Controlled foreign company and foreign investment fund rules
Issue: Attribution of income for personal services
Clauses 125 and 166
Submissions
(KPMG, PwC)
The submitters support the proposal to clarify that either the personal services attribution rules or the controlled foreign company rules can be used if personal services are provided through a foreign company.
There should be an appropriate communication strategy on the application of the CFC rules to individual taxpayers in this context and also in a wider context as the taxpayers who are likely to fall within these rules may not always have access to the same level of tax advisors that corporate taxpayers do. (PwC)
Comment
Officials welcome support for the proposal. The proposal clarifies that a taxpayer who derives income from providing personal services through an associated foreign company, and who attributes that income under the CFC rules, is exempt from attributing that income under the separate attribution rule for income from personal services (under section GB 29).
For example, Dr Paul could provide medical services to his patients, but incorporate a company to be the contractual provider of those services. The company would then employ Dr Paul, who would see the patients and carry out the services. Dr Paul may be required to attribute income derived by the company in relation to his services under the attribution rule in section GB 29. If the company were a CFC and the services were performed in New Zealand, the CFC rules would also attribute the services back to Dr Paul. Under the proposed amendment, Dr Paul would be able to make a one-off election to determine whether he attributes the income earned by the company for his services under the CFC rules or the rule in section GB 29. If Dr Paul would like to attribute under the rule in section GB 29, his one-off election would be in the form of filing an income tax return that includes the amount attributed to him under the rule in section GB 29 after the date of Royal asset of the Taxation (Annual Rates for 2015–16, Research and Development, and Remedial Matters) Act 2015.
The practical effect of the proposal is that a taxpayer who derives only personal services income through an associated foreign company can attribute this income either under section GB 29 or under the CFC rules. The rules are duplicated and have the same tax effect for a taxpayer who derives only personal services income from the foreign company, but the CFC rules are generally more complex to apply, as they require attribution of personal services income and other forms of passive income.
Officials will work to ensure that the communication strategy is appropriate to inform taxpayers who derive personal services income through a foreign company of their obligations.
Recommendation
That the submissions be noted.
Issue: Support for prepaid expenditure proposal
Clause 126
Submission
(Corporate Taxpayers Group)
The submitter supports the proposal to apply the prepaid expenditure rules to CFCs, so that deductions for prepaid expenditure would need to be spread over a number of periods.
Comment
Officials welcome the submitter’s support for the proposal.
Recommendation
That the submission be noted.
Issue: Prepaid expenditure – correctness vs compliance
Clause 126
Submission
(KPMG)
It should be considered whether the proposed rule, which increases the “correctness” of the amount attributed, is necessary when compared with the costs of complying.
Comment
Under New Zealand’s domestic tax law, New Zealand taxpayers are able to claim deductions for expenses incurred in generating taxable income. If a taxpayer incurs an expense in one year for something that will last more than one year, adjustments are made so that the deduction is spread over the relevant income years (subject to certain exclusions and exemptions). These rules, known as the prepayment rules, are separate to the depreciation rules, but have a similar function.
Officials consider that the application of the prepayment rules to CFCs is necessary to protect the integrity of the CFC rules, and that any additional compliance costs should be relatively minor, particularly as many taxpayers should be familiar with the prepayment rules (as a long-standing part of New Zealand’s domestic tax laws).
Recommendation
That the submission be declined.
Issue: Anti-avoidance rule for the test-grouping concession
Clause 165
Submission
(Corporate Taxpayers Group)
The submitter supports the proposal to introduce an anti-avoidance rule relating to the test-grouping concession.
Comment
Officials welcome support for the proposed anti-avoidance rule to prevent taxpayers from using the test-grouping rules, which were introduced as a compliance concession, to gain an unintended tax advantage.
Recommendation
That the submission be noted.
Issue: Anti-avoidance rule for the test-grouping concession – guidance
Clause 165
Submission
(KPMG)
Guidance should be provided on the criteria that the Commissioner of Inland Revenue will apply to the application of the anti-avoidance for the test-grouping concession. The concern is that the “consistency” requirement has been drafted as an anti-avoidance rule to allow the Commissioner to reject a test-grouping election, but there may be legitimate reasons for changing test groups.
