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Taxation Annual Rates for 201718 Employment and Investment Income and Remedial Matters Bill

Remedial amendments

EMPLOYEE MEAL ALLOWANCES AND DEFINITION OF EMPLOYER’S WORK PLACE

Clause 24

Submission

(Chartered Accountants of Australia and New Zealand, Corporate Taxpayers Group, PwC)

Submitters support the proposed amendment that clarifies the meaning of “employer’s workplace”. The definition is used in the provision that exempts certain work-related meal payments provided to employees from income tax.

Recommendation

That the submitters’ support be noted.

PIE REMEDIALS

Clause 217

Issue: Online registration process

Submission

(Matter raised by officials)

Proposed section 31B(1B) of the Tax Administration Act 1994 should not require the notice to be in the prescribed electronic form.

Comment

Section 31B(1) prescribes the electronic format for entities electing to become a portfolio investment entity (PIE). This online registration process does not cater for PIEs electing to change their calculation method. It is not cost effective to expand this process for the small number of PIEs that change their calculation method. There should not be a prescribed electronic form – Inland Revenue will accept these elections through normal correspondence channels.

Recommendation

That the submission be accepted.

Issue: Notification requirement cross-reference

Submission

(Matter raised by officials)

Sections HM 42(1), HM 43(1) and HM 44(1) should refer to section 31B of the Tax Administration Act 1994 rather than section 31C.

Comment

Sections HM 42 to HM 44 were amended by the Taxation (Annual Rates for 2015–16, Research and Development, and Remedial Matters) Act 2016 to refer to section 31C instead of 31B. Section 31B refers to notification requirements for one-off elections to become or cease being a PIE whereas section 31C refers to on-going notification requirements for a PIE to Inland Revenue or its investors. Neither section currently contains the notification requirements for a one-off calculation method election so the amendment in the Taxation (Annual Rates for 2015–16, Research and Development, and Remedial Matters) Act 2016 did not resolve the underlying issue. The calculation method election sits more appropriately in section 31B; this Bill proposes the introduction of section 31B(1B), and it is to this provision that sections HM 42(1), HM 43(1) and HM 44(1) should cross-refer.

Recommendation

That the submission be accepted.

Issue: Consistency of notification requirements

Submission

(Matter raised by officials)

The wording in sections HM 42(1), HM 43(1) and HM 44(1) should be consistent.

Comment

The final sentence of each of these provisions is intended to achieve the same purpose – to cross-reference to the notification requirements in the Tax Administration Act. However, each currently uses slightly different wording as follows (after the change to section 31B as discussed above):

  • HM 42(1) – The PIE must notify the Commissioner under section 31B of the Tax Administration Act 1994 of this election.
  • HM 43(1) – The notice requirements are set out in section 31B of the Tax Administration Act 1994.
  • HM 44(1) – Notification regarding the type of PIE and attribution period is made under section 31B of the Tax Administration Act 1994.

The current wording of section HM 42(1) is the clearest. However, a multi-rate PIE must choose an attribution period in section HM 34 and a calculation option in section HM 41 and these should both be reflected in sections HM 42(1), HM 43(1) and HM 44(1). Officials recommend that these three sections be amended using similar wording to existing section HM 42(1) but also referring to an attribution period.

Recommendation

That the submission be accepted.

CFC REMEDIALS

Issue: Insurance business CFC amendment – minor drafting issue

Clause 260

Submission

(KPMG)

The submitter suggests that drafting changes should also be made to section 91AAQ(2)(c) and section 91AAQ(3)(a) for readability.

Comment

Officials agree that minor changes should be made to sections 91AAQ(2) and (3), as these are currently drafted in the past tense due to the 30 June 2009 requirement. With the proposed removal of the 30 June 2009 ownership requirement, use of the past tense would no longer be necessary.

Recommendation

That the submission be accepted.

Issue: Insurance business CFC amendment – extension to New Zealand sourced premiums

Clause 260

Submission

(KPMG)

To qualify for an active income exemption determination under section 91AAQ of the Tax Administration Act 1994, section 91AAQ requires that all or nearly all of the income of the CFC (or group of CFCs) arises from insurance premiums covering risks in the same jurisdiction where the CFC or group is located. The submitter proposes that this requirement should be extended to premiums from insurance contracts offered or entered into in New Zealand.

The submitter considers that this extension would not circumvent the purpose of section 91AAQ or open the section to possible abuse as income derived from an insurance business carried on in New Zealand should already be subject to tax in New Zealand.

Comment

Insurance business CFCs that derive some income from New Zealand-sourced insurance premiums are not automatically precluded from meeting the requirements for a determination under section 91AAQ. This is because the current “all or nearly all” requirement is intended to approximate the active business test, which allows an active business to derive 5% of its income from passive sources before the active income exemption is denied. Therefore, an insurance business CFC that derives a relatively small portion of its income from New Zealand insurance premiums would still be able to qualify for a section 91AAQ determination.

While it is possible that an insurance business CFC may derive income from premiums from insurance contracts offered or entered into in New Zealand by virtue of the fact that it is owned by a New Zealand resident, officials consider the provision to be adequate and that allowing a CFC to satisfy the “all or nearly all” requirement with New Zealand-sourced premiums could raise integrity concerns.

New Zealand has different rules for taxing income from insurance contracts sourced in New Zealand depending on whether the insurer is a resident or non-resident. General insurers are taxed according to general income tax rules if they are New Zealand tax residents, but in the case of non-resident general insurers 10% of the gross premiums are treated as having a New Zealand source and the corporate tax rate (28%) is applied to that figure, without any deductions. This difference in treatment is due to the difficulty met in apportioning between New Zealand and foreign sources for general insurance compared with other types of businesses.

If a CFC could satisfy the requirements for an active income exemption determination under section 91AAQ by solely deriving New Zealand insurance premiums, an insurer earning large profits could restructure the business to benefit from the 10% source-deeming rule and the active income exemption to reduce its New Zealand tax liabilities, even if the CFC is 100% owned by a New Zealand insurance business. This would have the potential to undermine New Zealand’s tax rules.

Recommendation

That the submission be declined.

Issue: Insurance business CFC amendment – extension to fee income for administering and managing funds

Clause 260

Submission

(KPMG)

To qualify for an active income exemption determination under section 91AAQ of the Tax Administration Act 1994, section 91AAQ requires that all or nearly all of the income of the CFC (or group of CFCs) arises from insurance premiums covering risks in the same jurisdiction where the CFC or group is located. The submitter proposes that this requirement should be extended to include consideration for services provided to policyholders in administering and managing funds under the insurance contracts where the contracts would be saving product policies or not profit participation policies if they were subject to the life insurance rules.

Comment

As noted in the item above, Issue: Insurance business CFC amendment – extension to New Zealand sourced premiums, the “all or nearly all” requirement for the issuance of a determination under section 91AAQ is intended to approximate the active business test, which allows an active business to derive 5% of its income from passive sources before the active income exemption is denied. Therefore, an insurance business CFC that derives a relatively small portion of its income from these fees would still be able to qualify for a section 91AAQ determination.

Section 91AAQ was only intended and designed to operate in relation to insurance contracts/businesses, but not other types of financial institutions or finance activities. The determination facility was not made available for other types of financial institutions because the boundary between active and passive income is less apparent.

One concern is whether the submission could lead to financial institutions being able to access an active income exemption determination under section 91AAQ simply by pairing with an insurance business, which would not be the intended policy outcome, particularly where the income received in consideration for administering and managing funds represents a substantial part of the business. Part of the difficulty in relation to life insurance businesses in particular stems from the fact that life insurance can be used as a form of savings, so it would be difficult to establish a clear boundary between life insurance businesses and other investment providers.

While it is not certain when the work on extending the active income exemption in the CFC rules to financial institutions will be progressed, extending the determination facility to other types of income or financial institutions would be more than remedial in nature and would require substantial analysis to ensure the facility operates as intended.

Recommendation

That the submission be declined.

Issue: Non-attributing Australian CFCs – Australian unit trusts

Submission

(Corporate Taxpayers Group, PwC)

Australian unit trusts that are owned by Australian companies should qualify as non-attributing Australian CFCs. The legislation was recently amended to exclude unit trusts on the basis that Australian unit trusts are generally flow through in nature. However, Australian income tax is paid where an Australian resident company is interposed between the unit trust and the New Zealand investor, either because the unit trust forms part of an income tax consolidated group or the head company is subject to tax on the income it is presently entitled to as the unit holder. If the head company is not presently entitled to the income, the penal tax rate of 45% applies.

Comment

The rationale behind the exemption for Australian CFCs through the concept of the non-attributing Australian CFC is that any income derived in Australia would have been subject to tax in a similar manner as it would have been if that income were derived in New Zealand.

An amendment in the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014 excluded Australian unit trusts from this exemption on the basis that unit trusts are generally flow through in nature so where the unit holder is not resident in Australia, not all of the unit trust’s income would therefore be subject to tax in Australia. Under the Australian trust regime only a low rate of tax is withheld from passive income; under the New Zealand CFC or non-portfolio FIF regime that income is exempt. In addition, no Australian tax is paid on non-Australian sourced income to which a New Zealand-resident beneficiary is presently entitled.

