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Remedial matters

PORTFOLIO INVESTMENT ENTITIES

Issue: Application of portfolio class land loss amendment

Submission

(Ernst & Young)

Clause 22 of the bill proposes an amendment to the definition of “portfolio class land loss” to clarify that PIEs that own land offshore can allocate tax losses arising from foreign exchange contracts to investors. It is submitted that an equivalent amendment should also be made to the Income Tax Act 2004 to apply from 1 October 2007 for taxpayers’ 2007–08 income years.

Comment

Officials agree. It was not intended that foreign exchange losses relating to portfolio investments in offshore portfolio land companies should be required to be carried forward by the PIE. Therefore it is appropriate that the amendment applies from the beginning of the PIE rules.

Recommendation

That the submission be accepted.

 

Issue: Foreign exchange losses

Submission

(KPMG)

All foreign exchange losses should be able to be passed through by the PIE to investors even if the investment relates to a greater than 20% interest in a foreign land-owning company.

Comment

Officials agree in principle that foreign exchange losses should be able to be passed through to investors. However, in relation to certain PIEs that own predominantly land, this would require the rules to distinguish and treat differently losses that relate to the land (these would be carried forward) and foreign exchange losses (these would be passed through to investors). This would require major changes to the PIE calculation rules and would increase the complexity of the rules significantly. Officials consider that the approach adopted in the bill will solve the issue of allocating foreign exchange losses for the majority of PIEs that own interests in offshore portfolio land companies.

Recommendation

That the submission be declined.

 

Issue: Portfolio investment entity tax rates

Submission

(KPMG)

Remedial amendments should be made to portfolio investment entity (“PIE”) tax rates.

Comment

The Taxation (Consequential Rate Alignment and Remedial Matters) Act 2009 made changes to the tax rates on PIEs and the income thresholds so they align with the new personal tax rate structure enacted in 2008 (section 124 of the 2009 Act; schedule 6, table 1 of the Income Tax Act 2007).

However, schedule 6, table 1 does not accurately reflect the appropriate prescribed investor rates (“PIRs”) and income thresholds for New Zealand resident natural person investors. Accordingly, amendments should be made to ensure the rates and thresholds are correct.

Additionally, row 2 of schedule 6, table 1 should be amended to clarify that the 30% PIR applies to all non-resident investors, whether or not they have provided a notification.

Officials recommend that the amendments apply from 1 April 2010.

Recommendation

That the submission be accepted.

 

Issue: Miscellaneous drafting issues

Submission

(KPMG)

Section HL 4(2)(a) and (ab) should be linked with an “or” rather than an “and”.

Comment

Officials agree. Section HL 4(2) sets out the requirements for which an entity ceases to be eligible to be a PIE. Section HL 4(2)(a) sets out the requirements under sections HL 6 or HL 9 at a class level, whereas section HL 4(2)(ab) sets out the requirements under section HL 10 at an entity level.

Recommendation

That the submission be accepted.

 

Submission

(KPMG)

The reference to “investor membership requirement” in section HL 9(2) is incorrect and should be replaced with “investor interest size requirement”.

Comment

Officials agree. This was incorrectly changed in the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009.

Recommendation

That the submission be accepted.

 

Submission

(KPMG)

The reference to the “last day of the first quarter” in section HM 25(2)(a) should be amended to the “day following the last day of the first quarter”.

The reference to the “last day of the second quarter” in section HM 25(2)(b) should also be amended to the “day following the last day of the second quarter”.

Comment

Officials disagree. The date for cessation of PIE status is intended to be at the end of the quarter and not at the start of a new quarter.

Recommendation

That the submission be declined.

 

Submission

(KPMG)

Section HM 33(1) should include a requirement for a PIE investor proxy (PIP) to provide other information the Commissioner requires.

Comment

Officials disagree. This requirement has been placed within the “duties” of a PIP rather than within the eligibility requirements.

Recommendation

That the submission be declined.

 

Submission

(KPMG)

The reference to section HM 35(5) is not required in section HM 36(3)(b) and (c) as the taxable income/loss of the PIE is calculated under section HM 35(7).

Comment

Officials disagree. Section HM 35(5) calculates a “taxable amount”. Section HM 35(7) defines the result of HM 35(5) as “taxable income” or “taxable loss”. Therefore both sections are required for the purposes of section HM 36(3)(b) and (c).

Recommendation

That the submission be declined.

 

Submission

(KPMG)

The reference in section HM 53(2) to section HM 52 is incorrect. The correct reference is section HM 51.

Comment

Officials agree. This was incorrectly inserted in the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009.

Recommendation

That the submission be accepted.

 

Submission

(KPMG)

The reference to section CX 56B in section HM 60(4) should be removed.

Comment

Officials agree. The reference is unnecessary.

Recommendation

That the submission be accepted.

 

Submission

(KPMG)

Section HM 69(5) should clarify that any residual formation losses available after expiry of the three-year period should be applied under section HM 68.

Comment

Officials agree that an amendment is required to ensure that residual formation losses are made available after the three-year period has expired. This should be achieved by ensuring that residual formation losses are allocated to the next attribution period.

Recommendation

That the submission be accepted, subject to officials’ comments.

 

Submission

(KPMG)

The reference to “portfolio exit period” in section 31(2B)(a) of the Tax Administration Act 1994 is incorrect and should be “portfolio investor exit period”.

Comment

Officials agree.

Recommendation

That the submission be accepted.

 

Submission

(KPMG)

The submitter has raised the other minor drafting issues with the PIE rules. These are as follows:

  • There should be an exception for “zero-rated investors” from section HM 6(2)(a).
  • The reference to “correct rate” in section HM 6(2)(a) should be replaced by “prescribed investor rate”.
  • In section HM 6(2)(b) it should be clarified that an investor is liable for tax on any assessable income arising from proceeds for which the PIE has “no” tax liability.Section HM 24 should be aligned with section HL 15(2)(b). The loss of PIE status should be from the start of the next quarter.
  • In sections HM 26 to 28, loss of PIE status should be from the start of the next quarter to align with current requirements.
  • In section HM 30(1), the loss of foreign PIE equivalent status should be aligned with the rules for loss of PIE status.
  • In section HM 46, between the steps outlined in subsections (b) and (c), there should be an investor income attribution step, for clarity.
  • In section HM 60(3), subsection (3) should be reworded as follows: “the PIE has made a voluntary payment of tax under section HM 45 that is intended to satisfy its income tax liability for the period in relation to the investor, unless the multi-rate PIE applies the last notified investor rate to the voluntary repayment”.
Comment

Officials consider that these drafting issues required further consideration. It is therefore recommended that they be considered further and any changes arising will be included in a future tax bill.

Recommendation

That the submission be noted.

 

Submission

(KPMG)

In section HM 25(3)(b) the correct references should be “the first quarter ends within three months before an announcement by the entity to its investors that it, or the relevant investor class, is winding up within 12 months of the announcement”.

Comment

The exclusion in section HM 25(3)(b) is currently worded so that the further eligibility requirements do not need to be met if the relevant quarter ends more than three months before a wind-up announcement to investors. This gives rise to an anomalous outcome – that is, the further eligibility requirements do not need to be met at any time prior to a quarter ending within three months of a wind-up announcement to investors. This is unintended.

Recommendation

That the submission be accepted.

