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Inland Revenue

Tax Policy

Chapter 9 - Dividend simplification


9.1 In addition to changes to the LTC rules, the review has considered whether changes should be made to the rules around distributions/dividends made by close companies that are not LTCs, and not in many cases QCs. The issues that we have been considering in this area are:

  • ways to ensure that genuine capital gains made by small businesses do not become taxable merely because there is a transaction involving an associated party. There is scope to liberalise the current restrictions in this area;
  • whether resident withholding tax (RWT) obligations can optionally be removed from small companies, subject to the company or its directors providing guarantees. This would be designed to reduce an area of compliance costs;
  • likewise, whether the requirement to deduct RWT from fully imputed dividends between companies could be optionally removed;
  • ways of streamlining RWT obligations when cash and non-cash dividends are paid concurrently. Again this would reduce compliance costs and produce more sensible outcomes;
  • whether small businesses could be given the option of treating shareholder salaries as subject to a combination of PAYE and provisional tax. This would be aimed at providing businesses with greater flexibility.

Tainted capital gains when capital asset sold to non-corporate associated person

9.2 This issue concerns the distribution of capital gains and the associated party rules, particularly where there is a family business reorganisation. The basic issue can be illustrated by the following example:


Mark is the sole shareholder of C Ltd, which purchases two farms for $100,000 each. Mark has two sons, Henry and James, who each live on one of the farms. When Mark retires, his shares in C Ltd are transferred to his sons equally.

Soon after, Henry’s farm is transferred from C Ltd to himself. The transaction is concluded by Henry selling his shares to James for $150,000 (actual market value) and using the proceeds to buy the farm on which he resides also at the market value of $150,000; there is, prima facie, a $50,000 capital gain for C Ltd.

When C Ltd eventually liquidates, a $50,000 taxable dividend arises on the distribution of the gain from the sale of Henry’s farm, because it was transferred to an associated person.

The $50,000 gain does not qualify as a capital gain of the type that can be distributed tax-free under the company liquidation rules, because of the sale from C Ltd to Henry was to an associated person. Consequently, the gain is referred to as being ‘tainted’.

9.3 The policy rationale for treating a gain from the sale of an asset to an associated person as tainted is to prevent an asset being transferred around a group of companies for the purposes of creating additional amounts of capital reserves that may be distributed tax-free. The restriction dates back to the 1980s.

9.4 The original rationale only holds if the sale is to a company, but in practice the restriction also encompasses genuine transactions where the sale is not to a company. In other words, the restriction seems to extend beyond its intended ambit. Companies can be inadvertently caught by the rule, resulting in their being unable to be subsequently liquidated without a tax impost.

Proposed solution

9.5 To reduce the ambit of the restriction, we propose that the tainting rules should not apply when the associated person purchaser is not a corporate. This amendment would be restricted to companies meeting the current definition of “close company”, that is, a company that has five or fewer natural persons the total of whose voting interests in the company is more than 50 percent (treating all natural persons associated at the time as one natural person).

Potential related issue

9.6 It is not uncommon for a family-type company to go through a development phase and then either its shares or its assets are sold to a different organisation. When the former owners of the company have no interests in the new organisation this yields a non-tainted result.

9.7 However, when the acquiring organisation is a company in which the former owners end up owning shares as a result of the transaction, they might end up being associated persons. This would result in a tainted capital gain. We are hesitant to make changes in this area given the scope for inflating gains, the rationale behind the limitation. However, we will continue to analyse the issue and invite submissions on it.

Tainted capital gains when capital asset owned by more than one company in a group of companies

9.8 A similar concern about a possible over-valuation arises when a capital asset moves around a group of companies. This can be illustrated in the following example:


A Ltd and B Ltd are 100 percent commonly owned group companies. A Ltd purchases a property for $100. Several years later A Ltd sells the property to B Ltd for $1,000. A Ltd records a gain on sale of $900.

Several years later, Person Z, who is not associated with A Ltd and B Ltd, purchases the property from B Ltd for $1,200 and A Ltd and B Ltd are then liquidated.

Under current law, a taxable dividend of $900 arises from A Ltd on liquidation because the property was sold to an associated person (B Ltd) and therefore the gain is not recognised as a capital profit. B Ltd can distribute $200 tax-free to its shareholders (being $1,200 less $1,000).

Had the property not been transferred between A Ltd and B Ltd, but instead brought by a non-associated person/company for $1,200 shortly before A Ltd’s liquidation, the full $1,100 gain ($1,200-$100) could have been distributed tax-free.

Proposed solution

9.9 When there is a group of companies and one of the companies sells an asset to an unrelated third party, the extent to which the capital profit on the sale would qualify for a tax-free distribution on liquidation would be determined with reference to the original cost of the asset, ignoring any tainted gains arising from previous intra-group sales of the asset.