That amendment did recognise that a unit trust itself can be subject to income tax under Australian law on its income in the same way as a company, but did not contemplate the situations outlined by the submitters.

Officials recognise that where units in a unit trust are owned by an Australian resident company, the unit trust’s income in relation to those units is subject to comprehensive taxation either at the corporate rate (if the unit trust is part of the company’s income tax consolidated group or if the company is presently entitled to the income) or at the penal rate of 45%. This is also the case where the unit trust is held by other types of Australian resident entities that are taxed as companies.

In this situation, officials consider that the unit trust should be able to qualify as a non-attributing Australian CFC in respect of the units in the unit trust held indirectly by the New Zealand resident investor through the Australian resident entity that is comprehensively taxed as a company, as the unit trust’s income is subject to comprehensive income tax in Australia which is in line with the policy intent of the exemption for certain Australian CFCs (as would be the case in the examples provided by submitters).

Recommendation

That the submissions be accepted, subject to officials’ comments.

Issue: Foreign tax credits – support for proposal

Clause 112

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, PwC)

The Group supports the policy intent behind the proposed amendment. That is, a tax credit should be available where foreign income tax is paid by the interest holder or a member of the interest holder’s group (that is, anyone who is “economically part of the same unit as the person who has the income interest in the CFC”) in relation to a CFC from which attributable income is derived. (Corporate Taxpayers Group)

PwC supports the proposals in the Bill to allow a foreign tax credit to be claimed for tax paid in relation to a CFC by members who are part of the same functional economic unit. (PwC)

Chartered Accountants Australia and New Zealand support the proposal to allow a foreign tax credit for foreign income tax paid in relation to a CFC from which attributable income is derived, when the foreign income tax has been paid by the taxpayer’s parent or a member of the taxpayer’s group. (Chartered Accountants Australia and New Zealand)

Recommendation

That the submitters’ support be noted.

Issue: Foreign tax credits – drafting

Clause 112

Submission

(Corporate Taxpayers Group, PwC)

PwC considers that there may be a drafting issue in terms of how proposed section LK 1(1B) will interact with the rest of the section. Associated sections such as section LK 2 will also be required to be amended to ensure that the foreign tax credit provided can be included in the calculation of the amount of the credit. (PwC)

Corporate Taxpayers Group considers that the preferred (and in our view much simpler) approach to be to allow the tax credit to the New Zealand interest holder with the attributable CFC income in the first place. (Corporate Taxpayers Group)

Comment

Officials agree with submitters that the drafting of proposed section LK 1(1B) should be modified to ensure it interacts correctly with the rest of the section.

In relation to PwC’s comment regarding section LK 2, officials agree with the submission and note that further changes to section LK 2 also need to be made to take account of the insertion of section LK 1(1)(d) as a rewrite issue in the Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013, because a corresponding amendment to section LK 2 was not made at the time. Officials also note that a similar adjustment may need to be made to section LK 1(4).

Recommendation

That the submissions be accepted, subject to officials’ comments.

Issue: Foreign tax credits – tax paid by other CFCs

Clause 112

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group)

The proposed mechanism will not apply in a number of common scenarios and further amendments are required to the proposed legislation to ensure it addressed common commercial transactions. For example, in the case of a New Zealand interest holder who owns a US corporation which owns a US limited liability company (LLC), the proposed amendment would not allow the US corporation to offset the credit to the New Zealand interest holder because the US corporation does not meet the requirement in section IC 7 regarding tax residence. (Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group)

While it may be possible to relax the residence requirements in section IC 7 to allow the rule to work properly in this situation, this does not address the issues arising in relation to section LK 1(1)(d) in a two tier transparent CFC situation. Corporate Taxpayers Group considers the preferred (and in our view much simpler) approach to be to allow the tax credit to the New Zealand interest holder with the attributable CFC income in the first place when tax is paid by another group company in relation to the attributable foreign income. This would only require amendments to section LK 1 as previously discussed with officials. (Corporate Taxpayers Group)

Comment

Officials agree with submitters’ concerns and in particular that the tax credit should be transferrable to the New Zealand investor with the attributable CFC income in the example with the US corporation and the US LLC, even though the US corporation does not meet the residence requirements in section IC 7.

Recommendation

That the submissions be accepted, subject to officials’ comments.

Issue: Foreign tax credits –Australian unit trust CFCs and FIFs

Clause 112

Submission

(Corporate Taxpayers Group, PwC)

The scope of the amendment should be extended to include the scenario where a CFC is interposed between the New Zealand investor and the underlying FIF interest where the chain of entities are Australian unit trusts. There is an inability to claim foreign tax credits where a CFC is interposed between the New Zealand investor and the underlying FIF interest. This is because the New Zealand investor is deemed to hold the FIF interest directly.

Comment

Issues have previously been raised in relation to indirectly-held foreign investment fund (FIF) interests – that is, where an interest in a FIF is held through a CFC.

From a policy perspective, it is generally preferable to align the treatment of indirectly-held FIFs with directly-held FIFs to ensure that tax is not a strong motivator behind the decision to hold a FIF interest indirectly. In other situations, it may also be preferable to align the treatment of FIF interests and CFC interests.

However, officials note that by their very nature, the CFC rules are more complex and detailed than the FIF rules, and this characteristic extends to the availability of foreign tax credits and how they are calculated.

In addition, for income interests in FIFs of greater than 10%, taxpayers are permitted to use the attributable FIF income method if desired. The attributable FIF income method follows the CFC rules, including the rules that relate to the availability of foreign tax credits. This means that the proposed amendment would be available for both directly and indirectly-held FIF interests where the attributable FIF income method is used, therefore alleviating the submitters’ concerns in many situations.

Recommendation

That the submissions be declined.

Issue: Use of part-year accounts for accounting standards method – support for proposal

Clauses 58(2) & (3) and 59

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group)

The submitters support the proposal to allow a person who holds an income interest in a CFC for part of an accounting period to use accounts that cover that part-period to determine whether or not the CFC passes the active business test under the accounting standards method.

Recommendation

That the submitters’ support be noted.

Issue: Use of part-year accounts for accounting standards method – extension to the default test and attribution calculations

Clauses 58(2) & (3) and 59

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group)

The proposal should be extended to allow the default test and attribution calculations to be performed based on the period of ownership where CFCs are held for part of the year.

Comment

The accounting standards test is intended to be a concessionary approach available when audited and consolidated financial statements that meet an applicable accounting standard are prepared. It allows taxpayers to utilise the financial statements that have already been prepared. The proposal in the Bill allows the interest holder to use such accounts that are only prepared for a part-period due to the fact that the CFC was only acquired part-way through the accounting period or was disposed of before the end of the accounting period. It is intended to be an extension of the concessionary approach, so from a policy perspective it is not problematic if the accounting standards test does not fully align with the default test and attribution calculation.

Changing the CFC attribution calculation as submitted would be a fundamental change to the CFC rules and should be carefully considered. It would not be a remedial change and there are many complexities that would need to be considered and such a proposal should go through the full policy process.

It would not be appropriate to change the nature of the default test without also changing the nature of the attribution calculation, as this could create integrity concerns. Note that the default test is based on the attribution calculations, but with some modifications. Using a part-period for one and not the other may give substantially different results for certain calculations (for example, foreign exchange calculations for financial arrangements).

Regarding the lack of information available to the interest holders for the part of the accounting period either before they acquire their interest or after they dispose of their interest, officials expect that the interest holder would have the necessary information for the part-period prior to their acquisition of the interest in the CFC to undertake the calculation for the default test and attribution calculations. It is possible that there may sometimes be difficulty in obtaining the required information following the disposal of an interest in a CFC, but officials consider that it would not be appropriate to create a mismatch in the default test/attribution calculation between disposal and acquisition.

Recommendation

That the submissions be declined.

Issue: Deductible foreign equity distributions and apportioned funding calculations

Submission

(Corporate Taxpayers Group, PwC)

The amount of deductible foreign equity distributions (DFED) received by a New Zealand resident investor should be fully deductible in calculating the CFC’s net attributable CFC income (or loss) to ensure there is no double taxation to the New Zealand resident investor.

Comment

The CFC rules generally treat dividends from certain types of shares (DFEDs in this case) in the same way as interest on debt. This is because these shares have debt-like characteristics and are highly substitutable for debt.

Officials acknowledge that in the example given by submitters, double taxation may arise, but consider that the issue is complicated and requires further analysis, particularly as it is not related to a proposal in the Bill. Officials need to determine whether the same problem would occur with other fact patterns and structures and if so, what the optimal solution would be.

Officials do not consider that allowing a full deduction for the DFED would be an appropriate solution, as allowing the full deduction could make deductible foreign equity more attractive than debt in cases where there is no on-lending. A more appropriate solution may be to extend the on-lending concession instead. Note that the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014 amended the on-lending concession to align the treatment of DFEDs with that of interest.

Part of submitters’ concern may also stem from the broad definition of deductible foreign equity, which looks at whether there was a deduction further up in the chain of payments, not just at the level of the distribution. However, narrowing the definition would raise integrity concerns, as a taxpayer could insert a holding company to circumvent the rule.

