Hybrid and branch mismatch rules

OVERVIEW

Hybrid and branch mismatch arrangements are cross-border arrangements that exploit differences in the tax treatment of an instrument, entity or branch under the laws of two or more countries.

A hybrid or branch mismatch arrangement can result in a deduction with no corresponding taxable income inclusion or a single payment leading to a double deduction. The result of a hybrid mismatch arrangement is less aggregate tax revenue collected in the jurisdictions to which the arrangement relates.

The OECD in its BEPS Action Plan made a number of recommendations to help countries deal with hybrid and branch mismatches. This Bill includes a comprehensive adoption of the OECD recommendations with suitable modification for the New Zealand context.

Many submitters to the Bill opposed the comprehensive nature of the proposed rules, suggesting that a reduced set of measures targeting the known hybrid mismatches directly affecting New Zealand would be a better approach. Related to this is a common view that the proposed rules are highly complex, and this complexity will raise compliance costs for taxpayers in understanding and complying with the proposed new rules.

Many submitters have made valid points on technical matters or matters that will aid implementation and compliance, some of which are recommended as changes to the Bill by officials.

There are also a number of drafting submissions that have been made and which are summarised in tabulated form at the end of this section.

GENERAL ISSUES

Issue: Complexity of proposed rules and compliance costs

Submissions

(Chapman Tripp, Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY, KPMG, OliverShaw, PwC)

The proposed rules are complex. If enacted, the increased complexity of these rules will increase compliance costs for taxpayers and Inland Revenue.

The rules affect a number of different tax regimes. They also rely on an understanding of the laws of foreign jurisdictions. Proceeding with these rules will lead to a significant amount of uncertainty in practice. (Chartered Accountants Australia and New Zealand)

Taxpayers who may not have hybrid arrangements will need to confirm that the rules do not apply to them. (Corporate Taxpayers Group)

The complexity of the rules has little benefit and is likely to have unforeseen consequences. (KPMG)

The complexity results in an incoherent package of rules. (OliverShaw)

The complexity of the rules has been amplified by unsatisfactory drafting. (PwC)

Comment

While the hybrid and branch mismatch rules included in this Bill are complex, they are in line with the OECD’s recommendations and are being adopted by many countries with which New Zealand has close investment links (such as Australia and the UK). The US has also enacted some of the hybrid rules.

Officials also consider that the hybrid mismatch rules will not apply to most businesses, unless the business wants them to apply. That is, if a taxpayer replaces a hybrid arrangement with a simpler, non-hybrid arrangement they will be outside the scope of the rules and will not have to deal with the associated complexity from that point on. Taxpayers with branches are perhaps an exception to this optionality.

Finally, officials consider that the rules are unavoidably complex due to their intended application to highly complex arrangements.

Recommendation

That the submission be noted.

Issue: Breadth of proposed rules

Submissions

(Chapman Tripp, Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, EY, KPMG, OliverShaw, PwC)

New Zealand should not introduce a comprehensive set of hybrid and branch mismatch rules as this will affect more taxpayers than is needed and will increase compliance costs for those taxpayers. A targeted set of rules dealing with known hybrid arrangements affecting New Zealand would be a better approach.

The small scale of hybrid issues in New Zealand does not justify the full set of OECD recommendations as a response. Overreach will be inevitable. A targeted response would be sufficient to demonstrate that New Zealand is dealing with hybrids abuse. (Chapman Tripp)

Overreach in the rules will impact small and medium-sized enterprises. (Chartered Accountants Australia and New Zealand)

The number of taxpayers that have hybrid entities or instruments according to Inland Revenue’s International Questionnaire is small (3% of surveyed taxpayers) and compliance costs will be imposed on taxpayers without hybrid entities or instruments due to the breadth of the rules. (Corporate Taxpayers Group)

A targeted or phased approach would reduce the risk of overreach. (KPMG)

Hybrid mismatch proposals have been the subject of extensive consultation, but this has been focused on the central parts of the proposed rules. Other important parts, such as branch mismatches, imported mismatches, and changes to controlled foreign company (CFC) rules have not had the same level of attention. There is a risk New Zealand is going further than other countries in these areas and that it will affect unaware taxpayers. Only core hybrid rules relating to double deductions and deductions with no inclusion should proceed at this time. (OliverShaw)

Comment

The proposed comprehensive scope of the rules is comparable with the approach of other countries that have introduced or are introducing hybrid and branch mismatch rules.

If the proposed rules are modified by removing certain elements, this could invite undesirable tax planning in relation to those elements.

On compliance costs, initially it is true that all taxpayers will need to consider the potential impact of the rules, as they and their advisors become more familiar with them. This is the case for much new tax law. As familiarity grows, taxpayers and their advisors will become much more adept at determining quickly whether or not the hybrid and branch mismatch rules are relevant to their transactions. The vast majority of the time they will not be, and this is the intended aim of the rules. Officials consider that after the initial familiarisation period, any additional costs imposed will in most cases be negligible, and will only be significant where there is a genuine hybrids issue that needs to be addressed.

We note that the International Questionnaire which one submitter referred to is directed at inbound investment into New Zealand. Outbound investment which also produces hybrid mismatch concerns is not considered by the questionnaire, and nor are foreign-owned banks and insurers due to their particular compliance relationships with Inland Revenue. Furthermore, even if only a relatively small number of taxpayers do have arrangements currently subject to the rules, that is not a strong reason for not enacting them. Those arrangements can have large tax consequences, and the rules will also prevent the proliferation of such arrangements.

Branch mismatches were included in targeted consultation officials organised after the release of the Government discussion document Addressing Hybrid Mismatch Arrangements. Officials consider that branch mismatches will not apply as widely for New Zealand as other countries due to New Zealand’s approach to taxing the foreign branches of New Zealand companies.

Officials note that the imported mismatch rule has a deferred application date for unstructured imported mismatches, which should allow more time for taxpayers and advisors to understand the implications of what is undoubtedly a complicated rule.

Officials note that there are no CFC proposals in the Bill in relation to the hybrid and branch mismatch rules.

Recommendation

That the submission be declined.

Issue: New Zealand should not be a leader on hybrid and branch mismatch rules

Submissions

(Chapman Tripp, PwC)

New Zealand should not enact hybrid and branch mismatch rules in the form proposed at this time. This is due to the complexity of the proposals and the effect of discouraging foreign direct investment into New Zealand. (Chapman Tripp)

New Zealand should not be an early adopter of hybrid and branch mismatch rules. The UK’s rules have faced difficulties, and Australia is still in consultation on its rules. Enacting the proposed rules for the intended application date will result in complexity and uncertainty as to when the rules of other countries interact with New Zealand’s rules. US tax reform has also complicated the international tax context. (PwC)

Comment

Officials consider that the rules are being widely adopted, and by many countries with which New Zealand has close investment links. Australia, the UK and the countries making up the EU account for approximately 62% of the direct investment into New Zealand. It is expected that these countries will have hybrid and branch mismatch rules in place alongside New Zealand or will enact rules shortly after. For instance, EU countries are required to introduce rules by 1 January 2020. The US already has rules relating to double deductions, and has now added some rules relating to hybrid payments and entities, effective 1 January 2018. These rules are similar in their intent to some of the OECD hybrid recommendations.

Because Australia is committed to introducing hybrid mismatch rules, adoption of the rules will not make New Zealand a less favourable destination of investment from Australia (our largest source of direct investment), nor will it make New Zealand a less favourable investment jurisdiction than Australia.

While officials acknowledge that there may be some benefits to watching the implementation of hybrid and branch mismatch rules in other jurisdictions first, there is also a significant advantage to New Zealand being in a group of early adopters. New Zealand has the chance to have some influence in how the rules are implemented around the world, we have been able and are able to benefit from engaging with other countries who are also actively engaged in developing their rules (particularly with Australia).

Recommendation

That the submission be declined.

Issue: Purpose/targets of OECD recommendations are flawed

Submission

(Chapman Tripp)

Whether taxpayers are allowed deductions in New Zealand depends entirely on foreign tax outcomes under the proposed rules. This will often protect the tax bases of other countries, not New Zealand’s tax base. This is not appropriate given the limited uptake of these rules.

By only targeting character mismatches and not rate mismatches, the hybrid mismatch rules will be ineffective as taxpayers will use debt funding through low-tax jurisdictions instead of hybrid funding.

Comment

One of the core principles of the OECD hybrid mismatch proposals is for countries to look wider than their own tax base because it is often difficult to tell with hybrid and branch mismatch arrangements the country in which tax is being avoided. Officials consider that this approach is necessary to address the problem.

Officials acknowledge that financing New Zealand operations by debt funding through low or no tax countries is an alternative to the use of hybrid funding. The hybrid rules will not put an end to all tax planning using cross border transactions. But they make useful progress towards that objective.

Officials also note the integrity rule that was part of the revised Australian exposure draft legislation of hybrid mismatch rules. The Australian approach may be a solution to the debt funding through low or no tax jurisdictions issue that the submitter raises.

Recommendation

That the submission be declined.

Issue: Reassessment of corporate income tax rate

Submission

(Chapman Tripp)

New Zealand will need to reassess whether its corporate income tax rate is appropriate if it enacts hybrid and branch mismatch rules.

Comment

Officials consider that the corporate income tax rate issue the submitter refers to is outside the scope of the Bill.

Recommendation

That the submission be declined.

Issue: Transitional period

Submissions

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

If the application dates of hybrid and branch mismatch rules of New Zealand and another country (for instance, Australia) are misaligned, this should be ignored. (Chartered Accountants Australia and New Zealand)

A transitional period should be included in the measures in relation to other countries implementing hybrid and branch mismatch rules, particularly Australia. (Corporate Taxpayers Group)

Comment

Officials agree that a transitional period would help taxpayers comply with the defensive parts of New Zealand’s rules in situations where another country’s rules are implemented part of the way through a taxpayer’s income year. Officials consider that this is particularly relevant in the case of the entity based rules due to the possible interaction of other countries’ dual inclusion income rules and New Zealand’s surplus assessable income concept.

Accordingly, officials recommend that the defensive rules in proposed sections FH 6 and FH 9 should not apply in relation to a particular mismatch if another country’s rules are implemented and apply to that taxpayer or another taxpayer in the same control group (in respect of the same mismatch) in the same income year.

