Clarifications and remedials


ELIMINATING THE REQUIREMENT TO ESTIMATE AT THE FINAL INSTALMENT DATE FOR PROVISIONAL TAX


(Clauses 110 and 125(4))

Summary of proposed amendment

This proposed amendment removes the requirement for taxpayers to switch to the estimate method at the final instalment of provisional tax when they believe their residual income tax for the year will be less than the standard instalments and retain the interest concession contained in section 120KBB of the Tax Administration Act 1994.

Taxpayers will continue to be able to pay what they consider is the amount remaining at the final instalment date without changing from the standard “uplift” method. This will reduce compliance costs to the taxpayer.

Taxpayers who do estimate at any time during the income year will be subject to the standard use of money interest (UOMI) rules in section 120KB of the Tax Administration Act 1994 and will potentially be subject to UOMI from the date of their first provisional tax instalment.

In practical terms, this will not affect any taxpayers as they will continue to do what they always have, however, the method in which they do that will alter. Furthermore, the compliance costs of having to make an estimate will be removed.

Application date

The proposed amendment would apply from the 2019–20 income year.

Key features

These changes will allow provisional taxpayers who use the standard method to pay provisional tax to pay an amount lower than the standard method obligation on the final instalment date without having to switch to the estimation method.

Background

The interest concession rules are contained in section 120KBB of the Tax Administration Act 1994, these rules essentially allow those taxpayers who use the standard method and make the required payments to have no exposure to UOMI until the day after the final provisional tax instalment is due for the year.

This rule also applies to taxpayers who make the first two instalments using the standard method and make their final instalment under the estimation method. This rule was included in the final amending act due to a number of submissions made at the finance and expenditure committee which stated that if a person anticipated that their residual income tax (RIT) for the year in question was less than their uplifted provisional tax amount there was no legal ability for them to make a payment less than the standard instalment amount. This was notwithstanding the UOMI calculation would have calculated UOMI correctly and no late payment penalty would have been charged.

Example 12

Cookie Monsters Limited (Cookie) is a provisional taxpayer on a 31 March balance date who uses the standard uplift method. For the 2020–21 income year their standard instalments are based on 105% of their CY[6]-1 RIT which was $200,000. This gives them 3 instalments of $70,000. They pay both the first and second instalments on time on that basis but by the time the third instalment is due Cookie has calculated that due to the ongoing pressure from anti-obesity campaigns the market for their high sugar and fat content signature biscuit, “The Clogger”, has dramatically reduced. Cookie’s estimate of their 2020–21 RIT is $23,000 for the year.

Cookie decides to estimate their final instalment of provisional tax and make no payment. Cookie will still be able to use the interest concession rules even though they estimated at their final instalment date. UOMI will apply from the date of the final instalment where its tax liability is more than payments made.

This creates a compliance cost on taxpayers who then must switch provisional tax methods at their final instalment date and file an estimate. It also potentially exposes them to penalties for lack of reasonable care in making a reasonable estimate.

Detailed analysis

The proposed changes will allow taxpayers who make provisional tax payments under the standard method to vary their final instalment payment from the standard instalment to whatever they consider is owing at that date without having to switch provisional tax methods.

As UOMI will apply to any shortfall from the final instalment date taxpayers are always incentivised to pay their “actual” liability at that date and given the final instalment is some time after their balance date taxpayers should be able to reasonably accurately approximate the final amount payable.

The ability to use the estimation method will be removed from the interest concession rules in section 120KBB and therefore if a taxpayer estimates at any point during the year they will be under the estimation method for the entire year and potentially subject to UOMI from the date of the first instalment.

Practically, this will make no difference to taxpayers as they will continue to do the same as they always have but the compliance cost of switching provisional tax methods will be removed.


CLARIFYING THE “LESSER OF” CALCULATION OF INTEREST FOR STANDARD “UPLIFT” TAXPAYERS


(Clause 109(2) and (3))

Summary of proposed amendment

The proposed amendment clarifies the legislation to reflect the application of the “lesser of” calculation for standard “uplift” taxpayers to ensure this aligns with the way in which UOMI is calculated in Inland Revenue’s technology platforms.[7]

Application date

The proposed amendment would apply from the 2018–19 income year as the amendment aligns the legislation with the treatment within Inland Revenue’s systems. The proposed amendment is concessionary compared to the current legislation.

Key features

The proposed amendment aligns the application of the “lesser of” calculation of UOMI for standard “uplift” taxpayers with the way that Inland Revenue’s technology platforms have been calculating UOMI for those taxpayers. The proposed amendment provides that less UOMI is calculated than under the current legislation.

Background

For taxpayers who qualify to be able to use the interest concession rules contained in section 120KBB of the Tax Administration Act 1994, UOMI is calculated on a different basis than for other taxpayers. Generally, a taxpayer will be exposed to UOMI on the difference between their actual liability for the year divided by the number of instalments and what they paid. For example, a taxpayer who has residual income tax[8] (RIT) of $90,000 and has paid nothing will be charged interest on $30,000 at each instalment date (that is, $90,000 ÷ 3).

The interest concession rules operate differently and calculate UOMI (and late payment penalties) based on a “lesser of” rule contained in section 120KBB(3) of the Tax Administration Act 1994. This calculates UOMI on the difference between the lesser of the amount of the standard method instalment and the actual liability divided by the number of instalments. For example, if a taxpayer has an actual RIT of $40,000 at each instalment and their standard uplift instalments were $30,000 at each instalment date. UOMI for interest concession taxpayers will be charged on the $30,000 amounts less the amount paid at each instalment date (except for the final instalment which will have UOMI charged on the outstanding balance of RIT less payments made to date).

Detailed analysis

The standard “uplift” provisional tax method allows taxpayers to base their provisional tax instalments for the year on 105% of the prior year’s (CY[9]-1) RIT or 110% of the year previous to the prior year (CY-2) dependent on when they have filed their CY-1 tax return.

Up until the taxpayer files their CY-1 return a taxpayer will use 110% of the CY-2 RIT (initial uplift). When they file their CY-1 return and 105% of that RIT (the final uplift) is more than the initial uplift the system leaves the previous instalments at the initial uplift. The reason for this is that at that time the taxpayer made that payment, the only information they had to base the payment on was the initial uplift.

However, if the taxpayer files their CY-1 return and the final uplift is less than the initial uplift the system overwrites the initial uplift amount and replaces it with the lower final uplift amount. This is on the basis that once the taxpayer has filed their CY-1 return there is no ability to use the initial uplift and the final uplift effectively replaces that.

Logically these two rules make sense. If the initial uplift is lower than the final uplift, it should be used as it would be unfair to require a taxpayer to make a payment based on figures they had not yet calculated. Alternatively, if the final uplift is lower than the initial uplift that should replace the initial uplift as, firstly the taxpayer would have used that amount if they had known it at the time and, secondly, once that final uplift is known the initial uplift technically is no longer available. This rule will apply to instalments prior to the date the taxpayer files their CY-1 return (that is, the return with the final uplift).

Prior to the introduction of the interest concession rules this rule generally only mattered for the calculation of late payment penalties. Since the interest concession rule was introduced this distinction is more important as it affects the calculation of UOMI. As the lower of the two amounts is taken into account this treatment is taxpayer friendly, however, the distinction does matter when taxpayers transfer funds from a tax pool as they want to ensure they are making the correct transfer to avoid the payment of UOMI.

Inland Revenue’s legal team has determined that the legislation is not clear on this rule. The proposed amendment will clarify the legislation to ensure that the lowest amount of the initial or final uplift is used for the purposes of calculating UOMI and late payment penalties for instalments made prior to the date the taxpayer files the CY-1 tax return.

This rule does not change the obligation to pay either the initial or final uplift amounts in that if the taxpayers final uplift is less than their initial uplift they were still required to pay the initial uplift amount notwithstanding UOMI may not be charged on that basis. This will be important in determining if a taxpayer is an interest concession taxpayer if they are subsequently subject to a reassessment.

Both the FIRST and START systems apply this rule and thus the amendment will not affect taxpayers, but it will align the legislation with the system and policy intent.


CLARIFYING THE APPLICATION OF LATE PAYMENT PENALTIES APPLICABLE FROM THE FINAL PROVISIONAL TAX INSTALMENT DATE


(Clauses 124 and 130)

Summary of proposed amendment

An inadvertent legislative change meant that late payment penalties are applied to a taxpayer’s total provisional tax liability for the year rather than an instalment amount on the final instalment date. This proposed amendment aligns the legislation with administrative practice and with policy intention. As such, it will have no effect on taxpayers.

