Hon Peter Dunne
Minister of Revenue
Reducing the tax burden for NZ companies offshore
A review of international tax rules aims to improve the competitiveness of New Zealand companies operating in export markets overseas, Finance Minister Michael Cullen and Revenue Minister Peter Dunne said today.
"Active income from the offshore operations of New Zealand companies may be exempted from domestic income tax to help them compete internationally," the Ministers said.
The possible change is outlined in a discussion document released today that seeks feedback on options for a major revamp of New Zealand's international tax rules.
"We are looking at a radical shift in our approach to taxing offshore income from our companies operating overseas, one that distinguishes between active income, such as manufacturing and industrial activity, and passive income, such as royalties and interest," said the Ministers.
"Under such a distinction, offshore active income would be exempt from New Zealand tax, rather than taxed as it is earned, as happens now.
"The current rules may encourage New Zealand companies to relocate their headquarters to some countries where their offshore income is treated more favourably. Reducing the tax burden will improve their competitiveness and help to ensure New Zealand retains more activity.
"For example, a New Zealand-based company with operations in China would be able to take the same advantage of China's tax holidays as companies from other countries. Under New Zealand's current international tax rules, however, the company would pay tax at a 33 per cent rate on such income.
"We want to ensure New Zealand companies operating offshore with subsidiaries can obtain the same advantages in another country as their competitors.
"The tax rules of nearly all other countries distinguish between active and passive income, and either delay taxing offshore active income until dividends are paid or exempt it altogether, as Australia does.
"The rules can also create high compliance costs because they require New Zealand-based firms overseas to calculate their income tax in accordance with New Zealand tax rules, even though there may be little or no additional tax to pay here once they have paid foreign tax.
"Our tax system plays an important role in fostering a competitive business environment. That is why it is a key focus of the government's Economic Transformation agenda.
"The possible change would bring us in line with most other OECD countries and reinforce our efforts to improve competitiveness under the Business Tax Review.
"Reform of the international tax rules was urged by many in submissions to the Business Tax Review especially large, export focused companies. It has also been raised with government by a number of business groups. Some firms consider a move to an active/passive regime as important, if not more important, than lowering the corporate tax rate.
"Also under consideration is a possible reduction in non-resident withholding tax rates in the tax treaties that we negotiate with other countries. This is levied when a non-resident derives interest, royalties or dividends from New Zealand. Lower rates would help encourage inward investment and would also benefit New Zealand firms investing offshore because reciprocal arrangements could apply as tax treaties were renegotiated.
"If the government proceeds with the changes outlined in the discussion document, it will be necessary to introduce complementary domestic tax base protection measures to ensure that only offshore active income is exempted. For example, if active foreign income becomes exempt from New Zealand tax, we would need to ensure that excessive interest is not deducted from New Zealand earned income
"We anticipate lively interest in the possible reform, and look forward to receiving submissions on the ideas canvassed in the discussion document. Submissions are due by 16 February 2007 and the government expects to be in a position to make decisions by the middle of next year," the Ministers said.
Mike Jaspers, press secretary for Dr Cullen, 04 471 9412, 021 270 9013
Ted Sheehan, press secretary for Peter Dunne, 04 470 6985, 021 638 920
1. What are the major changes for New Zealand's international tax rules contained in the discussion document?
The discussion document explores three key areas for change:
- Relaxation of the current controlled foreign company (CFC) rules by introducing an active income exemption. In broad terms, "active" income would include income derived from active business, such as manufacturing or industrial activity. In contrast, passive income, which includes investment-type income such as dividends, interest, rents and royalties, would continue to be taxed on an accrual basis.
- Related changes to other aspects of our international tax rules such as the interest allocation rules, to protect the New Zealand domestic tax base.
- Possible changes to New Zealand's tax treaty policy on non-resident withholding tax (NRWT) on dividends, interest and royalties.
2. What are these changes intended to achieve?
The possible changes outlined in the discussion document are aimed at improving New Zealand's international competitiveness. They would bring New Zealand's international tax system into line with international norms, recognising that there could be costs to being different. The tax system plays an important role in fostering a competitive business environment and, as such, is a key focus of the government's Economic Transformation agenda.
The changes are aimed at promoting an enabling environment that allows New Zealand firms to internationalise and makes New Zealand better able to attract and retain capital.
Controlled foreign company (CFC) rules
3. What are the CFC rules and how are our rules different?
New Zealand's current CFC rules are designed to tax all offshore income of CFCs as it accrues, with a credit for foreign taxes paid. This approach is out of step with international norms, where active income is generally exempt from tax or has tax deferred until it is returned in the form of dividends. Australia, for example, has an active income exemption in its CFC rules.
4. Who will benefit from the proposed exemption for offshore active income?
An exemption for the active income of CFCs would benefit New Zealand firms operating overseas by placing them on a more equal footing internationally. It would remove an additional tax cost not faced by firms based in comparable jurisdictions, such as Australia. These New Zealand firms would not only see a potential reduction in their tax burden, but a reduction in tax compliance costs would also be likely.
The example at the end of these questions and answers illustrates the benefits of such an exemption for a New Zealand firm with a manufacturing subsidiary in China.
