Other matters

• Applications for overseas donee status
• Non-resident film renters’ tax
• Timing of determining serious hardship
• Rate for extinguishing tax losses when tax is written off
• RWT withholding certificates
• RWT exemption certificates
• Employer superannuation contribution tax
• Commissioner’s discretion to not rule on Section GA 1
• Additional declaration for advance pricing agreements
• Classification of change to fees for binding rulings and depreciation determinations as remedial
• PIE remedials
• Definition of “hire purchase agreement”
• Look-through companies
• The tax system
• Hardcopy returns
• Technical changes to the life insurance transitional rules
• Treatment of the outstanding claims reserve when general and non-life insurance is transferred to another insurer
• Rewrite amendments

 

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APPLICATIONS FOR OVERSEAS DONEE STATUS

Clause 91

Submission

(Deepavali Charitable Trust)

The overseas donee status of the four charitable entities to be added to Schedule 32 should be effective either from 1 April 2012 or from the date of Royal assent.

Comment

New Zealand organisations that support activities overseas and want their donors to be eligible for tax relief must be listed in Schedule 32 of the Income Tax Act 2007. The bill provides that four charitable organisations be added to Schedule 32, with donee status effective from 1 April 2013.

Officials consider that the application date of 1 April 2013 is appropriate. Additions to the list of overseas donee status have historically applied from the start of the income year. This is because the tax credit available for charitable donations is based on the donor’s annual taxable income.

Officials do not support applying the changes from 1 April 2012 because donations made previously would qualify for donation tax credits, although donation receipts were not issued on that basis. Similarly, if a part-year application date applies, donors would have to identify whether donations were made after the date of Royal assent when claiming a donation tax credit at the end of the income tax year. This exposes donors to the risk of mistakenly claiming tax credits when no legal entitlement exists, and could be particularly problematic if a charitable organisation issues annual donation receipts.

Recommendation

That the submission be declined.

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NON-RESIDENT FILM RENTERS’ TAX

Clauses 5, 12, 19, 56, 68, 72, 84, 88, 91, 92 and 93

Submissions

(KPMG, New Zealand Institute of Chartered Accountants)

The proposal to repeal the non-resident film renters’ tax regime is not remedial in nature and therefore should be deferred pending further consultation through the Generic Tax Policy Process (GTPP).

The ambit of the non-resident film renters’ tax regime may be wider than the definition of “royalty” in the Income Tax Act 2007. (New Zealand Institute of Chartered Accountants)

Comment

This proposal replaces the effective tax rate of 2.8% on income derived by non-resident companies renting films in New Zealand with non-resident withholding tax (NRWT). The standard NRWT rate on royalties is 15%; however, the rate applying to most non-resident film renters would be 5% or 10% under New Zealand’s double tax agreements.

The proposal was consulted through the GTPP as part of the Government discussion document, New Zealand’s International Tax Review: a direction for change, released in December 2006. Officials have also recently been in contact with those who made submissions on the discussion document about the proposal.

The definition of “royalty” in section CC 9 of the Income Tax Act is widely drafted; for example, a payment for an outright sale of property is a royalty if the amount of the payment is based on the use of the property by the purchaser. Therefore, practically all amounts received by a non-resident that are currently subject to the non-resident film renters’ tax regime will come within the “royalty” definition and be subject to NRWT. The treatment of a specific transaction, however, is dependent on its particular facts.

Recommendation

That the submissions be declined.

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TIMING OF DETERMINING SERIOUS HARDSHIP

Clause 131

Submission

(New Zealand Institute of Chartered Accountants)

The amendment should be applied retrospectively to 1 December 2002.

Comment

The amendment ensures that when a taxpayer applies for serious hardship, the financial position considered by Inland Revenue is the financial position at the date the application for relief is made rather than at the time the tax became due. The debt rules in the Tax Administration Act 1994 apply from 1 December 2002. In the period from 1 December 2002 to the enactment of this bill, there may be cases when serious hardship was determined at the time the tax became due rather than at the time the taxpayer applied for relief. Therefore, officials recommended that the amendment apply from the date of enactment of this bill.

Recommendation

That the submission be declined.

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RATE FOR EXTINGUISHING TAX LOSSES WHEN TAX IS WRITTEN OFF

Clause 132

Issue: Support for the amendment

Submission

(KPMG)

The submitter supports the proposal for Inland Revenue writing off tax losses at 28% (the company tax rate), when the taxpayer is a company. This matches the benefit a company would otherwise receive from use of such losses.

Recommendation

That the submission be noted.

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RWT WITHHOLDING CERTIFICATES

Clause 105

Submission

(New Zealand Institute of Chartered Accountants)

The submitter supports the proposal to retrospectively clarify that interest payers can make RWT withholding certificates available on their websites, as long as the recipient agrees to receive the certificate in that way.

Recommendation

That the submission be noted.

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RWT EXEMPTION CERTIFICATES

Submission

(New Zealand Institute of Chartered Accountants)

Taxpayers who have RWT exemption certificates should not be required to reapply every year. The period that the certificate applies for should be extended.

Comment

Taxpayers who have been issued with a certificate of exemption are not required to have RWT withheld on their interest or dividend income. Taxpayers can apply to Inland Revenue for a certificate of exemption if they meet certain criteria (for example, if they are a bank, or if they earned over $2 million in their last income year and complied with their filing obligations).

In most cases, Inland Revenue does not impose time limits on certificates of exemption. However, in certain limited circumstances Inland Revenue issues certificates of exemption for only one year. These circumstances are:

• The taxpayer expects that their income will be above $2 million.
• The taxpayer expects to have losses for a specific period of time.
• The taxpayer expects to get an RWT refund of over $500 for a specific period of time.

Taxpayers are required to provide certain information if they have been issued a certificate of exemption for one of these reasons.

If a taxpayer is granted a certificate of exemption on the basis that they expect their income to be above $2 million in the following year, it is reasonable that this is checked by Inland Revenue. (If the taxpayer did in fact earn above $2 million in that year, they would be issued with a certificate of exemption without a time limit.)

Inland Revenue can grant a certificate of exemption for a specific period of time if the taxpayer expects to have losses or to get an RWT refund of over $500 for that period. In these cases, the taxpayer is required to show budgeted accounts for the period. Taxpayers generally provide Inland Revenue with budgeted accounts for only a single year, which means that a certificate of exemption can be granted for only a single year.

Given the above, officials consider that the current administrative practice is reasonable.

Recommendation

That the submission be declined.

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EMPLOYER SUPERANNUATION CONTRIBUTION TAX

Submissions

(Investment Savings and Insurance Association, KPMG)

Employers should have the option of applying progressive rates of employer superannuation contribution tax (ESCT) to employer superannuation contributions made on behalf of past employees.

Comment

Under the progressive ESCT rate structure, the contributing employer usually calculates the ESCT rate for each employee by reference to their salary or wages from that employment for the previous tax year. The aim is for employer superannuation contributions to be taxed at a proxy rate which is broadly equivalent to the employee’s marginal tax rate on their salary and wage income. In establishing the ESCT rate, the contributing employer does not have to consider any income that is not from that employment – for example, investment income or income from any other employment the employee may have. This is largely for practical and compliance reasons, as it enables the contributing employer to use information it already has available to select the right rate.

In its current form, the progressive rate structure cannot be applied to past employees, for whom, by definition, the contributing employer does not have salary or wage information. So if the current method were applied, it would tend to lead to past employees being categorised within the lower ESCT rate bands, regardless of their actual current marginal tax rate.

Both submitters refer to employers who have often applied the progressive rates of ESCT to contributions made on behalf of past employees. Officials are aware of some recent approaches to Inland Revenue seeking to adopt a progressive rate approach, but are not aware that it has actually been used in practice.[2] Applying ESCT at a flat rate of 33% to contributions for past employees has been the generally accepted and long-standing practice of employers, practitioners and Inland Revenue.

Officials had considered the submitters’ suggestion of linking the ESCT rate to a past employee’s current total income instead. However, this would create a different basis on which to calculate the ESCT rate for contributions made on behalf of past employees vis-à-vis existing employees, for whom non-salary and wage income is ignored. It would require the past employee to provide his or her contributing employer with income information at the start of each tax year, which would impose a high compliance burden on employers and their past employees.

