Chapter 7 – Disclosure and Default Methods
7.1 Introduction
7.2 Disclosure: BE Regime
7.3 Disclosure: FIF Regime
7.4 Disclosure: Trusts
7.6 Default Methods
7.1 Introduction
7.1.1 The BE, FIF and trust regimes will be amongst the provisions of the Income Tax Act which are the most difficult for the Inland Revenue Department to administer. This is in part because of their relative complexity and in part because much of the information the Department will need to administer them will be found offshore and often in countries with which New Zealand has no tax treaty and hence no exchange of information agreement. Thus, in the first instance, the administration of the reforms will depend critically on the information which taxpayers provide to the Department. It follows that the information disclosure requirements, far from being a minor aspect, are central to the effective administration of the regimes. Considerable care needs to be given in deciding what information taxpayers should be required to disclose.
7.1.2 This is important not only for administration but also for satisfactory compliance with the regimes. Voluntary compliance is encouraged if taxpayers are required to disclose relevant information and if there are substantial penalties for non-disclosure. Disclosure needs, however, to be selective. Too much information may hinder administration and compliance as effectively as too little.
7.1.3 We commented briefly on the importance of the disclosure of information and appropriate penalties for non-disclosure in our first report. This chapter outlines the Committee's views in more detail. We also comment on the way in which alternative assessment provisions might operate where there is non-disclosure or insufficient information to apply the BE, FIF or trust regimes. You announced in the Government Economic Statement that the penalty provisions of the Act are to be reviewed and in the light of this we make no further comment on penalties. Special penalties for these regimes are not needed - the general provisions of the Act, strengthened as necessary, should be sufficient.
7.1.4 Section 245R of the draft legislation provides the Commissioner with a general power to require the disclosure of sufficient information to establish the nature of any interest a taxpayer has in a foreign entity, whether or not the entity is a CFC or a FIF, and to compute the taxpayer's attributed foreign income or loss. The disclosure requirements in relation to trusts are provided for in section 231 of the draft legislation.
7.2 Disclosure: BE Regime
7.2.1 In general, residents should be required to disclose their direct control interests in foreign companies and the direct control interests held by associated persons. Where a resident does not personally hold a direct interest in a CFC, he or she should not be required to disclose the interests held by associates unless they are non-resident.
7.2.2 In order to avoid requiring taxpayers to disclose interests in companies which are unlikely to be either CFCs or FIFs, exemptions from this general rule will be needed. For example, an exemption from any disclosure requirement could be given for minor interests in listed companies resident in grey list countries. Limiting the scope of any general disclosure provision in this manner would avoid duplication since disclosure of interests in such companies is required for the return of dividends.
7.2.3 Where a resident has a direct control interest in a CFC, his or her income interest in the CFC needs to be computed and disclosed. In addition, the person needs to disclose indirect interests held through that CFC or an associate of the CFC. Where an underlying foreign company becomes a CFC by virtue of the indirect control provisions, residents need to disclose their income interests in the underlying CFC.
7.2.4 Direct control interests held by persons in the capacity of a nominee should also be disclosed, though disclosure of such interests should also have been made by the principal. The nominee definition includes a person who, pursuant to an arrangement or understanding or otherwise, holds powers or rights on behalf of another person. The starting point in applying a provision such as this is to ask taxpayers to disclose such arrangements or understandings.
7.2.5 In addition to the disclosure of control interests held on any measurement day, disclosure should also be required of dispositions and changes in the capital structure of a CFC to support the "bed and breakfast" rules described in section 3.3 of chapter 3. The information disclosed would also assist in the application of section 65(2)(e) of the Act. Thus, taxpayers would be required to disclose (except where an exemption from disclosure applied):
a any interest in a foreign company disposed of before a quarterly measurement day and interests acquired in the same company within 183 days of the disposition;
b any acquisition of an interest in a foreign company before a quarterly measurement day and any disposition of an interest in the same company within 183 days of the acquisition; and
c any changes in the aggregate interests in a company before a measurement day to the extent to which they are reversed within 365 days.
7.2.6 As discussed in chapter 3, residents who have a control interest of 10 percent or more in a foreign company, whether a CFC or not, at any time during its accounting year should be required to disclose:
a their interests held on the balance date of the company and their disposals of such interests during the accounting year; and
b where a resident has a control interest of 10 percent or more in a CFC and that CFC has a control interest of 10 percent or more in another foreign company, the interests held by the CFC in that foreign company on its balance date and the disposals of such interests that the CFC makes during its accounting year.
Where appropriate, the disclosure requirements should apply to interests held, acquired or disposed of by persons associated with the taxpayer.
7.2.7 Where a person has an income interest of 10 percent or more in a CFC, the person should be required to provide a copy of the accounts of the CFC; details of the adjustments to accounting profit to arrive at the BE income of the CFC; the dividends received by the CFC; and the basis for calculating the person's attributed income or loss and tax credit claimed with respect to that CFC. A separate disclosure should be required in respect of each CFC in which a taxpayer has an interest in order to ensure compliance with the jurisdictional loss and tax credit limitation rules.
7.2.8 Where the aggregate income interests in a CFC of persons resident in New Zealand who hold income interests of 10 per cent or more in the CFC exceeds 100 percent, the names of persons who have those income interests should be disclosed to ensure that no more than 100 percent of an income interest in a CFC is taken into account in attributing BE income or BE losses.
7.2.9 A number of provisions of the draft legislation relate to arrangements or understandings between taxpayers. These cannot be effective unless the Department requires taxpayers, as a first step, to disclose the existence of such arrangements and understandings. Furthermore, as noted in chapter 3, taxpayers should be required to reconcile significant differences between their control and income interests in a CFC.
