Chapter 4 - Scope of deferral measure

4.1 In the May 2016 issues paper, we asked submitters for their views on which companies should be eligible to offer schemes with a deferred taxing point. For practical and administrative reasons, our proposal is to restrict the availability of the deferral regime to “start-up” companies (as defined).

Defining “start-up” companies

4.2 Some submitters suggested that in principle, the deferral option should be available to all companies without share liquidity. This could include all companies that are not quoted on the official list of a recognised stock exchange.

4.3 However, opening up the availability of deferral too widely could cause administrative difficulties for Inland Revenue, especially in the area of auditing compliance with the deferral regime, for example. Some restrictions on the availability of deferral are therefore necessary.

4.4 Further, more mature unlisted companies:

• can generally put in place mechanisms to deal with liquidity problems, because they are likely to have more cash than true start-ups;
• are more likely to have an earnings history or tangible assets which can be used to value the company.

4.5 Start-ups are especially affected by the valuation and liquidity problems because they lack the cash to pay the tax on behalf of their employees, and their shares are more difficult to value using orthodox methodologies.

4.6 There are difficulties associated with defining a “start-up company”. In Australia’s recently enacted start-up concession for ESS, a “start-up company” is, broadly speaking:[5]

• an unlisted Australian company;
• less than 10 years old; and
• with annual turnover less than A$50 million.

All three tests apply on a group basis.

4.7 One issue with this approach is that it creates a “cliff face” – once a company earns $1 more than $50 million or is 10 years and one day old, it is ineligible for the regime. This could, in theory at least, create perverse incentives at the margins – for example, a company would not want to earn more revenue because it would lose eligibility to adopt the deferral approach. For New Zealand’s purposes, we would prefer a definition which clearly excludes companies that would not have the same liquidity and valuation problems that start-ups do.

4.8 However, we consider that similar restrictions should be put in place in New Zealand so that unlisted companies that have enough cash and sophistication to overcome the valuation and liquidity problems are not included in the definition of “start-up”. The “cliff face” issue does necessitate a more careful analysis of what the parameters should be, and we welcome submissions on this point. Officials propose an annual turnover limit of $10 million per annum, reflecting the level of income at which a New Zealand company could be said to have left the start-up category.

4.9 Companies in certain industries may be able to satisfy the above criteria despite not being subject to the same valuation constraints faced by, for example, a start-up company in the technology industry which is developing some new, untested product to take to market. One option is for there to be a low value of tangible assets owned by a company in order to qualify for the deferral regime. Instead, or as well as an asset threshold, legislation could list a number of activities which would disqualify a company from the deferral regime. For example, section CW 12 sets out, for another purpose, a list of industries that may be considered for this purpose. These are land development, insurance, land ownership, mining, construction or acquisition of public infrastructure assets.[6]

4.10 In addition, officials seek comments on whether it would be appropriate to define a start-up company as one that has not paid a dividend. Payment of a dividend is an indicator of available cash (so liquidity is much less of an issue) and may also indicate that the company is easier to reliably value.

4.11 Ceasing to qualify as a start-up would have no effect on shares or share benefits already identified as subject to the deferral regime. It would simply prevent the company from issuing further shares subject to the regime.

5 Section 83A-33, Income Tax Assessment Act 1997 (Australia).

6 Section CW 12 exempts proceeds from share disposals by qualifying foreign equity investors, unless the resident company is engaged in certain activities. Australia also has rules prohibiting share trading and investment companies from accessing the deferral regime.