Using an approach based on the past employee’s total income to determine the ESCT rate creates difficulties when employer superannuation contributions are paid “for the benefit of a past employee”, but under the terms of the superannuation scheme benefit payments are being made to a dependent, such as a surviving spouse. In this situation it would not be possible to take into account the past employee’s income levels, but nor is it appropriate to calculate a progressive rate of ESCT in relation to the employer’s superannuation contributions by reference to the spouse’s current income.

The submission suggests involving the superannuation scheme in collecting income information from past employees. Although many schemes will contact members at least annually, this contact is not necessarily reciprocal. Further, ESCT obligations apply to employers not superannuation schemes, so it is not appropriate to involve fund managers or trustees in the collection of this income information.

Officials agree with the comment that superannuation contributions in respect of past employees occur almost entirely in the context of a defined benefit scheme. Using a flat ESCT rate will not usually affect the benefits received by scheme members from a defined benefit scheme, as the benefit levels are pre-set. The main reason the employer is required to pay employer superannuation cash contributions for past employees is because there is a scheme deficit in respect of these obligations. That is, insufficient contributions were made during the member’s working life to pay the benefits now due. Officials therefore considered the option of linking an ESCT rate to the member’s previous salary and wage levels, indexed, but this was considered likely to create a heavy compliance burden.

Officials also note that, at the request of industry representatives, the Income Tax Act 2007 already has a provision to enable employer contributions made to defined benefit schemes to be taxed at a flat ESCT rate of 33%. This is because such contributions are not often easily allocable to any particular scheme member. Instead, they are generally based on an actuarial calculation of future liabilities to pay benefits to all members. Adopting the same flat rate for past employees assures consistency with this approach for defined benefit schemes.

Recommendation

That the submission be declined.
 

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COMMISSIONER’S DISCRETION TO NOT RULE ON SECTION GA 1

Clause 118, new section 91E(3B)

Submissions

(New Zealand Law Society, Corporate Taxpayers Group, New Zealand Institute of Chartered Accountants, KPMG)

The Commissioner already has sufficient powers to decline to rule on any concerns that may arise. Sections 91E(3) and 91E(4) of the Tax Administration Act 1994 already give the Commissioner a discretion not to provide a ruling, or to preclude him from doing so, if doing so would require him to determine factual matters, or if insufficient information exists. If a ruling cannot be made without an investigation, the reason it is unable to be made is due to a lack of knowledge of factual matters.

If the Commissioner is able to determine that an arrangement is a tax avoidance arrangement, he should also be able to determine the tax advantage to be counteracted.

The proposed amendment would impose a blanket rule, effectively denying taxpayers the ability to require the Commissioner to rule on section GA 1 of the Income Tax Act 2007. Taxpayers who are prepared to use the rulings process are entitled to a full view of the risk they face if they decide to implement the arrangement. Allowing a discretion on whether to rule on section GA 1 may be detrimental to taxpayers who are denied a ruling and have no way of understanding the consequences of entering into an avoidance arrangement.

The status quo should be maintained as it ensures certainty for taxpayers. The proposed discretion is unjustifiable, unnecessary and should not proceed.

Comment

The purpose of the binding rulings regime is to allow taxpayers who apply for a ruling to obtain certainty on how taxation laws apply to an arrangement disclosed to the Commissioner. In most cases such arrangements will be prospective. However, the rulings regime is not intended be a full-scale audit or investigation of the arrangement and the parties to it. This is a separate process which can result in a tax adjustment by the Commissioner.

If the Commissioner rules that an arrangement is a tax avoidance arrangement, the Commissioner may currently be asked by the applicant to rule on how section GA 1 will apply. Section GA 1 is the reconstruction provision which allows the Commissioner to adjust the taxable income of a person affected by an arrangement in order to counteract a tax advantage obtained under the arrangement.

The proposed amendment would give the Commissioner a discretion to decide not to rule on the application of section GA 1. The proposed discretion is likely to be invoked in a minority of cases because it would require the Commissioner to take a position that an arrangement is avoidance and for a taxpayer (who is still determined to enter into such an arrangement) to seek a ruling on how the reconstruction power will apply. In order to rule on section GA 1, the Commissioner will need to undertake a thorough investigation of the arrangement, including the persons who may be affected by the arrangement, and other likely situations which might have arisen had the tax avoidance arrangement not been entered into. This can often be a lengthy process and rulings are not intended to be investigations or audits, nor is it appropriate or feasible for the Commissioner to handle rulings in that way. Often, because of timing issues, the tax advantage will not have fully crystallised or be able to be properly quantified until a full audit or investigation occurs.

A tax avoidance arrangement may affect more than one person. Accordingly, the Commissioner may need to adjust the taxable income of a number of people in order to appropriately counteract the tax advantages obtained. A taxpayer who is not a party to a tax avoidance arrangement can still be subject to the Commissioner's reconstruction power if they have obtained a tax advantage from the arrangement, even though they may not be aware that they have benefited from the arrangement. These matters can be difficult to determine using the binding rulings regime for complex arrangements involving multiple parties (who may not be applicants). This difficulty will be compounded if this involves prospective arrangements.
If an applicant for a ruling were able to require the Commissioner to rule on section GA 1, the Commissioner would have to rely on information (if obtainable) provided by the applicant about these other persons. The binding rulings regime is not the most appropriate place to determine what corrective adjustments may be required to be made to all taxpayers who have benefited, or would benefit, from a tax avoidance arrangement.

Requiring the Commissioner to make a ruling on section GA 1 may also give rise to a revenue risk should the Courts take a particular view on reconstruction that is less favourable than that obtained by ruling. The binding ruling would still be binding on the Commissioner if the arrangement was entered into, and could still be relied on by a taxpayer.

In addition, officials are concerned that a ruling on section GA 1 could be used to attempt to constrain the Commissioner’s ability to argue on the appropriate reconstruction (following an audit and proper investigation) in the context of the tax disputes process. Given the difficulty of arguments regarding counterfactuals and reconstruction, this may be undesirable.

Given these difficulties, officials do not consider that it will always be feasible or appropriate for the Commissioner to rule in a definitive and binding manner on the application of the reconstruction power. A discretion (rather than a requirement as submitted) is preferred by officials as, in straightforward cases, the Commissioner would be prepared to rule on the application of section GA 1.

The existing powers that the Commissioner has to decline to rule cannot readily be used in the reconstruction context given that the level of enquiry required will be tantamount to requiring an “audit or investigation”.

Recommendation

That the submissions be declined.
 

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ADDITIONAL DECLARATION FOR ADVANCE PRICING AGREEMENTS

Clause 119, new section 91ED(1B)

Submissions

(KPMG, New Zealand Institute of Chartered Accountants)

The proposed amendment is not required and should not proceed. If Inland Revenue has concerns about the completeness of some advance pricing agreement applications and documentation packages, the Commissioner can ask an applicant for further relevant information, or ask an applicant to attend a meeting to answer questions and clarify any uncertainty.

If facts contained in the application are found to be incorrect or if material facts have been omitted, the advance pricing agreement is void, so taxpayers gain nothing from not fully disclosing the relevant background.

It is not clear how this provision will be applied in practice. What is the threshold for meeting the requirement that the information disclosed is comprehensive? This may result in applicants wanting to disclose every single aspect of the transaction, whether relevant to the advance pricing agreement or not.

Comment

The Tax Administration Act 1994 already requires an application for a private ruling to disclose all relevant facts, but in a number of applications the relevant facts are not outlined sufficiently for the purposes of providing a ruling.

The purpose of the proposed amendment is to reduce the number of inaccurate or factually incomplete applications. Advance pricing agreements are fact-intensive and tax agents are often as dependent on information received from the taxpayer as Inland Revenue is.

The amendment therefore requires the applicant, not the agent, to make the declaration as the person who is likely to have knowledge of the full and complete picture.

