Other remedial matters

FBT “ON PREMISES” EXEMPTION

Clauses 28 and 89

Submissions
(PricewaterhouseCoopers, New Zealand Institute of Chartered Accountants (NZICA), Ernst & Young)

The submissions agree that the wording change adequately reflects the policy intent of the exemption. However, they do not agree with the application date of 1 April 2005. Instead, the clauses should apply prospectively (New Zealand Institute of Chartered Accountants and Ernst & Young) or from 1 April 2010 (PricewaterhouseCoopers).

NZICA also submitted that the amendment should have been referred to the Rewrite Advisory Panel.

Comment

Officials agree that retrospective legislation should not be introduced without strong justification, and competing considerations should always be balanced.

The factors in favour of prospective application were as follows.

• There is an underlying presumption that legislation should be prospective.
• Taxpayers should be able to rely on the statutory language.
• Inland Revenue is planning to dispute all cases where it considers abuse of the provision has taken place. If Inland Revenue were to win these disputes, this would have the same effect as retrospective legislation.

The factors in favour of retrospective application were as follows.

• The apparent law change was the result of a drafting error; it was not a policy change, and the Rewrite Advisory Panel did not indicate that a policy change was intended.
• The policy intent behind the provision has always been well understood by taxpayers – which may be the reason that only a few taxpayers exploited the drafting change.
• If Inland Revenue were to lose the disputes, there would be a fiscal cost associated with a drafting error.
• A retrospective change would reduce administration and potential litigation costs.
• Making the change retrospective reduces incentives for taxpayers to take aggressive positions based on what they understand to be drafting errors.
• Retrospective application arguably does not undermine the integrity of the tax system if it prevents taxpayers taking advantage of an obvious and unintended drafting error.

With regard to the Rewrite Advisory Panel, officials do not consider this is an amendment wholly within the Panel’s terms of reference. An unrelated amendment to the relevant provision, effective from 2006, takes the provision outside of the transitional rules from that time. The known disputes on the relevant wording span periods post-2006.

Recommendation

That the submissions be declined.

 

JOINT BANK ACCOUNTS

Clauses 16, 86 and 105

Issue: Amendment should not proceed

Submission
(New Zealand Institute of Chartered Accountants)

The ambit of section 157 of the Tax Administration Act 1994 should not be extended to joint bank accounts.

Comment

When a taxpayer fails to pay any income tax, interest or civil penalty, the Commissioner may issue a written notice under section 157 of the Tax Administration Act 1994 to any third party, for example a bank, requiring the third party to deduct and pay to the Commissioner funds from any amounts payable to the defaulting taxpayer. The deductions may be in the form of a lump sum or instalments.

Section 157 is a critical tool in collecting unpaid tax debts.

Currently, section 157 of the Tax Administration Act 1994 does not refer to joint bank accounts. The courts have held that the Commissioner cannot issue a deduction notice to obtain funds from a joint account for an income tax debt owed by one of the joint bank account holders, because there is no authority to do so under section 157. The High Court noted that the Social Security Act 1964 and the Child Support Act 1991 both contain deduction provisions that expressly refer to money held in joint bank accounts, whereas the Tax Administration Act 1994 does not. This raised an inference that a tax deduction provision like section 157 needed to contain an express reference to joint bank accounts for it to apply to such accounts.

The Child Support Act 1991 allows the Commissioner to require deductions from money payable to a liable parent to meet a child support debt. This deduction power extends to money held in joint bank accounts in the name of the liable parent and one or more other persons, when the liable parent can draw from that account without the signature of the other person.

The bill proposes to amend the provisions of some Inland Revenue Acts which allow deductions of tax from payments due to a defaulting taxpayer to allow the Commissioner to make deductions of tax from joint bank accounts. The amendments will allow deductions from a joint bank account if the defaulting taxpayer can make withdrawals from that account without the signature of the other person – in other words, they have unrestricted access to the funds in the account. The changes will ensure consistency of treatment for deductions from joint bank accounts.

Recommendation

That the submission be declined.

Issue: Requiring consent of District Court Judge

Submission
(New Zealand Institute of Chartered Accountants)

The deduction provisions contained in section 12L of the Gaming Duties Act 1971, section 43 of the Goods and Services Tax Act 1985, and section 157 of the Tax Administration Act 1994 should be amended to require consent of a District Court Judge before the power can be exercised.

Comment

Since 1 July 2007 Inland Revenue has issued approximately 9000 deduction notices to banks. Requiring the consent of a District Court Judge would place a significant burden on the court system and also on Inland Revenue (in preparing the necessary documentation). It could also impede the collection of unpaid tax debts. In particular, if Inland Revenue becomes aware of a source of funds, it may need to move quickly. The funds could shift in the period it takes to get the consent of a District Court Judge.

Although officials consider section 157 is crucial in collecting unpaid tax debts, it should not be used inappropriately. There are systems in place which allow for concerns to be addressed, for example, the Complaints Management Service. In the first case mentioned in the submission, the submitter informed Inland Revenue and money was refunded, allowing the issue to be addressed and preventing inappropriate consequences. These systems are preferable to adding a judicial consent requirement that is resource intensive and could unnecessarily impede the effectiveness of the provision.

It is also a principle of administrative law that all public powers must be exercised in good faith.

Recommendation

That the submission be declined.

 

Issue: Application of provision to electronic transactions

Submission

(Matter raised by officials)

It should be made clear that the amendments also apply to joint accounts which are accessed electronically.

Comment

As currently drafted, the amendments will allow deductions from a joint bank account if the defaulting taxpayer can make withdrawals from that account without the signature of the other person. Some joint accounts are accessed electronically and require two or more persons to authorise payments. The amendments should also apply to these accounts.

