Chapter 1 - Introduction
1.1 Imputation is central to New Zealand’s tax system. Every resident company, independent of size, is affected by the imputation tax credit rules, and every shareholder in a New Zealand company is eligible to receive imputation credits.
1.2 Imputation is a mechanism that allows credit for income tax paid at the company level to be passed through to shareholders on dividends paid by the company. Resident shareholders may use the imputation credits attached to their dividends to reduce the amount of New Zealand tax they pay, which means that the company tax is essentially a withholding tax for New Zealand-resident taxpaying shareholders. However, because surplus imputation credits cannot be refunded to shareholders, the company tax is a final tax for shareholders who do not pay income tax in New Zealand – non-resident shareholders and New Zealand-resident shareholders that are tax-exempt, such as charities. They have no final New Zealand tax liability against which to offset the imputation credits.
Scope of discussion document
1.3 This discussion document is very much a problem definition exercise that seeks the public’s views on certain features of New Zealand’s imputation system concerning the question of who can use imputation credits. The government is not reviewing whether to retain an imputation system, which will remain an integral part of the New Zealand tax system.
1.4 The main areas of interest in this review are the rules relating to streaming of imputation credits, which means directing them to shareholders who can use them, and the refundability of imputation credits, an issue of particular importance to charities.
1.5 Key objectives for the government when considering the areas addressed by this review are:
- keeping the company tax system as close to a fully integrated system as possible – that is, as far as possible, taxing income derived through companies at the tax rates of the shareholders who own the company at the time the income is derived;
- ensuring that New Zealand source-basis taxation is retained – that is, taxing non-residents on the income that is derived through their investments in New Zealand;
- ensuring that the relevant rules do not stand in the way of legitimate business transactions; and
- continuing to provide a “belt and braces” approach to reducing incentives for company tax to be avoided by continuing to tax domestic shareholders on their unimputed dividends.
1.6 At times there may be conflicts between these objectives that will need to be resolved.
1.7 This discussion document is the first step in a process of consultation on possible improvements to the imputation system. The document describes the policy behind the current rules and seeks views on whether there are problems with these rules, and especially whether they impede legitimate business activity. It also seeks readers’ views on whether there are better options that meet the government’s objectives but work more smoothly and provide greater certainty in practice.
1.8 It is important to understand the issues before concrete proposals are developed, so the government invites submissions from interested parties on these important areas of our imputation system. Following consideration of submissions, the government may develop detailed proposals and consult further on any such proposals.
1.9 Chapter 2 considers what streaming is and why we have rules to prevent it. It covers why allowing the streaming of imputation credits to those who can use them can be contrary to the government’s objectives. It invites submissions on whether not allowing streaming can stand in the way of valid business transactions.
1.10 Chapter 3 considers the current rules on streaming and seeks views on whether they create significant costs or uncertainties for business. It seeks views on possible improvements to these rules.
1.11 Chapter 4 examines the question of refunding imputation credits, which is not available under the current rules. The chapter sets out the basis for this approach and discusses the concerns raised by the possibility of allowing refunds and how that would fit with the government’s objectives. The question of refunds is of particular interest to the charitable sector. At present, charities that receive imputation credits with their New Zealand dividends are not able to use them given that they are exempt from New Zealand income tax. This is likely to bias their investment decisions away from New Zealand shares.
1.12 The matters outlined in this discussion document need to be considered in their entirety, since design changes in one area of the imputation system would put pressure on other areas of the system. For example, allowing imputation credits to be refunded in some circumstances would tend to place greater pressure on measures that protect against streaming. For this reason, the government would appreciate feedback that considers coherent packages of possible reforms and clearly communicates the submitters’ priorities.
1.13 There are two general issues that warrant some introductory comments: the relationship between the imputation review and the continuing review of New Zealand’s international tax rules, and mutual recognition of imputation and franking credits between Australia and New Zealand.
Relation to review of international tax rules
1.14 Some commentators have argued that New Zealand’s imputation system is inconsistent with the direction of the reform of our international tax rules, which has been to exempt the offshore active income of controlled foreign companies, in keeping with the practice of other OECD countries. However, that is a misunderstanding of the objectives behind the international review, the aim of which has not been to provide incentives for offshore investment ahead of investment in New Zealand. Nor is there any overarching principal that offshore income should be exempt.
1.15 Instead the exemption of offshore active income, which is the subject of legislation currently before Parliament, reflects an acceptance that if New Zealand attempts to tax the active income of its CFCs much more harshly than other countries do, New Zealand firms that want to internationalise will have incentives to migrate to countries that have more favourable tax rules. That is clearly not in New Zealand’s best interest.
1.16 Without the proposed legislative changes, firms looking to expand offshore might well have found it more attractive to base their head offices in a country such as Australia, which exempts offshore active income. The aim of the reform of our international tax rules has been to remove this bias.
1.17 There is no reason, however, for this income to be exempt from tax when it is distributed to shareholders in the form of dividends.
1.18 If a company migrates from New Zealand, any New Zealand portfolio shareholders will pay tax either through the fair dividend rate system or, if the company is listed in Australia, on any dividends received from the company. Taxing unimputed dividends in New Zealand is unlikely to make it more attractive for firms to migrate offshore. Moreover, it has allowed our proposed international rules to be less onerous than would otherwise be the case.
1.19 The imputation rules offer incentives for New Zealand-owned firms to pay tax in New Zealand because they can offer imputation credits to New Zealand shareholders. That provides some safeguards against erosion of the domestic tax base.
Mutual recognition
1.20 A major issue which is outside the scope of this review is the possibility of introducing a system of mutual recognition of imputation and franking credits between Australia and New Zealand, the subject of a joint media statement from the Australian Treasurer and the New Zealand Minister of Finance in July. In the government’s view, mutual recognition would increase the efficiency of trans-Tasman investment decisions and reduce incentives for the streaming of profits between the two countries. The Australian Treasurer, Mr Swan, has stated that the Australian government has an open mind on the question of whether or not to enter into a bilateral agreement on mutual recognition with New Zealand. He has invited the New Zealand Treasury to make a submission on this issue to the review known as Australia’s Future Tax System, which was recently established by the Federal Labor Government. Its final report is expected by the end of 2009.
1.21 The government believes that for mutual recognition to proceed, it would not be necessary to achieve complete harmonisation of our respective imputation systems. It would, however, be attractive for our systems to be aligned as much as is feasible and consistent with each country’s policy goals. The possibility of introducing mutual recognition might also place constraints on policy reform options that would make Australia less comfortable with entering into such an agreement.
1.22 The question arises of why issue a discussion document on imputation at this stage when there is so much uncertainty as to future developments. On this point, the purpose of this document is to make sure that private sector concerns about the imputation system are clearly understood by the government before further work is undertaken in this area. This will be useful irrespective of the future direction on mutual recognition.
How to make a submission
1.23 The government invites submissions on the issues raised in this discussion document. Submissions should be made by 10 October 2008 and be addressed to:
Imputation review
C/- Deputy Commissioner, Policy
Policy Advice Division
Inland Revenue Department
PO Box 2198
Wellington
Or email [email protected] with “Imputation review” in the subject line.
1.24 Submissions should include a brief summary of major points and recommendations. They should also indicated whether it would be acceptable for Inland Revenue and Treasury officials to contact those making the submission to discuss the points raised, if required.
1.25 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their publication. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider there is any part of it that should properly be withheld under the Act should clearly indicate this.