Outward Investment from New Zealand - The Offshore Perspective
Contributed by Jason Gorringe
08 September, 2008
In terms of making or maintaining offshore investments in New Zealand, whether for immigrating expatriates or New Zealand residents, the picture isn't an especially pretty one. World-wide taxation for resident entities and a stringent anti-avoidance regime combine to make legal tax minimisation using foreign or offshore vehicles almost an impossibility for individuals, and certainly very difficult (taxing?) for multinational and domestic New Zealand companies. The government has perhaps come to realise that punitive taxation on foreign investment may eventually be to the detriment of the country's economy, and certain changes are being made, particularly to the Controlled Foreign Company (CFC) rules.
Unlike some other developed trading nations, however, New Zealand has not leapt to enter Tax Information Exchange Agreements (TIEAs) with offshore investment destinations. In fact it did not enter its first TIEA (with the Netherlands Antilles) until March, 2007.
The agreement provides for full exchange of information on criminal and civil tax matters between the two countries. Revenue Minister Peter Dunne said: Ultimately, what tax information exchange agreements do is prevent people from avoiding tax by hiding their money in another country.
There is a growing trend internationally towards greater transparency and co-operation between countries in tax matters, and I welcome the signing of this tax information exchange agreement, which is a first for New Zealand.
It should also be said that for non-resident foreigners, New Zealand's Offshore Trust regime allows investments to be made and managed through New Zealand in a way which is completely exempt from New Zealand taxation.
Controlled Foreign Company Rules
CFC provisions in New Zealand (as everywhere that they exist) are designed to prevent New Zealand resident individuals or entities from sheltering their income, gains or profits from New Zealand taxation by locating them in a low tax country where they would be taxed lightly, if at all. To counter this, the CFC provisions impose tax on the resident shareholders of the foreign company on the accrued profits made by such companies, whether that profit is remitted to New Zealand or not. This is known as the attribution process. A parallel system of rules known as the Foreign Investment Fund (FIF) rules apply similar treatment to the interests of companies in investment funds.
Under New Zealand's Controlled Foreign Company (CFC) and Foreign Investment Fund (FIF) rules, a New Zealand resident company or individual is taxed on its share of the underlying income of a foreign company or fund. The CFC and FIF rules do not apply to foreign companies or funds in the 'grey list' countries (Australia, Canada, Germany, Japan, Norway, Spain, the UK and the USA).
If the CFC or FIF is in a grey list country then there is effectively no tax on any undistributed income from that CFC or FIF or on any dividends received. Until 2008, however, for any CFC or FIF in a country outside the grey list areas, all income, whether active or passive, distributed or not, was attributed to the New Zealand shareholder.
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 Zealands 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 governments 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 governments 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.
New Zealand Foreign Trusts
The New Zealand Foreign Trust is exempt from New Zealand taxation if it is set up by a non-resident, even if it is managed from New Zealand. Trusts do not need to be registered.
The governing statute is the Trustee Act 1956, based on English trust law. There is an 80-year perpetuity period and a 21 year wait and see rule. New Zealand bankruptcy law provides protection to trustees of New Zealand trusts against actions brought by creditors of the settlor. There are no forced heirship provisions in New Zealand trust law.
Under specific provisions of New Zealand tax law, a trust settled under New Zealand law by a settlor (or grantor) who is not resident in New Zealand is a foreign trust, even if the trustee is resident in New Zealand, and is not subject to New Zealand tax on income derived outside New Zealand.
If effective management of a trust is New Zealand resident then the trust may claim the benefit of New Zealand's tax treaty network.
A New Zealand-based trustee becomes liable for New Zealand income tax only on income derived from New Zealand, or if any settlor is resident in New Zealand at any time during the income year, or if any settlor of an inter vivos or a testamentary trust dies while resident in New Zealand.
Section OB 1 of the Act provides that, for a foreign trust to retain its status:
- on each date on which a distribution is made from it, no settler of it has been resident in New Zealand at any time since the later of
(i) 17 December 1987; and
(ii) the date on which a settlement was first made under its terms."
What if I already have offshore investments?
As we've seen, the New Zealand taxation system has most of the bases covered for resident individuals and companies. While you may be benefiting from higher returns as a result of offshore investments while you are resident in New Zealand, the reasonably high level of income taxation on nearly everything will certainly take a bite out of your returns.
Therefore, if you are planning to immigrate to New Zealand and already have offshore investments or vehicles in place, the sensible option is to take professional advice before departure, as there may be some way in which you can bring forward or postpone distribution, or redistribute your assets amongst family members.
International tax planning once resident in New Zealand is possible, but the emphasis should be on asset protection and transparency, as opposed to just tax minimisation. Fiscal transparency (for example using structures like Limited Partnerships and Limited Liability Companies, which are available in many offshore jurisdictions, and are usually untaxed there) is important because it may mean that gains from higher yielding international and offshore investments can be taxed in the New Zealand resident's hands on the same basis as domestic investments.
To conclude, then, it would seem that although it is now very difficult for individuals, whether resident expats or New Zealand citizens, to legally achieve tax minimisation by investing or sheltering assets offshore, there are still opportunities on a corporate level, although the balance does seem to be in favour of foreign multinationals with New Zealand subsidiaries or branches, rather than New Zealand companies with foreign interests. And it is fair to say that the overall taxation regime in New Zealand is noticeably less harsh than its equivalent in Australia.
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