Recommendation

That the submission be accepted.

 

CAP ON SHORTFALL PENALTIES

Clauses 84

Issue: Amendment should not proceed

Submission
(Ernst & Young, New Zealand Institute of Chartered Accountants)

The proposed express restriction to the $50,000 cap on certain shortfall penalties to voluntary disclosures made under section 141G of the Tax Administration Act 1994 should be deleted and the $50,000 cap should expressly apply both in cases of voluntary disclosure and in cases when adequate disclosure has been made at the time of taking the tax position. (Ernst & Young)

The proposal should not proceed. (New Zealand Institute of Chartered Accountants)

Comment

There are five shortfall penalties – not taking reasonable care (20%), unacceptable tax position (20%), gross carelessness (40%), abusive tax position (100%) and evasion or a similar act (150%). If a breach or default occurs, the relevant penalty is applied to the tax shortfall.

Shortfall penalties can be reduced for different reasons. For example, under section 141G, a shortfall penalty is reduced by between 40% and 100% if the shortfall is voluntarily disclosed before the beginning of an audit. Under section 141H, a shortfall penalty for an unacceptable tax position or an abusive tax position is reduced by 75% if the taxpayer makes adequate disclosure of their tax position at the time they take that tax position.

The unacceptable tax position penalty is imposed when the taxpayer’s tax position does not meet the standard of being “about as likely as not to be correct”. The penalty is applied only to significant income tax shortfalls – more than $50,000 and 1% of the taxpayer’s total tax figure for the relevant period. An abusive tax position is an unacceptable tax position taken with a dominant purpose of avoiding tax.

The shortfall penalty for an unacceptable tax position is intended as a signal to taxpayers who take a particular tax position in which there is a significant amount of tax at stake. It does not require that the treatment a taxpayer gives to a particular matter must be the better view, or must be more likely than not the correct treatment. Rather, it must be a position to which a court would give serious consideration but not necessarily agree with. The taxpayer’s argument should be sufficient to support a reasonable expectation that the taxpayer could succeed in court.

An aim of the shortfall penalty for an unacceptable tax position is to encourage taxpayers to get their tax position correct in terms of the law. This can be compared with the shortfall penalty for not taking reasonable care, which applies to a more general set of actions. When looking at whether a tax position is acceptable or not, the subjective elements, such as the effort the taxpayer went to, are not considered. In relation to the penalty for not taking reasonable care, taxpayers can argue that reasonable care has been taken by simply using a tax agent. This is not the case with the penalty for an unacceptable tax position – the penalty applies if the tax position taken fails to meet the required standard, irrespective of whether the taxpayer has engaged a tax agent.

The 75% reduction of the unacceptable tax position and abusive tax position shortfall penalties given for disclosures made at the time taxpayers take their tax positions reflects the complex nature of tax law, and not all taxpayers seek the certainty of a binding ruling when they are unsure of whether the position they are taking meets the standard of being about as likely as not to be correct.

Under section 141JAA(1) a shortfall penalty for not taking reasonable care or an unacceptable tax position can be limited to $50,000 if the taxpayer voluntarily discloses their tax position, or the Commissioner determines the shortfall, no later than the date that is the later of –

• the date that is three months after the due date of the return to which the shortfall relates; and
• the date that follows the due date of the return to which the shortfall relates by the lesser of –
  • one return period; and
  • six months.

This provision is aimed at ensuring that tax shortfalls which arise from the taxpayer not taking reasonable care or taking an unacceptable tax position and that are large in dollar terms, but which are speedily identified and corrected are not excessively penalised.

For example, a business taxpayer under-calculates their GST outputs by $45 million and, because no systems were in place to identify this shortfall, the under-calculation results in unpaid GST of $5 million. When the GST return is filed, Inland Revenue quickly identifies the shortfall and determines that the shortfall arose because the taxpayer did not take reasonable care. Because Inland Revenue quickly identified the shortfall the cap applies and the penalty is $50,000. If the cap did not apply, the penalty would be $1,000,000.

One of the reasons the cap was set at $50,000 was because that is the amount of the maximum criminal evasion penalty.

In 2007 amendments were made to the voluntary disclosure provisions. When a taxpayer makes a voluntary disclosure before being notified of an audit of a shortfall that arose from the taxpayer not taking reasonable care or taking an unacceptable tax position, the shortfall penalty is reduced by 100%. This amendment has led to an increase in voluntary disclosures being made. The number of disclosures of unacceptable tax positions made at the time the tax position is taken has fallen.

The cap is still relevant as it applies not only when the taxpayer makes a voluntary disclosure but also when the Commissioner identifies the shortfall within the time limit.

It is not clear that the limit in section 141JAA applies only to voluntary disclosures (under section 141G) and not to disclosures made when the tax position is taken (under section 141H) – when taxpayers make disclosures at the time the tax position is taken they are aware that the position taken might not meet the required standard.

It was never intended that the cap apply to disclosures made at the time the tax position is taken. If it applied to these disclosures, taxpayers could take tax positions that did not meet the standard of being “about as likely as not to be correct” (unacceptable tax position) knowing the maximum penalty they would face would be $50,000.

Recommendation

That the submission be declined.

AMENDMENTS TO THE PIE RULES

Clauses 42, 51 and 91

Issue: Interaction between new and existing timing rules

Submission
(KPMG)

It is not clear how the new sections HM 35B and HL 19B of the Income Tax Act 2007, introduced in the bill, are intended to interact with existing sections EG 3 (which applied prior to 1 April 2010) and HM 35(8) (which has applied since 1 April 2010).

It also appears that a timing rule for tax credits that was in section EG 3 has not been transferred to the post-rewrite version of the portfolio investment entity (PIE) rules.

