- PIE and unit trust remedials
- Working for Families abatement rates and thresholds
- Interaction between Best Start and paid parental leave
- Parental tax credit clarification
- GST remedial amendments
- Financial arrangement rules – treatment of foreign currency agreements for the supply of goods and services
- Residential and main home exclusions
- FIF cost method
- Resettlements of trusts
- Binding rulings and record-keeping requirements
- Trust rules
- Tax rules for deregistered charities
- Not-for-profits remedials
PIE AND UNIT TRUST REMEDIALS
(Clauses 167, 213(18), 214 and 217)
Summary of proposed amendment
The Bill makes two remedial amendments to the portfolio investment entity (PIE) rules and a remedial amendment to the public unit trust rules.
The proposed amendments to the PIE rules will come into force on the date of enactment.
The proposed amendment to the public unit trust rules will apply for the 2008–09 and later income years to align with the start of the Income Tax Act 2007.
Wind-up of a listed PIE
A listed PIE is an entity type for companies that are listed on a recognised exchange in New Zealand and meet a number of other requirements. Like other types of PIEs, a listed PIE has a number of benefits over a non-PIE, such as the ability to distribute income, including capital gains, without further tax in the hands of the investor.
The eligibility requirements to become a listed PIE include a two-year transitional period for an entity intending to become a listed PIE. This transitional period allows an entity that is not listed on a recognised exchange to become a listed PIE provided it:
- has 100 shareholders or more;
- has resolved to become a company listed on a recognised exchange in New Zealand if it were to obtain the required consents;
- has applied to the Financial Markets Authority for an exemption from disclosing in a product disclosure statement its intention to become a listed company; and
- satisfies the Commissioner that the company would apply to become a listed company if it were to obtain the required consents.
If the company becomes a listed PIE under these criteria but is not listed on a recognised exchange within two years, it will lose its listed PIE status unless the Commissioner of Inland Revenue considers it is reasonable to grant an extension.
The listed PIE rules do not include an equivalent provision for a listed PIE delisting as part of the process of winding up. The consequence of this is a distribution by a listed PIE while it is listed on a recognised exchange and a distribution by a former listed PIE once it is delisted will be subject to different tax rules.
It is not possible for a PIE to remain listed on a recognised exchange until after it has made its final distribution.
For a listed PIE that seeks to continue without being listed on a recognised exchange, there are other options available, such as becoming a multi-rate PIE. However, compliance with the multi-rate PIE rules requires systems and investor information that would not typically be available to a listed PIE so this option is not practical for a listed PIE that intends to wind-up.
The Bill proposes to allow a listed PIE to retain its PIE status for up to two years, or longer if the Commissioner considers it reasonable, after it ceases to be listed on a recognised exchange if this cessation is part of the wind-up process. This would be achieved by replacing section HM 28 so that a listed PIE can elect under existing section HM 29, prior to delisting, that it will cease to be a PIE at a future date. This will provide the PIE with up to two years, or longer if the Commissioner considers it reasonable, to distribute its remaining assets.
PIE status for a listed PIE using this method will be lost at the earlier of:
- two years (or longer) from the date the listed PIE is delisted;
- the date specified in the HM 29 election; or
- when the number of shareholders reduces below 100.
The Bill also proposes two changes to the definition of a listed PIE in section YA 1:
- paragraph (a) is extended to include a listed PIE going through the wind-up process described above; and
- paragraph (c) and (d) are to be repealed as they duplicate conditions that are already covered by section HM 7. This change is not intended to alter how the rules operate.
These amendments are proposed to apply to listed PIEs removed from a registered exchange after the date of enactment.
PIE maximum investor interest exemption for Northland Regional Council
The Bill proposes to add Northland Regional Council to schedule 29 of the Income Tax Act 2007. This will allow the council to own up to one hundred percent of a PIE without the PIE breaching their minimum number of investor or maximum investor interest requirements, which are normally 20 investors and no investor with more than twenty percent respectively. Northland Regional Council invests for the benefit of Northland ratepayers and therefore it’s holding of a majority interest in a PIE is equivalent to the PIE itself being widely held. Schedule 29 already includes a number of similar vehicles including Auckland Council and Quayside Holdings Ltd which is the investment arm of Bay of Plenty Regional Council.
This amendment is proposed to apply to investments by Northland Regional Council after the date of enactment.
Notional single person concession for public unit trusts
Minimum shareholder continuity requirements are imposed on companies, including unit trusts, for the carry forward of tax losses and imputation credits. Exemptions to these continuity requirements apply when shareholding changes are between less than ten percent holders and a number of other requirements apply – referred to as the notional single person concession.
A public unit trust is a defined term that covers unit trusts meeting one of a number of criteria indicating the unit trust is widely-held by unassociated persons. This definition was introduced to further extend the shareholder continuity exception to unit trusts by treating a public unit trust as being held by a notional single person that:
- is not a company;
- exists as long as the unit trust exists; and
- holds nothing other than the shares in the unit trust.
