Zero rate of AIL on qualifying bonds

(Clause 142)

Summary of proposed amendment

The Bill seeks to remove a potential tax barrier to non-resident investment in New Zealand corporate bonds. More specifically, the approved issuer levy would apply at a zero percent rate (as opposed to the usual 2 percent rate) on interest that is paid in respect of debt securities that satisfy a set of strict requirements designed to limit the zero rate to bonds that are widely held and issued in New Zealand and to guard against the fiscal risk of closely-held debt being packaged or reclassified so as to qualify for the zero rate.

The 2% rate of AIL will be retained and AIL will be considered to be paid when either the 2% rate, or the new nil rate applies. This ensures that a nil rate of non-resident withholding tax (NRWT) can still apply when the borrower and the lender are not associated.

Application date

The proposed changes would apply to interest payments made on or after the date the Bill is enacted. This means that the zero rate will be able to be used in respect of future interest payments on bonds which have been issued prior to the Bill being enacted.

Key features

The debt security must first comply with the existing AIL registration requirements in section 32M of the Tax Administration Act 1991 and section 86H of the Stamp and Cheque Duties Act 1971 to get the 2% rate of AIL.

The Bill proposes inserting a new section 86IB into of the Stamp and Cheque Duties Act 1971 which would set out the requirements that a registered security must meet to qualify for the zero rate of AIL. These are:

that the security is denominated in New Zealand dollars; and
that the security was offered to the public for the purposes of the securities Act 1978; and
that the security was not issued as a private placement; and
that the security is not an asset-backed security; and
that the registry and paying agent activities for the security are conducted through one or more fixed establishments in New Zealand; and
that the security is listed on an Exchange registered under the Securities market Act 1988 (i.e. the NZDX) or satisfies a widely-held test.

The widely-held test is outlined in new section 86IB(2). A bond needs to satisfy the widely-held test at, or before the time of the interest payment. This means that if the test has been satisfied on one previous occasion it is not necessary to re-apply the test a second time.

There are two parts to the widely-held test. Firstly, the securities must be held by at least 100 separate persons whom the issuer could not reasonably expect to be associated with the issuer or with one of the other 99 persons holding the bonds. The second part of the widely-held test is that no person or group of associated persons holds more than 10% of the value of the securities at the time the test is applied.

Regardless of whether they pay AIL at 2% or 0%, the approved issuer will generally need to continue to file an AIL return/payment slip by the 20th day of the month following the month in which an interest payment was made. This slip will now require the approved issuer to record the total amount of interest payments which have been zero-rated.

Background

New Zealand’s non-resident withholding tax (NRWT) and approved issuer levy (AIL) rules have been identified as a potential tax barrier to non-resident investment in New Zealand corporate bonds.

NRWT generally applies at a rate of 10% on interest payments made by a New Zealand borrower to a non-resident lender. However, in cases where the New Zealand borrower and the lender are unrelated, an approved issuer levy (AIL) of 2 percent can be paid as an alternative to paying NRWT.

The AIL and NRWT rules can increase the effective interest rate of bonds issued 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% to the investor and a further 0.2% to Inland Revenue, increasing the company’s cost of funds.

One way to remove the tax barrier to non-resident investment in bonds would be to have a zero rate of AIL apply on all debt instruments between unrelated persons. However, this would have very high fiscal cost. In addition to the foregone AIL revenues (about $62m a year), an unrestricted exemption could encourage some domestic lending activity to shift offshore. 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 because of the importance of the banking sector to New Zealand’s corporate tax base. This makes it critical to ensure that interest paid on closely-held debt (such as loans, syndicated loans and private placements) is excluded from any exemption.

Accordingly, the Bill limits the zero rate of AIL to bonds that meet a set of strict requirements designed to limit the zero rate to bonds that have been widely-held and issued in New Zealand and to guard against the risk of closely-held debt being packaged or reclassified so as to qualify for the zero rate.

Detailed analysis

In order to access the zero rate of AIL, the issuer of the security must register to pay AIL in the first place. The issuer of the security must be an approved issuer under section 32M of the Tax Administration Act 1991 and must have registered the security under section 86H of the Stamp and Cheque Duties Act 1971. This allows them to pay AIL at a rate of 2%.

The Bill amends section 86I of the Stamp and Cheque Duties Act so that AIL is considered to be paid when either the existing 2% rate is paid, or the new nil rate applies. When AIL is considered to be paid, a nil rate of non-resident withholding tax will apply under section RF 12 of the Income Tax Act so long as the borrower and lender are not associated and so long as the interest is not jointly derived with a New Zealand resident.

