July 2008
Latest phase of reforms
The recently introduced Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill (“Bill”) contains the latest instalment in the reform of New Zealand’s international tax rules. This follows reform of the taxation of offshore portfolio investment, which came into effect for the 2007/2008 income year and introduced, among other things, the fair dividend rate method.
CFC rules
An active/passive distinction for the attribution of income from controlled foreign companies (“CFC”) is being introduced. Under the proposed new rules, only passive income (predominantly interest, rent, royalties and dividend income) of a CFC will be attributed to the New Zealand shareholder(s). In addition:
- there will generally be no attribution (even of passive income) from CFCs that are resident and liable to tax in Australia, and that do not benefit from an exemption from Australian tax on income derived from a business carried on outside Australia or from concessions with respect to offshore banking units;
- if passive income makes up less than 5 percent of the CFC’s total assessable income, there will be no attribution from that CFC;
- the grey list exemption (which currently exempts the income of CFCs in certain countries from attribution) will be repealed; and
- interest allocation (ie thin capitalisation) rules will apply to New Zealand companies with interests in CFCs.
Dividends from foreign companies
Most dividends received by New Zealand companies from offshore will remain exempt from New Zealand income tax but will no longer be subject to a FDP (formerly DWP) deduction as is presently the case. This exemption will not apply to dividends that are tax deductible for the foreign company or dividends paid in respect of “fixed rate shares”, ie shares where the dividends are equivalent to a debt return. Such shares will be treated as debt and will be subject to the financial arrangements rules. This means the dividend will be treated as interest and taxed accordingly. As a result of these changes to the tax treatment of dividends, the BETA and FDP regimes will be phased out over time.
Repeal of the conduit regime
The conduit tax relief regime, which currently provides relief from FDP and tax on attributed CFC income for New Zealand companies that are foreign owned and derive foreign sourced income from overseas equity investments, will be repealed. Although existing conduit tax relief account balances will not automatically be cancelled for another two years, it is proposed that no tax liability will arise if the credits are forfeited in the 2009/10 or subsequent income year (for example because a CTR company is wound up or sold to New Zealand residents).
Future reform
The principal aim of the international tax changes is to allow New Zealand residents with overseas active businesses to compete on an equal footing with residents of other countries, many of which already benefit from an active income exemption. New Zealand residents with interests in CFCs carrying on an active business will have reduced compliance costs as they will not need to recalculate the income of the CFC according to New Zealand’s tax laws.
The Bill is not the end of the reform process for international taxation. The next stage in the process will deal with New Zealand residents who have interests of 10% or greater in overseas companies that are not CFCs. One possibility of reform in this area is that the active business exemption could be extended to such investments. In addition, the question of extending the exemption to New Zealand resident companies in respect of an active business carried on through a foreign branch, will also be considered.
Other changes
In addition to the changes to the international tax rules the Bill contains a number of other proposed amendments, including:
- reform of the taxation of life insurance businesses;
- a broad definition of “associated persons” for all purposes, with particular modifications as regards the application to land transactions and, related to this, changes to the deemed dividend and FBT rules;
- amendments to the rules relating to petroleum mining;
- introduction of a voluntary payroll giving system for charitable donations; and
- numerous miscellaneous technical amendments, including, in relation to the recently introduced portfolio investment entity (PIE) regime, to ensure that the intent of the regime is not undermined by certain structures involving land.
To view a copy of the Bill please click here.
On 23 April this year draft legislation relating to the tax treatment of stapled securities was released for comment. In short, the effect of the proposed amendments was to deem a debt security issued by a company to be a “share” for tax purposes if:
- the debt security is stapled to a share in the company or in another company; and
- the debt security would (but for the deeming rule) give rise to an interest deduction for the company in New Zealand.
Contrary to expectation, the stapled stock legislation was not included in the Bill as introduced to Parliament. However, it is likely to be added by way of supplementary order paper in due course. Once enacted, it is expected that the stapled stock rules will apply to securities that were stapled on or after 25 February 2008.
To view a copy of the draft legislation please click here.