However, the notional single person concession applies only where the public unit trust chooses to apply it. This optionality was included so that a public unit trust would not be disadvantaged by introducing the concession, for example if the existing unit holders in the public unit trust were deemed as selling all their units to this notional single person and therefore breaching shareholder continuity.
The current legislation assumes that a public unit trust will choose to apply the notional single person concession where it is advantageous to do so. However, the notional single person concession is also intended to apply to a chain of companies (or other entities) owned by that public unit trust including where the public unit trust is not a New Zealand tax resident. In this circumstance the public unit trust may not have chosen to apply the notional single person concession as they do not have a New Zealand tax liability and obtain no direct benefit from making this choice even though an entity they own would benefit.
A widely-held unit trust meets the definition of a public unit trust but has no association with New Zealand other than wholly owning a New Zealand incorporated company. During a certain period, there have been no ownership changes in the New Zealand incorporated company but the unit trust has had a number of ownership changes. The New Zealand company can rely on being owned by a public unit trust that is owned by a notional single person, and therefore not forfeiting losses or imputation credits because of a breach of shareholder continuity, but only if the public unit trust chooses to apply the notional single person concession. As the unit trust has no dealings with the New Zealand tax system they have not chosen to apply the notional single person concession even though there is no disadvantage in doing so.
The Bill proposes to allow a taxpayer who is, directly or indirectly, wholly or partially owned by a public unit trust to choose the treat the public unit trust as applying the notional single person concession without the public trust having to separately choose to apply it.
As this change is consistent with the existing policy intent and some taxpayers owned by public unit trusts may have already been applying the rules in this manner, the amendment is proposed to apply for the 2008–09 and later income years to align with the start of the Income Tax Act 2007.
WORKING FOR FAMILIES ABATEMENT RATES AND THRESHOLDS
(Clauses 179, 183, 184, 260 and 261)
Summary of proposed amendment
The average abatement rate, threshold and family tax credit rate should be repealed as they are no longer required.
The proposed amendment will apply from 1 July 2018, the date the changes to Working for Families take effect.
The Working for Families tax credit average abatement rate, threshold and family tax credit rates for the 2019 tax year would be repealed.
The Families Package legislation increased the Working for Families tax credit abatement rate from 22.5% to 25% and the abatement threshold from $36,350 to $42,700 a year from 1 July 2018. The family tax credit rates for most children also increase from 1 July 2018.
The changes are effective part way through the 2018–19 tax year. The Act sets out an average abatement rate, threshold and family tax credit rates for that year. The average rates assume that the family earns income evenly across a year and claims tax credits for the whole year. The end-of-year reconciliation (or square up) ensures the correct amount of tax credits have been paid relative to the family’s actual income and circumstances over the year and uses the average annual figures.
However, the end-of-year process is being built in START, Inland Revenue’s new computer system. This means that it is possible to make the reconciliation process more accurate. It is proposed that the actual income earned before 1 July will be reconciled using the old abatement rate and threshold and the income earned from 1 July will be reconciled using the new rate and threshold. This means that the average annual rates are no longer required.
INTERACTION BETWEEN BEST START AND PAID PARENTAL LEAVE
Summary of proposed amendment
A clarification is proposed to ensure that a person can receive paid parental leave and the Best Start tax credit for the same child.
The proposed amendment will apply from 1 July 2018, the date the Best Start tax credit takes effect.
It is proposed when a person receives paid parental leave for a child, they would also be entitled to receive any Best Start payments for that child.
The Families Package legislation includes the introduction of the new Best Start tax credit. It was intended that a person could receive paid parental leave and once it ceases to be payable, Best Start payments should be made for the rest of the eligible period. This prevents a person getting paid Best Start and paid parental leave at the same time for the same child. However, as currently drafted, if a person receives paid parental leave, they are not entitled to receive any Best Start payments for that child. It is proposed that the legislation be amended to reflect the policy intent.
PARENTAL TAX CREDIT CLARIFICATION
(Clauses 180–182, 263, 264 and 269)
Summary of proposed amendment
A minor retrospective technical amendment is required to enable the parental tax credit to be paid on a pro-rata basis to qualifying persons to reinstate the original policy intent.
The proposed amendment will apply from 1 July 2002, the date the amendment took effect.
The parental tax credit would be paid on a pro-rata basis to qualifying persons.
In implementing the Families Package, an issue has been identified with the current wording of the parental tax credit. The Families Package repeals the parental tax credit for children born on or after 1 July 2018 but is still available for children born before that date. The issue is an unintended consequence of an earlier amendment.
In 2002, an amendment inadvertently resulted in the removal of the ability to pay the parental tax credit on a pro-rata basis. The parental tax credit is not available if the person is in receipt of a specified payment (for example, a Ministry of Social Development benefit), or has a suspended entitlement to such a benefit, or if they claim paid parental leave.
However, the original policy intent was to permit the payment of the parental tax credit for the days when there was no such payment of a Ministry of Social Development benefit. Inland Revenue has continued to make pro-rata payments to qualifying persons inadvertently, contrary to the effect of the 2002 amendment.
