Chapter 1 - Summary
1.1 Since 2007 the government has overhauled New Zealand’s international tax system, making New Zealand a more attractive place to invest from or to base a multinational enterprise. The introduction of the fair dividend rate method for foreign portfolio investment and the active income exemption for direct investment have removed barriers to sensible investment choices, and brought New Zealand into line with other OECD economies.
1.2 This issues paper proposes further reform of the international tax system, but this time focuses on investments made by foreigners in New Zealand. It proposes changes to the thin capitalisation rules to ensure New Zealand collects its fair share of tax from such investments.
1.3 Past tax reviews have concluded that some reasonable level of tax can be imposed on foreign investors without unduly affecting incentives to invest. The thin capitalisation rules are one mechanism we use to ensure we do tax this investment.
1.4 The thin capitalisation rules aim to discourage the excessive debt-funding of New Zealand operations of multinational enterprises, by reducing tax deductions for interest in extreme cases. For the most part, the thin capitalisation rules appear to be effective in the standard case of a large multinational, listed on a stock exchange, with subsidiary operations in New Zealand. However, they seem deficient in the case of private equity investment.
1.5 One reason is that the rules currently apply only when a single non-resident controls the New Zealand investment, but private equity investors often work together in groups in a way that mimics control by a single controlling investor. In addition, the rules can also be ineffective when debt funding for an entire global group comes from the ultimate shareholders, rather than from third parties. While listed multinationals are unlikely to be obtaining their debt from shareholders, closely held investment vehicles can more easily do so.
1.6 We are proposing that the thin capitalisation rules for inbound investment be widened to extend to investments that are not controlled by a single non-resident. That is, they would apply to groups of non-residents as long as those investors were acting together, either by explicit agreement or because they were being co-ordinated by some party such as a private equity manager.
1.7 Our primary concern in this situation is the use of related-party debt when overall debt levels are high. To deal with this concern, related-party debt would be excluded from the debt-to-asset ratio of a multinational’s worldwide group for the purposes of the thin capitalisation calculations. When non-residents’ New Zealand debt levels are high, the worldwide debt-to-asset ratio can be used to justify the high level of debt. Excluding related-party debt from the worldwide ratio would ensure the world wide debt ratio could be used to justify high debt levels in New Zealand only to the extent it reflected genuinely third-party borrowing by the worldwide group.
1.8 The proposed rule should not affect the use of genuinely external debt, such as a loan from a third-party bank, even when the overall level of debt is high.
1.9 We propose a number of other technical changes to the rules.
1.10 We propose that any changes, if they proceed, would take effect from the income year beginning after enactment of any legislation.
1.11 The proposed changes to the rules are likely to reduce the returns to foreign investors in a limited number of cases (the outcome for affected taxpayers depends crucially on how the foreign tax laws treat the investment). This is a consequence of the fact that we want these investors to pay more New Zealand tax.
1.12 However, on balance we consider that the effect of reduced returns for these taxpayers will not have a significant effect on overall levels of investment and there are likely to be overall net benefits for New Zealand because of the increased tax collection. Since our starting point is that it is sensible to impose some tax on foreign investment, we have designed our proposals to reduce tax deductions for related-party debt that is unduly reducing the effective rate of New Zealand tax, while limiting the effect on other debt.
Summary of proposed changes
|Issue||Current rule||Proposed rule|
|Foreign controller||Must be a single non-resident controller for the rules to apply.||Must be a single non-resident controller, or a group of non-residents holding an interest of 50% of or more and acting together.|
|110% safe harbour||Worldwide debt includes all debt of the group.||Worldwide debt excludes debt linked to shareholders of group companies.|
|Resident trustee||Resident trustee is subject to the rules if the trust is a non-complying trust and more than 50% of settlements are made by a single non-resident.||Resident trustee is subject to the rules if more than 50% of settlements on the trust are made by a non-resident, a group of non-residents acting together, or another entity that is subject to the rules.|
|Capitalised interest||Capitalised interest is included in assets when the debt-to-asset ratio is calculated.||Capitalised interest excluded from assets when a tax deduction has been taken in New Zealand for the interest.|
|Consolidation for outbound groups||Individual owner of an outbound group of companies is treated separately from the group.||Individual owner’s interests consolidated with those of the outbound group.|
|Asset uplift||Some taxpayers are recognising increased asset values as a result of internal sales of assets.||
Ignore increased asset values as a result of internal sales of assets (exception for internal sales that are part of the sale of an entire worldwide group).
How to make a submission
1.13 You are invited to make a submission on the proposed reforms and points raised in this issues paper. Submissions should be addressed to:
Review of the thin capitalisation rules
C/- Deputy Commissioner, Policy
Policy Advice Division
Inland Revenue Department
PO Box 2198
1.14 Or email [email protected] with “Thin capitalisation review” in the subject line.
1.15 Electronic submissions are encouraged. The closing date for submissions is 15 February 2013.
1.16 Submissions should include a brief summary of major points and recommendations. They should also indicate whether the authors would be happy to be contacted by officials to discuss the points raised, if required.
1.17 Submissions may be the subject of a request under the Official Information Act 1982, which may result in their release. The withholding of particular submissions on the grounds of privacy, or for any other reason, will be determined in accordance with that Act. Those making a submission who consider there is any part of it that should properly be withheld under the Act should clearly indicate this.