The applicant will be required to attest that to the best of their knowledge and belief the information which is disclosed for the application is comprehensive. The amendment does not require the applicant to know everything, but is aimed at ensuring the applicant examines the application before it is submitted.

Recommendation

That the submissions be declined.

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CLASSIFICATION OF CHANGE TO FEES FOR BINDING RULINGS AND DEPRECIATION DETERMINATIONS AS REMEDIAL

Clauses 172 and 180

Submission

(KPMG)

KPMG supports changing the fee structure for binding rulings to a “plus GST” basis. It also notes that Inland Revenue should be able to set its fees for issuing depreciation determinations having regard to current conditions.

The classification of the changes to the fees charged for binding rulings and depreciation determinations as remedial items is misleading. It could have material financial consequences for taxpayers (as the cost of getting a depreciation determination will more than double) and may affect whether getting a depreciation determination is a viable option.

Comment

The binding ruling fees are being increased slightly, mainly to reflect the GST increase to 15% on 1 October 2010. The depreciation determination fees are being raised to reflect more accurately the costs currently associated with making determinations. The fees for depreciation determinations have not been changed since their introduction in 1993 although the costs of providing determinations have risen.

Recommendation

That the submission be noted.

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PIE REMEDIALS

Issue: Application of the foreign investor tax credit regime to foreign investment PIEs

Submissions

(KPMG, Fonterra)

The foreign investor tax credit (FITC) regime should be made available to investors in foreign investment PIEs. This would allow certain non-resident investors to receive similar treatment on imputed dividends earned through PIEs as they would have received if they had made the investment directly.

Comment

The FITC rules allow certain foreign portfolio investors that receive imputed dividends from New Zealand companies to claim credits for NRWT in their own country, while ensuring that New Zealand receives an appropriate amount of tax.

Officials agree that the FITC regime be made available to investors in foreign investment PIEs. Applying the FITC regime to foreign investment PIEs would align the tax treatment of non-resident portfolio investments made through foreign investment PIEs with that of portfolio investments made directly.

Key aspects of the proposal are that:

• the FITC mechanism applies at the level of the company paying the dividend to the foreign investment PIE, rather than the PIE;
• the foreign investment PIE must supply the company paying the dividend the necessary information in order for the company to appropriately apply the FITC rules;
• the FITC mechanism only applies to notified foreign investors that hold less than a 10 percent voting interest in the company paying the dividend and have a tax treaty rate of 15 percent or greater; and
• the mechanism is optional for foreign investment PIEs.

Recommendation

That the submissions be accepted and that this change apply from the 2013–14 income year.

 

Issue: Definition of the foreign PIE equivalent

Submission

(KPMG)

The foreign investment PIE equivalent definition should be amended to include an Australian managed investment trust (MIT) as a qualifying entity.

Comment

Officials agree that the definition of a foreign PIE equivalent should be amended to include a MIT, provided the MIT is not a New Zealand resident for tax purposes.

A foreign PIE equivalent is, broadly, a non-resident entity that would be eligible to be a PIE if it were resident in New Zealand. Foreign PIE equivalents are able to hold 100 percent of a New Zealand-resident PIE, and vice versa. This is subject to non-tax regulation, including the requirements of the Overseas Investment Office.

MITs are subject to similar or more stringent investment and investor restrictions as New Zealand PIEs and would therefore meet the definition of a foreign PIE equivalent. Further, including MITs within the definition of a foreign PIE equivalent would reduce the continued compliance costs of PIEs monitoring whether entities are foreign PIE equivalents.

Recommendation

That the submission be accepted.

 

Issue: Optional look-through rules for PIEs

Clause 41

Submissions

(KPMG, New Zealand Law Society)

Clause 41 should be amended to ensure that where a retail foreign investment variable rate PIE invests into a wholesale foreign investment PIE the flow-through rules work appropriately.

In particular, the drafting of the provision should be amended to refer to “amounts derived by the wholesale PIE” instead of “amounts paid to the wholesale PIE”. In addition, the proposed rule that would allow retail PIEs a deduction for expenditure incurred by the wholesale PIE should be clarified to ensure that it achieves what is intended.

 Comment

The rules are intended to allow retail PIEs to treat amounts that are derived by wholesale PIEs as if they had been derived by the retail PIE. Similarly, the rules are also intended to allow expenditure incurred by the wholesale PIE to be treated as if had been incurred by the retail PIE.

Officials agree that the wording of section HM 6B should be clarified to ensure that the rules achieve these results.

Recommendation

That the submissions be accepted and that this change apply from the 2012–13 income year – the start-date for foreign investment variable-rate PIEs.

 

Issue: Investments of foreign investment PIEs

Submission

(KPMG)

The current drafting of section HM 13(6) has greater application than was intended as it may also apply to non-land portfolio investment entities and PIEs.

Comment

Officials consider that it is clear from the legislation that a foreign investment PIE is able to hold a greater than 20 percent interest in another PIE. This ensures that foreign investment PIEs can invest in wholesale PIEs. Therefore, officials do not agree that an amendment to the legislation is necessary. This policy intention can be confirmed from a release of an item in a Tax Information Bulletin.

The submitter has also raised some useful comments in relation to the current rules that place restrictions on the level of ownership a foreign investment PIE can have in other widely held entities. These restrictions are in place as a result of concerns that foreign investment PIEs could find methods to transfer otherwise non-deductible expenditure to an entity it owns that is able to use the deduction. The submitter questions whether these restrictions are appropriate.

A comprehensive review of these restrictions is not possible as part of this tax bill, but could be considered as part of a future tax bill.

Recommendation

That the submission be noted.

 

Issue: Tax rebates on partial redemptions

Submission

(KPMG)

PIEs should be allowed to trigger a tax event when there is a partial redemption of a PIE interest. Currently PIEs are allowed to make voluntary payments towards their final tax when an investor makes a partial redemption. In these situations the PIE should also be allowed a rebate for any tax losses or excess credits crystallised by the partial redemption.

Comment

Officials agree. This clarification would ensure that the law reflects existing practice. However, also consistent with existing practice, this treatment should be allowed only if the PIE adopts a consistent approach to partial redemptions. That is, the PIE makes a voluntary payment when there is tax to pay and receives a rebate when there are losses or excess credits.

Recommendation

That the submission be accepted.

 

Issue: Exit rules for PIEs

Submission

(New Zealand Institute of Chartered Accountants)

It should be clarified that an entity ceases to be eligible to be a PIE if it fails to satisfy the entity-type requirements in section HM 9 and the rules in section HM 17 that prevent PIEs streaming different types of income to different investors to minimise tax.

Comment

Officials agree that the provisions should be amended to clarify that a PIE ceases to be a PIE immediately if it fails to meet the requirements in sections HM 9 and HM 17.

Recommendation

That the submission be accepted.

 

Issue: Technical drafting amendments

Submitters and officials have technical suggestions that fix a number of errors with the bill and the current PIE rules. Officials agree with these submissions unless otherwise stated. These are outlined below:

Section HM 14(1) of the Income Tax Act 2007 should be amended to refer to a “listed PIE” instead of “a company listed on a recognised exchange in New Zealand”. (KPMG)

• Section HM 19C(1) should be amended to replace the reference to “section HM 11(a) and (d)” with “section HM 11(1)(a) and (d)”. (KPMG)
• Section HM 19C(2) should be amended to replace the reference to “section HM 12(a) and (b)(iv) and (v)” with “ section HM 12(1)(a) and (b)(iv) and (v)”. (KPMG)
• The restriction on availability of a tax credit for a foreign investment PIE in section HM 47(6) should be noted in section HM 55. (KPMG)
• Officials do not agree that this amendment is necessary. Section HM 47(6) restricts the ability of foreign investment PIEs to have a credit and it is not necessary to repeat this restriction in section HM 55.
• Paragraph (a) of the section YA 1 definition of “fixed-rate share” should be amended to clarify that the definition also applies for the purposes of section CX 55(4). (New Zealand Institute of Chartered Accountants)
• Schedule 6, table 1B, row 2 should also refer to row 7.
• Foreign investment PIEs are not allowed deductions for expenses or credits in relation to “notified foreign investors”. This treatment should also apply to transitional residents who have elected a zero percent tax rate with the PIE. (Matter raised by officials)
• The definition of “foreign investment zero-rate PIE”, paragraph (a): should read “… section HM 19B (Modified rules for foreign investment zero-rate PIEs)”. (Matter raised by officials)
• The definition of “foreign investment variable rate PIE”, para (a): should read “… section HM 19C (Modified rules for foreign investment variable rate PIEs)”. (Matter raised by officials)
• Section 57B of the Tax Administration Act 1994 should be amended to ensure that foreign investment zero-rate PIEs are not required to file a return with Inland Revenue for exiting investors if the only exiting investors are notified foreign investors. Information relevant to exiting notified foreign investors would be included in the end-of-year return that the PIE is required to provide to Inland Revenue. (Matter raised by officials)