Comment

The provisions introduced in the bill, sections HL 19B and HM 35B, are designed to supplement the existing timing provisions in sections EG 3 and HM 35(8).

The existing provisions stated that a PIE should allocate income and deductions to when they were reflected in its unit price (or its financial accounts, if the PIE did not calculate a unit price). However, it is unclear whether these provisions allow a PIE to allocate future income or deductions in this way.

The new provisions are designed to clarify that a PIE should allocate income and deductions to when they are reflected in its unit price, even if the income or deductions have yet to be incurred or derived. The existing timing rule still applies, but the new provisions clarify that future amounts can also be taken into account.

The issue of the tax credit timing rule has been raised as a rewrite amendment item and is addressed in the other remedial matters section of this report.

Recommendation

That the submission be noted.

 

Issue: Definition of “land investment company”

Submission
(KPMG)

The definition of “land investment company” in section YA 1 of the Income Tax Act 2007 should be amended to accommodate intra-group financing between land investment companies and PIEs in the same tax group.

Comment

This submission is not directly related to any items in the bill. The PIE rules do not prevent these intra-group financing arrangements for listed PIEs, for which these arrangements are most practical. Finally, this specific issue generally arises in international transactions involving debt-financed investment, which raises some concerns that need to be carefully considered before any amendments to the rules are made.

Recommendation

That the submission be declined.

 

Issue: Investor interest requirements

Submissions
(AMP Capital Investors, Ernst & Young, PricewaterhouseCoopers)

Amendments are required to allow certain widely held investors to hold an unlimited investment in a listed PIE. There does not appear to be any sound policy rationale for the current distinction, whereby such investors are not allowed to hold interests of more than 40% in a listed PIE but may hold unlimited interests in unlisted PIE entities. This change should be effective from the commencement of the PIE rules on 1 October 2007.

The application of the “public unit trust” rules to maximum investors’ interests in PIEs should permit non-widely held investors to hold an interest of up to 25% in a listed PIE.

There is currently a five-year stand-down period that prevents an entity from becoming a PIE after losing PIE status. This stand-down period should not apply if an entity’s loss of PIE status was due to it not meeting the maximum investors’ interest requirements.

Provisions should be introduced to protect the tax position of investors if their presumed investment in a PIE changes due to the loss of PIE status by the entity in which they invested.

Comment

These submissions do not relate to the bill as introduced. Rather, they relate to the eligibility requirements under the PIE rules.

As a general principle, a PIE should be widely held. Therefore, the rules state that no single investor can hold more than 20% of a PIE.

• For unlisted PIEs, the 20% threshold does not apply if the investor itself is a widely held entity. This means that a PIE is able to own 100% of an unlisted PIE, allowing retail PIEs to invest in wholesale PIEs. In policy terms, it makes sense to waive the 20% threshold in these circumstances because, looking through to the ultimate investors, the PIE is still widely held.
• For listed PIEs, the 20% threshold is increased to only 40% for investors that are themselves widely held. At the time the rules were introduced, it was considered unlikely that a listed PIE would act as a wholesale fund. Increasing the threshold to 40% was therefore considered sufficient. However, officials do not have any policy objection to allowing a widely held investor to hold 100% of a listed PIE.

The background to these submissions is that a specific entity has been trading as a listed PIE when it fact it has failed to satisfy the eligibility criteria because the stake held in that entity by one of its investors exceeded the 40% threshold. The breach of this threshold was only recently identified by the entity in question.

While the breach has no direct impact on the entity’s own tax affairs, it impacts its investors. Retail investors on higher marginal tax rates become liable to pay top-up tax on distributions, which are treated as dividends from an ordinary company as opposed to exempt PIE distributions. Certain wholesale investors become liable for tax in relation to redemptions of their interests, which for tax purposes are again treated as taxable dividends. In addition, at least one wholesale investor into the entity will itself lose PIE status as a result of the entity not being a PIE: this is because of rules that limit the investments a PIE can hold in a non-PIE entity (under section HL 10 or HM 13). The consequential loss of PIE status for this investor will, in turn, impact on its own members. The impacts for investors affect current and previous tax years.

As noted above, officials agree with the first submission: that there is no strong policy rationale for allowing a widely held investor to hold only 40% of a listed PIE. It is the entity’s breach of this threshold that has caused it to lose PIE status. Accordingly, we support the proposal that a widely held investor should be able to hold up to 100% of a listed PIE. This would bring the treatment of listed PIEs into line with the treatment of unlisted PIEs in this regard. Given the real downstream consequences for investors into the entity, who acted in the belief that the entity in question was a PIE, we also support the proposal to make this change retrospective from the commencement of the PIE rules on 1 October 2007.

If these proposals are accepted, then the changes proposed in the three other submissions are not necessary and officials do not support them.

• The decision to limit the application of the “public unit trust” concession to exclude the paragraph that would allow non-widely held investors to hold an interest of up to 25% in a listed PIE was a conscious one made at the time the PIE rules were introduced. Officials consider that neither the submissions nor the particular circumstances outlined above raise new issues that warrant that decision being revisited at this time.
• Provided that the threshold for widely held investors holding interests in listed PIEs is retrospectively increased to 100% (as in the first submission), it is not necessary to provide any exemption from the five-year stand-down period in order to deal with the particular case referred to above. Officials do not consider that the submissions make the case for a general relaxation of the stand-down period, which helps to maintain the integrity of the PIE regime.
• Likewise, if the first submission is accepted, then amendments to protect the tax position of investors into the entity concerned are not necessary. Officials would generally be cautious about making such changes, again because of the implications for the integrity of the PIE regime.

