Chapter 3 - Suggested solution
3.1 Officials want to ensure that the current tax rules do not potentially hinder legitimate business structures or distort behaviour – for example, by driving investors to acquire 100 percent of a company solely to access the inter-corporate dividend exemption. Such a decision would not ordinarily make good business sense in the absence of tax as a factor.
3.2 Accordingly, the aim of any proposed solution will be to equalise the tax treatment between a wholly owned group engaging in loss grouping and a non-wholly owned group undertaking an equivalent loss grouping.
3.3 Officials therefore suggest that companies engaging in a loss offset should, by mutual agreement, be allowed to perform an “imputation credit transfer”.
3.4 The imputation credit transfer would involve, as part of a loss grouping arrangement, the loss company debiting its imputation credit account and the profit company crediting its imputation credit account by the same amount. It is proposed that the respective debit and credit to the imputation credit accounts would occur at the same time as the payment of the dividend by the profit company to facilitate the full imputation of that dividend.
3.5 Continuing on from the previous example the following diagrams set out how an imputation credit transfer would work in practice, and the effect on the imputation credit accounts of the loss company and the profit company.
3.6 As discussed previously, the profit company has a taxable profit of $20,000 and (through a combination of loss offsets and subvention payments) offsets the loss from the loss company of $10,000 giving a net taxable profit to the profit company of $10,000. $2800 income tax is then paid generating an imputation credit of $2800 as shown in Table 4.
3.7 Then subsequently when a dividend is paid by the profit company of its entire net of tax profit ($20,000 - $2800) = $17,200, an imputation credit transfer relating to the tax effect of loss offset $2800 can occur between the loss company and the profit company. The debit is shown in Table 3 and the credit in Table 4.
Diagram 2: Loss grouping by a 90 percent shareholding company with an imputation credit transfer
3.8 The following tables set out the relevant entries in the imputation credit accounts of the loss company and the profit company once the tax has been paid and the dividend made from ProfitCo to LossCo and Minority shareholder.
|Imputation credit transfer||$2,800||$2,800||Dr|
|Dividend received from ProfitCo||$5,040||$2,240||Cr|
|Dividend paid to Ultimate shareholder||$2,240||0|
|Imputation credit transfer||$2,800||$5,600||Cr|
|Dividend to ProfitCo||$5,040||$560||Cr|
|Dividend to Minority shareholder||$560||0|
3.9 The imputation credit transfer would mean that the profit company received extra imputation credits. This would enable the profit company to fully impute a subsequent dividend, as if it had paid tax on its taxable income before taking into account the loss grouping. This would consequently put the shareholders of the profit company in a better position, as the dividend they receive is more likely to be fully imputed.
3.10 The after-tax return to the shareholders, the tax paid by both the loss company and the profit company, and the imputation credit account balances are the same as they would be if the inter-corporate dividend exemption applied. If ProfitCo were instead a limited partnership, the tax paid and imputation credits generated would also be the same.
3.11 Other than the imputation shopping rules in paragraph 3.19 officials do not propose changing any other rules as a consequence of allowing companies to perform this imputation credit transfer. For example, the loss company would need to have sufficient imputation credits in its imputation credit account to undertake the transfer (although it may take into account the imputation credits it will receive when it receives the dividend) and no relief would be afforded if the loss company’s imputation credit account was in debit at 31 March each year as a result of debiting imputation credits for the purposes of the imputation credit transfer.
3.12 In practice, we anticipate that taxpayers would manage the imputation credits in their accounts. For example taxpayers could choose to prepay tax in order to generate imputation credits, and ensure that the loss company’s imputation credit account is not in debit at 31 March each year.
Details of the suggested solution
3.13 The imputation credit transfer mechanism would apply at the option of the participating companies. Companies that chose to use the mechanism would not be locked into using it every time they engaged in loss grouping in the future.
3.14 The two companies would be required to agree whether or not to use this proposed mechanism – this could not be a unilateral decision.
Other corporate structures
3.15 The example above involves a parent company in tax loss and a profitable subsidiary. However, loss grouping can also occur between a profitable parent and a subsidiary with tax losses, or sister companies (one in profit and one in loss).
3.16 Officials do not believe the proposed solution needs to be extended to a corporate group where the profit company is the parent and the loss company is the subsidiary. It is the profit company (parent) that requires the additional imputation credits to pay a fully imputed dividend to its shareholders and there is already a mechanism in the Income Tax Act 2007 – the taxable bonus issue – that allows a subsidiary to transfer imputation credits to its parent freely. Accordingly, if the loss company wanted to transfer imputation credits to its parent under the proposed mechanism, it is already able to do so under existing provisions.
3.17 Officials believe that the proposed imputation credit transfer mechanism should also be available to sister companies with a common corporate parent that owns between 66 percent and 100 percent of both the profit and the loss company. This is because the same issue arises if the profit company subsidiary has insufficient imputation credits as a result of a loss offset with its sister company to pay a fully imputed dividend to its parent company. The parent company in this scenario faces the same incentive to acquire 100 percent of the profitable subsidiary to access the inter-corporate dividend exemption. Therefore, the proposed solution should also be extended to this corporate configuration.