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DEFINITION OF “HIRE PURCHASE AGREEMENT”

Issue: Fundamental change in GST policy

Clauses 88(9), (10) and 168

Submission

(Brent Gilchrist)

There is no drafting error in the definition of “hire purchase agreement” so far as the definition applies to GST land transactions. Generally, a person who buys and sells residential homes can claim GST on purchases and pay GST on sales. However, the proposed amendment will result in a fundamental change in GST policy – the person will be required to pay GST on sales upfront if a tenancy agreement includes an option to buy the property.

The issue is more than remedial in nature and should be withdrawn pending proper review of its effect on businesses.

Comment

Officials note that the proposed amendment to the definition of “hire purchase agreement” in the Income Tax Acts 2004 and 2007 is simply intended to correct a drafting error from the rewrite of the Income Tax Act 1994, so that the definition remains consistent with longstanding case law.

The matter raised by the submitter relates to a policy concern about whether the definition should apply to GST land transactions – the GST Act relies largely on the Income Tax Act definition of “hire purchase agreement”. Officials are aware that there are different views on this matter and are currently reviewing the GST policy in this area.

As the GST issue relates in part to the definition of “hire purchase agreement”, officials consider that the proposed amendments to that definition, contained in the bill, should be withdrawn so that the policy and drafting issues can be considered together.

Recommendation

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

 

Issue: Exclude real property for income tax and GST purposes

Clauses 88(9), (10) and 168

Submission

(New Zealand Institute of Chartered Accountants)

The definition of “hire purchase agreement” in the Income Tax Acts 2004 and 2007 should be further amended to clarify that it does not include real property for income tax and GST purposes.

Comment

The proposed amendments to correct a drafting error are being withdrawn by officials so that the policy issue of whether the definition should apply to GST land transactions and the drafting error can be considered together. Whether the definition should explicitly exclude real property for income tax purposes will also be considered as part of this review.

Recommendation

That the submission be noted.

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LOOK-THROUGH COMPANIES

Overview of submissions

Seven submissions were received on the look-through company (LTC) amendments proposed in the bill and in Supplementary Order Paper 1. Some technical issues were raised on the drafting, particularly in the Supplementary Order Paper. A number of further amendments are recommended by officials to clarify the intent of the proposed legislation.

NZICA made two submissions. The first submission contained comments on the loss limitation rules which officials consider were largely addressed by the amendments proposed in Supplementary Order Paper 1, which was tabled on 8 February 2012. NZICA subsequently made a second submission on Supplementary Order Paper 1 which officials have treated as replacing the comments made on the loss limitation rules in their first submission.

Several of the submissions commented on the process by which the original LTC rules were introduced by the Taxation (GST and Remedial Matters) Act in late 2010. This followed the announcement in Budget 2010 that the existing qualifying company and loss-attributing qualifying company (LAQC) rules would be replaced by a full look-through tax treatment.

 

Issue: Approach to transparent taxation provisions generally

Submissions

(KPMG, New Zealand Law Society, New Zealand Institute of Chartered Accountants)

A single set of look-through provisions should apply, rather than a separate subpart for partnerships and for LTCs. Specific restrictions on entry qualifications could be included as needed, depending on the underlying common-law status of the entity involved.

The “separate capacity” approach that is used in both the LTC and the partnership legislation is unclear. The interaction between the different statuses of a partnership/partner, or LTC/shareholder, and the partner or shareholder in a personal capacity should be specifically addressed in the various tax provisions.

For example, clarification should be provided on the operation of the transparent taxation approach to:

• the resident mining companies and resident mining operator rules;
• local authority shareholders in LTCs;[3]
• transactions between a partnership/LTC and a partner/shareholder;
• the financial arrangement rules and the forgiveness of debt; and
• the disposal of interests in a transparent entity when deemed to be the disposal of the underlying assets.

The legislation should be more comprehensive on the extent of transparent taxation provisions in each circumstance.

More guidance should be provided by Inland Revenue on the application of a transparent taxation approach.

Comment

Officials understand the submissions to be seeking a complete review of the transparent tax rules for partnerships and LTCs. A review of all tax transparency rules would require considerable resources which are not currently provided for in the Government’s Tax Policy Work Programme.

The submissions raise some very technical aspects about the interaction of a transparent approach with other specific tax provisions – for example, the issue raised on the application of the resident mining companies and resident mining operator rules concerns the specific loss ring-fencing rules that are applied to that particular industry, rather than the transparency provisions in general. Some of these issues arise only with LTCs, because of the underlying existence of a company, but some may apply to limited partnerships (LPs), which also have a separate legal existence, and general partnerships too.

At present, officials would not support a comprehensive rewrite of the overall legislative approach to the taxation of partnerships and LTCs. The “capacity” approach used in the Income Tax Act 2007 merely encapsulates key concepts of transparency that have been in place internationally for many decades, primarily in the form of partnerships. For the most part, the current legislation simply codifies or modifies aspects of this capacity approach as necessary. Officials accept there are discrete areas where the interaction of a transparent tax approach with other specific tax provisions could be further reviewed to ensure they operate together more seamlessly. However, outside of these specific technical areas, the general transparent tax approach used for LTCs works well for straightforward, small business enterprises.

Officials will consider the comments about providing more guidance by Inland Revenue on the practical aspects of transparent tax treatment for partnerships/partners and LTCs/shareholders.

Recommendation

That the submissions be noted.

 

Issue: Tax transparency and withholding provisions

Submission

(New Zealand Law Society)

The reference to withholding taxes as they apply to LTCs should be removed from the opening language of section HB 1 as it is unnecessary, confusing and potentially harmful.

Comment

The submission refers to the opening language of section HB 1(1), which ensures that withholding tax obligations are applied to LTCs – that is, it ignores tax transparency. These provisions are necessary to allow payers making payments to the LTC to consider only the status of the LTC. Without them, taxpayers would have to consider the status of each of the underlying shareholders in the LTC, which is not generally feasible. The same outcome is achieved for partnerships by way of specific provisions in the withholding tax rules. Similarly, the opening wording means that the obligation to withhold taxes from payments made falls on the LTC. This is primarily for administrative simplicity as the LTC handles all withholding and paying obligations under these rules.

Officials note that there is no risk of economic double taxation of income derived through an LTC and later distributed to shareholders, because the LTC is not treated as paying “dividends” when it makes a distribution.

Recommendation

That the submission be declined.

 

Issue: Look-through companies – elections and methods

Submissions

(KPMG, New Zealand Law Society)

The proposed amendment to clarify that elections and methods relating to an LTC are made by the company should not proceed, as the matter can be addressed through guidance.

“Methods” should be a specifically defined term. (KPMG)

Comment

The amendment clarifies the treatment of tax elections and valuations carried out for tax administration purposes in relation to the assets of an LTC. It is considered necessary to make a specific provision for LTCs because, although they are taxed as transparent entities, and so are akin to partnerships, legally LTCs are separate entities and as such hold legal title to the assets. This is in contrast to a general partnership, where title is held by each partner, usually on a joint and several basis.