A minor retrospective technical amendment is recommended to enable the parental tax credit to be paid on a pro-rata basis to qualifying persons to reinstate the original policy intent.
GST REMEDIAL AMENDMENTS
(Clauses 223 and 225–228)
Summary of proposed amendment
A number of minor amendments to the Goods and Services Tax Act 1985 are proposed where the legislation does not technically give effect to the policy intent, or where there are obvious errors.
The proposed amendments will come into force on the date of enactment, with the exception of clauses 228 and 225. Clause 228 will apply on and after 1 April 2011. Clause 225 will apply on and after 1 October 2016.
The following proposed amendments clarify the relevant legislation, or correct a clear error.
Exemptions to the requirement to make an adjustment (clause 226)
Section 21(2) currently states that a person is not required to make an adjustment if one or more of the criteria listed in paragraphs (a) to (d) apply. Inland Revenue’s interpretation of this current drafting is that it prohibits a person from making an adjustment if any of the criteria listed apply. However, it is possible that some are interpreting the section as meaning that it allows but does not require adjustments when any of the criteria listed apply.
The amendment clarifies that a person may not make an adjustment if one or more of the criteria listed in section 21(2) apply, consistent with Inland Revenue’s interpretation of the current drafting.
Notification to the Commissioner of a change in company constitution (clause 227)
A registered person is required to notify the Commissioner within 21 days of a change in status. Changes in status include changes to a registered person’s name, address, constitution or principal taxable activity or activities.
The amendment will remove the requirement for a registered person to notify the Commissioner of a change in constitution, as this information is generally not necessary or relevant to Inland Revenue’s operations and it would only be in extremely rare circumstances where a change in a company’s constitution may have an impact on its GST position.
Outdated references to the former principal purpose test in section 55(7) (clause 228)
Section 55(7) of the Goods and Services Tax Act 1985 contains the rules for GST groups. Under the previous apportionment rules (which were based on the “principal purpose” test for deducting input tax), section 55(7)(db) treated a change in use as having occurred when a member of a group of companies (not being a member of the GST group at that time):
- acquired or produced goods or services for the “principal purpose” of making taxable supplies;
- later joined the GST group; and
- any other member of the GST group subsequently used the goods and services for non-taxable purposes (that is, for private purposes or for the making of exempt supplies).
Section 55(7)(dc) treated a change of use as having occurred in the reverse situation when a group member acquired or produced goods or services which they principally intended to use for non-taxable purposes, joined the GST group, and any other member of the GST group used the goods and services for making taxable supplies.
The apportionment rules in the Goods and Services Tax Act 1985 were significantly reformed in 2011 to allow input tax deductions “to the extent” that goods and services are used for (or are available for use in) making taxable supplies. The amendment therefore removes the outdated references to the former “principal purpose” test, clarifying that a change in use adjustment is required to be made by the representative member of a GST group when:
- a person (the “new member”) who previously acquired goods and services for their business or private use joins the GST group; and
- the extent of taxable use of those goods and services by any group member differs from the new member’s previous percentage of taxable use of those inputs.
Finally, the Bill will address two cross-referencing errors and oversights:
- Sections 10(3C) and (3D) link to services treated as being made in New Zealand by section 8(4B). Services treated as being made in New Zealand by section 8(4B) are subject to a reverse charge under section 5B. However, sections 10(3C) and (3D) are not linked to zero-rated remote services that are instead subject to a reverse charge under section 20(3JC). The amendment inserts this cross-reference (clause 225).
- Section 2A(4) aggregates the interests of two associated people for the purposes of paragraphs 2A(1)(a) and (b). However, section 2A(4) does not aggregate the interests of two people associated under paragraph 2A(1)(bb). The amendment inserts this cross-reference (clause 223).
FINANCIAL ARRANGEMENT RULES – TREATMENT OF FOREIGN CURRENCY AGREEMENTS FOR THE SUPPLY OF GOODS AND SERVICES
Summary of proposed amendment
The taxation of financial arrangements broadly follows accounting principles which can occasionally produce results outside the policy intent. This can happen when a foreign exchange denominated agreement for the sale and purchase of goods and services (ASAP) (being a business combination under NZ IFRS 3) has a contingent amount (an amount payable or receivable depending on a future event, say future performance). Accounting treats adjustments for these as being on revenue account, and as a result contingent payments are automatically treated as “interest” under the Income Tax Act 2007 (and assessable or deductible). This outcome is inconsistent with policy intent and changes are proposed so these adjustments have regard to the underlying transaction.
The proposed amendments will come into force for existing agreements on the date of enactment, with savings provisions for taxpayers who have taken tax positions relying on the current law.
The proposed amendments will:
- exclude amounts recognised in the Income Statement of purchasers and sellers from contingent payments for businesses acquired from being treated as interest for tax (being deductible or assessable) under the financial arrangements rules;
- for purchasers, exclude the amounts from the value/cost of property acquired under the business acquisition, except when the property is the shares of an entity acquired to obtain the business. The amounts excluded from the value of property are effectively positive or negative goodwill on acquisition; and
- for sellers the contingent amounts increase/decrease the sale price of the assets/liabilities or shares sold, which may result in adjustments to depreciation on sale of assets or income/expenditure for assets held on revenue account.