3.18 In this situation, as the common corporate parent rather than the profit company would receive the dividend, the profit company would not receive an imputation credit to offset the debit from the credit transferred to the loss company.
3.19 In this situation, compared with the examples previously outlined, there is greater potential for there to be an outstanding debit in the profit company with the attendant imputation credit shopping risks. For this reason the existing imputation credit shopping rules which apply to wholly owned groups that have loss balances will also be extended to groups where an imputation credit transfer has arisen.
Requirement to maintain an imputation credit account (ICA)
3.20 Only companies that are eligible to maintain an imputation credit account (mainly New Zealand resident companies) would be able to elect to undertake an imputation credit transfer.
Timing of the imputation credit transfer
3.21 Officials propose that the imputation credit transfer (both the debit and credit) should occur at the same time the profit company pays the dividend which utilises the imputation credits. This is the time at which the issue of insufficient imputation credits arises and mitigates the risk that this mechanism could be used as a way of imputation credit shopping. It removes the need for a claw-back mechanism if a loss company transfers imputation credits to a profit company and then liquidates with a debit balance in its imputation credit account.
3.22 However the imputation credit shopping risk can still arise in situations involving sister companies and so the proposal to extend those rules to companies who leave a group but have previously made an imputation credit transfer should mitigate against this risk.
3.23 Officials acknowledge that the profit company may choose the timing of its dividend payment unilaterally, and it could occur at a time that is difficult for the loss company in terms of a requirement to debit its imputation credit account. For example, the dividend payment might occur very shortly before 31 March. In this case the imputation credit transfer could result in the loss company having a debit balance in its imputation credit account at 31 March and not having time to remedy this. However this is unlikely to occur as a matter of course, because:
- where the loss company is the company that is receiving the dividend, it will receive imputation credits attached to that dividend that will offset the debit that has arisen to its imputation credit account as a result of the imputation credit transfer (noting that the debit does not arise until the profit company pays the dividend);
- there is likely to be a high level of coordination between the profit and loss companies required to effect loss grouping, and the need for a mutual imputation credit transfer election, such that in practice this timing requirement should not be problematic; and
- the proposed imputation credit transfer is elective, and companies are unlikely to apply it if it were to result in a loss company having a debit balance in its imputation credit account at 31 March.
3.24 There could be a substantial period of time (even years) between the loss grouping and the subsequent payment of dividends by the profit company. This would require companies to track their loss grouping transactions and ensure they complete the relevant imputation credit transfer elections at the appropriate time.
3.25 Further detail on this process is covered below. It is also possible that when the time comes for the profit company to pay a dividend, the loss company may not be in a position to be able to transfer imputation credits or may have even ceased to exist. These practical difficulties need to be balanced against the need to protect the tax base (as discussed above). Officials propose the risk to the tax base could be partially mitigated by only allowing an imputation credit transfer within four years of the balance date of the return that included the loss grouping.
How many credits should be transferred?
3.26 Officials propose that the amount of credits which would be able to be credited (and debited) will be capped. The upper level which is proposed is:
( amount of subvention payment + amount of loss offset election ) x the company tax rate
3.27 In the example above, this means that the maximum number of imputation credits which could be transferred would be $2,800 (($2,800 subvention payment + $7,200 loss offset election) x 28%). The companies could agree to credit and debit a smaller number of imputation credits, so long as the credit and debit amounts were equal.
3.28 Officials propose that both companies would need to inform the Commissioner of their election to engage in the imputation credit transfer as part of filing the imputation credit account return that included that transfer. Similar to the current loss grouping notification requirements, the prescribed form will require:
- the names and IRD numbers of both parties to the imputation credit transfer;
- the quantum of imputation credits debited and credited from and to each account;
- identification of the return that included the original loss grouping transaction;
- the quantum of losses grouped and the respective amounts of subvention payments/loss offset elections; and
- the date of the imputation credit transfer that the dividend was declared by the profit company.
3.29 Both companies would already be filing imputation returns (the IR 4J) and therefore, in addition to the notification to the Commissioner, they would need to include the amount of the transfer in the IR 4J. The two companies would simply be required to include the amount of the imputation credit transfer in the boxes labelled “other” for their relevant debit and credit.
3.30 If a loss company which has undertaken a loss offset has an amended assessment and its loss is consequently reduced below the level of the amount which was eligible to be offset, the Commissioner may amend the assessment of the profit company. Similarly, if a profit company which has undertaken a loss offset has an amended assessment and has reduced profits, the offset is only valid up to the amount of the reduced profits.
3.31 In these cases, corresponding adjustments may need to be made to the imputation credit accounts and other returns of the affected companies.
3.32 Officials are interested to hear whether such adjustments are likely to give rise to problems in practice and, if so, how these problems could be mitigated.