Overview of proposed amendments

The Taxation (International Investment and Remedial Matters) Bill builds on and extends earlier international tax reforms. The main proposal is to extend the active income exemption that currently applies to offshore subsidiaries so that it also applies to joint ventures and other significant shareholdings in foreign companies. This will remove a barrier to offshore expansion by New Zealand businesses.

In 2009 an active income exemption was introduced for foreign companies that are controlled by New Zealand investors (controlled foreign companies (CFCs)). This reform was designed to ensure that New Zealand businesses that expand offshore by operating subsidiaries in foreign countries can compete on an even footing with foreign competitors operating in the same country. This means that a New Zealand-owned manufacturing plant in China would generally face the same tax rate as other manufacturers operating in China.

An “active business test” is used to reduce the tax and compliance costs associated with calculating and attributing small amounts of passive income. The test is passed and no income is attributed, if less than 5% of the gross income of the CFC is passive. If the test is failed, then only the passive income (i.e. highly mobile income such as interest, rent or royalties) is attributed to the shareholder.

In 2007 some new methods were introduced for calculating income from less than 10% shareholdings in foreign companies (portfolio foreign investor funds (FIFs)). As a consequence, such investors generally calculate income based on an assumed 5% rate of return (fair dividend rate method), although a natural person and trustees of family trusts can choose to be taxed on the actual returns of all of their foreign portfolio investments (although any losses are reduced to zero).

The 2007 and 2009 reforms did not apply to interests of between 10% and 50% in companies that are not controlled by New Zealanders (non-portfolio FIFs). Within this tranche some investors take an active role in managing the foreign company or invest in companies that are strategically aligned with their own business (akin to a CFC), while others will enter an investment based mainly on expected dividends and share gains (akin to a portfolio shareholding).

The Taxation (International Investment and Remedial Matters) Bill (“the Bill”) aims to provide consistency of tax treatment between similar types of foreign investment. It achieves this by extending the active income exemption and active business test (with some small modifications) to non-portfolio FIFs. It also extends and rationalises the portfolio FIF reforms so that those investors who are unable to use the active income exemption (due to having an insufficient shareholding or access to information) will generally be taxed on an assumed 5% rate of return (fair dividend rate method).

The main exception to these rules is for foreign companies that are located in Australia. The Bill replaces the grey list for non-portfolio FIFs with an exemption for non-portfolio FIFs that are resident and subject to tax in Australia. This is consistent with earlier reforms that replaced the eight-country “grey list” exemptions with an exemption for CFCs that are resident and subject to tax in Australia and with an exemption for ASX-listed companies.