Companies tests
Issue: Application of aggregation rule to managed funds
Submission
(18 – Staples Rodway)
There should be an exception from the aggregation rule in section YB 2 on voting interests for portfolio investment entities (PIEs) or entities eligible to be PIEs.
Comment
Officials agree that a widely held fund should not be adversely affected because of the personal land dealings of the directors of that fund. After further consultation with Staples Rodway, this issue can be best addressed by including an exclusion, for the purposes of the land provisions, in the test associating two companies in section YB 2 for a company that is a portfolio investment entity (PIE) or that is eligible to be a PIE.
Recommendation
That the submission be accepted, subject to officials’ comments.
Issue: Scope of aggregation rule
Submission
(15 – WHK Taylors)
The intended scope of the application of the aggregation rule in sections YB 2 and YB 3 is unclear. The intent of how the aggregation rule applies should be clarified in the legislation and the commentaries. In particular, is the aggregation rule focused on countering the fragmentation of shareholder interests or does it act as a tripartite test?
Comment
The aggregation rule is an element of the companies tests in sections YB 2 and YB 3. For example, in determining whether two companies are associated under section YB 2, a person is treated as holding anything held by persons associated with them under sections YB 4 to YB 14. The examples on pages 81 and 82 of the commentary on the bill illustrate how the aggregation rule applies.
The aggregation rule is designed to prevent the companies tests in sections YB 2 and YB 3 being circumvented by the fragmentation of interests among associated persons, resulting in the interest thresholds in those sections not being met. The aggregation rule does not act as a separate associated persons test.
Recommendation
That the submission that the legislation be amended be declined. It is noted that the Tax Information Bulletin article on the legislation will confirm that the aggregation rule is an element of the companies tests and is not a separate tripartite test.
Issue: Application of the aggregation rule and the tripartite test
Submissions
(35 – PricewaterhouseCoopers, 53 – Ernst & Young, 57 – Tomlinson Paull, 67 – New Zealand Institute of Chartered Accountants)
The tripartite test in section YB 14 should not be applied as part of the aggregation rule because it could result in that rule applying too widely. Therefore, the aggregation rules in sections YB 2(4) and YB 3(4) should refer to sections “YB 4 to YB 13” and not to sections “YB 4 to YB 14”.
The combination of association under the tripartite test and the aggregation provisions proposed in sections YB 2(4) and YB 3(4) could possibly involve some reiterative effect. This could give rise to significant overreach in the context of land transactions. The interaction of these provisions should be clarified.
Comment
Officials do not agree that the tripartite test should not be applied as part of the aggregation rules in the company-related tests. The example on page 88 of the commentary on the bill involves the application of the tripartite test in the aggregation rule, which ensures that a closely held arrangement is treated as associated.
In relation to the example in the PricewaterhouseCoopers submission, officials do not consider that the two companies would necessarily be associated under the proposed rules. This is because the husband would be treated as holding only the wife’s share in the partnership, including her share in the development company. For example, if the wife only held, say, a 20 percent share in the partnership, the husband would be treated under the aggregation rule as holding only that 20 percent share. Therefore the two companies would not be associated. However, if the wife held a 60 percent share in the partnership, the two companies would be associated under section YB 2 because there would be a group of persons (the husband and the wife) holding at least 50 percent of the voting interests in both companies. This would be an appropriate application of the new associated person rules.
Officials note that the tripartite test in proposed section YB 14 cannot act reiteratively because the two persons associated with each other under that test cannot be associated with the same third person under the tripartite test itself. This is illustrated in the example in page 88 of the bill commentary – The Trust and A are not associated with A’s spouse under the tripartite test.
For the associated persons reforms to be effective, the aggregation rule in the company-related tests needs to incorporate the tripartite test.
Recommendation
That the submissions be declined.
Issue: “Control by any other means” limb
Submission
(35 – PricewaterhouseCoopers)
The “control by any other means” limb under the “two companies test” in section YB 2 should be removed. Alternatively, Inland Revenue should provide more definitive guidance as to how it is to be interpreted and applied.
Comment
The removal of the “control by any other means” limb in the test associating two companies has never been part of the proposal to reform the associated persons definitions. In particular, the removal of this limb was not raised in the issues paper Reforming the definitions of associated persons published in March 2007.
Officials consider that the “control by any other means” limb acts as a buttress to the other limbs of the tests associating two companies which are based on voting and market value interests. The role of the limb also needs to be kept in perspective. It mainly acts as a backstop only to the primary voting interest test.
Officials note there is a reasonable body of case law on the meaning of “control” in the company context, such as the House of Lords decision in British American Tobacco Company Ltd v IRC [1943] AC 335. This body of case law provides the appropriate guidance on the “control by any other means” limb.