Officials will recommend that the Government considers the priority of this issue for inclusion in the next tax policy work programme.

Recommendation

That the submissions be declined.

GST REMEDIALS

Submission

(Matter raised by officials)

Some remedial issues with recent amendments to the GST legislation have been identified as follows:

  • The Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Act 2017 has resulted in some amendments to sections 10(13) and 54B of the Goods and Services Tax Act 1985 that have two different potential application dates.
  • A recent change ensures that the rules dealing with changes in consideration for a supply apply correctly to deductions claimed by GST-registered purchasers of secondhand goods; however, the drafting of the provision is wider than what was intended. Further, the provision incorrectly refers to a “debit note” instead of a “credit note”.
  • Section 20H(1) of the Goods and Services Tax Act 1985 contains an incorrect cross-reference to section 20(3)(hc) of the same Act.

Comment

Section 2(5) of the Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Act 2017 incorrectly provides that the application date for an amendment to section 10(14)(b) of the Goods and Services Tax Act 1985 is 1 August 2003, while section 2(18) of the same Act provides for a 1 April 2012 application date for the amendment, which is the intended application date. Officials therefore propose an amendment to repeal the unintended application date of 1 August 2003 to provide certainty for taxpayers, and replace it with a 1 April 2012 application date.

Similarly, an amendment to section 54B(1)(d) and new subsections (4), (5) and (6) potentially come into force on either 1 April 2014 or 1 October 2016. The intended application date for both amendments is 1 April 2014.

Under the GST rules for secondhand goods, GST-registered persons can claim a GST deduction for goods that were not supplied as a taxable supply. This is typically the case when the vendor is not a registered person or when the supply is exempt. Recent changes to the GST Act ensure that the rules dealing with changes in consideration for a supply apply correctly to deductions claimed in respect of secondhand goods that were not supplied as a taxable supply; however, the drafting of the provision applies to all secondhand goods (including those that were supplied as a taxable supply). New section 25AB should be amended so that it only applies to secondhand goods when a deduction was claimed by the purchaser in line with the GST rules for secondhand goods, and so that subsection (1)(d) refers to “credit note” instead of “debit note”.

Section 20H(1), which allows GST-registered businesses that principally make taxable supplies to deduct the GST on their capital raising costs, should refer to new section 20(3)(hd) instead of (hc).

Recommendation

That the submission be accepted.

TRADING GAINS OF NON-RESIDENT INVESTMENT FUNDS

Clauses 26 and 30

Issue: Support for trading gains of non-resident investment funds proposal

Submission

(Russell McVeagh)

Comment

The submitter supports the proposal to exempt from tax the trading gains of foreign PIE equivalents. In particular, the retrospectivity of the proposal is appropriate given that it corrects an inconsistency in the law.

Recommendation

That the submitter’s support be noted.

Issue: Cross-referencing amendments in relation to trading gains of non-resident investment funds proposal

Submission

(Russell McVeagh, Matter raised by officials)

Comment

The submitter is of the view that there is an incorrect cross-reference in the relevant table for this proposal. The submitter proposes that the table be corrected with application from the 2013–14 and later income years. (Russell McVeagh)

Officials have noticed that, in relation to this proposal, the Bill incorrectly refers to the table for PIE investments rather than the table for foreign investment variable-rate PIEs and notified foreign investors. Officials propose that this be corrected. (Matter raised by officials)

Recommendation

That the submissions be accepted.

NON-EXEMPT CHARITIES: TAXATION OF TAX EXEMPT ACCUMULATIONS

Clause 90

Issue: Clarify the definition of “assets”

Submission

(Deloitte)

The Bill defines “assets” as “all assets of any kind, whether in the form of real or personal property, money, shares, securities, rights, or interests”. Listing specific assets after such a broad definition might be interpreted as narrowing the scope of what is meant by “all assets of any kind”.

Comment

Officials agree with this submission. The definition is not intended to narrow the scope of what is meant by “all assets of any kind” and should be amended.

Recommendation

That the submission be accepted.

Issue: Application of section HR 12 to deregistered entities that are still exempt under section CW 42

Submission

(New Zealand Law Society, Simpson Grierson)

Under current law, an entity may be deregistered as a charity by the Department of Internal Affairs – Charities Services, but still remain exempt from income tax under section CW 42, which exempts charities’ business income and does not require registration.

The deregistration tax should not apply in this situation if the entity remains eligible for the charitable business income exemption.

Comment

Officials have concerns about the scope of the exemption for business income under section CW 42. In particular, there are potentially wider implications for the transparency of the charitable sector if this submission is accepted, as entities may choose to deregister with Department of Internal Affairs – Charities Services but continue to be exempt from income tax.

The stated policy intent of the deregistration tax is to protect the integrity of the revenue base by ensuring the tax concessions that apply to charities are well-targeted. This includes ensuring that if an entity has claimed tax exemption as a charity and has accumulated assets, these assets should always be destined for a charitable purpose. This supports the broader policy objective of maintaining trust and confidence in the charitable sector through the regulation and transparency requirements of the Charities Act.

Recommendation

That the submission be declined.

Issue: Application of new section HR 12 to entities wholly or partly tax-exempt under section CW 42

Submission

(New Zealand Law Society)

If section HR 12 were amended as proposed, this would create a disincentive for taxpaying entities to “tithe” a percentage of their profits for charitable purposes, as the value of the taxpaying entity’s net assets would be treated as income if the charity ceased to be registered.

Comment

Officials do not consider that the proposed amendment would create a disincentive for taxpayers to “tithe” a percentage of their profits for charitable purposes. Taxpayers are at liberty to tithe any percentage of their income. In order to be exempt from income tax however, the requirement under existing law is that the entity must derive business income wholly for the benefit of a tax charity – which would require all of their income to be derived for the benefit of the charity.

Officials note that tax benefits are available to taxpayers that wish to make charitable donations. Donation tax credits are provided to individuals who make charitable gifts, and companies and Māori authorities are entitled to a deduction. The proposed amendments do not disturb taxpayer entitlements.

Recommendation

That the submission be declined.

Issue: Application date of the proposed amendments – savings provision

Submission

(New Zealand Law Society, Simpson Grierson)

The new section applies retrospectively but with a savings provision which allows entities that have already filed a tax return to be able to rely on the position they have taken in that return.

Submitters are concerned with the retrospective nature of the amendment, and that the current drafting of the grandfathering provision is too narrow.

Entities that have relied on the old section HR 12 will be charities that are exempt from income tax and most likely will not have taken a tax position in a return of income.

The new section should either not apply retrospectively at all, or at least delete the requirement that an entity must have taken a tax position in a return of income that the entity has filed.

Comment

The purpose of including the savings provision was to ensure that those entities which had relied on the previous law could continue to rely on the position they had taken.

However, officials agree that deregistered charities may not be able to evidence a tax position through a return of income relying on the current law, if they have remained exempt from income tax through another provision of the Income Tax Act.

The amendments should instead apply to charities deregistered on or after 6 April 2016, being one year prior to the introduction of this Bill. This is because sections HR 12 and CV 17 include as income the net assets of a deregistered charity one year following deregistration (or after all appeals and Court proceedings have been finalised – whichever is the later date).

Deregistered charities would therefore be subject to the current law if their net assets were included as income of that entity before the introduction of this Bill. However, other charities that were deregistered on or after 6 April 2016 would have had sufficient notice of the proposed new law and should be subject to it.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Potential over-taxation of charitable assets where members of a charitable group deregister

Submission

(Deloitte)

As currently drafted, if the parent entity in a charitable group ceases registration with Charities Services then an amount of income arises in each entity that ceases being a registered charity or that is no longer entitled to claim a charitable tax exemption. This would apply to the parent entity and any entity owned by the parent (as they would each lose their charitable tax exemption).

The shares that a parent charity holds in a subsidiary will form part of the assets of the parent, while the assets of the subsidiary are also income of the subsidiary. Therefore if the deregistration tax is applied to both the parent and the subsidiaries, the value of the underlying assets could effectively be taxed more than once.

Comment

Officials agree in principle that there could be an overreach of the rules in circumstances where a parent entity is deregistered and it, as well as its subsidiaries, are subject to the deregistration tax.

Officials propose to consider the extent to which the net asset calculation should exclude the value of an investment in a subsidiary company exempt under section CW 42 if that subsidiary is deregistered (or otherwise no longer meets the requirements for exemption under section CW 42) at the same time as its parent.

However, changing the net asset calculation to exclude the value of an investment in a subsidiary company would be a significant change to the deregistration tax rules and would benefit from being subject to wider consultation in order to consider its implications. For that reason officials do not recommend the changes to be made in this Bill but agree that this issue should be considered for inclusion in the tax policy work programme.

Recommendation

That the submission be declined.

Issue: Disposal of assets by a charitable group for market value

Submission

(Deloitte, PwC)

If a parent charity acquires shares in a subsidiary, holds those shares, and subsequently sells its shares, then that subsidiary will be taxed on the value of its net assets because it has exited the charitable group, and no longer meets the requirement of section CW 42.