Recommendation

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

Issue: Restructuring safely

Submissions

(EY, PwC)

A specific provision is needed that ensures that a taxpayer who restructures an arrangement that would be subject to the hybrid and branch mismatch rules so that it is not subject to those rules is not subject to the general anti-avoidance rule (GAAR). Additionally, Inland Revenue should publish guidance confirming this, and which specifies acceptable alternative arrangements to those within the scope of the rules. (EY)

Taxpayers that unwind hybrid arrangements are complying with the policy intent of the rules and should not be disadvantaged for doing so. This should be acknowledged in guidance and such an action should not carry audit or tax dispute risk. (PwC)

Comment

It would not be appropriate to limit the general anti-avoidance rule in the way suggested by the submitter. However, officials agree that guidance supporting the submitter’s position on restructuring safely would help with certainty of the rules. Some specific alternative arrangements that are acceptably outside the scope of the hybrid and branch mismatch rules may be included in this guidance. For example, suppose a New Zealand resident is the borrower under a hybrid debt instrument, and will be disallowed interest deductions once the Bill takes effect. If the non-resident lender transfers the debt to another group member who treats the instrument as debt and the return as income, the New Zealand resident will be allowed a deduction. That should not mean that the transfer is a tax avoidance arrangement.

Recommendation

That the submission as to a specific rule be declined, but that the suggestion that guidance on this issue be published be accepted.

Issue: Widened corresponding hybrid mismatch legislation

Submission

(KPMG)

The concept of corresponding hybrid mismatch legislation (which has the effect of ‘switching off’ the defensive hybrid mismatch rules in the Bill) should be widened so that it includes the laws of countries that have enacted hybrid and branch mismatch rules that predate the OECD recommendations on hybrid mismatch arrangements. An example is the US dual consolidated loss rule. This rule is similar to OECD recommendation 6 primary rule. However, it was not enacted in pursuance of the OECD BEPS programme, and is not part of a suite of rules which can be said to comprehensively address hybrid mismatches.

Comment

Officials agree that the Bill’s definition of “hybrid mismatch legislation” might be read as being limited to legislation that contains an equivalent to each of sections FH 3 to FH 11. This is not intended. When another country has a rule that achieves the same outcome as a hybrid primary rule, and that rule applies to a particular mismatch, then New Zealand should not apply its secondary rule to that mismatch, whether or not the other country’s rule was enacted in response to Action 2 and whether or not the other country has a comprehensive suite of rules.

Recommendation

That the submission be accepted and an appropriate change made to the definition of hybrid mismatch legislation to clarify that comprehensive anti-hybrid rules are not required.

Issue: List of corresponding hybrid mismatch legislation

Submissions

(Corporate Taxpayers Group, Russell McVeagh)

Inland Revenue should maintain a list of countries that have corresponding hybrid mismatch legislation (in relation to the disregarded hybrid payments rule).

Comment

Officials consider that the provisions that grant primacy to the hybrid mismatch rules of other countries are clear enough such that taxpayers will be able to comfortably determine whether to apply a New Zealand defensive rule or not. Like any other provision, this is also a matter on which IRD guidance can be sought. However, if there is a sufficient benefit to be gained from maintaining and publishing a list of such countries, this will be considered.

Recommendation

That the submission be noted.

Issue: Clarity of tax regimes affected by rules

Submissions

(New Zealand Law Society)

The proposed rules override a number of existing income tax regimes and will cause unintended consequences for those regimes. There should be an explicit list of the tax regimes affected by the proposed rules.

Comment

Officials acknowledge the interaction of the proposed hybrid and branch mismatch rules and several income tax regimes which are affected. However, the tax regimes affected can be identified from the Bill and, with more specificity, from the Commentary on the Bill. Guidance will also be published by Inland Revenue that helps taxpayers to understand the implications of any new rules on existing tax regimes.

Recommendation

That the submission be declined.

Issue: Split ownership

Submission

(Russell McVeagh)

The rules as drafted seem to be generally targeted at wholly owned hybrid mismatch structures, but in practice many arrangements have split ownership and the Bill does not appropriately cater to these arrangements. In particular:

The defensive deductible hybrid payments rule (proposed section FH 9) should be amended to ensure that it does not apply if the owner who is allowed a deduction is not a controlling owner; and
The definition of surplus assessable income, and in particular the component “unrecognised amounts” should account for split ownership. For example, if a New Zealand resident hybrid is 60% owned by a foreign shareholder who treats it as fiscally transparent, section FH 9 prima facie applies to 100% of the entity’s expenditure, even though there is only a double deduction as recognized by the hybrid rules for 60% of it. Similarly, 100% of its income should prima facie be surplus assessable income, even though the controlling shareholder will not be taxed on 40% of that income.

Comment

Officials agree that some parts of the Bill do not cater to situations of split ownership.

Recommendation

That the Bill be amended so that it more effectively caters for split ownership arrangements, and that in particular both of the above situations be addressed.

Issue: Determination-making power to correct errors

Submission

(Russell McVeagh)

Issues with the Bill will inevitably arise for complicated arrangements following enactment. Instead of relying on retrospective remedial amendments to get the right policy outcome, a binding determination or regulation making power should be provided to the Commissioner of Inland Revenue or the Minister of Revenue so that issues can be addressed quickly. Taxpayers should have the option of whether or not to apply such a determination or regulation.

Comment

This submission has merit. The Government has recently consulted on allowing such a power to exist with respect to the provisions of the tax law more generally (see Chapter 6 of the Government Discussion Document Making Tax Simpler: Proposals for Modernising the Tax Administration Act. That separate consultation and decision making process, which is currently on track to produce a policy decision in the near term, is the best forum to consider this kind of issue.

Recommendation

That the submission be declined, on the basis that it is better dealt with in the context of the existing consultation process regarding extra-statutory corrections.

Issue: Application of rules to consolidated groups

Submission

(Russell McVeagh)

A provision should be included in the hybrid and branch mismatch rules clarifying that the rules can be applied to a New Zealand consolidated group as if it were a single entity.

Comment

Officials consider that the consolidation rules already produce this result in many cases. For example, under those rules, if a company is not entitled to deduct expenditure on its own account, but (broadly speaking) would be entitled to deduct it if the consolidated group members were a single company, then a deduction is allowed for that expenditure. This would seem to allow a company with expenditure denied under section FH 4 or FH 8 (for example) to deduct that expenditure if there were surplus assessable income derived by another company in the consolidated group, though there may be doubt over whether the nexus requirements in section FM 11(2) is met. There also seems to be no ability for a company with mismatch income under proposed section FH 6 to use surplus assessable income arising to another consolidated group member to justify a deduction for that mismatch amount, in the same way as the company could if it earned the surplus assessable income itself.

Recommendation

That the submission be accepted, and a change made to the consolidation provisions accordingly.

Issue: Legislative deferrals and consultation

Submission

(KPMG)

Implementation of the OECD’s hybrid recommendation 5.2 does not feature in this Bill. This legislative deferral is supported, with hope that further consultation will be undertaken by officials before the proposal is progressed.

Comment

Officials consider this submission to be outside the scope of the Bill, but note the submitter’s comments.

Recommendation

That the submission be noted.

Issue: Branch mismatch rules consultation and application

Submission

(PwC)

Branch mismatches have not had the same level of consultation as the other rules due to the fact that the final OECD report on branch mismatches was only finalised in July 2017.[5] It is submitted that the branch mismatch rules should be removed from the Bill so that further consultation can occur.

The hybrid mismatch rules should also be deferred while branch mismatch rules consultation is taking place so that taxpayers can assess their structures against both sets of rules.

Comment

Officials recognise that some parts of the OECD-recommended branch mismatches were not part of the Government discussion document Addressing Hybrid Mismatch Arrangements, released in September 2016. This is because the first public document on branch mismatches released by the OECD was the discussion draft on branch mismatch structures, which was released very shortly before the Government discussion document.[6] The branch mismatches identified by the OECD are analogous to hybrid mismatches. The only difference is that these mismatches arise because of differences in countries’ rules for taxing branch income and allowing deductions for branch expenses, rather than because of differences in how countries tax entities or instruments.

Officials undertook targeted consultation on branch mismatches in March 2017 and considered that there was value in including branch mismatch proposals in the progress of the hybrid mismatch rules project. There was no objection to the inclusion of the proposed branch rules in the project.

There is no need to defer the application of the branch mismatch rules and officials do not agree with the submission that the whole package of hybrid and branch mismatch rules should be delayed.

Recommendation

That the submission be declined.

Issue: De minimis threshold/safe harbour

Submission

(PwC)

Due to the complexity, scope, and practical difficulties of complying with the rules, a safe harbour threshold should be adopted.

Even if not applied generally, then this safe harbour threshold should be applied to the imported mismatch rule.

Comment

The OECD Final Report does not have a de minimis/safe harbour threshold, and officials are not aware that any other countries have adopted or proposed such a threshold for their hybrid mismatch rules.

For many of the rules, e.g. The disregarded hybrid payments rule and the deductible hybrid payments rule, it would be very complex to have a safe harbour threshold based on transaction size which could not also be abused. The issue of size is partly resolved by observing that the rules only apply to taxpayers entering into more complex cross border transactions, and only where those transactions are between related parties, within a control group, or structured.

Officials also consider that the nature of hybrid mismatch rules weighs against a safe harbour threshold. This is because in some cases a threshold would only transfer the obligation to apply hybrid mismatch rules from a New Zealand group member to an overseas group member who would apply hybrid mismatch rules with no such safe harbour threshold.

Officials have greater sympathy for a safe harbour threshold for the imported mismatch rule. Such a safe harbour might make the process of checking a group for an imported mismatch less difficult. However, officials believe that for the moment, it is preferable to follow the OECD consensus. In large part this is because if New Zealand were to adopt a de minimis, residents of other countries making payments to New Zealand might have to consider the possible application of the imported mismatch rule to those payments. If there is no de minimis, they will not need to do so. Officials also note the deferred application date for the unstructured part of the imported mismatch rule.

Recommendation

That the submission be declined.

Issue: Practical implications of rule with foreign country laws

Submission

(PwC)

The Bill does not adequately deal with practical matters that may arise from the interaction between the proposed rules and foreign equivalent rules. It should be redrafted with further consultation to deal with this issue.