Recommendation
That the submission be declined.
Issue: Test associating a company and a person other than a company for the purposes of land provisions
Submission
(35 – PricewaterhouseCoopers)
The test in proposed section YB 3(6) and (7) should not apply to associate a company and a trust or trustee. Therefore, these provisions should only associate a company and a person who is a natural person (and not a trustee).
Comment
If a trustee wholly owns a company, it follows that the trustee and company should be associated for the purposes of the land provisions. There is no reason in principle to limit association to when the shareholder is a natural person only (not acting in a trustee capacity).
The submission refers to the reference on page 82 of the bill commentary to the “company-individual” test to describe section YB 3. This reference is intended to be a short-hand term only for “a company and a person other than a company”.
Recommendation
That the submission be declined.
Issue: Aggregation rule for purposes of land provisions
Submission
(Matter raised by officials)
The proposed rule aggregating the interests of certain associates in the test in section YB 3 associating a company and person other than a company for the purposes of the land provisions needs to be modified to ensure that the rules work as intended. The example on page 88 of the commentary on the bill involving a person’s spouse settling a trust which wholly owns a family company would not be covered under proposed section YB 3(6) if person A was a property developer. Such a closely held arrangement should be covered in the context of the land provisions.
Officials propose that the aggregation rules in section YB 3(6) and (7) should be replaced with a rule where a person is treated as holding anything held by persons associating with them under sections YB 4 (the limited version applying for the purposes of the land provisions), YB 7, YB 8, and YB 10 to YB 14. This means that the beneficiary-related trust tests and the general relatives test would not apply in the aggregation rule in the test associating a company and a person other than a company for the purposes of the land provisions.
Recommendation
That the submission be accepted.
Issue: Threshold in the company and person other than a company test
Submission
(32 – KPMG)
The required shareholding interest for a company and a person other than a company under section YB 3 should remain at 50 percent or more for particular sections.
Comment
The threshold for associating a company and a person other than a company in the general associated persons definition has always been 25 percent. In particular, officials note that the threshold for this test in the land provisions has always remained at 25 percent since its original enactment in 1973.
Although the associated persons definition currently applying for certain provisions (in particular, the “1988 version provisions”) uses a 50 percent threshold, we consider it is desirable to have a consistent threshold for associating a company and a person other than a company. Given that the 25 percent threshold is used most widely in the Income Tax Act, it is appropriate to adopt this threshold.
Recommendation
That the submission be declined.
Issue: Company acting in its capacity as trustee of a trust
Submission
(35 – PricewaterhouseCoopers)
The proposed section YB 3(8) is unnecessary.
Comment
Section YB 3(8) provides that for the purposes of section YB 3 (the test associating a company and a person other than a company), a person other than a company includes a company acting in its capacity as a trustee of a trust.
Officials note that the general position under the Income Tax Act is that a company acting in its capacity as trustee of a trust is treated as a trustee and not treated as a company (specific recognition of this position in relation to the voting interest definition which forms the basis of the main voting interest limb in section YB 3, is set out in the Tax Information Bulletin, April 1992, page 23). Section YB 3(8) ensures that this continues to be the position in section YB 3, which refers to a “person other than a company”. Section YB 3(8) makes it clear that the reference to a “person other than a company” includes a corporate trustee. We therefore consider that this clarifying provision will be helpful to readers of the legislation.
Recommendation
That the submission be declined.
Issue: Modifications to companies tests for listed or widely held companies
Submission
(62 – Minter Ellison Rudd Watts, 77 – Westpac)
Modifications should be made to the applicable determination of “voting interest” and “market value” to ensure that the rule is workable in practice in relation to listed or widely held companies. These modifications would be generally consistent with current sections YC 10 and YC 11 in relation to the continuity provisions.
Comment
The modifications in sections YC 10 and YC 11 to the measurement of voting and market value interests for certain listed and widely held companies were specifically designed for the purposes of the continuity provisions which mainly relate to the ability of companies to carry forward and use tax losses and tax credits.
The associated persons definitions, which also use voting and market interest concepts, have never incorporated the modifications to the measurement of voting and market value interests now contained in sections YC 10 and YC 11. The former section OD 8(3) of the Income Tax Act 2004, also contained a tripartite test but again, did not include the above modifications. This definition was applied in a wide range of operative provisions in the Income Tax Act, such as the depreciation, transfer pricing, thin capitalisation, share lending, and international tax rules. Officials therefore consider there is no reason to depart from the long-standing position of not applying the modifications to the determination of voting and market value interests now contained in sections YC 10 and YC 11 in the new associated persons definitions.
Recommendation
That the submission be declined.