Other policy and remedial changes

The proposed changes enhance the over taxation of investors in PIEs by not proposing symmetrical tax treatment for overpayments and underpayments that arise from the use of an incorrect prescribed investor rate (PIR). Current law enables Inland Revenue to impose additional tax on investors who specify a rate that is too low, but do not allow for any refund for investors who provide a PIR that is too high.

The submitter proposes a mechanism should be introduced to provide a form of refund for an over-taxed PIE investor and suggests a refundable tax credit for the individual investor to achieve this.

Comment

The PIE income attributed to an investor in a multi-rate PIE is generally excluded income to the investor. This means that the PIE income is not taken into account when calculating the investor’s income tax liability. Overpaid PIE tax cannot be refunded.

However, where tax on PIE income has been underpaid because the investor has notified a rate that is lower than their actual PIR, the PIE income ceases to be excluded income. It is required to be included in the investor’s assessable income and taxed at the investor’s marginal tax rate. A tax credit is given for the PIE tax that has already been paid.

Officials agree that a mechanism to provide a form of refund for an over-taxed PIE investor and create symmetry between over and underpayment of tax on PIE income is desirable. However, officials recommend a different mechanism to achieve this than the one suggested by the submitter. This is because mirroring the current legislative treatment of underpayment would in some cases result in inequitable outcomes for the taxpayer.

To achieve refundability of overpaid tax on PIE income and symmetry between over and underpayments, officials recommend that a year-end square-up process for all individual investors in multi-rate PIEs is introduced, regardless of whether tax on PIE income has been correctly, over- or under-withheld during the tax year.

This square-up would apply the correct PIR to the PIE income to determine the PIE tax payable. The PIE tax that had been deducted during the tax year would be a tax credit against the PIE tax payable. Any refund due or tax payable would be added to the person’s end of year tax position and would either be refunded, payable or reduce the person’s tax payable. This would address any over- or underpayment of PIE tax during the tax year.

This recommended square up would mean a change compared to the current treatment for investors who have notified a PIR that is too low. Their PIE income would no longer be subject to their marginal tax rates, but instead to their correct PIR.

It is recommended that this change apply from the 2020–21 tax year.

Recommendation

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

WIDENING THE COMMISSIONER’S POWER TO PUT PEOPLE ON THE CORRECT PRESCRIBED INVESTOR RATE

(Clause 99)

Issue: Support for the proposal

Submission

(AMP Capital, ANZ, Chartered Accountants Australia and New Zealand, EY, Financial Services Council)

The submitters supported Inland Revenue being able to correct an investor’s prescribed investor rate (PIR), by advising the investor’s portfolio investor entity (PIE) of the correct rate to apply.

A number of submitters caveated their support with specific concerns, which are set out below.

Comment

Officials welcome the support. The report notes the specific concerns raised by submitters as separate issues.

Recommendation

That the submitters’ support be noted.

Issue: Further widening the Commissioner’s powers to put people on correct prescribed investor rate

Submission

(Matter raised by officials)

Officials recommend further widening Inland Revenue’s ability under section HM 60 of the Income Tax Act 2007 so that it can proactively provide PIEs with their investors’ PIRs when Inland Revenue holds sufficient information.

Comment

Under section HM 60 of the Income Tax Act 2007 Inland Revenue can provide the PIR it considers appropriate for an investor directly to a PIE if Inland Revenue thinks the rate the investor has notified is incorrect. The Bill as introduced widens this ability to include situations when a PIE investor has not notified a rate and has defaulted onto the top PIR of 28%. However, under the new section HM 60 for new members of PIEs, there would have to be at least one incidence of using a wrong PIR for the new investor, before Inland Revenue could determine that the rate used is incorrect and can notify the PIE of the correct PIR.

Officials therefore recommend further widening Inland Revenue’s ability to provide PIEs with their investors’ correct PIRs. This would enable Inland Revenue to pro-actively provide PIRs for all investors to the PIE providers where Inland Revenue holds sufficient information to determine the PIR applicable for the tax year.

Officials recommend that this change apply from 1 April 2020.

Recommendation

That the submission be accepted.

Issue: 1 April 2020 application date should be deferred

Submission

(AMP Capital, Corporate Taxpayers Group)

Submitters sought a deferral of the 1 April 2020 application date of the change, noting that sufficient lead-in time is required for PIE providers to analyse Inland Revenue’s build specification, make IT and system changes and to educate frontline staff.

Submitters also noted that PIEs are busy with PIE end-of-year assessments during April of each year and therefore changing investors’ PIE tax rates at this time is not optimal.

Comment

Officials note that under section HM 60 of the Income Tax Act 2007 Inland Revenue has had the ability to advise PIEs where certain investors appear to be on an incorrect PIR, since the introduction of the PIE regime in 2007. Therefore, the proposed amendments would simply be widening the situations when Inland Revenue was permitted to communicate an investor’s PIR to a PIE. However, officials do recognise that the pre-existing power in section HM 60 of the Income Tax Act 2007 had not been widely used and, as a result, the amendment will require PIEs to make changes to their systems. Inland Revenue is currently engaging with PIE providers about the design of these changes.

There are currently a large number of PIE investors who are being taxed at an incorrect PIR. The proposed change would help to address this issue and therefore, benefit a significant number of PIE investors (including KiwiSaver members). Delaying this change would prolong the issue of investors being taxed at an incorrect PIR. Therefore, the earliest reasonably possible implementation date is needed.

Officials also note that although the change will apply from 1 April 2020, in practical terms, Inland Revenue is not likely to have sufficient information to determine correct PIRs for the tax year until at least June 2020. Advising PIEs of their investors’ correct PIRs will be actioned after that.

Recommendation

That the submission be declined

Issue: Clarification about liability for under and over paid tax for investors on Commissioner advised rate

Submission

(AMP Capital, Corporate Taxpayers Group, Financial Services Council, EY)

Submitters sought clarity about who would be liable for under or over deducted PIE tax, where the Commissioner had inadvertently advised the PIE to apply an incorrect tax rate.

Two submitters noted a PIE investor’s experience is likely to be adversely impacted if the investor were to end up having income tax filing obligations, as a result of an incorrect rate advised by Inland Revenue. (AMP Capital, Corporate Taxpayers Group)

Comment

The proposed change to refund overpaid PIE tax, in this report would mean that all PIE income is subject to an end of year square-up. Where an investor’s PIE income was taxed at an incorrect rate based on information provided by the Commissioner, the over or under paid PIE tax would be squared up at the end of the tax year. If adopted, this proposal would address the concerns raised by submitters. For most investors the square-up would happen automatically and they would not be required to do anything. For investors who are required to file an income tax return for their other income, the PIE income information Inland Revenue holds would be pre-populated into their income tax profile to be available when they file their income tax return.

Recommendation

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

Issue: Increased engagement about operationalisation of proposal

Submission

(ANZ, Financial Services Council)

Noting that the change would have impacts for PIEs’ IT systems and collateral, submitters sought increased engagement from Inland Revenue around the design and operational process for sharing PIR information with PIEs.

Comment

Inland Revenue is currently engaging with PIE providers on the changes proposed. This engagement will continue with an increased focus on the operational design of the proposal and the practical application of the change.

Recommendation

That the submission be accepted.

Issue: Notifying an investor of a change to the PIR

Submission

(Chartered Accountants Australia New Zealand, Financial Services Council)

Inland Revenue should notify a PIE investor where they are being placed on a different PIE tax rate. (Chartered Accountants Australia New Zealand)

Another submitter sought clarity about who would be responsible for notifying members that their PIE tax rate had been updated. (Financial Services Council)

Comment

During the current tax year Inland Revenue has been notifying investors directly where, based on information Inland Revenue holds, it appears they are being taxed at an incorrect PIR. When Inland Revenue begins notifying the PIE directly to change the investors’ PIR, Inland Revenue would also advise the investors that it has instructed their PIE to change their PIR.

Recommendation

That the submission be accepted.

Issue: Ultimate responsibility for determining the PIR

Submission

(ANZ, Financial Services Council)

Where Inland Revenue had advised a PIE of a tax rate to apply, the investor would still be able to subsequently advise the PIE to apply a different tax rate to the one supplied by Inland Revenue. The submitters recommended that instead Inland Revenue should be responsible for mandating an investor’s PIE tax rate (that is, an investor should not have the ability to advise their PIE to disregard a tax rate supplied by Inland Revenue).

Comment

Although officials are proposing that Inland Revenue would provide investors’ PIRs to PIEs, the ultimate responsibility for determining whether their PIE income is being taxed at the correct rate should remain with the investor. There will also be some instances where an investor has information relevant to determining their correct PIR that has not yet been made available to Inland Revenue. Therefore, an investor should have the ability to update their PIR in accordance with this additional information.

Recommendation

That the submission be declined.

Issue: Process required where Inland Revenue recommends the wrong rate

Submission

(Chartered Accountants Australia New Zealand, EY)

Inland Revenue should implement a process to allow an investor to notify Inland Revenue where the rate Inland Revenue advised the PIE to apply is incorrect, to avoid the same change being made each year. (Chartered Accountants Australia New Zealand)

Another submitter recommended that the PIE should be required to notify Inland Revenue if an investor had subsequently changed their PIR after a rate had been advised by the Inland Revenue. (EY)

Comment

Under current information provision requirements, the situation envisioned by the submitters is unlikely to arise. PIEs are already required to annually report notified investor rate information to Inland Revenue. Officials consider that this information is likely to be sufficient for Inland Revenue to identify where an investor has subsequently changed their PIE tax rate after Inland Revenue has advised the PIE of a rate to apply.

