Tax Tips Special 8/2009

In this issue:

Tax Bill reported back
NZ's international tax rules
Associated persons
Relocation costs
Overtime meal allowances
IFRS
Stapled stock
Payroll giving
Life insurance tax reform
Other matters
Remedial matters and technical amendments

Tax Bill reported back

The Finance and Expenditure Committee (FEC) has reported back to Parliament on the Taxation (International Taxation, Life Insurance and Remedial Matters) Bill (the Bill) introduced in July 2008. The FEC has recommended a limited number changes to the Bill following consultation with interested parties including PricewaterhouseCoopers.

The key reform measures included in the Bill are to New Zealand’s international tax rules, the “associated persons” definitions, the taxation of life insurance business and the treatment of relocation and overtime meal allowances. The Bill also introduces a new payroll giving system and includes a number of other remedial and technical amendments.

It is pleasing to see that the FEC has recommended deferring the commencement dates for the major reforms. Other key amendments recommended by the FEC include a number of changes to the definition of associated persons to reduce uncertainty and to narrow the scope of the proposed tests to ensure they do not inadvertently capture genuine arm’s length transactions.

NZ’s international tax rules

The Bill includes a number of proposals which will change fundamentally the way in which income derived from investments in foreign subsidiaries is taxed. The key aspects of the reform generally remain unchanged. However the FEC has recommended a number of technical changes to the Bill to reduce taxpayer compliance costs and better give effect to the policy intent of the reforms.

Application dates
For taxpayers with balance dates on or after 30 June the rules will apply from the 2009-10 income year (i.e. the rules would apply from 1 July 2009 for a 30 June balance date taxpayer). The FEC has recommended that the application of the international tax reforms be delayed until the 2010-11 income year for taxpayers with balance dates prior to 30 June (i.e. for 31 December and 31 March balance date taxpayers the rules will apply from 1 January 2010 and 1 April 2010 respectively). Disappointingly, there is no ability for such taxpayers to elect into the new rules early.

The new application dates are consistent with the dates recommended by Revenue Minister Peter Dunne in his press release on 25 March 2009.

Active income exemption
The Bill contains an exemption from New Zealand tax on active income derived by New Zealand residents from interests in controlled foreign companies (CFCs). Passive income (such as some dividends, interest and royalties) will be taxed on an attribution basis. CFCs that pass an “active business test” will not be required to attribute any income to New Zealand shareholders. A CFC will pass the active business test if its passive income is less than 5% of gross income. The active business test can be applied using either tax rules or audited financial accounting information.

A number of submissions expressed concern that the active business test based on accounting financial information was too complex and would result in significant taxpayer compliance costs. In response to these submissions, the FEC has recommended a number of technical changes to the active business test in order to make the accounting based test easier to apply.

Despite strong submissions that the “grey list” exemption be retained, it is to be removed under the new rules. However, an exemption for most Australian CFCs will continue to apply.

Interest allocation rules
The Bill extends the current thin capitalisation rules to New Zealand companies that are controlled by New Zealand residents and have interests in CFCs. These outbound thin capitalisation rules are intended to operate as a base protection measure to prevent New Zealand residents with CFC investments from allocating an excessive portion of their interest cost against the New Zealand tax base. To reduce taxpayer compliance costs the outbound thin capitalisation rules will not apply where the New Zealand taxpayer has:

90% or more of their assets in New Zealand; or
less than $1 million of interest deductions.

It is pleasing to see that the FEC has increased the de minimis interest deduction threshold from $250,000 to $1 million. In addition, the FEC has introduced rules to mitigate the impact of the interest allocation rules for taxpayers with interest deductions between $1 million and $2 million.

The Bill also amends the definitions of “debt” and “assets” for the purpose of calculating the New Zealand group debt percentage and worldwide group debt percentage under the thin capitalisation rules. Under the new rules equity investments in CFCs are excluded from assets, and “fixed rate shares” issued by a New Zealand company to New Zealand taxpayers are treated as debt. Payments made on fixed rate shares are included in interest when determining a taxpayer’s additional income adjustment under the thin capitalisation rules.

Whilst accepting that fixed rate shares can sometimes be used as a substitute for debt, it would have been preferable to consider this change within a broader based review of the debt/equity boundary. It is also disappointing that the Bill does not include any grandfathering rules for taxpayers that currently have financing structures in place involving fixed rate shares. In addition the Officials did not accept the submission that internally generated goodwill be included as an asset for thin capitalisation purposes.