The taxation rules for foreign ASAPs were substantially amended in 2014 to follow their accounting treatment. Subsequent analysis of the accounting treatment by officials has revealed the unintended tax treatment of contingent payments under foreign ASAPs. We are unaware of any transactions that have been subject to the unintended treatment.
RESIDENTIAL AND MAIN HOME EXCLUSIONS
Summary of proposed amendment
Remedial amendments to the residential and main home exclusions from the land sale rules in the Income Tax Act 2007 will:
- ensure that the residential exclusion in section CB 17(2) applies whether or not the taxpayer has a family member living with them, and align the wording in the various residential exclusions; and
- ensure that the “regular pattern” carve outs from the residential exclusion in section CB 16 and the main home exclusion in section CB 16A operate as intended, so that a pattern of transactions will only prevent the exclusions being available if it involves buying and selling, or building and selling, houses that were the person’s residence or main home.
The proposed amendments to sections CB 16, CB 17, and CB 18 will apply from the start of the 2008–09 income year, the first year to which the Income Tax Act 2007 applies.
The proposed amendment to section CB 16A will apply from 1 October 2015, when the bright-line test came into force.
Prior to the rewrite of the income tax legislation, the wording of what is now section CB 17(2) would clearly have allowed a person without a family member living with them to use the residential exclusion. However, this is not clear on the rewritten wording of the provision. The amendment to section CB 17(2) reinstates the pre-rewrite position, restoring the original policy intent. The rewrite also inadvertently introduced slight wording differences between the various residential exclusions, and these are being amended for consistency.
The residential exclusion in section CB 16 cannot be used if the person has engaged in a regular pattern of transactions. Prior to the rewrite, it was clear from the legislation that to be disqualified from using the exclusion, the transactions in the regular pattern had to involve dwellings used mainly as the taxpayer’s residence. This is not apparent from the wording of the rewritten legislation, which suggests that regular pattern of buying and selling houses or building and selling houses, whether or not they were the taxpayer’s residence, would disqualify the taxpayer from using the exclusion.
The amendment to section CB 16 restores the original policy intention that the regular pattern carve out will only apply if the taxpayer has a regular pattern of buying and selling or building and selling dwellings that they occupied mainly as a residence.
The above issue was inadvertently replicated in the wording of the main home exclusion (section CB 16A) from the bright-line test, when those rules were introduced, as the wording in the main home exclusion was based on the residential exclusion in section CB 16, which contained the unintended rewrite change discussed above.
The amendment to section CB 16A is to clarify that the regular pattern carve out will only apply if the taxpayer has a regular pattern of buying and selling residential land that was used predominantly, for most of the time the taxpayer owned the land, for a dwelling that was their main home.
FIF COST METHOD
Summary of proposed amendment
The cost method in the foreign investment fund (FIF) rules is being amended to ensure it works as intended, so the ability for a person to reset their cost base every five years through independent valuation is optional not mandatory.
The proposed amendment will apply from 1 April 2007, when the cost method provisions came into force.
The FIF rules provide for the taxation of equity investments that New Zealand tax residents hold in foreign entities they do not have a controlling interest in. There are five different calculation methods for determining the amount of FIF income a person has for the year. The starting point is that the “fair dividend rate” method must be adopted. But if that method is not practical to apply because the market value of the FIF can only be determined by an independent valuation, a person may use the “cost method”.
Generally an independent valuation is required on entry into the cost method. The cost method then taxes 5% of the “opening value” of the person’s interest in the FIF, plus an adjustment for shares bought and sold within the same income year. The “opening value” is uplifted by 5% each year as a proxy for an increase in the value of the investment.
It was intended that investors in FIFs who use the “cost method” for calculating their FIF income would have the ability to reset their cost base (the “opening value”) once every five years through an independent valuation. It was intended that such a revaluation would be optional.
However, the legislation as enacted appears to make the five-yearly revaluation mandatory, not optional. This outcome is not consistent with the policy intent, so an amendment to section EX 56(3)(b) will ensure the legislation operates as intended.
RESETTLEMENTS OF TRUSTS
(Clauses 159, 160(1), 161(3) and 161(6))
Summary of proposed amendment
The proposed amendments relate to a resettlement of property by the trustee of one trust (the head trust) onto a new trust (the sub-trust). The proposed amendments clarify:
- the relationship between foreign sourced trustee income derived by the sub-trust and the exempt income rule in section CW 54;
- if the head trust is a foreign trust, the extent to which the value of the resettled property is corpus of the sub-trust; and
- if the head trust is a foreign trust, the classification of gains deemed to be derived by the trustee of the head trust, as a result of the rules applying to distributions, transmissions, and gifts of property.
The proposed amendments do not affect the general operation of the settlor definition. In addition, the proposed amendments do not affect the requirement that a settlor of a foreign trust must not have been resident in New Zealand since the current trust rules were originally enacted.
The proposed amendments will come into force on the date of enactment.
