The taxation implications of company law reform
A discussion document
Chapter 5: Miscellaneous Issues
This chapter covers aspects of company law reform with tax implications which have not already been specifically addressed:
- capital structure: abolition of nominal and par value;
- use of new measurement of company ownership rules to replace obsolete company law concepts;
- revising associated persons and company control definitions to accommodate company law changes;
- substituting the closely-held company definition for private and proprietary company definitions;
- providing for references to both the new and old Companies Acts during the transition period;
- the effect of companies having only one shareholder or one share;
- replacing memoranda and articles of association references in the Revenue Acts with the term "constitution";
- other terminology changes; and
- the Commissioner of Inland Revenue's preferred creditor status.
5.2 Capital Structure: Abolition of Nominal and Par Value
The concepts of "par value" and "nominal capital" (and also as a consequence the concept of "share premium") are abolished under the new Companies Act. This will mean that the capital structure and financial accounts of a company incorporated or registered under the new Act will be significantly simplified.
Par value and nominal capital had their origin in the capital maintenance rule, which required a company to retain assets equal to its capital for creditor and shareholder protection reasons. The concept of capital maintenance is superseded under the new Act by the solvency test.
Par value was intended to provide protection for existing shareholders against stock watering (i.e. reducing the value of shares) by the issue of shares below the value established at par. This protection, however, is not effective in circumstances where the shares are worth substantially more than par value. Section 47 of the new Act addresses the problem of stock watering by effectively requiring there to be adequate consideration paid on the issue of a company's shares. The board of directors is responsible for deciding the consideration for which a company's shares will be issued. Before issuing any shares the board must be satisfied that the consideration received for the shares is fair and reasonable to the company and to all existing shareholders. If the shares are to be issued other than for cash the board must determine the reasonable present cash value of the consideration.
Section 35 simply defines a share as personal property. This means that the new Act retains an essentially common law definition of a share. The Income Tax Act mainly relies on the common law understanding of what is and what is not a share (with the exception of section 192 and 195 debentures, which are deemed to be shares for Income Tax Act purposes).
There are various provisions in the Revenue Acts which use the terms nominal value, nominal capital or par value. As these terms are obsolete under the new Act, references to them will be replaced. These references are listed in Annex 5.1.
The terms nominal value, nominal capital and par value are mainly used in the various Revenue Acts to measure shareholders' interests in companies. It will be possible to replace these terms with the voting and market value interest concepts used in sections 8A to 8D of the Income Tax Act. Such a change of terminology can have effect from date of enactment and therefore can apply to companies incorporated under either the Companies Act 1955 or the new Companies Act.
5.3 Measurement of Shareholder Interests
In addition to replacing such terms as nominal capital, nominal value and par value, the measurement of shareholder interest rules in section 8A to 8D of the Income Tax Act can also be used to replace references to issued capital, paid-up capital (where this term is not used for distribution purposes) and shares generally where those terms are used as a measurement of company ownership. Those rules are not dependent on the existing terminology of the Companies Act and can therefore be applied more generally in the Income Tax Act.
The company control definition in section 7 of the Income Tax Act and the various associated persons definitions are the main areas where the voting and market value interest concepts will be applied.
5.3.1 Associated Persons and Company Control Definitions
As noted above, it is proposed that the company control definition (section 7) and the various associated persons definitions in the Revenue Acts be amended to employ the measurement of shareholder interests rules contained in sections 8A to 8D. Under these rules shareholders' economic interests in a company will generally be measured by reference to their voting interests in that company. In certain limited circumstances, shareholders' interests may need to be determined by reference to both their voting interests and market value interests in the company.