Comment

Officials expect that practical solutions to the submitter’s concerns will be developed as Inland Revenue officials, foreign officials and taxpayers become more familiar with the proposed rules.

Recommendation

That the submission be declined.

Issue: Drafting issues

#	Section	Submitter	Submission	Recommended response
1	Various	KPMG, PwC	That character and timing mismatches are split into separate provisions or section in FH 3 and 4, and that branch mismatch rules are split from hybrid mismatch rules in other sections.	That the issue be considered at the revised track version of the Bill stage.
2	EX 46(10)(db)	PwC	The words “outside New Zealand” should be inserted after “country or territory” for clarity.	That the submission be accepted.
3	FH 1(3)	PwC	The word “mismatch” should be added before “situation”	That the submission be accepted.
4	FH 1(4)	KPMG	Paragraphs (f) and (g) should also refer to recommendation 4 of the Branch Report	That the submission be accepted.
5	FH 1(5)(b)	PwC	Since an election may only be made for certain financial arrangements, the words “an eligible” should be added before “financial arrangement”.	That the submission be accepted subject to wording.
6	FH 1(6)	PwC	Since some terms defined in section FH 15 are not the same as those used in the Final Report, the wording of this subsection should be changed to refer to equivalent terms.	That the submission be accepted.
7	FH 2(1)	PwC	Reference to “expenditure of loss” should be to “expenditure or loss”.	That the submission be accepted.
8	FH 2(2)	PwC	Reference to “mismatch amount” should be to “assessable income”.	That the submission be declined. A mismatch amount is an amount that will give rise to expenditure if offset under FH 12. Assessable income under FH 4 and FH 6 meets that test.
9	FH 3(1)	Matter raised in consultation	FH 3 needs to be clarified so it is clear that it looks at future payments as well as current ones. This could be clarified by adding the words “when made” after the word “payment” in FH 3(1)(b). It might also be useful to have a specific provision in section FH 3, such as a new subsection (10) “In this section references to a payment under a payment instrument include one or more payments which the payer has made or is required to make under the instrument.”	That the submission be accepted with exact wording to be finalised.
10	FH 3(2)(b)	CTG, Matter raised in consultation	The meaning of the phrase “if the classification of the payment or payment instrument were varied.” is not clear.	That the submission be declined.
11	FH 3(3)(c)	Matter raised in consultation	The words “including possible extensions” are too broad. It is always open to parties to agree to extend the term of an instrument.	That the submission be accepted with exact wording to be finalised.
12	FH 3(3)	Matter raised in consultation	It should be clear that a difference in the timing of recognition of FX gains and losses should not of itself attract the operation of section FH 3, even where the instrument has a term of more than 3 years.	That the submission be accepted.
13	FH 3(5)	Matter raised in consultation	The amount for which a deduction is denied should simply be the expenditure incurred in the income year in relation to the financial instrument. So “incurred amount” should simply be the amount incurred by the payer in relation to the financial instrument in the income year. No reference is required, in the disallowance subsection, to the payment. This would deal much better with FX fluctuations.	That the submission be accepted.
14	FH 3(5)(b)(i)	PwC	This amount should include any withholding tax credit, consistent with subparagraph (ii).	That the submission be declined. The amount in subsection (i) is not actual tax paid by the payee, it is income multiplied by the tax rate. Subsection (ii) does look at actual tax paid, and therefore the treatment of withholding tax credits is an issue that must be dealt with.
15	FH 3(5)(b)(ii)	PwC	The inclusion of an amount as CFC income should exclude it altogether from FH 3, rather than forming part of the calculation mechanism.	That the submission be declined. CFC taxation is treated by the OECD as requiring additional proof of payment in order to be relevant to the hybrid mismatch issue.
16	FH 3(6)(a)	PwC	The words “the amount can reasonably be treated as accruing” are too vague and should be made more specific.	That the submission be declined. It should be possible to form a judgement on whether or not an accrual method is reasonable. This sometimes needs to be done, for example, in the financial arrangement rules – see for example section EW 20(2)(c).
17	FH 3(7)	PwC	Taxpayers should have an option to take a deduction for amounts under this subsection in prior periods, when the deduction ordinarily would have been taken.	That the submission be declined. This would be complex and cause administrative difficulties out of proportion to the benefit.
18	FH 3(8)	PwC	The subsection should be redrafted as it is vague and ineffective.	That the submission be declined.
19	FH 3(8)	Matter raised by officials	The words “on payments” on line 16 of the Bill should be deleted	That the submission be accepted.
20	FH 4(1)	PwC	The subsection should apply to a person who receives or is deemed to receive the payment for New Zealand tax purposes.	That the submission be declined. This is the intended effect. The reference to “assessable income” in subsections (2) and (3) should achieve it.
21	FH 4(1)	PwC	The wording assumes the amount of the deduction equals the amount of the payment received. Partial amounts should also be included.	That the submission be declined. This is already the effect of the wording. A payment made by a single person to a number of persons at once (e.g. joint owners) can be treated as two or more) different payments.
22	FH 4	Matter raised in consultation, PwC, CTG	The opening words of section FH 4(1) do not accommodate the possibility that the payment does give rise to assessable income for the New Zealand payee but on a deferred basis. This could be accommodated by adding the words in the fourth line after section FH 6, “or would give rise to assessable income of the payee in the circumstances described in subsection (3).	That the submission be accepted.
23	FH 4(2)(b)	Matter raised in consultation, CTG	The meaning of the phrase “if the classification of the payment or payment instrument were varied.” is not clear.	That the submission be declined.
24	FH 4(3)	Matter raised in consultation, PwC	The words “including possible extensions” are too broad. It is always open to parties to agree to extend the term of an instrument.	That the submission be accepted with exact wording to be finalised.
25	FH 4(4)	PwC	Reference should be made to subsection (3).	That the submission be declined. FH 4(4) relates to (2) and (3)
26	FH 4(6)	PwC	The subsection should apply to a person who derives/receives or is deemed to derive/receive the payment under the Act.	That the submission be declined. Subsection (4) already deals with who it is that derives the income.
27	FH 4	PwC	Taxation of an amount under a CFC regime should mean this provision does not apply.	That the submission be declined. If the amount is taxed in New Zealand that will mean it does not have to be taxed under the relevant CFC regime.
28	FH 5(1)	PwC	“incurs a charge to the New Zealand branch” should be “expenditure allocated to the New Zealand branch”.	That the submission be accepted subject to exact wording.
29	FH 5(1)	Matter raised in consultation	As well as having a nonce term “branch charge” it would be helpful to have a nonce term “incurred amount”.	That the submission be accepted.
30	FH 5(1)(a)	Matter raised in consultation	The opening words should say “the incurred amount or branch charge.	That the submission be accepted.
31	FH 5(1)(b)	PwC	“tax status of the payer” is too vague.	That the submission be declined.
32	FH 5(1)(d)	PwC	“no country or territory outside NZ and the payee jurisdiction is paid tax” is unclear drafting.	That the submission be accepted.
33	FH 5(3) and (5)	KPMG	Subsection (3) should simply deny a deduction for the specified amount. The rest of the machinery in subsection (5) simply duplicates what already occurs in section FH 12. Mismatch amount should also go in the list of defined terms at the end of the section.	That the submission be accepted.
34	FH 5(3) and (4)	Matter raised in consultation	The mismatch amount should be the incurred amount or branch charge. There is no need for a reference to FX, since that is built in to the incurred amount or branch charge.	That the submission be accepted.
35	FH 5(4)(b)	PwC	References to financial instrument should be removed for foreign exchange fluctuations, and there is complex drafting in the provision – FH 5(1) inherently includes fx	That the issue be considered at the revised track version of the Bill stage.
36	FH 6(1)	PwC	The provision does not allow for partial deduction in payer jurisdiction.	That the submission be declined. Officials consider that the provision does apply to those situations.
37	FH 6(1)(a)	PwC	The provision should require that deduction is actually claimed, not that deduction can be claimed.	That the submission be declined. It is sufficient that a deduction can be claimed.
38	FH 6(1)(d)	PwC	“Tax status of the payer” terminology is too vague.	That the submission be declined. Officials disagree that the terminology is vague and consider that it reflects the policy.
39	FH 6(5)	KPMG	Subsection (3) should simply include income for the specified amount. The rest of the machinery in subsection (5) simply duplicates what already occurs in section FH 12. Mismatch amount should also go in the list of defined terms at the end of the section.	That the submission be accepted.
40	FH 8(1)	Matter raised in consultation	Readability would be improved by introducing a nonce term at the end of paragraph (a) “(the set off entity)” and using that term in paragraph (b).	That the issue be considered at the revised track version of the Bill stage.
41	FH 8(4)(a)	Matter raised in consultation	The requirements of subsection (1) do not all relate to the person to whom the section applies. so the last phrase of (4)(a) should be “but the requirements of paragraphs (a) and (b) are not met.”	That the submission be declined.
42	FH 8(4)(b)	Matter raised in consultation	The second to last line should refer to income of the set off entity.	That the issue be considered at the revised track version of the Bill stage.
43	FH 8(5)	PwC	Assessable income deemed derived at the start of the transitional period should instead be derived as the loss is used in the hybrid entity country.	That the submission be declined. Recognition at the transition time produces the same net income outcome as if the New Zealand resident had met the requirements of section FH 8(1) for the whole of the unaffected period. In that case, none of the net loss for that period would have been able to be used against income that was not surplus assessable income. The double deduction rules do not look at actual loss use but potential loss use.
44	FH 11(1)	PwC	Clarity required that the reference to a payment is to interest expenditure.	That the submission be declined. The provision applies to all deductible expenditure.
45	FH 11(1)(d)	PwC	The payment and the funded payment should be part of the structured arrangement.	That the submission be noted, as officials consider that this is already achieved by the drafting.
46	FH 11(5)	Chartered Accountants Australia and New Zealand, Matter raised in consultation	The cross reference should be to subsection (4), not (4)(a).	That the submission be accepted.
47	FH 12	Russell McVeagh	Clarify that surplus assessable income can be offset against mismatch amounts arising under different provisions.	That the submission be declined. Officials are not convinced this clarification is needed in the legislation. The commentary on the Bill already clarifies this, as will guidance.
48	FH 12	PwC	Dual inclusion income and carry forward provisions should not be in the same section.	That the submission be declined. Officials do not consider that having the two concepts in the same section is confusing.
49	FH 12	PwC	Current drafting does not take mismatch amounts from prior years into account.	That the submission be declined. Officials disagree and refer the submitter to the “earlier” item in FH 12(4)(a), as well as FH 12(6) which provides.
50	FH 12(4)(c)	PwC	“Owner” is undefined.	That the submission be noted. Officials do not consider that the term needs to be defined however.
51	FH 12(4)(d)	PwC	Definition of “unrecognised” is difficult to understand, unclear and vague.	That the submission be noted. Some amendments are proposed to this term, and officials undertake to clarify the intended application in guidance.
52	FH 12(8)	PwC	Current wording overcomplicated and could be simplified by replacing “a tax loss of the payee could be carried forward from the initial year to the carry year in the absence of offsets” with a subsection that outlines the continuity requirement.	That the submission be declined, but that an explicit reference is made to subpart IC of the Income Tax Act 2007 to clarify the provision.
53	FH 12(5) and (8)	Russell McVeagh, PwC	These provisions should refer to “the person” rather than “the payee”	That the submission be accepted.
54	FH 13	PwC	To provide clarity, section should stipulate that the election is available for “financial instruments”.	That the submission be declined. The dividend election rule in proposed FH 13 is only intended to be available for financial arrangements.
55	FH 13(2)	PwC	Clarification required that the share deemed to be issued is a non-participating redeemable share.	That the submission be accepted, but the clarification should go in paragraph 4(b). This will ensure that the NRPS treatment applies if the loan is repaid.
56	FH 13(5)	PwC	Situation where election ceases to be able to be made is not well expressed – currently it is only if a deduction would be allowed for a payment of interest.	That the submission be accepted. The dividend election only applies if the payment is non-deductible due to section FH 3. Subsection (5) should apply if section FH 3 ceases to.
57	FH 14(1)	PwC	Drafting presumes only one NZ person with an ownership interest in the entity. Clarification required whether each person with an interest must elect.	That the submission be declined. Officials consider that all owners must be members of a wholly owned group, but that only one needs to make the election.
58	FH 15	CTG	Act together definition – reference to a person or entity. Submitter suggests an entity and a person are the same thing for tax purposes and refers to the Interpretation Act 1999. If they are different does “entity” need to be defined.	That the submission be accepted. The reference should be to a person.
59	FH 15	CTG	The act together definition should only apply to arrangements involving non-residents.	That the submission be declined. Officials consider that for the purpose of the proposed rules these tests are about establishing the extent of common ownership. The residence of the owners is irrelevant.
60	FH 15	CTG	In relation to paragraph (b) of the act together definition, it is unclear what it means for a holder to typically act in a way preferred by another holder. What if the coincidence of actions is purely by chance, or a result of common sense, e.g. the business has made a profit so the shareholders agree to pay a dividend?	That the submission be accepted. The definition should be limited to where a holder typically acts in a way preferred by another holder because it is preferred by the other holder.
61	FH 15	CTG	Paragraph (c) of the act together definition could apply very widely, e.g. to any company with a shareholder agreement detailing what to do in the event of a shareholder dying or wanting to exit.	That the submission be accepted. Officials consider that there should be some safe harbours, so clauses in an agreement dealing solely with sale do not result in the parties acting together.
62	FH 15	CTG	Paragraph (d) of the act together definition and subsection (2) are closely related but far away from each other in the drafting. They should be combined in this definition.	That the submission be accepted.
63	FH 15	PwC	Mismatch amount definition is overly complex and multiple interpretations can be produced.	That the submission be declined. The mismatch amount concept is intended to be flexible, and its intended application will be further clarified in guidance.
64	FH 15	PwC	Surplus assessable income should instead be termed dual inclusion income.	That the issue be considered at the revised track version of the Bill stage.
65	YA 1	PwC	Deductible foreign equity distribution definition should not be amended as proposed. If a deduction is disallowed in the other country, NZ should not tax.	That the submission be declined. The OECD Final Report gives priority to the country receiving a deductible dividend. So New Zealand should tax if it is the receiving country, and the paying country’s hybrid mismatch rule should not apply to deny a deduction.