Taxation of foreign dividends
Under the proposed rules most foreign dividends received by New Zealand companies will be exempt from domestic tax. Exceptions to this general rule include:

dividends on fixed rate shares and dividends for which the CFC has received a tax deduction in its home jurisdiction will continue to be taxable in New Zealand; and
dividends from portfolio FIFs (i.e. interests under 10%) that are exempt from the FIF rules (e.g. interests in Australian listed companies) will continue to be taxable in New Zealand.

Officials rejected submissions that the deductibility of a dividend in a foreign country should not result in the dividend being taxable. More disappointingly they rejected submissions that dividends on fixed rate shares should be exempt, even where the dividend is non-deductible in the foreign company’s home jurisdiction.

The original drafting of the Bill treated distributions on fixed rate foreign equity investments and deductible foreign equity investments as interest income. This resulted in inconsistent treatment of income from these investments under the financial arrangement rules. The treatment of distributions from these investments as non-exempt dividend income ensures that the two types of investment are taxed consistently.

Transitional rules for foreign tax credits and losses
The Bill includes revised transitional provisions for the carry forward of losses and foreign tax credits derived by CFCs under the current rules. As these losses and tax credits relate to both active and passive income the Bill includes provisions to allocate these losses against active and passive income under the new rules (meaning that some losses and tax credits may not be utilised under the new rules).

Under the original drafting these transitional rules were very complex and would have resulted in considerable compliance costs for taxpayers. It is pleasing to see that the FEC has recommended a number of technical changes to the rules to make them easier to apply and to provide a better allocation of historical losses and foreign tax credits between attributable and exempt CFC income. However, the drafting of the revised rules for foreign losses and carry forward tax credits is still very complex and care will need to be taken in applying these rules in practice.

Associated persons

The Bill introduces significant changes to the definition of “associated persons”.

The Bill proposes replacing the four current definitions of “associated persons”, and other provisions employing a similar concept, with one standardised definition that will be subject to several modifications for the purpose of the land taxing provisions.

The definition originally proposed in the Bill included:

tests associating a trustee and a beneficiary, a trustee and a settlor, a settlor and a beneficiary, and the trustees of two trusts that have the same settlor;
tighter rules for aggregating the interests of associates – the Government is concerned that the current tests associating two companies and a company and an individual are being “circumvented by the fragmentation of interests among close associates”; and
a tripartite (daisy-chaining) test associating two persons if they are each associated with the same third person.

In addition, the Bill proposed removing the associated persons requirement from the dividend and FBT rules.

The Officials’ Report to the FEC considers that the proposed definition contains weaknesses. Therefore, the FEC has recommended a number of changes to the proposed definition to narrow the scope of the tests so that the rules do not inadvertently capture genuine arm's length transactions, and to reduce uncertainty.

The changes recommended by the FEC include:

the “trustee for relative test” should not apply for the purpose of the land provisions. The effect of this is that an individual will not automatically be associated with a trust if an associated relative (e.g. spouse) of the individual is a beneficiary of the trust. This is a surprising recommendation but it is consistent with the land provision exclusions in the other beneficiary related tests;
the changes proposed to the dividend and FBT rules should not proceed. Officials consider that the changes would result in more uncertainty;
the tripartite test is to be narrowed so that it does not apply to two persons if they are associated with the same third person under the same associated person tests. An intended consequence of this amendment is that person A and person B would not automatically be associated with each other where they both hold a 50% interest in a company (although each person would be associated with the company itself);
a limitation to the test associating relatives to ensure that a person is not associated with another person where that person could not reasonably be expected to have knowledge of the existence of the other party and/or their relationship to that party. The FEC considers it undesirable for such people to be captured by the definition of “associated persons”.

The intent of the proposed legislation with respect to land transactions remains clear. It is intended to ensure that land dealers, developers and builders are generally taxed on all their land sales and that (subject to the 10 year threshold) they cannot claim to hold non-taxable investment property portfolios. Land dealers, developers and builders who attempt to restructure their affairs to avoid being caught by the new rules should be mindful of the general anti-avoidance provision in the Act.

The FEC recommended that the general application date for the associated person amendments be deferred to the 2010-2011 income year and subsequent years. However, the FEC recommended that the amendments in the land provisions apply to land acquired on or after the date of the enactment, except in relation to section CB 11 (Disposal within 10 years of improvement: Building Business) where it will apply to land on which improvements started on or after the date of the enactment.

Relocation costs

The Bill provides that relocation costs paid by employers to employees are exempt from income tax and fringe benefit tax in most circumstances.