However, if the subsidiary is sold at arm’s length for market value, no value has left the charitable group and it is an overreach to impose the deregistration tax on the subsidiary.

Comment

Officials agree in principle that it may not be appropriate to apply the deregistration tax in the circumstances outlined by submitters. The charitable group in that situation has simply replaced a certain amount of value in shares with the same amount in cash (in the form of the proceeds of the sale of those shares).

However, an amendment to exclude investments in wholly owned subsidiaries from the scope of the deregistration tax rules would represent a significant change to the deregistration tax rules and would arguably be outside the scope of the proposals contained in this Bill.

Therefore while officials agree in principle with the broad thrust of this submission, any proposed amendments should be subject to wider consultation. Officials do not recommend that the changes be made in this current Bill but agree that this issue should be considered for inclusion in the tax policy work programme.

Recommendation

That the submission be declined.

Issue: Tax on assets held before an entity had tax exempt status

Submission

(Deloitte, PwC, New Zealand Law Society)

Where an existing non-charitable entity acquires tax exempt status and later loses that tax exemption (whether due to the sale of that entity to a third party, or otherwise), then the provision, as drafted, will include as income the value of the net assets at the date of deregistration.

Where an entity becomes a charity exempt from income tax, but had existing assets that it had acquired prior to becoming a registered charity, then section HR 12 should only seek to tax the gains made on those assets or any other income accumulated, while the entity had tax exempt status.

These assets were not funded by tax-exempt income, and including them in the “net assets” which are subject to tax would effectively tax those assets twice. Section HR 12 carves out certain assets like non-monetary gifts and assets received from a Treaty of Waitangi settlement claim, and the same treatment should be extended to “day-one capital”.

The Law Society suggests that the amount of income of “Person B” should be the lesser of: the value of the net assets at the date when it ceases to be exempt (less assets transferred within 12 months for charitable purposes), or the amount of exempt income derived by Person B under section CW 42 that has not been applied to charitable purposes within 12 months of ceasing to meet the requirements of section CW 42.

Comment

In the officials’ report to the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill in 2014 which first introduced the deregistration tax rules, officials addressed this issue. The deregistration tax has two purposes. Firstly, it is intended to ensure that charitable assets are ultimately used for charitable purposes and secondly, if charitable assets are transferred out of the charitable base, to claw-back an approximate value of the tax benefit that has been accrued on those assets and not used for charitable purposes. The latter claw-back is not intended to be a precise calculation because in most cases a precise calculation would be very difficult to calculate and verify. Rather, it is an approximation of a tax benefit claw-back and a disincentive to transfer assets out of the charitable base.

The current calculation of net assets is therefore consistent with the policy intent.

Recommendation

That the submission be declined.

CONSOLIDATED GROUPS AND LOCAL AUTHORITIES

Clauses 64 and 68(6), (7)

Submissions

(Greater Wellington Regional Council, KPMG on behalf of Christchurch City Council, PwC, PwC on behalf of the Auckland Council, Simpson Grierson on behalf of the Auckland Council)

  • The current exemption for local authorities that derive dividends from another member of the consolidated group should not only be preserved, but, in fact, be extended to all local authorities that derive dividend income from a Council Controlled Organisation (CCO). (Greater Wellington Regional Council)
  • Section CW 10(3)(a) of the Income Tax Act 2007 should be repealed. Instead dividends derived by local authorities from CCOs should be specifically exempt from tax. (Greater Wellington Regional Council)
  • The proposal to amend section FM 31 of the Income Tax Act 2007 should not proceed as the ability for a local authority to consolidate with CCOs does not in any way impact competitive neutrality – the policy rationale for taxing CCOs in the first place. (KPMG on behalf of Christchurch City Council)
  • State owned enterprises are subject to income tax for the same competitive neutrality reasons for taxing CCOs, yet dividends paid to their tax exempt shareholder are not considered to compromise neutrality. (KPMG on behalf of Christchurch City Council)
  • If the amendment proceeds, a transitional provision should be provided which grandfathers consolidations that are the subject of an existing binding ruling until at least the end of the income year in which the binding ruling ceases to apply. (KPMG on behalf of Christchurch City Council)
  • Any dividends paid to a local authority by a CCO should not be taxable and an amendment to sections CW 10 and CW 39 of the Income Tax Act 2007 should be made to ensure this is the case. (KPMG on behalf of Christchurch City Council)
  • The consolidation regime should remain an option for local authorities so that they can avail themselves of its benefits such as deferral of income tax consequences of intra-group asset transfers and simplified compliance (for example, lodgement of a single income tax return). (PwC)
  • The proposed amendment is an impediment to Auckland Council’s objective of building a better Auckland. (PwC on behalf of Auckland Council)
  • The amendment is at odds with Inland Revenue’s simplification focus. (PwC on behalf of Auckland Council)
  • The amendment represents a policy shift rather than a remedial change. (PwC on behalf of Auckland Council)
  • The proposal to exclude local authorities from the consolidated group rules should not proceed. (Simpson Grierson on behalf of the Auckland Council)
  • The proposed amendment is not remedial in nature. (Simpson Grierson on behalf of the Auckland Council)

Comment

Officials have analysed these submissions and consider that many of them comprise two consistent themes.

  • the payment of dividends by a CCO to a local authority does not impact on the competitive neutrality basis for taxing CCOs and the exemption for inter-corporate dividends paid within a wholly-owned group should be available for dividends paid by CCOs to their local authority; and
  • local authorities should continue to be eligible to be a member of a consolidated group because intra-group transactions are ignored in calculating taxable income for the group. This means that the policy objective of taxing the income of a CCO continues to be achieved under consolidation.

Other submissions focus on different points, as follows:

  • that the proposed amendment is non-remedial in nature;
  • that the exclusion for non-rates income under section CW 39(4) of the Income Tax Act 2007 should be subject to public consultation;
  • that if the amendment proceeds, a savings provision should be introduced to protect existing binding rulings relating to a consolidated group.

Officials comment on these submissions as follows.

Taxation of dividends

The current policy is that dividends derived by a local authority from a CCO are taxable and do not qualify for the wholly-owned group dividend exemption. This is consistent with the long-standing policy that all non-rates income derived by a local authority from a CCO is taxable.

As the consolidated group rules disregard intra-group dividends, allowing a local authority to be eligible to be a member of a consolidated group provides a permanent exemption from income tax for dividends derived by a local authority from a CCO.

However, officials consider the submissions raise a valid policy question about the policy for taxing dividends derived by a local authority from a CCO. This question is a substantive policy matter that should be considered for inclusion in the tax policy work programme.

Consolidated group rules and benefits for local authorities

A consistent view amongst submitters was that local authorities that have elected to join consolidated groups have benefited from reduced compliance costs and the deferral of tax on intra-group asset transfers (for example, depreciation recovery income).

The reduction in compliance costs is the key policy objective underpinning the consolidated group rules. The deferral of tax on intra-group asset transfers are intended outcomes of the consolidated group rules. The deferral crystallises when the asset is disposed of to a third party. Officials consider this is an appropriate outcome for local authorities.

Some of the submissions indicate that local authorities have made commercial decisions based on their membership of a consolidated group and have received binding rulings relating to tax positions taken or to be adopted.

Officials agree with PwC’s submission that preventing a local authority from being a member of a consolidated group could affect outcomes of past decisions and transactions, and have taken this into account in formulating the recommendations summarised below.

Consolidated group rules and non-rates income

The key policy objective for excluding local authorities from the consolidated group rules was to ensure that CCOs cannot benefit from the tax-exempt status of the local authority through intra-group deductible transactions.

With the exception of the taxation of dividends paid by CCOs to a local authority, officials agree with the submissions that the consolidated group rules do not change the next tax result of intra-group, non-rates transactions (for example, management fees paid to a local authority for management services provided to a CCO). This is because the consolidated group rules treat these non-rates transactions as non-deductible and non-assessable which results in the appropriate amount of tax being payable on such transactions.

The consolidated group rules result in dividends paid by a CCO to a local authority not being taxed. In particular, officials note that non-rates income derived from a CCO can include an untaxed capital gain included in a dividend paid to a local authority.

Not a remedial amendment

In support of this submission, both Simpson Grierson and PwC point to a submission on the Income Tax Bill that resulted in the Income Tax Act 2007 (a Bill relating to the project to rewrite income tax legislation using plain language techniques) relating to the definition of “eligible company”.

Those submissions misunderstand the mandate and policy objectives for the rewrite project. Those objectives were to reduce compliance costs by rewriting the law using plain language techniques. In this process, approved policy or remedial changes could only be made if it was necessary to clarify ambiguity or address irresolvable conflicts between rules.

None of these criteria existed in relation to the definition of “eligible company”, as it applied to local authorities. The rewrite project correctly re-enacted the law as it stood prior to the Income Tax Act 2007. Remedial amendments such as correcting the definition of “eligible company” was not a function of the rewrite project because it was never intended to be a forum for resolving policy or remedial matters.

