Trans-Tasman triangular tax - Chapter 5
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Original transactions
Operation of pro rata allocation mechanism

5.1     This chapter sets out a detailed example of how the pro rata mechanism would work with a group structure of companies that are not wholly owned. They earn income in their home jurisdictions as well as make an intercompany payment from a New Zealand to an Australian group company. The exchange rate is maintained constant throughout, so the issues raised in appendix 2 do not apply. The structure is shown in figure 7.

Original transactions

5.2     The original transactions are as follows and are illustrated in figure 8:

• The Australian operating company 1 earns A $1,000 and pays A $300 in tax, generating a credit balance of A $300 in the franking account.

• The New Zealand operating company pays the Australian holding company a royalty of NZ $900 after deducting non-resident withholding tax of NZ $100, generating a credit to the imputation credit account of NZ $100.

• The New Zealand operating company also earns NZ $5,000 and pays NZ $1,650 in tax, generating a credit balance in the imputation credit account of NZ $1,650.

• The Australian operating company 2 earns A $10,000 and pays A $3,000 in tax, generating a credit balance in the franking account of A $3,000.

• All Australian companies have elected to maintain an imputation credit account and all New Zealand companies have elected to maintain a franking account.

5.3     The corporate tax rates used are 30% for Australia and 33% for New Zealand.

Operation of pro rata allocation mechanism

5.4     Figure 9 illustrates the steps involved in passing on the tax paid by the lower tier companies as franking and imputation credits to the ultimate shareholders of the parent company, while figures 10 to 14 show these steps individually.

5.5     Although almost all the franking and imputation credits flow up the chain of companies, some of the accompanying cash dividends do not. This is because the pro rata allocation mechanism involves two credits being attached to one dividend payment, even though only one payment of tax has been made on the underlying income. Consequently, the cash from the dividend may remain in an intermediary company while the franking or imputation credit passes up the chain.

5.6     Figure 10 shows the Australian operating company 1 paying a fully franked dividend of A $700 to the New Zealand operating company. No dividend withholding tax is deducted as the dividend is fully franked.

5.7     There is now a nil balance in the franking account, as shown in table 7, because this dividend has transferred up the franking credit generated by the tax payment of A $300.

5.8     The New Zealand operating company pays a fully imputed dividend of NZ $3,350 with franking credits of A $300. Figure 11 shows the 50 percent received by the New Zealand holding company.

5.9     Table 8 shows the transactions in the New Zealand operating company's tracking account as a result of the original tax paid and the receipt of the dividend, as well as the effect of paying a fully imputed and partially franked dividend.

5.10     Figure 12 shows the New Zealand holding company paying a dividend of NZ $1,675 and a supplementary dividend of NZ $295[28] to the Australian operating company 2. Franking credits of A $150 and imputation credits of NZ $530[29] are attached to the dividend. Non-resident withholding tax of NZ $295[30] is deducted from the dividend and paid to the New Zealand government.

5.11     Table 9 shows the New Zealand holding company's receipt of a foreign investor tax credit of NZ $295,[31] as well as the franking credits and imputation credits that were attached to the dividend received from the New Zealand operating company. It also shows the remainder of both credits attached to the dividend paid to the Australian operating company 2.

5.12     Figure 13 shows the Australian operating company 2 earning income of A $10,000 and paying tax of A $3,000. This gives tax-paid income of A $7,000, which is then distributed as fully franked along with the maximum New Zealand imputation credits. The Australian holding company receives 70 percent of this distribution.

5.13     Table 10 shows all the transactions in the tracking accounts of the Australian operating company 2. It shows the original tax paid of A $3,000, the non-resident withholding tax paid to the New Zealand government and the credits attached to the dividend received from the New Zealand holding company. Finally, it shows the credits it attaches to fully frank the dividend and all the New Zealand imputation credits it passes on.

5.14     A balance remains in the franking account as not all the Australian credits were necessary to fully frank the dividend.

5.15     Figure 14 shows the Australian holding company receiving a royalty of NZ $900, which was paid by the New Zealand operating company. It also shows the Australian holding company paying a fully franked dividend of A $4,900 with New Zealand imputation credits of NZ $677.50 to the Australian ultimate parent. This dividend is then paid on equally to the Australian and New Zealand shareholders, who each own 50 percent of the Australian ultimate parent.

5.16     Table 11 shows the entries to the tracking accounts for the Australian holding company, and table 12 shows the entries for the Australian ultimate parent.

5.17     The Australian and New Zealand shareholders each receive a fully franked cash dividend of A $2,450 with New Zealand imputation credits of NZ $338.75. No dividend withholding tax is imposed on the New Zealand shareholder as the dividend is fully franked.

5.18     Table 13 shows the final tax treatment of the shareholders. Although both shareholders receive franking and imputation credits, the franking credits have value only to the Australian shareholder. Similarly, the imputation credits have value only to the New Zealand shareholder.

5.19     Although the New Zealand dividend would be only partially imputed under the proposed reform, at present it cannot be imputed at all, as shown in table 14. The effective tax rate has been reduced from 57% to 53%. Again, it is appropriate that the dividend is only partially imputed, as a proportion of the dividend is from Australian income. Triangular reform would provide relief relating only to the shareholders' proportion of the tax paid in their home country.