A transitional provision is also proposed to validate tax positions taken prior to the date of enactment, but only for those tax positions taken that are consistent with the outcome given by the amendments.
The amendments propose to clarify that a resettlement of property by the trustee of a head trust on another trust does not affect the entitlement of that sub-trust to the exemption from tax under section CW 54 for foreign sourced trustee income if:
- at least one trustee of the head-trust is resident in New Zealand;
- the head trust has only non-resident settlors at the time of the settlement; and
- the sub-trust satisfies the requirements of sections CW 54 and HC 26 when it derives the foreign sourced trustee income.
In addition, the amendments propose to clarify that a resettlement of property by a foreign trust on a sub-trust is included in corpus of the sub-trust (and consequently not treated as trustee income). However, if the head trust is a foreign trust and the settlor was a controlled foreign company, but no New Zealand resident is deemed to be a settlor of that trust (section HC 28(3), (4)), part of the value a resettlement of property may be excluded from corpus of the sub-trust.
The proposed amendments address some technical issues relating to a trustee of a foreign trust that settles property of that trust (the head trust) onto a sub-trust (a resettlement). Under current law, the trustee of the head trust is treated as a settlor in relation to the resettled property. If there are multiple trustees of the head trust and at least one trustee of the head trust is resident in New Zealand, the sub-trust will be taxable on its world-wide trustee income under the settlor regime. This is an unintended outcome as it is intended that the settlor of the head trust would be the settlor of the sub-trust. The proposed amendments clarify the law.
In addition, an administrative review of the trust rules identified that the valuation rules for distributions, transmissions and gifts of property in subpart FC of the Income Tax Act 2007 result in:
- the trustee of the head-trust being treated as having disposed of the resettled property at market value; and
- the trustee of the sub-trust being treated as having acquired the resettled property at market value.
The application of these valuation rules to a resettlement can result in a capital gain being deemed to be derived from an associated person. A capital gain derived by a foreign trust from an associated person can result in part of the resettlement being excluded from the corpus of the sub-trust and also treated as trustee income of the sub-trust.
Under the current income tax rules, there can be some unintended consequences when there is a resettlement of trust assets by the trustees of a foreign trust on a sub-trust.
Exempt income for trusts which do not have a New Zealand resident settlor
Under current income tax law, a resettlement of trust property of a trust will result in the trustee of the head trust being treated as a settlor of the sub-trust. Prior to the resettlement, if the head trust is a foreign trust, foreign-sourced income derived from that trust property would be exempt income of the foreign trust under section CW 54 of the Income Tax Act 2007.
Consequently, after the resettlement, if at least one trustee of the head-trust is a New Zealand resident, the sub-trust will have a New Zealand resident settlor. This will result in trustee income derived by that sub-trust being taxable in New Zealand on a world-wide basis. The resettlement of property of a foreign trust on a sub-trust is not intended to have this outcome.
The proposed amendments ensure that where a resident trustee of a head-trust resettles property on a sub-trust and no settlor of that head trust is resident in New Zealand at the time of resettlement:
- the trustee of the head trust is not treated as a settlor of the sub-trust; and
- the settlors of the head trust are treated as the settlors of the sub-trust;
- the trustees of the sub-trust will be entitled to the exemption from tax for foreign-sourced trustee income from the time of resettlement, provided the sub-trust meets the ongoing requirements of sections CW 54 and HC 26.
Resettlements and the valuation rules applying to distributions
A valuation rule (in subpart FC) applies to a resettlement of property on a sub-trust. For income tax purposes, this rule treats the resettlement of property on a sub-trust as a disposal and purchase at market value. If the head trust is a foreign trust, this could result in the head trust:
- deriving a capital gain from an associated person (a tainted gain) for the purpose of the definition of taxable distribution for a foreign trust; and
- to the extent the value of resettlement includes such a tainted gain, that gain would be excluded from the corpus of the sub-trust and taxed as trustee income in the sub-trust.
The proposed amendments ensure that, in most circumstances, when a foreign trust resettles property on a sub-trust, the valuation rules applying to a resettlement of property on a sub-trust:
- do not result in a tainted gain being included in the value of the resettlement; and
- provide that the full value of the resettlement is corpus of the sub-trust.
BINDING RULINGS AND RECORD-KEEPING REQUIREMENTS
Summary of proposed amendment
The proposed amendment clarifies that the Commissioner of Inland Revenue may make a binding ruling for any record-keeping requirement in the Tax Administration Act 1994.
The proposed amendment will come into force on the date of enactment.
The Commissioner of Inland Revenue has a power to rule on the record-keeping requirements of the Goods and Services Tax Act 1985. However, no such explicit power exists in the Tax Administration Act 1994 for other revenue types.
For consistency, the amendment proposes that the Commissioner be able to rule on record-keeping requirements for all tax types.
(Clauses 158, 160(2) and 162–164)
Summary of proposed amendment
The proposed amendments:
- ensure there is internal consistency within the Income Tax Act 2007 in relation to the tests for tax residence and some trustee elections;
- correct unintended legislative changes arising from the rewrite of the Income Tax Act 2007; and
- clarify internal cross-references and relationships with other parts of the Income Tax Act 2007.