Recommendation

That the officials’ recommendations, as shown above, be accepted.

HYBRID FINANCIAL INSTRUMENT RULE

Clause 30

Issue: Franking credits and partial deduction denial

Submissions

(ASB, New Zealand Bankers’ Association, Russell McVeagh)

The hybrid financial instrument rule should be clarified so that the amount of deduction denied is certain in cases where the payee country is Australia, franking credits are granted and the ultimate recipient is subject to residual tax after franking credits are used. The submitters suggest that some part of the deduction in New Zealand should remain available.

Comment

The intended effect of the provision in question is that the deduction is denied in its entirety. The attachment of franking credits to the payment is enough to achieve this outcome, because it means that none of the payment is taxed as ordinary income. Officials consider that the drafting could be made clearer on this point.

Recommendation

That the submission be declined, with a clarification in the drafting to better achieve the intent of the provision in question.

Issue: Scope of rule

Submissions

(Chartered Accountants Australia and New Zealand, EY)

The scope of the rule should be clarified as the current drafting leaves open the possibility of application to situations that are not intended by the policy.

The drafting of the rule should exclude mismatches that only arise due to foreign exchange fluctuations. (Chartered Accountants Australia and New Zealand)

Source and rate mismatches may be unintentionally caught by the current drafting. (EY

Comment

The submissions support the intention of the Bill, but say it has not been achieved or is not sufficiently clear. Officials agree that the rule in question should be clarified to exclude mismatches that are only caused by foreign exchange fluctuations. In addition, guidance will be published to clarify the intended scope of the rule.

Recommendation

That the submission be accepted in relation to foreign exchange fluctuations being explicitly excluded from the scope of the rule.

Issue: Full grandparenting

Submission

(Chartered Accountants Australia and New Zealand)

All financial instruments in place at the time of introduction of the Bill should be exempt (grandparented) from the proposed rules.

Comment

The Bill currently grandparents hybrid regulatory capital that was in place before 6 September 2016 when the Addressing hybrid mismatch arrangements discussion document was released. This grandparenting recognised that regulatory capital issued by financial institutions conforms with statutory requirements and that it is more difficult to unwind in comparison to related party financial arrangements due to the large number of third party retail investors that are party to the arrangement. Officials do not consider that grandparenting treatment should be provided to any other financial instruments in respect of the hybrid mismatch rules. This is the approach recommended by the OECD and that other countries are taking.

Recommendation

That the submission be declined.

Issue: Payment tax status in payee country

Submission

(Chartered Accountants Australia and New Zealand)

When determining whether a deduction should be denied in New Zealand for a payment made under a hybrid financial instrument, the issue should be the expected tax treatment in the payee country, not the actual tax treatment as the current drafting does.

Comment

In relation to assessing whether an amount is taxable in the payee country (proposed FH 3(2)(a)), using the expected tax treatment of the payment in the payee country to determine whether or not the hybrid rules apply to deny a deduction to the payer ultimately seems unattractive. For example, it means that if it is expected that the payee would treat the payment as a payment on a debt instrument, but for some reason does not do so, the hybrid rules would not apply. In cases where the characteristics of an instrument are such that Inland Revenue has a good basis for believing that it would be treated as equity by the tax law of the payee country, the taxpayer should be able to prove that in fact the payment is taxable as ordinary income. Using an “expected” test also seems to introduce an undesirable level of uncertainty and subjectivity to the issue.

However, officials consider that in relation to the counterfactual part of the hybrid financial instrument rule (proposed FH 3(2)(b)), the test should to a greater degree ask what the expected treatment would be for a taxpayer of ordinary status if the treatment of the relevant instrument is varied. The drafting of the rule should be amended to clarify this.

Recommendation

That the submission be generally declined, but that the drafting be clarified as per officials’ comments.

Issue: Scope of ordinary income counterfactual test

Submission

(Chartered Accountants Australia and New Zealand)

Remove the words “received under a financial instrument” from proposed section FH 3(2)(b) in order to narrow the scope of that provision.

Comment

Officials consider that the words can be removed, because the financial instrument reference is nonetheless part of the rule through the ordinary income provision in proposed section FH 3(9). Officials consider that the reference to financial instrument is appropriate.

Recommendation

That the submission be accepted, although officials do not consider that the suggested amendment will narrow the scope of the provision.

Issue: Level of association required for rule to take effect

Submission

(KPMG)

The hybrid financial instrument rule should rely on the ‘control group’ test that is used by other hybrid mismatch rules instead of the ‘related’ test which has a lower threshold of association.

Comment

The current proposal in the Bill is the OECD-recommended approach as to the threshold of association for the hybrid financial instrument rule and it provides a balance between effective targeting of transactions and reducing the risk of overreach.

Using the OECD-recommended approach also has the benefit of consistency with other countries that use the same or similar thresholds of association for their hybrid financial instrument rule.

Recommendation

That the submission be declined.

Issue: Need for defensive rule

Submission

(KPMG)

The defensive part of the hybrid financial instrument rule is unnecessary, given New Zealand law taxes dividends which are deductible in another country and has comprehensive financial arrangement rules. It should be removed, or its need should be clarified.

Comment

Officials acknowledge that the defensive rule in proposed section FH 4 will only apply in limited circumstances. However, officials are aware of possible fact scenarios where it will be needed. An example is where a non-resident borrower is entitled to deduct immediately an interest prepayment, which would be spread over time under the New Zealand financial arrangement rules. Section FH 4 would be required to tax this income on receipt in New Zealand so that there is no timing mismatch.

The rule also forms part of a coherent package of OECD-recommended hybrid mismatch rules and so the defensive rule’s inclusion in the proposals will be consistent with other countries.

Recommendation

That the rule remain in the Bill and that officials undertake to clarify its possible application as part of guidance.

Issue: Regulatory capital for insurers

Submission

(IAG)

One submitter specifically supported the grandparenting approach taken by the Government in relation to regulatory capital of insurers. However, that submitter noted that the drafting of the Bill’s grandparented treatment for regulatory capital instruments should be widened so that issuers who are licensed insurers or associated with a licensed insurer are able to access the exemption.