Comment
Officials understand the submitter’s desire for clarity on the operation of the proposed rule, and will provide appropriate guidance when drafting the Tax Information Bulletin item for any changes.
Recommendation
That the submission be noted.
Issue: Support for part-year exemption in Australian FIFs
Clause 134
Submission
(Corporate Taxpayers Group, KPMG)
Under current rules, a person’s income interest in certain Australian-resident foreign investment funds is exempt from the FIF rules for an income year if the income interest is 10 percent or more at all times in the year (on average). The submitters support the proposal in the bill to instead limit the 10 percent requirement for exemption to the period in the year over which the interest in the FIF is held.
Comment
Officials welcome support for the proposal.
Recommendation
That the submission be noted.
Issue: Inconsistency in the part-year exemption for Australian FIFs
Clause 134
Submission
(New Zealand Law Society)
The proposal to apply the test for exemption to the period in the year over which the Australian FIF is held gives rise to inconsistencies. The example given is that a taxpayer who holds no income interest in the FIF in the first half of the year, but a 15 percent interest in the second half of the year, would meet the test for exemption, but a taxpayer who holds a 4 percent income interest in the FIF for six months of the year, then increases their holding to 15 percent for the remainder of the year, would not – even though in the second situation, the taxpayer would hold a greater interest in the FIF over the entire period of the year. Further thought should be given to an alternative test – for example, one that focuses on whether the 10 percent threshold was met for a minimum period of time.
Comment
The current rule provides an exemption from the FIF rules for an income year when a taxpayer holds an income interest of 10 percent or more (a non-portfolio interest) in certain Australian FIFs at all times during the year. In determining whether a person’s income interest in the FIF satisfies the 10 percent threshold, the taxpayer’s interest in the FIF is averaged out across the year irrespective of whether the taxpayer had an interest in the FIF at all times in that year.
The proposed change relates to the situation when a taxpayer acquires an interest in an Australian FIF part-way through the year. Depending on the extent of the taxpayer’s income interest in the FIF, they may fail the 10 percent threshold test because they held a zero percent interest for part of the period, even if they satisfy the test in all subsequent years. The proposed change allows the taxpayer to effectively ignore the period in the year when they held no interest in the Australian FIF when undertaking the averaging-out calculation.
The averaging-out calculation means that in the example identified by the submitter, the taxpayer would not have the requisite 10 percent holding at all times of the year, as the taxpayer’s holding averages out to 9.5 percent.
The concern raised by the submitter is a common feature of threshold tests. However, officials consider that the issue is sufficiently mitigated in most cases by the use of an averaging-out calculation, which allows for fluctuations in shareholdings. Furthermore, officials note that the same averaging-out calculation is used in the CFC rules and certain other rules for non-portfolio interests in FIFs, and consider that the introduction of a minimum-holding period in the threshold test for this provision could introduce further complexity and create an inconsistency in the application of the rules.
Recommendation
That the submission be declined.
Issue: Support for indirectly held FIF proposal
Clauses 136, 140 and 213
Submission
(Corporate Taxpayers Group, KPMG, PwC)
The submitters support the proposal to align the treatment of directly held and indirectly held FIFs.
Comment
Officials welcome submitters’ support for the proposal.
Recommendation
That the submission be noted.
Issue: Definition of “indirect attributing interest”
Clauses 136, 140 and 213
Submission
(Corporate Taxpayers Group)
For the purposes of section EX 58, the proposed definition of “indirect attributing interest” does not appear to be correct. The definition is also used for the purposes of section EX 50, where it does make sense. An additional definition should be drafted for section EX 58.
Comment
Officials have reviewed the proposed definition for “indirect attributing interest” and agree that the current proposed drafting does not work as intended for the purposes of section EX 58.
Recommendation
That the submission be accepted, and the matter referred to drafters.
Issue: Disregarding the CFC
Clauses 136, 140 and 213
Submission
(Corporate Taxpayers Group)
To make the provision clearer, section EX 58 should be rewritten to essentially disregard the CFC interest and apply the FIF rules as if the person held the interest in the FIF directly. The proposed rules still apply the calculation rule “to the CFC and the CFC’s interest in the FIF” and only restrict it to the period in which the person held the indirect attributing interest. There may be situations when looking through the CFC gives rise to unintended tax consequences – for example, if an individual owns an interest in a FIF directly, they may be able to use the comparative value method, which is not available if the individual owns the FIF interest via a CFC.