Recommendation
7.2.10 Accordingly, the Committee recommends that the Commissioner be given a general power to require the disclosure of sufficient information to establish the nature of any interest a taxpayer has in a foreign entity, whether or not the entity is a CFC, and to compute the taxpayer's attributed foreign income or loss.
7.3 Disclosure: FIF Regime
7.3.1 Interests disclosed under the provisions outlined above will include interests in FIFs that are companies. Where a company is resident or domiciled in a tax haven, it may be a FIF. Thus, taxpayers should be required to disclose interests held in tax haven entities and to compute their FIF income or loss. In order to determine whether a foreign company or a unit trust is a FIF, a taxpayer will need to consider the nature of the assets of the company, its residence for tax purposes, whether it receives a concessionary tax treatment in that country and its distribution policy. In some cases, it will be obvious that a foreign company will be a FIF and, in order to reduce compliance costs, the Commissioner could publish a list of such entities.
7.3.2 In addition, taxpayers should be required to disclose life insurance and superannuation policies issued by foreign companies or superannuation funds. Depending on their characteristics, some such policies will be interests in a FIF.
7.3.3 The basis upon which a taxpayer values an interest in a FIF should be disclosed and copies of any financial reports or equivalent information in respect of the FIF should accompany an income return. Section 245R of the draft legislation gives the Commissioner sufficient power to obtain the necessary information.
7.4 Disclosure: Trusts
7.4.1 The primary liability for tax on trustee income will fall on the trustee. Where a trustee is a resident, he or she should be required to disclose the name and address of the settlor of the trust and the names and addresses of beneficiaries who receive distributions or beneficiary income. Residents who have settled trusts on resident or non-resident trustees after 1 April 1988 should also be required to disclose the settlements and the name and address of the trustee(s). As outlined in chapter 6, the definition of a settlor and a settlement are both very broad.
7.4.2 Where a non-resident trustee fails to file a return or meet an obligation to pay New Zealand tax on trustee income, the resident settlor will be liable for the tax. In this event, the resident settlor should be required to provide the accounts of the trust and details of the calculation of its taxable income.
7.4.3 Settlors of trusts in existence on 1 April 1988 that were settled prior to 17 December 1987 should be required to disclose the settlement and the nature of any financial assistance outstanding to the trustees of the trust. In addition, they should disclose whether they have elected to have the trust treated as a "qualifying trust".
7.4.4 Beneficiaries should be required to disclose sufficient information to establish the appropriate basis for the taxation of any property or income of a trust that vests to them in any income year. Where such property or income represents beneficiary income or non-assessable or taxable distributions, the names and addresses of trustees of the trust should be provided. Sufficient information should also be required to support:
a the claiming of a credit for any foreign income or foreign withholding tax paid in respect of beneficiary income;
b that a distribution is a non-assessable distribution; and
c if the tax rate on a distribution is the transitional 10 per cent rate, evidence of either the trust having been wound up on or before 31 March 1989.
7.4.5 Where a person receives income from a trust, the Commissioner's existing powers of disclosure are sufficient. An additional general power of disclosure is required to permit the Commissioner to require disclosure from settlors. A provision to this effect is contained in section 231 of the draft legislation.
Recommendation
7.4.6 Accordingly, the Committee recommends that provision be included in the legislation to permit the Commissioner to require disclosure of information from residents who are settlors of trusts in existence on or after 1 April 1988.
7.5 Default Methods
7.5.1 Cases may arise where taxpayers are unable to obtain the information necessary to apply the BE regime. Alternatively, taxpayers may fail to disclose information requested by the Commissioner. The information necessary to apply the FIF regime will generally be much less than that required under the BE regime though circumstances may occur where market values of interests in FIFs may not be available from published data or from the fund itself. It will then be necessary to estimate market values or, where this is not feasible due to insufficient information, both the taxpayer and the Commissioner will need to resort to alternatives.
7.5.2 Where the primary basis of computing income could be applied by the taxpayer, failure to apply it would constitute evasion. As discussed, the disclosure provisions and associated penalties will encourage compliance. Nevertheless, the alternative methods should not produce a more favourable outcome.
7.5.3 The draft legislation contains a non-exhaustive list of methods that the Commissioner could apply to determine the income or loss of a taxpayer in respect of an interest in a CFC or FIF. In particular, the Commissioner could make an assessment of income or loss by:
a having regard to the accounts or other information of the CFC or FIF prepared for tax purposes (whether in New Zealand or any other country), or for creditors, shareholders or other persons having an economic relationship with the CFC or FIF;
b having regard to the BE or FIF income or loss of the CFC or FIF for a prior period and, where it is an amount of income, applying a presumed compound rate of increase of not less than 10 percent;
c having regard to the income of the CFC or FIF as reported in its financial accounts for a prior year and applying a presumed compound rate of increase of not less than 10 percent;
d imputing an appropriate rate of return, such as a government stock yield plus a margin, to the value of the interest at the commencement of the relevant period; or
e treating as attributed income or loss or FIF income or loss, as the case may be, any gain derived or loss incurred on disposal of the interests in question or any increase or reduction in the market value of the interest over the relevant period.
7.5.4 A default provision has also been included in the draft legislation to apply to the calculation of trustee income.
Recommendation
7.5.5 Accordingly, the Committee recommends that provision be included in the legislation for the calculation of the income or loss of a taxpayer where the taxpayer is unable to obtain sufficient information or where there is failure to disclose information.