CFC remedials
Issue: Foreign exchange gains and losses on liabilities
Clause 74
Submissions
(Deloitte, Corporate Taxpayers Group, New Zealand Institute of Chartered Accountants)
In many cases a company’s accounts will report foreign exchange gains and losses relating to both assets and liabilities. To reduce compliance costs, the bill includes an amendment which allows taxpayers to use an aggregate figure when applying the active business test.
As currently drafted, the amendment applies more broadly than intended. It would capture other types of gains and losses such as gains and losses on derecognition of a liability and changes in the reported value of liabilities. It should be limited to foreign exchange gains or losses.
Comment
Officials agree that the amendment that allows taxpayers to include gains and losses on liabilities in the active business test should be limited to foreign exchange gains and losses.
Recommendation
That the submission be accepted.
Issue: CFCs with offshore branches should be able to join test groups
Submission
(Deloitte, Corporate Taxpayers Group, New Zealand Institute of Chartered Accountants)
The CFC rules allow taxpayers to group multiple CFCs together for the purposes of calculating the active business test. There are rules which limit the CFCs that can be included in the group, one of which says that each CFC must have a “taxed CFC connection” with the same country or territory.
The “taxed CFC connection” essentially requires that the CFC is taxed and resident in the country it is based in and not taxed or resident in any other country. This has the effect of barring any CFC that has an offshore branch from being included in a test group.
The issue is whether this has a disproportionate effect on CFCs that have minor business presences in other countries. The submission proposes allowing these CFCs to form test groups despite the presence of offshore branches. Any active income earned by the offshore branch would be disregarded in the active income test.
Comment
It is not unusual for the operating company to have an offshore branch in another jurisdiction which may, for example, comprise a small sales team. The rules determining whether a branch exists are not clear cut, and can vary from country to country, so it is possible that a CFC may unintentionally establish an offshore branch and unexpectedly fall outside of the test group rules.
Officials agree that this may have a disproportionate effect on the taxpayer’s position and the proposed amendment should include two additional safeguards to prevent abuse.
First, the CFC with the offshore branch must be a non-attributing active CFC in its own right. This eliminates the possibility of passive income earned through a branch being sheltered by active income earned in the country the CFC is based in.
Secondly, the anti-abuse provisions in sections GB 15B and 15C may need to be amended so that they also cover arrangements/supplies between offshore branches and head offices that have been entered into/made with the intent of gaining the active exemption.
Recommendation
That the submission be accepted, subject to officials’ comments.
Issue: Application date for relocation of apportioned funding income
Clause 70
Submission
(Ernst & Young)
The bill relocates an existing adjustment for apportioned funding income from sections EX 20C to 20B. This amendment should not apply retrospectively as it could affect a taxpayer’s active business test results.
Comment
Applying the amendment retrospectively could potentially mean that a CFC may now pass an active business test that it would have previously failed. Because taxpayers do not have to pay tax on profits from a CFC which passes an active business test, this will usually be taxpayer-friendly. In other words, if the amendment applied prospectively it would be more likely to disadvantage taxpayers.
Recommendation
That the submission be declined.
Issue: Section DB 55 should not be repealed
Clause 43
Submission
(Deloitte, PricewaterhouseCoopers, New Zealand Institute of Chartered Accountants)
Section DB 55 should not be repealed as the repeal will not have a material fiscal impact but would lead to uncertainty and compliance costs from having to apportion expenses between exempt and assessable income.
Some submitters have also suggested that the repeal could create “black hole” expenditure which is contrary to the Government’s recent work on reducing “black hole” expenditure.
Comment
As a general principle, expenses can only be deducted for tax purposes if they are incurred in earning taxable income. In other words, if the expenses relate to income which is exempt from tax, no deduction can be claimed.
When a New Zealand company receives a dividend from a foreign company, the dividend is exempt from income tax. Section DB 55 allows deductions despite the fact that the dividends are exempt from income tax.
The rationale for this, is that before 2009, the dividends were subject to a special levy, known as “foreign dividend payment” or “FDP” which was equivalent to income tax.
In 2009 there was a major reform of New Zealand’s international tax rules. This reform was designed to reduce tax barriers on New Zealand businesses that expand offshore. It did this by exempting most types of income that businesses earned through foreign subsidiaries. As part of this reform all tax on foreign dividends paid to New Zealand companies, including FDP was removed.
In the course of implementing the 2009 reforms, the need to repeal section DB 55 was overlooked. We are now seeking to repeal it as part of the current bill.