Comment
Officials consider owning an interest in a FIF via an interposed CFC to be fundamentally different from owning an interest in a FIF directly. As a result, the two situations should be treated differently under the income tax rules. For example, in the case of direct ownership in a FIF, if the FIF makes a distribution to the interest holder, it is made directly to the person – they have little control over when the funds will be repatriated to them. However, where the FIF distribution is made to the CFC, the person is likely to have control over when the FIF funds will be repatriated back to them, because of the control that the person has over the CFC’s affairs.
To maintain the distinction between directly held FIF interests, and FIF interests held through CFCs, officials consider that the reference “to the CFC and CFC’s interest in the FIF” to be a necessary feature of the proposed rule.
Recommendation
That the submission be declined.
Issue: Other anomalies relating to indirectly held FIFs
No clause
Submission
(PwC)
Further work is required to identify and address other legislative anomalies that exist with respect to indirectly held FIFs. The most common example is the interaction of sections EX 58 and EX 59. The attribution of FIF income is the only taxable income applying to attributable FIF investments, and section EX 59(2) provides for this policy intent for directly held FIFs. However, section EX 59(2) does not adequately deal with indirectly held FIFs. As a result, dividends paid by the CFC in respect of underlying FIF investments will be taxed in the hands of New Zealand-resident shareholders (that are not corporate taxpayers). Corporate taxpayers are not adversely exposed to this issue due to the foreign dividend exemption they enjoy. Therefore, individual and trust taxpayers are liable to a different level of taxation due to the existence of a CFC.
The legislation should be amended to ensure that the dividend income of underlying FIFs is included within section EX 59(2). This would align the New Zealand tax treatment of dividends received by directly and indirectly held FIFs. For this to work, a tracking account may be required to record what income has already been returned for New Zealand tax purposes to ensure only the relevant dividends fall within the scope of any section EX 59(2) amendment.
Comment
While the basis of this submission is slightly different from that raised in the previous submission, officials consider the analysis to be relevant in this context.
As noted above, officials consider owning an interest in a FIF via an interposed CFC to be fundamentally different from owning an interest in a FIF directly. As a result, the two situations should be treated differently under the income tax rules. An interest holder in a CFC has more influence over that foreign company’s affairs than an interest holder in a FIF would.
This additional level of control presumably extends to decisions relating to whether dividends are paid out or not. For example, in the case of direct ownership in a FIF, if the FIF makes a distribution to the interest holder, it is made directly to the person – they have little control over when the funds will be repatriated to them. However, when the FIF distribution is made to the CFC, the person is likely to have control over when the funds will be repatriated back to them because of the control the person has over the CFC’s affairs.
As noted by the submitter, section EX 59(2) does not apply to a dividend ultimately received by the individual from a CFC.
However, officials note that double taxation is relieved in another manner. Individuals are taxed on dividends paid by CFCs, but can claim a tax credit for tax paid under the CFC rules (and the FIF rules if the person is required to return FIF income on an indirectly held FIF interest).
This is because individuals can maintain a “branch equivalent tax account” or BETA. The BETA rules provide a credit for tax paid on attributable CFC income and tax paid in relation to indirectly held FIF interests. A BETA credit for the latter is provided for in section OE 5 of the Income Tax Act 2007. Officials note that the BETA rules operate similarly to the tracking account proposed by the submitter to record what income has already been returned for New Zealand tax purposes.
Officials are satisfied that this relieves any double taxation concerns relating to the payment of dividends by CFCs when the CFC also has an interest in a FIF.
The submitter notes that individual and trust taxpayers are subject to a different level of taxation than companies are on dividends paid by a CFC in relation to underlying FIF investments. Officials note that before the introduction of the foreign dividend exemption, foreign dividends received by New Zealand-resident companies were taxable but companies, like individuals, maintained BETAs to relieve double taxation. However, the foreign dividend exemption does not extend to taxpayers other than companies. This preserves equivalent treatment between individuals who hold their foreign investments directly and those who hold their interest through a New Zealand company. The latter group will be taxable when the New Zealand company subsequently distributes its profits relating to the dividend.
In general, officials consider that while there should be some alignment between the treatment of directly held and indirectly held FIFs, this does not necessarily require identical tax treatment due to underlying differences in the level of control exercised over the investment.
