Trans-Tasman triangular tax - Appendix 2
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Three options for incorporating the issue of exchange rates and currency conversions within the triangular reform have been identified. Essentially, each option involves a relaxation of one of the last three features of the current imputation systems. Submissions on these options as well as any other possible solutions are welcomed.

For reasons of compliance, consistency and administrative ease, the tracking account should continue to be maintained in the currency in which tax is paid.

Another important consideration is that there should be as much certainty of outcomes as possible for companies and shareholders.

Option 1 - Imputation and franking credits would be attached in the local currency of the company, with conversion being at the exchange rate on the day the dividend is declared.

This option would relax the proportionate requirement between the imputation/franking credit, total tax paid and membership interest.

The imputation and franking credits attached to a dividend would be in the same currency as the dividend paid. The imputation ratios[40] would be calculated on the date of declaration and the debit to the other country's tracking account would be converted at the exchange rate prevailing on the date the dividend was declared.

Shareholders in the other country would then convert both the dividend and their country's credit at the exchange rate applicable on the date of receipt.

Advantages

This option would maintain three features of the current imputation systems:

• The tracking account is maintained in the currency tax is paid.

• The imputation ratio remains the same for the company and the shareholder. When the company attached the New Zealand imputation ratio it was A $3447/A $7000, or 33/67. When the New Zealand shareholders return the dividend and imputation credit, the total returned will be NZ $2154 / NZ $4375 or 33/67.

• Foreign dividends are converted at the exchange rate on the day of receipt. The Australian dollar dividend of the New Zealand shareholders is converted for income tax purposes at 0.80, being the exchange rate on the date of receipt.

Disadvantages

Under this method the amount of credits may not reflect the underlying tax paid. Although this method would work if the shareholder receiving the dividend were not maintaining a tracking account, it would not be suitable for passing credits up a chain of companies.

If the Australian and New Zealand shareholders in example 1 were companies maintaining imputation credit accounts, on receipt of the dividend they would convert the New Zealand imputation credit of A $3447 at 0.80. This would give a total credit to the respective imputation credit accounts of NZ $4309, when in fact the underlying tax paid was only NZ $4055.

This effect of the difference in exchange rates between the date of declaration and the date of payment could be mitigated by calculating the New Zealand dollar debit to the imputation credit account, using the forward exchange rate on the date of declaration for the proposed date of payment.

Such an approach, however, would not eliminate the additional compliance costs of having to convert in and out of the base currency, the currency of the country the tax was originally paid in, for the tracking account.

Option 2 - The ratio of credits from the other jurisdiction would be calculated on the day the dividend is declared, using the forward exchange rate that relates to the day the dividend is expected to be paid. Both imputation credits would, however, be attached in their own currency.

This option would relax the requirement that the ratio of the value of the credits to the value of the dividend remains the same from when the company attaches the credit to the dividend to when the shareholders return their income to their respective tax authorities.

The imputation and franking credits would be attached in their local currency. The imputation ratios would be calculated on the date of declaration. In the case of the other country's credit, the forward exchange rate relating to the day the dividend was expected to be paid would be used for conversion purposes.

As the imputation and franking credits are in their local currency, shareholders in the other country will convert only the dividend at the exchange rate on the day of receipt.

Advantages

This option would maintain three features of the current imputation systems:

• The tracking account is maintained in the currency tax is paid.

• The credit is the same proportion of the total tax paid as the shareholder's proportionate membership interest. The imputation credit returned by the New Zealand shareholders, NZ $2077, is half the debit the company makes to its tracking account, NZ $4154, which equals their proportionate membership interest in the company.

• Foreign dividends are converted at the exchange rate on the day of receipt. The Australian dollar dividend of the New Zealand shareholders is converted for income tax purposes at 0.80, being the exchange rate on the date of receipt.

Disadvantages

The main disadvantage is that the imputation ratio calculated when the dividend is declared would not necessarily be maintained at the shareholder level. The New Zealand shareholders received, in total, a dividend of NZ $4375 and imputation credits of NZ $2077, which is a ratio of only 32/67. In other words, the dividend, in the hands of the shareholder, is less than fully imputed, although at the time the company declared the dividend it was fully imputed.

Under-imputation is not the only possible outcome: if the exchange rate were to move the other way, the dividend would become over-imputed.

Because the forward rate is being used, however, it is unlikely that the outcome would diverge as much from full imputation as in this example. In practice, the only difference would relate to unexpected changes in the exchange rate between declaration and payment, which is usually no longer than two months.

Option 3 - Shareholders would convert their dividends at the exchange rate used by the company for calculating the imputation ratio on the day the dividend is declared. Both imputation credits would, however, be attached in their own currency.

This option would relax the requirement that foreign dividends are taxed on the amount of local dollars the dividend could have bought on the day it was received.

The exchange rate used for calculating the imputation ratio is the rate to which the shareholder is required to convert its dividend income for tax purposes. The exchange rate used could be either the actual rate on the date of declaration or the forward exchange rate for the date of payment.

The exchange rate used for calculating the imputation ratio would be included on the shareholder's dividend statement, and the shareholder would convert its dividend income using that rate.

Advantages

This option would maintain three features of the current imputation systems:

• The tracking account is maintained in the currency tax is paid.

• The imputation credit is the same proportion of the total tax paid as the shareholder's proportionate membership interest. The credit returned by the New Zealand shareholders, NZ $2077, is half the debit the company makes to its tracking account, NZ $4154, which equals their proportionate membership interest in the company.

• The imputation ratio remains the same for the company and the shareholder. When the company attached the New Zealand imputation ratio it was NZ $2077 / NZ $4217, or 33/67, and New Zealand shareholders will return the same amount in total.

Disadvantages

The main disadvantage is that when shareholders converted their dividend income, they would do so at a rate that is different from that applying on the day they received the dividend. Using the forward exchange rate for the payment date when calculating the imputation ratio could, however, lessen this effect. This would mean that the only exchange rate difference would arise from unexpected changes in the exchange rate between declaration and payment, which is usually no longer than two months.