Application date

The proposed amendment would apply from the 2017–18 income year to provide certainty to taxpayers.

Key features

This change will align the legislation with Inland Revenue’s systems to ensure that late payment penalties are only calculated on an instalment amount at the date of the final instalment of provisional tax for the year rather than on the total outstanding tax liability at that date. UOMI will continue to accrue on the total tax liability outstanding. This change will align the legislation with the policy intent and the system configuration of Inland Revenue’s technology platforms.

Detailed analysis

The interest concession rules are contained in section 120KBB of the Tax Administration Act 1994, these rules essentially allow those taxpayers who use the standard method and make the required payments to have no exposure to UOMI until the day after the final provisional tax instalment is due for the year.

When the interest concession rules were introduced it was seen as desirable to align the basis for the calculation of UOMI and late payment penalties. This was done in the legislation and for the instalments other than the final one this is working as intended as both UOMI and late payment penalties are calculated using the lower of the standard instalment (105% of CY-1 or 110% of CY-2) or one third of their current year RIT.

However, on the final instalment the legislation currently requires the same formula to be used to calculate UOMI and the late payment penalty amount.[10] For the calculation of UOMI all of the taxpayer’s remaining tax liability is deemed to be due at the date of the third instalment as UOMI applies to that amount from the day after that date.

However, for late payment penalties this basis is inappropriate as charging a taxpayer for their entire RIT at that final instalment date is particularly unfair where they do not necessarily know the exact amount due. The basis for the penalty should be the lower of the instalment amount or one third of the taxpayer’s RIT. The legislation currently does not support this. Late payment penalties should only apply to an instalment amount rather than the total tax liability at that point although UOMI should apply on the full shortfall.

Inland Revenue’s systems have not been configured to reflect the legislation but have been configured to reflect the policy intent to charge a penalty based on the lower of the instalment amount or one third of the taxpayers RIT – the same basis as the other instalments.

It is desirable to align the legislation with the system in this case and change the legal basis for the calculation of the penalty on the final instalment to be the lower of the standard instalment due or one third of the taxpayer’s RIT.

In addition, the definition of RIT for the purposes of calculating UOMI will be clarified to ensure it more clearly refers to the taxpayer’s current year RIT.


REMOVING THE ABILITY FOR TAXPAYERS TO CHOOSE THE PROVISIONAL TAX INSTALMENT TO WHICH A PARTICULAR PAYMENT IS APPLIED


(Clause 126)

Summary of proposed amendment

The Tax Administration Act 1994 contains a provision that permits a taxpayer to direct the application of a provisional tax payment made to a particular instalment. Inland Revenue’s legal team has recently reviewed the application of this provision. Prior to the introduction of the interest concession rules in section 120KBB of the Tax Administration Act 1994 and the removal of incremental penalties from income tax it was always beneficial for taxpayers to apply payments to the oldest debt first.

Since the introduction of the interest concession rules and removal of incremental penalties this is no longer true. A taxpayer might now inappropriately apply the payment to more recent debt in order to avoid late payment penalties.

Removing the ability of taxpayers to choose the particular instalment to allocate a provisional tax payment will eliminate this issue. It is also proposed that the section be clarified to specifically require the Commissioner to allocate the particular payment to the oldest debt first.

Inland Revenue’s systems do not allow the allocation of a payment to particular payment dates when there is debt on a prior provisional tax date.

This proposed amendment will have no impact on most taxpayers but will prohibit non-compliant taxpayers from reducing their exposure to late payment penalties.

Application date

The proposed amendment would apply from the 2018–19 income year for integrity reasons. In the unlikely event of a taxpayer having previously requested and obtained a payment direction a savings provision will preserve this treatment.[11]

Key features

The ability for taxpayers to allocate their provisional tax payment to particular instalments will be removed and the Commissioner will be required to allocate payments to the oldest outstanding provisional tax instalment.

Detailed analysis

The payment allocation rules for provisional tax payments are contained in section 120L of the Tax Administration Act 1994. These provide that if a taxpayer makes a provisional tax payment and does not specify which instalment it should be directed to, the Commissioner must apply the payment where she thinks the taxpayer would have applied it.[12] Or if the taxpayer does specify which instalment, the Commissioner must apply the payment to that particular instalment.[13]

Prior to the inclusion of the interest concession rules and removal of incremental late payment penalties[14] from income tax it was always beneficial to apply payments to the oldest debt first as this would reduce the taxpayer’s liability to both incremental penalties and UOMI.

Since the interest concession rules were introduced it can be more advantageous for taxpayers to allocate their payments to specific provisional tax instalments to reduce their liability to late payment penalties on later instalments.

Example 13

Grouchy Limited is owned by Oscar and is a provisional taxpayer for the 2020–21 year. Its instalments are $25,000 at each provisional tax instalment. Oscar is a bit cash strapped and fails to pay the first instalment of provisional tax for Grouchy. Grouchy is charged a late payment penalty on the $25,000 debt of $1,250 as well as UOMI for that debt. At the second instalment date Grouchy has a spare $25,000 and decides to make a payment as provisional tax.

Prior to the removal of incremental penalties and the interest concession rules it would be more beneficial for Oscar to allocate that payment of $25,000 to the first instalment of provisional tax to reduce both incremental penalties and UOMI on that outstanding debt.

Subsequent to the changes Oscar now considers it more advantageous to allocate that payment to the second instalment. This will avoid any late payment penalties or UOMI arising on that payment. Given that there are no further late payment penalties on the debt from the first instalment and only UOMI is accruing on that, he will be $1,250 better off by allocating the payment to the second instalment.

This example is not appropriate. It gives a benefit to taxpayers who have outstanding debt. In addition, both the FIRST system and the configuration of the START system cannot allocate payments in this manner.

The proposed amendments remove the ability for taxpayers to request which provisional instalment their payment is allocated to. This will remove the ability for non-compliant taxpayers to reduce their exposure to late payment penalties and UOMI. In addition, it is recommended that a provision be added to the legislation to require the Commissioner to apply payments to the oldest unpaid instalment first.


CLARIFYING THE WAY IN WHICH PROVISIONAL TAX IS TRUNCATED TO WHOLE DOLLARS


(Clause 110)

Summary of proposed amendment

It is Inland Revenue’s operational practice to truncate provisional tax amounts to whole numbers and its technology platforms have been designed in keeping with that practice.

However, Inland Revenue’s legal team has concluded that the way in which its technology platforms truncates instalments to whole numbers is not consistent with the legislation.

Inland Revenue’s systems have been configured to apply these rules on truncated whole dollars and will not prevent taxpayers receiving a concession when partial dollars are truncated. The proposed amendment confirms that configuration. In practical terms, this amendment will not affect any taxpayers.

Application date

The proposed amendment would apply from the 2019–20 income year.

Key features

The proposed amendment would confirm that where Inland Revenue systems truncate provisional tax amounts to whole numbers, payment of those whole dollar amounts rather than the amount including cents will be considered to meet the requirements to take advantage of concessionary regimes such as the safe harbour.

Detailed analysis

Truncating to whole dollars for any instalment is beneficial to taxpayers both through simplicity and marginally financially. However, it can have negative consequences when assessing whether taxpayers meet certain requirements, such as the safe harbour[15] from UOMI. If cents are included and taxpayers pay the truncated whole dollar amount which the system has told them to pay, technically, they do not meet the requirements of the safe harbour.

Inland Revenues legal team has recently reviewed the legislation that deals with the calculation of provisional tax instalments and the application of UOMI to any shortfalls.

One of their conclusions is that the legislation and the system do not align for the way in which amounts are truncated. When provisional tax instalments are calculated under the standard method the legislation requires the uplifted amount to be divided into three equal instalments. For simplicity to taxpayers the system ignores, or truncates, any cents in that calculation.

For example, assume that Grover Limited is a provisional taxpayer who uses the standard uplift method. Their RIT for the 2020–21 income year was $124,567. This will make their standard method uplift amount for the following year $130,795.35. Grover’s three instalments will be calculated as follows:

Table 4: Truncation calculation example
Instalment Calculation Amount of instalment Truncated amount
1 $130,795.35 ÷ 3 $43,598.45 $43,598
2 ($130,795.35 × (2 ÷ 3)) − $43,598.45 $43,598.45 $43,598
3 ($130,795.35 − $43,598.45 - $43,598.45) $43,598.45 $43,599
Total   $130,795.35 $130,795

However, to determine whether a taxpayer has met the criteria for the interest concession rules, for example, technically the taxpayer should have paid the instalment outlined in the amount of instalment column in table 4, which is $43,598.45. The system does not use this amount and assesses the ability to use concessions based on the truncated whole number.