Local authorities were originally excluded from the consolidation rules as being ineligible to be a member of a consolidated group. This was to ensure that all dividends passing from a CCO to a local authority are taxable. However, an amendment to the definition of “eligible company” in the Taxation (Savings Investment and Miscellaneous Provisions) Act 2006 inadvertently resulted in local authorities not being excluded from the consolidation rules.

The purpose of that 2006 amendment to the definition of eligible company was to permit a dual-resident company to use the consolidated group rules only if the company was able to use the general loss grouping rules. This amendment was never intended to allow local authorities to access the consolidated group rules. As set out in the Commentary on the 2006 Bill introducing this amendment):

Certain dual-resident companies will be prevented from grouping foreign losses under the rules for consolidated groups if they cannot do so under loss rules applying to non-consolidated groups.

The amendment will make the rules for consolidated groups consistent with loss rules for non-consolidated groups by preventing losses from being used in two different jurisdictions.

Exclusion from the local authority exemption for non-rates income

Officials consider this submission raises a substantive policy matter about the scope of the local authority exemption. This issue should be considered for inclusion in the tax policy work programme.

Imputation

Officials agree with submissions that identify:

  • the ability to maintain a single imputation credit account for the consolidated group reduces compliance costs; and
  • imputation credits attached to a dividend may be credited against the income tax payable on dividends derived by a local authority.

A local authority is not able to maintain an imputation credit account in its own right because of the local authority exemption from income tax. Officials have analysed the effect on total tax borne if a local authority is a member of a consolidated group. Officials conclude that inclusion of a local authority in a consolidated group will not affect the total tax borne on non-rates income derived by a local authority, provided that local authorities continue to be taxed on dividends derived from a CCO.

Savings provision

Officials agree that, if the amendment proceeds as proposed:

  • Any existing binding rulings should be protected by a savings provision, as a local authority will have made commercial decisions based on the Commissioner’s ruling. As a change in law would cause such a ruling to expire, officials consider it is important that existing binding rulings should be saved for their term.
  • Past transactions that were previously disregarded in calculating taxable income for a consolidated group (such as intra-group asset transfers) should not give rise to taxable income. This is because the consolidated group rules permit deferrals of tax consequences on certain intra-group transfers of assets until either the company owning the asset exits the group or the asset is sold to a third party. Officials consider an appropriate savings provision would address this issue if local authorities are not able to be included in a consolidated group.
Summary

In considering the submissions officials are of the view that:

  • the proposed amendment should not proceed as currently set out in the Bill; and
  • local authorities should be eligible to be a member of a consolidated group; but
  • an amendment should be made to the consolidated group rules that ensures dividends derived by a local authority from a CCO that is a member of the consolidated group must be included in the calculation of taxable income of the consolidated group, consistent with the treatment for non-consolidated groups.

Officials recommend the amendment to the consolidated group rules should apply from the beginning of the 2019–20 income year, to give local authorities sufficient time to prepare for the proposed amendments.

This approach ensures that:

  • the law works as intended, in that all income derived by a local authority from a CCO is taxable;
  • local authorities can continue to benefit from reduced compliance costs and deferral of tax (for example, depreciation recovery) on intra-group transfers of assets without impinging on the above policy objective;
  • the policy matter raised relating to the scope of the local authority tax exemption could be referred for consideration as an item to include in the tax policy work programme;
  • grouping of tax losses is not affected; and
  • current binding rulings will be protected by a savings provision until the end of the year in which the binding ruling expires (this is likely to be the 2019–20 income year).

Officials have discussed the proposed approach with local authorities that have submitted on the Bill, including permitting local authorities to continue to use the consolidated group rules subject to dividends derived by local authorities from their subsidiaries being taxed. Officials consider that the main purpose of the original exclusion from the consolidated group rules was to ensure that dividends derived by a local authority from a CCO would be taxed. Officials also consider that the recommended amendments should reflect this current policy setting.

Recommendation

That the submission be accepted, subject to officials’ comments.

RESIDENTIAL LAND WITHHOLDING TAX (RLWT) RULES – REMEDIAL AMENDMENT

Submission

(Chapman Tripp)

The submitter contends that the definition of “offshore RLWT (residential land withholding tax) person” in section YA 1 is unintentionally broad in relation to trusts that have a statutory trustee company as one of the trustees.

Because of the definition of “offshore RLWT person”, the RLWT rules will apply to a trust where (among other things) 25% or more of the trustees are offshore RLWT persons. If a trustee is a company, it will be an “offshore RLWT person” if more than 25% of its directors or ultimate shareholders are offshore RLWT persons (among other tests).

As a consequence, if a statutory trustee company is an “offshore RLWT person”, any trust with three or fewer trustees for which it acts will be an “offshore RLWT person” and the RLWT rules will apply to that trust. This is the case even where the settlors, beneficiaries, and other trustees are all New Zealand residents. This would affect all professional trustee companies, including those registered under the Trustee Companies Act 1967. This outcome does not align with the policy objectives underlying the RLWT regime, and unduly prejudices affected trustee companies compared to their competitors who are not offshore RLWT persons.

The submission proposes the definition of “offshore RLWT person” be amended so that the status of a statutory trustee company (as defined in section YA 1) will not cause a trust for which it acts as trustee to be an “offshore RLWT person” if it would not otherwise be one.

A related remedial amendment is required to the definition of “statutory trustee company” in section YA 1. That definition says that “statutory trustee company” is defined in section 2 of the Trustee Companies Act 1967. However, section 2 of the Trustee Companies Act 1967 does not define “statutory trustee company” but rather “trustee company”. It is submitted that an amendment to the definition of “statutory trustee company” in section YA 1 be made, so that it refers to the definition of “trustee company” in the Trustee Companies Act 1967. It is submitted that this amendment have retrospective application to ensure that this drafting error does not affect historical positions taken by statutory trustee companies (for example by calling into question their entitlement to RWT exemption certificates).

Comment

Officials agree that it is not consistent with the policy objectives underlying the RLWT regime for the offshore status of a statutory trustee company (which must be one of a defined list of companies in the Trustee Companies Act 1967) to make any trust with three or fewer trustees for which the trustee company acts an “offshore RLWT person” if it would not otherwise be so.

Officials also agree that the reference in the definition of “statutory trustee company” in section YA 1 to the definition of “statutory trustee company” in the Trustee Companies Act 1967 is an error and should instead be a reference to the definition of “trustee company” in that Act.

Recommendation

That the submission be accepted.

TAX RATE FOR EXTRA PAYS PAID TO NON-RESIDENT SEASONAL WORKERS AND EMPLOYEES ON NON-NOTIFIED TAX CODES

Clauses 138(1), (2) & (4), 145(1) & (4) and 181(8)

Issue: Support for the proposal

Submission

(PwC)

The submitter supports the proposal to clarify that the general rule for calculating an amount of tax to withhold from an extra pay does not apply to extra pays paid to non-resident seasonal workers or employees who have not notified their employer of their tax code. This is the treatment that many taxpayers have already been applying, and how payroll systems are set up to function. However, a reading of the current legislation leads to a different outcome.

Recommendation

That the submitter’s support be noted.

Issue: Tax rate for extra pays made to employees who have not received any PAYE income payments in the previous four weeks

Submission

(PwC)

It is noted that issues arise for many taxpayers where extra pays are made to employees on primary employment tax codes who have not received any PAYE income payments in the four weeks prior to the date of the payment of the extra pay. This can occur in respect of payments made to former employees, or employees on parental or unpaid leave, and has become apparent in respect of holiday pay remediation payments. The submitter urges consideration of a legislative change to address this issue. It can create undue employment relations issues because tax is withheld from employees at a rate much lower than their marginal or average tax rate.

Comment

Officials acknowledge that employees on primary employment tax codes who have not received any PAYE income payments in the four weeks prior to the date of the payment of an extra pay will likely have tax under-withheld if the standard tax calculation for extra pays is used. This may lead to the employee being required to file an income tax return and pay any tax owed, which could conceivably create employment relations difficulties. However, officials note that there is an existing legislative mechanism by which this outcome could be avoided. Section RD 10(2) of the Income Tax Act 2007 enables an employee to notify their employer of their election to fix their rate of tax on extra pays at their expected marginal income tax rate.

Inland Revenue recently updated its guidance for individuals, to explain the implications for tax and for Inland Revenue-administered social assistance of receiving a lump sum payment (including of back-paid holiday pay).[15]

Inland Revenue also recently issued guidance for employers on how back-dated remedial payments of holiday pay should be treated for the purposes of PAYE and other deductions, such as student loan repayments and KiwiSaver contributions.[16]

The guidance for both individuals and employers specifically refers to an individual’s ability to request that their employer withhold tax from a lump sum payment at a higher rate, which they may wish to do to avoid a potential end of year tax debt.

Officials consider that providing guidance on the existing legislative mechanism is the best solution to the issue raised by the submitter. If a legislative amendment was made to require employers to withhold tax from extra pays made to employees on primary employment tax codes who have not received any PAYE income payments in the four weeks prior to the date of the payment at a specific tax rate, that rate would inevitably be either too high, or too low, for many of the recipients.

Recommendation

That the submission be declined.