An investor in a PIE has one correct PIR for a tax year. This PIR is determined by the investor’s taxable income and their PIE income for the last two income years before the tax year in which the PIR is to be applied. The PIR can change from year to year, if the investor’s relevant income passes a threshold. If Inland Revenue has the investor’s relevant income information, it will be able to determine the applicable PIR for the investor for the tax year.

Recommendation

That the submission be declined.

Issue: Require PIEs to report PIR information to Inland Revenue on a semi-regular basis

Submission

(EY)

PIEs (in particular KiwiSaver PIEs) should be required to report PIRs used by their members to Inland Revenue on a semi-regular basis (monthly or quarterly), to assist Inland Revenue in the earlier identification of incorrect PIR usage.

Comment

PIEs are currently required to report notified investor rates to Inland Revenue annually. As an investor’s PIR is set with reference to their two prior years’ income, this annual reporting requirement is likely to be sufficient for most existing PIE investors. Therefore, officials consider that the additional reporting burden this recommendation would create for PIEs would likely outweigh its benefits.

Recommendation

That the submission be declined.

Issue: Technical drafting issues

Submission

(EY, Financial Services Council)

Submitters raised the following technical drafting issues:

(a) The reference to “investor does not have a notified rate” should be replaced with the “investor does not advise a multi-rate PIE of their notified investor rate”, on the basis the current drafting implies the investor has no notified investor rate, when rather they have failed to provide their rate to the PIE. (EY)

(b) Rather than referring to a notified investor rate being “inconsistent” with an investor’s PIR, the legislation should refer to the rate as being incorrect. (EY)

(c) The current drafting provides that the “Commissioner may notify a multi-rate PIE to apply a rate”. The submitter is of the view the revised drafting makes it less clear that the PIE is required to disregard any earlier rate advised by the investor and must apply the rate advised by the Commissioner. (EY)

(d) That the existing drafting only enables the Commissioner to correct a rate notified by the investor, it does not make it clear the Commissioner is able to correct a previous Commissioner-notified rate. (EY, Financial Services Council)

Comment

“Notified investor rate” is defined in section YA 1 of the Income Tax Act 2007 to mean a rate notified under section HM 60 or HM 58. Therefore, officials are of the view where an investor has not notified a rate to their PIE then they do not have a notified investor rate, meaning issue (a) does not need to be addressed. In relation to issue (b), by virtue of its definition, it is not possible for a “notified investor rate” to be incorrect even if the rate is different from the investors PIR. Therefore, the current language of “inconsistent” is more appropriate than “incorrect”.

Officials agree with the submitters on issue (c). On issue (d), the current drafting allows the Commissioner to correct any incorrect notified investor rate, which includes one that has been notified by the Commissioner. However, officials acknowledge that the use of “notified investor rate” as a nonce term in section HM 60(1) for rates notified by investors could cause confusion, and consider that the clarity of the legislation could be improved.

Recommendation

That the submissions covering issues (a) and (b) be declined.

That submissions (c) and (d) be accepted, subject to officials’ comments.

Issue: Process for investor being listed in part A of schedule 29

Submission

(AMP Capital, Russell McVeagh)

To qualify as a PIE an entity must meet the eligibility criteria listed in section HM 7 of the Income Tax Act 2007 – this criterion includes requirements as to the minimum number of investors per investor class (section HM 14) and the maximum interest that can be held by a single investor (section HM 15).

However, there is an exception to the criteria in sections HM 14 and 15, for investors listed in part A of schedule 29 of the Income Tax Act 2007. For example, as PIEs themselves are listed in schedule 29, this means where a PIE invests in another PIE the above requirements do not need to be met.

Currently, an Act of Parliament is required to update schedule 29. The submitter proposes that investors should be able to be added to part A of schedule 29 by way of an Inland Revenue determination or an Order in Council.

Comment

Although officials note there are some examples where the Income Tax Act 2007 can be amended by Order in Council, to ensure maximum transparency in setting tax laws it is generally desirable for amendments to be made via primary legislation. Therefore, changing the method for updating schedule 29 would raise issues that would require prioritising and resourcing as part the Government’s tax policy work programme.

Moreover, as entities are generally included in Part A of schedule 29 by type (for example, the list currently includes all PIEs and life insurers) rather than by organisation, there is unlikely to be a need for the schedule to be frequently updated. Therefore, as omnibus tax bills are regularly progressed through Parliament, officials consider the current setting should not act as a significant impediment to part A of schedule 29 being updated in a timely manner.

Recommendation

That the submission be declined.

Issue: Extension of new PIE transitional period

Submission

(AMP Capital, Russell McVeagh)

Generally, where a PIE fails to satisfy certain investment and investor requirements on the last day of a quarter and does not remedy the issue by the last day of the next quarter, it will lose its PIE status. However, section HM 25(3)(a) of the Income Tax Act 2007 provides that a newly established PIE has six months before failure to meet these requirements will result in the entity losing its PIE status. This is to recognise when a new PIE is established, the investor base may be more concentrated than it typically would be.

The submitter seeks for this six month transitional period to be extended to a year, on the basis the length of the transitional period does not reflect the practicalities of establishing a new PIE (with institutional investors typically only meeting quarterly or semi-annually).

Comment

This submission raises issues that would require prioritising and resourcing as part of the Government’s tax policy work programme. Engagement with the managed fund industry about new PIE investment practices would be required to determine whether there is an issue with the current six month transitional period.

Recommendation

That the submission be declined.

TAXATION OF TRUSTS

Issue: Remedial amendments to trust rules supported

(Clauses 59, 89, 92(1) – (7), 93, 95, 97, 113(16) – (20))

Submissions

(Chartered Accountants Australia and New Zealand)

The proposed amendments to clauses 59, 89, 92(1) – (7), 93, 95, 97, and 113(16) – (20) are supported.

Recommendation

That the submission be noted.

Issue: Residence of co-trustees as a single notional person

(Clause 87)

Submissions

(Chartered Accountants Australia and New Zealand, KPMG)

The proposed amendment should be included in subpart YD of the Income Tax Act 2007.

The proposed amendment is a departure from the common law position and should be consulted on. (Chartered Accountants Australian and New Zealand)

The relevant provision should be:

reconsidered for whether it applies the correct test of residence;
included in Subpart YD rather than in Subpart HC of the Income Tax Act 2007;
the commencement date should be deferred; and
the consequential impacts should be further considered. (KPMG)

Comment

Residence of the trustee

We agree with submitters that the trustee is not necessarily the only determining factor for taxation of trustee income of a trust.

However, residence is an important factor for the taxation of New Zealand-sourced income as well for compliance with assessment obligations because:

the trustee of the trust is the person responsible for calculating and satisfying the income tax liability;
residence of the trustee is relevant for the determining if certain tax credits can be used in satisfying the income tax liability of the trustee; and
payers of passive income need to know the residence status of an investor to determine the correct tax rate (for example, is the passive income subject to resident withholding tax or non-resident withholding tax).

It is necessary for a trustee to determine their tax residence because, under the global/gross framework for calculating taxable income, New Zealand-sourced income is subject to New Zealand tax and a New Zealand resident is taxed on their world-wide income. The only exception in the trust rules for the global/gross framework is foreign-sourced income derived for an income year by a trustee of a trust that does not have a settlor resident in New Zealand at any time in that year. Residence is also relevant to determining the withholding tax payable on passive income and for the PIE rules.

The proposals for residence clarify the law to ensure it is consistent with how the Commissioner applies the current law.

Adopting a common law principle instead would put New Zealand out of step with most other jurisdictions including Australia. Officials consider it would also result in more uncertainty.

If a trust has a sole trustee, the residence of the trustee is based on the rules in subpart YD. If a trust has co-trustees, we consider it is appropriate to apply the residence rules on the basis that the trustees are a single notional person. We note that co-trustees have always been treated as if they were an individual deriving the trustee income.

We agree with submitters that the Commissioner applies the residence test for co-trustees in the same manner proposed in the amendment. The Commissioner has published her view in IS 16/03 and reaffirmed that administrative approach in IS 18/01.

We also note that an election can be made to pay New Zealand tax on world-wide trustee income, irrespective of the residence of the settlor or the trustee or any beneficiary of the trust.

Officials consider the comments made by the submitters in referring to the FATCA rules and common reporting standards are cross-border matters relating to those specific measures and do not affect how New Zealand approaches the taxation of trustee income generally.

Effect on withholding taxes

The proposed amendments clarify how trustees are to apply the withholding tax rules. The clarification is consistent with the conclusions drawn by the Rewrite Advisory Panel, which concluded that, a trust cannot meet the requirements to be a complying trust of trustee income derived by co-trustees is apportioned to give different (withholding) tax effects based on the personal residence of the co-trustees.

Location of the residence rule

Officials consider this submission has some merit. However, there are many examples in the Income Tax Act 2007 of definitions that are index entries in Part Y, and which point to the substantive definition within a complex set of rules (for example, many of the definitions within the depreciation rules).

Officials recommend that drafters consider either relocating the substantive definition or making an appropriate index entry in Part Y that refers to the substantive definition.

Deferral of effective date

To clarify, officials wish to point out that the proposed amendment does not apply from the date of enactment. Instead, clause 87 states that this proposed amendment applies to income years beginning after the date of enactment.

Our view is that this should result in the proposed amendment applying, in most cases, from the beginning of the 2020–21 income year. Officials consider this is enough time for trustees to advise payers of interest and dividends of the correct withholding tax rate or tax rate (for PIE investments).

Consequential impacts

The proposed amendments do not deem a trust to be a resident or a non-resident. They apply only to the trustee. It is the trustee (including co-trustees treated as a notional single person) who is responsible for compliance with income tax obligations for trustee income.

Officials consider the proposed amendments:

improve the clarity of how the tax residence rules apply to co-trustees of a trust;
are consistent with how the Commissioner has applied the residence rules to trustees since 2016; and
do not affect the taxation of distributions from a trust.