For relocation payments to be tax-free, the following criteria must be met:

the employee’s relocation must result from them:
- taking up employment with a new employer;
- taking up new duties at a new location with their existing employer; or
- continuing in their current position but at a new location.
the employee’s existing home must not be within reasonable travelling distance of the new workplace (unless accommodation is provided as an integral part of the new job);
the expense must be on a list of eligible relocation expenses to be issued by the Commissioner in a Determination;
the payment must reflect the expenditure incurred; and
the expenditure must be incurred within certain time limits.

The Officials’ Report to the FEC recommended:

that interpretation guidelines on whether other employee allowances are tax-free or taxable be finalised;
that submissions requesting that additional items be included on the list of eligible relocation expenditure be considered by the Commissioner in finalising his draft Determination on eligible expenses that was issued in December 2008. The intention is also to include a “catch-all” category to cover miscellaneous relocation expenses;
that guidelines be issued as soon as possible on how to interpret the reasonable daily travelling distance requirement; and
that guidance on what will constitute “corroborating material” when making a claim be provided in a Tax Information Bulletin.

The FEC confirmed that the amendment is retrospective and applies from the 2002-03 income year. The Officials’ Report to the FEC states that it is intended that the Draft Determination be finalised in time for the Bill’s enactment.

Overtime meal allowances

The Bill also provides that overtime meal payments and allowances will be exempt from income tax and fringe benefit tax provided the following criteria are met:

the employee’s employment contract must specify that the employee is eligible for a payment in relation to overtime hours worked; or
an employer must have a policy or practice of paying overtime meal allowances; and
the allowance must reflect the actual expenditure incurred by the employee; or
be a reasonable estimate of the expected costs likely to be incurred by the employee.

The amendments are retrospective and apply from the 2002-2003 income year. Employers who have paid tax on qualifying payments in the past will be entitled to seek reassessments. We support the Government’s decision to clarify the law in this area and to make the amendments retrospective.

Remedial changes to the IFRS provisions

The Bill includes remedial changes to the International Financial Reporting Standards (IFRS) financial arrangement legislation introduced by the Taxation (Business Taxation and Remedial Matters) Act 2007. It is intended that the remedial changes clarify the legislation and remove uncertainty. The FEC has recommended additional amendments as a result of submissions on the Bill.

The remedial changes include:

confirmation that borrowing costs capitalised in line with NZIAS 23 can be deducted for tax purposes unless a tax return has been filed by 30 June 2009 taking a contrary position;
the reintroduction of the choice to use the yield to maturity spreading method for New Zealand dollar denominated non-derivative financial arrangements;
the introduction of an exception, in some circumstances, from the requirement for all group companies to use the same spreading method;
the rewording of the “anti-arbitrage” rule to ensure it achieves its intended effect. The anti-arbitrage rule is intended to ensure there is consistent treatment between hedged financial arrangements;
confirmation that non-New Zealand dollar functional currency companies that use IFRS should use New Zealand dollars when applying the financial arrangement spreading methods; and
allowing deductions for impaired credit adjustments on non-derivative financial instruments held by dealers in those instruments.

All but two of the proposed amendments to the legislation will commence and apply from the original commencement and application dates of the IFRS legislation. However, the two exceptions, the capitalised interest deductibility provision and use of the yield to maturity method, will both apply prospectively.

Stapled stock

The Government introduced amendments to the tax treatment of stapled stock in a Supplementary Order Paper to the Bill. A stapled stock is a debt security attached to a share so that the two must be traded together.

The draft legislation provides that, when a debt instrument that would normally give rise to tax deductible interest is stapled to a share, the instrument will be treated as equity for tax purposes. Tax deductions will no longer be available for “interest” payments on the debt instruments. The purpose of the proposal is to protect the tax base from excessive interest deductions achieved through stapled stock arrangements.

It is intended that the rules be limited to arrangements involving “ordinary shares” or shares that are not “fixed-rate shares”. The company issuing the debt must be a party to the legal stapling arrangements and the debt component of the arrangement must be such that it would normally give rise to tax deductible interest.

The Officials’ Report to the FEC recommends that the stapling of an existing debt to a share should be treated as a subscription for shares, and that de-stapling be treated as a share cancellation with interest deductions subsequently available (unless other features of the arrangement, such as stapling to another share, cause the debt to continue to be treated as a share).

The FEC recommends that the Bill be amended so that:

arrangements that do not result in interest deductions, and debt that is stapled to shares before the announcement, are excluded;
stapled debt be excluded from the rule if it is stapled only to a share that would be a “fixed-rate share” but for dividends arising in certain circumstances;
in relation to the thin capitalisation rules the test of whether debt is stapled in proportion to all shares in the company be applied when total group debt is measured under these rules; and
the stapled stock rule should only apply to companies that are not widely held when the debt and share are stapled under the terms of the share, the debt, or the constitution of the company.

