Chapter 10 – Imputation: Related Issues
10.1 Introduction
10.2 Dividend Definition
10.3 Section 190
10.4 Section 197
10.4 Winding Up Distribution Tax
10.5 Fringe Benefits Received by "Major Shareholders"
10.6 Excess Retention Tax
10.1 Introduction
10.1.1 This chapter outlines the Committee's recommendations on sundry other issues raised by the imputation reforms, including the definition of a dividend, the amendments to the fringe benefit tax regime and excess retention tax.
10.2 Dividend Definition
10.2.1 In paragraph 4.7.1 of our earlier report, we advised that we were considering amendments to the section 4 definition of a dividend. One possibility was the extension of the ambit of the present section 4(2) dealing with proprietary company dividends, to all companies. The desirability of doing so, however, is due more to the weaknesses of the proprietary company definition rather than to any perceived avoidance policies of non-proprietary companies. In section 10.6, we suggest that the proprietary company definition requires review and, pending that review, we do not propose that the present section 4(2) ambit be broadened.
10.2.2 One deficiency of the existing dividend definition is that the provision of benefits to shareholders other than by way of distributions or dispositions are not clearly within the definition. As benefits can be conferred upon shareholders in this way, we propose to include as dividends the making available of any company property for the benefit of any shareholder if in the opinion of the Commissioner the making available of the property is virtually a distribution of an amount which, if distributed other than in the course of winding-up of the company, would be a dividend. We also propose to extend the dividend definition to include any excessive consideration provided by a company upon the acquisition of property from a shareholder. The taxable value of the dividend in the first case would be the amount by which the value of the benefit or property acquired by a shareholder exceeds any consideration provided by the shareholder. In the second case, the taxable value of the dividend would be the amount by which the consideration provided by the company exceeds the market value of the property acquired by the company.
10.2.3 Since these changes would extend the existing definition of a dividend, it is reasonable that taxpayers should have some notice of them before they come into effect. Accordingly, the Committee proposes that they take effect from 1 October 1988.
10.2.4 At present, section 4(2) deems to be a dividend any expenditure incurred by a proprietary company for the benefit of a shareholder, spouse of the shareholder, trust under which the shareholder or his or her spouse is a beneficiary or any other person associated with the shareholder. In order that we do not restrict the definition of a dividend with respect to a proprietary company, we propose that the extended definition of a dividend outlined in the previous paragraph apply where the person acquiring or disposing of the property in question is an associate of a shareholder of a proprietary company. By "associate", we mean any of the persons listed in the present section 4(2).
10.2.5 The CD proposed a definition of the term "paid up capital" meaning capital which could be returned free of tax upon winding-up or redemption. In our draft definition of dividend, we have adopted an alternative to this. A new section 4 defines widely the types of transactions which are initially considered to be dividends. A new section 4A contains exclusions from the section 4 net, so that no definition of "paid up capital" is required. Since our redrafted definition, apart from the changes proposed in paragraph 10.2.2 (which we suggest come into effect from 1 October 1988), merely attempts to state more clearly the present definition, we consider that it should come into effect from the commencement of the present income year.
Recommendation
10.2.6 The Committee therefore recommends that the definition of a dividend be extended with effect from 1 October 1988 to include, with respect to any person who is a shareholder of a company or, where the company is a proprietary company, an associate of a shareholder:
a the value of any benefit or property provided by the company to the person to the extent that it exceeds any consideration provided by the person for the provision of the benefit or property; and
b consideration provided by the company upon the acquisition of property from the person to the extent that it exceeds the market value of the property acquired by the company.
10.3 Section 190
10.3.1 Section 190 of the Act permits the Commissioner to disallow a deduction to a proprietary company for remuneration paid to a director, a shareholder or a relative of those persons if the remuneration is considered unreasonably high. The disallowed amount is deemed to be a dividend paid to the recipient. Such arrangements may appear more attractive in the light of the Committee's recommendation that, due to uncertainties in the application of the deemed dividend provisions, such dividends be excluded from the credit allocation rules. Hence, the Committee proposes that section 190 be retained in amended form.
10.3.2 The proviso to section 190 has the effect that the section does not apply where the recipient of the remuneration is an adult employed substantially full time in the business of the company and participating in its administration and management, and the remuneration is not influenced by the fact that the recipient is a relative of a shareholder or director. Because of the ease with which the proviso can be invoked and the possibility of streaming arrangements being entered into, the Committee proposes that, with effect from the commencement of the 1990 income year, the proviso exemption be limited to persons who are residents. This would have the dual effect of limiting the use of remuneration as a means of avoiding the allocation rules and reinforcing one of the few interjurisdictional allocation rules presently in the Act.
Recommendation
10.3.3 Accordingly, the Committee recommends that the proviso to section 190 be amended, with effect from the commencement of the 1990 income year, to limit its application to resident recipients of remuneration.
10.4 Section 197
10.4.1 Section 197 relates to distributions of trading stock to shareholders as such, with distributions treated as a sale by the company and a purchase by the shareholder at market value. Section 197(3) makes it clear that the Commissioner's ability to deem the distribution to be a dividend under section 4 is not derogated by the deemed sale treatment under section 197(2).
10.4.2 The Consultative Document proposed the repeal of section 197 from the commencement of the 1989 income year. In our first report, we advised we were still considering this issue. The objective of the Act in regard to such distributions of trading stock is to place the company and the shareholder in the same position as each would be had the trading stock been sold to a third party and the profit distributed as a dividend.