Maintaining section DB 55 in the absence of FDP would be contrary to general tax principles of not allowing deductions which relate to exempt income (now that the dividends are truly exempt). It would effectively be a tax concession or subsidy.
There would be fiscal risks associated with providing deductions in cases where the resulting income will not be taxed, as these could be used as building blocks for tax planning arrangements which shift income offshore or which generate artificial losses to shelter other forms of income.
The repeal of section DB 55 does not prevent deductions for head office expenses that relate to subsidiaries. These could still be claimed if they satisfy the “general permission” in section DA 1, which applies for all other types of expenses.
It is a common commercial practice for head offices to charge their subsidiaries for head office expenses and, in such cases, a deduction should be available under the general permission.
In other cases, apportionment of expenses between exempt and taxable income may be necessary. However, the compliance costs associated with apportionment are unlikely to be significant as taxpayers already have discretion to make fair and reasonable apportionments. Taxpayers are frequently required to apportion expenses in many other situations, such as when they relate to receiving an exempt government grant, or an untaxed capital gain.
There is no generally agreed definition of “black hole” expenditure. However it usually refers to expenses incurred in an activity that was expected to generate taxable income, but which cannot be claimed (either immediately or as a depreciable asset) as the activity fails to produce any income. This is not the case with section DB 55 as this provision specifically relates to expenses incurred in deriving exempt income.
Recommendation
That the submission be declined.
Issue: Repeal of section DB 55 application date
Clause 43
Submission
(New Zealand Institute of Chartered Accountants)
The application date of the repeal of section DB 55 should be the date of introduction of the bill to Parliament in order to preserve tax positions taken by taxpayers who have relied on the provision.
Comment
As currently drafted, the repeal of section DB 55 includes a “savings” provision which means it does not apply to tax positions taken in tax returns filed before the date the bill was introduced to Parliament (22 November 2013). This savings provision deals with the concern raised by the submitter.
Recommendation
That the submission be declined.
Issue: Repeal of DB 55 savings provision
Clause 43
Submission
(The Whyte Group)
The repeal of section DB 55 has a “savings” provision whereby it does not affect tax positions taken in tax returns that have been filed before the date the bill was introduced to Parliament.
This savings provision fails to accommodate taxpayers who have applied section DB 55 during their 2013 or 2014 income years, but had not yet filed their returns for these years as these returns are not due until after November 2013. This means the repeal could have a retrospective effect of denying deductions that have already been taken for these income years in cases when the relevant tax return has not yet been filed.
Comment
Officials agree that the savings provision should be extended to deal with the concern raised by the submitter.
Recommendation
That the submission be accepted.
Issue: Nexus requirement under section DB 55
Clause 43
Submission
(The Whyte Group)
The current nexus test provided by section DB 55 is too narrow as it only allows deductions that are directly incurred in deriving the exempt dividends.
This creates uncertainty over whether management fees could be deducted under this section.
In contrast, the general permission for deductions in section DA 1 has two limbs. It allows deductions for expenditure incurred in earning income and expenditure incurred in carrying on a business of deriving income.
Section DB 55 should be broadened so that it matches both limbs of the test provided by the general permission in section DA 1.
Comment
Section DB 55 was introduced in 2004 because at that time, foreign dividends were subject to a special levy, known as a “foreign dividend payment” or “FDP”, which was equivalent to income tax.
The 2004 Official’s report on the Taxation (Annual Rates, Venture Capital and Miscellaneous Provisions) Bill[17] which introduced the amendment explained that the policy intention was to allow a deduction for expenditure incurred by a company in deriving the foreign dividend, to the extent to which it was subject to FDP.
We note that FDP only arises when a dividend is actually received. This suggests that a relatively narrow nexus could have been intended. In contrast, management fees may be charged irrespective of whether a dividend is received (for example, the management fee may relate to making an investment in a company that never pays dividends).
Because the existing nexus requirement in section DB 55 appears to achieve the original policy objective, officials do not think there is a strong case for retrospectively broadening the nexus test. This is particularly true with respect to periods after 2009, after which FDP no longer applied to the dividends. This meant the original rationale for allowing deductions under section DB 55 was no longer required.
Recommendation
That the submission be declined.
Issue: Removing Australian unit trusts from the Australian exemption
Clauses 75 and 76
Submission
(KPMG)
The amendment to remove Australian unit trusts from the CFC and FIF exemptions in sections EX 22 and EX 35 is not a remedial item. It should be omitted from the bill and be subject to a proper consultation process.
