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Chapter 3 - Options for improving the current anti-streaming rules

Matters for discussion

Chapter 2 discussed the grounds for the government continuing to enforce some form of anti-streaming and credit allocation rules.

This chapter seeks feed-back on the current anti-streaming rules as follows:

  • The extent to which the rules:
    • interfere with normal commercial transactions;
    • impose unnecessary compliance costs; or
    • lack certainty.
  • Suggestions for changes to any or all of the current anti-streaming rules. Would adoption of some Australian anti-streaming concepts enhance our rules?

3.1 Chapter 2 discussed why New Zealand’s current imputation rules are aimed at preventing dividend streaming and the reasons for the government continuing to enforce some form of anti-streaming rules.

3.2 That means, regardless of the eventual decision on whether or not there may be limited circumstances when streaming should be allowable, that a review of the current anti-streaming rules is timely. It would be of particular importance if the government were to support some form of limited streaming as that would introduce a new boundary into the tax system. Limited streaming would inevitably place more pressure on the existing rules.

How will the government judge suggestions for change?

3.3 Some of the current anti-streaming rules target specific transactions, while others are of a general anti-avoidance nature. The rules are intended to be interdependent. When considering whether any or all of the rules can be enhanced, the government seeks comment on three broad questions.

3.4 The first question, taking into account the government’s objectives for this review, as set out in Chapter 1, is whether the rules inhibit normal commercial transactions. The government is especially keen to hear how the rules impact on arrangements using hybrid instruments (mixtures of debt and equity) such as redeemable preference shares, or the use of special purpose vehicles, as these type of arrangements are becoming increasingly common.

3.5 The second question is whether the rules impose an unnecessary compliance burden. As was pointed out in Example 3 of Chapter 1, the rules provide some protection for keeping the tax system as close as possible to an integrated tax system when the original and new shareholders are on different rates. The weight that is given to this concern when the rate differential is small is an open question. Take, for example, a share sale (including sale of an imputation credit balance) where the vendor shareholder is on a 39% percent tax rate and the purchaser on a 33% rate. In that case, the current rules would protect against a small loss of revenue ($6). It is clear, however, that concerns about this sort of arbitrage would be much larger if there were much bigger differences in tax rates.

3.6 The third potential question is whether the rules provide sufficient certainty for taxpayers to undertake commercial transactions with a clear understanding of the boundaries between what is legally acceptable and unacceptable.

3.7 The rules need to be considered in their entirety. Design change in one area of the rules puts pressure on other areas. The ease of administering any rule changes would also need to be considered.

3.8 This chapter outlines the current rules and suggests some possible areas where the anti-streaming provisions might be amended, particularly in light of the possibility of some movement in the direction of Australia’s anti-streaming rules.

Relationship with Australian rules

3.9 Contemplating rules that are more consistent with those in Australia may be helpful when negotiating whether to have a system of mutual recognition of imputation credits and in implementing such a system. Australian rulings issued under the rules, as well as relevant case law, may also help provide taxpayers and administrators with a greater degree of certainty.

3.10 Any consideration of moving towards the Australian rules, however, should recognise New Zealand’s different tax environment. Share sales in Australia are subject to a capital gains tax, which also has the effect of inhibiting short-term transactions. The absence of such a tax in New Zealand means that it is more likely that shareholder integrity measures have to be comprehensive, to avoid unintended manipulation of the rules. This means that, other things being equal, New Zealand may need tighter anti-streaming provisions than Australia does.

New Zealand’s current anti-streaming rules

Shareholder continuity rule (sections OA 8, OB 41, OZ 4)[3]

3.11 The shareholder continuity rule helps to protect both source-basis taxation and the objective of keeping that tax system as close to a fully integrated system as possible, by preventing the type of streaming discussed in Examples 2 and 3 of the preceding chapter. This rule attempts to prohibit a company from carrying forward imputation credits unless a substantial percentage of those people who benefit from imputation credits were shareholders when the income was derived. It works by cancelling imputation credits in the event of a change of ownership greater than 34 percent from the time when those credits were generated

Same credit ratio (sections OA 18, OB 60-63, OZ 7, OZ 8, OZ 9)

3.12 A company can attach imputation credits to its dividends from a minimum of nil to a maximum ratio of:

Company Tax Rate[4]
1 – Company Tax Rate

3.13 Companies are required either to maintain the same ratio of credit to net dividend distributions for all distributions during any income year as the credit ratio on the first (or benchmark) dividend, or make a ratio change declaration to the effect that the variation of credit ratio is not a streaming arrangement. Individual shareholders are therefore not able to gain a tax credit for a greater amount of tax than others who may have paid it on distributions within the current imputation year.