Recommendation
That the submission be declined.
Issue: Foreign tax credits in relation to dividends paid by CFCs when there is an indirectly owned FIF
No clause
Submission
(Corporate Taxpayers Group)
There is an inability to claim foreign tax credits in some circumstances when a New Zealand taxpayer holds a FIF through a CFC in the same jurisdiction. For example, when a New Zealand taxpayer holds an Australian CFC that in turn holds an Australian FIF, the FIF income is directly attributed to the New Zealand taxpayer rather than to the CFC. However, the withholding tax is deducted by the CFC on repatriation (there is no withholding tax paid when the FIF distributes income to the CFC as no funds have crossed a border). The outcome is that no foreign tax credit is available in New Zealand for the amount withheld, because the underlying income has been derived from the FIF rather than the CFC. This can be contrasted with the situation when the New Zealand taxpayer holds the FIF directly and a distribution is subject to withholding tax for which a foreign tax credit is available under section LJ 2(6). Interposing a CFC should not distort the outcome in this situation.
Comment
As noted above, officials consider owning an interest in a FIF via an interposed CFC to be fundamentally different from owning an interest in a FIF directly and, as a result, the two situations should be differentiated under the income tax rules. An interest holder in a CFC has more influence over that foreign company’s affairs than an interest holder in a FIF would.
This additional level of control may extend to decisions relating to whether dividends are paid out, and when. In the case of direct ownership, if the FIF makes a distribution to the interest holder, it is made directly to the person – they have little control over when the funds will be repatriated to them.
The difference between the issue raised by this submitter and the one raised by the submitter in “Issue: Other anomalies relating to indirectly held FIFs” is that the New Zealand interest holder is likely to be a company in this case (as opposed to an individual).
New Zealand-resident individuals are subject to tax on dividends received from foreign companies, but they are able to maintain a BETA which takes into account income tax they have paid under New Zealand’s international tax rules and may be able to claim a foreign tax credit for foreign income tax paid on the foreign dividend.
Dividends received by New Zealand companies from foreign companies are generally exempt from New Zealand income tax under section CW 9. Previously, New Zealand tax was payable on such foreign dividends under the foreign dividend payment (FDP) rules. However, the FDP rules generally took account of the foreign tax paid (both withholding tax levied on the dividend and underlying company tax paid) and also provided for credits under the BETA rules. When the CFC rules were substantially reformed at the time the active income exemption was introduced, the FDP rules and the BETA rules as they applied to companies, were repealed.
This means two things for New Zealand companies receiving foreign dividends: a credit is not available for foreign income tax withheld on the dividend, but at the same time, that foreign dividend is exempt from New Zealand tax. The former is a consequence of the latter.
Officials note that a distribution made by a CFC to a New Zealand interest holder will reflect the overall income earned by the CFC, not just the income that the CFC derives from the FIF. Designing a rule that would allow a New Zealand taxpayer to provide a foreign tax credit for the part of the withholding tax levied on the CFC distribution to be credited against income tax paid in relation to the indirectly held FIF interest would be complex and could be difficult to administer. This would especially be so when there is more than one interposed CFC.
Recommendation
That the submission be declined.
Issue: Reference to section EX 21(33) in section EX 58(1)(b)
Clause 140
Submission
(EY)
An additional amendment to section EX 58(1)(b) is required to remove or modify its current reference to FIF income or loss not being taken into account in calculating the net attributable CFC income or loss of the CFC for the period, because section EX 21(33) applies.
Section EX 21 applies for several purposes, including determining whether a CFC is a non-attributing active CFC under the default test in section EX 21D, and calculating net attributable CFC income or loss under section EX 20B.
Section EX 21 does not apply in determining whether a CFC is a non-attributing active CFC under the accounting test in section EX 21E. If a CFC is a non-attributing active CFC under section EX 21E, there is no need to calculate net attributable CFC income or loss under section EX 20B. Accordingly, it is arguable that section EX 58 does not apply in such circumstances, so it would be preferable to remove any remaining possible source of confusion.
Comment
Officials note that the proposed amendment to section EX 58(6) clarifies that the provisions of section EX 58 apply regardless of whether the CFC is a non-active attributing CFC or a non-attributing Australian CFC. However, officials acknowledge that the reference to section EX 21(33) in section EX 58(1)(b) may create confusion in relation to FIF interests held by non-attributing active CFCs when their non-attributing active status is determined under section EX21E.