Recommendation

That the investors’ interest requirements for PIEs be amended to allow a widely held investor to hold up to 100% of a listed PIE, and that this change apply retrospectively from the commencement of the PIE rules.

 

TAXATION OF GENERAL INSURANCE BUSINESS – TREATMENT OF EXPECTED REINSURANCE AND RECOVERIES

 

Issue: Discounting expected reinsurance and recovery amounts

Submission
(Insurance Council of New Zealand)

Change is needed to the Income Tax Act 2007 to require amounts that insurers expect to receive from third parties, by way of reinsurance or directly from those parties, to be discounted. These amounts affect the calculation of deductions for movements in an insurer’s outstanding claims reserve (OCR) allowed under section DW 4 of the Income Tax Act 2007.

The change should have retrospective effect so that the tax treatment of these amounts aligns with when a taxpayer adopts International Financial Reporting Standard 4: Insurance Contracts (IFRS 4).

Comment

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 clarified that movements in a general insurer’s OCR, as determined by applying IFRS 4, are deductible. The rules allow a deduction for claims paid in an income year and for the movement in the OCR between the beginning and the end of the year.

The OCR is the amount an insurance company sets aside which, when invested, will provide sufficient funds to cover the liabilities for outstanding claims in the future. The value of these claims is estimated, as either they have been reported but not paid at balance date, or an insured event has occurred but the insurer has not been notified about the claim by its balance date. The amount of expected future payments is discounted to reflect present value.

Estimates relating to reinsurance recoveries and non-reinsurance recoveries reduce the amount that can otherwise be deducted in connection with claims and movements in the OCR. For financial reporting purposes these amounts are treated as income and are discounted.

For taxation purposes, these amounts are not discounted and therefore reduce the amount that is otherwise deductible under section DW 4. The current rules therefore create a mismatch by overstating amounts connected with reinsurance and recoveries when compared to the discounting valuation rules that apply to claims estimates.

Recommendation

That the submission be accepted.

The change should apply from the first income year in which the taxpayer adopts IFRS 4 for financial reporting purposes.

 

Issue: Determination E12

Submission
(Insurance Council of New Zealand)

Paragraph (w) of Determination E12 should be removed as it is now superfluous following the enactment of section DW 4 of the Income Tax Act 2007.

Comment

While the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009 clarified that movements in a general insurer’s outstanding claims reserve are deductible, the rule applies only to taxpayers that use IFRS 4.

Officials note that there are taxpayers who have general insurance functions that do not use IFRS 4 as they are not required to prepare general purpose financial reports. Determination E12 deals with prepayments and provisions. Paragraph (w) is relevant for these taxpayers as it allows a deduction for provisions made for outstanding insurance claims, if the amount of the claim does not exceed $65,000 (excluding GST). Without this rule, the deduction only becomes available when the taxpayer settles (pays) the claim.

Recommendation

That the submission be declined.

TAXATION OF LIFE INSURANCE BUSINESS

 

Issue: Grandparenting reinsurance contracts sold before the start of the new taxation rules for life insurance

Submission
(PricewaterhouseCoopers on behalf of Hanover Life Re, Munich Re, Gen Re, Swiss Re and RGA Re)

The grandparenting rules, as they apply to life reinsurance treaties, need to be simplified.

Comment

The policy intent behind the grandparenting rules is to preserve the tax effect of the old rules for life business sold before the start of the new taxation rules for life insurance which started on 1 July 2010. However, to reduce compliance costs, life insurers were able to elect into the new rules before that date if they wanted to align the start date of the tax changes with the beginning of their financial reporting year.

Reinsurance policies sold before the start of the life insurance taxation rules are intended to be grandparented to the extent that the life reinsurer can “look though” the policy to the underlying individual whose life was covered and if there is no material change to the life reinsurance policy or the amount of insurance cover.

Discussions with a number of life reinsurers about the operation of the new taxation rules indicate that the current transitional rules do not reflect how life reinsurance products work, in terms of:

• whether life reinsurers can in practical terms “look through” a life reinsurance policy to the underlying life policy and the individual whose life is insured;
• whether life reinsurance policies can be grandparented when the underlying life policy is fully reinsured, thereby taking the seller of the underlying life policy outside the definition of “life insurer” in section EY 10; and
• potential mismatches that are created. For example, a life insurer sells a life policy to an individual in March 2010. The cover under the policy is $595,000 in year one. In April 2010, the life insurer then reinsures the life risk for all policies that have a cover amount of up to $600,000. In year one, the life reinsurer has no risk exposure. In year two, the cover under the individual’s life policy rises by CPI to $601,000 and the life reinsurer becomes “on-risk” for the $1,000 above $600,000. The increase in the reinsurance cover from $0 to $1,000 would breach the grandparenting rules and the contract would not receive transitional relief. In this situation, the underlying life policy continues to be grandparented, but the reinsurance policy is not even though it was sold before 1 July 2010.

To deal with the problems life insurers have identified, officials consider the grandparenting rules for life reinsurance should be simplified.

Transitional relief should apply to life reinsurance contracts in place before the start date of the new life insurance rules:

• to the extent that the underlying life policy is:
  • grandparented (this assumes the life reinsurer is able to use the information provided to it by the cedant life insurer about the underlying life policy); or
  • would be grandparented if the seller of the life policy was a “life insurer”; and
• if there are no material changes in the terms of the life reinsurance contract.

This solution would allow the life reinsurer to grandparent existing reinsurance contracts to the extent that the underlying life policy is also grandparented. Representatives from the life reinsurance sector have confirmed that the proposal aligns with their current practices and systems.

The changes should have effect from the date the new life insurance rules started: 1 July 2010 or an earlier income year that includes 1 July 2010.

