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Explanatory notes to the draft legislation

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New Zealand Government coat of arms in blue

The taxation implications of company law reform

A discussion document

December 1993


Explanatory notes to the draft legislation

The following notes provide an explanation of the proposed amendments to the Income Tax Act. In the interests of brevity, the commentary is confined to amendments that are considered to be significant and complex and that are not described in detail in the discussion document. The commentary should be regarded as a guide only, and it does not, for interpretation purposes, override the actual words used in the legislation.

Section 3(1)

The definition of "bonus issue" will be amended to reflect the absence of a company law concept of capitalisation.

The definition of "non-taxable bonus issue" will be retained, but will in future be synonymous with a share split.

The term "ten year bonus issue" will be repealed. Amounts bonus issued between 31 March 1982 and 1 October 1988 which have served their time or which are paid up after 20 August 1985 and sourced from capital gain amounts and qualifying share premium are credited to subscribed capital (see item i(i) of "Transitional capital amount" in section 4A(3)).

Section 3(2)

Section 3(2) will be repealed as "subscribed capital" is not reduced where losses are written off. The provision is therefore unnecessary.

Section 3(3)

Section 3(3) will also be repealed. The replacement subsection provides a mechanism for determining for tax purposes how much is converted to subscribed capital by a taxable bonus issue (other than a bonus issue in lieu). This is required because there is no longer a distinction between the types of reserves for company law purposes and therefore no external reference point for determining the amount bonus issued. The amount credited to subscribed capital is the amount which the company elects is bonus issued (by notifying the Commissioner). The amount of dividend arising on a taxable bonus issue is the amount per share that the company so elects (section 4(6)). The provision only applies to New Zealand resident companies.

Section 4(1) and (3)

It appears that there is no reason for the specific inclusion of "specified payments" in section 4(1)(a). "Specified payments" are defined in sections 4(3) and 4A(2) as (in effect) share premium. Distributions of share premium in cash appear to be covered in the general category "all sums in money" in paragraph (a). The proposed deletion of this term does not reflect any change in policy in relation to distributions of share premium.

Section 4(1)(g)

This paragraph has been redrafted to make it clear that amounts paid to shareholders on the acquisition by a company of its shares are included in the dividend definition (to the extent that they are not excluded under section 4A).

Section 4(7A)

New subsection (7A) reverses the tax effect of a distribution which is subsequently recovered by an insolvent company. The provision operates on the assumption that the net dividend (that is, the dividend less any resident withholding tax or non-resident withholding tax) will be recovered from the shareholder. The RWT or NRWT will be refunded by the Commissioner directly to the company.

Section 4(12)

The Government is concerned that companies, rather than purchase their own shares, will arrange for related companies to acquire those shares in order to avoid the dividend consequences that attach to the repurchase of shares. Such arrangements are likely to be caught by section 99(5). However, section 99(5) does not adequately deal with the tax consequences of an on-market repurchase.

Accordingly, section 4(12) will clarify how section 99(5) will apply in such circumstances. Where a company arranges for a related company to purchase shares in substitution for an on-market buy back, section 4(12) in effect provides that a debit will arise to the imputation credit account of the company that issued the shares.

Section 4(15)

Section 4(15) will be amended to provide that where a person holds shares on revenue account, and sells those shares off-market to the company, the shareholder is taxed on the profit on sale only to the extent it exceeds the dividend (exclusive of imputation credits) arising on the sale.

Section 4A(1)(c)

The new section 4A(1)(c) excludes from the dividend definition, if the conditions set out in subparagraphs (i) to (iv) are satisfied, amounts returned to shareholders when a company repurchases, redeems or cancels its shares (other than on liquidation) up to the amount of subscribed capital and realised capital gain per share.


This subparagraph contains the "brightline tests" discussed in section 2.4.4 of the discussion document.

Subparagraph (ii)

The brightline tests do not apply to fixed rate shares. The subscribed capital will be tax-free on redemption of such a share (assuming the anti-dividend substitution provisions in subparagraphs (ii) and (iii) do not apply).