Officials agree that this potential confusion could be resolved by removing from section EX 58(1)(b) “because section EX 21(33) applies”, while still retaining “FIF income and FIF loss is not taken into account in calculating the net attributable CFC income or loss of the CFC for the period for the person”. However, if the Committee accepts the submission, officials will consult with drafters to ensure that the removal of the reference to section EX 21(33) in section EX 58(1)(b) would not result in any unintended changes to the section.
Recommendation
That the submission be accepted, and the matter referred to drafters.
Issue: Four-year rule for FDR annual and periodic methods
Clauses 137, 138, 139 and 213
Submission
(KPMG)
The submitter can see the rationale behind the proposed change, as taxpayers are able to undertake the calculation with the benefit of hindsight (and switch between methods to minimise income for a FIF interest under the fair dividend rate (FDR) method).
Comment
The proposal is that the choice between an annual or more frequent basis (the periodic method) for calculating FDR income for a FIF interest will be available only once every four years.
Officials acknowledge the submitter’s acceptance of the rationale for the proposed change.
Recommendation
That the submission be noted.
Issue: Opposition to four-year rule for FDR annual and periodic methods
Clauses 137, 138, 139 and 213
Submissions
(Baucher Consulting Limited, Corporate Taxpayers Group, New Zealand Law Society)
The submitters do not support the proposed amendment to limit switching between the fair dividend rate (FDR) annual method and the FDR periodic method for calculating FIF income for a FIF interest to once every four years.
Why has the practice sought to be countered only now been identified as being contrary to the original policy intention? The proposals would prevent taxpayers who are unable to use the comparative value method from being able to adjust their position in the event of a dramatic market event, like the Stock Market Crash in October 1987 or the Global Financial Crisis in 2008. (Baucher Consulting Limited)
There are a number of instances where a choice of calculation method is available for each year – for example, individual taxpayers are able to choose between the FDR method and the comparative value method. Similarly, taxpayers should be able to choose between applying the FDR annual method and FDR periodic method for each year. (Corporate Taxpayers Group)
A lock-in period of four years is likely to be regarded by taxpayers as unacceptably long, with no self-evident reason for such a lengthy restrictive period. As an alternative, a similar policy objective could be achieved by requiring a global change across the full portfolio when an election to change method is made. (New Zealand Law Society)
Comment
The FDR periodic method was originally only available for unit-valuing funds such as portfolio investment entities (PIEs), which determine the value of an investor’s units in the fund’s investments on a periodic basis. However, the Taxation (Business Matters and Remedial Amendments) Act 2007 introduced an amendment which allows any other person to choose to use the method for an attributing interest in a FIF. This amendment was effective from 1 April 2008.
The FDR periodic method is information-intensive as it requires taxpayers to calculate the market value of their interest in the FIF on a daily basis. The policy intent behind the amendment to allow certain taxpayers to choose to use this method is that taxpayers who have access to such detailed information about their investments should be able to use that information to calculate their income. However, it was not envisaged that these taxpayers would only use the information-intensive FDR periodic method for the years in which its use resulted in a lower tax liability for the year, thereby gaining a tax advantage over the FDR annual method. Additionally, unit-valuing funds are required to use the FDR periodic method and are not able to choose between the FDR annual and periodic method.
Officials note that there is a general requirement in the FIF rules that once a person uses a particular calculation method to calculate their FIF income or loss for an attributing interest in a FIF for a year, they must use the same method the following year (section EX 62). However, section EX 62 only limits taxpayers from switching between the FDR method and other methods. It does not deal with switching between methods that fall under that wider FDR method umbrella.
Officials consider the proposed four-year rule would be consistent with the general requirement in section EX 62 that limits switching between FIF calculation methods, while also providing taxpayers with some flexibility to switch between the FDR periodic and annual methods from time to time.
The New Zealand Law Society has suggested an alternative proposal – that a global change across a taxpayer’s full portfolio could be required when an election to change method is made. Along similar lines, the effect of section EX 46(8) is that a taxpayer who chooses to switch to the comparative value method to calculate FIF income for one FIF interest must not use the FDR method for their other FIF interests. Note that this is not the same as requiring a global change across the taxpayer’s portfolio.
