Contents:
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December 2008
Contents:
A protocol updating the US-NZ double tax agreement was signed in Washington on 2 December. The main feature of the updated agreement is lower withholding taxes on dividends, interest and royalty payments made between New Zealand and United States residents, which is a welcome measure. However, while there seems to be an apparent reduction in withholding taxes on interest, that is illusionary given the reduced rate is dependent on approved issuer levy ("AIL") having been paid. Significant features of the protocol from a New Zealand perspective are outlined below.
Dividends will be subject to a maximum withholding tax rate of 15%. This rate will reduced to 5% where an investor holds at least 10% of the shares in the company that pays the dividend. Broadly, the withholding tax rate will further reduce to 0% if the investor has held 80% or more of the shares in the company for a 12 month period, and certain requirements in relation to the limitation of benefits article are met (there are exceptions for dividends paid by specified US resident investment vehicles). These are the lowest withholding tax rates in any of New Zealand's double tax agreements.
The withholding tax rate on interest will generally remain at 10%, except that interest paid to unrelated banking, lending and finance enterprises will be exempt from tax provided that the 2% AIL is paid where applicable and the interest does not relate to a back-to-back lending arrangement. That change has little practical effect in relation to withholding tax - if AIL is paid then the New Zealand withholding tax rate is zero percent in any event.
The withholding tax rate on royalties will reduce from 10% to 5%.
The business profits article is also amended so that income or gains attributable to a permanent establishment during its existence paid after the permanent establishment has ceased to exist may be taxed by the state in which the permanent establishment was situated.
The limitation of benefits article which prevents treaty shopping has been changed to reflect the 2006 US Model Income Tax Convention. The subjective element that required certain entities not to have a principle purpose of obtaining benefits under the convention has been removed and the test is now completely objective.
Article 1 is also amended so that an item of income, profit or gain derived by a resident of either state through a fiscally transparent entity (such as a partnership) will now be considered to be derived by that resident to the extent that the item is treated under the tax laws of the relevant state as being derived by the resident.
The signing of the updated double tax agreement has been described by Government Ministers Bill English and Peter Dunne as "an important development that will benefit both countries by helping to reduce tax barriers to two-way trade and investment".
The protocol will come into force once both countries have given legal effect to it. This will occur in New Zealand through an Order in Council.
No doubt we will see similar changes in other double tax agreements as they are renegotiated. A number of New Zealand's double tax agreements include "most favoured nation" clauses, (for example New Zealand's double tax agreement with Italy). These clauses will require negotiations with a view to providing similar treatment to the US-NZ double tax agreement in respect of dividends, interest and royalties.
To view a copy of the protocol please click here.
In September the Commissioner issued Determination FDR 2008/13 providing an exception to a specific unit trust from the rules which generally prevent use of the fair dividend rate ("FDR") method in relation to foreign investment funds ("FIF") that invest mainly in NZ$ denominated financial arrangements or instruments hedged into NZ$. Those rules are intended to prevent the FDR method applying in respect of FIF interests that are economically equivalent to debt.
The Determination applies in respect of a unit trust established outside New Zealand, namely the PIMCO Cayman Global Bond (NZD Hedge) Fund ("Fund"), which invests in an actively managed global bond portfolio hedged to the NZ$. The Fund is treated as a company for income tax purposes. In the absence of the Determination, its units would be FIF interests in respect of which the FDR method would not be available because over 80% of the Fund's assets are financial arrangements hedged to the NZ$. The effect of the Determination is that unit holders can apply the FDR method to calculate their FIF income from the Fund.
The Commissioner referred to the following characteristics of the Fund's global bond portfolio as being relevant to his decision to issue the Determination permitting unit holders to use the FDR method:
- the global bond portfolio is actively traded and for that reason may be more akin to equity than debt;
- the global bond portfolio is designed to deliver above-normal but volatile returns from trading on market opportunities; and
- the investment proposition in respect of the Fund is in the fund manager's ability to actively trade rather than only by reference to the Fund's underlying debt assets.
The Determination applies only to the Fund described in the Determination and cannot be relied on in relation to any other FIF. However, the Determination provides an indication of the considerations the Commissioner is likely to take into account in exercising his discretion to issue any such determination in the future.
To view a copy of the Determination please click here.
In Saha v CIR (23/09/08, Simon France J, HC Wellington) Simon France J considered the application of a market value deeming provision. This was in the context of the taxpayer applying the comparative value method in the FIF rules to shares forfeited, following breach of a restraint of trade arrangement by the taxpayer. His Honour's decision under the Income Tax 1994 is relevant to the interpretation of corresponding provisions in the Income Tax Act 2007.
The taxpayer received Cap Gemini shares from the sale of his interest in a consultancy business during the 2001 income year. As the taxpayer's services were important to the business, the terms of sale required him to continue working as an employee of the new owner for five years. Some of the taxpayer's shares were held in escrow and subject to forfeiture under a price adjustment arrangement if he did not complete his five year service period.
When the taxpayer resigned during the 2002 income year, before the five year service period expired, he forfeited a proportion of the shares held for him in escrow. In his income tax return the taxpayer treated the forfeited shares as having been disposed of for no consideration. This increased his FIF loss for the 2002 income year. The Commissioner disputed the taxpayer's 2002 income tax return, arguing that a market value deeming rule applied because the taxpayer had disposed of the shares for no consideration. On that basis, the Commissioner considered that the taxpayer had overstated his FIF loss for the 2002 income year.
Simon France J accepted the Commissioner's argument that the market value deeming rule applied, and that the taxpayer should be treated as having derived consideration equal to the market value of the shares.