Section 7 provides a standard company control definition which is used throughout the Income Tax Act (i.e. there is no multiplicity of definitions as there is with associated persons). By contrast, in addition to the general associated persons definition in section 8, there are currently four other associated persons definitions which apply only for the purposes of certain provisions in the Income Tax Act. They appear in:
- section 67 - tax treatment of profits and gains from land transactions;
- section 166 - notional interest on loans made to employees under an employee share repurchase scheme;
- section 214E - associated persons definition for the petroleum mining regime (sections 214D to 214N). (This definition is also used for section 74 purposes, where in the case of timber sold to an associated person of the seller the seller's deduction for the cost of the timber is limited to the amount of the profit or gain derived by the seller);
- section 245B - for purposes of the CFC and FIF regimes in Part IVA of the Income Tax Act. (For example, control interests held by associated persons are aggregated for the purposes of determining whether a foreign company is a CFC).
Each of these definitions also requires amendment to employ the new measurement of shareholders' interests. Similarly, it is proposed to amend the associated persons definition in section 2 of the GST Act.
The corporate and nominee look-through rules in existing section 8(2) are inadequate as they only refer to paid-up capital and not nominal capital, even though the latter is also used in section 8(1)(b) as a measure for determining whether a company and any individual are associated persons. The use of voting interest/market value interest tests in the recast section 8 will address this shortcoming.
5.4 Abolition of Private and Public Company Distinction
The new Companies Act does not retain the current distinction between private and public companies, which in effect distinguishes between closely-held and widely-held companies. It is not considered necessary to have a separate regime for closely-held companies in the new Act. The flexibility typically provided by such a regime, such as less formality in management and shareholder decision-making, can be achieved under the new Act by a particular company's constitution providing that various presumptions in the new Act will not apply to that company.
Tax references to the existing Companies Act private company definition are listed in Annex 5.2.
The use of the private/public company classification in certain Income Tax Act provisions recognises the desirability of distinguishing between closely-held and widely-held companies in certain situations for tax purposes. In light of the absence of a closely/widely-held company distinction in the new Companies Act, those Income Tax Act provisions which currently refer to a private company could use the closely-held company definition contained in section 8B of the Income Tax Act. This would have the advantage of reducing the number of similar definitions.
However, there are distinctions between the definitions. While a private company can currently have between 2 and 25 shareholders, there is no associated persons rule whereby associated shareholders are treated as one person. A closely-held company, as defined in section 8B, is a company in which five or fewer shareholders (with associated shareholders such as relatives being treated as one person) have in total over 50 percent of the direct voting interests (or direct market value interests where a market value circumstance exists). After receiving submissions the Government will determine whether its goal of applying a single definition in all circumstances is the best approach.
While the closely-held company concept is embodied in various provisions in the Income Tax Act through the use of private company and proprietary company terms, there is no similar need for a widely-held company concept to replace the term "public company" outside of the shareholder continuity provisions.
The term public company is used only once in the Income Tax Act, in section 147. This reference can remain as it is defined separately from the Companies Act 1955 and relies currently on the definition of the private company. In short, a public company for section 147 purposes will generally be defined as any company which is not a closely-held company.
There is a reference to a public company, within the meaning of the Companies Act 1955, in section 35 of the Inland Revenue Department Act 1974 relating to the treatment of evidence in Taxation Review Authority proceedings. It is proposed to replace the public company references in this provision with a reference to the widely-held company definition in section 8B of the Income Tax Act.
5.5 Proprietary Companies
In light of the removal of the private company references in the Income Tax Act, it is appropriate to review the proprietary company definition in section 2 of that Act. That definition also embodies a closely-held company concept of a company with a small number of associated shareholders and where ownership and management are often by the same persons. The proprietary company definition is utilised in various provisions which recognise that transactions between such companies and their shareholders (including persons associated with these shareholders) are more likely than in the case of other companies to be governed by other than arm's length considerations.
A proprietary company is defined generally as a company under the control of not more than four persons. Provisions in the Income Tax Act which use the proprietary company definition and the closely held concept that it embodies are set out in Annex 5.3. As discussed in the private company section of this chapter, the closely-held company concept is now also embodied in the appropriately named "closely-held company" definition in section 8B of the Income Tax Act.