The proposed amendments will come into force on the date of enactment.
The proposed amendments relate to some matters identified in an administrative review of a 1989 Tax Information Bulletin item on the taxation of trusts.
Transitional residence and election to be a complying trust
A foreign trust loses its status as foreign trust when a settlor of that trust migrates to New Zealand. That trust may then choose to become a complying trust. If that choice is not made, the trust becomes a non-complying trust, which affects the taxation of distributions made from the trust that are not beneficiary income.
A period of time is given to make this election (a grace period). There is an inconsistency between two provisions referring to this grace period. This inconsistency results in uncertainty about the correct starting date of the grace period if the migrating settlor is a transitional resident. The policy intent is that the start of that period is:
- if the migrating settlor is a transitional resident, the first day following cessation of the transitional residence status; or
- if the migrating settlor is not a transitional resident, the first day of residence in New Zealand.
The proposed amendment clarifies that the start date for a transitional resident is the first day the migrating settlor ceases to be a transitional resident.
Transitional residence, ordering rules, and distributions
At present, the law is unclear about the tax treatment of distributions from trustee income derived by a foreign trust in the year in which a migrating settlor ceases to be a transitional resident. This uncertainty could result in such a distribution being subject to economic double taxation because:
- the foreign trust becomes taxable on world-wide trustee income from the beginning of the income year in which the migrating settlor ceases to be a transitional resident; and
- if the distribution is a taxable distribution to a New Zealand resident beneficiary, that distribution is taxed at the marginal rate of the beneficiary with no credit for the New Zealand tax paid for income derived in the part-year before the settlor ceases to be a transitional resident.
The policy intent is that a distribution from such accumulated income in that part-year period should not be subject to economic double taxation. The proposed amendments clarify this by treating a distribution from this part-year period as being from a complying trust (that is, not taxed to the beneficiary).
Election to be a complying trust
The proposed amendments to section HC 16:
- relate to the election for a foreign trust to become a complying trust when a settlor migrates to New Zealand; and
- correct an unintended legislative change arising from the rewrite of the provision by clarifying that this election may be made by any settlor, trustee, or beneficiary of the trust.
Capital gains derived from an associated person and the ordering rules
The ordering rules are clarified to correct an unintended legislative change arising in the rewrite of the provision. The proposed amendment ensures that a capital gain derived from an associated person is treated as income derived by the trustee for the purpose of the ordering rules. This restores the intended timing effect for when such a capital gain is treated as distributed.
Minor beneficiary income
The proposed amendments correct an unintended legislative change arising in the rewrite of the minor beneficiary rules. The broad intent of these rules is to tax beneficiary income distributed to minors at the trustee rate of 33%. There is intended to be an exclusion from this broad intent if certain requirements (in sections HC 36 and HC 37 of the Income Tax Act 2007) about the trust are satisfied (for example, in some circumstances, minor beneficiary income derived that relates to a protected person under the Domestic Violence Act 1995).
However, the current law does not work as intended as it presently requires all listed circumstances to be satisfied before the exclusion applies. The proposed amendment clarifies that the exclusion applies if the requirements of either section HC 36 or HC 37 are satisfied.
No value in the beneficiary relationship for the purpose of section HC 14
There is an inconsistency between the rules applying to distributions, transmissions and gifts in subpart FC and the definition of distribution. The issue is that under subpart FC, a distribution of property may be treated as a purchase and disposal of that property at market value; whereas, in the definition of distribution, the beneficiary receiving property is treated as providing no value for a distribution by virtue of the beneficiary status.
The main purpose for the rules in subpart FC is to ensure that, for the trust making the distribution, the value of transferred revenue account property is correctly taken into account in calculating the trust’s trustee income.
The amendment proposes that the rules in subpart FC do not apply for the purpose of applying the definition of distribution. This will ensure that a distribution will continue to be determined by whether a transfer of value has been made to a beneficiary.
TAX RULES FOR DEREGISTERED CHARITIES
Summary of proposed amendment
Six remedial changes to the tax rules for deregistered charities are proposed in this Bill. They are intended to protect the integrity of the tax base by ensuring that if an entity has claimed tax exemptions as a charity and has accumulated assets, these assets should always be destined for a charitable purpose, even if the entity is deregistered by the New Zealand charity regulator, the Department of Internal Affairs – Charities Services, under the Charities Act 2005.
Key features and application dates
The proposed remedial amendments will better align the legislation with the policy intent of the tax rules for deregistered charities.
These proposed amendments will have retrospective effect from 14 April 2014 (when the tax rules for deregistered charities were first enacted):
- Addressing the tax treatment of land owned by deregistered marae charities.
- Preventing potential double-deduction for monetary gifts made within one year of deregistration.
These proposed amendments will apply to charities deregistered on or after 1 April 2019:
- Preventing potential over-taxation of deregistered charities in group structures in circumstances where multiple members in the group deregister together.