However, as there was no element of gratuity in the transaction, it does not seem to be correct to hold that when the taxpayer disposed of the shares that disposal was for no consideration.
In any event, it seems that the taxpayer must inevitably be treated as having disposed of the property for the market value. If the taxpayer has provided consideration, then if that consideration is not equal to the market value of the forfeited shares the deeming provision applies. Equally, if the taxpayer agrees that consideration was provided to him equal to the market value of the shares (for example, that consideration being discharge of obligations under the relevant restraint) then the taxpayer will be treated as having receiving that amount for disposal of the FIF interest.
We understand that this case is being appealed.
To view a copy of the case please click here.
BNZ Investments v CIR (22/10/08, MacKenzie J, HC Wellington) MacKenzie J dismissed an application by the Commissioner for a pre-trial ruling that two expert witness statements for the taxpayer were inadmissible. The statements provided by tax lawyers contained evidence on the commercial background to the tax legislation and the transactions at issue, the tax treatment of those transactions, and the policy background of the relevant legislation. This evidence was given in response to the Commissioner's allegations that the taxpayers had engaged in tax avoidance.
MacKenzie J stated that the expert evidence could be relevant in a tax avoidance context because the trial Judge should have a detailed understanding of the scheme and purpose of the specific black letter provisions in issue, and in this respect the expert evidence could be an aid to interpretation. His Honour stated that it would be for the Trial Judge to determine whether the evidence is substantially helpful (in terms of the Evidence Act 2006). MacKenzie J also rejected the Commissioner's argument that the expert evidence was inadmissible because it lacked independence.
MacKenzie J refused to rule that the expert evidence was inadmissible, and stated that it could potentially be useful to the trial judge. This is a practical decision which recognises the difficulties faced by New Zealand's generally non-tax specialist judiciary when required to make decisions in relation to complex tax matters.
MacKenzie J's judgment may be contrasted with Wild J's judgment on the issue of relevance in ANZ National Bank Limited v CIR (15/04/2008, Wild J, HC Wellington), concerning a discovery application by ANZ in the context of broadly similar allegations of tax avoidance made by the Commissioner. Wild J held that documents created by Inland Revenue's Policy Advice Division (which formulated the legislation) addressing the scheme and purpose of specific provisions in issue were not relevant to the tax avoidance dispute, and refused to order discovery of the documents on that basis. In our view MacKenzie J's approach to relevance is to be preferred in relation to both discoverability and admissibility of evidence.
We understand that this case is being appealed.
To view a copy of the case please click here.
New Zealand's submission to the Australian Government on mutual recognition of franking and imputation credits
At the invitation of Australian Treasurer Wayne Swan, the New Zealand Treasury and Inland Revenue made a joint submission to the Australian Government's review of Australia's tax system on 16 October 2008 ("Submission"). Broadly, the Submission supports the case for mutual recognition of franking and imputation credits on the basis that it would provide economic benefits for both nations and would represent an important step toward the shared goal of a "Single Economic Market". Specific reasons include:
- removing investment biases caused by differences in the treatment of New Zealand and Australian shareholders in the same company;
- removing the existing incentive to stream taxable profits to the country where the final shareholders of the company reside; and
- the progression of a Single Economic Market. The Submission states that mutual recognition would provide greater scope for underlying economics, rather than tax, to determine decisions regarding company location and organisation.
The Submission favours retaining the existing franking and imputation credit regimes, through deemed equivalence of franking and imputation credits. However, it recommends aligning some divergent aspects of the two regimes, most notably the differing approaches taken to credit streaming, and the dates on which account balances are tested. The Submission also states that neither nation should be bound to the scheme by a permanent bilateral commitment. This would allow for exit in cases such as deep cuts in the company tax rate of one nation, or a decision by one nation to provide credits for taxes paid in a third country.
A consultation paper is expected to be issued in December 2008, and a final report to the (Australian) Government in December 2009.
To view a copy of the Submission please click here.
In August 2008 the Australian Treasury released a report entitled "Architecture of Australia's tax and transfer system", also known as the "Henry Report". The report reviews Australia's existing tax collection and transfer (redistribution) rules. It has been described as the most comprehensive review of the Australian tax system for 50 years.
The Henry Report warns that corporate tax reform in Australia has stagnated since the Howard government cut the corporate tax rate from 36 percent to 30 percent in 2001, and that Australia's corporate tax rate has risen to the eighth highest in the OECD.
The Henry Report also discusses proposed Australian Government household assistance measures in relation to the Australian Government's Carbon Pollution Reduction Scheme Green Paper released in July.
The report offers no specific recommendations for reform. A review panel chaired by the Secretary to the Treasury (Dr Ken Henry) will author a final report, due by the end of 2009.
To view a copy of the report please click here.
Last month the Australian Taxation Office issued two Taxpayer Alerts (TA 2008/19 and TA 2008/20) raising its concern about structures non-Australian residents may be using to avoid Australian capital gains tax. The arrangements described in the Taxpayer Alerts relate to the staggered disposal of interests in entities that hold real property situated in Australia.
To view the Taxpayer Alerts please click here and here. To view an ATO summary please click here.
Russell McVeagh is pleased to announce the appointment of Shaun Connolly as a partner in the firm's tax team, effective 1 December 2008.
Formerly an associate, he will continue to be based in Russell McVeagh's Wellington office. Shaun joins tax partners Brendan Brown in Wellington, and Fred Ward, Richard Scoular and Campbell Rose in the firm's Auckland office. With five partners and 19 other lawyers, Russell McVeagh has the country's largest legal tax practice.
This publication is included in Russell McVeagh's website on the Internet: www.russellmcveagh.com
The transmission/publication is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance to any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact:
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