The partners of a partnership generally have the right to be involved with all of the partnership’s business. The shareholders of an LTC do not have this right in their capacity as a shareholder; the day-to-day operation of the LTC’s business is the responsibility of the LTC’s directors. In some cases a shareholder will also act as a director, but not in all cases. Thus, although the partnership and LTC rules have been deliberately written to mirror each other as far as possible, some variations are inevitable to deal with differences in their underlying legal structure and form.

The amendment applies in respect of elections and valuation and timing methods relating to LTC property and income. Although not defined in the Income Tax Act, the terms “election” or “method” are used directly in the relevant sections of the Act, and as such are defined by conventional usage. An example is the valuation of livestock, for which section EC 11 of the Income Tax Act 2007 provides three valuation methods. Under the current legislation, the shareholders must agree jointly which valuation method to apply, but then each shareholder is obliged to sign an election for this chosen method. In many cases the shareholder may not be directly involved in the day-to-day operations of the LTC; from an administrative perspective it would be the director or other relevant officer of the company who makes these elections for the LTC’s livestock.

The amendment will also ensure that, under the depreciation rules, an election to treat the LTC’s depreciable property as not being depreciable property is made by the LTC and applied by all shareholders, otherwise each shareholder could make a different election in relation to their portion of the same depreciable property. This would create huge compliance complexities and tax return discrepancies.

The amendment has deliberately been drafted to exclude “tax positions” that are neither elections nor valuations, because tax positions should be taken by a taxpayer. The LTC is not a taxpayer; the transparency rules mean that its shareholders are the taxpayers. Tax positions include provisions relating to whether an individual is a “cash basis” person (section EW 54(1)), and whether the cost of a person’s attributing interests in a foreign investment fund (FIF) is more than $50,000 (sections CQ 5 and DN 6). Tax positions must take into account a shareholder’s interests outside of the LTC – for example, any attributing interests in a FIF that are held by the shareholder in a personal capacity, as well as their attributed interests via the LTC.

Officials note that the full transparent approach applies to tax elections and valuations in relation to LPs. Like LTCs, but unlike general partnerships, LPs are separate legal entities, and limited partners cannot play any active role in the partnership’s business. Officials consider that there may be some merit in reviewing this position to consider when an LTC-style approach might be more appropriate for an LP. This review will take some time to complete, and is subject to available resources. However, it could be carried out separately so as not to delay these LTC amendments, which are helpful to LTC shareholders.

Recommendation

That the submissions be declined. Guidance on the amendments will be released in Inland Revenue’s Tax Information Bulletin.

 

Issue: Working owners and fringe benefit tax

Submission

(New Zealand Institute of Chartered Accountants)

A “working owner” of an LTC should have the option to be subject to either the fringe benefit tax (FBT) rules or to treat expenditure on the provision of a benefit as private expenditure and so non-deductible.

LTCs must comply with the reporting requirements in the Companies Act 1993 and the Financial Reporting Act 1993 to provide a “true and fair view” of the company’s position. If benefits are treated as distributions for income tax purposes, and made non-deductible, the income tax consequences will differ from the position portrayed in the financial statements.

The proposed amendment should apply prospectively from the date of enactment and not retrospectively from 1 April 2011.

Comment

Although a company at general law, a look-through company is a creation of the Income Tax Act 2007 – that is, it “exists” as an LTC for income tax purposes only. It is therefore unavoidable that there will be some divergence between accounts it must prepare as a company under the Companies Act, and the income tax approach and consequences for it and its shareholders resulting from its transparent tax status.

An LTC cannot “employ” its shareholders for income tax purposes, because under the principles of transparency, each shareholder is effectively treated as self-employed; they receive the income and the deductions of the business personally. Any money or benefits the shareholder draws from the business are not generally relevant to their tax position. This is exactly the same for a general partner.

To simplify administration for an LTC, the Income Tax Act allows a shareholder to choose to be treated as a “working owner”, so that regular payments made to that shareholder can be treated as salary or wages and the LTC can apply the PAYE rules. There is a similar long-standing provision for partnerships and “working partners”.

The amendments in the bill do not change the FBT position for working owners. Officials consider that even under the current legislation for LTCs, the FBT rules do not apply. However, the LTC legislation for working owners is drafted differently from the “working partner” legislation. Although there is no particular reason for this difference, it has led practitioners to query the difference in style. The amendments simply ensure that the LTC legislation is written in the same style as the longer-standing partnership legislation, to aid readers’ understanding.

Recommendation

That the submission be declined.

 

Issue: Definition of “employer” and “employee”

Submission

(New Zealand Institute of Chartered Accountants)

The current definitions of “employer” and “employee” in the Income Tax Act 2007 are insufficient. The definitions aim to exclude certain taxpayers from the definition for FBT purposes, which is consistent with the policy of treating such benefits as distributions of profits – for example, it excludes partnerships in relation to their working partners and LTCs in relation to their working owners.

However, the current drafting of the definition of “employer” does not appear to exclude partnerships or LTCs if they make PAYE income payments to other employees (employees who are not working partners or working owners). The drafting of the definition of “employee” also does not appear to exclude working partners or working owners if they receive PAYE income payments from another source (other than the partnership or LTC).

Comment

The parts of the employer and employee definitions referred to in this submission are not being amended by this bill.

However, officials do not agree with the analysis of these definitions. Whether a benefit is provided to a person under the FBT rules is established by the relationship between each individual recipient and the provider of the benefit. The fact that a partnership/LTC may have employees who are not working partners/owners does not prevent subparagraph (c)(i) of the definition of employer applying when considering the position of that partnership/LTC and a working partner/owner for FBT purposes. The fact that a working partner/owner may have another employment relationship elsewhere is not an issue that the partnership/LTC has to consider.

Recommendation

That the submission be declined.

 

Issue: Benefits provided to employee’s associates

Submission

(New Zealand Institute of Chartered Accountants)

Section GB 32 of the Income Tax Act 2007 should be amended to ensure that the provision does not unintentionally apply to fringe benefits provided to working owners who are associated with non-working owner-employees of an LTC, or working partners of a partnership who are associated with a non-working partner employees of a partnership.

Comment

Section GB 32 applies if a benefit is provided by an employer to a person who is associated with an employee, and would have been a fringe benefit if provided to the employee. This is an anti-avoidance provision.

Although this section is not being amended by this bill, officials agree with the points made in this submission and consider the opportunity could be taken to address this issue at the same time that other FBT-related legislation for transparent entities is being re-drafted.

The correct outcome should be that, if a benefit is provided to a working owner of an LTC, or a working partner of a partnership, who is associated with an employee (who is not themselves a working owner or partner) of that LTC or partnership, the benefit should not be treated as though it is provided by the LTC or partnership (as employer) to the employee. Instead it should be considered as a distribution to that working partner or working owner.

Recommendation

That the submission be accepted.

 

Issue: Aggregation of look-through counted owners

Submission

(nsaTax)

The changes to the definition of “relative” will mean that a number of LTCs will cease to qualify as a result of the look-through counted owner test no longer being satisfied, because under the revised relative definition trustee shareholders and their beneficiaries will count as two counted owners, not one.

Comment

Officials note that the current definition of “relative” does not connect trustees and beneficiaries directly. So under the current legislation, trustees and beneficiaries are not generally considered to be a single look-counted owner under the current rules. Further, all beneficiaries who derive as beneficiary income, income from the LTC will each be regarded as a look-through counted owner. Beneficiaries will only be aggregated and counted as one look-through counted owner to the extent that the beneficiaries themselves are relatives.

The LTC rules are intended for closely held businesses, so provide that an LTC must have five or fewer look-through counted owners. For the purposes of determining the number of look-through counted owners however, the shareholdings of relatives (for example, spouses, siblings, grandparents and grandchildren) are aggregated so that together they are treated as one look-through counted owner. An LTC can, therefore, have quite a large number of shareholders within these familial connections.

The amendment means that, for the purposes of the LTC rules, the interests of the trustees of a trust are not aggregated with another shareholder merely because that shareholder is a relative of a beneficiary of the trust. This inadvertent connection of trustees with relatives of beneficiaries greatly increases the complexity and scope of the look-through counted owners test.

Officials note that in practice there are usually other familial connections between trustee shareholders, trust beneficiaries and any other shareholder that will bring them within the “five or fewer” look-through counted owners requirements.