In a recent speech to the Australia-New Zealand Leadership Forum, Hon Dr Michael Cullen raised the possibility of mutual recognition of imputation and franking credits between New Zealand and Australia. Dr Cullen stated that a mutual recognition system could be of huge benefit to investors from both countries. Dr Cullen’s comments were made in the context of the current renegotiation of the Australia/New Zealand Double Taxation Agreement which includes discussions regarding reducing the current levels of non-resident withholding tax.
The Australian Treasurer, Wayne Swan, subsequently confirmed that the issue of mutual recognition will be considered in the review of the Australian tax system being led by Treasury Secretary Ken Henry. The Australian Treasurer invited the New Zealand Treasury to make a formal submission on mutual recognition to the review.
To view a copy of Dr Cullen’s speech to Leadership Forum please click here.
The Taxation (Personal Tax Cuts, Annual Rates, and Remedial Matters) Act 2008 results from the 2008 Budget, and amends a number of provisions in the taxation legislation, largely relating to personal tax cuts.
Other amendments in that Act relate to charities, including a concession for certain charities that have failed to complete their registration with the Charities Commission by the 1 July 2008 deadline, and clarification of the taxation treatment of education providers and foreign charities.
The Court of Appeal’s decision in CIR v BNZ Investments Ltd [2008] NZCA 141 concerned the relevance, in the context of BNZ’s challenge proceedings concerning certain structured financing transactions, of favourable binding rulings Inland Revenue had given in respect of substantially similar financing transactions. The question of relevance arose in the context of BNZ’s application for discovery of those binding rulings, and certain background documents relating to the rulings.
BNZ subsidiaries had entered into a number of cross-border sale and repurchase transactions and obtained positive binding rulings in respect of two such transactions. Other New Zealand banks had entered into substantially similar transactions, some of which were also the subject of positive binding rulings. The Commissioner subsequently disputed the tax consequences of the transactions not covered by binding rulings.
The appeal arose out of BNZ’s successful application to the High Court for orders requiring Inland Revenue to discover three classes of documents:
- the binding rulings obtained by other banks in respect of their transactions;
- documents Inland Revenue had considered when making those binding rulings; and
- documents Inland Revenue had considered in the course of considering one of BNZ’s binding ruling applications.
For essentially two reasons, the Court of Appeal overturned the decision of the High Court to order discovery by the Commissioner of these classes of documents. The first reason turned on the Commissioner’s concession that he would not call witnesses from within Inland Revenue to give evidence concerning the commerciality or acceptability of the transactions. Based on that concession, the Court reasoned that there would be no need for BNZ to refer to the other banks’ binding rulings to test such evidence. The second reason the Court relied on is that while public rulings, or private rulings issued to the relevant taxpayer, could be used as an aid in interpreting “esoteric and inherently complex” legislation, the Commissioner could not be required to give discovery of other taxpayers’ rulings for this purpose.
To view a copy of the decision please click here.
A high threshold will be required before a trust can be labelled as a “sham”. In Official Assignee v Reynolds [2008] NZCA 122, the Court of Appeal found that a sham would only exist when there was a common intention on behalf of the settlors and trustees to mislead, by concealing the true nature of the transactions underlying the trust. This high threshold to overturn a trust was considered justified because of the importance of providing certainty to beneficiaries about their legal entitlements.
The Court expressed concern that the beneficiaries of the trust were not represented, and held that the Official Assignee was unable to apply to overturn the trust because Mr Reynolds’ interests lay clearly in upholding it, and the Official Assignee was “in the shoes” of, and technically bringing the action on behalf of, the bankrupt Mr Reynolds.
To view a copy of the decision please click here.
The High Court considered whether the Commissioner of Inland Revenue has a power to determine the validity of a notice of response in Alam and Begum v CIR (High Court, Tauranga, CIV 2007-470-267, 17 June 2008, Woodhouse J).