RESIDENT WITHHOLDING TAX AND NON-CASH DIVIDENDS

Clauses 6, 106, 159 and 160

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY, FNZ)

Chartered Accountants Australia and New Zealand support the proposed amendment to clarify that a dividend includes any tax paid or withheld. (Chartered Accountants Australia and New Zealand)

The Group is supportive of the clarifications to the rules regarding RWT on non-cash dividends. The Group considers these amendments are uncontroversial and do not require further comment. (Corporate Taxpayers Group)

The clarifications are not fully effective:

(i) The proposed change to section CD 15 should be clarified to ensure the increase in dividends for RWT and NRWT is not a double-up.

(ii) Proposed section RE 14B should also apply to non-cash dividends derived by trusts as trustee income.

(iii) The term “intermediary” in proposed section RE 14B(a)(iii) should be defined.

(EY)

It should be clarified whether dividends arising under a dividend reinvestment plan come within the scope of the proposed amendment.

Consideration should be given to clarifying the new definition of “dividend” in section CD 15 to ensure that for both cash and non-cash dividends, there is no double counting between the ordinary meaning of dividend and RWT/NRWT deducted from dividends. (FNZ)

Comment

The proposed amendment to section CD 15 is to clarify that the assessable dividend is the gross amount of a dividend, including taxes withheld from or paid in relation to the dividend.

Officials agree that if a dividend of $100 is paid and has $33 withheld from the cash dividend (net cash of $67 to the investor), the assessable dividend will be $100. However, if a non-cash dividend of $100 is derived, $49 of RWT must be paid in relation to that non-cash dividend. The assessable dividend will be $149 (the sum of the non-cash dividend amount and the RWT paid). The proposed amendment confirms the long-standing application of the law.

Officials agree that it would be useful to revise the drafting to ensure that the gross amount of the dividend is correctly determined.

Officials consider that the amendments in section RE 14B should not apply to dividends derived by a trustee that are retained as trustee income. The policy intent is to ensure that a company or trustee acting as an intermediary is not required to pay RWT on a non-cash dividend derived from a foreign company provided that the dividend passes through to the investor in the same income year. In the absence of this amendment, the company or trustee would be required to pay RWT on the non-cash dividend derived from a foreign company.

The measure is a simplification that ensures a natural person investor is appropriately taxed on non-cash dividends derived from a foreign company, whether the dividend is derived directly or indirectly through a trust or a company. It is not consistent with the policy intent if a trustee retains the non-cash dividend as trustee income instead of passing the dividend through to the beneficiary.

Officials believe the meaning of intermediary in context is clear and do not consider it is necessary to define the term.

Officials consider the proposed amendments do not apply to dividends that arise from dividend reinvestment plans, which are taxed as bonus issues in lieu.

Recommendation

That the officials’ comments be noted. That submission (i) from EY and the submission from FNZ relating to clarifying the gross amount of the dividend be accepted.

CONSOLIDATED GROUP’S IMPUTATION CREDIT ACCOUNTS AND USE OF PRE-CONSOLIDATION IMPUTATION CREDITS

Clause 120

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, PwC)

The submitters supported the proposal.

One stated that the Commentary does not appear to correctly reflect the position under the Income Tax Act 2004 or the proposed legislative amendment. (Chartered Accountants Australia and New Zealand)

Another stated that the Commentary to the Bill misstates the operation of the rule and may cause confusion and this should be clarified in a Tax Information Bulletin following enactment of the Bill. The submitter also notes that the proposed legislation does not appear to limit the rules to the group debit balance. (Corporate Taxpayers Group)

One stated that the Commentary is incorrect as the transfer of imputation credits from a group company to the group imputation credit account (ICA) is intended to be allowed when a debit entry arises in the group ICA and there are credits older than the debit in a group company ICA. (PwC)

Comment

The proposed remedial amendment is technical in nature. It is intended to ensure the law works as intended, and correctly reflects the policy intent, which has remained unchanged since the enactment of the consolidated group rules. The proposed amendments also reflect the Commissioner’s application of the law.

The problem being addressed by the proposed amendments can be illustrated by the following example.

Company A in a consolidated group pays a dividend on 30 September 2016 with $50,000 imputation credits attached. Prior to paying the dividend, the consolidated group’s ICA credit balance was $10,000. Company B, another company in the consolidated group, has a pre-consolidation ICA credit balance of $70,000. No other transactions occur in the group ICA during the year to 31 March 2017.

Correct policy outcome

The transfer of pre-consolidation credits is limited to the amount by which the group ICA would go into debit as a result of the imputation credits being attached to the dividend on 30 September 2016.

Date Group ICA Company B ICA
1 April 2016 10,000 70,000
30 September 2016 (dividend paid by Coy A) (50,000)  
30 September 2016 (transfer from Coy B) 40,000 (40,000)
31 March 2017 (balance) 0 30,000
Submitters’ arguments

The submissions suggest that the legislation permitted the full amount of the debit entry to be matched by a transfer from the pre-consolidation credit balance of a group company. This outcome is inconsistent with the policy intention (as set out above) and with the Commissioner’s view of the law.

Date Group ICA Company B ICA
1 April 2016 10,000 70,000
30 September 2016 (dividend paid by Coy A) (50,000)  
30 September 2016 (transfer from Coy B) 50,000 (50,000)
31 March 2017 (balance) 10,000 20,000
Original policy explanation

An explanation of the policy was given in example 20 of the Tax Information Bulletin item in December 1992 (Vol. 4, No.5).

Example 20
ACo and BCo are members of ABC Group. Both companies have pre-consolidation credit balances and, in particular, credits of $100 and $200 which arose at the same time (5/7/92). On 10/10/95 a debit of $100 arises to the group ICA which is not offset by any group credit. Assume no election is made. The credits from ACo and BCo are offset proportionately, that is, one-third from ACo and two-thirds from BCo.

This example from the 1992 Tax Information Bulletin item illustrates that the transfer from an individual company’s pre-consolidation ICA balance is not determined by whether available pre-consolidation credits are older than the group credits, but solely by whether a debit arises to the group ICA to the extent that debit is not offset by a group credit. This example shows that only $100 of pre-consolidation credits may be transferred to the group ICA (that is, the debit entry that is not offset by a group credit). The example illustrates that the transfer may be made if:

  • a debit entry arises to the group ICA that is not offset by any group credit (that is, in practical terms, this means that the debit entry would result in the group ICA going into debit); and
  • a group company has a pre-consolidation credit balance.

Officials consider it is appropriate to further clarify the proposed amendment to ensure the correct policy outcome is achieved.

Recommendation

That officials’ comment on the submissions be noted.

TRUSTEE’S REQUIREMENT TO FILE INCOME TAX RETURNS

Clauses 73 and 225

Submission

(New Zealand Law Society)

The New Zealand Law Society is concerned that Inland Revenue may interpret proposed section 33(1D) of the Tax Administration Act 1994 (TAA) more widely than section 42(1)(a) of the TAA to require all trusts to file income tax returns, whether or not those trusts have derived any income or incurred any expenditure.

Further, the New Zealand Law Society is concerned that Inland Revenue may apply this interpretation with retrospective effect, to require all trusts (including those without IRD numbers) to file income tax returns from the 2008–09 income year. Such trustees could not rely on section 43B to excuse the trust from filing income tax returns as section 43B was only enacted on 16 November 2015 and does not apply retrospectively.

Comment

The purpose of the proposed amendment is to ensure that the trust rules correctly refer to a provision in the TAA that requires a trustee to file a return of income. The obligation to file a trust return can come within the general return filing requirements of section 33(1) of the TAA and a separate return filing requirement, such as proposed section 33(1D) is not necessary.

Therefore, officials consider the proposed amendment should be simplified to be a cross-reference from the trust rules to section 33(1). Officials agree with the submitter that there is no need for retrospectivity for this proposed provision.

On the second point raised, it should be noted that while non-active trusts will continue to be excused from filing returns under section 43B of the TAA, the declaration of non-active status requires the trust to have a tax file number.

It is important for wider tax and social policy purposes that all trusts have an Inland Revenue number.

Recommendation

That the submission be accepted, subject to officials’ comments.

SMALL AMOUNTS OF PENALTIES AND INTEREST NOT CHARGED

Submission

(Matter raised by officials)

In general, penalties and interest are not charged on small balances of $100 or less of tax. In 2009, an unintended legislative change in section 183F of the Tax Administration Act 1994 has meant that some tax types were inadvertently removed from this concessionary rule.

Comment

Because this change was inadvertent, Inland Revenue has continued to apply the historical position notwithstanding this change. Officials submit that the tax types that were inadvertently removed from this concessionary rule should be reinstated so that small amounts of penalties and interest are not charged to taxpayers consistently across tax types.

Officials propose this change apply retrospectively back to the date that the inadvertent change was made.

Recommendation

That the submission be accepted.

CLARIFY THE DEFINITION OF “PROVISIONAL TAX ASSOCIATE”

Submission

(Matter raised by officials)

A number of external parties have raised some uncertainty with respect to the definition of “provisional tax associate” that was inserted into the Tax Administration Act 1994 in section 120KBB by the Taxation (Business Tax, Exchange of Information, and other Remedial Matters) Act 2017.