Payroll giving

The Bill introduces a voluntary payroll giving system that will enable employees to make regular donations from their salary or wages to charities of their choice. The system will enable employees to receive the tax benefit of their donations each payday without the need to retain receipts for donations.

The key features of the proposed system are:

participation in the payroll giving scheme will be voluntary for employers and employees;
payroll giving will be available only to employees whose employers file their monthly schedules electronically;
employees who choose to make payroll donations will receive a tax credit on the amount of those donations each payday. The tax credit will be calculated at a set rate of 33 1/3% of the donation;
the tax credit will be offset against the PAYE calculated on the employee’s gross pay, reducing the amount of PAYE payable for that period; and
employers will be responsible for ensuring that payroll donations are transferred to the selected charities within three months.

In order to minimise risk to employees, the FEC has recommended that payroll donations be held in trust for employees until the donations are transferred to the relevant charity. The FEC has also asked Inland Revenue to explain the following issues in a Tax Information Bulletin as comprehensively as is possible:

the non-prescriptive and voluntary nature of the payroll giving scheme;
the donee organisation list for the administration of the payroll giving scheme;
record-keeping requirements for payroll giving;
the process for correcting errors in PAYE resulting from the extinguishment of a payroll giving tax credit; and
the application of the penalty and use-of-money interest rules to payroll giving.

Following a submission by PwC, the application date for payroll giving has been changed to three months from the date the Bill is enacted. This will give employers time to adapt their payroll systems.

Life insurance tax reform

The Bill introduces a new framework for the taxation of life insurance businesses. Under the new rules, income from a life insurer’s business will be separated into shareholder income (income earned by the equity owners in the company) and policyholder income (income earned for policyholders from life insurance products).

Under the new framework, shareholder base income will be taxed at the corporate tax rate in a similar manner to other businesses. The current portfolio investment entity (PIE) rules will apply to policyholder income. This will mean that the tax treatment for those who save through life insurance policies will be consistent with that which applies to other investment products.

Following consultation with industry representatives, Officials have recommended that the application date for the life insurance reforms be delayed. The reforms will now apply from 1 July 2010. However, insurers may elect to apply the rules from the beginning of the income year which includes 1 July 2010. Electing to apply the earlier application date will save compliance costs for the life insurer while also allowing the benefits of the PIE regime to be passed to policyholders sooner. Grandfathering rules for policies entered into prior to the new regime taking effect will also apply from 1 July 2010, or the start of the income year which includes 1 July 2010 if the insurer chooses to adopt the rules from the earlier date.

The FEC also makes a number of minor technical amendments to give better effect to the overall policy objectives of the reforms.

Other matters

The Bill includes amendments in a range of other areas including:

Emissions trading
The Bill contains provisions for the income tax treatment of transactions under the Emissions Trading Scheme introduced by the Climate Change Response (Emissions Trading) Amendment Act 2008.

The Bill amends:

the Income Tax Act 2007 to include provisions governing the tax treatment of emissions units under the Government’s Emissions Trading Scheme; and
the Goods and Services Tax Act 1985 to ensure both the supply of emissions units and the actual, or deemed, supply of any services in exchange for emissions units are zero-rated for GST purposes.

The FEC considers that the legislation does not need to be further amended to provide expressly for deductions for emissions liability accruals.

To avoid the confusion of applying different GST treatments to different types of emissions units, the FEC has recommended that the existing zero-rating GST treatment of Kyoto emissions units be extended to include non-Kyoto emissions units with effect from 1 April 2010.

Payments to volunteers
New rules clarifying the tax treatment of reimbursement and honoraria payments made to volunteers will apply from 1 April 2008.

The proposed rules provide that reimbursement payments to volunteers will be exempt income (and therefore not taxable) where:

the payment is based on actual expenditure incurred by the volunteer; or
the paying organisation puts in place a process for making a reasonable estimate of the amount of expenditure likely to be incurred by a volunteer and the payment is based on that estimate.

Payments characterised as honoraria will continue to be taxed under the PAYE rules. As originally drafted, payments that are partly honoraria and partly reimbursements would have been subject to PAYE. The FEC has accepted PwC’s submission that, where a payer makes a combined payment of reimbursement and honorarium to a volunteer, the payer is not required to treat the whole payment as subject to PAYE as long as the payer can identify clearly which portion of the payment is honorarium and which portion is reimbursement. The reimbursement portion will be treated as exempt income and the honorarium portion will be subject to PAYE.