 

Issue: Electronic returns by PIEs

Submission

(Matter raised by officials)

A number of cross-referencing errors need to be amended in the Tax Administration Act 1994. In section 40(2)(a) there should be references to sections 35, 36AB, 36BB, 36BC and 36E. In section 36C there should be a reference to section 36AB.

Comment

These are cross-referencing amendments of a technical nature only and have been raised in the context of Transform IR, Inland Revenue’s major programme to move its paper-based processing to electronic forms.

Recommendation

That the submission be accepted.

 

Issue: Rewrite amendment

Submission

(Matter raised by officials)

In the definition of “land investment company” in section YA 1, at the end of subsection (a) the “:” should be changed to “; and”.

Comment

This unintended change was made in the rewritten legislation in the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 and should be corrected.

Recommendation

That the submission be accepted.

 

Issue: Credits for PIE tax liability

Submission

(Matter raised by officials)

Section LS 2 should be clarified to provide investors with a credit for the PIEs tax liability on income when that income is taxed to the investor.

Comment

In certain situations PIE income is taxed to the investor as well as the PIE. This can occur when the investor has elected a rate with the PIE that is lower than their correct PIE tax rate. To prevent double taxation, section LS 2 is designed to provide the investor with a tax credit for the PIE tax. There is a technical problem with section LS 2 as it currently does not provide a credit when the PIE’s tax liability is offset by a credit at the PIE level (for example, an imputation credit). It is recommended that section LS 2 be changed to provide investors with a credit for the PIE’s tax liability on that income rather than PIE tax paid. This amendment would be consistent with the policy intention of the PIE credit rules and is taxpayer-friendly. It is therefore further recommended that the change applies retrospectively from the start of the PIE rules in October 2007.

Recommendation

That the submission be accepted.

 

Issue: Hedging tax mismatch with FDR securities

Submission

(KPMG)

The NZ dollar hedging arrangements entered into by PIEs (and other taxpayers) in respect of fair dividend rate (FDR) equities should be excluded from the scope of the financial arrangements rules. The gain or loss on the hedge should instead be taxable as part of the FDR return.

A hedging tax mismatch will arise for a PIE because the gain or loss under a hedge is fully taxable under the financial arrangements rules whereas the taxable income in respect of the underlying equities is limited to 5% of their market value, under the FDR regime. This can result in a portfolio of offshore securities, which is perfectly hedged on a pre-tax basis, being imperfectly hedged on an after- tax basis.

KPMG has previously made submissions on this issue. Officials have agreed, in principle, with the above approach but have consistently indicated that further work and consultation was necessary to develop the detail of any solution.

Comment

Officials agree that the hedging mismatch described by the submitter can result in compliance issues for PIEs. Resolving this issue is complex and the appropriate solution is not obvious. Officials will continue to consider the issue and will include the submitter in any consultation.

Recommendation

That the submission be noted.

 

FOREIGN INVESTMENT FUNDS

Issue: $10,000 limit on foreign non-dividend income for qualifying companies

Submission

(KPMG)

The foreign non-dividend income requirement, under the qualifying company rules, should also take account of income under the foreign investment fund (FIF) rules (or FDR income should be excluded as it is effectively a proxy for a “fair dividend”).

Alternatively, qualifying company status should cease only if the amount of foreign non-dividend income, less the amount of foreign dividend income which would be treated as arising if the FIF rules did not apply, is greater than $10,000.

Comment

Officials agree that it is appropriate that FIF income calculated under the FDR method should be excluded from the limit on foreign income in section HA 9.

Recommendation

That the submission be accepted, subject to officials’ comments.

 

Issue: Ring-fencing of certain foreign losses under qualifying company rules

Submission

(KPMG)

The ring-fencing of FIF losses under section HA 25 in the qualifying company rules should be removed.

Comment

Officials note that FIF losses that are no longer subject to the FIF loss ring-fencing rules are not within the ambit of section HA 25. This is because section HA 25 applies only to “a FIF net loss” which is now restricted to a FIF loss calculated under the branch equivalent method. Officials also note that section HA 25 only applies if an election has been made. Officials therefore consider it is not necessary to make any further amendment to section HA 25.

Recommendation

That the submission be declined.

 

MEANING OF CONTROLLED FOREIGN COMPANY

Clauses 18 and 85

Submission

(Ernst & Young, New Zealand Law Society)

The proposed changes to the meaning of a controlled foreign company (CFC) should be worded as “the person’s control interest is no greater than a control interest in the same category held by another person; and” or as “the person’s control interest is less than or equal to a control interest in the same category held by another person”. (Ernst & Young)

That the savings provision in the proposed section 85(2)(b) be extended to include the 2005–06 income year. (New Zealand Law Society)

Comment

Officials agree that the amendment to section EX 1(1)(b)(i) in the Income Tax Act 2004 and 2007 in clauses 18 and 85 is intended to state that a New Zealand resident’s control interests in a foreign company must be less than or equal to the control interests held in the same company by the other person.

The other subparagraphs in section EX 1 require that the other person must be a non-resident who is not an associated person of the New Zealand resident. That reflects the policy intention.

Officials agree with the New Zealand Law Society that the savings provision in clause 85(2)(b) should apply from, and including, the 2005–06 income year.

Recommendation

That the submissions be accepted.

 

IMPUTATION CREDITS AND TAX POOLING – AMENDMENTS TO SECTION OB 6

Clause 28

Submissions

(New Zealand Institute of Chartered Accountants, PricewaterhouseCoopers, Tax Management New Zealand Ltd, matters raised by officials)

We support the sentiment behind this amendment, but the drafting of the legislation needs to be improved. (New Zealand Institute of Chartered Accountants)

Proposed paragraphs OB 6(1)(b) and (c) should be removed from the bill. (New Zealand Institute of Chartered Accountants, Tax Management New Zealand Ltd)

Proposed section OB 6(3) should be amended by removing paragraph (a) and amending paragraph (c) so that it also deals with the situation where the intermediary transfers a deposit to another taxpayer. These changes will restore the effect of section ME 492)(ad) of the 2004 Act. Paragraphs (b) and (c) should be re-lettered (a) and (b). (New Zealand Institute of Chartered Accountants, Tax Management New Zealand Ltd)

Section OB 6 should provide that the credit date for an amount transferred by an intermediary from a tax pooling account to a taxpayer’s tax account with the Commissioner be determined under the effective date rules in sections RP 19 and RP 20. (PricewaterhouseCoopers)

The drafting of section OB 6 in clause 28 of the bill should be amended to clarify that the provision:

  • should not apply to a company in relation to funds it has deposited into a tax pooling account; and
  • applies to a company in relation to an amount representing an entitlement to funds in a tax pooling account that the company has acquired from another person under the tax pooling rules. (Matter raised by officials)

Sections OB 34, OB 35, OP 9, OP 32 and OP 33 of the 2007 Act should be amended to more appropriately reflect the policy intention. (Matter raised by officials)

The tables of imputation credits and debits should be consequentially amended as necessary in relation to the above submissions. (Matters raised by officials)

Comment

The provisions of section OB 6 were the subject of a submission to the Rewrite Advisory Panel. The Panel agreed with the submission and their recommendation to amend the provision resulted in an amendment to section OB 6 being included in the first reading of the Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver and Remedial Matters Bill) 2009.

The Panel had recommended that section OB 6 should be amended to correct an unintended change in outcome. The unintended change identified was that section OB 6 did not provide for an imputation credit for a company disposing of an entitlement to funds in a tax pooling account.