Comment
The exemptions from the CFC and FIF rules in sections EX 22 and EX 35 are based on the assumption that Australian companies generally face similar tax rules and a similar level of tax to New Zealand companies.
Australian unit trusts are not taxed as companies in Australia, and investments made through an Australian unit trusts often face a lower rate of tax than Australian companies.
For this reason, the policy intention at the time of the 2009 international tax reforms was that Australian unit trusts should not be able to qualify for the Australian exemption. The policy of excluding Australian unit trusts was explicitly expressed, on page 49 of the 2009 Official’s Report on the Taxation (International Tax, Life Insurance, and Remedial Matters) Bill which introduced the Australian exemption.
The change in the current bill ensures that the law achieves the original policy intent.
Recommendation
That the submission be declined.
Issue: Application date for removing Australian unit trusts from the Australian exemption
Clauses 75 and 76
Submissions
(Vital Healthcare Property Limited, The Whyte Group)
As currently drafted, the removal of Australian unit trusts from the Australian exemption applies from the 2014–15 income year. This could have a retrospective effect for some taxpayers who will have begun their 2014–15 year before the bill is enacted.
To prevent this retrospective effect, a savings provision should be provided for taxpayers who have applied for a binding ruling before the date the bill was introduced (22 November 2013).
The application date for taxpayers who did not apply for a binding ruling should be deferred by one year, until the start of the 2015–16 income year. (Vital Healthcare Property Limited)
The application date should be for income years beginning on or after 1 July 2014:
- Previous amendments to section EX 22 have been by reference to this 1 July date.
- The Australian unit trusts which are affected by the provision typically have a 30 June balance date.
- Other proposed amendments to the CFC rules contained in the bill also have application dates that refer to 1 July.
(The Whyte Group)
Comment
We agree that the application date should be amended to apply to income years beginning on or after 1 July 2014. Because the bill is expected to be enacted before July, this should reduce the possibility of a retrospective effect, while still providing taxpayers with certainty about when the amendment will take effect.
Recommendation
That the submissions be accepted, subject to officials’ comments.
Issue: Further guidance material on CFC remedials
Submission
(PricewaterhouseCoopers)
Inland Revenue should publish examples of the application of the CFC remedial changes in a Tax Information Bulletin.
Comment
Officials agree that the remedial changes are complex and that further guidance material, including examples, will be provided in a Tax Information Bulletin following enactment.
Recommendation
That the submission be accepted.
Issue: Indirect interests in FIFs
Clauses 78 and 80
Submission
(New Zealand Institute of Chartered Accountants)
The bill attempts to clarify the rules that apply to interests in FIFs that are held indirectly through another FIF or CFC.
However, as currently drafted, the proposed amendments will not entirely resolve the uncertainty and the proposed drafting needs further consideration and refinement.
In addition, if the indirect interest in a FIF is minor or immaterial it should be disregarded for the purposes of these rules.
Comment
Officials consider that the current drafting achieves the intended policy result. We will, however, discuss the specific drafting suggestions with the bill’s drafters.
With regard to the submission on disregarding indirect interests in FIFs when these are minor or immaterial, we note that this would have wider policy implications which would need to be further considered and consulted on. For these reasons it would not be appropriate to advance this suggestion in the current bill but we will consider this issue as part of our future policy work on CFCs and FIFs.
Recommendation
That the submissions be declined.
Issue: Extending the on-lending concessions and exemptions for group funding
Submission
(Matter raised by officials)
The CFC rules should be amended so that the on-lending concession and exemptions that apply to certain interest payments also apply to those dividends that are taxed like interest payments.
Comment
The CFC rules generally treat dividends from certain types of shares (deductible and fixed-rate shares) in the same way as interest on debt. This is because these shares have debt-like characteristics and are highly substitutable for debt.
Taxpayers have identified two areas where the rules for these shares are less favourable than the equivalent rules that apply to debt. This can lead to the same income being taxed twice.
Under the current CFC rules, a CFC that borrows money and then lends that money on to an associated CFC is able to claim a full deduction of any expenses incurred (the on-lending concession). There is also an exemption for interest income that a CFC receives from lending money to an associated active CFC that is located in the same country.
Officials recommend that this on-lending concession and exemption be extended so they also apply to deductible and fixed-rate shares.
Because this amendment is taxpayer-friendly and consistent with the over-arching policy treatment of the affected shares, we recommend the amendments apply retrospectively to the date these rules were first introduced.
Recommendation
That the submission be accepted.
17 http://taxpolicy.ird.govt.nz/publications/2004-or-arvcmp/overview.