- Addressing the disposal of wholly-owned subsidiaries by a charitable group for market value.
- Clarifying the valuation of assets and liabilities at the date of deregistration.
- Introducing a de minimis threshold for charities with a low value of accumulated assets.
Under the charity deregistration tax rules, the net assets of a deregistered charity must be transferred or disposed of for charitable purposes or in accordance with the charity’s rules contained on the Department of Internal Affairs (DIA) Charities Services register, within 12 months; otherwise it will be subject to income tax on the value of its net assets. The calculation of net assets excludes assets received from the Crown in relation to a Treaty of Waitangi settlement claim or in accordance with the Maori Fisheries Act 2004, and any non-cash assets which were gifted to the organisation when it was exempt from income tax.
Deregistered charities in group structures
Large charities will often operate as part of a group, with charitable entities holding equity investments in other registered charities. If a parent entity and its subsidiaries are deregistered by DIA Charities Services, then the deregistration rules apply to each of those entities and each entity must pay tax based on the value of its net assets. The value of the underlying assets could therefore be taxed more than once.
This is an over-reach of the policy intent of the deregistration tax rules, and it is appropriate to allow the deregistered charitable parent entity to make an adjustment in its net asset calculation.
Amendments are proposed to ensure that if a parent entity and one or more members of a charitable group deregister at the same time, the value of the parent’s shares in the subsidiary is ignored for the purposes of calculating the parent’s income under the deregistration tax rules.
Disposal of assets by a charitable group for market value
If a charity acquires one hundred percent ownership of an investment company, it will typically register that company as a charity in its own right. When it later sells its shares, then that subsidiary may be required to deregister and therefore be taxed on the value of its net assets.
However, if the subsidiary is sold at arm’s length for market value, no value leaves the charitable group and it is an overreach to impose the deregistration tax on the subsidiary.
It is not appropriate to apply the deregistration tax in these circumstances, because the charitable group has simply replaced a certain amount of value in shares with the same amount in cash. In addition, the deregistration tax liability is likely to be reflected in the sale price of the shares, which would mean that the charitable group bears the economic burden of the tax liability.
An amendment is proposed to ensure that if a charity sells an interest in a subsidiary at arm’s length for market value, the deregistration tax does not apply to that subsidiary if it is deregistered as a result of the sale.
Carve-out for marae assets
Generally, a deregistered charity can reduce the amount of tax payable under the deregistration rules by disposing of or transferring their assets within one year of the day they were deregistered. However, “reservation” land, upon which marae are built, cannot be disposed of or transferred to pay the resulting tax bill because of restrictions on alienation of reservation land under the Te Ture Whenua Māori Act 1993. This means that marae that are registered as charities are unable to reduce their deregistration tax liabilities, unlike other deregistered charities.
Amendments are proposed to ensure that for marae built on reservation land established under the Te Ture Whenua Māori Act 1993, the value of the land and improvements on the land will be excluded from the net asset calculation. This would ensure that they are no longer taxed on the value of assets which they are legally unable to dispose of or transfer.
Valuation of assets and liabilities
The legislation currently refers to a deregistered charity being taxed on its “net assets”. However, there is no indication in the Income Tax Act 2007 as to what valuation method should be used to measure the entity’s net assets. Providing a valuation method in the legislation will help provide more certainty for taxpayers.
Using the historical cost of the asset does not provide the desired deterrent effect against deregistration, as sometimes what is today a very valuable asset could be recorded at a much lower historical cost value. This is inconsistent with the policy intent of the deregistration tax rules, which is to provide an incentive for charitable assets to remain in the charitable sector.
It is proposed that the legislation specify that assets and liabilities should be valued at their market value. Market value refers in general terms to the price an asset would be sold for in an arm’s length transaction. This is usually determined from market-based evidence by appraisal. Under the accounting standards for charities, the market value for an asset can also be established by reference to other items with similar characteristics, in similar circumstances and location – for example, by accepting the council ratings valuation as a market valuation for land.
Prescribed valuation methods for certain assets (premises, plant, equipment, and trading stock) are already contained in the deregistration rules. It is proposed that the market value requirement applies only to those assets which do not already have a prescribed valuation method.
Monetary gifts made within one year of deregistration
Under current law, a deregistered charity that is a company or Māori authority may make a monetary donation to another charity within 12 months of deregistration and this donation will both reduce its deregistration tax liability and be eligible for a gift deduction under the charitable giving rules.
A deregistered charity holds $1 million worth of funds in its bank account at the date of deregistration. It donates half of that amount to another charity within 12 months of deregistration.
This has the effect of excluding $500,000 from tax under the deregistration tax rules. However, as the deregistered charity is now subject to normal income tax rules, it can also receive a $500,000 income tax deduction for the gift.
The one donation of $500,000 is therefore eligible for two tax concessions, despite not adding any new funds to the charitable sector.
This double benefit is not consistent with the policy intent, as the assets are effectively already in the charitable sector.
An amendment to the charitable giving rules is proposed to clarify that assets transferred to another charity in accordance with the deregistration rules do not also qualify for a gift deduction.