The Panel also noted that section OB 6 in the 2007 Act did not appear to reflect its corresponding provision in the 2004 Act. The Panel suggested that policy officials should review that issue, with a view to correcting the provision further, if necessary. In carrying out this review, the other imputation (tax pooling) provisions in the 2007 Act were reviewed. The matter raised by officials reflects the outcome of that review.

Purpose of tax pooling

The purpose of “tax pooling” is to provide a pool of funds for use by companies to reduce exposure to use-of-money interest and late payment penalties – in particular, for provisional tax. A tax pooling intermediary administers the tax pooling account, including a transfer (when requested) of funds to a taxpayer’s tax account with the Commissioner of Inland Revenue.

Under the tax pooling rules, if a taxpayer pays an amount for tax into a “tax pooling account”, that payment is held under trust for that taxpayer’s benefit. Funds held for the benefit of a taxpayer in a tax pooling account are normally described as an entitlement to funds in the tax pooling account.

However, taxpayers may “sell” their entitlement to funds in a tax pooling account to another taxpayer. On that sale, the tax pooling intermediary transfers the entitlement to those funds to the other taxpayer.

Tax pooling and imputation credits

Under the tax pooling imputation rules, the policy is that a company is intended to have a credit in its imputation credit account (ICA) for:

  • a payment for tax made into the tax pooling account (that is, the taxpayer’s own deposits into the tax pooling account);
  • the purchase of an entitlement to funds in a tax pooling account.

It is also possible that a purchaser of an entitlement may, instead of transferring the underlying funds to the purchaser’s tax account with the Commissioner:

  • later on-sell that entitlement to another taxpayer; or
  • later request that the intermediary refunds to the purchasing company the funds representing that entitlement from the tax pooling account.

The tax pooling imputation rules provide specific timing rules for the imputation credit that relates to a deposit of funds or purchase of funds. These timing rules are necessary to ensure consistency with the overall objectives of:

  • the tax pooling rules;
  • enabling the benefit of tax paid at the corporate level to be available for shareholders; and
  • the rules relating to the transfer of other tax types to a taxpayer’s income tax account with the Commissioner.

The policy intention for imputation in relation to an entitlement to funds in a tax pooling account is as follows:

  • The date of the imputation credit for a deposit into a tax pooling account is the date of the deposit. If an entitlement to funds is on-sold, the vendor company must debit its ICA for the amount of the entitlement sold.
  • For a purchased entitlement, the date of the imputation credit for a purchased entitlement to funds in a tax pooling account is permitted to be backdated if the funds are transferred to the company’s tax account with the Commissioner. The backdating of the credit is to a date selected by the taxpayer, but can be no earlier than the date of the original deposit made to the tax pooling account. Some restrictions also apply to the backdating to prevent abuse of the backdating rule.
  • The date of the imputation credit for a purchased entitlement to funds in a tax pooling account that is on-sold (transferred) to another taxpayer is the date of the transfer. A debit to the company’s imputation credit also arises for the amount on-sold on the transfer, because the purchased amount is not transferred to the company’s tax account with the Commissioner and therefore does not represent tax paid by the company.
  • The date of the imputation credit for a purchased entitlement to funds in a tax pooling account that is refunded to the company from the tax pooling account is the date of the refund. A debit to the company’s imputation credit also arises for the amount on-sold, because the purchased amount is not transferred to the company’s tax account with the Commissioner and therefore does not represent tax paid by the company.

Technical issues existing in the imputation credit tax pooling rules

Officials agree with the New Zealand Institute of Chartered Accountants and the Rewrite Advisory Panel that the imputation rules for tax pooling:

  • should not result in a company having an imputation credit for a deposit of funds into a tax pooling account and another imputation credit when that payment is later transferred to the company’s tax account with the Commissioner; and
  • should not result in a company having an imputation credit for a deposit of funds into a tax pooling account, and another imputation credit when the company either on-sells the entitlement to those funds or has those funds refunded from the tax pooling account.

Section OB 6

As currently drafted in the 2007 Act, section OB 6 applies to a company that has either made a deposit into a tax pooling account or has purchased an entitlement to funds in a tax pooling account.

Officials agree with the New Zealand Institute of Chartered Accountants that the policy intention for section OB 6 is that it should apply only to a company that has purchased an entitlement in a tax pooling account. Section OB 5 addresses the imputation effects for a company that has made a deposit into a tax pooling account.

Section OB 6 in the bill should be redrafted to provide that the purchasing company has an imputation credit for the acquisition of an entitlement to funds in a tax pooling account, and further provide that the date of the credit is as follows:

  • if the purchasing company requests the intermediary to transfer to the company’s tax account with the Commissioner, an amount representing an entitlement to the funds in the tax pooling account, the date of the credit is determined under the effective date rules in sections RP 19 and RP 20; or
  • if the purchasing company on-sells to another taxpayer that entitlement to the funds in the tax pooling account, the date of the credit is at the date the entitlement is transferred to the other taxpayer; or
  • if the purchasing company requests that the intermediary refunds the funds representing the purchased entitlement from the tax pooling account to the company, the date of the credit is the date of the refund.

Other imputation (tax pooling) provisions

In addition, as recommended by the Rewrite Advisory Panel, officials have now completed a review of other imputation tax pooling provisions in sections OB 34, OB 35, OP 9(1) and (3)(b), OP 32 and OP 33. Officials have identified that those provisions contain similar drafting issues for purchased entitlements to funds as contained in current section OB 6. For example:

  • Section OB 34 provides for a debit to a company’s imputation credit account for a refund to the company of funds representing an entitlement in a tax pooling account. As drafted, section OB 34 applies only to a company in relation to a deposit of its own funds in a tax pooling account. Its corresponding provision in the 2004 Act applied also to a company that had purchased the entitlement to those funds in the tax pooling account.
  • Section OB 35 provides for a debit to a company’s imputation credit account for an amount equal to the entitlement to funds on-sold to another taxpayer. As drafted, section OB 35 applies only to an on-sale of an entitlement that was deposited by the selling company. Its corresponding provision in the 2004 Act applied also to an on-sale of the entitlement by a company that had previously purchased the entitlement to those funds in the tax pooling account.
  • Section OP 9 is a provision for consolidated imputation groups that should “mirror” the effect of section OB 6. As drafted in the 2007 Act, section OP 9 contains the same drafting concerns identified by submitters and the Rewrite Advisory Panel for section OB 6. Section OP 9 should be amended in a similar manner to section OB 6.
  • Sections OP 32 and OP 33 apply to consolidated imputation groups and should “mirror”, respectively, the effect of sections OB 34 and OB 35. As drafted, section OP 32 has same drafting issues as identified above for sections OB 34 and OB 35. Section OP 33 as drafted in the 2007 Act is inconsistent in its language to section OB 35 and, in particular, does not refer to the intermediary’s role in transferring entitlements to funds in a tax pooling account, as the trustee of those funds. Sections OP 32 and 33 should be redrafted to be consistent with the recommended drafting changes for sections OB 34 and OB 35.
Recommendations

That New Zealand Institute of Chartered Accountant’s and Tax Management New Zealand Ltd’s first submission be accepted, and that its second and third submissions are accepted in principle, subject to officials’ comments on the intended policy outcomes.

That PricewaterhouseCoopers’ submission is accepted.

That the matters raised by officials’ be accepted.