Recommendation

That the submission be declined.

 

Issue: Commencement date of amendments

Submission

(Ernst & Young)

The commencement date for the amendment to section HB 11(7)(a) of the LTC loss limitation rules should not be earlier than 1 April 2011.

The proposed 1 April 2011 commencement for any changes to the partnership loss limitation rules in section HG 11(12) needs to be clarified in relation to partners’ prior and current income years and any unfiled returns of income. A savings provisions may be required to protect limited partner taxpayers.

Comment

The commencement dates referred to are both drafting errors.

Officials agree that the commencement date for the amendment to the LTC rules should be 1 April 2011.

The commencement date for the majority of changes to the partnership rules was intended to be 1 April 2012, to avoid difficulties with partnership returns already filed using the existing calculations. There are two exceptions when the proposed amendments apply from 1 April 2008, being the start of the limited partnership rules.

The first exception is the clarification to the definition of “capital contribution”, which officials consider simply states the existing position more explicitly, for taxpayer ease of use. The second exception is the clarification of the inclusion of excess FIF dividends within the “income” item of the loss limitation formula. This corrects a legislative drafting error to ensure that this provision operates as intended, and delivers the outcome that, in practice, it had been understood to achieve. Both are taxpayer positive.

Recommendation

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

 

Issue: Look-through company elections and revocations

Submission

(Ernst & Young)

Taxpayers’ decisions on whether to use the LTC rules may have been influenced by the definition of “secured amounts”. These taxpayers should be able to make a late election or revocation of LTC status.

Comment

Officials do not agree that late elections or revocations should be permitted as it would be impossible to confine these only to the circumstances when the “secured amounts” calculation was the prime motivating factor in a taxpayer’s decision-making process.

The majority of the proposed changes to the “secured amounts” definition are to simplify and broaden the application of the rules in line with the original policy intention, and are in the taxpayer’s favour. Officials do not consider that taxpayers would have based their decision to use the LTC rules solely on the basis of the extent of the owner’s basis they could establish by virtue of guarantees provided in respect of the company’s debt.

Recommendation

That the submission be declined.

 

Issue: Inclusion of dividends from a foreign investment fund as income in the loss limitation formula

Submissions

(Ernst & Young, New Zealand Institute of Chartered Accountants)

The inclusion of the “difference” between FIF distributions and attributed FIF income does not adequately address situations when there is a FIF loss. Also, when the FIF dividends received are less than FIF income, the inclusion of the “difference” could reflect some double counting.

Comment

This amendment corrects an error in the original legislation to ensure that this provision operates as intended and delivers the outcome that, in practice, it had been understood to achieve.

The policy intention has always been that when a shareholder or partner’s proportionate share of the dividend actually distributed by a FIF is higher than their amount of FIF income as calculated using the shareholder/partner’s chosen FIF calculation method, the difference should be added to their “income” for the purposes of the loss limitation formula, because they are at economic risk for these dividends. In the case of a FIF loss being calculated under the FIF rules but FIF dividends being received, the actual dividend amount should be counted.

Officials agree that the drafting should be clarified to confirm that the section applies only when there is an “excess” of FIF dividends received over FIF income, and that when there is a FIF loss only, the positive dividend amount is counted.

Recommendation

That the submissions be accepted.

 

Issue: Inclusion of capital improvement costs as income in the loss limitation formula

Submission

(New Zealand Institute of Chartered Accountants)

Capital improvement costs should be reflected in the loss limitation formula because they represent an increase in the asset base of the LTC, and so are an amount for which a shareholder is at risk.

Comment

The policy objective for the loss limitation formula is to measure an individual’s economic risk exposure – that is, the amount they have personally put in to the LTC (or stand liable for in the case of a guarantee or indemnity for the LTCs debt). Extending this to include capital improvements that are funded by the company would not be consistent with this policy, as these improvements have not increased the economic investment made by, or risk exposure of, the shareholder.

The submission draws an analogy with realised capital gains. Realised gains are included in the formula because the shareholder could draw these down as dividends; if the gains remain in the company the individual has foregone access to this money. That is not the case with internal revaluations or expenditure reflected in capital improvements.

Officials note that to the extent that capital improvements are funded by the company directly from retained profit, the income that produced that profit will previously have been counted in the loss limitation formula. The realised capital gain/loss items in the formula effectively take into account, at point of realisation, expenditure on capital improvements that would not previously have been recognised for income purposes.

Recommendation

That the submission be declined.

 

Issue: Secured amounts and loans made by a shareholder

Submission

(New Zealand Institute of Chartered Accountants)

An LTC shareholder can only include a guarantee within their “secured amounts” items if those secured amounts are not accounted for by another person that is another shareholder. It is unclear how a shareholder would know how another shareholder has treated this secured amount for tax purposes.

Comment

The “secured amounts” definition concerns guarantees made by a shareholder in relation to an LTC’s debt. It excludes a guarantee made by one shareholder (the guarantor shareholder) in relation to a loan given by another shareholder (the creditor shareholder) to the LTC, because that loan amount will be counted by the creditor shareholder directly in determining their owner’s basis. If the guaranteed amount were also included by the guarantor shareholder as a secured amount it would result in the same amount being double counted. It also opens up avoidance opportunities by “reciprocal” loans and guarantees being made by shareholders of the same LTC.

Officials do not consider there will be any difficulty with either shareholder knowing about the existence of the loan or guarantee in this circumstance, because the guarantor shareholder will have provided the guarantee to the creditor shareholder.

Recommendation

That the submission be declined.

 

Issue: Definition of “guarantor” – LTCs

Submissions

(nsaTax, PricewaterhouseCoopers)

The definition of “guarantor” should aggregate the shareholder, and all their associates who have provided a guarantee for the same debt, as one single guarantor. (PricewaterhouseCoopers)

A guarantor means a person who has an effective look-through interest for the LTC. (nsaTax)

Comment

The new definition of “guarantor” does provide for the aggregation of a shareholder, and all their associates who have provided a guarantee for the same debt, as one single guarantor.

Although in most cases this means that a guarantor will be a shareholder, the second part of the definition covers circumstances when there is a guarantee provided by a third party who is neither a shareholder nor an associate of a shareholder. In this situation the denominator figure for “guarantors” by which the amount of debt secured by guarantee is divided recognises this third-party guarantee. The policy rationale is that the presence of this third-party guarantor reduces the economic risk exposure of the shareholders who have provided a guarantee.

Recommendation

That the submissions be noted.

 

Issue: Definition of “guarantor” – partner’s associate

Submissions

(Ernst & Young, Meridian Energy)

Where a limited partner is a company and all guarantors are members of the same wholly owned group of companies as the limited partner, the limited partner and all guarantors should be collectively treated as one guarantor. (Meridian Energy)

Companies that are not limited partners but are partly owned by the same group as a company that is a limited partner should also be counted with the single guarantor. (Ernst & Young)

Comment

The definition of “partner’s associate” as it relates to companies in the same wholly owned group as the partner is not changed by the bill. These will be collectively treated as one guarantor with the relevant limited partner(s).

Members of partly owned groups are not currently included in the definition of “partner’s associate”. The definition applies only to companies in the same wholly owned group. Part-ownership means others outside of the company’s economic group are sharing the risk exposure from the guarantee, and so are reducing the economic exposure/risk of the limited partners (and their associates) who have also provided a guarantee. As such, it is consistent with the policy approach to third-party guarantors that these partially owned companies should be reflected as separate guarantors.

Recommendation

That the submissions be declined.

 

Issue: Definition of “recourse property”

Submissions

(Ernst & Young, Meridian Energy, New Zealand Institute of Chartered Accountants, PricewaterhouseCoopers)

“Recourse property” means property to which a creditor has recourse to enforce a guarantee or indemnity for a debt, if the guarantee or indemnity expressly provides recourse to “only” that property. The word “only” should be removed as it implies that the provision will not apply if the creditor has limited surety over two or more properties. (New Zealand Institute of Chartered Accountants)

The “secured amounts” definition uses a “lesser of (a) or (b) approach; it is unclear how this approach operates when there is no comparator in (b) – that is, there is no recourse property. It should be clarified whether the amount is “zero” or whether this part of the definition does not apply.

