Executive summary
Approved issuers are required to pay a 2 percent levy on interest paid to non-residents on certain securities. [6] This approved issuer levy (AIL) has been identified as a possible impediment to the development of New Zealand’s corporate bond market. This impediment could be reduced by modifying AIL so that a zero percent rate (as opposed to the usual 2 percent rate) applies on interest paid in respect of certain qualifying bonds. An issues paper has been prepared to consult on this option.
A zero rate of AIL on qualifying bonds would be preferred to the status quo if the benefits of increased bond market development outweigh the costs of increased fiscal risk and the compliance costs associated with the legislative change. The issues paper aims to gather sufficient information to assess whether the suggested changes will meet this test.
Adequacy statement
An adequacy statement will be provided on the final regulatory impact statement.
Status quo and problem
Well-developed domestic capital markets have an important role in relation to economic growth, as they provide increased access to finance for New Zealand firms, capture the benefits of finance arrangements in New Zealand, and encourage firms to remain in or move to New Zealand. Bond markets have a part to play in well developed capital markets, as a well-functioning bond market has a number of important signalling and support roles which affect the performance of the capital markets, and the wider financial system.
New Zealand’s overall financial system is patchy; a large, efficient and sound banking system sits alongside equity, venture capital and debt markets that in size, depth, liquidity and skill base are relatively underdeveloped. As at December 2008 the domestic bond market was the source of about 4 percent of all debt for non-financial businesses. The bulk of business debt was raised through domestic financial institutions (61 percent) and from offshore (26 percent from significant stakeholders and 9 percent from others).
New Zealand’s corporate bond market is a minor part of our financial system, but has experienced strong recent growth. Since 2005 the total value of corporate bonds on issue has increased from $12 billion dollars to $23 billion dollars.
The approved issuer levy (AIL) has been identified in forums such as the Jobs Summit as a possible tax impediment to the development of New Zealand’s corporate bond market. This is because AIL increases the cost of issuing bonds to non-residents. For example, a non-resident investor who requires a 10 percent return to buy bonds from a New Zealand company would require the company to pay an interest rate of 10.2 percent to ensure that the investor gets the required return after AIL is deducted.
The impact of AIL on the domestic bond market could be exacerbated by the fact that it is possible for companies to establish foreign branches and borrow through these branches without paying AIL or (as an alternative) non-resident withholding tax (NRWT). On the other hand, interest payments on bonds issued in the domestic market are subject to either AIL or NRWT. This means that issuing bonds on the domestic market may be discouraged relative to issuing bonds through an offshore branch or borrowing directly through domestic banks.
Objectives
The issues paper is focused on investigating the extent to which AIL and NRWT may hinder bond market development and how this impediment could be removed without undermining New Zealand’s ability to tax closely held debt (such as bank loans).
This tax focus is deliberate, as non-tax issues associated with the bond market are best considered through the Capital Market Development Taskforce, which is to produce a blueprint and action plan to develop New Zealand’s capital markets more generally.
Should submissions contribute non-tax suggestions for how to improve the performance of domestic capital markets we will advise Ministers on these and pass them on to the Capital Market Development Taskforce.
Alternative options
The simplest solution that would enhance the domestic bond market would be to have a zero rate of AIL apply on all debt instruments between unrelated persons. However this is likely to have a very large fiscal cost, both directly in terms of lost AIL revenues and indirectly in terms of lost corporate tax revenues to the extent that it may encourage domestic lending activity (particularly from banks) to shift offshore.
Another option of attempting to remove all the existing exemptions to NRWT was, for technical reasons, not considered feasible.
Preferred option
The impediment could be reduced by modifying AIL so that a zero percent rate (as opposed to the usual 2 percent rate) applies on interest paid in respect of certain qualifying bonds. This is preferred to the alternative options outlined above because it is better targeted at reducing the cost of issuing bonds in New Zealand and would involve less fiscal cost and risk.