 

CURRENCY CONVERSIONS – ADMINISTRATIVE APPROVAL FOR RATES AND METHODS OF CONVERTING FOREIGN CURRENCIES INTO NEW ZEALAND CURRENCY

Clause 33

Submissions

(Corporate Taxpayers Group, Ernst & Young, matter raised by officials)

The legislation allows taxpayers to use whatever method they have historically applied, as long as it is consistently applied by the taxpayer across income years. (Corporate Taxpayers Group)

Clarification is required to ensure that the Commissioner’s approval is given on a general basis and does not require each affected taxpayer to make specific or repeated applications to the CIR for approval of the rates and methods used. (Ernst & Young)

For a provision of the Act (other than section YF 1) that provides a rate or method for currency conversion, the CIR should be empowered to determine a rate that is representative of the actual rate or close of trading spot exchange rate. (Matter raised by officials)

Comment

The policy intention is that the Commissioner is able to approve a currency conversion rate or method, for the purposes of determining a person’s income tax obligations. This was the Commissioner’s administrative practice under the 2004 Act and earlier legislation, under which the Commissioner had approved a currency rate or methods for general application.

If a taxpayer did not use a method approved by the Commissioner (either generally or a specific method approved for a taxpayer), the law required foreign currency amounts to be converted using the spot rate applying at the transaction date, unless a legislative conversion rule applied (for example, conversion of attributed CFC income expressed in a foreign currency).

The purpose of the amendment in the bill is to empower the Commissioner to approve:

  • a general method or methods for converting foreign currency into New Zealand currency, which may include approval of the use of certain rates (for example mid-monthly exchange rates published by the Reserve Bank of New Zealand); and
  • a specific method for converting foreign currency into New Zealand currency to suit a taxpayer’s particular circumstances.

Officials agree that the bill is not sufficiently clear that the Commissioner is empowered to approve for general application (including setting of rates), methods for the conversion of foreign currency into New Zealand currency amounts for income tax purposes. Officials also agree with the Corporate Taxpayers Group that the bill is not sufficiently clear that a taxpayer would normally be required to use an approved method consistently across income years.

Officials do not agree that taxpayers should be permitted to use specific conversion methods without that method having been approved by the Commissioner, unless that specific method is provided for under an existing legislative rule. Such an approach is inconsistent with the previous administrative practice of the Commissioner and would give rise to unacceptable risks to the tax base.

Officials consider that if a taxpayer’s specific conversion method had been approved by the Commissioner under the previous administrative practice at the time the 2007 Act commenced, that approval would continue to be effective.

Officials consider that, if a taxpayer applies a previously approved conversion method consistently across tax years, the amendment to section YF 1 will not require taxpayers to re-apply for approval of their method for currency conversion. This will mean that a taxpayer will need to apply where they wish to use a new currency conversion method or rate that has not already been approved for the taxpayer or as a rate or method for general application. This point can be emphasised in the TIB item on this amendment.

Section YF 1, including the amendment in the bill, applies to transactions arising in a foreign currency but for which there is no specific currency conversion rate or method (as, for example, in the calculation of income from a foreign investment fund).

However, the Commissioner has also adopted an administrative practice for specific currency conversion rules, to permit taxpayers to use an exchange rate that is representative of actual exchange rates. The purpose of this administrative practice is to minimise compliance costs for taxpayers.

Consistent with the recommendation that the submissions on section YF 1 officials consider that it would assist in minimising compliance costs for taxpayers if the Commissioner’s administrative practice for specific currency conversion rules is also codified.

Recommendations

That the submission of the Corporate Taxpayers Group be declined in so far as it relates to currency conversion methods not previously approved by the Commissioner.

That the submission of the Corporate Taxpayers Group be accepted in so far as it relates to a requirement that the currency conversion method be consistently adopted across tax years.

That the submission of Ernst & Young be accepted.

That the matters raised by officials be accepted.

 

PAYMENTS BY RWT PROXIES – CROSS-REFERENCING ERROR IN SECTION RE 18(2)

(Matter not in the bill)

Submission

(Ernst & Young)

The definition “tax rate” in subsection RE 18(2) of the Income Tax Act 2007 should refer to clause 3, not clause 2, of schedule 1, part D.

Comment

Officials agree with the submission. The corresponding provision in the 2004 Act is section NF 1(2B), and the cross reference from the term “tax rate” was to clause 1 of schedule 14 of the 2004 Act. Clause 1 of schedule 14 of the 2004 Act corresponds to clause 3 of schedule 1, part D of the 2007 Act.

Recommendation

That the submission be accepted.

 

DEFINITION OF “CULTIVATION CONTRACT WORK”

(Matter not in the bill)

Submission

(New Zealand Institute of Chartered Accountants)

In schedule 4, part C, clause 2 of the Income Tax Act 2007, the definition of “cultivation contract work” should be amended to clarify that the schedular payments regime only applies to works or services provided under a contract or arrangement for the supply of labour, or substantially for the supply of labour in relation to land that is intended to be used for the cultivation of fruit crops vegetable orchards or vineyards.

Comment

Officials agree with the submission. The amendment corrects an unintended consequence from the drafting of the definition of “cultivation contract work”.

The policy intention is for tax to be withheld at source (under the PAYE rules) from payments for cultivation contract work that was for labour-only services, or substantially labour-only services. As drafted, the definition could include payments for services that involved a high capital element such as the use of a combine harvester.

Recommendation

That the submission be accepted.

 

REWRITE REMEDIAL ITEMS – DISPOSAL OF TRADING STOCK FOR LESS THAN MARKET VALUE

Submission

(Matter raised by officials)

Sections GC 1 and EB 24(1) of the 2007 Act should be amended retrospectively:

  • to correct an unidentified change in legislation as identified by the High Court with retrospective effect from the commencement of the 2007 Act; and
  • include an appropriate savings provision to protect taxpayers who have taken a tax position on the basis of the wording of section GC 1 or EB 24(1) in a return of income filed before 28 October 2009.
Comment

The High Court has identified that the effect of section GC 1 of the 2007 Act contained an unintended change in legislation in a recent High Court decision (Foodstuffs (Wellington) Co-Operative Society Limited v CIR (CIV 2009-485-1224). That decision of the High Court was released on 28 October 2009.

The particular issue before the Court was whether the market value of shares (held as trading stock), which were cancelled on an amalgamation, was income of the shareholder. The Court held that section GD 1 of the 1994 Act (which corresponds to section GC 1 of the 2007 Act) applied and the market value of the shares was income of the taxpayer.

The taxpayer’s argument was that section GD 1 required a recipient before it could apply. The Court rejected that argument, holding that section GD 1 did not require a recipient, noting that the section could apply to a sole trader who withdrew trading stock from the business for private consumption, which also did not require a recipient to be a separate person.

In the 2007 Act, both sections GC 1 and EB 24(1) address the disposal of trading stock for less than market value by one person to another person. Section EB 24(1) stems from the same policy background as section GC 1 and contains the same type of unintended legislative change identified in section GC 1 by the Court.

Officials recommend that sections GC 1 and EB 24(1) be retrospectively amended to ensure that the sections do not require a recipient of the trading stock, as noted by the High Court relation to section GD 1 of the 1994 Act.

However, taxpayers have notice of the Court’s finding of the meaning of the law in the 1994 Act only from 28 October 2009, being the date the High Court released its decision in Foodstuffs. Until that date, it is possible that a taxpayer has taken a tax position in a return of income filed before 28 October 2009 for either of the 2008–09 or 2009–10 income years, on the basis of the plain wording of sections GC 1 or EB 24(1) of the 2007 Act. In this circumstance, a savings provision is recommended to protect taxpayers who have adopted this tax position.