This is a taxpayer friendly treatment and is much simpler. This proposed amendment would align the legislation with the system to ensure that taxpayers are not prohibited from using a concession because they have not paid the cents for an instalment.


NON-STANDARD PROVISIONAL TAX INSTALMENTS


(Clause 129)

Summary of proposed amendment

An amendment was made to section 139B(6)(bb) of the Tax Administration Act 1994 when the interest concession rules in section 120KBB were inserted into the Tax Administration Act 1994 to ensure the definitions worked with the new rules. A taxpayer that has more or less than three instalments of provisional tax, were not correctly dealt with and this should be corrected for clarity.

Application date

The proposed amendment would apply from the 2019–20 income year.

Key features

This proposed amendment alters section 139B(6)(bb) of the Tax Administration Act 1994 to account for taxpayers who have a non-standard number of instalments of provisional tax.

Detailed analysis

When the interest concession rules were introduced in the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Act 2017 a late change was made to the legislation to deal with taxpayers who had more or less than three instalments of provisional tax.

A number of references were correctly altered in the final Act to account for this change, however, one appears to have been missed. A definition in section 139B(6) of the Tax Administration Act 1994 was not updated for the inclusion of these taxpayers and still refers to three instalments of provisional tax.

While this has not adversely affected any taxpayers as Inland Revenue has applied that section as it was intended officials suggest this now be corrected to account for taxpayers who have more or less than three provisional tax instalments from the 2019–20 income year.


TAXATION OF TRUSTS


(Clauses 59, 87 to 97, and 113(16) to (20))

Summary of proposed amendments

The proposed amendments arise from an administrative review of the taxation of trusts which identified several areas in the current law that are unclear or do not appropriately reflect the policy intent.

The proposed amendments are:

  • remedial in nature; and
  • clarify the trust rules so that they work as intended, as described in IS 18/01.

Application date

The proposed amendments would apply from the date of enactment unless otherwise stated in this commentary item.

Detailed analysis

The Commissioner’s application of the Income Tax Act 2007 (ITA) relating to the taxation of trustees and beneficiaries (the trust rules) is set out in Interpretation statement IS 18/01 Taxation of trusts – income tax[16] (IS 18/01).

Clause 59: Clarifying the relationship between section BB 2 and BF 1

The core provisions of the ITA (the core provisions) impose:

  • income tax on taxable income, withholding taxes on some classes of income and other forms of tax (termed ancillary tax); and
  • provide the method for calculating a person’s income tax liability links to parts of the Act that set out detailed mechanisms for calculating withholding tax and ancillary taxes.

The proposed amendment ensures that the wording in section BB 2(5) refers to both income tax and ancillary tax, to provide consistency in terminology between sections BB 2(5) and BF 1 (ITA 2007).

Clause 87: Residence of a trustee treated as a notional single person

In the ITA 2007, the term trustee is defined to include all co-trustees for the time being. Under section HC 2 of the ITA, co-trustees are treated as a notional single person for satisfying the income tax obligations for trustee income of that trust.

Under the core provisions, the source of the income and the residence of the trustee are important for determining the income tax obligations for trustee income. These obligations are determined by either:

  • the residence of the trustee (a New Zealand resident trustee is taxable on world-wide trustee income);
  • the source of the income (New Zealand taxes income sourced in New Zealand);
  • the residence of the settlor, if the trust derives foreign sourced income (New Zealand taxes foreign sourced income only if the settlor of the trust is a New Zealand resident).

Under IS 18/01 and Interpretation statement 16/03: Tax residence[17] (IS 16/03), the Commissioner considers that the current law treats co-trustees as resident in New Zealand as follows:

  • at any point in time, or for a period, the trustee (as a notional single person) is a New Zealand resident if at least one of the co-trustees is resident in New Zealand at that time or for that period; and
  • correspondingly, the trustee (as a notional single person) is a non-resident only if all the co-trustees are non-resident at that time or for that period.

The proposed amendments to section HC 2 align the law with how the Commissioner applies the law. As a result, the residence of co-trustees is determined (as described above) for:

  • calculating the trust’s taxable income for an income year;
  • providing a joint return of income for the trust for each income year;
  • assessing the trust’s taxable income and income tax liability for each income year;
  • satisfying the income tax liability on trustee income of the trust for each income year; and
  • satisfying the trustee’s obligations as an agent under section HC 32 for a distribution of beneficiary income and a taxable distribution.
Application date

The proposed amendment would apply for income years beginning after enactment date.

Clause 88: Corpus of a trust

What is not included in corpus

The proposed amendment to section HC 4(1) clarifies that if a settlement is not capable of being distributed as income to beneficiaries, it cannot be included in the corpus of the trust, that is, the assets such as property, bank accounts, stocks, etc.

For example, the value of free legal services provided to a trustee for the benefit of the trust is a transfer of value (unless those services are incidental to the operation of the trust). Under current law, the value of those free services:

  • the person providing the legal services is a settlor of the trust (the residence of the settlor is important for determining whether a trust is a foreign trust);
  • constitute a settlement; and
  • is not capable of being distributed.
Consistency with section HC 3 (ITA)

Under trust law, each settlement creates a separate trust. For income tax purposes, this is modified to permit trustees to elect to treat multiple property settlements on the terms of a trust deed as being additions to corpus of the same trust (section HC 3 of the ITA). The value of each settlement is equal to the market value at settlement.

The proposed amendment (new section HC 4(1B)) clarifies that, when a trustee treats multiple property settlements as being on one trust, the total value of corpus is the market value of all those property settlements. This clarification:

  • is consistent with practice; and
  • ensures that the ordering rules for distributions (section HC 16 of the ITA) can be applied in a manner consistent with the ability of trustees to elect for multiple settlements to be treated as being on one trust for income tax purposes.

Clause 89: Exclusions from corpus that are treated as trustee income

The policy purpose for excluding property settlements from corpus under section HC 7(3) is to mitigate against a deferral of tax.

The proposed amendment clarifies that when a settlement excluded from corpus it is included in trustee income for the income year in which the settlement occurred unless the income is distributed in the same income year to a beneficiary. The amendment is proposed to apply from 1 April 2008 to validate tax parties taken on this basis.

If the trustee distributes this income as beneficiary income or a taxable distribution in the same income year (which is taxed to the beneficiary), the amount of trustee income for a settlement excluded from corpus is reduced by the amount of that distribution.

The proposed amendment applies to the following types of resettlements so that the beneficiary and not the trustee is taxed if that re-settlement is distributed to a beneficiary in the same year:

  • A re-settlement by a trustee on a sub-trust that could otherwise have been distributed as income that would be taxable to a New Zealand resident beneficiary.
  • A settlement that is an allowable deduction for the settlor (for example, an employer’s contribution to a trust that provides non-retirement benefits for employees).
  • A settlement that would otherwise be income of the settlor and assessable for income tax in New Zealand.

Clause 90: Election to be a complying trust

The proposed amendment to section HC 10(1)(ab) clarifies the point in time from when a trust may be treated as a complying trust if an election has been made to pay New Zealand tax on worldwide trustee income.

The main clarification is that a trust will be a complying trust for a distribution of trustee income earned after the application date of election.

Under the proposed amendments to section HC 33 in clause 97, a trust may elect to alter its status from a foreign trust or a non-complying trust to become a complying trust, but only from the date from which the election applies.

The proposed amendment confirms that a complying trust is either:

  • a trust that has always had a New Zealand resident settlor and has always satisfied its New Zealand tax obligations on its taxable income; or
  • a trust that has elected (or is deemed to have elected) to pay New Zealand tax at the trustee rate on world-wide trustee income and from the date the election applies, the trust has always satisfied its New Zealand tax obligations for its taxable income.

This proposed clarification, together with the proposed amendments to section HC 33 (clause 97 refers), ensures that the taxation of distributions from a trust operates as intended for tax-paid trustee income and capital gains.

Clause 91: Taxable distributions from foreign trusts and non-complying trusts

Clause 91(1): Source of a capital gain included in a taxable distribution

A distribution (other than beneficiary income) from a trust that is not a complying trust is subject to tax because it may consist of income and gains derived by the trustee that have never been subject to New Zealand tax.