The taxpayers in this case had issued a “notice of response” to reject a “notice of proposed adjustment” issued by the Commissioner. The Inland Revenue investigator responsible decided that the notice of response did not comply with content requirements in section 89G of the Tax Administration Act 1994 (“TAA”), and purported to reject it for that reason. On that basis, the Commissioner relied on the deemed acceptance rules in the TAA to deem the taxpayers to have accepted his notice of proposed adjustment. The taxpayers applied for relief by way of judicial review.
In the High Court, Woodhouse J held that the Commissioner does not have the power to determine the validity of a notice of response, or to reject it based on such a determination. He stated that, if the Commissioner wished to challenge the notice of response, the appropriate course would have been for him to apply to the Court for a declaration as to its validity. The alternative course of action for the Commissioner was to proceed with the statutory disputes procedure.
Although the taxpayer’s notice of response was sparse, Woodhouse J held that it complied with the TAA because it set out sufficient detail to reasonably inform the Commissioner. His Honour stated that there was no need to set out an arguable case in a notice of response. Such a requirement would lead to lengthy notices of response, and would not help further the policy of the statutory disputes procedure.
Inland Revenue published a standard practice statement on the disputes procedure on 3 July 2008 (applying from 10 June 2008), after the date of the Alam judgment, stating that Inland Revenue may inform a taxpayer that their notice of response is invalid. To this extent, the standard practice statement is inconsistent with Woodhouse J’s judgment which would require Inland Revenue to seek a declaration from the Court. (Refer Inland Revenue standard practice statement SPS 08/01 - Disputes resolution process commenced by the Commissioner of Inland Revenue.)
To view a copy of the decision please click here or to view a copy of the Standard Practice Statement please click here.
High Court of Australia rules on GST consequences of forfeited deposits: Reliance Carpet Co Pty Ltd v Commissioner of Taxation
The High Court of Australia recently handed down its first decision under the Australian GST legislation - the A New Tax System (Goods and Services Tax) Act 1999 (“Australian Act”) in Reliance Carpet Co Pty Ltd v Commissioner of Taxation [2008] HCA 22. The case concerned the GST treatment of a forfeited deposit under a sale of land contract which did not proceed.
The Court allowed the Commissioner’s appeal, holding that a vendor of land makes a supply to a purchaser when a contract for sale is entered into, and that the deposit paid by the purchaser is consideration for that supply where the deposit is forfeited. The Court held that the fact that the contract did not proceed to completion did not prevent there having been a “supply” within the meaning of section 9-10 of the Australian Act, when the contract was entered into. Reliance Carpet’s supply was not simply of land itself. As this was an executory contract, it created rights in relation to the land and obligations to be performed, and these, rather than the land itself, constituted the subject matter of the contract.
This approach was also in line with the expansive definition of “real property” in section 195-1 of the Australian Act, which includes any interest or right over land. The Court may also have been influenced by the fact that the Australian Act has specific provisions addressing forfeiture of deposits from which it might be inferred that a deposit, upon forfeiture, is treated as consideration for a supply. Section 99-5 for example states that:
A deposit held as security for the performance of an obligation is not treated as consideration for a supply, unless the deposit: (a) is forfeited because of a failure to perform the obligation; or (b) is applied as all or part of the consideration for a supply.
The High Court of Australia’s approach can be contrasted with that adopted in the New Zealand context. In a statement published in the Tax Information Bulletin Volume 17, No. 4 (May 2005), Inland Revenue concluded that where a contract is cancelled, GST will not be chargeable on the amount of the deposit retained by the vendor.
The different approaches arise from differing interpretations as to whether entering into a sale of land contract is itself a “supply”. Inland Revenue takes the view that entering into the contract is not a supply for GST purposes. Instead, the only relevant supply is of land. Therefore, the New Zealand approach seems to be that if the supply of land does not proceed because the contract is cancelled, there is no supply in consideration for the deposit. Instead, the deposit is considered to be compensation for non-performance of the contract, and not consideration for a supply.
A number of GST related changes have been proposed in an issues paper recently released by the Government, entitled “Options for strengthening GST neutrality in business-to-business transactions”.