Trusts and partnerships (sections LE 1-6, LF 2-4)

3.14 Imputation credits on dividends distributed to trust beneficiaries are allocated according to the proportion of aggregate distributions (whether capital or income) made to each beneficiary from the trust in that year. The allocation rules for partnerships mirror those of trusts.

Imputation credit shopping (section OB 71, OB 72)

3.15 These rules are intended to prevent imputation credits earned by one group of companies being paid to the shareholders of a different group of companies. In broad terms, a company that has an imputation credit account debit balance when it leaves or joins a wholly owned group must pay an amount of tax equal to the debit. When there is no change in the ultimate owners of the group the leaving company can elect to have the debit balance debited to the imputation credit account of another company in the group. The shareholder continuity rule is also intended to prevent imputation credit shopping.

Share lending (section GB 49)

3.16 Share lending rules allow qualifying transactions to be taxed on the substance of the transaction, which is a loan of shares, rather than the legal form, which is a sale of shares. Therefore, for imputation purposes, the imputation credits remain with the economic owner of the shares (the share supplier), who is the person who originally transferred the shares to another person (the share user). This is achieved by transferring the imputation credits to the share supplier and denying the tax credit to the share user. A specific anti-avoidance provision ensures that taxpayers do not attempt to structure arrangements to fall outside of the Income Tax Act (not merely the share lending rules). In that situation, Inland Revenue may treat the arrangement as a returning share transfer, with the person affected by the arrangement treated as a share supplier or share user. These rules guard against the type of arrangements illustrated in Example 2 of Chapter 2.

General anti-avoidance rules

Arrangements to defeat continuity rule (section GB 34)

3.17 When shares have been subject to an arrangement intended to defeat the intent and application of the shareholder continuity rule, under this rule the company is deemed not to have met the continuity requirements in respect of those shares.

Stapled stock (section GB 37)

3.18 This rule is aimed at arrangements in which a taxpayer is a shareholder of, say, a non-resident company but the rights of shareholding include allowing the shareholder to receive dividends from an associated company resident in New Zealand. (This kind of arrangement is not to be confused with arrangements that involve equity stapled to debt instruments. These are being addressed separately.)

3.19 If an arrangement is entered into for a purpose of having another company pay a dividend to the shareholder, a dividend is deemed to be paid by the company that entered into the arrangement. Also, the imputation credits attached to the dividend are deemed to be a debit to that company’s imputation credit account.

3.20 Any imputation credit subject to this provision is neither eligible as a credit of tax against the recipient’s income tax liability nor is it eligible for conversion and carry-forward as a net loss or tax credit.

Arrangements to obtain a tax advantage from imputation credits (section GB 35)

3.21 The imputation rules have a general anti-avoidance provision directed at counteracting trading in or recycling of credits and temporary transfers of interests in companies in order to obtain a tax advantage.

3.22 An arrangement to obtain a tax advantage includes streaming arrangements in which the streaming will give a higher credit value to a person receiving the credit than would have been case for the person who would have otherwise received the credit. A dividend has a higher credit value if it has an attached imputation credit and it replaces a dividend that does not, or if the imputation ratio of the dividend is higher than that of the other dividend.

3.23 When an arrangement is subject to this provision, the person who would get a tax credit advantage is denied it, and the company that would get an account advantage (a credit to its imputation credit account) has a debit to its imputation credit account equal to the imputation credit.

What are the private sector’s concerns about the current rules?

3.24 The government is uncertain about the overall depth of private sector concern about the current anti-streaming rules, and therefore seeks comment about whether they need change and, if so, the form that change should take.

