Chapter 7 - The Taxation of Distributions
7.1 Introduction
7.2 Foreign Dividends
7.3 Assessable Distributions from Trusts
7.4 Relief for Branch-Equivalent Taxes
7.5 Foreign Tax Credits
7.6 Disguised Distributions
7.1 Introduction
To this point, this consultative document has outlined the treatment of foreign income earned by residents through non-resident companies and trusts that will be taxable on a current basis in New Zealand. This chapter outlines the proposed treatment of distributed income in residents' hands, whether in the form of dividends from non-resident companies or distributions from non-resident trusts.
7.2 Foreign Dividends
7.2.1 Dividends Received by Companies
All foreign dividends received by resident companies will continue to be exempt from tax with the exception of portfolio dividends. However, companies receiving non-portfolio dividends will be required to collect a withholding payment on behalf of shareholders.
Foreign portfolio dividends received by companies resident in New Zealand after the time of the Minister of Finance's Statement on 17 December 1987 will be included in assessable income. A credit will be allowed for foreign withholding taxes paid in respect of such dividends. Portfolio dividends will be defined as dividends received from a non-resident company in which the recipient company owns less than 10 percent of the paid-up share capital at the time that the dividends are received. A dividend will be deemed to be received when it is declared by the payer company.
7.2.2 Dividends Received by Individuals
Foreign dividends received by individuals who are residents of New Zealand will continue to be included in assessable income. Foreign withholding taxes levied on such dividends will continue to be creditable against a resident's New Zealand tax liability.
7.3 Assessable Distributions from Trusts
It is necessary to amend existing income tax rules with respect to distributions by non-resident trusts to beneficiaries who are residents of New Zealand. These amendments will make it clear that all distributions will be taxable in the hands of beneficiaries resident in New Zealand with the exception of distributions made from the capital of the trust.
7.3.1 Definition of a Distribution
In order to minimise opportunities for deferral of New Zealand tax, beneficiaries' income in respect of distributions received from non-resident trusts will be defined to include any amount which vests indefeasibly in a beneficiary, whether or not the beneficiary is entitled to enforce immediate payment of the amount. This definition of beneficiaries' income is consistent with the definition of trustee income of a non-resident trust set out in section 5.3.2 which excludes any income that vests indefeasibly in beneficiaries of the trust. This definition will be restricted to distributions from non-resident trusts. However, the extension of the definition to distributions from resident trusts will be considered in due course.
Distributions out of the capital of the trust will not be included in assessable income. For the purpose of these rules, distributions will be deemed to be made out of trust income unless the beneficiary can show that it represents distributions of the capital of the trust.
These rules will apply to distributions received and amounts that vest indefeasibly in beneficiaries after the time of the Minister of Finance's Statement on 17 December 1987.
7.3.2 Non-Resident Trusts That Became Resident Trusts
An opportunity to avoid New Zealand tax on distributions exists when a non-resident trust with accumulated funds appoints a resident trustee, thereby becoming a resident trust. Distributions from the accumulated funds of the trust to beneficiaries in New Zealand would not be subject to New Zealand tax.
Therefore, when a non-resident trust becomes a resident trust, the resident trustee will be assessable on the market value of the trust assets reduced by the value of the capital of the trust, being the original capital and any subsequent contributions, at historical cost.
7.4 Relief for Branch-Equivalent Taxes
As noted in section 5.2.1, relief for New Zealand tax is available for dividends or distributions paid from income that has been reported by a taxpayer on a branch-equivalent basis. This is provided by permitting a deduction for dividends or distributions to the extent that branch-equivalent income is earned in the year of distribution.
There will be no provision for relief from New Zealand tax for dividends or distributions from income that has been reported by a taxpayer on a comparative-value basis. This is because the payment of such dividends or distributions will reduce the value of a resident's interest in the non-resident company, thereby reducing the resident's income measured on a comparative-value basis.
7.5 Foreign Tax Credit
7.5.1 Dividends from Non-Resident Companies
Tax credits will be provided for foreign withholding taxes paid on portfolio dividends received by resident companies and dividends received by resident individuals in accordance with the provisions in Part VIII of the Income Tax Act.
Foreign non-portfolio dividends, while exempt in the hands of resident companies, will be assessable when distributed to individual shareholders. Certain foreign withholding taxes on dividends received by a resident company will be added to the company's imputation credit account and thereby flow through to individual shareholders. This is explained in greater detail in the consultative document on full imputation.
7.5.2 Distributions from Non-Resident Trusts
Foreign withholding taxes paid on assessable distributions received by resident beneficiaries from non-resident trusts will be creditable against New Zealand tax payable on such distributions.
Section 293 of the Income Tax Act currently permits a credit to be claimed against New Zealand tax payable by a beneficiary for foreign income taxes and withholding taxes paid in respect of the beneficiaries' income. This section will be amended to provide a tax credit for foreign withholding taxes only.
The credit for foreign withholding taxes paid on distributions to resident beneficiaries will be subject to conditions and limitations similar to those under the provisions of Part VIII of the Income Tax Act.
Where both exempt and assessable distributions are received, foreign withholding tax must be apportioned between them on a pro-rata basis.
7.6 Disguised Distributions
Dividends from non-resident companies or distributions from non-resident trusts received by a resident will be broadly defined to include benefits received directly or indirectly by the resident. Such benefits must be reported at market value.
Examples of benefits considered to be distributions or dividends include those enjoyed pursuant to loans to a resident shareholder or beneficiary at non-market interest rates, or property transferred or services performed for consideration that differs from market value. The value of the benefit in such circumstances will be the difference between market value of the arrangement and the actual value of any consideration paid or received by the resident shareholder or beneficiary to or from the non-resident entity.