Recommendation

That the submission be accepted.

 

Issue: Calculation of transitional relief under the grandparenting rules

Submission
(Matter raised by officials)

The formula in section EY 30(8) of the Income Tax Act 2007, which is used to calculate the value of transitional relief allowed under the grandparenting rules, includes references to the rules about the outstanding claims reserve (section EY 24) and the capital guarantee reserve (section EY 27).

Comment

The rules for calculating the transitional relief available for grandparented life policies include references to the various rules that apply to reserves. Reference to the rules relating to the calculation of the outstanding claims reserve (OCR) and the capital guarantee reserve (CGR) are not relevant to the calculation because they are not premium-related reserves but could give rise to a higher deduction than would otherwise be available. References to the OCR and CGR rules should be removed from the calculation of transitional relief. We note that taxpayers have not yet filed their first returns and have not yet taken a tax position under the new rules.

The changes should have effect from the date the new life insurance rules started: 1 July 2010 or an earlier income year that includes 1 July 2010.

Recommendation

That the submission be accepted. References to sections EY 24 and EY 27 should be removed from section EY 30(8)(b).

 

Issue: Definition of “profit participation policy”

Submission
(Matter raised by officials)

The scope of the definition of “profit participation policy” should be narrowed to life insurance policies that provide a savings facility to individuals.

Comment

Profit participating life policies allow policyholders to participate in the distributions of profit and were once the most common product offered by life insurance companies. The current definition of “profit participation policy” in the Income Tax Act 2007 is broad and could include life reinsurance policies and group life policies with risk cover. Officials consider this outcome is inappropriate because such policies have the characteristics of pure risk policies and, unlike traditional profit participation policies, do not contain a savings component. Such life reinsurance policies and group life policies (life insurance policies that insure multiple lives under the one policy, for example, workplace policies) should be taxed under the non-participating rules (premiums less claims) with any profit participation features being treated as other income or expenditure.

The changes should have effect from the date the new life insurance rules started: 1 July 2010 or an earlier income year that includes 1 July 2010.

Recommendation

That the submission be accepted. The definition of “profit participation policy” in section YA 1 should specifically exclude life insurance contracts that are “life reinsurance” and “multiple life polices” as defined in sections EY 12 and EY 30(14) respectively.

CARVE-OUT FROM “CFC ATTRIBUTABLE AMOUNT” FOR THIRD-PARTY ROYALTIES RECEIVED BY A LOWER-TIER CFC

 

Submission
(KPMG)

Section EX 20B(5)(d) of the Income Tax Act 2007 needs clarification to ensure that it is consistent with the policy intention of the new CFC rules. In particular, royalty income derived by a lower-tier CFC from a non-associated third party should also be excluded from attributable CFC amount.

Comment

Officials have noted the issue raised by the submission and agree in principle with the point made by the submitter. Officials consider, however, that the change would be more appropriately included with other legislative amendments to be made to the international tax rules later this year, rather than put in this bill.

Recommendation

That the submission be noted.

APPROVED ISSUER LEVY

Clauses 79, 102 and 103

Issue: Application date

Submission
(Corporate Taxpayers Group)

The amendments to the rules for approved issuer levy (AIL) should apply retrospectively so that taxpayers that have applied the pre-clarified law are not subject to the risk of penalisation by Inland Revenue. Alternatively, Inland Revenue could provide comfort in a future Tax Information Bulletin, or in the Officials’ Report on the bill, that it will not pursue the matter if a taxpayer has paid AIL prior to 1 August 2010 (the application date for the amendments).

Comment

The bill makes technical changes to the rules for approved issuer levy, to ensure a better fit between domestic and treaty laws. The amendments are intended to make existing law more transparent, rather than to substantively alter its effect.

The submitter is concerned that, unless the changes apply retrospectively, a taxpayer that has paid AIL prior to 1 August 2010 in order to qualify for a treaty exemption for interest paid to a foreign bank may risk penalisation.

The relevant scenario involves interest payments to a foreign bank with a branch in New Zealand. In this case, the NRWT rules do not apply and the AIL regime is therefore not relevant domestically. Provided the interest is not connected with the New Zealand branch, the interest may still qualify for an exemption under a double tax agreement. The availability of this exemption depends on the borrower paying AIL – but only if the borrower is eligible to elect to pay AIL.

We consider that the borrower in this scenario is eligible, under existing law, to elect to pay AIL for the purposes of qualifying the interest for a treaty exemption. The bill clarifies this. We see no risk for a taxpayer that has relied on this interpretation of the law prior to the clarification taking effect. The treaty requires that, if a borrower is eligible to pay AIL, then the levy must be paid for the exemption to apply. This is not the same as the exemption being contingent on the borrower’s eligibility to elect to pay AIL. As long as the borrower has paid AIL and the other requirements for the exemption are satisfied, we see no basis on which the exemption would be denied. There are no penalties for paying AIL in circumstances where this is not relevant for the purposes of the domestic NRWT rules.

Recommendations

That the application date of 1 August 2010 not be changed and that the foregoing analysis be reflected in a subsequent Tax Information Bulletin.

 

Issue: Related proposals

Submission
(Corporate Taxpayers Group)

Interest paid by a New Zealand borrower to a foreign bank in respect of property situated offshore should not have a New Zealand source, provided the interest is not connected with a New Zealand branch of the foreign bank. (The result would be to exempt the interest from the NRWT/AIL rules.)

Alternatively, certain practical changes should be made to the AIL regime: the non-resident bank should be able to register and pay AIL on behalf of the borrower; either the bank or the borrower should be able to register to pay AIL retrospectively; and it should be possible to pay AIL on an annual basis (rather than monthly).