The FIF rules do not generally require a taxpayer to use the same calculation method for all of their foreign investments. This is because the rules recognise that a taxpayer may have a varied investment portfolio with investments in a number of different types of FIFs and a particular income calculation method may not be practical or even possible for all of their investments. Officials consider that requiring a global change across the full portfolio when an election to change method is made could be complex and may be impractical in a number of situations.
Recommendation
That the submissions be declined.
Issue: Four-year rule – prospective application
Clauses 137, 138, 139 and 213
Submission
(Corporate Taxpayers Group)
The introduction of the four-year consistency requirement should be prospective, so that decisions made by taxpayers up to the introduction of the consistency requirement do not limit their ability to change methods going forward. Taxpayers should only be bound by the method decisions they make from the 2017 income year and after. This could be achieved by amending the drafting so that the period for which decisions under the FDR method are taken into account begins from the start of the 2015–16 income year.
Comment
Officials understand the submitter’s concern that the introduction of a consistency requirement should be truly prospective, otherwise taxpayers may be locked into a specific method based on decisions they made before introduction of the bill.
Officials consider that the proposed four-year rule should strike a fair balance between maintaining the integrity of the FIF rules and acknowledging the decisions that taxpayers have taken in previous income years under the current rules.
Recommendation
That the submission be accepted, and the matter referred to drafters.
Issue: Four-year rule – drafting
Submission
(Corporate Taxpayers Group)
We recommend that officials revisit the wording of the proposed new section and consider whether it can be simplified. In addition, the positioning of the proposed new section could create some confusion among taxpayers.
Comment
Officials understand the concerns raised by the submitter in relation to the drafting of new section EX 51B, with respect to the clarity of the drafting and the placement of the provision.
Section EX 62 of the Income Tax Act 2007 deals with limitations on changes of method and officials are considering whether it would be appropriate to insert the provision there instead.
Recommendation
That the submission be noted, and the matter referred to drafters.
Issue: Exclusion for certain types of passive income
No clause
Submission
(Corporate Taxpayers Group)
There are a number of same jurisdiction, non-attributing active CFC exemptions (royalties, rent, financial arrangements) that can be applied in determining “removed passive” under section EX 21E(9) and the attributable CFC amount under section EX 20B. However, an exemption is not provided for a deductible foreign equity distribution or a distribution from a fixed-rate foreign equity received from an associated non-attributing active CFC. There should be an exclusion for these types of passive income from same jurisdiction active CFCs.
Comment
Officials contacted the submitter for clarity on the submission and understand that this concern was remedied in the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014.
Recommendation
That the submission be noted.
Issue: General support
Submissions
(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY)
The submitter supports the proposals in the bill relating to CFCs and FIFs and is pleased that the remedial issues they and others have identified are being addressed. (Chartered Accountants Australia and New Zealand)
The submitter is generally supportive of the policy behind most amendments in the bill, subject to comments within the submission. (EY)
The submitter is supportive of the minor technical remedials in the bill relating to international tax. (Corporate Taxpayers Group)
Comment
Officials welcome submitters’ support.
Recommendation
That the submissions be noted.
Issue: Test grouping for part-year acquisitions and disposals
Clauses 128 and 129
Submission
(KPMG)
The submitter is supportive of the proposal to allow groups of foreign companies acquired (or disposed of) during a year to be included in CFC test groups.
Comment
Officials welcome the submitter’s support for the proposal, but note that the proposal the submitter is referring to is to allow taxpayers who acquire or dispose of a group of foreign companies at the same time to have access to the test group concession in that year for those companies.
Recommendation
That the submission be noted.