Comment

It is the policy intent that hybrid regulatory capital issued by banks and insurance companies in accordance with their regulatory requirements can be grandparented from the application of the hybrid financial instrument rule. Extending the rule to issuers associated with a licensed insurer is consistent with that policy.

Recommendation

That the submission be accepted.

Issue: Taxation in jurisdiction other than payee jurisdiction

Submission

(Russell McVeagh)

The hybrid financial instrument rule needs clarification to ensure that it only applies where the relevant payment is not taxed in any payee jurisdiction.

Comment

Officials agree that if a payment is included in ordinary income in any jurisdiction, it should not give rise to a hybrid mismatch under the rule.

Recommendation

That the submission be accepted.

Issue: Definition of ordinary income

Submission

(PwC)

The ordinary income definition is too wide. It could include capital gains tax in some countries but not others. It could also include income taxed at source in New Zealand.

Comment

The definition of ordinary income is only relevant to financial arrangement mismatches. In order to be ordinary income, income must be taxed at a person’s full marginal rate, without exemption, exclusion, credit or tax relief other than for foreign withholding tax. It does not matter whether the tax imposed is described as capital gains tax or income tax. It also seems to make sense that if a payment on a financial instrument which is deductible to a New Zealand borrower and exempt to the lender in its home country due to the treatment of the instrument is nevertheless subject to New Zealand net income tax, the payer (borrower) should not be denied a deduction under the proposed rules

Recommendation

That the submission be declined.

Issue: Effect of delayed recognition

Submission

(Russell McVeagh)

The calculation of the amount denied under the hybrid financial instrument rule for character and timing mismatches should be redrafted so that it does not deny a deduction for mismatches that have delayed recognition tolerated by the rule (under proposed section FH 3(6)).

Comment

Officials agree that the status quo is not appropriate in cases where a hybrid financial instrument mismatch has both character (through partial taxation) and timing elements (although officials do not consider these cases to be common). To remedy this, the formula in proposed FH 3(4) and (5) should be amended so that it incorporates the level of delayed recognition contemplated by proposed section FH 3(6).

Recommendation

That the submission be accepted.

DISREGARDED HYBRID PAYMENTS RULE AND DEEMED BRANCH PAYMENTS

Clause 30

Issue: Third party expense margin

Submission

(KPMG)

The disregarded hybrid payments rule should apply in the same way that the deemed branch payments rule works in relation to branch charges. That is, the rule should only apply to the extent the disregarded payment exceeds third party expenses.

Comment

The disregarded hybrid payments rule and the deemed branch payments rule are separate rules that are located in the same provisions in the Bill due to their structural similarity. The rules do not have to be consistent in relation to this issue. The Bill as drafted reflects the OECD approach for the two rules. In relation to branch charges, section FH 5 applies to the margin over third party expenses, and section FH 9 applies to the third party expenses themselves. In relation to disregarded payments, section FH 5 applies to the whole amount of the payment.

Recommendation

That the submission be declined.

Issue: Payments taxed in New Zealand

Submission

(Russell McVeagh)

Payments that are subject to tax in New Zealand should be excluded from the scope of the rule.

Comment

There is no potential for hybrid mismatch abuse if a disregarded payment is subject to tax in New Zealand. The Bill should be amended so as to exclude such a payment from counteraction under the disregarded hybrid payments rule.

Recommendation

That the submission be accepted.

Issue: No definition of a branch

Submission

(PwC)

The term “branch” should be defined. In particular, it needs to be clear whether or not this term includes a deemed permanent establishment (PE) under the proposed PE avoidance rule.

Comment

Officials agree with this submission. The definition of a branch should be appropriate to the purpose of this rule in preventing a deduction in New Zealand for an amount which is disregarded in another country due to that other country’s rules for determining the allocation of profit to the branch. Accordingly, the definition should pick up any activity of a non-resident as a result of which the non-resident is entitled to a deduction in New Zealand in calculating its income subject to New Zealand income tax.

Recommendation

That the submission be accepted, and the legislation amended to achieve the outcome referred to above.

REVERSE HYBRID RULE AND BRANCH PAYEE MISMATCH RULE

Clause 30

Issue: Foreign trusts

Submission

(Chartered Accountants Australia and New Zealand, PwC)

The Bill should specifically exclude foreign trusts established in New Zealand from the scope of the ‘reverse hybrid entity’ definition. (Chartered Accountants Australia and New Zealand)

The Government should clarify whether the foreign trust (and limited partnership) proposals are to proceed. (PwC)

Comment

Officials consider that a New Zealand foreign trust is a reverse hybrid entity. This Bill does not contain hybrid mismatch proposals relating to New Zealand reverse hybrid entities. The reverse hybrid rule in this Bill deals with mismatches caused by a New Zealand-sourced payment to a foreign reverse hybrid entity.

Recommendation

That the submission be declined.

DEDUCTIBLE HYBRID AND BRANCH PAYMENTS RULE

Clause 30

Issue: Active income exemption for branches

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

An active income exemption for branches should be considered or introduced, on either a mandatory or elective basis. This would reduce much of the complexity associated with applying the hybrid rules to branches, which are a common feature of SME business structures.

The Government is to be commended for ensuring that simple offshore structures are not subject to the hybrid rules. However, in any case where the hybrid rules mean a foreign loss is not able to be deducted against New Zealand income, then the foreign income should also be exempt if it is active (Chartered Accountants Australia and New Zealand)

The proposed rules will capture any New Zealand company with a foreign branch and a subsidiary in the same country.

This submission was made in connection with proposed section FH 6 as well as proposed section FH 8. In relation to the former provision, a submitter gave the example of a New Zealand company with a foreign branch where the foreign branch sells goods manufactured in New Zealand. The goods are sold for some amount (call it $400), and the foreign country allows the branch a deduction of $250. This represents an allocation of third party costs incurred by the branch and New Zealand operations in manufacturing and transporting the goods of $150, and a mark up for profit in New Zealand of $100. This $100 might be assessable in New Zealand under proposed section FH 6. (Chartered Accountants Australia and New Zealand)

Comment

An active business exemption was ruled out during the policy development process due to it being outside the scope of the proposed reforms. Officials also consider that an active income exemption for branches carries increased risks of branch mismatches.

Officials note the support for the Bill’s narrowing of the OECD proposal. That is, that the double deduction primary rule in proposed section FH 8 does not apply to losses of foreign branches which are not able, in the foreign country, to use their losses against any income which is or may be earned by an entity which exists and which New Zealand does not tax. Officials believe this narrowing will ensure that the vast majority of SME foreign branches will not be affected by that provision.

Officials do not agree that proposed section FH 8 will deny a New Zealand company the ability to use a foreign branch loss against its New Zealand income if the company has a subsidiary in the same country. It is only when the branch loss is able to be used against the subsidiary’s income that the loss will be subject to that section. Officials understand that in Australia, branch losses cannot be offset against corporate income so section FH 8 would not apply in that case.

The example given by Chartered Accountants Australia and New Zealand and set out above in relation to section FH 6 (which taxes income from disregarded payments and branch mismatches) in fact supports the continued taxation of foreign branch profits. So long as New Zealand taxes those profits, the full $400 earned by the foreign branch from the sale of the goods is taxable. The $100 mark up would only be potentially taxable as a branch mismatch if New Zealand:

exempted foreign branch profits, so did not tax the $400 of foreign sales;
recognised as income attributable to New Zealand less than the $100 mark up allocated to it by the branch country.

Recommendation

That the submission be declined.

Issue: Actual offset before deduction denial

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

The rule that denies deductions to New Zealand entities with foreign branches or New Zealand owners of foreign hybrid entities should be restricted to cases where an actual offset of a foreign loss against foreign income not taxed in New Zealand has occurred.

Comment

The rule in question works by denying a New Zealand tax deduction only if the relevant country allows losses of the hybrid entity/branch to be offset against income of a person whose income is not taxed in New Zealand. The advantage of this rule is that it provides a clear exclusion from the rule for simple offshore structures, such as a New Zealand company with (only) a foreign branch in a country. If this exception was wider and relied on actual offset of losses, it would become much more complicated for taxpayers to self-assess and for Inland Revenue to administer the rule.

Recommendation

That the submission be declined.

Issue: US dual consolidated loss rules

Submission

(KPMG)

The rules should be amended such that the US dual consolidated loss (DCL) rules are explicitly said to be hybrid mismatch legislation equivalent to the New Zealand primary deductible hybrid payments rule. These US DCL rules were enacted before the OECD’s work on hybrid mismatch arrangements.

Comment

Officials agree that the US DCL rules are broadly equivalent to the Bill’s proposed deductible hybrid payments rule, and that where they apply, the defensive rule in proposed section FH 9 should not apply. However, officials disagree that legislation is needed to specify this equivalence (other than amendment to the definition of hybrid mismatch legislation as referred to earlier). Instead, guidance will be published explaining that foreign tax rules that deny dual use of a loss (such as the US DCL rules) but which predate the OECD recommendations on hybrid mismatch arrangements do correspond to the New Zealand deductible hybrid payments rule. However, this position may be limited by the particular way in which those foreign tax rules apply. For instance, if a US taxpayer subject to the DCL rule were to make a “domestic use election”, (as referred to in the KPMG submission) the defensive deductible hybrid payments rule would apply in New Zealand.

Recommendation

That the submission for legislative change be declined, but that officials undertake to produce guidance that generally supports the submitter’s position.

DUAL RESIDENT PAYER RULE

Clause 30

Issue: Rule should not be enacted

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

New Zealand’s hybrid and branch mismatch rules do not need the dual resident payer rule. Dual residence is often accidental, can be difficult to avoid, and is partly due to New Zealand’s wide definition of company residence.

Comment

New Zealand tax law already prevents a dual resident company from grouping its losses or forming a tax consolidated group. However, the dual resident payer rule is needed as existing law does not prevent a dual resident company offsetting expenditure against non-dual inclusion income earned through a reverse hybrid, such as (potentially) a New Zealand limited liability partnership. Importantly, any deductions denied by the rule are able to be carried forward against surplus assessable income in current or future years.

Recommendation

That the submission be declined.

Issue: Priority of rules

Submission

(Chartered Accountants Australia and New Zealand)

If the dual resident payer rule is to proceed, it should include a priority similar to other hybrid and branch mismatch rules so that two countries do not counteract the same dual resident mismatch. Without this priority in the rule, double taxation could result.

