Trans-Tasman triangular tax - Chapter 3
	Home      Contents     Previous     Next

Scope of reform
     Ownership through wholly owned groups
     Ownership through interposed companies
     Ownership through non-wholly owned groups
     Ownership through chains involving third countries
Proposed relief mechanism - "pro rata allocation"
Alternative approaches
     Mutual recognition including pro rata revenue sharing
     Streaming
     Apportionment

3.1     The proposed triangular tax reform would provide tax relief to Australian and New Zealand shareholders on income which has already been taxed in the home jurisdiction and derived through a company resident in the other jurisdiction.

3.2     This chapter presents an overview of the important considerations in developing a triangular relief mechanism. In particular, it considers the scope of reform, introduces the proposed relief mechanism and discusses alternative approaches not being pursued.

Scope of reform

3.3     To make the underlying concepts and distortions clear, chapters 1 and 2 discussed triangular tax in very simple terms. The examples used have the intermediary company itself making the investment in the other country. This happens, however, only when investment takes place through a branch structure or some other direct investment[12] by the ultimate parent company rather than through a holding company.

3.4     Although investment through a branch, or some other form of direct investment, in the other jurisdiction by the ultimate parent company would receive relief from triangular taxation, it would not be restricted to such forms of investment.

Ownership through wholly owned groups

3.5     Although triangular relief would apply to branch investment, it would also cater for structures involving an ultimate parent and subsidiary holding companies that are resident in the other country. Figure 2 shows a sample structure having an Australian company as the ultimate parent company.

3.6     Although the New Zealand shareholders of the Australian ultimate parent company in figure 2 will own a proportion of its capital, the Australian parent company itself does not directly invest or pay tax in New Zealand. As the companies in the group form one economic unit, triangular tax reform must be wide enough to cater for such commonly used ownership structures.

Ownership through interposed companies

3.7     In some cases, as a result of takeover and merger activity, the trans-Tasman chain of companies is not as "clean" as the one shown in figure 2. For instance, an Australian company may be owned by a New Zealand company that in turn is owned by an Australian company. This sort of structure is illustrated in figure 3. Because it is still an Australia/New Zealand group of companies, such a structure should not preclude triangular tax relief.

Ownership through non-wholly owned groups

3.8     It is not uncommon for companies further down the corporate chain to engage in joint venture activity with investors other than the ones holding shares in the ultimate parent. The result is a chain of companies that do not have a 100 percent common ownership, as in figure 4.

3.9     Although the shareholders of the Australian ultimate parent company in figure 4 have full rights to the Australian income, they have rights only to 50 percent of the income from the New Zealand operating company. The question, therefore, is whether triangular relief should be restricted to wholly owned chains, as is the case for both countries' grouping rules, or whether chains that are not wholly owned are acceptable. It appears that the avoidance concerns that provide the rationale for the 100 percent restriction for New Zealand's consolidation and grouping rules do not apply to triangular investment. It also appears that the rationale for the 100 percent restriction in Australia's proposed consolidation rules similarly does not apply to triangular investment. Relief could, therefore, be allowed for chains that are not wholly owned.

Ownership through chains involving third countries

3.10     Consideration has also been given to chains of companies in which a holding company from a third country is interposed between Australian and New Zealand companies, as shown in figure 5. As neither government has jurisdiction over a third country holding company, triangular tax relief should not extend to such structures. It is proposed, therefore, to restrict triangular reform to chains of ownership consisting of Australian and New Zealand entities only.

Proposed relief mechanism - "pro rata allocation"

3.11     The proposed mechanism for providing triangular tax relief is one known as "pro rata allocation". It is the preferred approach for both governments as it is the only method of those considered that apportions the tax benefits on the basis of the shareholders' ownership, which is consistent with both countries' current policy on imputation. Shareholders have the right to a proportion of the total income of a company rather than to a specific income source derived by the company. It seems appropriate, therefore, that the credit allocation rules continue to require a company paying a dividend to attach the same proportion of each type of credit to each dividend that it pays. This also ensures that the total Australian or New Zealand tax rate imposed on shareholders is consistent with their proportionate share of each source of income derived by the company.

3.12     Relief from triangular tax that is based on a pro rata allocation of imputation credits would see dividends paid by an Australian or New Zealand company have both an Australian and a New Zealand imputation credit attached. Subject to the respective countries' rules on the maximum allocation of credits (maximum ratio), the imputation credits would be allocated to shareholders in proportion to their shareholding in the company.

3.13     Take, for example, a company of which Australians owned 65 percent, New Zealanders 25 percent and other shareholders 10 percent. Subject to the maximum ratio, Australian shareholders could receive up to 65 percent of the Australian tax paid as an Australian imputation credit and 65 percent of the New Zealand tax paid as a New Zealand imputation credit. In this case only the Australian imputation credit would have any value to the Australian shareholder, as the New Zealand imputation credit could not be used.

3.14     The mechanism would work as follows:

• Australia would generally allow New Zealand resident companies to maintain franking accounts, and New Zealand would generally allow Australian resident companies to maintain imputation credit accounts.

• Companies would be able to elect into the triangular rules to pass on the other country's imputation credit.

• For Australian companies, dividends would continue to be exempt from dividend withholding tax to the extent they are franked, but the dividend withholding tax deducted from unfranked dividends would be creditable to the New Zealand company's franking account.

• For New Zealand companies, the foreign investor tax credit rules would continue to apply, but both the imputation credit attached to the dividend and the non-resident withholding tax deducted from the dividend would be creditable to the Australian company's imputation credit account.