Comment

Whereas the bill makes only limited technical changes to the AIL rules to clarify the relationship between domestic and treaty laws, these proposals would involve substantive changes to the scope of the tax base and the way the AIL regime operates. The submission notes that these proposals are outside the scope of the current bill and indicates that the submitter would be happy to discuss them separately with officials.

Recommendation

That officials meet with the Corporate Taxpayers Group to discuss wider policy issues related to NRWT/AIL on interest, with any further legislative changes being a matter for a later bill.

AUCKLAND COUNCIL RESTRUCTURING AMENDMENT

Clause 106

Submission
(Matter raised by officials)

Clause 106(20) of the bill should be amended to include a reference to section 19B of the Local Government (Tamaki Makaurau Reorganisation) Act 2009.

Comment

This amendment will ensure that the new Waterfront Development Agency which is established pursuant to an Order in Council made under section 19B of the Local Government (Tamaki Makaurau Reorganisation) Act 2009 is also covered by the proposed tax amendment. Therefore, like other new council-controlled organisations, the new Waterfront Development Agency would not be entitled to a deduction for the principal amount of the debt (that was transferred as part of the restructuring), but will still be entitled to an interest deduction.

Recommendation

That the submission be accepted.

 

EMISSIONS TRADING PROVISIONS

Clauses 22, 34 and 74(4)

Issue: Conversion of New Zealand Unit to Kyoto unit

Submission
(PricewaterhouseCoopers)

There is no provision which allows a deduction when a New Zealand Unit is converted to a Kyoto unit, which may result in the same unit being taxed twice.

Comment

The Climate Change Response Act 2002 includes provisions enabling a holder of a New Zealand Unit (NZU) to convert it to an Assigned Amount Unit (AAU), which they might want to do if they want to sell the unit outside New Zealand. The submitter points out that an Income Tax Act 2007 provision provides that, when such a conversion is made, the NZU is treated as being disposed of for market value. The submitter is concerned that no provision provides a contemporaneous deduction for the acquisition of the AAU. If this were correct, it would mean that a person who then sold that AAU would be taxed twice: once on the conversion of the NZU to the AAU and then again on the sale of the unit.

Officials consider that a deduction is available for the cost of the AAU. Emissions units (which include AAUs) are included within the definition of revenue account property in section YA 1. Section DB 23 of the Income Tax Act provides that a person is allowed a deduction for expenditure they incur as the cost of revenue account property. In this instance, the expenditure incurred by the person is the transfer of the NZU to the registry, and the amount of that expenditure is defined by income tax legislation as the market value of the NZU. Officials are therefore comfortable that no double taxation can arise here.

Recommendation

That the submission be declined.

Issue: Deductibility of underlying emissions obligations when free units are awarded

Submission
(PricewaterhouseCoopers)

The legislation should include a specific provision stating that the amount of the deduction which arises for an ETS obligation should be calculated by reference to the assessable income arising from the surrender or valuation of those units.

Comment

The following two examples explain the two circumstances in which a business may have an emissions obligation and be holding units awarded by the Government.

In the first situation, at the end of the income year the business has accrued a liability to surrender emissions units, which it has not yet satisfied by the transfer of units. At the end of the income year, it will need to value the liability at its best estimate, which (assuming it holds no units) will be the market value of an emissions unit on balance date. Assume the business later receives free emissions units, and uses them to meet its surrender obligation. This will be taxed as a disposal of the units at market value (in order to recognise for tax purposes the free unit awarded). However, if the market value of the units when surrendered is different from the market value of units used to work out the original deduction, an adjustment will be made.

In the second situation, the end of the emissions year occurs part-way through the income year, and the liability is met by the surrender of free (zero-value) emissions units, also during the course of the income year. Income will arise on the transfer of the free units equivalent to the market value of units on that date. The deduction for the liability will also be calculated by reference to the value of units surrendered, so no mismatch will arise. If instead the surrendered units were those which had previously been valued, the deduction would be calculated by reference to that previously-calculated value.

Accordingly, officials do not consider that any mismatch can arise.

Recommendation

That the submission be declined.

 

Issue: Application of accounting treatment for tax purposes

Submission
(PricewaterhouseCoopers)

It would be desirable in the future to align the tax treatment of emissions unit transactions with the accounting treatment. The development of accounting standards should be monitored so that this alignment can be made in the future.

Comment

Businesses incur compliance costs in accounting for emissions units transactions for both tax and financial reporting purposes. If the tax and accounting treatments could be aligned, businesses’ compliance costs could be reduced.

The submitter suggests that such alignment will need to be deferred until accounting standards relating to emissions transactions and government grants are finalised.

Officials agree with this submission. It would be highly desirable from a compliance perspective to align tax treatment and accounting treatment. However, the accounting treatment is not yet sufficiently certain for officials to be confident that alignment ought to be allowed at this stage.

Officials will continue to monitor the development of accounting standards, with a view to allowing businesses to apply accounting rules for tax when they are confident that this will lead to appropriate outcomes.

Recommendation

That the submission be accepted.

Issue: Income tax treatment of certain emissions units received by NGA parties

Submission
(Matter raised officials)

The new rules for the recognition of income from the transfer of units by the Government to certain industrial and agricultural businesses should also be extended to emissions units transferred to Negotiated Greenhouse Agreement (NGA) participants to compensate them for the increased cost of their inputs.

Comment

Provisions in the bill deal with the income tax treatment of the transfers to industrial and agricultural businesses under the Climate Change Response Act 2002 (CCRA). It provides that the amount of income arising is determined by the business’ entitlement under the CCRA, and values an appropriate number of the units transferred at market value.