5. How would the exemption for offshore active income improve New Zealand's international competitiveness?
An exemption for offshore active income would make New Zealand relatively more attractive as a location for global firms. As the current CFC rules are more comprehensive than those of other countries, New Zealand-resident firms with offshore operations may face a higher tax burden than firms resident in comparable jurisdictions, creating an incentive for New Zealand firms to migrate. An exemption for offshore active income would align New Zealand's rules with those of other countries, removing this factor as an incentive for firms to migrate, and would make New Zealand more attractive for foreign investment. It would also reduce the tax costs for New Zealand firms looking to expand their operations offshore.
6. What other changes to the international tax rules are likely to be necessary if offshore active income is exempt from New Zealand tax?
If offshore active income were exempt from New Zealand tax, consequential changes to the interest allocation rules would be necessary to protect the domestic tax base. The "grey list" exemption under the current CFC rules and the conduit rules might no longer be necessary if offshore active income were exempt from New Zealand tax.
7. What are the compliance cost implications for New Zealand firms?
CFC rules with an active/passive distinction could be simpler in operation than our current rules for the types of firms and activities the change would seek to benefit. A firm with genuinely active operations abroad would no longer face the compliance costs of applying New Zealand tax rules to its foreign operations that exist under the current CFC rules. If dividends could be exempted, the firm would not need to comply with the dividend withholding payment rules.
The one area of extra complexity could be the extension of our interest allocation rules, which would be necessary to target the exemption appropriately. However, these rules should affect only those firms that over-allocate their global interest costs against their New Zealand income. In addition, these rules would rely on domestically available information, and should be reasonably straightforward to apply.
8. How would the new rules compare with Australia's?
Changes canvassed in the discussion document would bring our CFC rules more in line with international norms and Australia's system of taxing offshore income. However, the design of the New Zealand system would need to reflect the realities of our business environment and other features of our tax system.
9. When will the government make decisions on the possible changes?
The government recognises the importance of CFC reform for New Zealand-based firms with offshore CFC investment. Once submissions have been received and analysed, the government expects to be in a position to make decisions on the options by mid-2007.
Non-resident withholding tax (NRWT)
10. How would lower NRWT rates benefit New Zealand firms?
Lower treaty rates of NRWT would encourage inward investment. This would complement a lowering of the company rate from 33% to 30%, one of the options set out in the recent Business Tax Review discussion document.
Lower treaty rates of NRWT would also benefit New Zealand firms investing offshore, because they would enjoy lower rates of foreign withholding tax. This would increase after-tax returns from outbound investment, consistent with the International Tax Review's focus on international competitiveness.
11. Why is the case for reducing NRWT on dividends stronger for direct investment than for portfolio investment?
The international trend is to reduce rates on non-portfolio dividends. For example, Australia has agreed lower rates on such dividends with the United States and the United Kingdom, amongst others. Lower treaty limits on portfolio dividends are less common internationally. The OECD continues to recommend NRWT of 15% on such dividends, which is consistent with New Zealand's current treaty policy.
12. Why might reduced rates on interest and royalties not be justified?
There are likely to be material fiscal costs and avoidance implications. These may outweigh any benefits associated with lower rates.
13. Why rely on double tax agreements? Why not just reduce rates in domestic law?
Reducing rates of NRWT makes sense only if done through bilateral treaty negotiations because of the potential benefits of agreeing reciprocal changes with our major trading partners, which will benefit New Zealanders investing offshore.
Example – Impact of an active income exemption
The move to an active income exemption under New Zealand CFC rules would be a significant policy shift designed to benefit New Zealand firms with outbound investments.
Consider a New Zealand company, NZ Co, with a manufacturing subsidiary in China, China Co, which earns a net income of $100. Under China's foreign enterprise income tax, special reductions in tax rates are provided in the first years after an investment is made. This income is fully exempt in the first and second profitable years, and a fifteen percent rate of tax applies in the third, fourth and fifth years.
If China Co is in its first year of operation in China and is fully exempt from tax in China, NZ Co would still be subject to tax on that income in New Zealand under the current CFC rules. A company like NZ Co would be taxable in New Zealand on its global profits of $100, and would pay $33 in tax. On the other hand, if the foreign income were taxed in China at 15%, New Zealand would provide tax credits for any taxes paid in China. The total tax that the NZ Co faces would still have been $33 in total, but $15 would be paid to China and $18 to New Zealand.
If there were an active income exemption, New Zealand firms would be able to benefit from any tax exemption or reduced tax rate that China offers. The income of China Co would not be taxable in New Zealand. Taxes payable in New Zealand would be eliminated, and the net returns to New Zealand investors would increase correspondingly. This treatment would be consistent with other countries' treatment of offshore active income and would remove the current incentive for New Zealand firms to migrate to other countries to gain access to the reduced taxation.
|Current rules||With active income exemption|
|Foreign income exempt in China||Foreign income taxed at 15% in China||Foreign income exempt in China||Foreign income taxed at 15% in China|
|New Zealand tax at 33%||$33||$33||$0||$0|
|Credits for foreign taxes paid||$0||$15||$0||$0|
|Tax payable in China||$0||$15||$0||>$15|
|New Zealand tax payable||$33||$18||$0||$0|
|Returns to NZ investors||$67||$67||$100||$85|