10.4.3 Merely to treat the distribution as a dividend without deeming the distribution to be a sale does not achieve this result, as it leaves the company with a deduction by way of a lower closing stock figure. Hence it is necessary to deem the distribution to be a sale and for this reason we recommend the retention of section 197.
Recommendation
10.3.5 The Committee recommends that section 197 be retained.
10.4 Winding Up Distribution Tax
10.4.1 Winding up distribution tax ("WUDT") is designed to encourage the winding-up of companies which have ceased trading by levying tax at a concessional rate on taxable reserves distributed before 1 April 1989 in the course of and for the purpose of winding up. Winding up for this purpose includes a dissolution procedure provided for in section 335A of the Companies Act 1955. In our earlier report, we proposed that this should be a final tax. This means that non-resident withholding tax should not be levied on such distributions to non-residents, nor should any withholding payment be levied on such distributions received by companies upon the winding up of a non-resident company.
Recommendation
10.4.2 The Committee recommends that distributions which have been subject to the winding up distribution tax not be liable for either non-resident withholding tax or dividend withholding payment.
10.5 Fringe Benefits Received by "Major Shareholders"
10.5.1 The CD proposed that as from 1 April 1988 fringe benefits provided by a company to any shareholder/employee should be subject to fringe benefit tax. Fringe benefits received by "major shareholders" of private companies had previously been treated as dividends and were excluded from the fringe benefit tax regime.
10.5.2 The Committee accepts that retention of the major/minor shareholder employee distinction for FBT purposes is now redundant. We have become aware that, as we did not comment on this proposal in our first report, there is an expectation amongst many taxpayers and their advisers that we did not support the CD proposal. As this expectation can be attributed to an omission on our part to comment explicitly in our earlier report, we believe that a delay in the implementation date of the proposal is justified in respect of some but not all fringe benefits.
10.5.3 Most benefits, with the exception of loans at concessional rates, to major shareholders who are also employees are currently subject to a deemed dividend provision. In respect of such fringe benefits other than loans, we believe that taxpayers will not be prejudiced by a 1 April 1988 commencement date as proposed in the CD.
10.5.4 The existing provision applicable to loans at concessional rates to major shareholders who are also employees is not a very effective provision so that bringing such loans into the fringe benefit regime will be a substantial change of treatment. Ideally such change should have a prospective application date. Due to the confusion over whether the CD proposal was to be implemented, we propose that the application of FBT to concessional rate loans to major shareholders who are also employees be postponed to 1 October 1988. Such loans should remain subject to the deemed dividend provision before that date.
Recommendation
10.5.5 Accordingly, the Committee recommends that fringe benefits received by any shareholder who is an employee be subject to the FBT regime rather than the current deemed dividend provisions:
a in respect of fringe benefits other than loans, with effect from 1 April 1988; and
b in respect of loans, with effect from 1 October 1988.
10.6 Excess Retention Tax
10.6.1 The CD at paragraph 6.6 proposed the repeal of excess retention tax ("ERT") with effect from the commencement of the 1989 year. The CD noted that ERT has two objectives under the classical company tax system - first, to ensure that non-corporate taxpayers cannot defer personal tax liability on dividend income by holding shares through a company and, secondly, to reinforce the classical company tax system by requiring a minimum distribution of income each year. The CD suggested that, with the introduction of imputation,the reinforcement of the classical tax system was no longer relevant. In addition, it argued that there will be no incentive for a company to retain dividends which bear imputation credits and that, while privately controlled investment companies may still be used to defer shareholder tax liability on dividends without credits, that opportunity exists for all companies, not just privately controlled investment companies.
10.6.2 In our first imputation report, we noted at paragraph 2.4.8 that it might be necessary to retain ERT in order to ensure that credits are utilised by individual shareholders rather than held in a company which, together with the credits, is then sold. We believe that there would be a considerable incentive for credits to be trapped for this purpose. While our proposal, discussed in section 10.7, for a 75 percent commonality provision for carry-forward of credits goes some way to limit credit trap and sale opportunities, we believe it should be supplemented by retention of ERT. This will also limit the deferral opportunities such companies would provide in respect of uncredited dividends.
10.6.3 We noted in our first report that the ERT provisions have had little impact since the abolition of bonus issue tax and that they would need strengthening if ERT were to be retained. Accordingly, we recommend that non-taxable bonus issues made after 30 September 1988 be excluded from the calculation of dividends distributed by a privately controlled investment company for ERT purposes.
10.6.4 The Committee and the Inland Revenue Department have reservations about the effectiveness of the current definition of "privately controlled investment company" given the ease with which the definition of "proprietary company" may be avoided. This should be reviewed by the Department.
10.6.5 The Department has proposed that the current exemption from ERT for companies not having share capital should be repealed. We are not aware of the reason for the original exemption and, in the absence of any compelling reason for its retention, we recommend the repeal of the exemption with effect from the commencement of the 1990 income year.
Recommendation
10.6.2 The Committee recommends that:
a excess retention tax be retained;
b non-taxable bonus issues made after 30 September 1988 be excluded from the calculation of dividends distributed by a privately controlled investment company for the purposes of excess retention tax calculation; and
c the exemption from ERT for companies without share capital be repealed with effect from the 1990 income year.