NGAs were entered into between the Government and two industrial emitters in 2003 and 2005, prior to the introduction of the ETS. In order to meet its obligations under those original agreements, the Crown is in the process of entering into side agreements with these parties under which they will be transferred emissions units. These transfers will be on a similar basis to the transfers which are made under the CCRA to certain industrial and agricultural businesses.

The income tax treatment of these transfers is governed by ordinary law, which is unclear and will certainly give a different result to the statutory rules in the bill. There is no conceptual difference between the CCRA transfers and the NGA transfers, so officials consider that the new rules in the bill which apply to the CCRA transfers should also be extended to the NGA transfers.

Recommendation

That the submission be accepted.

 

Issue: Minor technical issues

The following matters are proposed by officials to deal with minor issues which have arisen in the tax legislation dealing with emissions trading.

Correction of drafting error in CB 36(7)

Officials submit that a drafting error in the amendments proposed to section CB 36(7) in the bill be corrected. An amendment is proposed to make it clear that the provision applies when an emissions unit is transferred to a person by the Government.

Capital account treatment of units allocated to owners of fishing quota

Officials submit that an amendment to section ED 1(7B) should be made to make it clear that where an emissions unit is allocated to a person who holds fishing quota on capital account, that unit has a value of zero at the end of the income year.

Recommendation

That the submissions be accepted.

 

EXTENSION OF THE RWT DEADLINE

Submission
(FNZ)

FNZ is one of a number of firms in New Zealand that provide investment administration services for their clients. These services include withholding resident withholding tax (RWT) on interest income received on behalf of clients and performing portfolio investment entity (PIE) tax calculations for clients’ PIE investments and returning PIE tax to Inland Revenue. Firms performing these functions for clients are often known as “wrap account” providers.

An important aspect of these functions is providing information to investors concerning the amount of interest and PIE income earned and the amount of tax that has been deducted. This enables investors to complete their end-of-year tax returns.

It is efficient for wrap account providers to provide this information in a consolidated form to investors. Currently the Tax Administration Act requires that RWT information for a tax year is provided by the 20th of May following the end of the relevant tax year.

FNZ submits that this deadline should be extended to 15 June or, at a minimum, 31 May. This would provide more time for wrap account providers to consolidate the RWT information with PIE information – which may be provided by the PIE to the wrap account provider on or close to the current 20 May deadline for providing investors with RWT information.

Comment

Officials consider that the submission illustrates the need for the various legislative deadlines for providing RWT and PIE information to be reviewed in order to provide greater coherence. We do not recommend that the specific change suggested by FNZ should be made independently of such a review.

Recommendation

That the submission be noted and considered again when a comprehensive review of the deadlines for providing RWT and PIE information is conducted.

KIWISAVER

Issue: Transfer from complying superannuation fund to KiwiSaver scheme

Submission
(Matter raised by officials)

A person over the New Zealand Superannuation qualification age should not be entitled to the initial Crown contribution (the kick-start) if they transfer from a complying superannuation fund to join KiwiSaver for the first time.

Comment

The KiwiSaver Act 2006 contains rules that prevent persons over the age of entitlement to New Zealand Superannuation from joining KiwiSaver. They are not enrolled via the automatic enrolment rules when starting new employment, nor can they opt in directly. Thus they cannot receive the initial Crown contribution (the $1,000 kick-start payment).

But members of a complying superannuation fund may choose to transfer to a KiwiSaver scheme, including those over the New Zealand superannuation age. Also, members of a complying superannuation fund may be involuntarily transferred into KiwiSaver at any age, for example if the Government Actuary revokes approval of their existing fund.

To maintain equity with those who are not members of complying schemes, when a person who is over the New Zealand superannuation age transfers from a complying superannuation fund into KiwiSaver for the first time, they should not be entitled to the kick-start payment.

These amendments are remedial in nature and consistent with the policy intent of KiwiSaver.

Recommendation

That the submission be accepted.

Issue: Repayment of a member’s tax credits following permanent emigration to Australia by member of a complying superannuation fund

Submission
(Matter raised by officials)

A member of a New Zealand complying superannuation fund which is not a KiwiSaver fund can apply to withdraw their funds, less any Government tax credits, following their permanent emigration to Australia. The New Zealand provider should return the amount of the member tax credit to the Government.

Comment

The Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010 introduced new rules to allow a person who has retirement savings in both Australia and New Zealand to consolidate them in one account in their current country of residence.

KiwiSaver members transferring their retirement savings to Australia will be able to transfer accumulated member tax credits. However, at present, the ability to transfer these tax credits does not apply to complying superannuation schemes in New Zealand that are not KiwiSaver schemes; instead, the provider must return the amount of the member tax credit to the Government.

However, one of the amendments in the Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act means that the legislation governing the providers’ return of the tax credit to the Government no longer covers situations where a member of a complying superannuation fund emigrates permanently to Australia. This was an unintended change.

The proposed amendment is remedial in nature, to ensure consistency with the policy intent of KiwiSaver.

Recommendation

That the submission be accepted.

 

Issue: Use of KiwiSaver first home withdrawal facility to purchase a “leasehold estate”

Submission
(Matter raised by officials)

A KiwiSaver member who is eligible for the first home withdrawal facility can withdraw their accumulated savings to purchase their first home. The property or “estate” they purchase should include a “leasehold estate”.

Comment

The Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010 altered the eligibility criteria for the first home withdrawal, by removing “leasehold estate” from the definition of the word “estate” in clause 8(6) schedule 1 of the KiwiSaver Act 2006.

The change was intended to allow a KiwiSaver member who had previously been party to a leasehold residential tenancy, to meet the eligibility criteria for the first home withdrawal facility. The member could then withdraw their accumulated savings, less the one-off $1,000 Crown contribution and any member tax credits, to use for the purchase of their first home.

