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Inland Revenue

Tax Policy

Chapter 4 - International aspects – foreign income and non-resident ownership


4.1 Currently there is no restriction on foreign investments by LTCs or on a LTC having non-resident shareholders. A LTC can earn foreign income and, unlike a QC, is not restricted to earning a maximum of $10,000 non-dividend foreign income.

4.2 This open approach raises several policy issues:

  • it allows LTCs to be used to avoid the features of the imputation system that apply to foreign income and allows branch losses to be applied against individual income; and
  • it provides a relatively low-cost conduit structure for non-residents to utilise.

4.3 The issue of whether LTCs should be used as a vehicle for cross-border investment has not been closely examined from a policy perspective before. A key aspect to consider is whether the rules for LTCs in respect of cross-border investment are consistent with the general policies underpinning New Zealand’s international tax rules more generally. There are also some concerns that LTCs could be used as part of a conduit arrangement.

Policy considerations

4.4 There are three scenarios in the international context:

  • A non-resident investing in New Zealand assets through a LTC.
  • A New Zealand resident investing offshore through a LTC.
  • A LTC owned by a non-resident with only foreign assets (the conduit case).

A non-resident investing in New Zealand assets through a LTC

4.5 In respect of the first scenario, flow-through treatment means that the non-resident owner of the LTC will be taxed only on their New Zealand-sourced income. Source taxation may also be reduced or eliminated under New Zealand’s double tax agreements.

4.6 In this context hybrid entity mismatches where an entity is treated as flow-through in one country but not in another, which could be the case with LTCs,[22] are under scrutiny by the OECD as part of its work on base erosion and profit shifting (BEPS). The OECD is developing recommendations for domestic rules intended to neutralise the tax effect of hybrid mismatches and New Zealand is looking at the suitability of implementing these recommendations.

A New Zealand resident investing offshore through a LTC

4.7 As discussed earlier, LTCs are designed for investments that would be made by an individual or small group of individuals, including through a family trust, but for the fact that the investors decide on a limited liability structure. This prevents tax being a distorting factor in what would otherwise be a commercial decision to incorporate. This distortion is less obvious when it comes to some forms of outbound investment. In many situations, making a significant outbound active investment, which typically is of a more significant scale, without the protection of a limited liability structure for the offshore investment would not be commercially realistic.

4.8 The QC regime requires that a company cannot earn more than $10,000 a year of non-dividend foreign income. The reason for this requirement was largely because of the concern that some foreign income earned at the QC level could be distributed to shareholders tax-free, as unimputed dividends paid by QCs are tax exempt. At the time the LTC rules were being developed, a similar restriction was considered not to be necessary because the look-through mechanism would ensure that foreign income would be taxed at the appropriate marginal tax rate when attributed to shareholders. However, the availability of foreign tax credits to offset some or all of the New Zealand tax owing adds a further overlay.

4.9 New Zealand’s imputation system means that preferences earned by companies, such as foreign tax credits, are not passed through to shareholders.[23] This has been a cornerstone of New Zealand tax policy since the late 1980s.[24] Arguably, allowing LTCs to earn significant income offshore is not consistent with this policy given that any foreign tax credits flow through to LTC shareholders. On the other hand, the counter argument is that those credits would be available if the individual shareholders invested directly.

4.10 LTCs also allow foreign branch losses to be applied against individual income, which creates a coherence risk. This is because the branch may be converted to a foreign company when it becomes profitable and, therefore, the foreign branch loss is never recaptured by future foreign income – instead it is available to offset domestic income. This possibility can arise with company offshore investment generally, although in the case of a LTC there may be an additional risk from being able to flow losses back to shareholders where they can be offset against the shareholder’s non-business income.

4.11 Foreign personal services income, on the other hand, may not raise the same concerns. Also, the concerns around direct outbound investment via LTCs may not be an issue in practice as only a very small proportion of LTCs (around 0.5 percent) earn foreign income and the vast bulk of those that do, earn less than $10,000 of foreign income (see Tables 11 and 12 in Appendix 1 for more detail).