Recommendation

That the submission be accepted.

 

NON-REWRITE REMEDIALS – REWRITE ADVISORY PANEL RECOMMENDATIONS

Issue: Section CX 16(4) – 2004 Act remedial item

Submissions

(Matters raised by officials)

Section CX 16(4) should be amended retrospectively, with an appropriate savings provision, to prevent a company from electing to treat any benefit provided to a shareholder employee as a dividend.

Section CX 17(4) of the 2007 Act should be consequentially amended, as it is the corresponding provision to section CX 16(4) of the 2004 Act.

Comment

The Taxation (Annual Rates, Venture Capital and Miscellaneous Provisions) Act 2004 amended section CX 16(4), by replacing the punctuation between paragraphs (a) and (b) in section CX 16(4) of the 2004 Act. A submission to the Panel set out that this amendment had made a change to the outcome and was inconsistent with the policy intention of the rule.

The policy for section CX 16(4)(a) and (b) is that a company may elect to treat as a dividend (instead of a fringe benefit), an “unclassified benefit” provided to a shareholder-employee. This election was not available to other types of fringe benefit that were specifically listed (such as, for example, a motor vehicle).

However, as drafted, section CX 16(4) permits the company to elect that any benefit provided to a shareholder employee may be treated as a dividend. Officials agree that outcome is inconsistent with the policy intention.

The Rewrite Advisory Panel noted that the submission was not a rewrite matter, but concluded that the change in legislation produced an incorrect policy outcome. The Panel therefore recommended to officials that the provision should be retrospectively amended to restore the correct policy effect, as a minor remedial item. The Panel also recommended that the amendment should contain an appropriate savings provision to protect taxpayers who may be adversely affected by such a retrospective amendment.

Officials agree with the conclusion and recommendations of the Panel.

Recommendation

That the submissions be accepted.

 

REWRITE REMEDIAL ITEMS – REWRITE ADVISORY PANEL RECOMMENDATIONS

(Matters raised by officials)

Issue: Sections CB 33, DV 19 – Mutual associations and the mutuality principle

Submissions

Section CB 33 of the 2007 Act should be amended retrospectively to ensure it overrides the common law principle of mutuality in the same manner as its corresponding provision in the 2004 Act.

Section DV 19 of the 2007 Act should be amended retrospectively to ensure that an association may deduct an association rebate paid to members to the same extent as was allowed under the corresponding provision in the 2004 Act.

Comment

The Rewrite Advisory Panel has agreed with a submission that section CB 33 of the 2007 Act contains an unintended change by not overriding the principle of mutuality in the same manner as its corresponding provision in the 2004 Act (section HF 1(1)).

The principle of mutuality arises under common law. The Courts consider that a person cannot derive taxable income from mutual transactions, as a mutual transaction is of a similar nature to trading with oneself. The policy intention is for the income tax rules to override the common law principle of mutuality for amounts derived that would otherwise be income under the Act.

However, to give some effect to the mutuality principle, a “mutual association” is allowed a deduction, under section DV 19 of the 2007 Act, for a distribution to its members of net taxable profits (known as “an association rebate”). The amount of the deduction can be no greater than the part of the association’s net income that arises from certain types of transactions made between the association and its members.

The Panel concluded that, consequential on the unintended change in section CB 33, section DV 19 of the 2007 Act contains an unintended change in outcome. Section DV 19 allows a deduction for the association rebate, but its current drafting results in a smaller deduction than was allowed under its corresponding provision in the 2004 Act (section HF 1(2)).

Officials agree with the Panel’s conclusions and recommendation that sections CB 33 and DV 19 should be amended retrospectively.

Recommendation

That the submissions be accepted.

 

Issue: Section EE 51(3)(b) (2004 Act) and section EE 60(3)(b) (2007 Act) – Accumulated tax depreciation and mothballed assets

Submission

Section EE 51(3)(b) of the 2004 Act should be amended retrospectively to ensure that a depreciable asset that has been withdrawn from the business is not required when accounting for accumulated tax depreciation while the asset is not available for use in the business.

Comment

The Rewrite Advisory Panel has agreed with the submission that section EE 51(3)(b) of the 2004 Act contains an unintended legislative change. The Panel noted that this unintended change had been re-enacted as section 60(3)(b) of the 2007 Act.

The Panel recommended that sections EE 51(3)(b) of the 2004 Act and EE 6)(3)(b) of the 2007 Act should be retrospectively amended to restore the effect of the defined term “adjusted tax value” in the 1994 Act.

During the time a depreciable asset is withdrawn from a business, a taxpayer is not allowed a deduction for depreciation. In addition, accumulated depreciation is stopped at the time of that withdrawal from business use. An example where the rule is intended to apply is if a taxpayer “mothballs” an asset, such as plant or equipment, which has become obsolete and replaced.

Officials agree with the Panel’s conclusion and recommendation that section EE 51 of the 2004 Act (and consequentially section EE 60 of the 2007 Act) should be retrospectively amended.

Recommendation

That the submission be accepted.

 

Issue: Section FM 12(2) – Interest deductions for consolidated groups

Submission

Section FM 12(2) of the 2007 Act should be amended retrospectively to disallow a deduction for interest incurred on money borrowed from another company, when both companies are members of the same consolidated group of companies.

Comment

Section FM 12(2) of the 2007 Act allows a company a deduction for interest incurred on money borrowed from another company within the consolidated group. The Rewrite Advisory Panel considers this outcome is an unintended legislative change, when compared with section HB 2(1)(d) of the 2004 Act, and has recommended that the provision be amended retrospectively.

Section HB 2(1)(d) of the 2004 Act which is the corresponding provision to section FM 12 of the 2007 Act, prevented a company within a consolidated group from being allowed a deduction for interest incurred on money borrowed from another company within the same consolidated group. This prohibition on deductibility is matched by section HB 2(1)(e) of the 2004 Act, which provided that interest derived by one company from money lent to another company within a consolidated group of companies is not income for income tax purposes.

Officials note that section FM 12(2) in the 2007 Act has inadvertently omitted the word “not”, and that the consolidated companies regime reduces compliance costs by providing that many transactions within the group are ignored for income tax purposes. Therefore, officials agree with the Panel’s conclusion and recommendation.

Recommendation

That the submission be accepted.

 

Issue: Section GB 25(3) (b) – Excessive remuneration paid by a close company to a shareholder, director or relative

Submission

Section GB 25(3) of the 2007 Act should be amended retrospectively to ensure that it does not apply to a director, shareholder or a relative of the director or shareholder who is employed substantially full-time and is participating in the administration of the business.

Comment

The Rewrite Advisory Panel has agreed with the submission that section GB 25(3) of the 2007 Act should not permit the Commissioner to re-assess a director, shareholder or a relative of the director or shareholder, if that person is employed substantially full-time and is participating in the administration of the business.

The Panel considered that section GD 5 of the 2004 Act (which corresponds to section GB 25 of the 2007 Act) did not apply to a director, shareholder or a relative of the director or shareholder who was employed substantially full-time and participating in the administration of the business.

Officials agree with the Panel’s conclusions and recommendation that section GB 25(3)(b) should be amended retrospectively.

Recommendation

That the submission be accepted.

 

Issue: Section HA 1(1)(a) – Qualifying companies

Submission

Section HA 1(1)(a) should be amended retrospectively to replace the term “tax paid” with a phrase that is consistent with the treatment of dividends pad by a qualifying company as being fully imputed or as exempt income.