This rule ensures that New Zealand tax cannot be avoided by sheltering income and capital gains in a foreign trust or in a trust that is non-compliant with New Zealand’s tax laws. Instead, when this sheltered income or gain is distributed to a beneficiary, the distribution is taxable to the beneficiary and the trustee is liable as agent to pay this tax. Such a distribution is termed a taxable distribution.

A taxable distribution may consist of tax-paid trustee income and certain capital gains arising in a year before the distribution is made. Ordering rules in section HC 16 determine the composition of a taxable distribution. Some clarifications for these ordering rules are discussed in the commentary item for clause 92.

A taxable distribution is treated as:

  • income of the beneficiary, if it is distributed from a foreign trust and included in the calculation of the beneficiary’s assessable income and taxed at the beneficiary’s marginal rate of tax;
  • excluded income of the beneficiary, if it is distributed from a non-complying trust. This amount is not included in the beneficiary’s assessable income but is instead subject to a special income tax at the rate of 45%; and
  • for both cases, a non-resident beneficiary is not taxable on a foreign-sourced amount included in that taxable distribution.

Proposed new section HC 15(5C) of the ITA clarifies that the source of a capital gain included in a taxable distribution is determined by applying the source rules in section YD 4 of the ITA that apply to income. This clarifies that a non-resident beneficiary will not be taxed on a capital gain included in a taxable distribution if that capital gain is not sourced in New Zealand. This is because New Zealand taxes non-resident beneficiaries only on their income and gains sourced from New Zealand.

Clause 91(2): Taxable distribution not subject to the ordering rule

The proposed amendment to subsection HC 15(6) removes redundant wording relating to the tax consequences of distribution, transmission and gifts of property. These rules treat distributions of property from a trust as being made at market value and the omitted words are no longer necessary.

However, the provision of financial assistance or any services by the trust to beneficiaries at less than market value continues to be a taxable distribution in the year of the distribution (for example, rent-free house accommodation provided to a beneficiary of the trust). Such a distribution is not subject to the ordering rules in section HC 16.

Clause 92: Ordering rules

Clause 92(1) to (5): Order of distributions

The current ordering rules in section HC 16 of the ITA determine the amounts of tax-paid trustee income, capital gains and corpus that are included in a distribution to a beneficiary from either a foreign trust or a non-complying trust. The ordering rules do not apply to a distribution from a complying trust.

The current ordering rule is unclear on how a distribution of beneficiary income from a prior year is to be treated. This is because the ITA gives a trustee a period after the end of the income year to determine the amount of beneficiary income and provide for the distribution of that income.

The proposed amendments to section HC 16(2) of the ITA ensure that distributions of beneficiary income in the preceding and current years are treated as intended.

Clause 92(6), (7): Manipulating the nature of a distribution

Section HC 16(5) of the ITA is intended to prevent trustees using the ordering rule to manipulate the nature of a distribution for New Zealand tax purposes to stream income and capital to different classes of beneficiary (for example, resident and non-resident beneficiaries). The rule ignores the tax effect of an earlier distribution in determining whether a subsequent distribution would not be treated as either beneficiary income or a taxable distribution.

The proposed amendments address a question raised about whether the rule should apply to genuine transactions that result in a distribution of beneficiary income that is not placed beyond the control of the trustee. A normal practice for trustees is to credit a beneficiary’s current account for an amount of beneficiary income. However, this practice does not necessarily result in that amount of beneficiary income being placed beyond the control of the trustee, even though the amount of income that has been vested in the beneficiary.

The proposed amendments to section HC 16(5) clarify that the provision:

  • applies to a second distribution that is not treated as either beneficiary income or a taxable distribution; and
  • removes the requirement that the distribution be placed beyond the control of the trustee to ensure that commercial practices for vested distributions are not disturbed.

Clause 93: Foreign sourced income, resident trustees

The proposed amendment to section HC 26 of the ITA addresses a question raised about the scope of the exemption for foreign sourced income derived by a resident trustee during an income year for a trust that does not have a New Zealand resident settlor at any time during that year.

The proposed amendment clarifies that foreign sourced income derived by such a trustee will be exempt income only if it is retained as trustee income. Therefore, the exemption will not extend to either:

  • foreign sourced income that is distributed as beneficiary income; or
  • minor beneficiary income that is attributed back to the trustee and taxed as if it were trustee income (33% tax rate applies).

Clause 94: Who is a settlor – direct or indirect settlements

The administrative review of the taxation of trusts identified uncertainty about the scope of section HC 27 that deems a person to be a settlor of a trust for a series of transactions that result in a transfer of value to a trust.

The proposed amendment clarifies that for a person to be a settlor for an indirect transfer of value to a trust, that person must have some influence or control over the transactions involved so that it can be said that the person causes the transfer or provision to occur. IS 18/01 indicates at paragraph 2.62 a causative factor is more likely to occur where associated parties are involved.

Clause 95: Activities treated as those of a settlor

The proposed amendments to section HC 28 clarify when a shareholder of a controlled foreign company (CFC) is treated as a settlor. If a CFC has settled a trust, it is intended that a shareholder in the CFC is also treated as a settlor of that trust if the shareholder has a control interest of at least ten percent in the CFC either:

  • at the time of the settlement; or
  • for the accounting period of the CFC in which the settlement occurs.

The proposed amendment aligns the law with the policy intent and is consistent with the Commissioner’s practice set out in IS 18/01.

Clause 96: Valuation for transfer of values by deferral or non-exercise of right to demand payment

The proposed amendment (which inserts a new section HC 31B) addresses a question raised during the administrative review of the taxation of trusts relating to the valuation of financial assistance provided if there is:

  • an obligation to repay interest or principal on demand;
  • and the right to demand repayment is not exercised or is deferred.

The proposed new section provides a formula for calculating the value of either a settlement under section HC 27(2)(b) or a distribution arising from a transfer of value, in either case arising from:

  • the provision of financial assistance (including a guarantee) by one person (the creditor) for the benefit of another person; and
  • the right of the creditor to demand the debt amount, or a guarantee, is not exercised or is deferred.

The proposed formula is like the calculation of the value of a fringe benefit for on-demand shareholder current accounts and is consistent with the recent law change proposed for section HC 27(5) (see clause 56 of the Taxation (Annual Rates for 2019–20, GST Offshore Supplier Registration, and Remedial Matters) Bill.

The formula is based on the nominal value of the financial assistance given (the debt amount) and the prescribed interest rate. The value of the distribution or settlement for any period (for example, an income year) is the amount by which the prescribed rate of interest (currently 5.77%) exceeds the actual rate of interest payable for the financial assistance.

If a trustee owes an amount to a beneficiary of the trust, the beneficiary will not be a settlor of the trust if either of the following applies:

  • the trustee pays interest at a rate equal to or greater than the prescribed rate of interest; or
  • the amount owing at the end of the income year is not more than $25,000.

Clause 97: Elections to pay New Zealand tax on worldwide trustee income

Redundant wording omitted

Clause 97(1) proposes the removal of redundant wording from section HC 33(1B), consequential to other proposed amendments in this clause.

Notification requirements

Clause 97(2) proposes a clarification to section HC 33(1B) that treats a notification of complying trust status in a return of income as an election to pay New Zealand tax on the trust’s worldwide trustee income.

This deemed election applies to a trust that derives income that would either not be taxed in New Zealand or not be taxed at the trustee rate (33%) on any of the following classes of income:

  • non-resident passive income (for example, dividends and interest derived by a non-resident trustee from a New Zealand source);
  • non-resident’s foreign sourced income (for example, rents derived by a non-resident trustee from a foreign source); or
  • foreign sourced income that is exempt income of a resident trustee under section CW 54 (the exemption applies to trustee income if the trust does not have a settlor resident in New Zealand).

The deemed election applies in any year in which the classes of income described above are not fully taxed in New Zealand. An example of such a trust is one that does not have a resident settlor because the settlor has migrated from New Zealand and the trust was a complying trust up to the migration. Because this trust no longer has a New Zealand resident settlor, it might not satisfy the requirements of section HC 10(1)(a) to be a complying trust because for example:

  • if the trust has a non-resident trustee, foreign sourced income would not automatically be taxable in New Zealand under the rule in section HC 25 (a trust with a resident settlor is taxable on its world-wide trustee income);
  • if the trust has a resident trustee, foreign sourced income may become exempt under section CW 54 (a trust with a non-resident settlor is taxable only on income sourced from New Zealand).