Regardless of whether they pay AIL at 2% or 0%, approved issuers will need to continue to file an AIL return/payment slip by the 20th day of the month following the month in which the interest payment was made. This slip will now require the approved issuer to record the total amount of interest payments which have been zero-rated. A person will not generally be able to get the zero rate of AIL in respect of any interest payments in which they fail to provide this information by the 20th day of the following month. However, there is scope for the Commissioner to provide a later deadline in a notice given to the approved issuer. Alternatively an approved issuer that is late at supplying this information would still be able to get a 2 percent rate of AIL (i.e. under section 86I(a)) if they pay AIL at a later date along with any interest and penalties.

The Bill proposes inserting a new section 86IB into the Stamp and Cheque Duties Act 1971 which would set out the requirements that a registered security must meet to qualify for the zero rate of AIL.

Issued in New Zealand

To qualify for the zero rate of AIL the bonds must be issued in New Zealand.

Bonds issued offshore do not contribute to the development of capital markets within New Zealand. The objective of the zero rate of AIL is to remove a potential obstacle to the further development of the New Zealand bond market (bonds issued in New Zealand and denominated in New Zealand dollars) as opposed to reducing taxes on foreign debt funding more generally.

The first requirement is that the securities are denominated in New Zealand dollars.

A supporting requirement is that the activities of the registrar and paying agent for the security are conducted through one or more fixed establishments in New Zealand (i.e. these activities are carried out in New Zealand). Bonds will be registered with a registrar whose role is to check that the bonds comply with relevant legal obligations and that the amount of bonds on issue matches the amount of bonds authorised by the company. A paying agent is an agent who accepts payments from the issuer of a security and then distributes the payments to the holders of the security.

Issued publicly

Two requirements are used to limit the zero rate to bonds that are issued publicly.

Firstly the securities must be an offer of securities to the public under the Securities Act 1978. The Securities Act does not expressly define an offer of securities to the public, but section 3 of the Act provides guidance as to how the phrase should be interpreted. Section 3 of the Act lists people who are not considered to be members of the public. These include associates, institutional investors, underwriters and investors who pay a minimum subscription price of at least $500,000 before allotment of the securities. The Securities Act requires the preparation of an investment statement, a registered trust deed and (generally) a registered prospectus before a debt security can be issued to the public.

Secondly the securities were not issued as a private placement. A “private placement” is not a formally defined term in the Income Tax Act so this exclusion relies on the ordinary commercial meaning of a private placement. For example, securities that were exclusively issued to a group that were pre-selected by the issuer would probably be considered to be a private placement.

Not an asset-backed security

The securities cannot be asset-backed securities. Again, an “asset-backed security” is not formally defined so would be interpreted using the ordinary commercial meaning of this term. For example, securities whose interest payments were directly financed out of cash-flows from a pool of financial assets such as mortgages or other loans could be considered to be asset-backed securities. The purpose of this requirement is to deny the nil rate of AIL in cases where a group of loans have been bundled together and securitised into a bond. The concern is that such securities could be used to effectively shift the margin earned on closely-held loans (such as mortgages) outside the New Zealand tax base. Note that this measure is not intended to exclude bonds that are simply secured against a collateral asset which the bond holder can claim in the case of default.

Listed on the NZDX or widely-held

Finally the securities must either be listed on an exchange registered under the Securities Market Act 1988, or alternatively pass a widely-held test. Currently, the NZDX is the only debt exchange that is registered under the Securities Market Act. Securities listed on the NZDX will not need to apply the widely-held test and are expected to generally satisfy the other requirements listed above.

There are two parts to the widely-held test. Firstly, the securities must be held by at least 100 separate persons whom the issuer could not reasonably expect to be associated to the issuer or with one of the other 99 persons holding the bonds. For example, if there are two associated persons who each hold a bond, these persons should only be counted as one person for the purposes of this test.

Note that the securities need not all be issued on the same date so long as the debt securities are identical (i.e. they are fungible). For example if half the bonds were issued in January and half in August and by the 14th of September the total number of bondholders has reached 100 persons, then the test could be satisfied in respect of interest payments made on or after the 14th of September. This means that issuers can build up to 100 investors over time, although they will only get the nil rate of AIL in respect of interest payments made on or after the first day that the securities satisfy the test.

If the number of persons who holds the bonds subsequently drops below 100, the test will still be satisfied so long as this threshold was not met simply because of an arrangement (that the issuer could reasonably be expected to be aware of) that was intended to temporarily increase the number of persons holding the bonds.

The second part of the widely-held test is that no person or group of associated persons holds more than 10% of the value of the securities at the time the test is applied. If a person subsequently comes to hold more than 10% of the bonds, the test will continue to be satisfied.