Worldwide group debt test
Issue: Extent of owner-linked debt rule
Clause 94
Submissions
(Corporate Taxpayers Group, New Zealand Institute of Chartered Accountants, New Zealand Law Society, Russell McVeagh)
The bill proposes to exclude debt that is linked to a person who owns part of a company’s worldwide group for the purpose of the group’s worldwide debt test. Here, a debt is linked to an owner if they are a party to the loan, have guaranteed the loan, or the loan is part of a back-to-back arrangement the owner is party to.
Shareholder guaranteed loans should not be counted as linked to an owner. A shareholder guaranteed loan does not involve provision of funds by the shareholder to the borrowing company. It therefore cannot be a substitute for equity. There may also be difficulties in finding out whether a loan is guaranteed or not, especially if the borrowing company is outside of the New Zealand group. (New Zealand Institute of Chartered Accountants, New Zealand Law Society, Russell McVeagh)
There should be an exemption where an owner on-lends third party borrowing to the worldwide group. (New Zealand Law Society)
Debt that has been lent to the worldwide group by an owner should not be excluded if that debt is on the same terms as genuine third-party debt. This would ensure the loan is for a commercial level of debt. (New Zealand Institute of Chartered Accountants)
Debt should not be counted if it is on arms-length terms and not in proportion to, or a substitute for, equity. (Corporate Taxpayers Group)
Comment
Broadly speaking, thin capitalisation rules have three related objectives. These are to ensure:
- that non-residents are not replacing equity with debt when investing into New Zealand;
- only a fair amount of the non-resident’s worldwide debt has been allocated to New Zealand; and,
- the New Zealand operation has a commercial level of debt.
When a company is owned by a group of non-residents who meet the definition of a “non-resident owning body”, there is no test to determine whether they have allocated a fair amount of their worldwide debt to New Zealand. This test is proxied by the requirement that, in essence, any debt of the New Zealand company (in excess of 60 percent) must be from a third party. This demonstrates that the New Zealand business, on its own, is able to support that level of debt. This provides a reasonable indication that the debt in the New Zealand business is not attributable elsewhere.
Having shareholder-guaranteed loans not counted as owner-linked would weaken this. It would mean that the New Zealand business may not actually be able to commercially support its level of debt – the guarantee may have been required in order for the loan to proceed. This provides an indication that debt that should be allocated elsewhere in the world has been put in New Zealand – since the loan is implicitly supported by assets outside of New Zealand.
For the same reason, officials do not support removing on-lent debt from being counted as owner-linked. If a shareholder borrows an amount and on-lends that, the shareholder is implicitly acting as a guarantor.
The issue of shareholder-guaranteed debt is less significant in the case of a company controlled by a single non-resident. In this case the worldwide group debt test can act to ensure only a reasonable amount of the worldwide group’s debt is allocated to New Zealand.
Shareholder guarantees could nonetheless be used to excessively gear the worldwide group. However, officials understand the concerns raised by submitters that a New Zealand company may struggle to get information about guarantees provided by shareholders of the ultimate parent company. On this basis, we recommend that shareholder-guaranteed debt not be treated as “owner-linked” in relation to a company controlled by a single non-resident. Officials will reconsider this position if evidence arises that guaranteed debt is being used to excessively gear a company’s worldwide groups.
Officials agree that related-party debt is not necessarily on terms different to arm’s-length debt. However, whether debt is truly at arm’s length can be difficult to determine. This was noted in the original issues paper on these changes. Further, even if related-party is truly at arm’s length, it can still be a substitute for equity. Officials therefore do not favour the submissions that arm’s length related-party debt, or arm’s length related-party debt that is not in proportion to equity, should be excluded from being owner-linked.
Recommendation
That the submission relating to upstream guarantees of third-party debt be accepted.
That the other submissions be declined.
Issue: Carve-out for widely held debt
Clause 94
Submissions
(Ernst & Young, KPMG, New Zealand Institute of Chartered Accountants)
Proposed section FE 18(3B)(c) provides an exemption to the requirement to exclude owner-linked debt. The exemption applies if a shareholder owns less than 10 percent of a member of the worldwide group and the financial arrangements held by the shareholder are traded on a recognised exchange.
The requirement for the debt to be traded on a recognised exchange is too restrictive. Limiting ownership interests to 10 percent should be sufficient. (Ernst & Young, New Zealand Institute of Chartered Accountants)
The requirement for debt to be traded on a recognised exchange should be sufficient as it would be difficult for shareholders to manipulate their debt funding when it is widely traded. The 10 percent ownership threshold is therefore not necessary. (KPMG)
A consequential amendment to the definition of “recognised exchange” will be required. As currently defined, a recognised exchange is limited only to an exchange for trading shares or options – not financial arrangements. (KPMG)
Comment
Officials agree that it would be difficult to manipulate a company’s debt financing through publicly traded debt where the debt is widely traded. Officials also agree that limiting the owner-linked rule to taxpayers with substantial interests reduces compliance costs, as it limits the number of shareholders that a company needs to investigate to determine if they hold owner-linked debt.
Officials therefore recommend that the exemption be changed so it applies when a person owns less than 5 percent of a member of the worldwide group, or when the debt of the person is widely traded on a recognised exchange.
The reduced ownership threshold is to counterbalance the removal of the recognised exchange requirement for minority shareholders. Officials note that, with a 5 percent threshold, a maximum of 20 shareholders would need to be considered by the company to determine if they hold owner-linked debt.
Officials note that this rule does not refer to interests held by associates for the purposes of the 5 percent ownership threshold. This is intentional. Otherwise the exemption’s purpose as a compliance reduction measure would be defeated. However, it is not intended to provide an opportunity for a non-resident with a significant interest in a company to avoid the application of the owner-linked debt rules by spreading their interests across numerous associated entities. We note that the general anti-avoidance provision may apply to this type of structure.
Finally, we agree that a consequential amendment to the definition of “recognised exchange” is required.
Recommendation
That the submissions be accepted, subject to officials’ comments on reducing the ownership interest threshold from 10 percent to 5 percent.
Issue: Direct ownership interests and amendments to section FE 41
Clause 94
Submission
(Ernst & Young)
Clarification is needed over whether an owner’s direct ownership interests should include the direct ownership interests held by their associates. This relates to the amendments to section FE 41 included in the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act 2014.
Comment
Consistent with the amendments to section FE 41 in the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Act, a person’s direct ownership interests do not include the interests of their associates.
Recommendation
That the submission be noted.