It would be desirable if the Income Tax Act could employ a single, general closely-held company definition. Accordingly, it is proposed that the existing proprietary company references in the Income Tax Act also be replaced with the section 8B closely-held company definition.
5.6 Companies Act References
Sections of the Revenue Acts which refer to the Companies Act 1955 are listed in Annex 5.4. This does not include Income Tax Act references which are used only for the purpose of defining a private company and which will therefore be omitted when private company references are removed.
Immediate replacement of all Companies Act 1955 references with Companies Act 1993 references will not be possible because during the three year transition period following the enactment of the new Companies Act there will continue to exist companies incorporated under the 1955 Act, which will not be repealed until the end of the transition period. Therefore, until the expiration of the transition period there will have to be references in the Revenue Acts to both Companies Acts.
5.7 One Shareholder/One Share Companies
It is possible under the new Companies Act for a company to have only one shareholder and/or one share. Under the present law a company must have a plurality of shareholders and shares (i.e. at least two of each).
Many provisions in the Revenue Acts referring to shares or shareholders are predicated on the basis that a company must have a plurality of shares and shareholders and accordingly use words importing the plural number. The advent of one shareholder/one share companies should not, however, be problematical. Section 4 of the Acts Interpretation Act 1924, relating to the general interpretation of terms used in New Zealand statutes (unless inconsistent with the express provisions or context of an Act), provides that words and statutes importing the plural number are to include the singular number.
Consequential amendments to the Revenue Acts to take account of the possibility of one shareholder/one share companies will therefore not be necessary.
5.8 Company Constitutions: Abolition of Memoranda and Articles of Association
A company's constitutional arrangements under the new Act will no longer be governed by a separate memorandum of association (containing the objects of the company and the amount of its authorised share capital) and articles of association (providing for the company's internal government). Instead, each company will have a constitution.
The absence of memorandum of association and articles of association terminology in the new Companies Act will involve little change to the Revenue Acts as they already typically use the generic term "constitution". For example, the term is employed in section 394B(2)(c) and the measurement of company ownership provisions in sections 8A to 8D. The few references to "memorandum of association" and "articles of association" in the Revenue Acts (listed in Annex 5.5) can be immediately replaced with the analogous term constitution.
5.9 Other Terminology Changes
5.9.1 Change from Allotment/Allotted to Issue/lssued
The new Companies Act refers to shares being issued by a company and the issued shares. This is a change from the language used in the current Companies Act, which refers to the allotment of shares by a company and the allotted shares.
The Income Tax Act currently uses both types of terms (i.e. allotment/allotted and issue/issued) in relation to shares. It would therefore be sensible for reasons of conformity with the new Companies legislation and the standardisation of terms within the Income Tax Act itself to change the allotment/allotted references in the Income Tax Act to the terms "issue" or "issued". In those sections where allotment/allotted is used in tandem with issue/issued, the allotment/allotted references merely need to be omitted. The Income Tax Act sections which currently use allotment/allotted terminology are listed in Annex 5.6.
As the allotment/allotted and issue/issued references, in relation to shares, have exactly the same meaning, it will be possible to change these terms from the date of enactment of the taxation legislation.
5.9.2 Change from Wound Up/Winding Up to Liquidated/Liquidation
The rules for ending the life of a company have been greatly simplified in the new Act. Partly because of this simplification the following terms used in the Companies Act 1955 - "winding up", "voluntary winding up", "dissolution", and "striking off" - have been able to be dispensed with and replaced simply with the concepts of liquidation and removal from the register in the Companies Act 1993.
The term "liquidation" describes the process under which a company's assets are liquidated. The removal from the register of companies (equivalent to dissolution under the Companies Act 1955) is the final step on the liquidation of a company. Removal from the register can also constitute the entire process of ending a company's life in its own right (i.e. a prior liquidation process may not be necessary).
It should be noted that where the grounds for the removal from the register are that the Registrar is satisfied that the company is defunct, or the director or shareholders of an insolvent company have applied for it to be removed, notice must be given to the Commissioner of Inland Revenue. This notice allows the Commissioner to object to a company being removed from the register where there is outstanding tax owing by the company.
