Distributions to cooperative company members
(Clauses 6, 7, 12 and 32)
Summary of proposed amendments
The bill in effect extends the scope of sections DV 11 and CD 34 of the Income Tax Act 2007, which allow a cooperative company to deduct a distribution to a member if the distribution is in proportion to the sale and purchase of trading stock between the member and the cooperative. Amendments to section DV 11, and new section CD 34B, remove the requirement for strict proportionality by permitting a 20 percent differential.
This flexibility is being introduced to reduce compliance costs for cooperative companies that pay dividends on a limited number of shares in excess of those held to match trading stock transactions. There will be a general review of the tax treatment of dividends paid by cooperatives within the next year.
The amendments will apply to distributions made on or after 1 April 2010.
- Section CD 34 will be repealed and replaced by section CD 34B, which is slightly broader in scope.
- Section CD 34B provides that a distribution on certain types of shares by a cooperative company to a member is not a dividend. This applies to shares held in proportion to actual or expected trading stock transactions between the member and the cooperative, and also to a limited number (20 percent) of other shares.
- Section CD 34B(9) provides an exception to section 125 of the Companies Act 1993 for cooperatives that elect deductible dividend treatment for tax purposes, and that provide a copy of the election to the Registrar of Companies. Subsection (9) gives such companies some flexibility in fixing the date of entitlement which establishes members’ right to receive dividends.
- Section DV 11, which currently provides for a cooperative company to deduct distributions to which section CD 34 applies, now refers to section CD 34B.
Cooperative companies can require members to hold shares in proportion to trading stock transactions between the member and the cooperative. Shares linked to supply in this way are described as “supply-backed shares”. Sections DV 11 and CD 34 provide that, subject to certain limitations, cooperatives with these types of shares may deduct distributions paid to members if the payments are in proportion to trading stock transactions. This would enable a cooperative to deduct a distribution paid on a supply-backed share.
A cooperative company with such a capital structure can make distributions in relation to non-transaction shares as well as supply-backed shares. Non-transaction shares are shares that enable the member to supply trading stock to the company in a season but in relation to which the member does not actually supply or expect to supply trading stock.
The boundary between supply-backed and non-transaction shares is not clear during a trading season. To avoid increased compliance costs for these cooperatives, which would arise from treating these shares differently for income tax purposes, the government has decided in the shorter term to extend the existing treatment for distributions on supply-backed shares to distributions on a limited number of non-transaction shares.
It is satisfied that, provided the number of non-transaction shares held by a member does not exceed 20 percent of the number of other shares, there is still a close enough link between a member’s overall shareholding and the member’s trading stock transactions with the cooperative to warrant the same treatment for distributions on both types of share.
However, the government intends to review the tax treatment of distributions paid on shares held in cooperative companies within the next year as part of its general review of mutual transactions.
New section CD 34B will generally apply in the same circumstances as the existing section CD 34, which will be repealed.
The new section describes four types of shares – transaction shares, projected transactions shareholding, limited non-transaction shares and other shares that entitle members to enter into trading stock transactions. The distinction exists only for the purposes of tax rules relating to deductibility and dividends – the shares may be of the same, or a different class, for company law purposes.
Distributions in proportion to actual or estimated trading stock transactions
Under new section CD 34B, transaction shares are those that are held in proportion to trading stock transactions in a season. Projected transactions shareholding are shares held in proportion to estimated trading stock transactions in a season.
Under the proposed changes, distributions paid by a cooperative company on such shares will be deductible to the cooperative (section DV 11) and are not a dividend (new section CD 34B(2)(a) and (b)).
Distributions on limited non-transaction shares
Non-transaction shares are shares that are not held in proportion to actual or estimated trading stock transactions but that entitle the member to enter into trading transactions with the cooperative.
A distribution paid by a cooperative to a member on such a share is deductible to the cooperative, and is not a dividend, only if the member does not hold, and the constitution of the cooperative does not allow any other member to hold, more non-transaction shares than 20 percent of the greater of the number of their transaction shares or projected transactions shares.
If the constitution allows any member to hold more non-transaction shares than the 20 percent level, only distributions on transaction and projected transactions shareholding will be deductible to the cooperative and will not be a dividend. Distributions to any member on other shares will not be eligible for this tax treatment.
A is a member of a farmers’ meat cooperative company. The company requires a member to hold one share for each 10 kilograms of meat the member sells to the cooperative in a season. Members can also hold additional shares up to a maximum of 20 percent of shares held by the member to back their recent or estimated sale of meat to the cooperative. Shares held in excess of this are redeemed by the cooperative at the end of the season.
A estimates that he will supply 1,000kg of meat in the 2010–11 season so he purchases 120 shares. He only supplies 800kg of meat in the season. After the end of the season, the cooperative company distributes $1 per share to members for that season so A receives $120.
A holds 100 projected transactions shares (80 of which are transaction shares) and 20 limited non-transaction shares for the 2010–11 season. The distribution of $120 is not a dividend under new section CD 34B and is deductible to the cooperative under section DV 11.
The cooperative company changes its constitution so that an individual member may hold any number of non-transaction shares. A estimates that he will supply 1,000kg of meat in the current season, and actually supplies 900kg. He holds 200 shares. The company pays a $200 dividend on the shares.
A holds 100 projected transactions shares and 100 other shares. The $100 paid on the projected transaction shares is deductible to the cooperative and excluded as a dividend. The remaining $100 is non-deductible and may be a dividend.
In this case, section CD 34B(3)(b) applies so that distributions on shares other than transaction shares or projected transactions shareholding held by any member (not just A) are not deductible and may be a dividend.
As noted earlier, the government proposes to review the tax treatment of distributions from cooperative companies to shareholders within the next year. This will enable full consultation on the appropriate treatment of such distributions.
Section 125(2) Companies Act 1993
A problem arises for cooperative companies with a particular capital structure that pay dividends to shareholders and have different financial years and trading seasons (for example, a trading year ending 31 March and a financial year ending 31 May).
Under section 125 of the Companies Act 1993, there is a maximum 20 working-day period between the time shareholders’ entitlements to receive a dividend are determined (the “record date”) and the date the company’s board resolves to pay the dividend.
This creates a problem for cooperative companies that require shares to be held in proportion to trading stock transactions, that pay dividends to shareholders and that have a different financial year and trading season. If such companies pay a dividend in respect of a trading season after the end of the equivalent financial year, the record date can be in the new trading season. The appropriate record date should be in the trading season for which the dividend is paid.
Proposed subsection CD 34B(9) therefore provides an exception to the 20 working-day rule for cooperative companies that have elected the tax treatment in section CD 34B. However, the exception applies in relation to all shares of the cooperative that entitle a member to enter into trading stock transactions. That is, the 20 percent limitation that applies for tax purposes does not apply for the purposes of the exception to the Companies Act 1993.
A Co is a cooperative company whose members hold 1 share for each $10kg of meat they supply to the cooperative. It has a trading season of 1 April to 31 March and a financial year of 1 June to 31 May. It intends to pay a dividend based on its 2010–11 trading season on 1 August 2011, after the end of its 2010–11 financial year. It wants to pay that dividend to members in relation to their shareholding in the 2010–11 trading season.
It elects, under section CD 34B, to deduct the dividends paid on its shares and also gives a copy of the election notice to the Registrar of Companies. It resolves to fix a record date for all future distributions of 31 March, being the last day of its trading season. As this resolution was made before the end of the 2010–11 trading season, the board can resolve to pay a dividend on 1 August 2011, in respect of the 2010–11 trading season, based on shareholding on 31 March 2011.