July 2009

Contents:

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill ("Bill"), originally introduced in July 2008 and reinstated by the National-led government in February 2009, was reported back from the Finance and Expenditure Committee on 30 June 2009 ("Committee's Report"). 

The proposals contained in the Bill are significant and complex, covering a wide range of taxation issues.  Most notably, the Bill provides for the reform of the international tax rules by, among other measures, introducing a tax exemption for the foreign active income of controlled foreign companies, exempting most foreign dividends received by New Zealand companies from tax and repealing the conduit tax and dividend withholding payment rules.  Also of note is the reform of the "associated persons" definition.  In addition, the Committee's Report considers Supplementary Order Paper 224 regarding the tax treatment of stapled debt securities.

The Bill has passed its first reading and the select committee stage.  Before it becomes law, the Bill will need to successfully pass through its second reading.  Due to delays in the legislative process, the Committee's Report proposes new application dates for many provisions in the Bill as previously signalled by the Minister of Revenue.  We expect that the Bill will be enacted in the next two to three months.

To view the Committee's Report please click here.

On 26 June 2009 New Zealand and Australia signed a new double tax agreement that will replace the existing 1995 agreement and its 2005 amending protocol.  The new agreement will not come into force until both countries have given legal effect to it.  In New Zealand's case this will occur by way of an Order in Council, which is expected to be made later this year.

The most significant changes relate to withholding taxes and the definition of "permanent establishment", as outlined below.

Lower source country withholding tax rate limits on dividends, interest and royalties (Articles 10, 11 and 12)

The new agreement contains revised limits for source country withholding taxes as follows:

a) For dividends (formerly 15%):

• 0% where the recipient is a company that has owned shares representing at least 80% of the voting power in the payer for the 12 month period ending on the date the dividend was declared and is either:

  1. listed in New Zealand or Australia; or
  2. owned directly or indirectly by a company listed in New Zealand or Australia; or
  3. owned directly or indirectly by a company that, had it derived the dividend, would be entitled to equivalent benefits under a tax treaty between its country of residence and the source country.

  There is also the ability for dividends to be exempt from tax in the source country where the above requirements are not met, if the competent authority of the source country so determines;

• 0% where the dividends are derived by a government body that holds, directly, shares representing no more than 10% of the voting power of the payer;

• 5% where the recipient is a company that holds, directly, shares representing at least 10% of the voting power in the payer;

• 15% in all other cases.

b) For interest payments (formerly 10%):

• 0% where the interest is derived by a financial institution that is unrelated to the payer.  (However, in the case of interest arising in New Zealand and where the payer is eligible to elect to pay the approved issuer levy, the 0% limit applies only if the 2% approved issuer levy is in fact paid on the interest.  This is the position in relation to New Zealand non-resident withholding tax in any event);

• 0% where the interest is derived by a government body;

• 10% in all other cases.

c) For royalties, 5% (formerly 10%).

Changes to the definition of "permanent establishment" (Article 5)

The agreement extends the definition by deeming a permanent establishment to exist in one country if a person habitually exercises in that country an authority to "substantially negotiate or conclude" contracts on behalf of a resident of the other country (the equivalent paragraph in the current agreement refers only to authority to conclude contracts). 

The new agreement also extends the definition of permanent establishment so that a resident of one country will be deemed, in certain circumstances, to have a permanent establishment in the other country if it performs services in the other country through one or more individuals for more than 183 days in any 12 month period.

Other changes

The new agreement contains other developments, including:

• specifically providing for income derived by or through fiscally transparent entities;
• provisions that clarify the residence of dual listed companies;
• revised provisions dealing with income from superannuation arrangements;
• granting source-country tax relief on income from short term trans-Tasman secondment arrangements;
• removing the Article that dealt with income from independent personal services (independent personal services will now generally be covered by the business profits Article); and
• denying benefits under the double tax agreement to New Zealand transitional residents.

To view a copy of the new Australia and New Zealand double tax agreement please click here.

The most significant development coming out of the Taxation (Budget Tax Measures) Act 2009 ("Budget Act") was the deferral of the planned 2010 and 2011 tax cuts which the Government estimates will save around $900 million per year from 2011.  These tax cuts were part of the National Government's progressive personal tax cuts package and would have resulted in a reduction in marginal and average tax rates.  The tax cuts have been deferred until "economic conditions allow" which is unlikely to be anytime during the National Government's current term. 

However, the Government reaffirmed its commitment to an alignment of personal, company and trust tax rates at 30% in the medium term (again perhaps a policy consideration that will not be implemented during the National Government's current term).  The Government's tax policy objectives are clearly taking a back seat to the short term aim of maintaining the tax base.

Apart from the deferral of the planned tax cuts, there are few specific tax measures in the 2009 Budget Act.  However, the Budget documents did record a list of policy initiatives including:

• the possible implementation of recommendations from the Tax Working Group established by the Government;

• reviewing the imputation regime to identify possible changes required to effect mutual recognition of imputation/franking credits with Australia; and

• reviewing the international tax regime (particularly considering the prospect of extending the active income exemption to non-portfolio foreign investment funds and branches, and a possible exemption from approved issuer levy and non-resident withholding tax for New Zealand bonds issued to non-residents).