Subparagraph (iii)

This subparagraph contains a redraft of the current anti-dividend substitution provision.

Subparagraph (iv)

This provision contains the "slice rule" described in sections 2.3.1 and 2.4.3 of the discussion document.

Section 4A(1)(ca)

This paragraph excludes from the dividend definition amounts returned to shareholders when the company's shares are redeemed or cancelled upon its liquidation. The exclusion is limited to the aggregate of the subscribed capital per share and realised and unrealised capital gains per share.

Section 4A(1)(cb)

This paragraph excludes from the dividend definition amounts returned to shareholders when a company repurchases its shares on the stock market. Such amounts are treated as dividends only for the purposes of:

  • requiring that a debit arises to the repurchasing company's imputation credit account in relation to the dividend component of a distribution;
  • enabling section 99(5) to apply (in the circumstances where it can apply) where there is an on-market acquisition;
  • the recovery of dividend provisions in section 4(7A).

Section 4A(1)(h)

Paragraph (h) will be repealed because losses written off will not affect a company's "subscribed capital amount" (defined in new section 4A(3)).

Section 4A(3)

A new section 4A(3) will replace the current provision. It will contain definitions of new terms to be used in section 4A as well as amended definitions of terms currently in use. The terms used are in relation to a single share.

"Excess return amount”

This formula is used in section 4A(1)(c) and (ca). It distinguishes between realised capital gains (item d) that may be distributed tax free on a cancellation or repurchase of shares, and unrealised capital gains (item e) which are available for tax free distribution only on liquidation.

The formula spreads such gains across all shares of the company, other than fixed rate shares.

Paragraph (ii) of the present item e has been broadened to align that paragraph with section 4A(11).

"Fixed rate share"

Fixed rate shares are essentially shares in respect of which the rate of dividends paid is not commensurate with the company's profits. The definition in this subsection is similar to the definition of that term in sections 8B and 63(2D). It has a further requirement that there be no shareholder decision-making rights available to the holder of the shares except in very limited circumstances.

"Fully credited"

This term is used in the definition of "subscribed capital amount" (item f(iv)) and discussed in section 4.2.5 of the discussion document.

The calculation of the subscribed capital amount of a share excludes:

  • taxable bonus issues made to shareholders who are exempt from tax under section 63; and
  • consideration received by a company on the issue of shares which is attributable to the payment by the company of a dividend exempt to those shareholders.

The exclusion applies except to the extent to which the taxable bonus issue or the dividend is fully credited.

"Fully credited" in relation to a dividend thus refers to that proportion of a dividend which is credited with imputation or withholding payment credits at the maximum imputation ratio.

"Ineligible capital amount"

This concept is the "anti-avoidance" provision referred to in section 4.2.6 of the discussion document. The term is used in the definition of subscribed capital amount (item f(vi)). It is intended to prevent the inflation of the subscribed capital of an acquired company in anticipation of a share swap.

"Subscribed capital amount"

The subscribed capital amount is a new concept which refers in essence to consideration received by a company on the issue of its shares. Its relevance is in determining the amount that can be distributed tax-free to shareholders under section 4A(1)(c) and (ca) described above. The predecessors of the subscribed capital amount are the current "returned capital amount" and "returned share premium amount" which effectively compute the subscribed capital per share based on an overall average of shares ever issued of the same class.

It is considered that the current returned capital amount computation will be deficient in the context of the "slice rule" in that where less than market value is paid for a share the rule restricts the amount of subscribed capital that may be returned to shareholders. Accordingly, there is a need for a new concept of subscribed capital which is based on a "moving average". The "moving average" formula will in effect calculate subscribed capital attributable to shares on issue at any particular time.

Subscribed capital amount is thus the aggregate of:-

  • for a company that was in existence before the application date, its "transitional capital amount" (see below); and
  • consideration received by a company on the issue (after the application date) of shares of the same class as the share being cancelled (subject to certain exclusions);


  • subscribed capital amounts which have previously been returned to shareholders on the cancellation of shares of that class on or after the application date and which have been treated as tax-free distributions under section 4A(1)(c).