Under current law, this deemed election ensures that when a New Zealand resident settlor of a complying trust migrates out of New Zealand, the trust’s complying trust status is not disturbed provided the return of income from the year of migration indicates the trust is a complying trust and the trustee continues to pay New Zealand tax on the worldwide trustee income.

The proposed amendment clarifies that the deemed election can also apply to a registered foreign charitable trust, as such a trust is required to file an annual return of income for periods ending after 1 April 2019.

A trust that has previously elected to pay New Zealand tax on its world-wide trustee income may become an inactive trust. An inactive trust is a trust that derives no income, has no deductions, and makes not distributions to beneficiaries that are income of the beneficiary. An inactive trust may wish to retain this complying trust status after the trust notifies the Commissioner it has non-active status.

The proposed amendment clarifies that such a trust must notify the Commissioner on an annual basis that the election to pay New Zealand tax on world-wide trustee income is to continue. This requirement is to draw the trustee’s attention to the requirements for being a non-active trust, and to assist the Commissioner in identifying whether any distribution from such a trust is from a complying trust. It is expected that this requirement will be satisfied by notifying the commissioner through the trustee’s MyIR account.

Election requires taxable income to be calculated on world-wide trustee income at the trustee rate

Clauses 97(3) and (4) propose a clarification in new section HC 33(1C) to ensure that if an election is made for a trust to pay tax on its world-wide trustee income, it must calculate its taxable income:

  • as if it had both a New Zealand resident trustee and a New Zealand resident settlor; and
  • the obligations for New Zealand income tax on world-wide trustee income must be satisfied on that basis.

The interaction between the proposed amendments in HC 10 (clause 90), HC 33(1C) and HC 33(2)(a) mean that a trust electing to pay tax on world-wide trustee income can only be a complying trust if:

  • New Zealand has full taxing rights to that world-wide trustee income;
  • the New Zealand tax obligations for that trustee income are satisfied for each income year from the application date of the election (N.B. this requirement considers that foreign tax credits may be allowed to the trustee for foreign tax paid on trustee income not sourced in New Zealand).
Application date of elections

Clause 97(5) proposes to clarify in section HC 33(3) the date from which an election to pay New Zealand tax at the trustee rate applies:

  • From the date of the election for a settlor who has migrated to New Zealand and who makes the election within either one year of the migration or one year of transitional residence ceasing.
  • From the date chosen by the person making the election in other cases (this is either the date of the election or the beginning of the income year in which the election is made).
  • For a deemed election (for example, for a trustee company that wasn’t aware the settlor of their client trust had migrated out of New Zealand), from the beginning of the first income year the return of income indicates the trust is a complying trust.

In addition, the proposed amendment in section HC 33(3B) clarifies that if the trust’s New Zealand tax obligations are not satisfied, the complying trust status is lost from the beginning of the income year in which those obligations are not satisfied.

Taxation of distributions from a trust that has elected to become a complying trust

Clause 97(6) proposes an amendment to insert a new subsection HC 33(5). This would apply for all trusts that have elected (or deemed to have elected) to pay New Zealand tax at the trustee rate on world-wide trustee income.

The proposed amendment clarifies that the tax treatment of a distribution of tax-paid trustee income or a capital gain from a trust that has elected to become a complying trust is dependent on:

  • the compliance status of the trust at the time when the trustee derives the income or capital gain being distributed;
  • the ordering rules that apply to determine the composition of distributions from a foreign trust or non-complying trust.

The proposed amendment ensures that distributions from tax-paid trustee income are treated as being made from a complying trust only if the distribution is made from trustee income is derived after the date from which the election applies. The ordering rules in section HC 16 are applied to determine the composition of a distribution.

For example, a non-complying trust elects to be a complying trust in March 2021, for the year beginning 1 April 2020 and the tax obligations for that trustee income are fully complied with from 1 April 2020. However, all distributions from trustee income and capital gains earned before 1 April 2020 would continue being treated as a distribution from a non-complying trust and included in a taxable distribution.

The amendment also proposes that, when all income and capital gains from the trust during the period it was a non-complying trust have been fully distributed, only then would distributions be treated as being made from a complying trust.

Clause 113(16) to (18): Definition of transfer of value

Clearer distinction in terminology

The amendment proposed in clause 113(16) and (17) provide a clearer distinction in the definition of “transfer of value” in section YA 1 of the ITA. A distinction is drawn between a transfer of value relating to dividends paid by a company and a transfer of value relating to the meaning of the definitions of settlor and distribution. Clauses 63 to 68, 76, 77, 79, 82 and 86 propose consequential effects for this clarification.

Unintended legislative change corrected

In clause 113(18), it is proposed to clarify the definition of “transfer of value” to correct an unintended legislative change in the rewrite relating to the scope of the meaning of settlor, settlement and distribution. This proposed amendment restores the law to its pre-rewrite effect to ensure that a transfer of value by providing money’s worth occurs whether or not that money’s worth is convertible into money.

Clause 113(19) and (20): Definition of trust rules

The proposed amendments ensure that the defined term “trust rules” in section YA 1 of the ITA refers to provisions that were inadvertently omitted from this definition during the rewrite of the trust rules.

The proposed amendment would apply from the beginning of the 2008–09 income year. This reflects the Commissioner’s practice.


TAX CREDITS FOR BENEFICIARIES OF TRUSTS


(Clause 104)

Summary

The proposed amendment:

  • corrects an unintended legislative change in the rewrite of the provision; and
  • restores the law to its Income Tax Act 2007 pre-rewrite position to ensure that tax credits attached to distributions from trusts are pro-rated by reference to the amount of all distributions made to beneficiaries.

Application date

The proposed amendment would apply from the beginning of the 2008–09 income year. A savings provision is proposed to protect taxpayers who have taken a tax position in a manner consistent with the pre-rewrite legislation.

Key features

Māori authority tax credits attached to a distribution from a trust are intended to be apportioned by reference to all distributions and all tax credits distributed from that trust.

An unintended legislative change in the rewrite of this provision resulted in the formula working incorrectly. The proposed amendment restores this aspect of the law so that it works as intended.


INCOME ATTRIBUTION RULE AND FOREIGN TAX CREDITS


(Clauses 84 and 103)

Summary of proposed amendment

The proposed amendment addresses two issues raised about the income attribution rules in the Income Tax Act 2007 (ITA). If an associated entity of a working person under the rules pays tax overseas, a foreign tax credit (FTC) does not appear to be available to either the entity or the person for the foreign tax paid. The term “net income” is clarified to reflect the policy intent and how the Commissioner is applying the law.

Application date

The proposed amendments would apply retrospectively from 1 April 2008, being the date from which an FTC is intended to be allowed.

Key features

  • Section GB 29 is amended to clarify how the calculation of the associated entity’s “net income”, which is attributed to the working person, interacts with the definition of “net income” in the ITA.
  • Section LJ 2 is amended to ensure the working person receives an FTC for foreign income tax paid by an associated entity on an amount attributed to the working person.

Background

The income attribution rules apply when an individual (“the working person”) earns income from providing their own services to a buyer (“personal services income”) through an interposed entity (“the associated entity”)[18] that has one main source of such income. The rules disregard the entity and seek to tax the working person directly to ensure that the personal services income is taxed at the working person’s marginal rate, rather than at the company tax rate. Under the attribution rule:

  • an amount attributed from the associated entity to the working person is income of the working person; and
  • the associated entity is allowed a deduction for the amount attributed to the working person so that the personal services income derived by the entity is not subject to double taxation.

The proposed amendments to sections GB 29 and LJ 2 ensure that if the associated entity pays foreign income tax on its personal services income, the working person can obtain an FTC for that foreign tax.

Detailed analysis

The proposed amendments seek to address:

  • the clarity of the calculation in the income attribution rule; and
  • the inability of the working person (who is a New Zealand resident) to obtain a foreign tax credit for foreign income tax paid on personal services income attributed to them from the associated entity.

Income attribution rule

An issue has been identified concerning the use of the term “net income” in section GB 29, which provides the calculation for the amount of income to be attributed from the associated entity to the working person. Officials consider that the use of “net income” in this calculation is confusing. The Commissioner interprets this “net income” amount as ignoring the deduction allowed to the associated entity for the attribution of the net income amount, otherwise the provision is circular and therefore unclear.