Taxation of distributions from a trust remain unchanged as the proposals do not impinge on the factors that determine the nature of a distribution. The four main factors that determine the nature of a distribution are:

the classification of the trust as either a complying trust, a foreign trust or a non-complying trust in relation to the amount being distributed;
the tax residence of the beneficiary;
the source of the distribution from the trust fund; and
the ordering rules which stipulate the order in which distributions from either a foreign trust or a non-complying trust are to be made.

Recommendations

That the submission that requests a reconsideration of the policy for tax residence of co-trustees be declined.

That the submissions that the tax residence rule be included in Part Y be accepted, subject to officials’ comments.

That the submissions on the proposed amendments affecting the tax residence of the trust be declined.

That the submissions on the effect on withholding taxes be declined.

That the submissions on the deferral of the effective date (application date) be declined.

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

Issue: Corpus

(Clause 88)

Submissions

(Chartered Accountants Australia and New Zealand, KPMG, New Zealand Law Society, nsaTax)

The proposed amendment should consider the situation of debt forgiveness. (Chartered Accountants Australia and New Zealand)

The definition of corpus be reconsidered. (KPMG)

The wording of the proposed amendment to section HC 4(1) may create uncertainty as to whether certain amounts are included in the corpus of the trust.

Confirmation should be given that debt forgiveness would give rise to corpus under the proposed amendment to section HC 4(1). (New Zealand Law Society)

The proposed amendment should include, within the definition of property, money that is loaned to the trustee where the loan is subsequently forgiven by the lender. (nsaTax)

Comment

Corpus is an amount that is analogous to the capital of the trust and so is intended to consist of property settled on the trust. That capital is applied by the trustee as required in the trust deed to generate income and gains for the purposes of the trust. Under the trust rules, corpus may be distributed tax free.

The proposed amendment that an amount included in corpus should be capable of distribution is consistent with the Commissioner’s application of the law. KPMG suggests the proposed amendment is unnecessary. We have consulted with submitters on this point and we now consider that under the general law, an amount can only be distributed if it is capable of being distributed. Therefore, we agree that it is unnecessary for the definition of corpus to state that the amount must be capable of being distributed.

In our consideration of the submissions, we noted that a forgiveness of a loan owed by a trustee of a trust is within the technical meaning of “disposition of property”, a defined term for the purpose of the trust rules. As both a settlement and a distribution are defined by reference to the concept of a transfer of value in the Income Tax Act 2007, we reviewed the technical components of the definitions of “settlor” and “distribution” in Income Tax Act 2004. The components of these definitions in the Income Tax Act 2004 were rationalised into a single concept of “transfer of value” in the Income Tax Act 2007 during the rewrite of the trust rules.

In the Income Tax Act 2004, a settlement and a distribution include a forgiveness of a loan, because they are included in the definition of “disposition of property” in the Income Tax Act 2004. The rationalisation of these various rules during the rewrite may have obscured this policy.

Therefore, we agree that the legislation should be clarified to ensure that a forgiveness of a loan is treated as a disposition of property for both a settlement on a trust and a distribution from the trust.

Recommendation

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

Issue: Drafting relating to trustee income

(Clause 89)

Submission

(New Zealand Law Society)

The drafting of clause 89 could be improved by reflecting the exclusion of beneficiary income from trustee income.

Comment

The proposed amendment is a response to a submission made during the administrative review of trust taxation. The submission identified that certain settlements on a trust would be taxed to the trustee as trustee income, and could not be taxed to the beneficiary, even if the amount of that settlement had been on-distributed to a beneficiary.

We consider the proposed amendment is clear that such an on-distribution would not be taxed to the trustee as trustee income.

Recommendation

That the submission be declined.

Issue: Source of capital gain

(Clause 91)

Submission

(KPMG, Chartered Accountants Australia and New Zealand)

The efficacy of the rule should be confirmed, and consideration given to whether an equivalent rule is required for capital losses. (KPMG)

That the rule should specify how section YD 4 should apply to capital losses. (Chartered Accountants Australia and New Zealand)

Comment

Officials consider it is appropriate for the source rules applying for income to be also used to determine the source of a capital gain.

A distribution of a capital gain from a trust may be untaxed (distribution from either a complying trust and foreign trust) or taxed (distribution from a non-complying trust). The submissions are primarily concerned with a capital gain included in a taxable distribution made from a non-complying trust to a non-resident beneficiary. This is because if such a taxable distribution is made to a non-resident beneficiary, the beneficiary is taxed only to the extent that distribution is sourced from New Zealand.

As the ordering rules require capital losses to be netted off from capital gains, we agree with the submitter that the source of a capital loss should also be determined on a similar basis as proposed for capital gains. We consider that the proposed amendment should be adjusted to reflect this effect.

Recommendation

That the submissions be accepted.

Issue: Taxable distribution not subject to the ordering rule

(Clause 91(2))

Submission

(New Zealand Law Society)

Further consideration should be given to the current interpretation and the scope and application of subpart FC of the Income Tax Act and the wider ramifications of the interpretation underlying the proposed amendment to clause 91(2) of the application of other aspects of the trust rules.

Comment

The submitter raises two issues:

valuing a distribution at market may result in circularity because there is not a transfer of value from the trustee to the beneficiary (a bitcoin example is used to illustrate the submitter’s point); and
gifted property to a trust would not be a transfer of value to the trust.

We agree with the submitter that the purpose of subpart FC of the Income Tax Act 2007 is to tax holding gains on revenue account property when certain transactions occur (for example a distribution of property from a trust, or the making of a gift).

In relation to the issue raised about distribution of property, officials note that a recent amendment in section FC 2(4) of the 2007 Act ensures that the valuation of a distribution of property is only for the purpose of determining:

whether the trustee is liable for tax on any holding gains or depreciation recovery on revenue account property being distributed; and
the cost base of the distributed property for the beneficiary (if that property is revenue account property).

Under that amendment, the value of distributed property under subpart FC is not considered in determining whether a transfer of value has occurred from the trustee to the beneficiary. We agree this rule should be expanded to ensure that the valuation rules in subpart FC should not apply in determining whether a gift is a settlement on a trust.

Recommendation

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

Issue: Foreign-sourced income of a resident trustee – distributions

(Clause 93(1))

Submission

(KPMG)

The treatment of a distribution of beneficiary income should be confirmed in a Tax Information Bulletin item.

Comment

Officials agree with the submission.

Recommendation

That the submission be noted.

Issue: Foreign-sourced income of a resident trustee

(Clause 93(1))

Submission

(New Zealand Law Society)

That the term “trustee income” should be used instead of references to income as for example in section HC 26(1) of the Income Tax Act 2007.

Comment

In section HC 26 of the Income Tax Act 2007, the term trustee income could be misinterpreted as the provision is about defining when an amount of foreign-sourced income is treated as exempt income for the purpose of calculating taxable income of a trustee. The rule is not about trustee income but about a subset of trustee income.

The purpose of section HC 26 is to override the general rule that taxes the world-wide trustee income of a resident trustee. This rule is concerned with:

a subset of trustee income (foreign-sourced income derived by a trustee);
defining the circumstances when that foreign-sourced income is not included in the calculation of the trustee’s taxable income.

Although the foreign-sourced income referred to is also included in trustee income, the concept of trustee income is more relevant for the application of the ordering rules, the nature of a distribution, and for the election to pay tax on world-wide trustee income.

Recommendation

That the submission be declined.

Issue: Foreign-sourced income of resident trustees – a trust that has no settlor

(Clause 93(2))

Submission

(New Zealand Law Society)

That the relevant issue is whether any settlor of the trust died or ceased to exist when it was a New Zealand resident, and this can be addressed by amending section HC 25(2)(c).

That section HC 25(2)(c) be reviewed in light of the amendment proposed by clause 87 of the Bill (which clarifies the tax residence of co-trustees treated as a notional single person).

Comment

(Clause 93(2))

A submission received during the administrative review of the taxation of the trust rules noted that the current wording of section HC 26 implies it will apply only in situations where a trust has a settlor. The proposed amendment addresses this submission.

The proposed amendment seeks to clarify that the exemption for foreign-sourced income under section HC 26(1) can apply when the trust has no settlor provided that the last remaining settlor of the trust was a non-resident at the time of death or the time it ceased to exist.

We consider the proposed wording achieves this objective.

Suggested review of section HC 25(2)

The general rules for taxing income result in a New Zealand resident being taxed on their world-wide income unless a specific exemption applies.

The proposals in clause 87 result in co-trustees being treated as a New Zealand resident (as a notional single person) for the purpose of calculating the income tax liability on trustee income as follows:

if the settlor of a trust is resident in New Zealand, the trustee of that trust will be taxed on their world-wide trustee income for an income year; and
if the settlor of a trust is non-resident, foreign-sourced income derived by the trustee of that trust may be exempted under section HC 26.

If the proposals in clause 87 result in co-trustees being treated as a non-resident (as a notional single person), section HC 25 will apply to those trustees only if the trust has a resident settlor.

Officials consider these effects are consistent with the application of the law set out in IS 18/01.

We note that the New Zealand Law Society also suggests section HC 25(2)(c) should be modified to apply to corporate trustee that has ceased to exist. We agree with this submission.

Recommendation

That the submission relating to a trust that has no settlor be declined.

That the submission to include a reference to non-natural person trustees in section HC 25(2)(c) be accepted, subject to officials’ comments.

Issue: Foreign-sourced minor beneficiary income drafting

(Clause 93(4))

Submission

(New Zealand Law Society)

That the proposed amendment in clause 93(4) is unnecessary.