Comment

The OECD-recommended dual resident payer rule does not assign priority in counteracting the mismatch to a particular country affected by the mismatch. This is because there is no logical way to assign priority where both countries have the same outlook regarding the mismatch; that a company is resident under domestic law and it is also resident under the laws of another country. Pre-hybrids laws denying loss grouping to dual resident companies already achieve this outcome in many cases.

Officials do not want New Zealand’s hybrid and branch mismatch rules to depart from the OECD recommended approach to the dual resident payer rule and consider that the risk of double taxation is minimal.

Recommendation

That the submission be declined.

Issue: Stranded losses

Submission

(KPMG)

The hybrid and branch mismatch rules should provide for stranded losses in a dual resident company context. The OECD recommends that double deductions should be allowed to the extent that they are not able to be set off against income in the relevant foreign country.

Comment

Officials agree with the submitter regarding the OECD recommendation. On the other hand, there is currently no stranded loss exception in relation to the existing rule against grouping dual resident company losses. It would seem odd to have such a rule in relation to proposed section FH 10 and not also in relation to the more generally applicable rule in existing section IC 7(2).

Recommendation

That the submission be declined until such time as it can be considered along with an amendment to the existing rule regarding dual resident company losses.

IMPORTED MISMATCH RULE

Clause 30

Issue: Incorporation of OECD guidance into domestic law

Submissions

(Chartered Accountants Australia and New Zealand, PwC)

The imported mismatch rule should not incorporate the OECD recommendations on hybrid mismatch arrangements into New Zealand law.

The recommendations are insufficiently clear and detailed, nor are they easily understood. (Chartered Accountants Australia and New Zealand)

It is not appropriate to refer to an external document in legislation when this is to be relied on for more than guidance. (PwC)

Comment

Officials agree that determining the amount of a payment that should be denied under the non-structured imported mismatch rule is complicated. However, this rule is only likely to apply to highly sophisticated corporate groups. By the time the rule applies, if it does apply there will also be other countries applying their versions of the rule.

Officials believe there is a much better chance of a sensible allocation if New Zealand adopts a broad and flexible approach that refers to the OECD report. This approach can be adjusted to fit the circumstances of any particular case and is preferable to drafting what is likely to be a complex and lengthy rule to govern a handful of cases, which is more likely to result in unfair results.

Recommendation

That the submission be declined.

Issue: Opposition to imported mismatch rule

Submission

(KPMG)

New Zealand should not enact the imported mismatch rule. Its introduction will increase complexity, compliance costs and uncertainty for taxpayers.

Alternatively, the rule should be limited to structured arrangements and should only apply from January 2020.

Comment

The structured and unstructured imported mismatch rules are important to the integrity of the hybrid and branch mismatch rules. Without the structured rule, multinational companies have the ability to structure a mismatch between countries without hybrid mismatch and branch rules and import the mismatch into New Zealand through inbound investment. The unstructured rule seems to have a more general purpose, which is to use the hybrid rules to eliminate the benefit of tax arbitrages between countries without the rules, even where those arbitrages are not intended to produce tax benefits in countries that do have the rules.

Once EU countries begin enacting hybrid and branch mismatch rules, the imported mismatch rule will be prevalent worldwide and most multinational groups will have to deal with the implications of the rule regardless of whether New Zealand has an imported mismatch rule or not. This is why the legislation proposed to delay implementation of the unstructured imported mismatch rule until 1 January 2020, when the EU countries are also required by the EU to have unstructured imported mismatch rules in place.

Recommendation

That the submission be declined.

Issue: Timing mismatches

Submission

(KPMG, PwC)

The imported mismatch rule should not include timing or temporary mismatches. The mismatch can be reversed over time, and it would be difficult to measure the magnitude of an imported timing mismatch. (KPMG)

Dual inclusion income has not been taken into account for the imported mismatch rule. (PwC)

Comment

Officials agree that the imported mismatch rule currently contains no provision for reversing a deduction denial. This is consistent with the OECD Final Report. Determining and allocating a reversal could be complex. However, officials also note that the timing mismatch rule in this respect is less prescriptive than it is in relation to proposed sections FH 3 and FH 4. That is because proposed section FH 11 counteracts hybrid mismatches as defined in section FH 15, rather than as defined in the other operative provisions of the subpart. Under the definition in proposed section FH 15, there is only a timing mismatch if an amount is not recognised as ordinary income within a reasonable period of time. What is a reasonable period of time can be interpreted broadly, having regard to the lack of any reversal provision.

Recommendation

That the submission be declined.

Issue: Guidance on imported mismatch rule

Submission

(KPMG)

Guidance needs to be published by Inland Revenue to help taxpayers correctly discharge their obligations in relation to the imported mismatch rule.

Comment

Officials acknowledge that the imported mismatch rule is complex, and will endeavour to provide enough guidance to assist taxpayers to comply with the rules, particularly in relation to the level of enquiry that should be made by a New Zealand taxpayer to its foreign payees to ensure taxpayers have met their reasonable care obligations when filing tax returns.

Recommendation

That the submission be accepted.

Issue: Redraft of imported mismatch rule

Submission

(PwC)

It would be difficult for a taxpayer to reach a position on whether the rule applies or not. The rule needs to be redrafted.

Comment

Officials acknowledge that the imported mismatch rule is complicated, but consider that the drafting accurately reflects the policy intent of the rule. Guidance will help taxpayers take positions on the rule with certainty.

Recommendation

That the submission be declined.

SURPLUS ASSESSABLE INCOME

Clause 30

Issue: Application to each mismatch situation

Submission

(Chartered Accountants Australia and New Zealand)

The surplus assessable income rules should be clarified so that they apply separately to each mismatch situation. Examples should be included in the legislation to aid understanding.

Comment

Officials consider that the current drafting is clear in that the surplus assessable income calculation applies to each mismatch situation. Officials do not consider that examples should be part of the legislation itself, but undertake to produce more examples in published guidance to assist taxpayers in complying with the rules.

Recommendation

That the submission be declined.

Issue: Definition of surplus assessable income needs to be revisited

Submission

(PwC)

The surplus assessable income definition is confused and overcomplicated and needs to be revisited. The label of the concept is not helpful either.

Comment

Officials accept that the surplus assessable income definition is complex. The role of the definition is to allow a person who is prima facie denied a deduction for expenditure in New Zealand on the basis that the same expenditure is also deductible in another country, to take that deduction. The basis for this allowance is that the person also has income that has been taxed in two countries.

The OECD Final Report recommends that countries adopt administrative practices to make it as simple as possible for taxpayers to identify double deductions. After extensive consultation, New Zealand has decided not to try to apply these rules by looking at the actual amounts of deductions and income claimed in each country. Such an approach would be very complex. It would also be somewhat arbitrary, in terms of foreign currency differences, timing differences, and differences in the definition of income. Accordingly the approach taken in the Bill is to start with New Zealand taxable income, and then to make certain adjustments. While defining these adjustments is inevitably somewhat complex, and amendments may be required at some time, officials consider this is the only workable approach.

The label “surplus assessable income” is intended to more accurately identify the approach described above than the label “dual inclusion income” would do. However, officials accept that it may be confusing on a first encounter.

Recommendation

That the submission be declined, and that the drafter consider the label issue.

Issue: Continuity

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

The surplus assessable income rules should not be subject to the 49% of ownership continuity rules that apply to tax losses.

A mismatch amount is not a tax loss, it is a tax deduction that has been deferred pending possible surplus assessable income in the future. (KPMG)

Comment

It is established New Zealand tax policy that tax losses are subject to continuity rules that prevent loss companies from being traded. Mismatch amounts that are denied a deduction under a hybrid mismatch rule are conceptually similar to tax losses, and officials therefore consider that the continuity requirement in the Bill is appropriate and will assist with the integrity of the rules. Without them, it would be possible for a company to incur an expense, and for that expense to be deducted in a subsequent year when the company is owned by shareholders who did not bear that expense.

Recommendation

That the submission be declined.

Issue: Offset of carried forward mismatch amounts

Submission

(PwC)

It is difficult to see how the definition allows denied deductions carried forward from a prior year to be offset against surplus assessable income.

Comment

Section FH 12(6) allows mismatch amounts to be carried forward. These amounts then form part of the total of the mismatch amount for the succeeding year, which can be set off under section FH 12(2) against surplus assessable income. Officials believe this is clear.

Recommendation

That the submission be declined.

Issue: Unrecognised amounts

Submission

(Russell McVeagh)

The formula for surplus assessable income should be amended so that it:

includes a new positive item for unrecognised deductions, being those deductions not recognised in the relevant counterparty jurisdiction due to the tax status of the payer; and
clarifies that unrecognised income includes income not subject to tax due to the tax status of the payer.

Comment

Officials consider that the suggested amendments will more closely align the surplus assessable income provisions with their intended effect.

Recommendation

That the submission be accepted.

Issue: Grouping of surplus assessable income amounts

Submission

(Russell McVeagh)

It is submitted that mismatch amounts of one taxpayer should be able to be offset against or grouped with the surplus assessable income of a taxpayer that is in the same group (if those entities are able to group losses). This is consistent with the policy intent of the rules.

Comment

While the suggestion may increase the complexity of the surplus assessable income calculation to some extent, officials on balance agree with the submitter that the wrong economic outcome is reached without the grouping mechanic that is suggested. However, grouping should not allow companies to offset mismatch amounts with surplus assessable income if that would not have occurred were the companies a single company.

Recommendation

That the submission be accepted, subject to the above comments.

Issue: Broader stranded losses provision

Submission

(Russell McVeagh)

It is submitted that the stranded losses provision in proposed section FH 12(9) should apply to the defensive deductible hybrid payments rule found in proposed section FH 9 in addition to its current application to the primary deductible hybrid payments rule found in proposed section FH 8.

Comment

Officials consider that stranded losses are unlikely to apply in situations where New Zealand is the country of the hybrid entity or branch (proposed Section FH 9). It would also be difficult to verify the use of losses in a foreign country in order to appropriately apply the rule the submitter has asked for.

Recommendation

That the submission be declined.