The uncertainty relates to para (c)(iii) of section 120KBB, which can be read as requiring two natural persons to use the same provisional tax method, which was not intended. It was only intended this test consider association between a person and a company.

Comment

Officials recommend the wording be clarified to ensure that the association test does not include two natural persons. The test is only in respect of the association of a person and a company.

Officials propose this change apply retrospectively back to the application date of the original change to section 120KBB.

Recommendation

That the submission be accepted.

CLARIFY THAT TAXPAYERS WHO HAVE A TRANSITIONAL YEAR CAN USE THE CONCESSIONARY PROVISIONS OF SECTION 120KBB OF THE TAX ADMINISTRATION ACT 1994

Submission

(Matter raised by officials)

Officials have received feedback that it is not clear that a provisional taxpayer who has a transitional year but otherwise meets the requirements of section 120KBB of the Tax Administration Act 1994 can use section 120KBB.

It was agreed during the select committee process for the Taxation (Business Tax, Exchange of Information, and other Remedial Matters) Act 2017 that section 120KBB should apply to those taxpayers in a transitional year. It was thought at the time that a wording change made to the Bill was sufficient to permit this. This does not appear to have been the case.

Comment

Officials recommend clarification be made to the legislation to make it clear that those taxpayers who have a transitional year but otherwise meet the requirements of section 120KBB can use those provisions.

Officials propose this change apply retrospectively back to the application date of the original change to section 120KBB.

Recommendation

That the submission be accepted.

REMOVE NEW PROVISIONAL TAXPAYERS WHO HAVE A TRANSITIONAL YEAR FROM THE ABILITY TO USE THE CONCESSIONARY PROVISIONS OF SECTION 120KBB OF THE TAX ADMINISTRATION ACT 1994

Submission

(Matter raised by officials)

New provisional taxpayers cannot use the concessionary rules in section 120KBB of the Tax Administration Act 1994.

However, for those taxpayers who have an initial provisional tax liability and also have a transitional year they are dealt with under section 120KD as that section includes those taxpayers who have an initial provisional tax liability and a transitional year.

This means that for a new provisional taxpayer who also has a transitional tax year they will be permitted to use the concessionary rules in section 120KBB although those new provisional taxpayers who do not have a transitional year cannot use those rules.

Comment

This was not intended and those new provisional taxpayers who have a transitional year should have use of money interest calculated under the current rules in section 120KD.

Officials recommend that the provisions be amended to ensure that all new provisional taxpayers are treated on the same basis whether they have a transitional year or not.

For some taxpayers in this situation the date for the first instalment of provisional tax has passed it would be unfair to now expose them to use of money interest where the taxpayer has applied the rules under section 120KBB in calculating their instalment for the current year.

Officials therefore recommend the application date for this change should be the 2018–19 and later income years.

Recommendation

That the submission be accepted.

ACCOUNTING INCOME METHOD AND STUDENT LOANS

Submission

(Matter raised by officials)

The legislation enacted in February 2017 to provide for the accounting income method (“AIM”) did not correctly provide for those taxpayers who use AIM but also make student loan payments with their provisional tax payments. Currently the legislation provides for student loan repayments to be made along with AIM payments which could be from 6 to 12 payments per year. However, these repayments are only able to be accepted by Inland Revenue systems from provisional taxpayers three times a year.

Comment

Officials recommend that the Student Loan Scheme Act 2011 be amended to provide that those taxpayers paying provisional tax using AIM make student loan repayments only three times a year rather than with each AIM payment.

Officials recommend this change apply from the 2018–19 income year. This is the same application date as the AIM provisions.

Recommendation

That the submission be accepted.

EMPLOYEE TAX CODES

Submission

(Matter raised by officials)

Due to an oversight the lower bound on the “S” tax codes has been omitted. The “S” code is described in section 24B(3)(c) as applying for secondary employment earnings for an employee whose annual income is not more than $48,000. The range should read as “is more than $14,000 but not more than $48,000”.

Recommendation

That the submission be accepted.

WITHHOLDING TAX TREATMENT OF BACK-DATED REMEDIAL PAYMENTS OF EMPLOYMENT-RELATED ENTITLEMENTS

Submission

(Matter raised by officials)

Retrospective amendments should be made to the Income Tax Act 2007 to clarify the withholding tax treatment of back-dated remedial payments of entitlements under the Holidays Act 2003 and/or an employment agreement.

Comment

As a result of apparently widespread miscalculation of entitlements under the Holidays Act 2003, numerous employers across the public and private sectors have made, or will soon be making, remedial lump sum payments to affected employees and former employees.

Inland Revenue recently considered how the law applies to such payments and concluded that the character of a back-dated payment (that is, whether it is “salary or wages” or an “extra pay” for the purposes of the PAYE rules) should follow that of the original incorrectly calculated payment. This view was inconsistent with common employer practice and the existing policy intent, and would have given rise to a number of undesirable implications, including that:

  • it would have been difficult for employers to implement;
  • it would be more likely to result in employees having tax over-withheld than if all back-dated remedial payments were treated as extra pays; and
  • it would have meant more individuals would have needed to contact Inland Revenue to obtain tax refunds.

To respond to this issue on a timely basis, the Income Tax (Employment-related Remedial Payments) Regulations 2017 were made to declare such payments to be an “extra pay” for the purposes of the PAYE rules on a prospective basis.

To address the issue with the past treatment by employers, officials recommend that retrospective amendments to the Income Tax Act 2007 are added to the Bill. Officials recommend an amendment to categorise past remedial payments made to a person in respect of their entitlements under the Holidays Act 2003 and/or an employment agreement as an “extra pay” (consistent with how employers likely treated them).

Officials also recommend an amendment to protect the position of employers who may have applied the withholding tax treatment that was correct according to Inland Revenue’s legal view prior to the Income Tax (Employment-related Remedial Payments) Regulations 2017 coming into force. Officials recommend that these amendments apply from 1 April 2008, the date the Income Tax Act 2007 came into force.

As the proposed retrospective amendments to the Income Tax Act 2007 will also apply prospectively, there will no longer be a need for the regulations. Accordingly, officials also recommend that the Bill revoke the Income Tax (Employment-related Remedial Payments) Regulations 2017 on the date the Bill receives Royal assent.

Recommendation

That the submission be accepted.

TRANSFERRING PAYE CREDITS TO SHAREHOLDER-EMPLOYEES

Submission

(Matter raised by officials)

As part of the recently enacted labour hire rules, labour hire firms are required to withhold tax from payments that are made to a company established by the contractor (the shareholder-employee) performing the relevant services. In this situation, it is common for the company to pay out all of its income to the shareholder-employee through shareholder salaries or attribute the income through the personal services attribution rule.

The issue is that there is currently no mechanism to transfer the PAYE credits arising from withholding tax withheld from the company to the shareholder-employee in the correct income year.

Comment

From a policy perspective, tax credits should be able to be transferred from the company to the shareholder-employee, since the tax credits arise from withholding tax deducted on income earned through labour services provided by the shareholder-employee of the company. If the tax credits cannot be transferred, there is a risk of the shareholder-employee being subject to use-of-money-interest (“UOMI”) on income that has actually been taxed.

Accordingly, a rule should be introduced to allow taxpayers to elect to transfer the PAYE credits from the company to the shareholder-employee for the income year in which the income is derived.

The issue is not confined to labour-hire contractors. Officials therefore consider the rule should apply broadly where withholding tax is deducted from schedular payments made to a company, rather than being limited to withholding tax deducted by labour-hire firms.

The application date should be 1 April 2017, to align with the application date for the labour hire rules.

Recommendation

That the submission be accepted.

CLOSELY-HELD COMPANIES REMEDIAL AMENDMENTS

Submission

(Matter raised by officials)

Officials recommend remedial amendments to correct provisions in the recent Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Act 2017 to:

  • ensure that the qualifying company continuity provisions are included in the list of continuity provisions (treating all trustees as a single notional person and to maintain continuity in the event of death);
  • correct an error in the “entry tax” formula for look-through companies (LTCs). This error results in a company effectively not getting the benefit of an imputation credit for income tax payable for an earlier income year, but not due to be paid after the date of entry into the LTC regime;
  • ensure the self-remission provisions work as intended when a LTC converts to an ordinary company by ensuring there is an effective base price adjustment at the time of conversion for the owner in their various capacities;
  • simplify the rules that enable variable employment income to be subject to PAYE, provisional tax, or a combination of both by removing the shareholder-salary “anti flip-flop” rule. The rule is considered unnecessary as the recently enacted provisional tax interest avoidance arrangement rule can be relied on instead;
  • ensure the transitional rule for companies affected by the changes to the LTC eligibility criteria only applies to LTCs that lose their LTC status in the income year the new eligibility rules commenced;
  • clarify the drafting of section RD 36, which currently provides the option for a company to not withhold RWT on fully imputed dividends; and
  • minor drafting clarifications in relation to the definitions of “grandparented charity” and “look-through company”.

An amendment is also proposed to correct an unintentional narrowing of the provisions for PAYE and shareholder salaries that arose out of the rewrite of the Income Tax Act.

Recommendation

That the submission be accepted.