Comment

The proposed amendment addresses a matter raised in submissions received during the administrative review of the taxation of trusts. The proposed amendment clarifies that minor beneficiary income that is foreign-sourced does not enjoy the benefit of the exemption for foreign-sourced income derived by a trustee of a trust having only a non-resident settlor. That exemption is intended to apply only to income retained by the trustee (that is, it does not apply to a distribution that is beneficiary income).

As a base protection measure, minor beneficiary income is intended to be attributed to the trustee and taxed at the trustee rate. This attribution of minor beneficiary income:

is only for the purpose of ensuring New Zealand tax is paid on that income at the trustee rate; and
ensures that minor beneficiary income is not taxed to the beneficiary.

The submitter’s concern likely relates to foreign-sourced income derived and retained by the trustee which is exempt income of the trustee under this rule. We agree with the submitter that a subsequent distribution of that income is likely to be a taxable distribution and would be taxed to the minor beneficiary under the normal source and residence principles. However, for the reasons stated above, we feel that the amendment is necessary.

Recommendation

That the submission be declined.

Issue: Settlement by acts of associates

(Clause 94)

Submissions

(Chartered Accountants Australia and New Zealand, KPMG, New Zealand Law Society, nsaTax, Russell McVeagh)

The proposed rule should apply only where the person has influence or control over the actions of an associate. (Chartered Accountants Australia and New Zealand)

The proposal does not clearly meet the objective and it may expand the definition of settlor significantly and inappropriately. (KPMG)

Clause 94 should be amended so that the proposed amendment specifies which persons must be associated.
Clause 94 should clearly set out which subsection of section HC 27 of the Income Tax Act 2007 is being referred to in the reference to “paragraphs (a) or (b)”. (New Zealand Law Society)

The interaction between the proposed amendment for section HC 27(4) and existing section HC 27(6) be clarified by making section HC 27(6) subject to section HC 27(4). (nsaTax)

Clause 94 should not proceed as the proposed replacement of section HC 27(4) of the Income Tax Act 2007 would result in a significantly broader definition of “settlor” for income tax purposes. (Russell McVeagh)

Comment

The Commissioner considers the current provision concerning the treatment of indirect settlements is very broad and overreaches. The objective for the proposed amendment is to limit when a person is treated as a settlor because they have a connection with an indirect transaction that results in a transfer of value to a trust.

The purpose of the proposed amendment (as introduced) was to restrict the current rule to transactions where:

a person (person A) controls or influences the actions of another person (person B) for that transaction; and
a result of that transaction is that a transfer of value is indirectly made to a trust.

An example of a transaction that is intended to be within the scope of the proposed amendment would be where Person A influences person B to make a gift of property to a company, which is owned 100% by a trust of which person A is a trustee and a beneficiary. The interpretation statement (IS 18/01) notes that the control or influence effect of such a transaction is more likely to occur if the two persons are associated with each other.

Officials agree that the wording of the proposed amendment should more clearly reflect the intent of the provision. We have also consulted on this issue with submitters and we agree the proposed amendment is not intended to apply to advice (which could be considered to be influence), for example professional or family advice offered on the establishment of a trust.

The reference to paragraphs (a) or (b) grammatically can only be the paragraphs listed in the proposed amendment. However, we note that the submission is likely suggesting that the issue relates more to the reference in the proposed amendment to subsection (2) of section HC 27. Changes made to the proposal relating to control or influence, will render references to paragraphs (a) or (b) unnecessary.

We agree that the relationship between subsection HC 27(6) and proposed subsection HC 27(4) be clarified.

Recommendations

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

Issue: Value of deferral and non-exercise

(Clause 96)

Submission

(Chartered Accountants Australia and New Zealand, KPMG, New Zealand Law Society)

The rule should apply only where the interest rate is less than market.

The relevant rate should be reconsidered. (KPMG)

Further work is required to ensure the formula works in a guarantee situation and that officials provide detailed examples to illustrate the application of this provision where financial assistance is provided in the form of a guarantee. (New Zealand Law Society)

Comment

Officials agree that the prescribed rate of interest at present can be substantially in excess of market rates in some sectors or markets. We consider that the relevant rate should be, as submitted, the lower of the market rate (but cannot be less than zero) or the prescribed rate.

Officials consider that the proposed amendment should state that for a guarantee, the guarantee fee should be the basis for determining the amount that is calculated as the transfer of value for a guarantee. An example will be provided in the Tax Information Bulletin on the enactment.

Recommendation

That the submissions be accepted.

Issue: Election to pay New Zealand tax on world-wide trustee income

(Clauses 90 and 97)

Submission

(Chartered Accountants Australia and New Zealand, KPMG, New Zealand Law Society)

That a retrospective election should be allowed. (Chartered Accountants Australia and New Zealand, KPMG)

That an annual notification obligation on non-active trusts is unnecessary and imposes a compliance burden which diminishes the advantage that non-active trust status affords such trusts (clause 97(2)). (New Zealand Law Society)

Comment

The purposes of the election rule and taxable distribution rules are to encourage people to elect into the complying trust regime at an early stage rather than when a problem or adverse effect arises. We agree with the submission that the tax status of a trust may be fluid.

We also note that the ability to elect into the complying trust regime was enacted before the current penalties and interest regimes came into force. We considered the submissions of Chartered Accountants Australia and New Zealand about:

the interest and penalties regime; and
the fluid nature of family trusts.

We discussed this issue with the advisor to the Committee and consider that it would be appropriate to provide the ability to make a retrospective election subject to the following requirements:

the trustee has always been compliant with their New Zealand income tax obligations on New Zealand sourced income;
use-of-money interest is applied on any trustee income derived in prior years not previously taxed in New Zealand;
the date of a change in status of the trust can be identified;
the date from which the election applies must not include any period that is subject to the time bar for amending assessments;
the election changes the status of the trust for future distributions from income derived after the effective date of the election; and
tax payable on distributions made before the date the Commissioner is notified of the election is not affected.

Non-active trust

The submission is concerned with the situation of a non-active trust, which is a complying trust that derives no income. We agree with the submitter that it is unnecessary for the trustee of a non-active trust to give an annual notice of an election for the trust be a complying trust unless the trust begins to derive income. We consider that the proposed amendment for section HC 33(1B)(c)(i) should not apply to a non-active trust.

The proposed amendment applies to trustee of a complying trust if certain technical requirements relating to income derived by the trustee.

The amendment is intended to apply to:

a trustee of a trust when a settlor of the trust migrates from New Zealand, which may result in a change to the way in which income of the trust may be taxed or exempted; or
a foreign registered charitable trust. If the trustee of such a trust wishes to have complying trust status, the proposed amendment requires the complying trust status to be notified when the trustee files its annual foreign trust disclosure form.

Recommendation

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

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

(Clause 97(8))

Submission

(New Zealand Law Society)

That careful consideration should be given to whether it is appropriate that the ordering rules are applied in the way (provided in the proposed amendment) and whether doing so gives rise to the appropriate outcome in all circumstances.

That a detailed analysis of the fact scenarios should be carried out to ensure that the proposed amendments result in an appropriate outcome for a trust which “flips” in and out of being a complying trust under the proposed amendment and for a trust which has suffered losses in some periods over its lifetime.

Comment

The New Zealand Law Society’s submission on the application of the ordering rules is to the effect that the status of the trust at the date of the distribution should determine the taxation of the distribution because the trust fund is a single fund. We agree this is the policy for a trust that does not change its status during its lifetime.

However, this is not the policy for a distribution from a trust that has changed its status, as for example, if a settlor of that trust has migrated to New Zealand and has become a tax resident of New Zealand. The proposed amendment is based on the approach taken under current law for distributions from a trust that was a foreign trust and a settlor of that trust has migrated to New Zealand which taxes distributions based on when the income was derived by the trustee and not just by the date of the distribution.

For such a trust, an election may be made within one year of the time the settlor becomes a New Zealand tax resident for all purposes. If the election is made, the trust is treated as a complying trust from the date of the election (settlor migration rule), provided the trustee satisfies their income tax obligations for world-wide trustee income on an ongoing basis.

However, under the settlor migration rule, a distribution from the trust after the election is treated as follows:

a distribution of an amount derived by the trustee before the date of the election is treated as a distribution from a foreign trust; and
a distribution of an amount derived by the trustee after the date of the election is treated as a distribution from a complying trust.

If the election to be a complying trust is not made that one year period, a distribution from the trust after the election is treated as follows:

a distribution of an amount derived by the trustee before the date of the election is treated as a distribution from a foreign trust; and
distribution of an amount derived by the trustee after the date of the election is treated as a distribution from a non-complying trust; and
in both cases there are may be some technical adjustments to the amount of the distribution to take account of New Zealand tax payable on income derived before the election date.

Officials consider that the proposed amendment for the taxation of distributions is consistent with the policy that already applies for a foreign trust that changes its status by electing into the complying trust rules. We also consider that it is appropriate for the ordering rules to be applied for all trusts to determine the timing of when the amount being distributed was derived by the trustee.

Recommendation

That the submissions be declined.

MĀORI AUTHORITY TAX CREDITS

(Clauses 104 and 108)

Issue: Correction of unintended legislative change in the rewrite of the provision into the Income Tax Act 2007

Submission

(Chartered Accountants Australia and New Zealand)

That the proposed amendment is supported.

Recommendation

That the submission be noted.

REMOVAL OF THE REQUIREMENT TO ESTIMATE AT FINAL PROVISIONAL TAX INSTALMENT DATE

(Clause 110 and 125)

Issue: General support for the measure

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Tax Management New Zealand Limited, EY, KPMG, Deloitte)

General support for the removal of the requirement to estimate a taxpayer’s final instalment of provisional tax where they believe their residual income tax will be less than the final instalment amount.

Recommendation

That the submissions be noted.