Comment

The inclusion of the word “only” is pivotal to the definition of “recourse property”. It ensures that the guaranteed amount is restricted in situations when the creditor’s recourse is restricted to identified assets – for example, the terms of a guarantee may be restricted to allow a creditor recourse against the guarantor’s share portfolio and rental bach, but not his family house. If the combined values of that share portfolio and bach are less than the amount of debt guaranteed, the guarantor is only “at risk” up to the value of the share portfolio and bach and so only the value of the share portfolio and bach should be included in the owner’s basis.

Officials consider that the word “applicable” in the proposed amendment is sufficiently clear to provide that when there is no recourse property the paragraph of the definition dealing with recourse property is “not applicable”.

Recommendation

That the submissions be declined.

 

Issue: Attribution of secured amounts when there is no recourse property – pro rating

Submissions

(Ernst & Young, New Zealand Institute of Chartered Accountants)

The “secured amounts” definition should pro-rate the amount of the guarantee based on the particular LTC shareholder’s share of the guarantee or indemnity, rather than averaging, as this better reflects their proportion of economic risk.

This definition should use the same proportional attribution method used for “recourse property” in situations when more than one shareholder has provided a guarantee for the same debt.

Comment

In some situations more than one shareholder may provide a guarantee for the same amount of a debt. The amount of the debt that both shareholders have guaranteed is apportioned between each guarantor on an equal split basis. Any debt amounts that are not covered by more than one shareholder’s guarantee will not be apportioned.

 The total economic risk is only the amount of the debt guaranteed. The policy rationale for an equal split basis is that each shareholder has full and equal exposure under the guarantee to the extent they have guaranteed the same debt amount. Averaging the guaranteed debt amount to each shareholder is the equitable way to account for this shared risk. The shareholders’ respective level of shareholding in the LTC is not relevant to the risk exposure under a separate guarantee.

There is no recourse property so the “proportion of ownership interests in the recourse property approach” is not a suitable apportionment mechanism.

Recommendation

That the submissions be declined.

 

Issue: Attribution of secured amounts when there is recourse property – clarification

Submissions

(Ernst & Young, New Zealand Institute of Chartered Accountants, nsaTax, PricewaterhouseCoopers)

The definition of “secured amounts” should set out how the value of recourse property should be “attributed” to a shareholder. It should particularly set out the position in situations when the recourse property is offered under a guarantee or indemnity provided by an associate so that the shareholder himself or herself has no ownership interest in the recourse property.

Comment

If the same recourse property is used as security by more than one guarantor making a limited recourse guarantee, then it is their proportional interests in the recourse property that should be attributed to them. For example, a guarantor may provide a guarantee limiting recourse to a piece of land held as tenant-in-common. The guarantor’s economic exposure under the guarantee is reflected by their percentage ownership interest in the land (recourse property), so this should also carry through to be their secured amount. If the ownership interest is on a joint tenancy basis, the “proportion” of a person’s interests in that recourse property will be divided equally by the number of joint tenants who have an interest in that same property. Officials agree that the proportional attribution could be more clearly set out in the legislation.

The term “recourse property” is defined by reference to the “relevant debt”, which therefore includes debts for which an associate provides a guarantee or indemnity. These are aggregated together as a single guarantor in the new definition of “guarantor”. The interests of the associate in the recourse property are therefore treated as the shareholder’s interests for these purposes. In the case of more than one association, the interests will be equally shared among all shareholders who have an association with the person providing the guarantee. Officials consider the current drafting achieves this first outcome, but on the second, officials agree that it could be improved to address more explicitly the approach to proportional attribution where an associate of more than one shareholder provides a guarantee or indemnity, if this will help taxpayer understanding.

Recommendation

That the submissions be accepted.

 

Issue: Application of initial basis provisions

Submissions

(Ernst & Young, New Zealand Institute of Chartered Accountants)

There is uncertainty between the interaction of section HZ 4C(1), which provides that the section applies in the “transitional year”, and section HZ 4C(2) which is to be used when applying sections HB 11 and HB 12 not only in the transitional income year, but also in later years. (New Zealand Institute of Chartered Accountants)

The amendments should be made in section HB 11 – for example, section HB 11(5)(a) should be amended to refer to either the transitional value as determined under subpart HZ or the market value of a person’s shares in the LTC at the time when the person purchases or subscribes for them.

Comment

Officials do not agree that there is any divergence between subsections (1) and (2) of section HZ 4C. “When” may be used to convey the section’s application “if” there is a situation in which a qualifying company has first become an LTC for the transitional year. Therefore it does not affect the application of section HZ 4C(2) to both the transitional income year and later years, as necessary. In any case, section HZ 4C(2) is specific about when it applies, so there is no doubt about its application

Section HB 11 contains the primary loss limitation formula, which applies to all look-through companies, not just those that have transitioned from being a qualifying company. Therefore, the amendments are made not in section HB 11, but to subpart HZ because that specifically deals with these transitioning qualifying companies.

Recommendation

That the submissions be declined.

 

Issue: Calculation of initial basis for a qualifying company using the market value or the accounting book value method

Submission

(Ernst & Young)

Section HZ 4C should not preclude the addition of any further investment amount arising from transactions or events occurring after the start of the transitional year, so that the year-end balance date amounts may be truly representative of a taxpayer’s investment. It should also be clear that year-end amounts are included for items referred to in paragraphs (b) and (c) of section HB 11(5).

The proposed amendments relating to capital gain amounts and capital loss amounts which require any calculations of those amounts to be changed to account for the opening valuation of the “investments” are complex and will lead to uncertainty.

Comment

The amendments to section HZ 4C relates to investment amounts in section HB 11(5)(a) only in terms of valuing shares on the last day of the income year before the transitional year. Further investment amounts arising from transactions or events occurring after during the transitional year, or any later year, will be included in the formula under the primary provision at section HB 11(5)(a). The amendments mean that section HZ 4C no longer includes items referred to section HB 11(5) (b) or (c) because these are valued when applying the formula on the last day of the transitional income year, and each later year in which the company is an LTC, not before.

It is necessary to adjust for the inclusion of values in the initial basis that relate to internal revaluation reserves (both increases and decreases) when these eventually are realised as capital gain or loss amounts, otherwise there would be double counting or under-valuation of an owner’s basis in later years. This does require detailed calculations, but the rules already require a shareholder to calculate and apportion a capital gain or loss on assets when realised, for the purposes of applying the loss limitation formula. Shareholders will also have access to the company records detailing the revaluation of assets before the company transitioned into the LTC rules. This will enable the necessary adjustment to be made to reflect the revaluation adopted in their “initial basis”.

Recommendation

That the submission be declined.

 

Issue: Drafting amendments

Submissions

(nsaTax, New Zealand Institute of Chartered Accountants)

The drafting of section HB 11(8)(a) should be clarified, to remove the repetition of the expression “by virtue of section HB 1” which serves no useful purpose. (New Zealand Institute of Chartered Accountants)

The phrase “net of higher ranking calls” is not defined. (nsaTax)

Comment

Officials do not consider that these provisions as currently drafted are unclear. The current wording meets the policy intent and no amendment is necessary. Although not a defined term, officials consider that the phrase “net of higher ranking calls” is sufficiently defined by conventional and commercial use; the proposed alternative does not enhance the current drafting.

Recommendation

That the submissions be declined.

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THE TAX SYSTEM

Submission

(Andrew Sheldon Crooks)

The submitter disagrees with the current system of government in New Zealand and the basis on which tax is levied.

Comment

The matter raised in the submission is not in the bill.

Recommendation

That the submission be noted.

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HARDCOPY RETURNS

Clause 110

Submissions

(KPMG, New Zealand Institute of Chartered Accountants)

The change is supported. (KPMG)

The provision should not specify who should sign the return, as this would be more consistent with the rules that apply to paper-based returns. (New Zealand Institute of Chartered Accountants)

Comments

The amendment is to clarify that an agent or a taxpayer can sign the hardcopy of a return filed electronically. Officials agree that there should be symmetry between paper returns and electronic returns whenever possible and are therefore comfortable with the NZICA submission that the signatory need not be specified.