Other recommended changes include removing the requirement that a “volunteer” has to be a New Zealand resident.

GST
The Bill includes changes to the GST Act to allow:

certain loyalty programme operators to defer imposing GST until loyalty points have been redeemed; and
exported second-hand goods to be zero-rated in certain circumstances even if the exporter has claimed a second-hand goods input tax deduction.

The FEC recommended that the amendments apply from the date of the Bill’s enactment. It also accepted a submission that the ability of operators of loyalty programmes to defer charging GST on the supply of loyalty points should also apply when the GST “reverse charge” provisions in the GST Act apply.

The FEC also noted PwC’s submission that the GST treatment of loyalty point transactions should be reviewed with specific legislation enacted to cover the GST implications of loyalty point schemes more comprehensively.

Right of non-disclosure
The Bill amends a taxpayer’s right not to disclose tax advice documents so that it applies to discovery and similar processes that occur during litigation with the IRD. The new rules will allow the Courts to have access to the facts (the tax contextual information) but not to the tax advisor’s view of the facts.

The FEC has recommended the following changes:

that the new provisions apply to current disputes that have not advanced to the first conference required under the High Court rules or the Taxation Review Authority regulations as at the date of Royal assent, and to future disputes; and
that the non-disclosure right will not apply to challenges that raise substantially similar issues already being considered by the courts.

Tax pooling
The Bill amends the tax pooling rules to ensure that they reflect the original policy intent of the Government and extends the availability of tax pooling to include reassessments of all tax types.

The FEC has recommended the following changes:

that a taxpayer who owes additional tax as a result of the resolution of a dispute with the Commissioner be able to access funds from a tax pooling intermediary within 60 days of the date of resolution;
that any person, not just provisional taxpayers, be able to deposit money into a tax pooling account;
that the Bill be clarified to ensure that an amount held in a tax pooling account on behalf of a person might be refunded to the person or used to satisfy the person’s liability for terminal tax, provisional tax or an increased amount of tax resulting from a reassessment, voluntary disclosure, or the resolution of a dispute; and
that the Bill enable an intermediary to instigate the transfer of tax pooling funds between intermediaries when one of them starts or ceases its business. As previously drafted, intermediaries would have had to arrange for each taxpayer who had money invested in the pool to separately request a transfer to another intermediary. This would have led to unnecessary compliance costs.

The FEC also recommends that the proposed amendments apply from the date of Royal Assent.

Petroleum mining
The Bill includes several changes to the petroleum mining tax rules. The key changes:

ring fence the deductibility of foreign petroleum mining expenditure to foreign petroleum mining income applying retrospectively from 4 March 2008; and
allow petroleum miners to amortise petroleum development and expenditure on a units of production basis or a straight line basis over seven years.

The FEC has recommended an amendment to clarify that petroleum mining losses incurred though a foreign branch can be offset against petroleum mining income from any country other than New Zealand.

R&D
Although the R&D tax credit regime has been repealed, the FEC has made a number of minor amendments that have retrospective effect to ensure the legislation achieves the policy intent. These include:

in relation to the eligibility of group companies, amending the “on behalf of” rules to allow the control and ownership elements to be met by members within a group instead of an individual entity being required to meet each element of the test. A group will exist where there is 66% or more commonality of ownership;
removing the eligibility of Crown entities as defined in the Crown Entities Act 2004 for R&D tax credits. State-owned enterprises are not affected by this change;
amending the treatment of revenue account property (also referred to as the “feedstock” rules) to make it clear that, where valuable output is produced as part of an R&D testing process, only the costs of inputs of items and materials that are the subject of testing are denied the credit; and
amending the rules to ensure that the credit is available for capitalised labour R&D costs (such as design and testing but not construction of the underlying asset) whatever the ultimate use of the underlying asset.

Remedial and technical amendments

The Bill includes several remedial amendments to the PIE rules relating to the:

eligibility criteria for becoming a PIE and exceptions to certain entity types e.g. community trusts;
allocation of tax credits received by PIEs;
filing and information requirements;
investors’ tax rates that are used by PIEs (includes trusts being able to elect a non-final 19.5% rate); and
listed PIEs may elect to be portfolio tax rate entities.

The Bill also contains several remedial amendments to the offshore portfolio share investment rules addressing the:

application of the quick sale rules;
Australian-resident listed company exemption;
comparative value method and currency conversion rules; and
exclusions from using the fair dividend rate method.

Other remedial amendments contained in the Bill relate to KiwiSaver aimed at ensuring the legislation gives full effect to the policy intent of the regime.