Issue: Foreign tax credits and surplus assessable income

Submission

(Russell McVeagh)

The definition of surplus assessable income should not include protected amounts, those being amounts for which a New Zealand foreign tax credit is granted.

In addition, surplus assessable income carried forward should not be limited by the foreign tax credits granted by another country in relation to the mismatch situation. There is no explanation for this limitation in the Commentary on the Bill.

Comment

Officials consider that mismatch amounts should not be able to be offset against surplus assessable income to the extent that income is not subject to double taxation because a foreign tax credit is available for that income.

The inclusion of protected amounts in proposed FH 12(4)(e) is necessary to ensure that mismatch amounts are not allowed a deduction due to income which is not actually taxed twice due to New Zealand’s foreign tax credit rules.

The limit on carrying forward surplus assessable income is necessary to ensure that net New Zealand income from a mismatch situation cannot be offset against future mismatch amounts if foreign tax credits are granted by a foreign country in relation to that net New Zealand income. Officials do acknowledge there is insufficient explanation as to this rule in the Commentary on the Bill and undertake to provide guidance as to this rule.

Recommendation

That the submission be declined.

Issue: Additional limit on ability to carry forward mismatch amounts

Submission

(Matter raised by officials)

In relation to the transitional period submission above, officials have realised that an additional limit is needed on the ability of a taxpayer to carry forward mismatch amounts. A limit should be applied in situations where defensive entity based rules (proposed sections FH 6 and 9) have been applied in New Zealand and the other relevant country introduces hybrid mismatch legislation equivalent to New Zealand’s primary rules (proposed sections FH 5 and 8). This will ensure that if surplus assessable income (dual inclusion income) arises in a later year, it will not result in allowed deductions in both countries.

Recommendation

That the submission be accepted.

ELECTION RULES

Clause 30

Issue: Support for rules

Submissions

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

Submitters supported the Government’s inclusion of a dividend election rule and an opaque election rule in its hybrid and branch mismatch rules.

The dividend election rule will relieve double taxation arising from the application of the hybrid financial instrument rule and any possible interaction with existing non-resident withholding tax rules. (Chartered Accountants Australia and New Zealand, KPMG)

The opaque election rule will reduce compliance costs and add simplicity to the rules. (Corporate Taxpayers Group, Chartered Accountants Australia and New Zealand)

Comment

Officials proposed the dividend election rule after consultation with industry groups on the issues of potential double taxation arising from the hybrid financial instrument rule and existing non-resident withholding tax rules. These would arise when a non-deductible interest payment is subject to NRWT.

Similarly, the opaque election rule provides an option for a taxpayer with a double deduction hybrid structure to forfeit its tax advantage but keep funding and arrangements relating to the structure in place. This will help with taxpayers’ compliance costs and some of the complexity of the deductible hybrid payments rule can be avoided by taxpayers who choose to make an opaque election.

Recommendation

That the submissions be noted.

Issue: Broadening the opaque election to non-wholly owned entities

Submissions

(Chartered Accountants Australia and New Zealand, KPMG, PwC)

The opaque election rule should be broadened such that the foreign hybrid entity for which an opaque election would be made does not have to be wholly owned by a New Zealand resident or the New Zealand resident’s wholly owned group.

Comment

Officials are concerned that a broadening of the opaque election rule in the way suggested could increase the complexity of the rule. For instance, a potentially arbitrary threshold of ownership of the foreign hybrid entity would have to be considered sufficient to make the election. Further, this opaque treatment would apply to all owners of the foreign hybrid entity and this would have to be communicated in a way that is certain. From an administrative perspective, it is better that the rule is limited to cases where there is clear and complete control over the foreign hybrid entity.

Recommendation

That the submission be declined.

Issue: Opaque election for new entities

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

Currently the opaque election is only available in respect of wholly owned foreign hybrid entities that are owned by the relevant New Zealand taxpayer at the time of the Bill’s introduction. It is submitted that the opaque election rule should be available for New Zealand taxpayers that acquire interests in a foreign hybrid entity at a later point in time.

Comment

The purpose of the opaque election is not to make a significant change to the definition of a company in New Zealand tax law. That would require significant policy and administrative resource. For example, Inland Revenue would need to be satisfied that once a person chose to treat a foreign entity as a company for New Zealand tax purposes, that choice continued to be made by all future New Zealand owners of that entity or that if it did not, there was a deemed liquidation of the deemed company. Taxpayers might also want the ability to revoke the election, which would create the need for further legislation and procedures.

The purpose of the election is to ameliorate the complexity of applying the hybrid rules for taxpayers who committed themselves to structures before those rules came into existence. Accordingly, the rule is narrow and targeted.

Recommendation

That the submission be declined.

Issue: Further consideration needed on election regimes

Submission

(PwC)

There is potential for a dividend election under proposed section FH 13 to result in a negative available subscribed capital impact.

Deemed disposal for an opaque election under proposed section FH 14 could have adverse impacts, including base price adjustments.

Comment

Officials do not believe the dividend election can result in a negative available subscribed capital (ASC) impact, though it may result in income or expenditure under the base price adjustment, and in an NRWT obligation. When the election is made, the loan is deemed to be repaid for the amount owing. Any unpaid interest will be deemed to be paid, which will give rise to an NRWT liability for the debtor. There may also be expenditure or income to the debtor under the base price adjustment. Generally the base price adjustment will not apply to the lender, since that person is non-resident. The reinvestment of that amount (net of NRWT) will give rise to additional ASC. When the election ceases to apply, the amount owing at that time will be treated as a return of capital. This should eliminate the ASC arising when the election was made. There is unlikely to be any net ASC impact.

In relation to deemed disposals under the opaque election, it is intended that any disposals of appreciated revenue account assets or financial arrangements will give rise to tax obligations. If they did not, these gains, which currently are in the New Zealand tax base, would never be taxed. At the same time, deemed disposals of depreciated revenue account assets or financial arrangements will give rise to a tax loss.

Recommendation

That the submission be declined.

Issue: Opaque election should not be permanently binding

Submission

(PwC)

The election to treat a foreign hybrid entity as a company under proposed section FH 14 should not be permanently binding on that entity due to future uncertainties if the entity is sold.

Comment

The opaque election rule must be simple for taxpayers and Inland Revenue so that it may be effective in reducing compliance and administrative costs. Officials do not consider that the opaque election should be undone and redone as a foreign hybrid entity is sold and on sold as this will reduce the simplicity of the rule.

Recommendation

That the submission be declined.

INTERACTION WITH OTHER TAX REGIMES

Clauses 41, 19(1)–(3), and 26, 12–16

Issue: Removal of NRWT liability when deduction denied permanently

Submissions

(Chartered Accountants Australia and New Zealand, EY, PwC)

The Bill should be amended to ensure that there is no non-resident withholding tax (NRWT) liability when a deduction is permanently denied under the hybrid and branch mismatch rules. This is inequitable, and will push up the cost of capital if there is a gross up clause in the agreement.

It should be clarified in commentary or guidance as to whether a denied deduction is removed or included in the denominator for the equation that calculates a person’s non-resident financial arrangement income. (Chartered Accountants Australia and New Zealand)

Comment

Officials do not agree that denial of a deduction under the hybrid rules for a payment of interest should mean that the payment is not subject to NRWT. There is no general principle in the NRWT rules that interest is only subject to NRWT if it is deductible. The election to treat a hybrid financial instrument as a share allows the NRWT to be eliminated, so long as the payment is treated as a dividend. Simply eliminating the NRWT would allow a non-resident to extract unimputable profits and capital gains from a New Zealand company with no tax cost, which would not be appropriate.

Regarding the cost of capital argument, it seems unlikely that such a minor issue will have any effect on the general cost of capital in New Zealand. Furthermore, it may well be the case that the NRWT is eligible for a foreign tax credit.

Officials agree that the commentary on the Bill contains an error. The last sentence on page 99 should say “Once the deductions are allowed, they are intended to be included in the denominator.”

Recommendation

That the submission be declined and that officials will clarify the intention of the rule in guidance.

Issue: NRWT overreach

Submission

(PwC)

A taxpayer making a dividend election may have NRWT liability as the loan will be treated as repaid. There may also be a dividend if the dividend election ceases to apply, and the shares are treated as cancelled and replaced by a loan. These are both cases of over-taxation, and amendments should be made to remove the NRWT.

Comment

Officials agree that there may be an NRWT liability if there is accrued interest outstanding on a hybrid instrument when a dividend election is made. This is entirely appropriate. It is the same outcome as if the hybrid instrument were fully repaid and the funds used to subscribe for shares.

Officials do not agree that there will be a dividend if the dividend election ceases to apply. That is because the hybrid instrument is deemed to be a non-participating redeemable share (NPRS) (proposed section FH 13(5)(a). Redemption of a NPRS will not give rise to a dividend except if it is in substitution for a dividend.

Recommendation

That the submission be declined.

Issue: Support for consequential thin capitalisation changes

Submission

(Chartered Accountants Australia and New Zealand)

The submitter supports the thin capitalisation changes consequential to the hybrid mismatch rules. These changes ensure that interest for which a deduction is denied does not result in income and corresponding debt is not treated as debt under the thin capitalisation rules.

Recommendation

That the submission be noted.

Issue: Banking thin capitalisation rules

Submissions

(ASB, New Zealand Bankers’ Association)

The Bill’s amendments to ensure that the hybrid and branch mismatch rules do not inappropriately interact with thin capitalisation calculations should be widened to apply to bank thin capitalisation rules also. Interest for which no deduction is available should be removed from the scope of interest expenditure under the bank thin capitalisation rules, and corresponding debt arrangements should be treated as equity under those rules.

Comment

Officials agree that if a member of a banking group issues capital that qualifies as regulatory capital, or which is part of a chain of transactions giving rise to regulatory capital, and a deduction is denied for the interest on that regulatory capital under the hybrid rules, the regulatory capital should be treated as shareholders’ equity for purposes of the banking thin capitalisation rules.

Similarly, the hybrid instrument and the interest in respect of it should be excluded from the calculation of additional income under the thin capitalisation rules, in cases where the rules do deem additional income to arise. This treatment reflects the fact that for banking regulatory purposes, the instrument is prima facie treated in the same way as shareholder’s funds. It is only the interest deduction that takes it outside that treatment. If the interest deduction is no longer available, the regulatory capital should revert to treatment as shareholders’ equity.