The result of the above calculation is divided by the number of shares of the same class on issue immediately prior to the relevant cancellation.

It is important to note (see item f(vi) in the calculation) that the amounts making up the consideration received by a company on the issue of its shares do not include consideration in the form of shares in another company acquired by the company to the extent to which the value of those shares exceeds the subscribed capital amounts (after deducting the ineligible capital amounts ) in respect of such shares. Thus, if (for example) a company ("A Co") issues shares to a shareholder of another company ("B Co") in exchange for shares in B Co the subscribed capital amount of A Co increases only by the subscribed capital amount attributable to the shares acquired in B Co (calculated after deducting the ineligible capital amount).

"Transitional capital amount'

This term is only relevant to companies formed before the application date. As noted above, the calculation of the subscribed capital amount based on a moving average will require knowledge of amounts of subscribed capital paid up on shares of a class currently on issue. It was thought that it may be time consuming for companies to identify amounts of paid up capital returned to shareholders on shares previously cancelled.

Therefore, the simplest solution was to include in the subscribed capital amount calculation, a "transitional" amount which would relieve companies from having to identify those amounts. The transitional capital amount is thus simply an amount calculated by multiplying the outstanding shares in each class by the returned capital and share premium amounts determined under the current averaging formula.

Section 191WD

Corporate Amalgamations

Some corporate amalgamations qualify for particular taxation treatment under this section. The taxation treatment minimises administrative impediments to corporate restructuring through amalgamations by permitting, for example, tax-free asset transfers on amalgamation and preservation of accumulated losses and imputation credits for use by the amalgamated company. The provision also details the tax consequences for non-qualifying amalgamations.

Section 191WD(1)

This subsection contains a number of definitions relevant to the operation of section 191WD. It limits the particular taxation treatment to "qualifying amalgamations" occurring under the 1955 and 1993 Companies Acts. Each amalgamating company must be an "eligible company" (essentially resident in New Zealand and not exempt from income tax). Amalgamations between qualifying and non-qualifying companies are not qualifying amalgamations.

Section 191WD(2)

Amalgamating companies have up to 63 days from the date documentation evidencing the amalgamation is given to the Company Registrar for registration purposes to give notice of the amalgamation in writing to the Commissioner of Inland Revenue.

Section 191WD(3)

This subsection explains how to calculate the subscribed capital amount of shares issued in the amalgamated company. It has the same effect as item f(vi) in the definition of subscribed capital amount (a separate provision is included here as the term ineligible capital amount referred to in that item relates only to the acquisition of shares).

Except as discussed in relation to subsection (4), generally the subscribed capital amount of the amalgamating company becomes subscribed capital of the amalgamated company. However, a portion of the amalgamating company's subscribed capital may be ineligible to be attributed in this way. This restriction is intended to prevent an amalgamating company increasing the level of its subscribed capital in anticipation of amalgamation with another company, in order to inflate the amount which may be credited to subscribed capital of the amalgamated company. This provision is only triggered to the extent a shareholder in the amalgamating company receives cash or other liquid property for shares converted.

Section 191WD(4)

The effect of this subsection is to subtract the subscribed capital of shares held by an amalgamating company and cancelled upon an amalgamation from the subscribed capital of the amalgamated company. The subscribed capital attributable to the cancelled shares therefore does not form part of the subscribed capital of the amalgamated company.

Section 191WD(5)

The transfer of assets out of an amalgamating company may affect the market value of the shares held by an amalgamating company in that company. The cancellation of the shares and the issue of new shares in the amalgamated company in effect result merely in the gain or loss being transferred to the amalgamated company. Accordingly, this provision prevents that gain or loss from being taken into account by deeming the amalgamating shareholder company to have disposed of the shares at their opening book value (for shares purchased in prior years ) and at cost ( for newly acquired shares ).

Section 191WD(6)

This provision ensures the continuity of the liabilities and rights of an amalgamating company that ceases to exist after the amalgamation. For tax purposes, this ensures continuity of the amalgamating company's objection rights, loss election rights and rights to refunds.