The proposed amendment aligns the law with both the policy intent and how the Commissioner applies the law.

Foreign tax credit

A person resident in New Zealand is allowed an FTC for foreign tax paid on an amount of foreign sourced income. The amount allowed as an FTC is the lower of:

  • the NZ tax payable on that foreign sourced income; and
  • the foreign income tax paid on that foreign sourced income.

Under the current law, it is not possible to treat foreign sourced personal services income derived by the associated entity as also being foreign sourced income of the working person. This prevents the working person (being a New Zealand resident) from receiving an FTC for foreign tax paid by the associated entity on that attributed income.

The proposed amendments ensure that:

  • the working person receives an FTC for foreign tax paid by the associated entity on income attributed to the working person, provided they are a resident of New Zealand when the income is derived; and
  • the associated entity does not receive a FTC for the foreign income tax paid on income attributed to the working person.

INCOME ATTRIBUTION RULE AND TREATMENT OF DIVIDENDS


(Clause 83)

Summary of proposed amendment

The proposed amendment resolves an issue regarding one of the income attribution provisions in the Income Tax Act 2007 (ITA). The amendment ensures that a dividend paid by a company (“associated entity”) that has previously attributed income to a shareholder (“working person”) will be exempt only if the company can show that the dividend has been paid out of income that has already been attributed to and taxed in the hands of the working person.

Application date

The proposed amendment would apply retrospectively from 1 April 2008, when section GB 27(4) came into force, with a savings provision (to apply from 1 April 2008 until the date of introduction of the Bill) to protect tax positions taken based on the existing law.

Key features

Subsection GB 27(4) is amended to ensure that a dividend is exempt only if it is paid:

  • by the associated entity to the working person no earlier than the end of six months after the end of the income year; and
  • it is paid from personal services income that has been previously attributed to the working person under the income attribution rules.

There is an additional criterion that the entity must keep sufficient records to enable the Commissioner to verify the source of the dividend.

Background

The income attribution rules apply when an individual (“the working person”) earns income from providing their own services to a buyer (“personal services income”) through an interposed entity (“the associated entity”)[19] that has one main source of such income. The rules disregard the entity and tax the working person directly to prevent tax on income from the individual’s personal services being paid at the company rate of 28%, instead of at the working person’s marginal rate of tax.

The income attribution rules effectively distinguish between two types of dividend paid by an associated entity to the working person:

  • a dividend paid during the income year in which the income was derived and is to be attributed, or before the end of six months after the end of that income year (“in-year dividend”);
  • a dividend paid later than six months from the end of the income year in which the income was derived and attributed (“post-year dividend”).

The distinction between the two types of dividend is intended to ensure that:

  • when calculating the amount of income to attribute to the working person, the associated entity can recognise in that calculation the amount of an in-year dividend paid out of personal services income derived by the associated entity;
  • a dividend sourced from personal services income derived by the associated entity, and which has already been taxed to the working person, is not taxed a second time when it is paid to the person (post-year). This is achieved by exempting the post-year dividend in the hands of the working person.

The current wording in subsection GB 27(4), which treats post-year dividends as exempt from tax, is not sufficiently clear that its application is limited to dividends paid out of income that has already been attributed. Therefore, the proposed amendment more clearly limits the exemption to post-year dividends.


DATE WITHDRAWAL TAKES EFFECT FOR BINDING RULINGS ON MATTERS NOT INVOLVING ARRANGEMENTS


(Clauses 119 to 121)

Summary of proposed amendment

The amendments clarify that where the Commissioner of Inland Revenue has issued a private, short-process, or product ruling for an issue that does not involve an arrangement, and the ruling is withdrawn, taxpayers can continue to apply the ruling for the period specified in the ruling.

Application date

The proposed amendments would apply for:

  • private and product rulings from 18 March 2019; and
  • short-process rulings from 1 October 2019.

Key features

The key feature of the proposal is to make it clear that taxpayers can continue to rely on a private, short-process, or product ruling for the period specified in the ruling, if the ruling is on a matter not involving an arrangement.

Background

The binding rulings regime is contained in Part 5A of the Tax Administration Act 1994. The provisions within Part 5A enable the Commissioner to issue binding rulings, which provide certainty to taxpayers about how the Commissioner will apply tax laws in relation to a person’s circumstances.

Until recently, the Commissioner was only able to issue binding rulings for an arrangement. Amendments included in the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 extended the scope of matters for which the Commissioner could issue binding rulings (without the need for an arrangement) to allow rulings on:

  • a person’s status (for example, on their New Zealand tax residency);
  • whether an item of property meets the definition of “trading stock” or “revenue account property” as defined in section YA 1 of the Income Tax Act 2007; and
  • whether an amount derived by a person is income under certain provisions in subpart CB of the Income Tax Act 2007 relating to land transactions.

The Commissioner has an existing ability to withdraw binding rulings under various provisions in the Tax Administration Act 1994. Where a ruling is withdrawn, if it relates to an arrangement, taxpayers can continue to rely on the ruling for the period specified in the ruling if they have already entered into the arrangement prior to receiving notification that the ruling has been withdrawn.

The existing rules do not cater for circumstances where a binding ruling is issued for a matter that does not involve an arrangement. An amendment is therefore proposed to allow taxpayers to continue to rely on a ruling for the period specified in the ruling where the ruling is for a matter not involving an arrangement.

Detailed analysis

The Bill proposes to amend existing sections 91EI and 91FJ of the Tax Administration Act 1994. These provisions contain the rules for withdrawing private and product rulings.

The amendments provide that where a private or product ruling is issued for an issue that does not involve an arrangement, if that ruling is subsequently withdrawn, taxpayers can continue to rely on the ruling for the remainder of the period or tax year specified in the ruling.

It is proposed that these amendments apply from 18 March 2019 as this is the date from which the Commissioner can issue binding rulings on a broader range of matters without the need for an arrangement.

A corresponding amendment is also proposed to be included in proposed section 91ESB of the Tax Administration Act 1994 which would provide the Commissioner with the ability to withdraw short-process rulings. This amendment would apply for short-process rulings issued on or after 1 October 2019, which is the date from which the Commissioner can issue short-process rulings.


ABILITY TO WITHDRAW SHORT-PROCESS RULINGS


(Clause 120)

Summary of proposed amendment

The proposed amendment provides the Commissioner with the ability to withdraw short-process rulings.

Application date

The proposed amendment would come into force from the date of enactment and includes an application provision to ensure that the Commissioner is not precluded from withdrawing short-process rulings that are issued before the passing of this Bill.

Key features

The key feature of the proposal is to provide the Commissioner with the ability to withdraw short-process rulings. The proposed amendment mirrors the existing rule which allows the Commissioner to withdraw private rulings.

Background

The short-process binding rulings regime was introduced as a cheaper, more straightforward binding rulings service targeted at small-to-medium sized taxpayers as part of changes made to modernise core components of the Tax Administration Act 1994 by the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019.

The provisions within the Tax Administration Act 1994 that provide the rules for short-process rulings are modelled on the existing rules for private rulings. Section 91EI of the Tax Administration Act 1994 provides the Commissioner with the ability to withdraw private rulings, which may occur where there is a change in the interpretation of the law, or where the ruling needs to be withdrawn and reissued with a variation. A similar provision was inadvertently omitted from the rules for short-process rulings.

Detailed analysis

Proposed section 91ESB of the Tax Administration Act 1994 would provide the Commissioner of Inland Revenue with the ability to withdraw a short-process binding ruling. The new section is modelled on the provision that allows the Commissioner to withdraw private rulings (section 91EI of the Tax Administration Act 1994).

A short-process ruling may be withdrawn (as in the case of a private ruling) where there is a change in the interpretation of the law (either by the courts or by the Commissioner) or where the ruling needs to be replaced with a variation.

Proposed section 91ESB(2) provides that where the Commissioner withdraws a short-process ruling, the withdrawal takes effect from the date of withdrawal which is included in the notice of withdrawal. The date cannot be earlier than the date on which the person could reasonably be expected to receive the notice of withdrawal.

Proposed section 91ESB(3) replicates the rule that allows the Commissioner of Inland Revenue to withdraw private binding rulings and provides that where a short-process ruling is withdrawn for an arrangement, the ruling no longer applies if the arrangement had not been entered into after the date of withdrawal. However, the ruling continues to apply for the period specified in the ruling, if the arrangement was entered into before the date of withdrawal.

