Dividend integrity and personal services income attribution
A Government discussion document
Hon Grant Robertson
Minister of Finance
Hon David Parker
Minister of Revenue
March 2022
Chapter 4 – Current practice and issues
Summary
Distributions by a company are not taxable to the extent they are:
- a return of capital subscribed by shareholders (referred to as “available subscribed capital” (ASC)) on a liquidation or share cancellation, or
- a net capital gain of the company distributed in a liquidation.
When there is a share repurchase or liquidation, determining the dividend amount requires subtracting the ASC and the capital gain amount. Because a company may have been in existence for a long time before liquidation and these amounts may not be relevant before then, it is sometimes difficult for the company to determine them (going through historical records) and for Inland Revenue to verify them.
There are different ways to improve the reliability of this information. This chapter and the next consider two possible options:
- Option one: Require the amount of ASC and the capital gain amount to be determined annually and reported to Inland Revenue.
- Option two: Require taxpayers to record the information to evidence that they have calculated the dividend amount correctly (with Inland Revenue determining the amounts in the absence of reliable evidence), with no annual reporting requirement.
4.1 The determination of a company’s ASC and available capital distribution amount (ACDA) is provided for in sections CD 43 and CD 44 respectively.
4.2 The calculation of these amounts is not straightforward. The ASC definition has 40 subsections and comprises approximately 2,820 words. Although the core definition (amounts received for the issue of shares less amounts returned on the cancellation of shares) is simple enough, complexities arise by reason of the tax treatment of (among other things):
- taxable bonus issues
- share for share exchanges
- shares issued as part of an employee share scheme, and
- amalgamations.
4.3 In relation to ACDA, the calculation requires:
- capital gains and losses to be calculated
- an understanding of whether the transaction was with a related party or not, and
- special calculations in relation to foreign investment fund (FIF) interests.
4.4 Not only are the rules complex, they change from time to time, meaning that the appropriate treatment of a transaction depends on the year in which it takes place.
4.5 An example of the kind of issue that can arise is where a company (the acquirer) issues its shares in exchange for 100 percent of the shares in another company (the target). From an accounting perspective, the acquirer will generally take the target into its books at the purchase price paid, and the increase in the acquirer’s shareholders’ equity will reflect the market value of the issued shares. However, for tax purposes, the ASC is limited to the historic amount paid to the target for the issue of its shares, whenever that occurred. Currently, there is no explicit requirement for any contemporaneous record of this discrepancy to be maintained.
4.6 In relation to both ASC and the ACDA, many years may pass between the occurrence of the transactions giving rise to positive or negative entries in the account, and the time when a distribution is made for which those entries are relevant. And in relation to ASC in particular, in many cases the figure will never be relevant. If the company is a wholly-owned subsidiary of another company at the time it is wound up, its ASC will be essentially unused. This may be the case for a company that is always part of a corporate group, or for a company initially owned by individuals or trusts and then sold to a corporate group.
4.7 In cases where a company does have to determine its ASC or ACDA, unless it has been very well run, the determination will often be extremely difficult, as it requires a careful record of both the law and transactions going back to the formation of the company.
4.8 There does not appear to be any explicit requirement for a company to keep records in relation to its ASC or ACDA. Section 22 of the Tax Administration Act 1994 (the TAA) does not apply, since these amounts are not required for the calculation of the company’s own income or deductions (see section 22(2)(g) and (h) of the TAA). Nor are they otherwise specifically dealt with in that section.
4.9 Section 22AAB(2) of the TAA does require a person who is liable to pay RWT for resident passive income paid to another person to keep proper records relating to the income paid by them, sufficient to enable the Commissioner of Inland Revenue to ascertain the information set out in Schedule 3 table 2. Row 5 of table 2 refers to the amount of resident passive income. When a company makes a payment in consideration for the cancellation of shares, or makes a liquidating distribution, in order to ascertain the amount of a dividend (which could be zero) the Commissioner would require information about the company’s ASC and ACDA. It is therefore arguable that section 22AAB(2) imposes a requirement to keep records. However, the section seems primarily directed to the ascertainment of information about who has received a dividend and when, rather than the ascertainment of whether a distribution to a shareholder is a dividend in the first place.
4.10 Despite the lack of any explicit requirement, a company that does not have records to substantiate its ASC and ACDA will effectively lose those amounts, as it will not be able to satisfy the burden of proof required to take a position that some or all of a distribution is not a dividend. This issue is considered in draft operational statement ED 0239, released in December 2021.