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Inland Revenue

Tax Policy

Chapter 4 – Treatment of Dividends

4.1 Corporate Recipient
4.2 Non-Corporate Recipient

4.1 Corporate Recipient

4.1.1 The CD distinguishes between "portfolio" and "non-portfolio" dividends received by a resident company from a non-resident company. Portfolio dividends are defined to be dividends received by a resident company from a non-resident company in which the resident owns less than 10 percent of the paid-up share capital. All other foreign dividends received by a resident company are defined to be non-portfolio dividends.

4.1.2 The CD proposes that portfolio dividends be assessable to companies in accordance with general international practice. Non-portfolio dividends are to be subject to a withholding payment system, as outlined in the Government Economic Statement of 17 December 1987. The withholding payment system does not come directly within the Committee's terms of reference but it is necessary to consider it in order to integrate the taxation of dividends with the taxation of undistributed income under the BE regime. The treatment of dividends received by a controlled company for the purposes of calculating BE income was discussed in section 2.5.

4.1.3 A number of submissions called for the retention of the existing dividend exemption for companies. Other submissions took the view that dividends should be assessable to a company only if credit were given for both foreign withholding tax and the underlying foreign company tax. A number of other countries have such a system in respect of non-portfolio dividends, including the United States, the United Kingdom and Australia. While credit for foreign taxes may be allowed at the corporate level, no country passes credits for foreign taxes through to non-corporate or individual shareholders. In this respect, the proposal to allow credits for non-resident dividend withholding tax to pass through to individuals under the New Zealand imputation system goes further, as far as we are aware, than any other country. Thus, all countries ultimately claw back credits given to companies for underlying foreign company tax. This is not surprising since the revenue consequences of permitting credits to flow through to individual shareholders could be substantial.

4.1.4 If credits for foreign taxes do not pass through to individual shareholders, they are allowed to them in effect as a deduction from assessable income. Under the proposed withholding payment system, the conversion to a deduction system will be advanced from the ultimate individual recipient to the first corporate recipient of a foreign dividend. This is very much the objective of the withholding payment system and it would be incompatible with it to allow the corporate dividend recipient a credit for underlying foreign company tax. Foreign tax credit systems are also extremely complex, as the United States and Canadian systems illustrate, and inherently arbitrary because of the practical difficulty of tracing foreign dividends through time and among different companies. The Committee therefore considers that it would not be feasible from a compliance or administrative point of view to introduce a foreign tax credit system for intercorporate dividends, at least in the current context.

4.1.5 Submissions also questioned the need for a separate withholding payment system for non-portfolio dividends. It would undoubtedly be simpler to make all foreign dividends assessable to a corporate recipient but this would not be consistent with a number of New Zealand's tax treaty obligations.

4.1.6 One of the differences between taxing such dividends and the proposed withholding payment system is that a company in tax loss receiving foreign dividends would not incur any tax liability if the dividends were assessable but would incur the withholding payment. This problem could be overcome by allowing a company in tax loss to offset the dividend against its loss. Thus, the loss would reduce by the amount of the gross dividend (i.e. the dividend received plus any foreign withholding tax), thereby extinguishing the withholding payment liability.

4.1.7 In order to avoid taxing foreign-source income twice, once as BE income and again on receipt, the CD proposes that, in calculating BE income, taxpayers be able to deduct any dividends received from the foreign company concerned. We consider that there are serious problems with this deduction system. For example, a company which had a BE loss in the year it received a dividend would obtain no relief from double taxation. There are potentially many timing differences between New Zealand's and other countries' tax rules which could lead to this result.

4.1.8 In order to avoid these problems, in principle a separate account needs to be kept of tax paid on BE income. When a resident receives a dividend from a controlled company, the tax (or withholding payment) liability on the dividend would be offset in whole or in part according to the balance of the tax paid in the special account. In practice, for resident companies, the Imputation Credit Account ("ICA") proposed for the imputation system can perform just this function so that a separate account is not necessary.

4.1.9 The Committee propose to detail its recommendations on the integration of the international, imputation and withholding payment regimes in Part 2 of this report and in our report on the imputation proposals.

4.2 Non-Corporate Recipient

4.2.1 For the same purpose of avoiding the double taxation of offshore income, it would be necessary to require individual and other non-corporate non-minor shareholders to keep the equivalent of an ICA. We will also report further on this aspect in Part 2 of this report and our report on full imputation.