Proposed section 91ESB(4) is included to make it clear that where the Commissioner issues a short-process binding ruling on a matter that does not involve an arrangement (such as on a person’s New Zealand tax residence status) and that ruling is subsequently withdrawn, the person can continue to apply the ruling for the period specified in the ruling.

It is proposed that new section 91ESB of the Tax Administration Act 1994 comes into force on the date of enactment. An application provision has been included to make it clear that the Commissioner is not precluded from withdrawing short-process rulings that were issued on or after 1 October 2019 (which is when the short-process rulings regime comes into force) but before the passing of the Bill.


BRIGHT-LINE MAIN HOME EXCLUSION


(Clause 60)

Summary of proposed amendment

The main home exclusion for the bright-line test requires that a person use the land as their main home for most of the time they own the land. The proposed amendment aligns the period of ownership for the main home exclusion for the bright-line test with the period in the bright-line test itself.

Application date

The proposed amendment would apply from the date of enactment.

Key features

The proposed amendment clarifies that, for the purpose of the main home exclusion for the bright-line test in section CB 16A, the period a person owns the land is the same as the period that the bright-line test applies for. It is consistent with the policy intent for the periods to be aligned.

Background

The main home exclusion for the bright-line test in section CB 16A applies where land has been used predominantly, for most of the time the person owns the land, for a dwelling that was the main home for the person.

“Own” is defined in section YA 1 for land as having an estate or interest land. “Estate or interest” is defined as including all estates and interests in land whether legal or equitable. Under these definitions, a person will typically own land from the date a binding contract to purchase the land is formed until the date of registration of the transfer on sale.

However, this period can be different from the period that is counted for the purpose of the bright-line test. Under section CB 6A(1), a person generally acquires land for the purposes of the bright-line test on the date the instrument to transfer the land to the person was registered. The bright-line test period ends on the “bright-line date”, which is defined in section CB 6A (7) as the earliest of the date the person enters into an agreement for the disposal of the land, or the date on which the land is disposed of (including by way of gift, compulsory acquisition or mortgagee sale).

Because the period that a person “owns” land for the purposes of the main home exclusion can be different from the period that the bright-line test applies for, it is possible that taxpayers may not be eligible for the main home exclusion because, although they have used land as their main home for most of the period the bright-line test applies to, they have not used it as their main home for most of the time they owned the land. The opposite could also occur.


CONSIDERATION FOR GRANT OF AN EASEMENT


(Clauses 61 and 62)

Summary of proposed amendment

The proposed amendments address the tax treatment of a one-off payment for the grant of a permanent easement. The proposals aim to ensure that periodic payments for a permanent easement and any payment for the grant of a non-permanent easement (whether one-off or periodic), should be taxable, but one-off payments for the grant of a permanent easement should not be taxable.

Type of payment Permanent easement Non-permanent easement
Periodic payment Taxable Taxable
One-off payment Currently taxable, but should be non-taxable Taxable

Application date

The proposed amendment would apply retrospectively from 1 April 2015, being the date from which the current provision that was intended to make one-off payments for a permanent easement non-taxable had effect.

Key features

  • Repealing section CC 1(2C).
  • Introducing an exception for one-off payments for the grant of a permanent easement in section CC 1B.

Background

There is currently an exclusion for one-off payments for the grant of a permanent easement in section CC 1(2C). However, in Commissioner of Inland Revenue v Vector Limited [2016] NZCA 396, the Court found, contrary to the policy intention, that a lump sum payment for the grant of an easement could not be taxable under section CC 1. This is because a one-off payment is a capital receipt and could not fall under “other revenues” in subsection CC 1(2)(g), and none of the other amounts listed in section CC 1(2) was applicable. Therefore, a one-off payment for the grant of a permanent easement is not captured by section CC 1, and consequently section CC 1(2C), the specific exception for that type of amount, is redundant and needs to be repealed.

One-off payments for the grant of an easement, permanent or non-permanent, are subject to tax under s CC 1B (this section was enacted after the years at issue in the Vector case). However, section CC 1B requires an amendment to ensure it does not tax one-off payments for the grant of a permanent easement, consistent with the policy intent.


MĀORI AUTHORITY TAX CREDITS ATTACHED TO DISTRIBUTIONS


(Clause 108)

Summary of proposed amendment

The proposed amendment corrects an unintended legislative change relating to the ability to retrospectively attach a Māori Authority Tax Credit (MATC) to a distribution from a Māori authority. The unintended change occurred during the rewrite of the Income Tax Act 2007.

Application date

The proposed amendment would apply from the beginning of the 2008–09 income year. A savings provision is also proposed to protect a taxpayer who has taken a tax position based on the existing legislation.

Key features

Imputation credits and MATCs may be attached retrospectively to a distribution only if the Commissioner has made an assessment under the transfer pricing rules to change the effect of a transaction.

The rewrite of this provision incorrectly resulted in Māori authorities being able to retrospectively attach a MATC to a distribution for any reason. The proposed amendment restores the law to its pre-rewrite position so that it works as intended.


RECIPROCAL EXEMPTION FOR INCOME FROM INBOUND INTERNATIONAL AIR TRANSPORTATION


(Clauses 75, 113(2), 137, 139, 143, and 144)

Summary of proposed amendment

As a member of the International Civil Aviation Organisation (ICAO), New Zealand is obligated to reciprocally grant a full income tax exemption to non-resident aircraft operators. New Zealand gives effect to this obligation in section CW 56 of the Income Tax Act 2007, first introduced in 1985 as section 64A of the Income Tax Act 1976.

Application date

The proposed amendment would apply retrospectively from 1 April 1984 for section 64A of the Income Tax Act 1976 (the application date of the original legislation). The application date of the proposed amendments to equivalent provisions in subsequent Acts (the Income Tax Act 1994, the Income Tax Act 2004 and the Income Tax Act 2007) would be the original date of enactment of each of those Acts. Retrospective application ensures that any full exemption previously granted by the Commissioner under any Act has been granted correctly.

Key features

The proposed amendment corrects a deficiency in section CW 56. As currently worded, the provision only permits an exemption to be granted for income from outbound air transport when it should also apply to inbound air transport. Extending the scope of the provision to cover inbound transportation will ensure that New Zealand has given full effect to its international obligations.

To meet the ICAO obligation to grant an income tax exemption to the fullest possible extent, section CW 56 should also expressly apply to inbound air transportation. The proposed amendments achieve this by providing that, to the extent there is reciprocity, both air transport from New Zealand and air transport to New Zealand is exempt income.

Background

ICAO member jurisdictions are obligated to reciprocally grant an exemption from income tax to international aircraft operators “to the fullest possible extent”. Members are primarily required to give effect to this obligation by including a reciprocal exemption mechanism in their double tax agreements (DTAs). As a backup, members are also required to include a domestic legislation provision that enables reciprocal exemptions to be granted in the absence of a DTA. As an ICAO member, New Zealand introduced a domestic legislative provision to give effect to the backup exemption mechanism in 1985. The provision is currently located at section CW 56 of the Income Tax Act 2007.

Section CW 56 is not an automatic exemption. Rather, to ensure reciprocity, the provision authorises the Commissioner of Inland Revenue to exempt income of a non-resident aircraft operator from New Zealand tax if the Commissioner is satisfied that in reciprocal circumstances the other jurisdiction will exempt the income of a New Zealand aircraft operator. The exemption is typically exercised by means of an exchange of letters, in which each side’s tax administration confirms that it will exempt the other side’s international airlines. The exemption mechanism only needs to be exercised on rare occasions, as most international air services to and from New Zealand are with jurisdictions with which New Zealand has a DTA. On the few occasions that it has been exercised, the Commissioner has granted full exemption (that is, for both inbound and outbound transportation).

However, section CW 56 only expressly refers to income that is attributable to “carriage outside New Zealand by an aircraft of cargo, mail or passengers emplaned or embarked on the aircraft at an airport in New Zealand” (outbound transportation). The provision is silent about income from the carriage of cargo, mail or passengers into New Zealand (inbound air transportation).

Income derived by an international airline from inbound transportation has a New Zealand source under section YD 4(2) or (3) of the Income Tax Act 2007 to the extent that it is attributable to business carried out in New Zealand or a contract made or performed in New Zealand. This means that at least some inbound air transportation is potentially taxable in New Zealand.