The Income Tax Act currently uses the terms winding up or wound up to describe the process of ending a company's life. Winding up is defined in section 2 of the Income Tax Act as including the final dissolution of a company. In order to achieve conformity with the new terminology in the new Companies Act relating to the termination of a company's existence the current Revenue Act references to the terms winding up or wound up (listed in Annex 5.7) should be changed to liquidation or liquidated. This change can apply from the date of enactment. The term liquidation should be defined in section 2 of the Income Tax Act as including the removal of a company from the register of companies under the new Companies Act or a dissolution under the Companies Act 1955. The reference to dissolution under the Companies Act 1955 can be deleted at the end of the three-year transition period. As with the term liquidation, winding up refers to the process by which a company's life is ended. Dissolution is the final step in the winding up of a company.
5.10 Commissioner's Status as Preferred Creditor
Section 312 of the new Companies Act provides that a liquidator, after meeting the claims of secured creditors (other than the claims of debenture holders under any floating charge), must pay out of the assets of the company the preferential claims set out in the Seventh Schedule of the new Act.
Clause 2(d) of the Seventh Schedule refers to amounts deducted by the company from the wages or salary of an employee in order to satisfy obligations of the employee. The total sum to which priority can be given under section 2(d) is limited by section 6 of the seventh schedule to $6,000 in the case of any one employee. This section is widely drafted and could include PAYE liability. The Commissioner would, however, rely on his specific priority under clause 5 in respect of this liability.
Clause 2(e) of the Seventh Schedule includes any amounts relating to child support which are required to be deducted from an employee's wages or salary by a company and paid to the Commissioner of Inland Revenue in accordance with the Child Support Act 1991.
Clause 5 of the Seventh Schedule gives the Commissioner of Inland Revenue preferred creditor status in respect of:
- source deduction payments under Part XI of the Income Tax Act (this specifically includes PAYE obligations without any limit as to the amount to which priority is given);
- non-resident withholding tax deductions;
- resident withholding tax deductions.
Clause 9 of the Seventh Schedule provides that after a liquidator's or receiver's expenses are met all other preferential claims rank equally and if a company's assets are insufficient to meet them the debts abate and are paid in equal proportions.
Clause 9 also provides that preferential debts are paid in priority to the claims of holders of debentures under any floating charge. If the assets available for payment of general creditors are insufficient to satisfy preferential debts, then the shortfall can be taken from assets which are subject to a floating charge.
The existing preferential creditor status of the Commissioner is unchanged by Clause 5 of the Seventh Schedule, which specifically states the nature and extent of the Commissioner's priority. The Commissioner's preferred creditor status is not specifically referred to in section 308 of the Companies Act 1955 (the equivalent provision to section 312); instead, this status is "imported" by specific provisions in the GST Act (section 42) and the Income Tax Act (section 365(2)(b)). It is proposed to amend these preferred creditor provisions in the Revenue Acts so that they contain cross-references to the Seventh Schedule to the new Companies Act.
5.11 Summary of Proposals
The proposals in this chapter are that:
- The current references in the Revenue Acts to nominal capital, nominal value, par value, issued capital, paid-up capital and shares generally - where those terms are used to measure shareholders' interests in companies - be replaced with the concepts of voting interest and market value interest contained in the measurement of company ownership rules in sections 8A - 8D of the Income Tax Act.
- The Income Tax Act employ a single, general closely-held company definition (outside the qualifying company regime) which would be substituted for the current private company and proprietary company references in the Income Tax Act.
- The public company reference in section 35 of the Inland Revenue Department Act 1974 be replaced with a reference to the widely-held company definition in section 8B of the Income Tax Act.
- Other existing company law references in the Inland Revenue Acts identified in Annexes 5.4 to 5.7 be amended to align the Revenue Acts with the new definitions and concepts used in the Companies Act 1993.