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And they’re off – first tax bill of 2016 introduced
The beginning of the month of May not only reinforced the shocked realisation of how quickly yet another year was passing, but also saw the introduction of the first significant tax Bill for 2016.
Similar to the recently announced tax simplification proposals by the Government, the Bill has a number of welcomed changes to present legislation. The Bill is predominantly focussed on three specific areas – closely held companies, non-resident withholding tax (“NRWT”) with respect to related party & branch lending and GST current issues. It also contains changes to deal with other policy matters that had been identified. This article provides commentary on the changes affecting closely held companies and NRWT. A future article will comment on the GST and other policy matters amendments.
The wording “closely held companies” should not be confused with the concept of a “close company”, defined in the Income Tax legislation, as being a company with five or fewer natural person shareholders. Instead the reference is with respect to closely controlled companies, in particular look-through companies (“LTC”) and qualifying companies (“QC”).
With regard to closely held companies some of the welcomed proposed changes include:
- An LTC will be able to have more than one class of shares provided all shares have the same distribution rights. Present rules only permit a single share class.
- The deduction limitation rule will be removed unless a partnership or joint venture of LTC’s exists. Presently, annual deduction claims are limited to an owner’s basis calculation which essentially requires an annual computation of each owner’s economic risk of loss in the LTC, with any excess deductions being carried forward to the following income year.
- It will be clarified that a shareholder/partner who remits a debt owed to them by the LTC/partnership will not derive assessable income of an equivalent amount (due to the tax look-through nature of these entities).
- The definition of associated party capital gains derived by a company (which are still taxable as a dividend upon liquidation) will be redefined to narrow the situation where capital gains will be tainted to only apply in cases where a common association of greater than 85% exists between a vendor and purchaser company. The rules will also no longer apply to non-corporate purchaser transactions.
- Clarification that a fully imputed dividend will be able to be backdated to clear or reduce an overdrawn shareholders current account with no RWT deduction requirement, which presently restricts the use of this mechanism due to the timing obligation with respect to the payment of the RWT.
- Permitting shareholder employees of close companies to receive a mixture of PAYE and non-PAYE salaries for a particular income year, which is restricted under present rules.
Not so welcomed however, are the amendments which will:
- Trigger a loss of LTC status where the company has greater than 50% foreign ownership and derives the greater of $10,000 or 20% of its gross income for the year from foreign sources.
- Have the LTC entry tax now calculated based on the shareholders’ relevant tax rate as opposed to the present 28% corporate rate, which currently provided an opportunity for tax paid retained earnings held by the company upon entry into the LTC regime to have no further tax imposition when paid out to shareholders.
- Introduce a QC shareholder continuity test requiring a minimum continuity interest of 50% for the QC continuity period otherwise QC status will be lost.
Most of the changes will apply from the beginning of the 2017/2018 income year.
The changes to the NRWT rules are promoted as being to “address holes” within the current law. The main change will see an alignment in the timing of when the borrower obtains a tax deduction for the interest on a related party loan and the requirement for the borrower to deduct NRWT on the interest paid (via the application of a new deferral calculation formula). Under existing tax rules, usually a NZ borrower can obtain a deduction for the interest payable on a loan from a foreign lender (or any lender for that matter), as soon as the interest expense is accrued as a liability in the borrowers’ financial statements. However, since the obligation to deduct NRWT is only triggered when the interest is deemed to have been paid, significant timing benefits can be obtained by simply accruing the interest that is payable in accordance with the terms of the loan agreement, and then leaving the amount sitting as an accrual for a number of reporting periods.
Naturally the longer the interest remains accrued in the financial statements, the Inland Revenue, through the use of existing anti-avoidance legislation, can question the actual commerciality of the arrangement, on the basis that it would be unlikely an unrelated lender would have allowed the interest to have remained unpaid for the same period of time, without exercising some sort of default rights against the borrower in accordance with the terms of the loan agreement.
There will also be amendments to the legislation to prohibit the use of approved issuer levy (“AIL”), where the lending arrangement is structured in such a way to disguise what is in essence a related party loan. AIL is available as an alternative to NRWT, lessening the cost to the borrower from a minimum 10% of the interest paid to a 2% levy on the amount of interest paid. AIL is only available for loans between unrelated parties however, so the changes will counter situations where for example a third party is interposed between the borrower and in essence the true lender, to ensure that the NRWT deduction rules still apply.
Finally, the rules are being tightened in the area of branch lending, to ensure that funding transactions that are economically equivalent have consistent tax treatment. Presently, NRWT or AIL is only payable with respect to non-resident passive income (“NRPI”), which only includes income that is deemed to have a NZ source. The NRWT rules can presently be circumvented via the use of a branch structure, the consequence of which due to the presence of a number of existing exemptions, results in the interest paid to the non-resident lender not falling within the NRPI definition. The amendments will ensure the branch is essentially looked through so that the interest payments to the non-resident lender do satisfy the NRPI definition and are therefore subject to either NRWT or AIL as appropriate.
We will keep you updated as to the progress of the Bill as it moves through the various reading stages.