Section 191WD(7)

Income received by the amalgamated company for the provision of services by an amalgamating company is treated as assessable in the recipient's hands if the income would have been assessable to the amalgamating company that provided the services.

Section 191WD(8)

Taxation consequences apply on the transfer of assets in a non-qualifying amalgamation. There is a deemed disposal at market value.

Section 191WD(9)

This subsection contains several provisions relating to the tax treatment of the asset transfers that occur from an amalgamating company to an amalgamated company.

First, it provides for the tax-free transfer of assets other than trading stock at the time of amalgamation. In determining the assessable income that may arise later to the amalgamated company in respect of these assets, the consolidation provisions in section 191N(1) to (4) apply with some modifications.

Second, the transfer of trading stock of the amalgamating company to trading stock of the amalgamated company is treated as a deemed disposal at opening book value (for trading stock on hand) and at cost ( for new acquisitions ). This prevents movements in the opening and closing values to the date of amalgamation being taken into account by the amalgamating company.

Third, it provides for tax to be payable where an asset is converted from revenue account to capital account on amalgamation. This provision ensures the tax-free treatment of asset transfers is not used to convert assets without taxation consequences.

Section 191WD(10)

This subsection provides for a deemed consideration for the base price calculation required on the transfer of a financial arrangement (of which the amalgamating company is the issuer) to an amalgamated company. In certain circumstances, for example, where the same method of allocating income or expenditure is used by both the amalgamating and amalgamated companies, the deemed consideration is one that results either in a nil allocation or a fair and reasonable allocation. Where a different method of allocation is used, the market price of the financial arrangement is taken into account. This provision is identical to the treatment of financial arrangements of which the amalgamating company is the holder.

Section 191WD(11)

An amalgamating company that ceases to exist may, subject to certain conditions, carry forward any accumulated loss, attributed foreign loss, foreign investment fund loss or tax credit into the amalgamated company. The amalgamated company is allowed to succeed to losses of an amalgamating company only if the shareholder continuity requirement is satisfied with respect to the amalgamating company after the amalgamation, and immediately prior to the amalgamation, offset of the losses of that amalgamating company was allowable against the income of all the other amalgamating companies.

Section 191WD(12)

This subsection provides an ordering rule for the offset of losses and the tax credits referred to in subsection (11) of two or more amalgamating companies against the future income or tax liability of the amalgamated company.

Section 191WD(13)

The liability of an amalgamated company to make provisional tax instalment payments after an amalgamation is based on the residual income tax of the preceding income year of each amalgamating company.

Section 191WD(14)

This subsection contains several provisions relating to debits and credits of an amalgamating company in its imputation credit account, dividend withholding payment account, branch equivalent tax account and policyholder credit account.

First it provides for the pre-amalgamation debits and credits to be treated with effect from the amalgamation as debits and credits of the amalgamated company provided the continuity of shareholding has been maintained.

Second, it provides the mechanism for posting any debits or credits of an amalgamating company that arise after the amalgamation to the equivalent accounts of the amalgamated company.

Finally, it mirrors the limits applying to refunds contained in sections 394M and 394ZO of the Act.

Section 327C(1)

Resident withholding tax on taxable bonus issues (except bonus issues in lieu) will be calculated under paragraph (c). For the purposes of item b of the formula, the dividend paid is the amount which the company elects to transfer to subscribed capital.

Paragraph (d) will be redrafted so that it applies only to a bonus issue in lieu.

Section 394E(1) and (2)

Where a company repurchases shares on-market, a debit arises to that company's imputation credit account. The formula for calculating the amount of the debit is contained in proposed new paragraph (1)(ab). The debit arises on the date of acquisition of the shares. The slice rule automatically applies in calculating the debit amount, i.e. the brightline tests do not apply in relation to an on-market repurchase.

Section 394ZW (1)

This section will be amended to remove the reference to refunds under section 394ZO. This is to accommodate a refund of dividend withholding payment arising on the recovery of a dividend distribution from a corporate shareholder by a non-resident insolvent company.

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