Issue: Relationship between sections RC 7 and proposed sections RC 10(5) and (6) should be clarified to avoid the confusion of terms

Submission

(EY)

The drafting as currently worded could pose potential confusion when taxpayers look to apply this section because of the use of terms such as “RIT estimate” with reference to the standard uplift method which could be confused with the estimation method in section RC 7. We recommend that the relationship be clarified.

Comment

Officials considered that using the term “RIT estimate” was sufficiently different from the use of the term “estimate” in section RC 7, however, on reflection we can see how that wording could create some confusion so drafting will be amended to “expected RIT”.

Recommendation

That the submission be accepted.

Issue: A subsequent change is required to account for early balance date taxpayers

Submission

(Corporate Taxpayers Group, Deloitte)

While the removal of the requirement to estimate at the final instalment makes sense there would need to be a subsequent change to sections RC 5(2) and RC 5(3) to account for early balance dates as these sections do not allow taxpayers to use 110% for the final instalment.

Comment

Officials agree that sections RC 5(2) and RC 5(3) as currently written do not work well for early balance date taxpayers who are unable to use a standard uplift based on 110% of the year preceding the prior year at the final instalment date but yet, because of an extension of time to file their prior year tax return they are unable to use an uplift of 105%. This issue has existed for some time.

However, taxpayers who have early balance dates have a significant amount of time to file their tax returns (up to 18 months following their balance date) and, in addition, most taxpayers will generally prefer to base their final instalment under the standard method on their approximation of their RIT for the year as it is from this date that use of money interest will apply to any shortfall which is five weeks after their balance date.

To provide more certainty to taxpayers they can make use of other tools to minimise their exposure to use of money interest from this date including using a tax pooling intermediary.

Officials consider that to make a special rule around early balance date taxpayers would add significant complexity to the rules and raise integrity concerns.

Recommendation

That the submission be declined.

Issue: The practical implications of the change to eliminate estimating the final instalment should be fully considered

Submission

(Chartered Accountants Australia and New Zealand)

Potentially there may be some practical issues around debt demands issued automatically by START if a taxpayer pays less than the amount calculated under the standard method. We understand no formal estimate will be required so it is not clear how START will know that a payment has been made under section RC 10(4) as opposed to a taxpayer short paying their provisional tax.

We recommend the practical implications be fully canvased and the necessary changes (if any) are made to START to prevent any unnecessary angst for taxpayers.

Comment

Officials have been actively engaged with our technical experts in designing this change. A taxpayer who does pay less than the instalment required under the standard uplift because they believe their residual income tax will be less than what they have already paid will not be able to be identified within START, however, the correct calculation of penalties and interest will occur when that taxpayer files their returns.

It may be that notices outlining that a payment has been short-paid may be issued to taxpayers who make a short payment and do not inform us that this has been done under proposed section RC 10(4), however, there is no practical way to identify those payments without increasing compliance costs.

Recommendation

That the submission be declined.

CLARIFYING THE “LESSER OF” CALCULATION FOR STANDARD UPLIFT TAXPAYERS

(Clause 109)

Issue: General support for the amendment

Submission

(Chartered Accountants Australia and New Zealand, EY, KPMG, Tax Management New Zealand Limited, Corporate Taxpayers Group)

Support for the amendment to clarify the “lesser of” calculation for standard uplift taxpayers.

Recommendation

That the submissions be noted.

Issue: The proposed amendment should be located in the Tax Administration Act 1994

Submission

(Chartered Accountants Australia and New Zealand)

The inclusion of the provision clarifying the application of the use-of-money interest (UOMI) rules in the Income Tax Act 2007 is contrary to the principles of the rewrite of the Act and this amendment should be included in the Tax Administration Act 1994.

Comment

Officials agree that this provision is better placed in the Tax Administration Act 1994 and recommend moving that section to section 120KBB of the Tax Administration Act 1994.

Recommendation

That the submission be accepted.

REMOVING THE ABILITY FOR PROVISIONAL TAXPAYERS TO ALLOCATE PAYMENTS TO PARTICULAR INSTALMENTS

(Clause 126)

Issue: Disagree with the proposed amendment

Submission

(Chartered Accountants Australia and New Zealand, KPMG, Tax Management New Zealand Limited)

Removing the ability for taxpayers to choose the provisional tax instalment to which a particular payment is applied is unacceptable and unprincipled.

This amendment may unfairly penalise taxpayers by exposing them to additional late payment penalties even though payment has been made on time.

Comment

In practical terms the ability for taxpayers to allocate provisional tax payments to particular provisional tax instalments has never been available to taxpayers. Neither the heritage FIRST system nor the configuration of the new START platform have had the facility to apply payments to an instalment other than the oldest.

However, it is noted that prior to the removal of incremental penalties on income tax it was always more beneficial to allocate payments to the oldest debt to stop incremental penalties being charged. Once those penalties were removed it now gives non-compliant taxpayers the ability to reduce the impact of penalties by applying payments to later instalments.

Officials agree that this will be an adverse outcome to those taxpayers who do not pay their provisional tax instalments. Submitters made the point that this would be particularly harsh on taxpayers who inadvertently missed an instalment. However, with the ability to purchase funds from tax pooling intermediaries we consider that taxpayers in the situation where they have inadvertently missed a payment have the ability to correct that issue.

To allow those taxpayers who are non-compliant to reduce their exposure to late payment penalties by allocating payments to later instalments is not equitable to those taxpayers who make their payments on time.

Recommendation

That the submission be declined.

Issue: The Government should add a review of the coherence of the interest and penalty rules

Submission

(EY)

While the example given as the justification for the amendment is one of deliberate non-compliance, and we agree in those circumstances that taxpayers should not be able to game the system for advantage in relation to late payment penalties, we are also concerned that the amendment will also apply to taxpayers who under pay because of oversight.

We recommend that the Government undertake a review of the coherence of the use of money interest and penalty regime as part of future business tax reforms in that context to ensure that taxpayers who inadvertently under pay, or late pay, provisional tax are not disproportionally penalised because of the way in which Inland Revenue’s systems allocate the payments.

Comment

For those taxpayers who inadvertently fail to pay instalments there are other options available to them to ensure that no penalties are incurred.

The coherence of the use of money interest and penalties regime is always considered when changes are made to the legislation. The practical impact of this change is insignificant as no one has ever allocated payments in such as manner as the legislation allows.

Recommendation

That the submission be noted.

CLARIFYING THE WAY IN WHICH PROVISIONAL TAX INSTALMENTS ARE TRUNCATED TO WHOLE DOLLARS

(Clause 110(1))

Issue: General support for the amendment

Submission

(Tax Management New Zealand Limited, EY, Corporate Taxpayers Group)

Support for the amendment to clarify the way in which provisional tax is truncated to whole dollars.

Recommendation

That the submissions be noted.

Issue: Legislation should be altered to deal with taxpayers who have short paid their instalments by small amounts

Submission

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

The legislation should be altered to deal with taxpayers who have short-paid their instalments by less than $1 to ensure they can still use safe harbour concessions.

Comment

Officials have recommended that a tolerance be added to the legislation and system to ensure that taxpayers who do underpay their instalments by $20 or less will be deemed to have paid the instalment for the purposes of assessing concessionary rules such as the safe harbour.

This is included in the new matters raised at Select Committee section of this report.

Recommendation

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

Issue: Example in the commentary

Submission

(Chartered Accountants Australia and New Zealand)

The example in the commentary about truncation is incorrect.

Comment

The example in the commentary is correct according to the calculation in the legislation.

Recommendation

That the submission be noted.

Issue: Inland Revenue should provide further guidance

Submission

(EY)

Inland Revenue should provide further guidance as to what is required at each instalment to provide greater certainty.

Comment

Inland Revenue’s technology platform provides taxpayers with clear direction on the amounts that are payable for provisional tax purposes at particular dates. This is via both notices and via taxpayers’ myIR accounts. Taxpayers should be aware from those sources how much they need to pay, by when, and if they have overdue amounts.

Recommendation

That the submission be noted.

Issue: The proposed amendment is in the wrong section

Submission

(EY)

Support the codification of the current practice of truncation within the legislation.

However, considers this amendment should be made to section RC 9(2) rather than section RC 10(7). Section RC 10 details the method of calculation for instalments under standard and estimation methods whereas section RC 9(2) clarifies a general principle for the way in which payments are to be divided into instalments.

Comment

Truncation is important for assessing whether a taxpayer has made the correct payments to make use of concessions within the Tax Administration Act 1994 including the safe harbour rules in section 120KE and the interest concession rules in section 120KBB.

Section RC 10 of the Income Tax Act 2007 calculates the amount of each instalment required at each payment date and this is where truncation will apply. We consider that RC 10 is the preferred place to have a rule that applies to the calculation of the instalments.

However, after reviewing the way it is proposed that numbers will be truncated officials do recommend some adjustments to the wording in the legislation to reflect this and this is raised below.

Recommendation

That the submission be declined.

Issue: The amendment should apply retrospectively to the 2017–18 income year

Submission

(Tax Management New Zealand Limited)

Support the codification of the current practice of truncation within the legislation but believe it should apply retrospectively to the 2017–18 income year, as this is when the safe harbour concession was changed.

Comment

The submitter is correct that the safe harbour concession was changed to require taxpayers to make their instalments from the 2017–18 income year, however, this rule was not applied in the heritage FIRST system for that year and therefore no one was impacted by this issue for that year.

We do, however, agree that for completeness the application date should be made retrospective although note that practically this will not change the outcome for any taxpayers.

Recommendation

That the submission be accepted.

Issue: Additional truncation

Submission

(Matter raised by officials)

Truncation takes place at two points when determining the amount of provisional tax instalments. There is a truncation when the uplift is undertaken and also when the uplift amount is divided into thirds.

The truncation points are illustrated in figure 1.