General anti-avoidance rules

3.25 Most comment to date has been that the general anti-avoidance rules present a number of difficulties of interpretation for both taxpayers and Inland Revenue, particularly when taxpayers contend the arrangements in question have legitimate commercial purposes. Existing rules have been criticised as being unclear on complex arrangements. Also, they should be flexible enough to allow arrangements that are commercially desirable.

3.26 One alternative would be to replace the general rule with rules that target particular types of transactions (as is done with imputation selling transactions, referred to earlier). If we move in the direction of closer alignment between the Australian and New Zealand imputation provisions, another possibility would be to adopt some of the Australian provisions.

3.27 Australia has four basic anti-avoidance rules (see Appendix) and while one rule is similar to New Zealand’s current stapled stock provisions, referred to earlier, and another is purely of an administrative nature, the others attack arrangements that might otherwise be allowable in New Zealand under the current rules.

Continuity rules

3.28 If there was no continuity test or it was set at a lower threshold than the present 66 percent, a credit that had been earned in the past could be transferred to a new owner (say, a taxable resident) who might be in a very different tax position from that of the original owner (say, a tax-exempt entity). The continuity test also helps prevent sales of companies with imputation credit balances to companies who can more benefit from them.

3.29 Generally, when a continuity breach is imminent, a company may take action to prevent the loss of the imputation credits to shareholders by paying a dividend (often by way of a bonus issue) to reduce the imputation credit account to zero. Therefore the continuity rule can fill a useful function in that it can prevent the build up of unusable credit balances.

3.30 Some companies, however, lose their imputation credit balances because of errors in calculating shareholding changes. Moreover, the rules sometimes require companies to pay dividends or bonus shares, which may be costly for those companies, when there are no policy concerns with the shareholding change.

3.31 For example, suppose a company that is 100 percent owned by a shareholder on capital account on the 33% tax rate earns $100 profit and pays $30 tax. Under our current continuity rules, if these profits and imputation credits are not distributed before a sale of more than 66 percent of the shares of the company, the credits are cancelled in full. However, assuming the purchaser is able to make use of the imputation credits, if there were no continuity rules the value of the credits would be factored into the sale price for the shares. If the purchaser is also on capital account and on a 33% tax rate the vendor would receive a $67 after-tax return. Although this is, on the face of it, inconsistent with the integration principle, it is of no practical effect as the aggregate tax liabilities are unchanged.

3.32 The share sale in these circumstances, therefore, does not appear to create concerns as the transfer of a credit is accompanied by an offsetting obligation to pay tax on the underlying income. On the other hand, Examples 2 and 3 in Chapter 2 show that the risks of removing the rule in its entirety could be significant, especially if at some point in the future imputation credits could be refunded to some non-taxpayers, such as charities, as discussed in Chapter 4.

3.33 In the light of these policy concerns, the government seeks comment on whether the continuity rules have practical compliance consequences or if they constrain commercial activity, and if so, how these problems can be addressed without opening up arbitrage opportunities. For example, if a continuity rule is retained, is the 66 percent continuity threshold still appropriate, or should the ratio go up or down? What are the costs and practical implications of complying with the current rules, including taking action such as making bonus issues before a major shareholding change occurs? Alternatively, are there better ways of targeting arrangements, such as those described in Examples 2 and 3 in Chapter 2?

Exempting credit rule

3.34 Australia does not have quantitative tests for shareholding continuity. Instead it protects its source-basis taxation by an exempting credit rule that is designed to prevent the trading of imputation credits when foreign-owned companies or companies owned by tax-exempt entities are sold to residents. This rule is described in the Appendix.

3.35 A question for New Zealand is whether any such rules should be considered as a replacement for continuity provisions or in addition to continuity. If refunds are provided to charities and/or other non-taxpayers, transfers of imputation credits from non-resident shareholders to domestic taxpaying shareholders will not be the only issue of policy concern. Similar concerns would arise with transfers between domestic taxpayers on different rates. New Zealand may be subject to much greater pressures here than Australia would be because of the absence of a capital gains tax.

