New Zealand: Recent and Proposed Tax Reforms

Recent and Proposed New Zealand Tax Reforms
By Caroline Maxwell, London

The New Zealand government has been busy in the last year or two responding to complaints that its tax regime is anti-competitive, particularly on the international level. Here we examine some of the specific changes that have been made, or are going to be made.

The 2008 Tax Package

2008 tax package which reduced the coporate tax rate from 33% to 30% also introduced a 15% tax credit for research and development expenditure. To qualify for the credit, a business must control the R&D project, bear the financial and technical risks of it, and own the project results. The R&D must be carried out predominantly in New Zealand. R&D credits will be paid out in cash to loss-making businesses such as start-ups.

Expenditure eligible for the tax credit includes the cost of employee remuneration, the depreciation of tangible assets used primarily in conducting R&D, overhead costs, and the costs of consumables and payments to entities conducting R&D on behalf of the business.

Reform Of The Controlled Foreign Company Regime

A bill to reform the CFC and FIF rules 'to help New Zealand-based companies compete more effectively overseas' was introduced into the country's parliament on 2nd July 2008.

“The proposed changes represent a fundamentally different approach to taxing New Zealand companies that have offshore operations,” Finance Minister Michael Cullen and Revenue Minister Peter Dunne announced upon the bill's introduction.

“The cornerstone of the reform is the exemption from tax of the offshore active income of New Zealand’s controlled foreign companies, regardless of where it is earned. That will bring our tax rules into line with the tax systems of comparable countries, particularly that of Australia, and remove a tax cost that similar companies in other countries do not face,” the Ministers added.

“Further important features of the proposed changes are an exemption from tax of most foreign dividends paid to companies and measures to protect the tax base as a result of adopting an active income exemption," the Ministers explained.

The changes represent the first stage of those to emerge from the government’s review of New Zealand's international tax rules and have been influenced by consultation with businesses and their advisors.

“Most aspects of the reforms were signalled in a series of consultative papers, although there has been further work to develop the detail in some areas," the Ministers said.

Cullen and Dunne said that under the reforms, comprehensive attribution of income from controlled foreign companies (CFCs) to New Zealand owners will be replaced by attribution of passive income only. Passive income – such as interest – will continue to be attributable.

There will be some exceptions to attribution of passive income, however, to reduce compliance costs. For example, there will generally be no attribution of passive income for CFCs in Australia, which is usually the first country of choice for New Zealand's smaller businesses that want to expand overseas.

There will also be an exception for CFCs that pass an ‘active business’ test: no attribution of passive income will be required for CFCs whose passive income is less than five percent of total income.

Passive income will consist mainly of interest, rent, royalties and dividends. Certain services will also be classified as passive income, as will income from speculative derivative instruments and derivatives that hedge passive income.

Most dividends paid by a foreign company will be exempt from income tax when received by New Zealand companies, as was previously announced by the government. Deductible dividends and dividends on fixed rate shares will be continue to be taxable as interest, and fixed rate shares issued by foreign companies will be treated as debt. This is designed to prevent double New Zealand taxation, since a deduction will be allowed against the attributable income of the CFC.

As part of the exemption for ordinary dividends, there will be a change to the qualifying company rules: a qualifying company may no longer hold an attributing interest in a controlled foreign company or non-portfolio foreign investment fund. This change is designed to prevent foreign dividends being passed through to shareholders tax-free.

Interest allocation rules will be extended to cover New Zealand residents that have outbound interests in a CFC. Several ‘safe harbour’ provisions will, however, minimise the impact of the rules and permit much of the cost of debt-funding for a foreign investment to be deducted against the New Zealand tax base.

The present ‘grey list’ exemption from attribution of CFC income is being replaced with the active business test for CFCs in all countries, with one exception – Australian CFCs will generally continue to be exempt from the requirement to attribute any income to New Zealand residents.

The existing conduit relief mechanism, which exempts from tax the foreign-sourced income of New Zealand companies owned by non-residents, is being removed. Even so, the active income exemption and the foreign dividend exemption provide the same results as conduit relief for active income, Cullen and Dunne said.

The ministers added that companies’ foreign dividend payment accounts, branch equivalent tax accounts and conduit tax relief accounts will become unnecessary under the reform. It is the government’s intention that existing FDP credit balances can be carried forward for five years and BETA debit balances and conduit tax credits can be carried forward for two years, with legislation repealing them to be introduced at a later date. BETA credit balances will be cancelled from the beginning of the 2009-10 income year.