Officials have since noticed that the amendment means that the legislation now precludes a member who is purchasing a leasehold estate from accessing the first home withdrawal facility. This effect was not intended.

The proposed amendment is remedial in nature and is consistent with the policy intent of KiwiSaver. The amendment will apply from 1 July 2010.

Recommendation

That the submission be accepted.

 

REWRITE AMENDMENTS

Clauses 76 and 93

Issue: Low-interest loans to shareholder-employees and backdating of income not subject to withholding of taxation at source

Submission
(BDO and New Zealand Institute of Chartered Accountants)

If the policy intention of the low-interest loan backdated repayment rules is to permit shareholder-employees to retrospectively reduce the balance of low- or nil-interest loans by applying their own funds, the backdating rules should not depend on whether withholding tax is withheld from a payment of a dividend, or whether a dividend is fully imputed.

Comment

The amendments in clauses 76 and 93 are in response to a recommendation of the Rewrite Advisory Panel that a minor drafting change in the repayment rules for low- or nil-interest loans from the Income Tax Act 1994 to the 2004 Act (and re-enacted in the 2007 Act) should be retained, despite the drafting change being an unintended change in legislation. (The term “gross income” in the 1994 Act was replaced by the term “income” in the 2004 Act.) The amendments confirm that drafting change as an intended change.

However, the submissions relate to a matter that has been raised separately with the Minister of Revenue. NZICA and officials have agreed on a process to progress this matter, which incorporates a wider set of policy issues. Officials understand that BDO are aware of this agreed process, which includes the point raised in submission.

As the submissions are beyond the scope of the rewrite amendments, and relate to a wider policy problem, officials recommend that the submissions should be addressed within the agreed policy process for those issues.

Recommendation

That the submissions be declined.

 

Issue: PIE rules

Submission
(Matters raised by officials)

That the following rewritten provisions of the PIE rules be amended to correct minor drafting errors arising on the rewrite of these provisions, so as to correctly reflect their corresponding provisions in subpart HL of the Income Tax Act 2007.

These amendments should apply from the beginning of the 2010–2011 income year.

Comment

These items are included on the list of minor maintenance items under the processes adopted by the Rewrite Advisory Panel.

Definition of investor class

Section HM 5(4) should be amended to correctly reflect the outcome in the corresponding provision, section HL 5B(3) of the 2007 Act: that both paragraphs (a) and (b) must be satisfied before an investor is entitled to the benefit of the relief under this provision.

Definition of foreign PIE equivalent

Section HM 3(e) should be amended to correctly reflect the outcome in the corresponding provision, section HL 5(d). The amendment is that for a foreign investment vehicle to be considered a foreign PIE equivalent, the investor size requirement of section HM 15 only needs to be met for New Zealand residents. The other requirements remain unchanged.

PIE criteria – collective schemes

Section HM 9 should be amended to correctly reflect the pre-rewrite position: that trustees of a group investment fund in relation to category B income can elect to be a multi-rate PIE.

Recognition of tax credits

Section HM 35 should be amended to correctly reflect the corresponding provisions of section EG 3, so that:

• tax credits received by the PIE are taken into account in determining the amount “assessable income” in the formula in subsection (3); and
• tax credits are apportioned on the same basis as the income is apportioned under subsection (8).

Cross reference to “portfolio tax rate entity”

In section IC 3(1), the term “portfolio tax rate entity” should be replaced by the term “multi-rate PIE” consequential on the rewrite of the PIE rules.

Non-resident withholding tax

The cross-reference in section RF 2(2) to section CX 56C should be replaced by a cross-reference to sections CX 56B and 56C to correctly reflect the provisions of NG 1(2)(f) of the 2004 Act.

Definition of “land investment company”

The definition of “land investment company” in section YA 1 is the rewritten definition of portfolio land company.

The following minor drafting errors in the definition of land investment company should be corrected to correctly reflect its pre-rewrite meaning.

• Paragraphs (a) and (b) should be conjunctive (as per paragraphs (a) and (b) of the definition of portfolio land company).
• In paragraph (b), the $100,000 market value threshold should be determined by whether the value is “more than or equal to” $100,000, instead of “more than” as currently drafted (as per paragraph (b) of the definition of portfolio land company).
• In paragraph (b), the words “the market value” should be inserted between “90% of” and “that property” (as per paragraph (b)(ii) of the definition of portfolio land company).
• The definition should be amended to clarify that a company (company A) will not be a land investment company if it invests in another land investment company which in turn invests back into company A (as per paragraph (b)(i) of the definition of portfolio land company).

Tax Administration Act – portfolio investor allocated income

In section 33A(1)(b)(xi) of the Tax Administration Act 1994, the term “portfolio investor allocated income” should be amended to refer to “attributed PIE income” as a consequence of the rewrite of the PIE rules.

Recommendation

That the submissions be accepted.

 

Issue: Meaning of foreign income tax

Submission
(Matter raised by officials)

That the meaning of foreign income tax for the purposes of the foreign tax credit rules in the Income Tax Act 2007 be amended to correctly reflect the corresponding provisions in the Income Tax Act 2004.

This amendment should apply from the beginning of the 2008–2009 income year.

Comment

This item is included on the list of minor maintenance items under the processes adopted by the Rewrite Advisory Panel.

Section YA 2(5) of the Income Tax Act 2007 should be amended to ensure that income tax of a foreign country includes income tax imposed by a state or local government, as well as income tax imposed by a central government. This would reinstate the explicit reference to tax imposed by a central, state or local government that was contained in section OB 6(1)(c) of the Income Tax Act 2004.

Recommendation

That the submission be accepted.