Comment

The Rewrite Advisory Panel has agreed with a submission to the Panel that the use of the phrase “tax paid” in section HA 1(1)(a) is an unintended legislative change, and has recommended that the provision be retrospectively amended. The Panel concluded that the use of the phrase “tax paid” is inconsistent with the treatment of a dividend paid by a qualifying company as exempt income, when the dividend does not have imputation credits attached at the maximum imputation ratio.

Although the drafting of section HA 1(1)(a) was intended to be read as a purpose provision, outlining the scheme of subpart HA, officials agree that the use of the phrase “tax paid” is inconsistent with the treatment of an unimputed dividend paid by a qualifying company as exempt income.

Officials agree this inconsistency might give rise to an erroneous interpretation and, therefore, agree with the conclusion and recommendation of the Panel.

Recommendation

That the submission be accepted.

 

Issue: Section HA 11(4), section HA 11B – Loss-attributing qualifying companies

Submission

Section HA 11(4) of the 2007 Act should be repealed and replaced retrospectively by section HA 11B to provide that a loss-attributing company that ceases to be a loss-attributing company also ceases to be a qualifying company, in the same manner as provided in section HA 11(4)’s corresponding provision in the 2004 Act (section HG 18).

Comment

The Rewrite Advisory Panel has agreed with a submission that section HA 11(4) contains an unintended change in outcome when compared with its corresponding provision in the 2004 Act and recommends it be retrospectively amended.

Officials agree that the corresponding provision in the 2004 Act (section HG 18) provides that when a loss-attributing qualifying company no longer satisfies the ongoing shareholder decision-making requirements, the company also ceases to be a qualifying company. Officials agree with the Panel’s conclusion and recommendations for this issue.

Recommendation

That the submission be accepted.

 

Issue: Section HA 24(5) – Loss carry-forward and loss-attributing qualifying companies

Submission

Section HA 24(5) should be amended to ensure that a loss-attributing qualifying company is able to carry forward a loss balance arising in an earlier income year in which the company was a qualifying company, but prior to the company becoming a loss-attributing qualifying company.

Comment

The Rewrite Advisory Panel has agreed that section HA 24(5) incorrectly prevents a loss-attributing qualifying company from carrying forward a loss balance arising in income years, during which it was a qualifying company, and prior to it becoming a loss-attributing qualifying company.

Section HG 16(1)(c) of the 2004 Act permitted a qualifying company that later became a loss-attributing company to carry forward unused tax losses that arose during the years in which the company was a qualifying company but not a loss-attributing company.

Officials agree that section HA 24(5) does not correctly reflect the effect of section HG 16(1)(c) of the 2004 Act. Therefore, officials agree with the Panel’s recommendation that the unintended change be corrected retrospectively.

Recommendation

That the submission be accepted.

 

Issue: Section HA 26 – Loss-attributing qualifying companies

Submission

Section HA 26 of the 2007 Act should be retrospectively amended to permit a shareholder in a loss-attributing qualifying company to elect, in the same circumstances provided for in section HG 16(2) of the 2004 Act, to defer the transfer the net loss of a loss-attributing qualifying company to shareholders of the company.

Comment

The Rewrite Advisory Panel has agreed with a submission that section HA 26 of the 2007 Act does not permit a taxpayer to elect, in certain circumstances, to defer the transfer the net loss of a loss-attributing qualifying company to shareholders of the company. The Panel noted this right existed in the corresponding provision to section HA 26, being section HG 16(2) of the 2004 Act.

Under section HG 16(2), a shareholder could elect to defer the transfer of a loss-attributing qualifying company’s net loss to shareholders to the following tax year. This election could be made if the company’s tax balance date was later than the electing shareholder’s tax balance date and the difference in balance dates meant that waiting for the information could cause the shareholder to file their return of income later than the due date.

The Panel has recommended that section HA 26 be retrospectively amended to restore the effect of section HG 16(2) of the 2004 Act. Officials agree with the Panel’s conclusions and recommendations for this issue.

Recommendation

That the submission be accepted.

 

Issue: Section IC 3(3) – Commonality of shareholding for groups of companies and tax losses

Submission

Section IC 3(3) of the 2007 Act should be amended retrospectively to ensure that the commonality of shareholding rules are not applied in a manner akin to the shareholder continuity rules.

Comment

The Rewrite Advisory Panel has agreed with a submission that section IC 3(3) of the 2007 Act contains an unintended legislative change. Section IC 3(3) sets out certain requirements a company must satisfy for that company to be able to offset tax losses against another company in the same group.

In section IG 1(2) of the Income Tax Act 2004, a group of shareholders was required to have at least a 66% common shareholding interest in both companies for each tax year, from the tax year the tax loss arose until the loss is offset. Provided there was at least the 66% common interest between the two companies for each year, it did not matter if the group of shareholders was different in one year from another due to transfers of shareholding.

However, in the 2007 Act, section IC 3(3) requires the lowest common shareholding after a change in shareholding to be taken into account in determining whether the 66% common shareholding threshold was breached in tax years before that change in shareholding. That outcome is inconsistent with the policy and therefore the Panel has recommended that section IC 3(3) be retrospectively amended to restore the effect of section IG 1(2) of the 2004 Act.

Officials agree with the conclusions and recommendation of the Panel that section IP 5 of the 2007 Act should be amended retrospectively.

Recommendation

That the submission be accepted.

 

Issue: Section IC 12 – Loss carry-forward and grouping

Submission

Section IC 12 of the 2007 Act should be amended retrospectively to permit a company to carry forward tax losses from one year to another, and then use that carried-forward loss to offset against the company’s own net income for that later income year.

Comment

The Rewrite Advisory Panel has agreed with a submission that section IC 12 of the 2007 Act incorrectly prevents a company from carrying forward tax losses and offsetting those losses against its own net income for a later income year. The Panel concluded that this outcome differed from the outcome under section IG 2(6) of the 2004 Act. The Panel recommended that section IC 12 be amended retrospectively.

Section IG 2(6) of the 2004 Act prevented a company from grouping tax losses that have arisen from bad debts or share losses if the financing of the debt or shares was provided by a group company. However, section IG 2(6) did not prevent the company from carrying forward those losses for use against its own income in future income years.

Officials agree that section IC 12 of the 2007 Act does not correctly reflect the outcome given by section IG 2(6) of the 2004 Act and therefore agree with the Panel’s recommendation to restore to section IC 12, the effect of section IG 2(6) of the 2004 Act.

Recommendation

That the submission be accepted.

 

Issue: Section IP 5 – Carrying forward losses and part-year rules

Submission

Section IP 5 should be amended retrospectively to ensure that in a year in which a company breaches the shareholder commonality or continuity requirements, section IP 5(2) does not prevent the company’s tax losses from earlier tax years being carried forward to the year in which the breach of commonality or continuity occurs.

Comment

The Rewrite Advisory Panel has agreed with a submission that section IP 5 of the 2007 Act incorrectly prevents a company from carrying forward tax losses to a year in which either of the commonality or continuity of ownership rules are breached. The Panel considers that section IP 5 should be retrospectively amended.

For part-years, a company is permitted to carry forward tax losses arising in one tax year to the next tax year, provided the company satisfies both of the commonality and continuity of ownership rules. Unused tax losses carried forward may then be carried forward to the next succeeding tax year or years, until the benefit of those tax losses are fully utilised.