Figure 1: Provisional tax truncation points

Comment

The proposed truncation amendment in clause 110(1) should be applied to sections RC 5(2) and RC 5(3) and RC 20 of the Income Tax Act 2007 in addition to RC 10.

In the truncation rule in clause 110(1) replace the word “amounts” with “instalments” – this is to ensure that there is no argument that residual income tax should be truncated.

All the above have application from the 2017–18 and later income years.

Recommendation

That the submission be accepted.

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

(Clause 130)

Issue: Concerned about unintended consequences for a taxpayer who has residual income tax of less than the amount due to settle the liability

Submission

(Tax Management New Zealand Limited)

The submitter had concerns as to how the rule will apply in practice and whether any late payment penalty will take into account any over payments on previous instalments. They consider the wording should be supported by examples.

Comment

Officials agree that these types of changes are best illustrated with examples and these will be provided with the accompanying Tax Information Bulletin that will be published once the Bill is enacted.

Recommendation

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

NON-STANDARD PROVISIONAL TAX INSTALMENTS

(Clause 129)

Issue: Support for the amendment

Submission

(Tax Management New Zealand Limited)

General support for the amendment.

Recommendation

That the submission be noted.

Issue: Application date of this clause should be amended

Submission

(Chartered Accountants Australia and New Zealand)

The application date should be amended to apply to the 2017–18 and later income years.

Comment

This issue has not arisen in practice as the Inland Revenue computer systems have been applying the rule as if the definition is correct. However, we agree the change should apply retrospectively to the 2017–18 income year, when section 120KBB applied from.

Recommendation

That the submission be accepted.

THE EFFECT OF REGULAR AMENDMENTS TO PROVISIONAL TAX

Issue: Constant changes provide a negative impact to the provisional tax rules

Submission

(EY)

Broadly support the amendments to clarify the provisional tax rules, but believe the Select Committee should be mindful of the wider impact that regular changes to this regime has and ensure that only those amendments that are sustainable and clearly needed are progressed.

Comment

We note the submitter’s concerns. However, the majority of the proposed amendments ensure that the legislation matches the administrative practice to provide certainty to taxpayers and these amendments have been necessitated where there are gaps in the legislation.

We agree that regular amendments do impact on taxpayer certainty and ensure that only those amendments that are clearly needed to improve certainty should be made. However, in the majority of cases the legislation is catching up to the administrative practice and should have no practical effect on taxpayers.

Recommendation

That the submission be noted.

TAX ADMINISTRATION MATTERS

(Clause 134)

Issue: Support for permitted disclosure relating to representatives

Submission

(Chartered Accountants Australia and New Zealand, Institute of Certified NZ Bookkeepers)

The submitters support the proposal to extend the ambit of an existing rule that allows Inland Revenue to disclose information to associations or groups that represent tax agents to also allow Inland Revenue to disclose information to associations or groups that represent “representatives” (including bookkeepers) in the same circumstances.

Recommendation

That the submission be noted.

(Clauses 2(19) and 119 – 121)

Issue: Support for remedial amendments relating to the binding rulings regime

Submission

(Chartered Accountants Australia and New Zealand)

The submitter supports the proposals to:

enable the Commissioner to withdraw short-process binding rulings; and
specify the period that a person can continue to rely on a withdrawn private, short-process, or product ruling in relation to a matter that does not involve an arrangement.

Comment

The proposed amendments were identified following the enactment of the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019, which extended the scope of matters for which the Commissioner could issue binding rulings and introduced a new type of binding ruling – short-process rulings.

The proposed amendment includes new section 91ESB of the Tax Administration Act 1994, which would enable the Commissioner to withdraw short-process rulings. This corrects an oversight following the drafting of the short-process rulings provisions, and mirrors existing provisions which allow the Commissioner to withdraw other binding rulings. Binding rulings are generally only withdrawn where there has been a change in the interpretation of the relevant taxation law, or where the ruling needs to be withdrawn and reissued with a variation.

The other proposed amendments (to sections 91EI and 91FJ of the Tax Administration Act 1994) provide that where a private, short-process, or product ruling has been withdrawn in relation to a matter that does not involve an “arrangement”, the person to whom the ruling applies can continue to rely on it for the period specified in the ruling. This is consistent with the rules that apply for private, short-process, and product rulings on matters involving arrangements where these rulings still have effect for the applicant (despite being withdrawn) where the applicant has already entered into the arrangement described in the ruling before it is withdrawn.

Recommendation

That the submission be noted.

Issue: Clarifications to the legislative drafting for removing tax agents, representatives, and nominated persons

Submission

(Matter raised by officials)

Officials recommend remedial amendments to section 124G of the Tax Administration Act 1994 which contains the discretion for the Commissioner to remove a person from the list of tax agents, disallow a person’s status as a representative, and disallow a person as a nominated person.

The proposed amendments would ensure the rules operate as intended. Specifically, the amendments would ensure that there is no ambiguity about the effective date a person is removed from the list of tax agents or disallowed as a representative or nominated person.

It is intended that before a person is removed as a tax agent (or disallowed as a representative or a nominated person) the Commissioner will be required to consider arguments against the proposed removal (or disallowance) unless the Commissioner considers it necessary in the circumstances to remove the person immediately to protect the integrity of the tax system. For example, this could be the case where the Commissioner becomes aware of a person acting fraudulently and it is necessary to revoke their access from Inland Revenue’s computer systems. In such circumstances it would be inappropriate for the Commissioner to continue to allow the person to act on behalf of others.

Officials also recommend a proposed amendment to section 124G(6)(a) of the Tax Administration Act 1994 to make it clear that the Commissioner is not required to divulge information that could, for example, be withheld under section 6 of the Official Information Act 1982. The proposed amendment is consistent with the same rules requirements on the Commissioner when she refuses to list a person as a tax agent (see section 124G(5)(a) of the Tax Administration Act 1994).

Officials recommend the proposed amendments apply from the date of enactment.

Recommendation

That the submission be accepted.

Issue: Clarification to the rules that allow for the self-correction of certain errors in subsequent returns

Submission

(Matter raised by officials)

Officials have identified several refinements which can be made to ensure that the rules that enable taxpayers to self-correct certain errors in returns for income tax, fringe benefit tax (FBT) and goods and services tax (GST) operate as intended. The refinements are to address interpretative and practical issues that have been raised with officials since the changes were made to the rules as part of the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 earlier this year.

The refinements aim to:

Confirm that the $10,000 limit in the materiality threshold test refers to the tax discrepancy caused by the error(s) and not the amount of the error(s).
Ensure that there is no confusion between the application of the thresholds in section 113A (either a tax discrepancy of $1,000, or a tax discrepancy that does not exceed the greater of $10,000 and two percent of the taxpayer’s annual gross income or GST payable for the relevant period) and the self-correction rules for PAYE, RWT and NRWT which have their own rules.
Clarify that multiple errors that do not exceed the new materiality threshold can be corrected, provided the total discrepancy caused by the errors do not exceed the relevant thresholds.

Officials recommend the proposed amendments apply from the date of enactment.

Recommendation

That the submission be accepted.

Issue: Self-correction of certain errors in subsequent returns – guidance and changes to the test for GST errors

Submission

(Deloitte)

The meaning of “total discrepancy in the assessment” should be clarified.

The correct interpretation of section 113A(4) of the Tax Administration Act 1994 is that the two percent threshold is two percent of the output tax for the return period in which the error occurred, not the annual output tax.

To resolve the fact that exporters have a limited ability to use these rules in relation to their GST returns (because export sales do not generate output tax), measuring materiality for GST errors should involve a test that looks at a person’s “taxable supplies” instead.

Comment

The phrase “total discrepancy in the assessment” is intended to refer to the total amount of the tax discrepancy caused by the error, or errors, that were included in the original return. For example, if a return contained an error that resulted in an omission of output tax of $800 (a debit), and an error that resulted in an omission of input tax of $400 (a credit), the total discrepancy in the assessment caused by those errors is $400 (that is, $800 minus $400). Officials intend to include further examples in the Tax Information Bulletin that covers the changes made by the Bill.

Officials also agree that the two percent test in section 113A(4) for GST errors is intended to be two percent of “output tax” for the relevant return period, and not two percent of a taxpayer’s “annual output tax”. The expression “annual gross income” is defined for the purposes of the Tax Administration Act 1994 in section BC 2 of the Income Tax Act 2007. The use of the word “annual” in section 113A(4) is intended only to refer to “annual gross income” as in the defined term, and it is not intended to extend to “annual output tax”, which is not a concept that is used in either the Tax Administration Act 1994 or the Goods and Services Tax Act 1985.

Officials can see merit in changing the test from “2 percent of output tax” to “2 percent of taxable supplies” (or another alternative) for the purposes of GST to address the issue raised by the submitter. However, officials consider that before an amendment be made to change the test, further consultation should be undertaken on whether “2 percent of taxable supplies” is the most appropriate solution. Officials recommend that this consultation occur as part of a future taxation bill.

Recommendations

That the submissions about “total discrepancy in the assessment” and the correct interpretation of the two percent materiality test for GST be noted.

That the submission to change the materiality test for GST to address a possible issue for exporters be declined.

CONSIDERATION FOR GRANT OF AN EASEMENT

(Clauses 61 and 62)

Issue: Transitional rule

Submission

(EY)

A transitional rule should be introduced for taxpayers who have previously treated a one-off payment for a permanent easement as taxable, because of the uncertainty of treatment in the period between the release of the Vector decision and this amendment coming into force. These taxpayers should be able to claim refunds in respect of these amounts; it does not appear fair to penalise taxpayers who may have conservatively paid tax on such receipts in the interim period.