“The aim in developing this comprehensive reform has been to devise flexible rules that are consistent with the realities of the business environment and that help New Zealand businesses to expand their operations but keep their head offices in New Zealand,” the Ministers concluded.

Limited Partnerships

The cause of venture capital in New Zealand took a major step forward in May 2008 when after many years of discussion The Limited Partnerships Act 2008 came into force, enabling registration of Limited Partnerships and Overseas Limited Partnerships.

The Limited Partnerships Act replaces Special Partnerships that exist under Part 2 of the Partnership Act 1908. Special partnerships are considered obsolete as they do not provide the appropriate structure preferred by foreign venture capital investors.

The government believes that the introduction of an internationally recognised Limited Partnerships regime will remove barriers to foreign capital investment which provides a valuable source of funding for new companies and early stage expansion capital. The Act will enable New Zealand businesses to compete internationally on a level playing field for venture capital funds.

Features of New Zealand Limited Partnerships include separate legal personality, an indefinite lifespan if desired, a list of activities that the limited partners can be involved in while not participating in the management of the Limited Partnership (safe harbour activities).

An Overseas Limited Partnership is a partnership that has been formed in a country other than New Zealand but because it is engaged in business activities in New Zealand it must register as an Overseas Limited Partnership.

Limited partners will not be taxed at the partnership level. Instead each will be taxed individually at their personal marginal rate in proportion to their share of the partnership's income. Limited partners’ tax losses will be restricted to their economic losses in that year. There is provision for limited partners to have a say in how the partnership is run, without being treated as participating in the management of the partnership and thus losing their limited liability status.

Goods And Services Tax

A tax policy issues paper published in July, 2008, by New Zealand's Inland Revenue Department for public consultation looked at options for strengthening the GST neutrality of business-to-business transactions, and reducing the risks that GST can present to both businesses and the government.

“A fundamental principle of our GST system is that the tax must be neutral for businesses whose supplies are subject to GST,” Revenue Minister Peter Dunne explained.

“That means businesses should not bear the cost of the tax. The GST they charge on taxable supplies is balanced by input tax claims. GST should not be a permanent business cost in these circumstances."

“If the tax rules do not clearly provide neutrality for businesses, they can face unexpected GST payments or tax penalties."

“It is also important to the government that GST claims are balanced against payments. The GST refunds it issues should be offset by corresponding GST payments."

He went on to explain that: “When there is a large claim but no corresponding payment, that may be may be for legitimate reasons, the result – for example – of a business’s liquidation or bad debts. It may also be for other reasons, such as the exploitation of timing mismatches or through the deliberate use of ‘phoenix’ entities to avoid paying GST."

“The issues paper released today, which has been prepared by tax policy officials as a first step in the consultation process, seeks feedback on a range of legislative options for ensuring that business-to-business transactions are neutral."

“To strengthen the GST neutrality of transactions involving high-value assets such as ‘going concerns’, land and assets with a value of NZD50 million or more, the paper suggests replacing the going concern rules with an expanded set of rules that ensure neutrality and that apply to a wider range of transactions. Associated changes would ensure that input tax deductions are not denied for nominee and related transactions."

“The paper outlines three options for reducing the risks arising from phoenix entities, which are a particular problem for GST systems that are based on the ‘credit-invoice’ method. They are to enforce GST neutrality on certain transactions created between close associates, allow Inland Revenue to impose caveats on certain land transactions, and extend the time available to Inland Revenue before it must release a refund.

“To reduce the revenue risks associated with timing mismatches, the paper suggests either limiting access to the invoice basis of accounting and strengthening the application of existing anti-avoidance measures or increasing the payments basis threshold."

The Revenue Minister concluded by announcing that: “Also covered in the paper are a number of possible changes to simplify and clarify the change-in-use rules and to clarify the GST treatment of short-term accommodation – including redefining the terms ‘dwelling’ and ‘commercial dwelling’ and removing very small-scale and non-commercial supplies of accommodation from the definition of ‘taxable activity’."

“These are all matters that will doubtless be of interest to tax professionals and to businesses that buy and sell significant assets, and I urge all interested parties to have their say on the options presented in the issues paper.”