Recommendation

That the KPMG submission be noted and the NZICA submission be accepted.

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TECHNICAL CHANGES TO THE LIFE INSURANCE TRANSITIONAL RULES

Clauses 2(16), 26 and 27

 

Issue: Support for proposed changes

Submissions

(KPMG, New Zealand Institute of Chartered Accountants)

The changes to the transitional rules for life insurance are supported, including backdating the changes to the start of the new life insurance taxation rules.

Recommendation

That the submissions be noted.

 

Issue: Scope of proposed change

Submission

(KPMG)

The scope of the proposed change should also include the transitional rule that provides that premium increases on pre-1 July 2009 participating policies to meet increases in the Consumer Price Index (CPI) do not affect the grandparented status of the policy.

Comment

The transitional rules for profit participation life insurance policies provide for a simpler calculation of taxable income. The simplified calculation applies to participating life policies sold on or before 30 June 2009 – known as “old life policies”. Profit participating life policies sold after that date are taxed using a more comprehensive measure of income as a tax base integrity measure.

The proposed change to section EY 28 of the Income Tax Act 2007 clarifies that the transfer or sale of old life policies (after the start date of the new rules) does not result in those policies being taxed under the more comprehensive taxation formula applicable for participating business sold after 30 June 2009. Life insurers are concerned that any consolidation or rationalisation of the life industry could create additional tax compliance costs if old life policies are not appropriately grandparented. The concern arises because the life insurer who acquires the old life policies will often issue “new” life insurance policies on the same terms and conditions, including bonus entitlements. Increases to premiums that reflect increases in the amount of life cover may also feature as part of the issue of the “new” policies. Provided that the premium increase is no greater than the higher of the CPI rate or 10 percent (as currently provided for in section EY 28), the life policy should continue to be treated as a continuation of existing business.

Recommendation

That the submission be accepted.

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TREATMENT OF THE OUTSTANDING CLAIMS RESERVE WHEN GENERAL AND NON-LIFE INSURANCE IS TRANSFERRED TO ANOTHER INSURER

Clause 21B

Submissions

(KPMG, Matter raised by officials)

Technical changes are required to the Income Tax Act 2007 to clarify the tax position of insurance companies when there is a transfer of business partway through an income year. (Matter raised by officials)

KPMG supports the suggested legislative change and submits that it should have retrospective effect to facilitate the transfer of general and non-life business if the transfer is made to ensure the insurer meets the new licensing requirements under the Insurance (Prudential Supervision) Act 2010. (KPMG)

Comment

Under the Income Tax Act, a deduction connected with movements in an insurer’s outstanding claims reserve (OCR) (or income depending on the nature of the actual movement) is calculated on an income year basis. This means that the legislation does not provide an appropriate closing value if the OCR for a particular line of general or non-life insurance business is transferred at a point of time other than at the end of an income year. As a result, a selling insurer can lose its entitlement to deduct the closing value of its OCR.

Instead, the tax deduction that would otherwise be available is effectively transferred under the Income Tax Act to the insurer that acquires the business. If the transfer occurs within New Zealand, the tax difference can be resolved by the parties agreeing to adjust the transaction value of the transfer to ensure a tax-neutral outcome. If, however, the transfer involves relocating New Zealand-based insurance business offshore, a permanent tax can be created against the taxpayer.

Officials recommend a technical amendment to the Income Tax Act that sets an appropriate closing and opening balance for the OCR when it is transferred from one insurer to another.

Application date

KPMG, on behalf of Cigna Taiwan Limited, notes that the application date of the amendment is important for their client and submits that the change should be backdated.

To meet the regulatory requirements of the Insurance (Prudential Supervision) Act 2010, Cigna Taiwan is restructuring its business. This restructure is likely to be completed before the bill is enacted. As such, the application of current law to Cigna Taiwan would result in it losing its entitlement to a deduction for any movements in its OCR up to the date of transfer. Cigna Taiwan advises that this will create a one-off tax liability of $3 million.

Reasons for backdating the suggested amendment are:

• The current law creates an outcome that is inconsistent with the policy intent to allow insurers a deduction when they are reasonably expected to be liable for a claim.
• The Income Tax Act, in this particular instance, should not create a tax liability in respect of actions to ensure compliance with the Insurance (Prudential Supervision) Act 2010.

In terms of the case against backdating, officials have undertaken limited consultation with two insurance representative groups about the suggested amendment. Both groups supported the change, subject to it applying prospectively and noting that a number of transfers have already been completed on the basis of the current legislation. Backdating the change could disturb these transactions. One group, however, supported the change applying retrospectively on an elective basis if the current legislation has the effect of denying an insurer a deduction.

In balancing these competing arguments, officials agree with KPMG’s suggestion that the amendment apply to transfers occurring on and after 1 October 2012, but allow the option for the change to apply retrospectively in following limited circumstances:

• The taxpayer elects to apply the rule from a date no earlier than 7 September 2010, being the date the Insurance (Prudential Supervision) Act 2010 was enacted.
• The transfer of the general insurance contracts are to a transferee who is non–resident and does not carry on a business in New Zealand through a fixed establishment.
• The transfer is made by the seller for the purposes of complying with the Insurance (Prudential Supervision) Act.

Recommendation

That the submissions be accepted. The Income Tax Act should be amended to set an appropriate closing and opening balance for the OCR when it is transferred from one insurer to another. The amendment should apply to transfers made on and after 1 October 2012, or at the election of the taxpayer from a date no earlier than 7 September 2010 if:

• the transfer is to a non-resident who does not carry on a business in New Zealand through a fixed establishment; and
• the transfer is made for the purposes of complying with the Insurance (Prudential Supervision) Act 2010.

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REWRITE AMENDMENTS

Issue: Valuation of livestock

Clauses 20 and 165

Submissions

(New Zealand Institute of Chartered Accountants, Matter raised by officials)

The proposed amendments to section EC 1(1) should clarify that, as is currently the case, the livestock valuation rules under sub-part EC will continue to not apply where livestock is used in a dealing business. (New Zealand Institute of Chartered Accountants)

That the proposed amendments to section EC 1(1) should clarify that, as is currently the case, the livestock valuation rules under sub-part EC will continue to not apply where livestock is used in a dealing business. Clause 165 of the bill proposes an amendment to section EC 1(1) of the Income Tax Act 2004, mirroring the amendment proposed in clause 20 for section EC 1(1) of the Income Tax Act 2007. (Matter raised by officials)

Comment

Officials agree that the valuation rules in subpart EC should not apply to livestock that is trading stock of a dealing business. This is contemplated by the definition of trading stock in section EB 2, which includes livestock that used in a dealing business.

Recommendation

That the submissions be accepted.

 

Issue: Trustee income

Clause 38

Submission

(New Zealand Institute of Chartered Accountants)

NZICA (although not considering a legislative amendment necessary) broadly supports a clarification amendment to section HC 25(1).

Comment

Section HC 25 is a key component of the settlor trust regime. This section ensures that a non-resident trustee of a trust, which has a New Zealand resident settlor (and certain other trusts), is taxable on undistributed income derived from sources outside New Zealand.

The Rewrite Advisory Panel noted that section HC 25(1) of the Income Tax Act 2007 contains an ambiguity. The ambiguity could result in the provision applying to income distributed as beneficiary income. This is not the policy intention, and we agree with the Panel that the drafting should be improved.

Recommendation

That the submission be noted.
 

2To be certain that taxpayers are not disadvantaged by the retrospective nature of this amendment the bill contains a “savings” clause which protects the positions previously taken by taxpayers, in the event that any taxpayers have previously not applied ESCT at this flat rate, or have applied fringe benefit tax (FBT) instead.

3Officials note that a local authority cannot be a shareholder in an LTC, as a local authority is neither a natural person nor a trustee (in its capacity as a local authority) so the status issue as set out in the submission could not arise in practice.