  Number of LTCs with foreign income Total foreign income Total FTCs Number of LTCs with foreign losses Total foreign losses
Table 4: Foreign income/losses and foreign tax credits earned by LTCs
2012 184 $217.1m $7.2m 14 -$0.2m
2013 239 $29.8m $6.7m 21 -$1.4m
2014* 273 $36.2m $6.0m 24 -$3.9m

*almost a complete year

Conduit investments

4.12 LTCs were designed as a domestically focussed vehicle, not as a vehicle for conduit investment. There are reputational risks with allowing conduit structures and there is some anecdotal evidence that LTCs have been used to facilitate illegal activity, though they are not the only vehicle to be so used.

4.13 In saying this, however, it is not intended to deny access to the LTC regime when shareholders have a connection to New Zealand and there are no potential reputational concerns, such as if a New Zealand family business has a shareholder that relocates to Australia for personal reasons.

4.14 Apart from reputational risks, there is the question of whether there are revenue risks associated with allowing conduit investments via a LTC. Our conclusion is that although there is some risk, it is not a major issue, for the following reasons:

  • Unlike ordinary companies, LTCs do not benefit from the interest deduction provision (section DB 7 of the Income Tax Act) that provides that a company’s interest expenses require no nexus with income to be deductible. This means that, on its face, a non-resident shareholder in a LTC could not deduct their share of a LTC’s interest expense incurred to derive foreign income.
  • Furthermore, an interest expense incurred by a LTC will be subject to the thin capitalisation rules to the extent it is owned by non-residents. The thin capitalisation rules restrict debt deductions based on a person’s assets that are within the New Zealand tax base. As such, a non-resident with shares in a LTC with both foreign and New Zealand assets will not be able to deduct any more interest under the thin capitalisation rules than if the LTC had only New Zealand assets. There is scope however, for LTCs to be geared up to the 60 percent safe harbour – even if that funding is, in substance, being used to fund offshore assets.

Proposed approach

4.15 We consider the status quo should be retained for LTCs that are used either for onshore investment into New Zealand or offshore investment out of New Zealand. This is an “on-balance” decision taking all the above factors into account. If, in the future, concerns emerged about the efficacy of the imputation system or about the material erosion of the tax base, we would need to revisit this decision. In doing so, we would want to consider the use of similar vehicles such as limited partnerships and trusts for inbound and outbound investment.

4.16 We do, however, consider it appropriate to restrict the ability for LTCs to earn offshore income in the conduit context.

4.17 One option for this restriction would be to apply the foreign income restriction in the QC rules, where there is effectively a cap on non-dividend foreign income. However, this approach might be viewed as unduly restrictive outside of the conduit situation, such as in cases when there might be a genuine option for an individual to earn foreign income through personal services.

4.18 Therefore, the proposal is to restrict the extent to which a company can derive foreign income and retain LTC status if it is controlled by non-resident shareholders. In order to retain LTC status when more than 50 percent of the shareholding in a LTC is held by non-residents, the LTC’s annual foreign income[25] would have to be restricted to the greater of $10,000 or 20 percent of the LTC’s gross income. This would be made an entry criterion. If this condition is breached during the income year, LTC status would be revoked for that year and any subsequent year that the condition was not met.

4.19 This approach should ameliorate any reputational risks related with conduit investment while providing flexibility for some degree of combined non-resident shareholding and foreign income. It should prevent a domestic family business inadvertently falling outside the rules through an owner emigrating.

4.20 It is important to note that addressing the LTC aspects of conduit investment does not necessarily mean that we are comfortable with conduit investments being made through other structures. Any wider review would, however, need to be undertaken as a separate project. As a general matter, we propose to monitor how different entities are used cross-border, especially in light of BEPS concerns and the broader international tax framework.


[22] For example, a LTC is a look-through vehicle in New Zealand but is treated as a company for tax purposes in Australia.

[23] The theory is that this helps to incentivise investors to make foreign investments only when it is in the interests of New Zealand as a whole.

[24] This policy position was confirmed during the International Tax Review, and also when New Zealand’s position on mutual recognition of imputation credits was reviewed.

[25] This would be all foreign income, not just non-dividend foreign income. The current QC restriction of $10,000 “foreign” income excludes passive dividend and interest income from overseas. However, given that the concern is particularly in relation to reputational risk, with some LTCs being used as tax sheltering/laundering vehicles, then including all foreign income in the proposed conduit limitation rule seems appropriate.