9.10 There would be no limit on the type of companies to which this could apply.

RWT compliance issues

9.11 There are several issues with the application of RWT to dividend and interest payments made by closely held companies to their shareholders.


9.12 Subject to the attachment of imputation credits, the RWT rate on dividends is a flat 33%. The lowering of the company tax rate to 28% means that even fully imputed dividends must have RWT deducted. This creates a compliance burden on companies, and in particular SME companies that pay fully imputed dividends. It also creates over-taxation for corporate shareholders who suffer RWT deductions from fully imputed dividends and for individual shareholders who are not on the top personal tax rate. Any excess RWT then needs to be claimed as a refund when the tax return for the relevant income year is filed, which not only means refund delays but also a compliance burden on those individuals who may not otherwise have had to file a return.

9.13 Two specific compliance issues that have been raised with us in relation to the timing of dividend payments and associated RWT deductions are:

  • RWT is due the month after the dividend is “paid”, but for many companies the dividend’s quantum is sometimes not determined until after this time.
  • It is common practice to retrospectively clear a shareholder’s overdrawn account by a year-end credit for dividends. This credit is deemed to arise on the later of the first day of the relevant income year or the date the “loan” (by way of overdrawn account) was made; so that no tax or FBT arises on the “loan”. However this treatment does not apply if tax is deducted from the dividend. Because the company tax rate change means that RWT is now required to be deducted from all dividends, whether fully imputed or not, the ability to backdate a dividend to clear an overdrawn account no longer exists.


9.14 On interest, the RWT varies according to the shareholder’s marginal tax rate. It is common for companies to pay interest to associated persons. Again, if RWT on this interest did not need to be accounted for there would seemingly be compliance savings for the payer.

9.15 These matters were considered in the review.

Possible solution

9.16 One possible solution would be to allow a close company to elect to remove RWT on its dividends, and possibly interest payments, to shareholders (and persons associated with shareholders), subject to the directors of the company providing a guarantee that they will pay the tax on any untaxed part of the imputed dividend or interest payment should the shareholders fail to do so. A directors’ guarantee would be considered a necessary backstop even though the shareholders and the company would be likely to be closely linked.

9.17 There would be both compliance cost savings for the paying company and very likely administration cost savings with this approach, especially when returns are manually prepared. However, some of the compliance costs would be switched from the payer to the recipient. Some recipients of the dividends or interest may face increased compliance costs through having to file a tax return when they would not otherwise have to do so and/or through having to pay provisional tax when they are currently under the provisional tax threshold.

9.18 The optional removal of RWT would also give rise to fiscal costs from the deferral of tax. Some of this deferral is transitional, involving the deferral of tax that would have been paid in the first year of the change as RWT to its being paid as a combination of terminal tax and higher provisional tax payments in the following year. This one-off retiming of payments accounts for much of the deferral. However, there is also a permanent deferral for those who would have had RWT deducted in the current year but who instead for all future years pay the tax by way of terminal tax in the following year. Added to this is a higher potential for non-compliance in the absence of a withholding tax. Our best estimates of these various elements in combination is as follows:

Optional removal of: Year 1
Year 2
Year 3
Year 4
Year 5
Table 7: Fiscal costs of possible RWT solutions
RWT on dividends  -145 +102 -4 -4 -4
RWT on interest -161 +117 -2 -2 -2

9.19 It is not clear that the possible compliance savings warrant incurring such fiscal costs. In these circumstances, these matters would best be considered in the wider context of the work being undertaken to streamline business tax processes, as discussed in the Government green paper Making Tax Simpler (March 2015). Part of this work involves looking at ways to streamline the methods for paying tax more generally.

9.20 In deriving these estimates, it is assumed that the dividend RWT is received in the fiscal year before it is claimed by the receiving shareholders. However, it has been suggested to us that the recognition of some dividend RWT payments may in fact arise later. We are interested in feedback on what is the current practice in terms of paying the RWT, including in relation to clearing a shareholder’s overdrawn current account.

Associated issue – RWT on dividends between companies

9.21 The lowering of the company tax rate to 28% has also meant that even fully imputed dividends between companies are subject to RWT unless they are part of the same wholly owned group or the recipient holds a certificate of exemption. Giving the paying company the option of not withholding RWT in such cases would lower compliance and administration costs in relation to those companies who are able to readily identify their corporate shareholders. This should be of benefit to a wide range of companies. It is expected to have only a transitional fiscal cost ($9m, in the first year of application).