Comment

Taxpayers who have conservatively paid tax on one-off payments for the grant of a permanent easement after the Vector decision and before this amendment comes into force may be able to claim refunds in respect of these amounts. However, officials do not consider that a transitional rule is necessary to achieve this. Taxpayers can already apply to the Commissioner to have an assessment amended under section 113 of the Tax Administration Act 1994. It is also unlikely there are any taxpayers in this position, as section CC 1(2C) has always had the clear intent of excepting these payments from tax.

Recommendation

That the submission be declined.

Issue: Payments for the grant of a land right

Submission

(Matter raised by officials)

An existing remedial amendment in the Bill moves section CC 1(2C) – a provision that excepts one-off payments for the grant of a permanent easement from income tax – from section CC 1 to section CC 1B of the Income Tax Act 2007.

Doubts have arisen as to whether section CC 1B taxes consideration for the grant of an easement (or other land right). A clarifying amendment should therefore be made to ensure that, consistent with the policy intent, such payments are taxable.

Comment

It is intended that payments for the grant of an easement or other land right are taxable.

Originally, it was thought that payments for the grant of a land right were taxable under section CC 1. However, the Court of Appeal in CIR v Vector Limited [2016] NZCA 396 found that the words “other revenues” in section CC 1 do not capture traditionally capital amounts such as one-off payments for the grant of an easement, and none of the other “amounts” listed in section CC 1(2) captures such payments. This meant that the exception for permanent easements in section CC 1(2C) is redundant.

It was noted by the Court that section CC 1B – introduced with effect from 1 April 2013 – would have captured the amount for the grant of the easements in Vector had it existed at the time of the transaction. Officials were similarly of the view that section CC 1B captured payments for the grant of a land right. However, doubts have arisen as to whether this is the case.

Section CC 1B should be amended to ensure that payments for the grant of a land right (such as a licence or a limited term easement) are taxable, because economically, such payments can be substituted for a taxable rental stream. This amendment is also necessary to ensure that relocated section CC 1(2C) (proposed section CC 1B(6)) has its intended effect of carving out a one-off payment for the grant of a permanent easement from tax in a legislative scheme that would otherwise tax such a payment.

The proposed amendment should apply retrospectively from 1 April 2013, the date that section CC 1B became effective. However, a savings provision should be included so that taxpayers who have already filed a tax return, or been given a binding ruling, on the basis that section CC 1B does not tax these payments, are not affected by the amendment. The savings provision should only apply to positions taken before the date of announcement of the proposed amendment by the Minister of Revenue, which was 23 August 2019.

Officials consider this proposed amendment should be included in the current Bill rather than the next bill that is introduced to preclude what could otherwise be a significant fiscal risk.

Recommendation

That the submission be accepted.

EMPLOYEE SHARE SCHEMES

(Clauses 69 – 71)

Issue: General support

Submitters generally support the proposed amendments to the employee share scheme (ESS) rules. However, they also recommend some further changes to improve the workability of the rules.

Recommendation

That the submission be noted.

EMPLOYEE SHARE SCHEMES – DEFINITION OF MARKET VALUE

(Clauses 69 and 71)

Issue: Refreshed valuation statement should be released

Submission

(PwC)

In conjunction with the introduction of the new definition of “market value”, the Commissioner should release a refreshed valuation statement (replacing CS 17/01) that sets out a volume weighted average price (VWAP) equivalent and other valuation methods accepted by the Commissioner. Also, prior to releasing this refreshed valuation statement, the Commissioner should consult with taxpayers to ensure that the approaches included in it are practical and workable.

Comment

Officials understand that the valuation methods approved in the existing valuation statement reduce compliance costs, and in most cases will be practical and workable for companies that choose to use them. However, officials can see value in reviewing the content of the statement and consulting further with taxpayers to ensure that the list of available methods is as practical as it can be. A refreshed list of methods could potentially be published as a Tax Information Bulletin item, or as a new valuation statement, as the submitter suggests. Officials will consult further to determine the best approach.

Recommendation

That the submission be accepted.

Issue: Section CE 2(4) should be amended

Submission

(Russell McVeagh)

Section CE 2(4) should be amended so that where an employee disposes of shares under an employee share scheme (or exempt ESS) immediately upon acquisition (often to fund the payment of PAYE), the employee is not treated as having a further gain or loss for tax purposes (as a result of the way the shares are valued) where the shares are on revenue account. Currently, the cost base for shares is determined with reference to their “market value”, but this market value – however it is determined – is unlikely to match the actual proceeds derived by the employee on sale. The most administratively simple solution would be to deem the value of the shares to be equal to the sale proceeds for cost base purposes but continue to use “market value” for PAYE purposes.

Comment

Officials acknowledge the concerns raised by the submitter, but do not consider that the problem is significant enough to warrant specific legislative change. Officials consider that in the vast majority of cases, shares acquired by an employee under an ESS will be on capital account, as an employee normally holds these shares because their employer has chosen to remunerate them that way, rather than because the employee has a particular intention of resale. Any further gain or loss made on the sale of the shares will therefore not be taxable.

In the uncommon case that the employee holds the shares on revenue account and sells them immediately, a further gain or loss on the sale of the shares represents a real positive or negative difference in the economic benefit to the employee against the market value. While compliance costs would be reduced by not taxing this additional amount, taxing it is technically correct and officials do not think that position should be departed from.

Officials note that in the current Commissioner’s statement on the valuation of ESS shares (CS 17/01), one of the options for valuing listed shares is to use the sale proceeds (for both cost base and PAYE purposes), if the employee disposes of the shares on a recognised exchange on the date of acquisition. This option may be expanded as part of a refresh of the statement.

Recommendation

That the submission be declined.

EMPLOYEE SHARE SCHEMES – FLEXIBILITY TO ALLOW EMPLOYEES TO KEEP SHARES IF THEY LEAVE EMPLOYMENT

(Clause 70)

Issue: Use of the word “purchase” does not allow for nil consideration

Submission

(Corporate Taxpayers Group, Deloitte)

The proposed amendment to section CW 26C(8) provides for arrangements in which, if an employee who is not currently employed breaches the restricted period for an exempt employee share scheme, the employee’s shares must be “purchased” back by the employer for the lesser of the cost of the shares to the employee or the market value of the shares on the date the period of restriction ends. The use of the word “purchase” in this context is problematic if an employee was granted shares for nil consideration, as the employer must “purchase” the shares back for that nil consideration, but definitionally, a “purchase” requires a contract and consideration. As a workaround, employers can grant shares for a nominal amount such as $1, and subsequently “purchase” the shares back for that amount. But this fix creates onerous compliance costs and is often questioned by Boards. To correct this issue, references to “purchased” or “bought” should be replaced with either “acquired” or “transferred”.

Comment

Officials agree that the use of the word “purchased” in the legislation may be problematic where shares are granted for nil consideration. The exempt employee share scheme rules were not intended to preclude such arrangements, and officials agree that using the word “acquired” or “transferred” instead would resolve the issue.

Recommendation

That the submission be accepted.

Issue: Proposed section CW 26C(8) is unclear

Submission

(Chartered Accountants Australia and New Zealand)

Proposed section CW 26C(8) is unclear and should be rewritten. The new drafting could be:

When the period of restriction ends, the arrangement must provide:

if the employee is currently employed that the shares are transferred to the employee, or if the employee chooses, that the shares are purchased for the lesser of

the cost of the shares to the employee;
the market value of the shares on the date the period of restriction ends; or:
if the employee is not currently employed and the employee chooses, that the shares are transferred to the employee or purchased for the lesser of:
- the cost of the shares to the employee; or
- the market value of the shares on the date the period of restriction ends.

Comment

Proposed section CW 26C(8) is complex, as it has to provide for two possible arrangements from which the employer can choose (in relation to an early termination of the “restricted period”).

One of these options distinguishes between an employee who is currently employed and an employee who is not currently employed. The other does not.

This is because the policy intent of the proposed amendment is to allow companies to choose whether a particular subset of employees – those who are not currently employed – (a) have a choice between keeping their shares or having the company buy them back, or (b) are required to have them bought back.

While complex, officials consider that the current drafting covers all of the permutations that are intended to be allowed under the amendment. Officials do not consider that the submitter’s suggested drafting covers all of the possibilities. However, we will investigate whether there is a simpler way to draft the provision, while still ensuring that it covers all of the arrangements intended to be permitted.

Recommendation

That the submission be accepted.

Issue: Potential unintended change in the 2004–2008 rewrite

Submission

(Deloitte)

In section CW 26C, there is no requirement for dividends paid during the restricted period to flow to employees. In the prior version of the section – section DC 12(5) of the Income Tax Act 2004 – this requirement was included as part of the requirement to have a trustee to hold the shares during the restrictive period. The requirement to have a trust was (sensibly) deleted when the rules relating to tax-exempt ESS were amended, as a trustee should not be required for a scheme to qualify. However, with it, it appears that the dividend requirement was also removed. This deletion does not seem likely to have been a policy intention during the rewrite. Section CW 26C should be revised to clarify and confirm the original policy intention.

Comment

Officials agree that removing the requirement for dividends to flow to employees was unlikely to have been a policy intention. Section CW 26(C) should be revised to clarify the original policy intent that dividends must flow to the employees holding the shares.

Recommendation

That the submission be accepted.

OVERSEAS DONEE STATUS – SCHEDULE 32

(Clause 114)

Issue: Updates to the list

Submission

(Matter raised by officials)

Two changes are required to the existing list of organisations named on schedule 32 of the Income Tax Act 2007:

Remove “Onesight New Zealand” with effect from 30 May 2019. This trust was wound up on that date.
Remove “Orphans Refugees and Aid of New Zealand Charitable Trust” and replace the reference with “Hope Street Charitable Trust” with effect 15 June 2019, the date the charity was rebranded.