AMEND THE DATE A GOODS AND SERVICES TAX CREDIT BECOMES AVAILABLE FOR A TAXPAYER TO USE


(Clause 131)

Summary of proposed amendment

This proposed amendment moves the day a GST credit is available from the day after the return was filed, to the day the credit arises. As this amendment is minor and is taxpayer favourable this change has already been operationalised within the system and thus will not practically affect any taxpayers.

Application date

The proposed amendment would apply from the date the original change was made, for taxable periods on or after 1 April 2018, as practically this will have no impact on any taxpayer and it will protect those taxpayers who have already received credits at the earlier date.

Key features

This amendment alters the date that a GST credit becomes available to a taxpayer when they file their GST return other than on the due date for the return. It moves the date the credit is available to be used from the day after the return is filed to the day the return is filed.

Detailed analysis

The Taxation (Annual Rates for 2017–18, Employment and Investment Income, and Remedial Matters) Act 2018 made a change to the day on which a GST refund was available to a taxpayer. This more closely aligned the availability of a GST refund to when the taxpayer filed the return in which the credit arose.

Credits are currently available on:

  • the earlier of either the day after the taxpayer filed their return or the day after the GST period which the credit relates to if the taxpayer filed early, or
  • the day after the end of the GST period to which the refund relates if they filed on the due date, or
  • the day after they filed their return if they filed their return late.

Having the credit available the day after it arises (that is, the day the return is processed, and the refund established) is problematic for administrative purposes. It is generally good practice to have the credit available on the same date that it arises within the system. As a consequence, it is prudent to change the date in the legislation to the date the GST refund arises.

As this change is taxpayer friendly and the issues that arose from treating the credit available the day after it was assessed were problematic this change has already been operationalised within the START environment and will have no practical effect on taxpayers.

It is proposed that this amendment would apply from the date the original change was made (taxable periods ending after 1 April 2018) to provide certainty to taxpayers who may have received credits earlier than specified in the legislation.


INBOUND THIN CAPITALISATION DE MINIMIS


(Clause 81)

Summary of proposed amendment

The Bill proposes to restrict access to the de minimis in the inbound thin capitalisation rules (no adjustments when interest is up to $1 million and reduced adjustments up to $2 million), so it is not available when the borrower has related party debt from a non-resident. This is consistent with the original intent of the inbound thin capitalisation de minimis.

Application date

The proposed amendment would apply to income years starting on or after 1 July 2018 to align with the original application of this de minimis to inbound thin capitalisation.

Key features

The “adjust” term in the thin capitalisation formula to apportion interest by an excess debt entity, which is defined in section FE 6(3)(ac), is zero when the de minimis does not apply. Section FE 6(3)(ac)(i) is proposed to be extended so that “adjust” will be zero if a borrower subject to inbound thin capitalisation has related party debt from a non-resident.

Background

There is a de minimis in the thin capitalisation rules in section FE 6(3)(ac) of the Income Tax Act 2007 so that certain excess debt entities do not need to make adjustments upon breaching the thin capitalisation threshold. This applies when these entities have a group finance cost of up to $1 million and abates up to a group finance cost of $2 million.

Changes in the Taxation (Neutralising Base Erosion and Profit Shifting) Act 2018 extended this de minimis from the outbound thin capitalisation rules to also apply to the inbound thin capitalisation rules provided the borrower does not have any owner-linked debt.

However, owner-linked debt, which is described in section FE 18(3B) of the Income Tax Act 2007, exists only where the borrowing is, directly or indirectly, from an owner who is not a member of the group. It was always intended that the de minimis should not be available where there was borrowing from a non-resident member of the same group. This is because a group with related party lending that does not have to apply thin capitalisation could have very high levels of debt in New Zealand and derive a return on their total investment without making any taxable profits due to high interest deductions. This is not appropriate, even where the interest expense is less than $1 million or $2 million.


DISCLOSURE OF INFORMATION ABOUT REPRESENTATIVES


(Clause 134)

Summary of proposed amendment

The proposed amendment extends the coverage of an existing rule which permits the Commissioner to disclose information about tax agents to associations or groups that represent them to also permit the Commissioner to disclose information about representatives (including bookkeepers) to associations or groups that represent them.

Application date

The proposed amendment would apply from the date of enactment.

Key features

The key feature of the proposal would allow Inland Revenue to provide information about representatives (as defined in the Tax Administration Act 1994) to associations or groups that represent them. The proposal mirrors an existing rule that allows Inland Revenue to disclose such information about tax agents to associations and groups that represent them in certain circumstances.

Background

As part of Inland Revenue’s Business Transformation programme it has extended its online service offerings to a broader range of intermediaries. This was facilitated, in part, by changes made to the Tax Administration Act 1994 in the recent Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 which introduced a new category of intermediary referred to as “representatives”. This includes intermediaries such as bookkeepers, who typically represent their clients for GST and PAYE (but not income tax).

Inland Revenue has an existing ability to, in defined circumstances, disclose information about tax agents to associations and groups that represent them. This applies where:

  • the person is, or purports to be, a member of the association or group as a person who is in the business of preparing tax returns for other people; and
  • the members of the association or group are subject to a professional code of conduct and a disciplinary process that enforces compliance with the code of conduct; and
  • the information being disclosed is relevant to a decision of the Commissioner to remove the person from the list of tax agents, refuse to list the person as a tax agent, or in the Commissioner’s opinion, would be relevant to such a decision.

This exception to the general rule of confidentiality contained in section 18 of the Tax Administration Act 1994 is confined to tax agents and consequently does not permit Inland Revenue to disclose information in the same circumstances about representatives. From a policy perspective, there is no reason why representatives should be treated differently from tax agents in these circumstances.

Detailed analysis

Section 18D of the Tax Administration Act 1994 allows Inland Revenue to, despite the confidentiality rules in section 18 of the Tax Administration Act 1994, make disclosures for the purposes of carrying into effect revenue laws as set out in schedule 7, part A.

Schedule 7, Part A, clause 3 is the provision under which Inland Revenue can disclose information about tax advisors or persons acting as tax agents. Proposed subclause (3) would permit Inland Revenue to disclose information about a person to an association or group if:

  • the person is, or purports to be, a member of the association or group as a person who is in the business of preparing tax returns for other people as a representative meeting the criteria of section 124D(2) of the Tax Administration Act 1994; and
  • the members of the association or group are subject to a professional code of conduct and a disciplinary process that enforces compliance with that code of conduct; and
  • the information being disclosed is relevant to a decision of the Commissioner disallowing the person’s approval as a representative, or refusing to approve the person as a representative, or would, in the Commissioner’s opinion, be relevant to such a decision.

Without the amendment Inland Revenue may not be able to disclose such information to associations or groups that represent representatives (such as the Institute of Certified New Zealand Bookkeepers). This could inhibit the representative from being subjected to the association or group’s disciplinary processes.

 

[6] CY = Current year.

[7] Inland Revenue’s technology platforms are FIRST (Future Inland Revenue Systems and Technology), the heritage platform, and START (Simplified Tax and Revenue Technology), the new platform.

[8] Residual Income Tax is the amount of tax liability after tax credits such as PAYE and RWT have been deducted.

[9] CY= Current year.

[10] Note that for the final instalment taxpayers cannot use 110% of the year previous to the prior year as they must have filed their prior year return before the date of this payment.

[11] This is an unlikely event as the FIRST system does not support this type of payment allocation.

[12] Section 120L(2)(b).

[13] Section 120L(2)(a).

[14] Incremental late payment penalties applied at 1% for each month the debt was outstanding. These were removed from income tax from 1 April 2018. Thus, the only late payment penalties that apply to income tax are the initial penalty of 1% the day after the due date and 4% seven days after the due date.

[15] The safe harbour includes taxpayers with RIT of less than $60,000 who have made the required standard instalments. In this case UOMI will not start until the terminal tax date (usually 7 February the following year).

[16] https://www.classic.ird.govt.nz/resources/2/9/2999de34-26c3-4ac3-bdb3-cad3e97c3cd6/is18-01.pdf

[17] https://www.classic.ird.govt.nz/resources/9/2/9227e1f5-aaac-4bab-8bf1-5ef527fd4441/IS+1603.pdf

[18] “Working person”, “associated entity” and “personal services” income are technical terms used in the legislative provisions for the income attribution rules. They are replicated in this commentary for precision.

[19] “Working person”, “associated entity” and “personal services” income are technical terms used in the legislative provisions for the income attribution rules. They are replicated in this commentary for precision.