The paper outlines a range of options for ensuring that transactions between businesses are GST neutral, to address perceived base maintenance concerns and to clarify the GST treatment of certain accommodation and of changes in use. In summary, the paper proposes (for consultation):
- Replacing the zero-rated going concern rules with a domestic reverse charge mechanism for certain high value transactions, all land transactions and transfers of going concerns.
- Clarifying the GST treatment of transactions involving nominees, in particular to ensure neutrality where appropriate.
- Limiting opportunities for “phoenix” entities to erode the GST base.
- Preventing inappropriate GST timing mismatches due to differences between the various GST accounting bases.
- Adjusting the current payments basis threshold.
- Extending the time limit for Inland Revenue notifying that it wishes to delay a GST refund, and allowing Inland Revenue to lodge certain caveats against land.
- Changes to the rules for change-in-use adjustments.
- Clarifying the GST treatment of accommodation.
The proposals in respect of high value asset transfers and accommodation are two of the most significant areas of the proposals.
Going concerns and high value transfers
The paper proposes to remove the current zero-rating of going concerns and introduce a domestic reverse charge mechanism that will apply to all transactions involving the supply of a going concern, high value assets, and land. This mechanism would shift the obligation to charge GST from the GST-registered vendor to the GST-registered purchaser, who would be required to self-assess GST in their own GST return and could (where appropriate) simultaneously claim a GST input tax credit. This would eliminate any potential cash flow issues for both the vendor and the purchaser that are normally associated with paying/claiming back GST.
The suggested approach would be mandatory for all transactions involving the sale of a business as a going concern, land and other assets of significant value (proposed to be over $50 million, excluding GST) between GST-registered persons.
Accommodation
The paper also discusses options for better defining the boundary between taxable and exempt supplies of accommodation for GST purposes. These options involve amending the current definition of “dwelling” and “commercial dwelling” in the Goods and Services Act 1985 (“GST Act”). In relation to the “commercial dwelling” concept, one option is to extend the current list in the GST Act, while the other is to remove the list and instead have generically defined categories of “guest accommodation” and “care accommodation”.
Further, the paper suggests that GST registration should not be permitted where the taxable supply of accommodation is less than $10,000 in any 12 month period. This proposal is apparently aimed at preventing “non-commercial” or small-scale operations from GST registering. This is in turn intended to reduce compliance costs and prevent inappropriate claims of GST input tax credits.
Submissions
The Government has invited submissions on the merits of the options suggested in the issues paper, as well as inviting submissions on alternative measures that meet the objectives of enhancing business neutrality as it affects the application of GST to day-to-day business activities. The closing date for submissions has been extended to 11 August 2008.
To view a copy of the issues paper please click here.
After two previous drafts in 2004 and 2007, Inland Revenue last month released its Interpretation Statement for Deductibility of Feasibility Expenditure (IS 08/02) (“Interpretation Statement”). The term “feasibility expenditure” is not defined in the Income Tax Act 2007 (“Act”); it is described in the Interpretation Statement as expenditure incurred to determine the practicability of a new project.
There are no specific provisions relating to the deductibility of feasibility expenditure in the Act. The Interpretation Statement considers the application of the general permission to deduct expenditure incurred in the course of a business, and the capital limitation which denies a deduction where such expenditure is capital in nature, to feasibility expenditure.
In relation to the general permission, the Interpretation Statement focuses on whether the feasibility expenditure is incurred before or after a business has commenced. It states that the general permission will not be satisfied in respect of pre-commencement activities.
However, where a deduction for feasibility expenditure would be allowed under the general permission (ie a business has commenced), the Interpretation Statement states that the capital limitation will deny a deduction from the point a firm commitment has been made to acquire a specific capital asset - because the feasibility expenditure will be treated as capital in nature from that point.
As an illustration of how these principles might apply in practice, a deduction may be available in respect of expenditure incurred by a company making preliminary investigations into a new project as part of its existing business activities (assuming no decision has been made to acquire a specific capital asset). Careful consideration will need to be given to the deductibility of feasibility expenditure in any particular case.
To view a copy of the Interpretation Statement please click here.
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