An issues paper has been prepared to consult on this option. We are interested in feedback on the following points:
Should AIL apply at a rate of zero on qualifying bonds?
A zero rate of AIL on qualifying bonds would be preferred to the status quo if the benefits of increased bond market development outweigh the costs of increased fiscal risk and compliance costs associated with the legislative change. The issues paper aims to gather sufficient information to assess whether the suggested changes will meet this test.
To what extent would this affect bond issuance and the way that businesses raise funds?
A zero rate of AIL on qualifying bonds would make it marginally cheaper to issue bonds to non-residents. This could lead to further growth in issuance and a better-functioning New Zealand bond market as it would reduce the cost of foreign funds and increase the pool of potential investors.
It is difficult to gauge the extent to which a zero rate of AIL would lead to increased bond issuance. Many factors influence bond issuing decisions besides interest costs. These include a desire to secure larger or longer-term finance, maintain a good credit rating, or gain access to a larger pool or different set of investors.
Similarly, in many cases it may remain suitable to lend from a single party (or syndicate), issue new equity, or fund the investment out of retained earnings, for reasons other than the relative cost of funds.
Would this effect the decision to issue bonds offshore (as opposed to in New Zealand)?
It may be cheaper for firms to issue debt in offshore markets, regardless of the impact of AIL. Compared with the New Zealand bond market, offshore markets can sometimes provide access to more favourable exchange and interest rates, and to a larger pool of investors. This means that some corporates may continue to raise much of their debt offshore if AIL were zero-rated, rather than issue new bonds into the New Zealand market.
Which companies would make use of a zero rate of AIL for qualifying bonds?
It is anticipated that a zero rate of AIL could lead to large corporates and existing bond issuers issuing additional bonds in New Zealand. It would be less likely to prompt smaller corporates to issue bonds for the first-time, because of the high set-up costs of becoming a bond issuer.
How can the proposed tests and safeguards be improved?
The amount that a zero rate of AIL increases fiscal risk and compliance costs depends on the design of the suggested changes.
Designing the zero rate of AIL is not a straightforward exercise. To keep fiscal risks at a manageable level it needs to ensure that the full rate of NRWT or AIL still applies to interest paid on closely held debt. Otherwise, there could be an increased incentive for loans to be made directly from offshore (for example, by a foreign bank). In such cases, the margin earned on the loan would no longer be subject to New Zealand tax. This could pose a significant fiscal risk to New Zealand because of the importance of the banking sector to our corporate tax base.
Rather than requiring those making submissions to anticipate what level of risk is acceptable and how this risk can be managed, the issues paper outlines a specific suggestion for them to respond to. Submissions can then focus on how the suggested tests and safeguards could be improved to increase uptake and reduce uncertainty and compliance costs.
Implementation and review
The preferred option could be implemented in the next available tax bill. Administration of the new rate of AIL could be carried out by Inland Revenue in accordance with existing practices for administering the approved issuer levy and non-resident withholding tax.
If the preferred option is implemented, officials plan to monitor changes in bond market activity and discuss with market participants how well the new rules are working. Any necessary corrections or improvements could be included in a subsequent tax bill.
Consultation
Consultation will be conducted through public submissions and meetings with interested parties in accordance with the generic tax policy process. We expect to receive submissions from banks, large corporates, market participants and tax practitioners.
We would be interested to receive feedback on questions such as:
Should AIL apply at a rate of zero on qualifying bonds?
To what extent would this affect bond issuance and the way that businesses raise funds?
Would this affect the decision to issue bonds offshore (as opposed to in New Zealand)?
Which companies would make use of a zero rate of AIL for qualifying bonds?
How can the suggested tests and safeguards be improved?
6 If you pay interest to a non-resident lender and do not wish to deduct non-resident withholding tax (NRWT) from the interest payments, you have to apply to Inland Revenue to become an approved issuer. Instead of deducting NRWT, approved issuers must pay a 2% levy on the interest for those securities they register with Inland Revenue.