Proposed solution

9.22 When a fully imputed dividend is paid to another company, applying RWT to that dividend would be optional.

Cash and non-cash (taxable bonus) dividends

9.23 The contemporaneous payment of a cash and non-cash dividend (such as a taxable bonus issue) is regarded as being two separate dividends. Consequentially, the RWT can be higher than it should.

9.24 Sections RE 13 and RE 14 of the Income Tax Act, respectively, deal with the amount of RWT necessary for cash and non-cash (other than taxable bonus issues) dividends, as follows:

Cash dividends

9.25 The section RE 13 formula is:

RWT = (tax rate × (dividend paid + tax paid or credit attached)) – tax paid or credit attached


tax rate is the basic tax rate applying to dividends, that is 33%;

dividend paid is the net amount of the dividend before the addition of credits;

tax paid or credit attached is imputation credits and FDP credits (or foreign withholding tax paid or payable on the dividend where the company is not resident in New Zealand).


A cash dividend of $72 with imputation credits of $28, and no FDP credits:

RWT = (0.33 × ($72 + $28)) – $28 = $5

Non-cash dividends other than bonus issues in lieu

9.26 The section RE 14 formula is:

RWT = (tax rate × dividend paid / (1 – tax rate)) – tax paid or dividend attached

9.27 The key point is that “dividend paid / (1 – tax rate)” is a gross-up calculation to allow the gross dividend including both imputation credits and RWT to be calculated.


A non-cash dividend of $72 with imputation credits of $28, and no FDP credits:

RWT = (0.33 × $72 /(1 - .33)) - $28 = $7.46

The gross dividend in this case is, therefore, $72 + $28 + $7.46 = $107.46,[36] in other words the dividend has been grossed-up for the RWT amount. This is because RWT cannot be deducted out of a non-cash amount.

9.28 Now take the situation where both a cash dividend and a non-cash dividend are paid out contemporaneously with the objective of using the cash dividend to pay the RWT on both the cash dividend and the non-cash dividend. In such a situation gross-up should be unnecessary.


A cash dividend of $5 and non-cash dividend of $67, with imputation credits over both dividends of $28.

Intuitively, this is equivalent to a gross dividend of $100 with imputation credits of $28, on which RWT would be $5, with no gross-up necessary. However, under the current legislation, a gross-up is required on the non–cash dividend.


9.29 The proposal is to provide the option of combining cash and non-cash dividend payments as a single cash payment, where the cash dividend alone is sufficient to cover the total RWT.

9.30 A legislative amendment would be required to enable the two dividends to be treated as a single dividend. It would only apply when the cash dividend was sufficient to cover the RWT for both dividends (so RWT would be paid by deduction, rather than gross-up). In such cases, the term “dividends paid” in section RE 13 would include both the cash and non-cash dividends, that is, the formula for determining the amount of RWT would be:

tax rate × (cash dividend + non-cash dividend + tax paid or credit attached) – tax paid or credit attached

9.31 There would be no limit on the type of companies to which this could apply, although it is likely to be particularly relevant for closely-held companies that are not LTCs.

Shareholder salaries

9.32 Shareholder salaries are theoretically either totally subject to PAYE or not subject to PAYE at all. There have been suggestions that allowing a combination of PAYE and provisional tax would be helpful, in particular when the base amount is subject to PAYE.

9.33 Under section RD 3, a shareholder-employee in a “close company” who either:

  • does not derive as an employee salary or wages of a regular amount for regular periods of one month or less throughout the income year or that total 66 percent or more of their annual gross income in the corresponding tax year as an employee, or
  • is not paid an amount as income that may later be allocated to them as an employee for the income year,

can choose to treat all amounts paid to them in the income year in their capacity as an employee as not subject to PAYE. This “no PAYE” option is designed to deal with situations where the annual “salary” is not known until after year-end – that is, it is dependent on the year-end results. The employee then includes the income in their tax return and there may be provisional tax implications.

9.34 The provision predates imputation and, therefore, focuses on preventing double taxation of “family” type companies by allowing pre-tax profits to be designated as shareholder’s salary in qualifying circumstances. This payment mechanism is still widely accepted and used today.


9.35 A combination of PAYE on some payments and no PAYE on others should be an option available to shareholder-employees of close companies. This would be available when a base salary is provided to the employee (which would be subject to PAYE) but the overall salary payments would not be known until after year-end because it is dependent on the year-end results. Such an approach, if adopted, should be applied consistently from year to year so that a shareholder-employee should not be allowed to swap in and out of the provisional tax regime.

9.36 This change would also impact on QCs as well as other closely controlled companies given the current definition of “close company” in the Income Tax Act.


[36] Tax at 33% on this gross amount of $107.46 equals the sum of the tax credits ($28) and RWT ($7.46), that is $35.46.