3.36 There is also an element of arbitrariness in the Australian rules. Should there, for example be a foreign/tax-exempt ownership threshold before the rules kick-in (in Australia it is 95 percent) and if so what is an appropriate ratio?

Holding period rule

3.37 While some of the impact of the exempting credit rules can be avoided by a temporary transfer of shares, the Australian franking credit holding rule, which generally allows only shareholders to benefit from imputation credits if shares are held for a minimum period (45 days, as discussed in the Appendix) provide some barriers to such arrangements. Would a similar rule be sensible for New Zealand and, if so, is 45 days a reasonable period? If such a rule were introduced, how should we best assess when a substantial part of the risks of ownership of shares is subject to an arrangement to defeat their application.

3.38 Finally, would compliance costs be eased by repealing our continuity rule and adopting the Australian holding period rule, together with the exempting credit rule?

Same credit ratios

3.39 The benchmark dividend rule is intended to ensure that imputation credits are evenly spread across all shareholders and not directed at those best able to use the credits. However, the current rule does not prevent the unequal distribution of imputation credits. This is because it looks only at actual distributions within the current year. Therefore it is possible to stream imputation credits by paying dividends only on one class of share, or using a special purpose vehicle with a different payout ratio to the head company or by paying dividends in alternate years. The question is whether, in practice, this causes major concerns.

3.40 The rules could be changed to measure imputation credit ratios across a two-year period and require them to be maintained. Moreover, to target transactions that consistently pay dividends only on certain classes of share or from special purpose vehicles, the benchmark rules could be extended to all shares from all entities within a group of companies. Would such a change have a substantial effect on compliance costs or hinder valid commercial transactions?


3.41 The rule preventing streaming of credits to beneficiaries applies even if, for example, one beneficiary receives all dividend income and another receives non-dividend or capital payments only. This can lead to capital beneficiaries losing all of their allocation of imputation credits, as illustrated in Example 5.

Example 5. How beneficiaries can lose imputation credits

An estate has a number of beneficiaries. Beneficiary A has a lifetime interest in the income from half the original capital. The other half of the capital plus accrued income is to be paid to the deceased’s children (Beneficiaries B and C) when they turn 25.

The income of the estate includes dividends that carry imputation credits.

In a particular year, Beneficiary A is paid out her share of the estate’s income, being $4,000 of dividends. Beneficiary B turns 25 and is paid out her capital of $36,000. Therefore the total distribution is $40,000. $500 of imputation credits were attached to the dividend income distributed.

Based on her share of total distributions, Beneficiary A is entitled to 10 percent of the $500 of imputation credits, being $50. The remaining imputation credits are forgone as Beneficiary B is not entitled to an allocation of imputation credits because she is a capital beneficiary only.

3.42 The current requirement to pro-rate the imputation credits in the circumstances described in Example 5 produces results that are not equitable to the beneficiaries when there is no avoidance concern. Therefore some have argued that the scope of the rule is too wide.

3.43 One option would be to remove the current rule and instead rely on the general anti-avoidance rule. Alternatively, a formulaic approach could be used, although in the past this has been rejected as unworkable and not sufficiently robust.

3.44 The government is not considering a change to the rule requiring pro rata allocation of imputation credits to partners in a partnership as it was decided during the review of partnership taxation that all tax attributes associated with partnership income must be allocated pro rata, in proportion to partnership income. This is to prevent partnerships from using special allocations as a way of streaming tax benefits to partners who can best use them.

Imputation credit shopping

3.45 The imputation credit shopping rules preserve the integration principle, and the government would be reluctant to narrow it unless there was evidence of legitimate commercial transactions being prevented. If the continuity rule is relaxed, however, there may be a case for its extension to deal with situations involving change of ownership of group companies with credit balances to prevent inappropriate access to tax refunds by corporate purchasers.

Share lending

3.46 The specific anti-avoidance rule in the share lending provisions targets the streaming possibility outlined in Example 2, so the government would also be reluctant to change it without providing some clear substitute preventing temporary share transfers


3 All statutory references are to the Income Tax Act 2007.

4 Following the change in the company tax rate to 30% from the start of the 2008-09 income year, a transitional rule allows existing credits to be passed through at the 33/67 ratio until 1 April 2010.