AIRCRAFT OVERHAUL EXPENSES

Submission

(Matter raised by officials)

A cross-reference error in new sections EZ 23BA(4) and EE 60(2)(e) results in aircraft having an incorrect opening tax value of zero tax at the start of the 2017–18 income year.

Comment

The Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Act 2017 contained amendments to the timing of tax deductions for aircraft overhaul expenses.

One of the amendments related to a transitional deduction which allowed a faster deduction for an aircraft engine overhaul component. As a result of the transitional deduction, the historic cost and accumulated depreciation of the aircraft needed to be adjusted.

Officials recommend that the following cross-references giving effect to these adjustments be corrected to ensure that the legislation cannot be interpreted to mean that an aircraft would have a zero tax depreciated value at the start of the 2017–18 income year:

  • Section EZ 23BA(4) should apply for the purpose of section EE 60, not section EE 56 as currently stated.
  • Within section EZ 23BA(4), the adjustment should be clarified to equal the difference between the two amounts referred to in section EZ 23BA(2) and (3).
  • Section EE 60(2)(e) should refer to section EZ 23BA(4) and not section EZ 23BA(3).

Recommendation

That the submission be accepted.

ALLOCATION OF RESIDENT WITHHOLDING TAX CREDITS BY A TRUSTEE

Submission

(Matter raised by officials)

That the RWT substitution payment rules be clarified to ensure that they achieve their intended outcome.

That the proposed amendments:

  • are retrospective to the beginning of the 2008–09 income year, consistent with the commencement of the RWT substitution payment rules; and
  • include a savings provision applying to tax positions taken on the basis of the current law as it was prior to enactment of the Bill.

Comment

A recent review of an Inland Revenue publication relating to trusts revealed that the RWT substitution rules enacted in 2011 (but applying from the beginning of the 2008–09 income year) do not achieve their policy intent.

The RWT substitution payment rules are intended to allow the trustee to more efficiently manage the trustee’s obligation to pay income tax on beneficiary income, so that the total tax paid by the trustee takes into account each beneficiary’s marginal rate of tax.

The rules were intended to permit a trustee to either:

  • retain the benefit of refundable RWT credits for use in satisfying the trustee’s income tax obligation on trustee income; or
  • re-allocate refundable RWT credits attached to resident passive income (interest and dividends) between beneficiaries, for use by the trustee in satisfying the trustee’s obligation to pay income tax on beneficiary income; or
  • a combination (at the discretion of the trustee) of both of the options set out in the two bullet points above.

This was expected to have the same effect as the trustee requesting the Commissioner to transfer a refund of RWT to another beneficiary or to the trustee, and so would result in a compliance saving for a trustee. However, the current law does not allow the trustee to re-allocate that credit as intended.

The proposed amendments to the RWT rules are to ensure that a trustee may retain the benefit of or re-allocate RWT credits between beneficiaries, as was originally intended. The retrospective application is intended to ensure that past tax positions taken on the basis of policy intent are validated, and also to ensure that a trustee cannot seek an amended assessment to re-allocate RWT credits retrospectively.

Under the RWT substitution payment rules, a trustee may detach a RWT credit from resident passive income paid to one beneficiary and obtain the benefit of that credit in calculating the trustee’s income tax liability on trustee income. No change is proposed to the law in this respect.

Chartered Accountants Australia and New Zealand, the New Zealand Law Society, the Trustees Association of New Zealand and other stakeholders have been consulted on the framework for these remedial amendments. Two responses were received which supported the framework for the proposed amendments.

Recommendation

That the submissions be accepted.

AVAILABLE CAPITAL DISTRIBUTION AMOUNT AND DEPRECIABLE ASSETS

Submission

(Matter raised by officials)

That an error in section 23(2) of the Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Act 2017 be corrected.

Comment

Section 23 of the Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Act 2017 amended the calculation of the available capital distribution amount that is not taxed on distribution from a company. The available capital distribution amount is the net difference between total capital gains and total capital losses of a company over its life.

That amendment works correctly for depreciable assets that do not give rise to a depreciation loss on disposal (for example, a building) but does not work correctly for other depreciable assets.

This error could result in the available capital distribution amount taking into account depreciation losses arising on disposal of a depreciable asset, and would result in unintended double taxation.

Officials recommend this issue be corrected to ensure the legislation works as intended.

Recommendation

That the submission be accepted.

AVAILABLE CAPITAL DISTRIBUTION AMOUNT AND DISREGARDED FIF INCOME

Clauses 27 and 61

Submission

(Matter raised by officials)

That section CD 44 of the Income Tax Act 2007 (ITA 2007) should be amended to clarify how it applies to amounts that are disregarded in calculating a New Zealand resident’s income from an interest in a foreign investment fund (for example, shareholdings in non-resident companies).

That the proposed amendments to sections CX 57B and EX 59 section be clarified.

Comment

Section CD 44 of the ITA 2007 sets out how much of a distribution from a company is treated as a capital gain amount and not taxed on distribution. Under this rule, a gain on disposal of an asset can only be distributed tax free if the asset is capital property.

Proposed amendments in clauses 27 and 61 clarify that disregarded FIF income amounts are excluded income and so not counted in determining taxable income for a tax year. These disregarded amounts comprise dividends and gains on disposal derived by a New Zealand investor that are not separately taxed on derivation, if the investor calculates their FIF income (which is taxed) using either:

  • the fair dividend rate method (FDR);
  • the comparative value method (CV method);
  • the deemed rate of return method (DRR method); or
  • the cost method.

An intended effect of the proposed amendments is to also clarify that, if the FIF investment is held through a New Zealand company, distribution of the disregarded amounts will not be a capital gain (and tax free on distribution) if the FIF interest is revenue account property.

The ability to distribute such disregarded amounts tax-free from a company is intended to be restricted to FIF interests for which income is calculated using either the CV or DRR methods. However, technical arguments have been raised that all such FIF interests are revenue account property and therefore all distributions of disregarded amounts are taxable. This is not the intended outcome if a company calculates FIF income using either the FDR or cost methods.

At present, the rule in section CD 44 is unclear how it applies to FIF interests for which the FIF income is calculated using the FDR or cost methods. Officials recommend that this provision be amended to clarify how it applies to distributions of disregarded amounts from FIF interests held by a company.

In addition, officials consider the drafting in clauses 27 and 61 should be improved to address an ambiguity.

Recommendation

That the submissions be accepted.

DONATION TAX CREDITS FOR DONATIONS TO COMMUNITY HOUSING ENTITIES

Clause 109

Submission

(Matter raised by officials)

The proposed amendment to section LD 3(2)(ac) should be refined by substituting the current drafting with the words “entity, if the gift is made at a time the entity is eligible to derive exempt income”.

Comment

The amendment to section LD 3(2)(ac) is intended to ensure that donation tax credits for donations made to community housing entities can be claimed only for the period the entity qualifies for the income tax exemption in section CW 42B of the Income Tax Act 2007. The proposed refined drafting better achieves this intent.

Recommendation

That the submission be accepted.

MULTIPLE STATEMENTS AND CO-EXISTENCE WITHIN START

Submission

(Matter raised by officials)

There are current rules within the Tax Administration Act around issuing multiple statements of account and cancellation of use of money interest (UOMI) when a taxpayer pays the entire amount of tax, penalties and UOMI within 30 days of the issue of the statement.

A rule was added to the provision by the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Act 2017 which introduced a transitional solution for goods and services tax (GST) statements when GST was migrated to the new START computer platform.

The amended rules were designed specifically for GST when it migrated to the new START system, now with the continuation of the business transformation programme, it is necessary to modify the cancellation of interest rules for those taxes which will be migrating to START from April 2018.

A clarification is also required to the rules to reflect a modification made to the system which reduces the negative application of the previous amendment. The amendment will also extend to multiple notices of assessment as well as statements of account.

The rule defines the period in which interest cancellation will run where multiple statements of account or notices of assessment are issued. The rules only apply where two statements or two notices are issued. The current rules will continue to apply where a notice and a statement are issued in respect of the same liability.

Where a statement of account has been issued (the first statement) and a second statement is issued, interest will be cancelled from the date of the first statement and ending on the date payment is received as long as that is within 30 days of the first statement being issued.

Where a notice of assessment has been issued (the first assessment) and a second assessment is issued, interest will be cancelled from the date of the second assessment and ending on the date payment is received as long as that is within 30 days of the second assessment.

This new cancellation of interest provisions will apply for notices and statements issued after 1 April 2018 for the following taxes:

  • goods and services tax;
  • approved issuer levy;
  • resident withholding tax on dividends;
  • resident withholding tax on interest;
  • non-resident withholding tax;
  • residential land withholding tax;
  • fringe benefit tax;
  • gaming machine duty; and
  • portfolio investment entities that pay tax on an exit or quarterly basis.

Recommendation

That the submission be accepted.

 

15 http://www.ird.govt.nz/yoursituation-ind/taxing-lump-sum/

16 http://www.ird.govt.nz/resources/e/a/ea3bfec0-424f-43ba-ad3f-06af818dcf1c/CS+17-02+Tax+treatment+of+backdated+remedial+payment+of+holiday+pay.pdf