Issue: Test grouping proposal too limited
Clauses 128 and 129
Submission
(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group)
The 50 percent grouping requirement should be amended to make it clear that same-jurisdiction CFCs that are only held for part of an accounting period are able to form a test group with each other as long as the interest holder has a more than 50 percent interest in the CFCs for that part of the income year that the interest is held by the person. There is no reason why a group of target companies all acquired during the period should not be able to be grouped under the active business tests. The same argument applies to groups disposed of during the period that could otherwise have been grouped in prior years. (Chartered Accountants Australia and New Zealand)
The submitter supports the intent of the proposed amendment and the retrospective application date. However, the drafting of the amendment is too restrictive and there are a number of legitimate instances where the proposed amendment will not apply in practice. In particular, the test grouping concession should be able to be accessed where sister CFCs are acquired or disposed of during the year. The requirement that the New Zealand interest holder acquires or disposes of the relevant CFCs “at the same time” is also too restrictive as acquisition or disposal transactions can take a variety of forms in practice. This rule should also be extended to apply to income interests held by companies that are members of a wholly owned group of companies that include the interest holder (in line with section EX 21E(2)(c)(ii)) and not be restricted to CFCs held by one interest holder alone. (Corporate Taxpayers Group)
Any concerns regarding a CFC being a member of more than one test group for an accounting period (which is unlikely) could be removed by requiring the part-year test calculation option detailed below to be utilised for the purposes of the test group calculations if this part-year grouping approach is utilised. (Corporate Taxpayers Group)
Comment
The intent of the proposed amendment is to account for situations when a pre-existing structure of companies is acquired or disposed of, and to maintain the treatment that this structure of companies would otherwise be subject to.
Officials understand that acquisitions and disposals can take a variety of forms and that these transactions may not occur at the same time. While the original intent of the proposed amendment focuses on a very particular type of disposal or acquisition, officials consider that it is appropriate to extend the proposed part-year test grouping proposal to include sister companies acquired or disposed of in the same accounting period, as well as income interests acquired or disposed of by members of a wholly owned group of companies that includes the interest holder.
However, to maintain the integrity of the test-grouping rules, officials would consider it necessary to distinguish between CFCs acquired during the same accounting period and CFCs disposed of during the same accounting period.
Regarding the submission on a part-year test calculation option, please refer to “Issue: Other matters relating to part-year acquisition and disposal – calculation of ownership interest” and “Issue: Other matters relating to part-year acquisition and disposal – calculation of income” for further discussion. Officials consider that further work needs to be undertaken in relation to the part-year test calculation option proffered by the submitter to ensure that any change in this area does not create unintended consequences in the operation of New Zealand’s international tax rules.
Recommendation
That the submissions, subject to officials’ comments, be accepted.
Issue: Other matters relating to part-year acquisition and disposal – calculation of ownership interest
No clause
Submission
(Corporate Taxpayers Group)
A number of sections in the international tax rules refer to the need for a 10 percent or more income interest in the CFC/FIF for the relevant accounting period for the section to apply.
In particular, section EX 46 provides that at all times in the accounting period the person must hold an income interest of 10 percent or more in the FIF to apply the attributable FIF income method. This means that if a FIF is acquired or disposed of during the year, the taxpayer would not meet the 10 percent threshold at all times in the accounting period, and would be unable to apply the attributable FIF income method.
Sections CQ 2 and EX 14 provide that a person has an attributed CFC income or loss only if the person has an income interest in the CFC of 10 percent or more for the relevant accounting period. If a CFC is acquired or disposed of during the year, then they may not meet the requirements to attribute under the CFC rules and may be considered a FIF in the relevant period.
The issues are the same as that being addressed by the proposal concerning the part-year exemption for Australian FIFs. The rules should be amended by providing that the 10 percent or more income interest required under section EX 46 and 14, and section CQ 2 applies to the total period in the year in which the person has rights in the CFC/FIF, as proposed for section EX 35. The amendment should be retrospective back to the start of the new regime.
Comment
Officials consider that the proposed amendment to section EX 35 (the FIF exemption for Australian FIFs) is different from the issues raised by the submitter in relation to part-year acquisitions and disposals of CFCs and non-portfolio FIFs.
The issues that the submitter raises relate to rules that determine whether income should be attributed to the interest holder. This is more complex than determining whether an exemption from the FIF rules applies.
Officials note that one potential issue relating to part-year acquisitions or disposals of attributing interests in CFCs and non-portfolio FIFs is whether the interest holder has the ability to get the required information to correctly apply the attribution rules.
Officials consider that this submission should be analysed in conjunction with “Issue: Other matters relating to part-year acquisition and disposal – calculation of income” as both matters relate to the complexities of dealing with part-year acquisitions and disposals.
Further work needs to be undertaken to ensure that if any change is made to how income interests are calculated in years of acquisition or disposal, there would be no unintended consequences in the operation of New Zealand’s international tax rules.