To view a copy of Budget Act please click here.

In two recent fair dividend rate ("FDR") determinations (FDR 2009/1 and FDR 2009/2), the Commissioner has interpreted tax legislation aggressively in policing the FDR method for calculating income under New Zealand's foreign investment fund rules.  Under the FDR method a taxpayer calculates income from shares in a foreign investment fund ("FIF") based on 5% of their opening market value for the income year.  However, the income tax legislation contains rules to prevent the FDR method being applied to shares in FIFs which produce returns similar to NZ$ denominated debt.  These determinations were made under the Commissioner's power to determine that a FIF interest is "a type of attributing interest in a FIF for which a person may not use the fair dividend rate method to calculate FIF income from the interest", and apply only in respect of the FIFs referred to in them.

Determination FDR 2009/1 relates to units held by a New Zealand fund in an Australian FIF which invests at least 80% of its funds in financial arrangements.  The New Zealand fund entered into separate arrangements to hedge its return from the Australian FIF to the NZ$.  The Commissioner determined that because of the hedging arrangements the New Zealand fund (and other investors with similar hedging arrangements) cannot use the FDR method to calculate its income from the Australian FIF.

Determination FDR 2009/2 relates to units held by New Zealand residents in an Australian FIF which invests in global fixed interest securities.  New Zealand investors can enter into separate hedging arrangements to hedge their interests in the Australian FIF to the NZ$.  The Commissioner determined that New Zealand investors who undertake currency hedging arrangements to at least 80% of the value of their FIF interest cannot use the FDR method to calculate their income from the Australian FIF.

The Commissioner stated that the policy intention is that the FDR method should not apply to these types of FIF interests, because they are sufficiently hedged as to be akin to NZ$ denominated debt investments.

This policy intention is not stated in the legislation, and it is questionable whether the Commissioner's determination making power extends to making these determinations.  His power appears to apply only in respect of particular "types of" FIF interests, rather than determinations based on arrangements entered into by taxpayers to manage risks in respect of their FIF interests.  The position may be different if the hedging arrangement were so closely connected to a FIF interest that the arrangement could be said to affect the FIF interest itself.   

In addition to the determinations, the tax Bill reported back on 30 June 2009 proposes an amendment to prevent taxpayers applying the FDR method in respect of certain FIF interests hedged to the NZ$ (retrospective to 1 April 2009).  Broadly, the amendment will prevent the FDR method being applied in respect of a FIF interest if 80% or more of the FIF's assets are debt or debt-hybrids, and the FIF interest is treated as a hedged item under New Zealand accounting standard NZIAS 39. 

To view a copy of determination FDR 2009/1 please click here. 

To view a copy of determination FDR 2009/2 please click here.

In the recent case of CIR v Albany Food Warehouse Limited (CIV-2008-485-1444, Wellington, 26 May 2009) the High Court considered when a dividend is "paid" for the purposes of the imputation rules.  The taxpayer's directors declared a dividend which they credited to the relevant shareholders' current accounts.  Payment from those accounts was expressed as being conditional on the shareholders passing a resolution to subordinate payment from the current accounts to the payment of all other liabilities incurred in the normal course of business and stating that payment would only be effected when finance permitted.  Later that afternoon there was a change in the taxpayer's shareholding which breached shareholder continuity for the purposes of the imputation rules.  The shareholder current account balances were subsequently paid in instalments. 

The Commissioner contended that the breach of shareholder continuity occurred prior to the dividends being paid, on the basis that crediting the shareholders' current accounts did not satisfy the definition of "paid" for the purposes of the imputation rules.  If accepted, the Commissioner's contention would have resulted in the imputation credits being forfeited rather than attached to the dividends.

Clifford J rejected the Commissioner's contention and held that when the shareholder current accounts were credited the dividends were "paid" for the purposes of the imputation rules (as the dividends were paid within the definition of "paid" in section OB 1 of the Income Tax Act 2004) and that the dividends were also "paid" within the ordinary meaning of the word. 

The Commissioner's argument appears inherently flawed as "paid" is defined for the purposes of the imputation rules to include "credited".  In fact, Clifford J stated in his judgment that counsel for the Commissioner acknowledged that if it was not for the subordination arrangements, the Commissioner would have accepted that the dividend had been paid.  This acknowledgment begs the question as to why the Commissioner had a problem with the subordination arrangements.  The subordination arrangements were consistent with the policy underlying the imputation regime - that the shareholders who bear the burden of the tax gain the benefit of the imputation credits.  There is no policy basis for the Commissioner to deny these shareholders the benefit of imputation credits for tax the company had paid.

To view a copy of the decision please click here.

This publication is included in Russell McVeagh's website on the Internet: www.russellmcveagh.com

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