Recommendation

That the submission be accepted.

Issue: FIF rule changes

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

The foreign investment fund (FIF) rule amendments proposed in the Bill as consequential to the hybrid and branch mismatch rules are unnecessary and should be removed. These amendments may affect small investors who will be unable to request the information they need to use the comparative value (CV) method to calculate FIF income.

Comment

Officials consider that the amendments are targeted and appropriate.

The amendment proposed to section EX 46(10)(db) applies only if the investor and the FIF are related or the FIF is structured to provide a hybrid tax benefit. A similar rule, denying a FIF investor the ability to use the FDR method, already applies to FIF interests which are economically similar to debt investments.
Proposed section EX 47B, and the amendments to sections EX 52 and EX 53, apply only to persons who are parties to a returning share transfer, and so will only apply to large sophisticated investors. Officials consulted on this change and no issues were raised, largely because these changes apply only to related party or structured arrangements.

Recommendation

That the submission be declined.

Issue: Share lending provision difficult to understand

Submission

(Bryce Jensen)

The submitter encountered difficulty in understanding the provision and expressed that the effect should be a level playing field.

Comment

Officials acknowledge that some of the provisions in the Bill are complex and may be difficult to understand. Officials note that the rules apply unevenly as the hybrid mismatch rule will apply only where the parties are related or are party to a structured arrangement. Guidance will be produced to aid taxpayers in their understanding and compliance.

Recommendation

That the submission be noted.

OTHER DEFINITIONS

Clause 30

Issue: Structured arrangement facts and circumstances and exclusion

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

The definition of a structured arrangement should be consistent with the OECD report recommendations 10.2 and 10.3 which state respectively that the definition:

should list facts and circumstances to be considered in determining whether an arrangement is structured or unstructured, and
should exclude taxpayers from the structured arrangement if they (and any person in their control group) could not reasonably expect to have been aware of the mismatch and did not share in the tax benefit.

Comment

The definition of a structured arrangement in the Final Report does refer to an arrangement where the facts and circumstances indicate that it has been designed to produce a hybrid mismatch, and then goes on to provide an inclusive list of relevant facts and circumstances. The Australian exposure draft definition also refers to facts and circumstances, though it does not go on to provide a list. The UK definition (see e.g. section 259CA(7) refers to an arrangement if it is reasonable to suppose that it has been designed to secure a hybrid mismatch, or the terms share the economic benefit of a mismatch between the parties or otherwise reflect the fact that the mismatch is intended to arise. It also mentions that a financial arrangement may be designed to secure a hybrid mismatch despite also being designed to secure another objective.

Officials agree that it would be useful for the legislation to include a reference to “facts and circumstances”. The precedent of the Australian and UK legislation suggests it may be preferable to have a list of relevant facts and circumstances included in guidance rather than legislation.

Officials also agree that a taxpayer should not be considered party to a structured arrangement if neither they nor a person in their control group is aware of the hybrid mismatch and did not share in the tax benefit of the arrangement.

Recommendation

That the submission be accepted.

Issue: Definition of a control group

Submission

(PwC)

The control group definition is too wide, particular in light of the inclusion of the “acting together concept”. “Acting together” could be read to catch shareholder agreements, or unitholder subscription agreements

Comment

An “acting together test” is recommended by the OECD (Final Report recommendation 11.3) and has been adopted by the UK (section 259NC(6) –(8). The “acting together” definition in section FH 15(1), along with the exception in subsection (2), reflects both of these precedents. The definition is intended to cover the situations referred to in the PwC submission as an over-reach. Where a group of minority shareholders acting together control a company, it is reasonable to apply the hybrid rules to a hybrid transaction between the company and one of those shareholders.

Officials do note that because the acting together test is limited to paragraphs (g) and (h) of the control group definition, it may not apply as widely as it should.

A shareholder agreement which has the result that the shareholders act together to control the company should mean that the shareholders and the company are in a control group. If the shareholders agreement is more limited, for example it only deals with sales of shares, then there is no control element to the agreement and the shareholders and the company will not be in a control group. A unitholder subscription agreement is analogous to a shareholder agreement.

Recommendation

That the submission be declined. Officials also recommend that the acting together test be incorporated into paragraph (c) of the control group definition.

Issue: Trumping existing legislation

Submission

(PwC)

The submitter has asked for confirmation that the hybrid mismatch rules will not trump specific legislation. Specifically, the following two examples are raised:

the choices made by a person under the foreign superannuation rules in section CF 3 of the Income Tax Act 2007 should not be considered a structured arrangement and subject to the proposed rules; and
clarification is needed as to whether the proposed rules are intended to apply to transitional residents.

Comment

The hybrid and branch mismatch rules have the effect of trumping various parts of specific existing legislation. This is because the vast majority of existing tax legislation does not consider the tax treatment of an arrangement in a relevant foreign country. For instance, New Zealand’s existing financial arrangement rules routinely allow deductions for expenditure across the life of a financial instrument rather than when payments on the instrument are made and when they are taxed in the payee jurisdiction. However, under the rules proposed in the Bill in some circumstances those deductions will be denied.

However, the hybrid rules do not apply in every case of deduction/no inclusion. Taking the transitional residence exemption as an example, this rule is only likely to be relevant in relation to the defensive rules in section FH 4 and FH 6. However, these rules will not trump the transitional rule, because the reason for the transitional residence exemption has nothing to do with the status of the relevant financial instrument (section FH 4) or the New Zealand tax treatment of the paying entity (section FH 6). No further legislative clarification is necessary or desirable. Officials will consider providing specific guidance on the issue if it is appropriate to do so.

Recommendation

That the submission be declined.

NRWT ON HYBRID ARRANGEMENTS – TREATY ISSUE

Clauses 4 and 42

Issue: Amendment should not override New Zealand’s DTAs

Submissions

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

The amendment ensures that NRWT or AIL applies in all instances where a deduction is allowed in New Zealand for an interest expense, notwithstanding any DTA.

Currently, when a New Zealand branch or PE of a non-resident company borrows money from another non-resident in the same jurisdiction as the PE’s corporate residence, and the borrowing takes place under a hybrid instrument (ie. the instrument is treated as debt in New Zealand but shares in the foreign jurisdiction) there is some doubt as to whether NRWT can be withheld. The particular legal issue is whether the payments on the hybrid instruments should be classified from the source state’s perspective (in which case they would be interest, and so NRWT could be withheld) or the residence state’s perspective (in which case they would be dividends, and so interest could not be withheld). The proposed amendments clarify this issue, by providing that NRWT can be withheld notwithstanding any DTA. Accordingly the amendment overrides New Zealand’s DTAs.

The proposed amendment unilaterally changes the effect of New Zealand’s DTAs. An indirect amendment to override DTAs is unacceptable. If the proposed change is a clarification then this should be clearly stated in our treaty negotiation papers and supported by our DTA partners. Any change should be a negotiated amendment with our DTA partners. Unilateral action undermines our international reputation and could have significant ramifications for future treaty negotiations and international agreements more generally.

Comment

Overriding a DTA is very undesirable and something Officials do not take lightly. However we consider it is justified in this case. As the problem arises under a DTA, a DTA override is necessary for the amendment to be effective. Further, there is general consensus that DTAs should be applied from the source country’s perspective. Accordingly, it is unlikely that the proposed rule would draw any opposition from our DTA partners – as it merely clarifies the current treaty interpretation approach.

We also note that Australia already has a domestic rule providing for the same result. In particular Australia’s rule also overrides its DTAs. However this rule has not attracted any adverse comment from other countries (including New Zealand).

Further it is clear that NRWT or AIL was intended to be payable on cross border interest payments. This was also Inland Revenue’s interpretation of the law until now, which was followed by many taxpayers. The ability to avoid NRWT or AIL through the use of a hybrid instrument is a clear loophole in the current rules, and taxpayers aware of the issue would have perceived it as such.

Recommendation

That the submission be declined.

Issue: Lack of certainty and consolation

Submission

(Corporate Taxpayer Group)

The Disclosure statement to the change states that the proposed rule “should not conflict with New Zealand’s DTAs”. It is inadequate to be giving only tentative “should” views on the implication for tax treaties, and in particular to not even consult with MFAT about some of the rule changes (which have been proposed since September 2016). New Zealand Officials having informal discussions with Officials in another country on the potential acceptability of a tax law overriding a double tax agreement does not create certainty for affected taxpayer

Comment

Officials disagree that “Should” is tentative view. Instead, it represents a high degree of confidence, but one falling short of 100% certainty.

The particular issue at which the change is directed arose very late in the policy process and unfortunately there was insufficient time to consult with MFAT.

It is the DTA override which provides certainty for affected taxpayers about the proposed change. In the absence of the DTA override, the effectiveness of the legislation would be uncertain.

Recommendation

That the submission be declined.

Issue: Clarify drafting of RF 11C(2)

Submission

(Matter raised by Officials)

The operative part of proposed section RF 11C(2) provides that “the NRWT rules apply to the amount as being interest, despite any provision in a double tax agreement that would otherwise require the NRWT rules to apply to the amount as being a dividend”.

Some Inland Revenue officials in the technical interpretation area have suggested that the NRWT rules have always applied to the amount as if it was interest and the DTA does not actually affect this. Instead the DTA arguably just prevents NRWT from being withheld from the amount on the basis that the DTA separately treats the amount as being a dividend.

To clarify this, officials recommend that proposed section RF 11C(2) be amended to provide something like “the amount is treated as interest for the purpose of the NRWT rules and any double tax agreement, despite any provision in a double tax agreement that would require the amount to be treated as a dividend”.

Recommendation

That the submission be accepted.

Issue: Hybrids treaty issue and tax havens

Submission

(Bryce Jensen)

The submitter objects to the use of offshore tax havens to pay a fair share of tax in relation to clause 42 of the Bill.

Recommendation

That the submission be noted.

[5] OECD (2017), Neutralising the Effects of Branch Mismatch Arrangements, Action 2: Inclusive Framework on BEPS, OECD/G20 Base Erosion and Profit Shifting Project, OECD Publishing, Paris

[6] OECD (2016), Public Discussion Draft, BEPS Action 2 Branch Mismatch Structures¸OECD/G20 Base Erosion and Profit Shifting, OECD Publishing, Paris.