This could raise wider policy considerations, 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 submission be noted.
Issue: Other matters relating to part-year acquisition and disposal – calculation of income
No clause
Submission
(Corporate Taxpayers Group)
The active business test is performed based on the full accounting period for CFCs (or FIFs applying the attributable FIF income method). This is the case even for CFCs/FIFs that are not held for the full accounting period (that is, they are acquired or disposed of during the year).
In order to use the accounting method active business test in section EX 21E, audited IFRS accounts (or US GAAP for FIFs under section EX 50) are required for the full accounting period. There is often a problem in the year of acquisition and disposal as the New Zealand interest holder’s IFRS accounts will only cover the period for which the CFC/FIF is held. In addition, when a CFC is sold, it is often very difficult for taxpayers to obtain financial information from the purchaser for the period in which they do not own the CFC/FIF. For commercial and accounting purposes there is no reason to have this information and therefore it is not usually able to be obtained.
This means that taxpayers are forced to use the default (tax) method which is significantly more complex and compliance-intensive, or alternatively adopt a pragmatic approach of simply applying the accounting test based on 100 percent of the IFRS results for the period for which the CFC/FIF is held.
An option should also be included for taxpayers to apply the active business test and undertake attribution calculations for the period for which the CFC/FIF is held. This will allow taxpayers to use the reduced compliance accounting test, as they will in other years when the CFC is held for the entire accounting period, as IFRS accounts for this period will be available. For calculation purposes, the income interest would be treated as 100 percent such that the calculations would reflect 100 percent of the result for the ownership period and would more accurately reflect the position of the New Zealand interest holder. The application date for this change should be retrospective back to the start of the new regime.
Comment
Officials consider that this submission should be analysed in conjunction with “Issue: Other matters relating to part-year acquisition and disposal – calculation of ownership interest”. There are complexities in undertaking the active business test calculation when a CFC is only held for part of an accounting period.
Officials consider that further work needs to be undertaken to ensure that if any change is made to how the active business test is calculated in years of acquisition or disposal, there would be no unintended consequences in the operation of New Zealand’s international tax rules.
This could raise wider policy considerations, 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 future policy work on CFCs and FIFs.
Recommendation
That the submission be noted.
Issue: Review of the FIF rules
No clause
Submission
(Baucher Consulting Limited)
There should be a full review of the FIF regime’s impact and effectiveness. As part of this review, the underlying growth assumption for some FIF calculation methods (such as the fair dividend rate and costs methods) should be revised as the current 5% rate ignores the effect of events such as the global financial crisis. A lower rate, say 3%, should apply. In addition when the FIF interest is not paying dividends, the investor should be allowed to roll up his or her FIF liability until such time as the shares are sold or a dividend is paid.
Comment
There is no full review of the FIF regime planned, and officials do not consider that a review is necessary at this time.
Officials regard the 5% annual growth rate used in some of the FIF calculation methods as an accurate representation of medium- to long-term investment growth rates. Events like the global financial crisis are temporary and the growth rates of many financial asset classes have recovered quickly.
Officials note that if the investor is an individual or a trustee of a family trust and the return is less than 5%, tax can be paid on this lower amount using the comparative value method, with no tax payable when the total return is negative. Availability of the comparative value method means that the 5% growth rate acts as an upper limit for many investors.
As noted by the submitter, the current FIF regime was introduced as part of the Taxation (Savings Investment and Miscellaneous Provisions) Act 2006. As noted in the Tax Information Bulletin item related to that legislation, the rationale for taxing offshore portfolio investments in shares on accrual is that dividend-taxation is not feasible for taxing investments in companies resident in jurisdictions whose tax systems do not encourage the payment of dividends:
“Dividend-only taxation was, in many instances, an inappropriate tax base because many foreign companies have a policy of paying low or no dividends. The investor could still, however, derive an economic gain from the investment via an increase in the share price. It was therefore quite easy to achieve a low tax or no tax result for direct portfolio investment in shares outside New Zealand. This could give higher income or more sophisticated taxpayers significant scope to minimise their tax burden by investing offshore.”[3]
Recommendation
That the submission be declined.
[3] https://www.ird.govt.nz/technical-tax/legislation/2006/2006-81/2006-81-offshore/