For a year in which a company breaches the commonality or continuity requirements, tax losses arising from earlier years may be carried forward to the year of breach and the benefit utilised for the part-year before the breach.

Officials agree with the conclusions and recommendations of the Panel relating to section IP 5 of the 2007 Act.

Recommendation

That the submission be accepted.

 

Issue: Section OB 32(2)(b) – Imputation credits and refunds of income tax

Submission

Section OB 32(2)(b) should be amended retrospectively to ensure that the debit to an imputation credit account for a breach in shareholder continuity is correctly adjusted for a debit for income tax refunded to the company before the breach in shareholder continuity occurred.

Comment

The Rewrite Advisory Panel has agreed with a submission that section OB 32(2)(b) of the 2007 Act limits the adjustment to a debit for breach of continuity for income tax refunded prior to the breach, to an amount that is less than the debit for the breach in continuity. The Panel has recommended that section OB 32(2)(b) should be retrospectively amended.

The purpose of this adjustment is to prevent two debits being made to a company’s imputation credit account in relation income tax that refunded before the breach and for which continuity is lost.

On a breach of shareholder continuity, the company’s imputation credit account (ICA) is debited for the amount of imputation credits for which shareholder continuity is not satisfied. However, as income tax refunded prior to a debit for breach of shareholder continuity also gives rise to a debit to the ICA, section OB 32(2)(b) provides an adjustment to the debit for breach of shareholder continuity to take into account the earlier debit for a refund of income tax.

Officials agree with conclusions and recommendation of the Panel for section OB 32(2)(b) of the 2007 Act.

Recommendation

That the submission be accepted.

 

Issue: Minor maintenance items referred to the Rewrite Advisory Panel

Submissions

The following minor maintenance items provided to the Rewrite Advisory Panel should be amended retrospectively as follows:

  • Section CW 31(3) Income Tax Act 2004 should be added retrospectively to the list of unintended changes in schedule 22A.
  • The definition of “amount of tax” in section YA 1 should be amended retrospectively to clarify that the meaning of “amount of tax” includes “income tax”.
  • The section 52(a) of the Tax Administration Act 1994 should be amended to insert “not” after “for which RWT is”
Comment

For drafting consistency, section CW 31(3) is inserted into schedule 22A to ensure that the schedule refers to section CW 31(3) and section CW 32(3), as both sections are drafted in the same manner.

The term “amount of tax” in subpart RM is ambiguous as to whether it includes income tax for the purpose of the refund rules. The amendment removes the ambiguity.

The amendment corrects a drafting error in the consequential amendment in schedule 50 of the 2007 Act.

These amendments have been referred to the Rewrite Advisory Panel as minor maintenance items and retrospectively correct any of the following:

  • ambiguities;
  • compilation errors;
  • cross-references;
  • drafting consistency, including readers’ aids, for example the defined terms lists;
  • grammar;
  • punctuation;
  • spelling;
  • subsequential amendments arising from substantive rewrite amendments; or
  • the consistent use of terminology and definitions.
Recommendation

That the submissions be accepted.

 

LIFE INSURANCE – TRANSITION AND TECHNICAL ISSUES

The Taxation (International Taxation, Life Insurance and Remedial Matters) Act 2009 introduced comprehensive changes to the taxation of life insurance business.

The current bill does not contain any provisions dealing with life insurance. Officials consider it desirable, however, to address the remedial matters identified below in order to provide clarity and certainty for the life insurers who are implementing the new rules, which are due to start 1 July 2010 (or earlier if the insurer elects).

The recommendations in this report are a practical response to matters that insurers have raised with officials in respect of the application of the transitional provisions. As such, the changes recommended in this report are largely technical in nature and ensure the new life insurance rules are broadly consistent with policy intent. Officials have consulted with representatives from various insurers in developing the majority of these recommendations.

 

Issue: Workplace group policies – definition

Submission

(Sovereign Limited, Tower Limited and AXA New Zealand)

The rules supporting the application of the transitional rules to workplace-related life policies should be extended to deal with the following situations:

  • life policies provided to members of an employment-related superannuation scheme;
  • broker-administered schemes that allow multiple employers (typically smaller-sized firms) to provide life insurance cover to their employees; and
  • life insurance policies sponsored by industry associations.
Comment

“Workplace group policies” are life insurance policies provided by an employer or union. The policy compulsorily covers employees or union members. The rules for workplace group policies are meant to overcome practical difficulties faced by insurers in obtaining information about the underlying lives covered by the policy. The grandparenting period for these policies is up to three years instead of up to five years for most other life insurance policies. The shortened period of time is a trade-off for allowing workplace group policies to cover new lives after 1 July 2010 (the start date of the life insurance tax changes).

Life insurers note that the current rules do not adequately cover all situations when workplace group policies are sold. Specifically identified as being outside the scope of “workplace group policies” are policies sold to trustees of workplace superannuation schemes, and life policies sold to industry associations and employer-collective groups. Officials agree that the rules for workplace group life policies should be extended as suggested by submissions because they are similar in nature to life policies provided directly by employers and unions.

Recommendation

That the submission be accepted.

 

Issue: Workplace group policies – voluntary elements

Submission

(Sovereign Limited, Tower Limited and AXA New Zealand)

Related to the submission above, some workplace policies allow for voluntary top-ups in the amount of life cover and allow spouses of employees to be covered under the policy. Policies with these features should also be included in the transitional rules for workplace group policies.

Comment

Officials understand that these voluntary elements are generally an incidental part of workplace group life policies. Provided that the policy is in effect, for example, the policy has been issued and the insurer has received a deposit from the insured before 1 July 2010, the workplace group policy can be grandparented.

Recommendation

That the submission be accepted.

 

Issue: Level-premium life policies – adjustments for CPI

Submission

(Matter raised by officials)

Life insurers have asked officials to review the operation of the current rules as they apply to level-premium policies (sometimes referred to as “term life policies”).

Section EY 30 provides transitional relief for level-premium policies. The purpose of the relief is to reflect that such policies have been priced on the basis of certain conditions and may not provide the insurer with the opportunity to alter premiums. The legislation limits transitional relief to level-premium policies when there is no movement in the premium.Insurers have advised that a considerable portion of the level-term insurance market provides the policyholder with the option to index the level of cover to protect its real value. Such adjustments have a natural reflex in the premium.

Comment

The current rules were designed to cater for life policies where the insurer had little or no ability to change premiums, or for commercial reasons chose not to increase premiums in response to the taxation changes.

We have since been advised that the rules may not apply to a large proportion of the level-premium market because most policyholders choose to preserve the real value of life cover. While this increase has a reflex in the premium charged, it is usually determined by a predetermined formula that may not allow the life insurer to adjust for matters other than movements in the consumer price index (CPI). Officials consider that an increase in the premium for a level-premium policy should not remove it from the scope of the transitional rules if the increase is as a result of using a CPI formula to preserve the amount of cover under the life policy.

Recommendation

That the submission be accepted.

 

Issue: Group life policies

Submission

(Matter raised by officials)

Life insurers have asked officials to consider two issues concerning the application of group life policies.

  • The definition of “group life master policy” (life insurance policies that cover more than one life) has a requirement that the policy is not available to the general public. The requirement is not necessary and practical.
  • Section EY 30(3) needs to be clear that its application is based on an individual life in connection with group life master policies. For example, if a life policy provides cover to a couple/family and one of the lives insured results in a breach in transitional rules, the current rules would appear to disqualify the entire policy, not just the cover connected with the affected life.
Comment

These changes are recommended to ensure that the transitional rules can be applied in a practical manner.

