creditable under the BE regime;
b 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;
c residents be able to aggregate their proportionate shares of the creditable taxes paid by CFCs resident in the same jurisdiction;
d the maximum credit allowable to a resident in any income year in respect of his or her aggregate attributed income derived from interests in CFCs resident in the same jurisdiction be the New Zealand income tax payable on that income in that year;
e residents be able to carry forward excess tax credits in respect of CFCs resident in the same jurisdiction for offset against New Zealand income tax payable in any future income year on attributed income in respect of CFCs resident in that jurisdiction;
f the carry forward of an excess credit by a company be subject to a 40 percent shareholding continuity test equivalent to that in section 188;
g a credit allowed to one company in a specified group of companies in respect of an income interest in a CFC be able to be transferred to another company in the specified group for offset against the New Zealand income tax payable by that company on attributed income derived from a CFC resident in the same jurisdiction as the first-mentioned CFC, subject to provisions equivalent to those in section 191; and
h foreign income tax paid by a CFC in respect of income attributable to another CFC be deemed to be paid by the latter CFC.
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.
4.6.6 Accordingly, the Committee recommends that:
a an attributed loss of a taxpayer derived from an income interest in a CFC be able to be offset only against attributed income derived from income interests in CFCs resident in the same jurisdiction as the first-mentioned CFC in the same or a future income year;
b the carry forward of an attributed loss by a company be subject to a 40 percent shareholding continuity test equivalent to that in section 188; and
c companies in the same specified group be able to aggregate attributed income and losses in respect of income interests in CFCs resident in the same jurisdiction subject to provisions equivalent to those in section 191.
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.
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.
4.8.1 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.
4.9.1 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.