• Australian shareholders in receipt of a New Zealand dividend with Australian imputation credits might have their franking rebate reduced by the amount of any supplementary dividend paid, but other options that give an equivalent result might be considered as well.[13]

3.15     The operation of the pro rata allocation mechanism would require Australian companies with an imputation credit account to comply with the New Zealand law governing its maintenance, as New Zealand companies currently do. Conversely, it would require New Zealand companies with a franking account to comply with the Australian law governing its maintenance, as Australian companies currently do.

Alternative approaches

3.16     There are three alternatives to the provision of triangular tax relief which both governments have considered but do not wish to pursue:

• mutual recognition, including pro rata revenue sharing;
• streaming; and
• apportionment.

Mutual recognition including pro rata revenue sharing

3.17     Mutual recognition would involve either providing imputation credits for company taxes paid in another country, or extending the full benefits of imputation to residents of another country on a reciprocal basis. Compensation might also be paid to the country that recognised the imputation credit from the country that received the tax. This is known as pro rata revenue sharing.

3.18     If compensation were paid, relief would be provided by the source country; otherwise the cost of the imputation credits would be borne by the residence country. Either way, the recognition could apply to all taxpayers or it could be limited to natural persons.

3.19     Mutual recognition would involve the Australian government recognising a New Zealand imputation credit attached to a dividend that was distributed to an Australian resident shareholder, and vice versa. In this case, the imputation credit would be generated through the payment of New Zealand company tax, but could be used as a rebate against the Australian individual's tax liability. The Australian government, as the residence country, would bear the cost of recognition.

3.20     For the shareholders themselves, pro rata revenue sharing would be equivalent to the extension of the full benefits of imputation to residents of another country on a reciprocal basis. For individual shareholders, this method would see each country recognising the other country's imputation credits as if they were its own, but in turn receiving compensation from the other government. The compensation would be netted out and the government that had recognised the greater amount would receive a payment from the other for the difference. For example, if the Australian government had recognised $20 million in New Zealand imputation credits and the New Zealand government had recognised $15 million in Australian imputation credits, the latter would pay the Australian government $5 million.

3.21     The effect of pro rata revenue sharing is equivalent to each government's company tax being treated as a withholding tax on behalf of the other. Both countries would preserve full residence taxation while giving up some source taxation. The mechanism would be similar to that already in place for social welfare.

3.22     Mutual recognition in whatever form, however, raises complex issues involving a possible substantial revenue impact, avoidance opportunities, international tax treaty obligations and national economic welfare. Mutual recognition would involve a loss of tax revenue from each government to its resident shareholders in respect of company tax paid to the other government. Alternatively, in the case of pro rata revenue sharing, there would be a loss of tax revenue from each country to the other country's resident shareholders in respect of company tax paid in its own country.

3.23     In theory, mutual recognition could offer potential efficiency gains and, as a result, generate revenue gains that could offset the initial revenue costs. The net revenue effects are, however, uncertain and could be substantially negative.

3.24     Mutual recognition also exceeds what is required to achieve triangular reform because shareholders in either country would receive imputation credits, regardless of whether tax was paid in their respective home countries. Neither government is willing, therefore, to pursue mutual recognition further at this stage.

Streaming

3.25     Streaming would see all tax paid in Australia being available to provide imputation credits solely to Australian shareholders, and all tax paid in New Zealand available to provide imputation credits solely to New Zealand shareholders. Such a model is contrary to Australia's and New Zealand's imputation rules as it provides tax benefits to shareholders disproportionate to their shareholdings.

3.26     A streaming model, however, would address some of the concerns of pro rata revenue sharing, as tax would have to be paid in the home country of the shareholder before an imputation credit was given. Both governments, however, are concerned about the fiscal risks of such a model, given that imputation credits would be allocated only to shareholders of countries in which the tax was paid. This means that most[14] of the imputation credits allocated could be used to reduce the shareholders' home country tax liabilities.

3.27     Another concern is that to allow streaming in this environment might also signal that streaming of credits more generally is now acceptable. Both governments wish to avoid such a result, as it is still both countries' policy that imputation credits should not be streamed and should be allocated across all shareholders.

Apportionment

3.28     Apportionment would see the tax credit attached to dividends split into Australian and New Zealand imputation credit components according to the ratio of income earned in either country and in equal proportions for all shareholders. This method is similar to pro rata allocation except that the imputation credits are allocated not only in proportion to the residence of the shareholder, but also in proportion to the country in which the income is earned. It would give the same result as pro rata allocation when a company had no previous balances of imputation credits and fully distributed all tax-paid income.[15]

3.29     The source of income would become important under an apportionment approach, as each shareholder could receive Australian and New Zealand imputation credits in total only up to the maximum ratio. Thus if a company earned 50 percent of its income in Australia and 50 percent in New Zealand and paid full tax in both countries, the shareholder could at most receive 50 percent of a full Australian imputation credit and 50 percent of a full New Zealand imputation credit. If the company were resident in Australia, where it had previously been able to fully frank the dividend, it would now frank up to 50 percent and impute up to 50 percent. Alternatively, if the company were from New Zealand, a previously fully imputed dividend could now be imputed only up to 50 percent and franked up to 50 percent.

3.30     Such a mechanism would be advantageous to the shareholders who currently do not receive any of their country's imputation credits, but it would disadvantage shareholders who can currently benefit from a fully franked or imputed dividend. It is also not consistent with the current imputation policy of both countries, which allows imputation credits to be allocated across all shareholders to the extent that tax has been paid, and not over sources of income.