Comment

The proposed changes are recommended by officials ensure the statutory list remains current. The proposed changes are not new additions to the list of donee organisations and update existing references to reflect changes in the named charities’ circumstances.

Recommendation

That the submission be accepted.

TAXATION OF LIFE INSURANCE BUSINESS – TRANSITIONAL RELIEF

Issue: Implementation concerns

Submission

(AIA New Zealand Ltd, Cigna Life Insurance New Zealand Ltd, Financial Services Council)

Submissions raise three matters with the implementation of an amendment made by the Taxation (Annual Rates 2019–20, GST Offshore Registration, and Remedial Matters) Act 2019 at it applies to transitional relief for level premium life insurance policies sold before 1 July 2010.

The issues are:

The current description for CPI movements in section EY 30(5BA) of the Income Tax Act 2007 do not reflect life insurer practices. (AIA New Zealand Ltd, Financial Services Council)
The savings provision that accompanied the legislative change made by the Taxation (Annual Rates 2019–20, GST Offshore Registration, and Remedial Matters) Act 2019 is too limiting for some life insurers to take advantage of the amendment to section E 30. (Financial Services Council)
Transitional relief should be available for life insurance policies that were sold as “level premium” and provided life cover indexing benefits of more than three percent. (AIA New Zealand Ltd, Financial Services Council, Cigna Life Insurance New Zealand Ltd)

Comment

In 2010 the taxation of life insurance business was substantially reformed. Accompanying the reform was transitional relief for life insurance policies sold before the start of the new rules (1 July 2010). The transitional relief provides life insurers with a tax deduction to reflect the tax that would otherwise be paid before the 2010 tax reforms.

One form of term life insurance policy offers premiums that remain at a set level over the term of the cover. Section EY 30(5)(b) allows life insurers tax transitional relief for these “level premium” policies sold on or before 30 June 2010. Section EY 30(5)(b) allows for increases in the base premium for such policies if the increase is a result of increasing the amount of life cover for movements in the consumer price index (CPI). The base premium is the premium agreed at the time the life insurance policy is sold. Such increases are annually activated by the life insurer unless the policyholder expressly cancels it.

The rule did not adequately respond to situations when, because of a low-inflation environment, increases in the sum assured under the formula were higher than percentage changes in CPI.

Most level premium policies allow for an incremental increase in premiums over its contractual duration by a formula to reflect percentage changes in the CPI to maintain the real value of life insurance cover. These increases are typically framed by an increase of 3 percent or movement in the CPI index – whichever was the higher.

The amendments made by the Taxation (Annual Rates 2019–20, GST Offshore Registration, and Remedial Matters) Act preserved transitional relief for life insurance policies that provided benefits giving an increase in the amount of life cover where that increase does not exceed three percent or the percentage increase in the CPI (whichever percentage is the higher).

Officials have had ongoing discussions with life insurers regarding the implementation of the amendments made by the Taxation (Annual Rates 2019–20, GST Offshore Registration, and Remedial Matters) Act 2019 and agree that improvements can be made to the wording of the legislation in respect of the first two submission points to ensure the amendments made by that Act operate correctly.

Officials recommend two remedial changes be included in the Bill to:

Replace the current description of the CPI period being, “consisting of the last 4 quarters preceding the year”, with a reference to the CPI percentage change movement to the annual rate specified in the formula in the life policy.
Revise the application section (section 65(4) of Taxation (Annual Rates 2019–20, GST Offshore Registration, and Remedial Matters) Act 2019) to ensure that life insurers wanting to use the amendment can do so.

Regarding the third matter raised by submitters, officials’ discussions with affected life insurers and the Financial Services Council on the implementation of the amendment to section EY 30 has revealed a moderately complex background. An array of understandings and expectations exist about the outcomes of the 2010 reforms to the taxation of life insurers, including the extent to which transitional relief is available for level premium life insurance policies sold and in existence immediately before the reforms took effect. To further complicate matters, life insurers have taken different approaches in terms of their compliance systems and the matters on which Inland Revenue’s view has been sought. An illustration of this point can be found in the different recommendations put forward by AIA and Cigna.

Officials consider the solution sought by submitters for the third matter goes beyond the scope of a remedial matter that can be included in this Bill and warrants deeper consideration. Officials recommend, subject to current priorities on the Government’s tax policy work programme, that submitter concerns regarding transitional relief for level premium life insurance policies be considered for a later bill.

Recommendation

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

BRIGHT-LINE MAIN HOME EXCLUSION

(Clause 60)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand)

The submitter supports the proposal to amend the main home exclusion for the bright-line test to align the period considered for the exclusion with the period in the bright-line test itself.

Recommendation

That the submission be noted.

Issue: Suggestion for different period

Submission

(KPMG)

The submitter agrees that the applicable period for the main home exclusion for the bright-line test should be aligned with the date the five-year period for the bright-line test begins but suggests the period should extend to the date of settlement of any sale.

The submitter agrees that the period from which a mere equitable interest in the property is acquired to when settlement on purchase occurs should be excluded from consideration for the main home exclusion. This is because the owner does not have occupancy rights during that period. However, the submitter suggests that the period considered for the bright-line test artificially curtails the period of use because it ends when an agreement for sale and purchase is entered into. The submitter suggests that where a bright-line property is subject to an extended settlement period on sale and the owners continue to reside in the property it would be inappropriate to exclude this period from consideration for the main home exclusion.

Comment

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, for a dwelling that was the main home for the person. Therefore, the time period that the property is used as a main home is important in determining whether the main home exclusion will apply. Officials consider it is important that this time period is consistent with the period that the bright-line test applies to. This is to ensure that a person cannot manipulate the application of the main home exclusion by occupying the property after the period considered for the bright-line test has ended.

Recommendation

That the submission be declined.

Issue: Settlements of relationship property

Submission

(Matter raised by officials)

Clause 60 of the Bill contains an amendment to the main home exclusion for the bright-line test to align the period considered for the exclusion with the period in the bright-line test itself. A further amendment is needed to clarify when this period starts when land is transferred on a settlement of relationship property as defined in section FB 1B.

Comment

Section FB 3A applies where residential land that may be subject to the bright-line test is transferred on a settlement of relationship property. It clarifies that the transfer will be treated as occurring for an amount equal to the cost of the land to the transferor, and at the date the transferor acquired the land. Section FB 3A currently applies for the purposes of section CB 6A (the bright-line test). Section FB 3A should be amended to clarify that it also applies for the purpose of section CB 16A (the main home exclusion for the bright-line test).

The proposed amendment would apply from the date of enactment.

Recommendation

That the submission be accepted.

INTEREST LIMITATION

Issue: Restricted transfer pricing – optional credit rating method

Submission

(Corporate Taxpayers Group, Deloitte, Russell McVeagh)

Section GC 16(11) of the Income Tax Act was amended by the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 to extend the optional credit rating method to long-term senior debt that is “secured”. However, section GC 16(5) still makes specific mention of the requirement for the long-term senior debt to be “unsecured”, with the unintended consequence that taxpayers with only secured debt are excluded from using the optional credit rating method on the basis that they do not meet the strict requirements of section GC 16(5).

Section GC 16(5) should also have the word “unsecured” removed so that taxpayers with secured debt are then able to use the optional credit rating method in section GC 16(11).

Comment

As noted by the submitters, amendments to section GC 16(11) in the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 were intended to allow taxpayers to apply the optional credit rating method based on long-term senior debt whether it was secured or unsecured. As a taxpayer can only calculate their interest rate under the optional credit rating method in section GC 16(11) if they satisfy the criteria in section GC 16(5) the word “unsecured” should have been removed from both sections.

Recommendation

That the submission be accepted.

Issue: Non-debt liabilities – shareholder loans

Submission

(Deloitte)

The wording “a shareholder that is a member of the group” in section FE 16B(1)(b) should read “a shareholder”. This wording is likely to be an unintentional drafting error. This is because the wording will, essentially make the provision redundant as, if the shareholder was a member of the New Zealand group, the debt would be consolidated away.

Comment

Section FE 16B(1)(b) excludes from non-debt liabilities, in the thin capitalisation rules, financial arrangements providing funding that are pro rata with shareholding or by a substantial shareholder.

As thin capitalisation is calculated on a group basis, a financial arrangement between a company and a shareholder where both were members of the group would not increase the debt of the group as the arrangement would disappear upon consolidation. Therefore, the submitter is correct that the current wording would apply only to arrangements that would not affect the group’s debt levels.

Also, officials have been made aware of situations where two members of a wholly-owned group exist where the first member is a shareholder of a New Zealand group member and the second member provides either an interest free loan or redeemable preference shares in proportion with the first members shareholding. By removing the wording discussed in the paragraph above this situation will be covered by the associated person reference in section FE 16B(1)(b)(ii) and (c)(ii) but there is no equivalent for proportional shareholdings where the total shareholding in the New Zealand group member is less than ten percent. Officials recommend changes to section FE 16B(1)(b)(i) and (c)(i) to ensure this situation is also excluded from being a non-debt liability.

Recommendation

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

(Clause 83)

Issue: Dividend paid out of previously attributed income

Submission

(Matter raised by officials)

That the proposed amendment in clause 83 does not achieve the policy intent.

Comment

A submitter on the Bill has queried whether the proposed amendment in clause 83, relating to the income attribution rules, achieves its policy intent.

As set out in the commentary on the Bill, the policy intent for this proposed amendment is to ensure that a dividend paid by a company (“associated entity”) that has previously attributed income to a shareholder (“working person”) is exempt income of the recipient if it is paid out of the previously attributed income, and the company’s records demonstrate this.

Officials agree that the wording proposed does not clearly identify that the dividend is exempt only if it represents a distribution from income attributed to and taxed to a working person in an earlier income year. We recommend that the drafting be updated to clarify this intent.

Recommendation

That the submission be accepted.