Recommendation

That the submission be accepted.

 

Issue: Transitional relief for reinsurance products

Submission

(Matter raised by officials)

If reinsurance relates to workplace group life or credit card repayment insurance, the requirement to look through should be removed.

Comment

Reinsurance treaties are deemed to be group life master policies and therefore have up to five years’ transitional relief as long as the reinsurer can look through to the underlying lives. This outcome is not appropriate if the underlying policy is a workplace group policy or credit card repayment insurance. These policies are subject to more concessionary criteria for compliance cost reasons and this should be reflected in the rules applying to reinsurance.

Recommendation

That the submission be accepted.

 

Issue: No restoration of transitional relief allowed

Submission

(Matter raised by officials)

The transitional rules could be interpreted in such a way to allow insurers at the beginning of each cover review period to reinstate life policies that breached the transitional rules in an earlier period.

Comment

Life insurance policies that breach the transitional rules during the grandparenting period should not be restored for the purposes of receiving transitional relief. The purpose of the transitional rules is to provide a single opportunity to allow life insurers to grandparent life products where contractually or commercially it would be difficult to alter the price. If a policy breaches the transitional rules (for example, when the cover under an annual renewable term policy adjusts by more than the greater of 10 percent or a movement in the CPI index), the policy is treated as being a new contract for tax purposes and should not benefit from the tax treatment under the previous rules.

Recommendation

That the submission be accepted.

 

Issue: Bifurcation of life insurance policies

Submission

(Matter raised by officials)

Life insurers have asked officials to allow life policies to be bifurcated. Some life policies provide multiple benefits or products relating to a life policy. Apart from non-life-related cover, the legislation does not split or divide a life policy if it has aspects that would be subject to differential tax treatment under the transitional rules.

Comment

The transitional rules are based on a “single unified supply” notion, whereby a life policy is the sum of all its parts. Most life insurance policies are a “wrapper” for a range of life-related insurance.

Life insurers have asked whether the entire life policy is disqualified or only the cover connected with that particular life product is disqualified. It is argued that without the ability to bifurcate life insurance policies, transitional relief for existing business could be unduly cut short.

Because separate rules apply to life-related products such as credit card repayment insurance, and to core life products themselves (for example, single premium, term life, annual renewable term and group life master policies), it would seem sensible that life insurers are able to split a life policy according to the rules for those products.

Any split or division of a life policy must be transparent to the policyholder, and policy documentation must clearly show that there is a separate price for each life product that forms part of the life insurance policy “wrapper”.

Recommendation

That the submission be accepted.

 

Issue: Application of the term “cover review period” – balances that change in response to a financial arrangement or security

Submission

(Matter raised by officials)

Life insurers have asked officials to clarify the application of the “cover review period”.

Comment

The “cover review period” is a means to establish a point in time for the insurer to consider whether a life policy breaches the transitional provisions, which would result in the affected life policy ceasing to qualify for grandparenting. The test is based on a per policy basis and should be considered whenever the policy is renewed (and repriced). If the repricing results in a breach of the transitional rules, transitional relief ceases.

Some life insurance products track an underlying financial arrangement (for example, a mortgage). The premium payable for the life cover will rise and fall in response to any changes to the balance of the financial arrangement.

A similar issue has been identified in respect of life policies that provide cover in connection with superannuation benefits under KiwiSaver. The life insurance cover meets any shortfall in income and capital to the desired amount. Like the mortgage protection, the amount of insurance cover will vary in accordance with the investment returns and other issues that are outside of the control of the life insurer.

Recommendation

That the submission be accepted; specifically that increases in life cover be measured at the beginning of a cover review period and contrasted against the beginning of the next cover review period.

 

Issue: Application of the term “cover review period” – transitional relief up to and including date of breach

Submission

(Matter raised by officials)

Life insurers have requested that relief under transitional rules should cease on the date that a life policy ceases to qualify. Currently, the relief ends at the beginning of the income year in which a breach occurs.

Comment

Related to the previous submission, insurers have asked that the transitional relief connected with an existing life policy under section EY 30(8) ceases on the date the breach occurs.

For a class of policies, a life insurer can elect to calculate a part-year transitional relief up to and including the date a breach occurs. If the life insurer does not make such an election, transitional relief will end at the start of the income year in which the breach occurs.

Recommendation

That the submission be accepted.

 

Issue: Definition of “savings product policy”

Submission

(Matter raised by officials)

Life insurers have asked for changes to ensure that the treatment of life policies that provide a payback of all or a portion of the premium for life risk is consistent with policy intent.

Comment

The Taxation (Consequential Rate Alignment and Remedial Matters) Act 2009 included changes to the definition of “savings product policy” to ensure that life policies that provide for a return of premiums paid in connection with providing life risk cover (contrasted against any savings component) were not treated as a savings product policy under the new life insurance rules. Further changes are required to ensure that the exclusion applies to situations when the entire life risk component of the premiums is repaid. Currently, the rule applies only when a portion of the total premium for life risk is repaid.

Recommendation

That the submission be accepted.

 

Issue: Part-year calculations

Submission

(Matter raised by officials)

The calculations for part-year adjustments need refinement.

Comment

Two issues have been identified with the treatment of reinsurance when life business is transferred.

  • Section EY 5(4) should be changed so it produces an amount for reserves that is gross of reinsurance (because sections EY 23 to EY 27 calculate amounts net of reinsurance). In the absence of the change, the seller’s position will reflect a situation where the reinsurance arrangement has not been assigned, as the closing balance of the reserves will not include reinsurance amounts. This outcome is contrary to what the section should achieve.
  • Section EY 5(6) produces an amount for reserves that is gross of reinsurance. The section adds reinsurance into the calculation on the basis that sections EY 23 to EY 27 are net of reinsurance. This produces an incorrect amount as section EY 5(6) is intended to reflect the situation where the recipient assumes the reinsurance, therefore this should be reflected in the value of reserves carried over to the new owner.
Recommendation

That the submission be accepted.

 

Issue: Opening balance of OCR and UPR reserves for the first year the new rules take effect

Submission

(Matter raised by officials)

The effect of the current rules is that both the Outstanding Claims Reserve (OCR) and Unearned Premiums Reserve (UPR) may not report any movement for the first year of the new life insurance rules.

Comment

The current rules for determining the opening balance of the OCR for the first income year could arguably be read so that the amount calculated for the opening balance of the OCR will be the same as the closing balance. This would result in no movement in the reserve.

A similar problem has been identified with the operation of the opening balance of the UPR for the first income year.

The sections should refer to an amount that would have been the closing value in the prior income year as if the new rules had effect, and ensure that the calculation is made with necessary modification for the beginning of the income year when the new rules have effect.

Recommendation

That the submission be accepted.

 

Issue: Incorrect reference

Submission

(Matters raised by officials)

Several changes are required to correct erroneous references in the new life insurance rules.

  • In section EY 24 the adjustments for “mortality” profit and reinsurance amounts already returned under the old life rules have been put in backwards (mortality profit).
  • Life insurers that offer general insurance are also required to discount the balance of the Outstanding Claims Reserve. Defining “general insurance contract” by reference to IFRS 4 means that life insurers are excluded and therefore the legislation does not recognise situations when a life insurer has non-life policies.
Recommendation

That the submission be accepted.