Persons the rules apply to
Issue: Use of the term “acting as a group”
Clause 88
Submissions
(Ernst & Young, Deloitte, New Zealand Institute of Chartered Accountants, Staples Rodway, Corporate Taxpayers Group)
The proposed changes refer to persons “acting together as a group” in several places, such as in determining whether the rules apply to a company that is owned by a trustee and other persons acting together with the trustee.
The phrase “acting together as a group” is expressed without any limitation, context or purpose. It is not used elsewhere in the legislation. This creates undue uncertainty as to whether the thin capitalisation rules will apply. A more certain test should be provided.
The phrase “acting in concert” should be used instead of “acting as a group”. That phrase has an established meaning in both case law and other legislation. (Staples Rodway)
Comment
Officials agree that referring to persons that are “acting together as a group” is not necessary in proposed section FE 2(1)(cc). This section is intended to catch, among other things, companies that are controlled by a group comprising a trustee (or trustees) and other persons where both the trustee and the other persons are subject to the thin capitalisation rules.
In defining whether a company controlled by a group of trustees and other persons should be subject to the rules, officials consider that the same concepts employed in the definition of a non-resident owning body could be used instead. This would mean, for example, the company would be subject to the rules if the group holds debt in proportion to equity in the company.
This should provide more certainty about when the thin capitalisation rules apply when a company’s shareholders include a trust.
Proposed section FE 2(1)(d)(iii) also refers to “a group of persons who act together as a group” to settle a trust. In the case of settling a trust it is not possible to use the concepts used for a non-resident owning body. It does not make sense, for example, to refer to proportionality of settlements and debt lent to a trust as there is no link between settlements on a trust and entitlement to income from the trust.
Officials do not think it possible to provide a more certain rule for when the rules should apply to a trust settled by a group of people. During the policy development process, officials asked several submitters if they had any suggestions for a more certain rule. None were received.
Officials consider it important that the rules apply to trusts settled by a group of non-residents acting together. This will ensure a group of investors cannot easily circumvent the rules through the use of a trust.
We note the rule is unlikely to create much uncertainty in practice as trusts are not a common part of a commercial company structure. Further, greater certainty can be achieved by channelling an investment through a company.
In terms of the specific wording of when people are acting together, officials consider that “acting in concert” and “acting together as a group” have much the same meaning. Officials recommend the specific wording used be changed in section FE 2(1)(d)(iii) to “acting in concert” on the basis it is used elsewhere in New Zealand legislation.
Recommendation
That the submission in relation to the wording in proposed section FE 2(1)(cc) be accepted.
That the submission in relation to section FE 2(1)(d)(iii) be declined except in relation to the phrase “acting in concert”.
Issue: The meaning of “control by any other means” is unclear
Clause 88
Submission
(Ernst & Young)
The bill proposes that the thin capitalisation rules will apply to a company if a non-resident owning body has control of that company “by any other means”. While this phrase is used in the existing rules, its intended meaning has never been clear. Inland Revenue should provide guidance on the meaning of this phrase.
Comment
The proposed extensions of whom the thin capitulation rules apply to are designed to mirror the existing rules. This includes the paragraph that provides the rules apply where a company is controlled by “any other means”.
Officials will convey the request for more guidance on the phrase to the relevant areas of Inland Revenue for consideration alongside other priorities.
Recommendation
That the submission be noted.
Issue: Meaning of “settlements” on a trust
Clause 88
Submission
(Ernst & Young)
A trust will be subject to the thin capitalisation rules if 50 percent or more of the settlements on the trust are made by a non-resident. Whether a settlor is non-resident should be tested at the time the settlement is made. A trust should not be subject to the rules if, say, it is settled by a person who is a resident but later becomes a non-resident.
Further, the definition of “settlement” for tax purposes is very wide. It includes the provision of services for below market value, for example. There can be difficulties in determining the value of these types of settlements. For thin capitalisation purposes, a settlement should include only dispositions of property.
Comment
The definition of “settlement” for tax purposes is intentionally very wide, designed to capture all transfers of value to a trust. This is to ensure the rules operate robustly. Officials do not see a strong case for using a narrower definition of settlement only in the thin capitalisation rules.
Officials do not agree that the residence of a settlor should only be tested at the time of settlement. If a resident owner of a New Zealand company moves offshore, the thin capitalisation rules will begin applying to the company. It seems reasonable for settlors of a trust to be treated in a similar manner.
Recommendation
That the submission be declined.