De minimis threshold for small deregistered charities
Small deregistered charities with limited resources may find it difficult to value assets for the purposes of the deregistration tax. It is inefficient for Inland Revenue to dedicate compliance resources to these small charities as the potential tax liability would be very low.
A “de minimis” threshold of $5,000 in net assets is proposed to exclude small charities from the deregistration tax rules.
A $5,000 net asset threshold would remove about half of all deregistered charities from the deregistration rules. It is also consistent with the settlement de minimis threshold used in relation to minor beneficiaries under the trust rules.
(Clauses 5(52), 5(58), 42(16)–(18), 125, 134, 157, 176 and 213(32))
Summary of proposed amendments
A number of remedial changes to the tax rules for not-for-profit entities are proposed in this Bill. They are intended to improve the integrity and coherency of the tax system, as it applies to these entities.
The application dates for these proposed amendments are set out under their respective sections below.
Amendments to the Income Tax Act 2007 and the Tax Administration Act 1994 are proposed to ensure that:
- the charitable business income tax exemption applies only to charities registered under the Charities Act 2005;
- the deemed disposal provision for depreciation recovery income applies when a taxable entity becomes a registered charity;
- the disclosure requirements which apply to foreign trusts also apply to foreign trusts that are registered charities;
- organisations seeking donee status for donation tax credit, gift deduction or fringe benefit tax exemption purposes must be approved by the Commissioner of Inland Revenue;
- organisations with charitable purposes must be registered charities in order to obtain donee status; and
- relevant penalty, interest and avoidance provisions apply to donation tax credits.
Application of the charitable business income exemption
Registration under the Charities Act 2005 carries with it a number of reporting obligations, which improves transparency and promotes public trust and confidence in the charitable sector.
Entities are generally required to be registered as a charity in order to access the charitable tax exemption for non-business income.
However, an entity is not always required to be registered as a charity in order to access the charitable exemptions for business income under section CW 42 of the Income Tax Act 2007. Business income is exempt if it is derived by a registered charity, or by a separate business “carried on for, or for the benefit of” a registered charity. This ability to claim a charitable income tax exemption without being subject to the public reporting requirements of registered charities is contrary to the policy intent.
A small but increasing number of businesses are seeking to take advantage of the business income exemption without being registered charities themselves. This risks undermining public trust and confidence in the charitable sector. It also increases the extent to which Inland Revenue is involved in charity oversight and regulation. This does not align with the government policy that regulation of the charitable sector should sit primarily with the Department of Internal Affairs – Charities Services.
An amendment is proposed to section CW 42 to ensure that the business income exemption applies only to organisations that are registered under the Charities Act 2005.
The proposed amendment will come into force on the date of enactment.
Application of the deemed disposal provision for depreciation recovery income
Under the depreciation rules, a change in the use of an asset is treated as if that asset was disposed of for the market value of the asset. One of the events which could trigger this deemed disposal occurs when a business changes its constitution or rules in order to meet the legal requirements for an exemption from income tax (for example, if a registered charity buys one hundred percent of the shares in a business, and that business registers as a charity under the Charities Act 2005).
Once there has been a deemed disposal, any excess depreciation deductions are clawed back as depreciation recovery income arising in the following income year. However, if the change is from a taxable use to being used for exempt purposes (for example, for charitable purposes), then it is not possible to claw back the excess depreciation deductions because by the following income year the entity will be exempt from income tax.
An income tax exemption should not extend to depreciation recovery income, which is attributable to income years before the entity became exempt. Such an outcome is contrary to policy intent. Amendments are proposed to ensure that depreciation recovery income arises immediately before the entity is treated as being exempt from income tax, to ensure that excessive depreciation deductions are clawed back.
The proposed amendment will apply from the date this Bill was introduced.
Disclosure requirements for charities that are foreign trusts
If a New Zealand registered charity is also a “foreign trust” (a tax term, being a trust established in New Zealand but where no settlor is resident in New Zealand at any time), then it is not subject to the foreign trust disclosure requirements in the Tax Administration Act 1994, including the new foreign trust disclosure requirements implemented by the Taxation (Business Tax, Exchange of Information, and Remedial Matters) Act 2017. The historic reason for this exclusion has been that such foreign trusts are already subject to public disclosure and regulation requirements under the Charities Act 2005, so no further disclosure requirements were considered necessary.
However, the new foreign trust disclosure requirements now require some information that is not collected under the Charities Act 2005. The additional information involves identifying particulars and contact details for settlors, trustees and beneficiaries.
Amendments are proposed to the definition of “resident foreign trustee” in the Tax Administration Act 1994 to ensure that registered charities are not exempted from the foreign trust disclosure requirements. Foreign trusts that are also registered charities will be required to make annual disclosures to Inland Revenue like any other foreign trust.
The proposed amendment will come into force on the date of enactment.
Donee status – approved donee list
At present it is possible for an organisation to self-assess whether it satisfies the criteria in section LD 3(2) for donee status. Such an organisation can issue donation receipts to donors that qualify for a donation tax credit or gift deductions without being on Inland Revenue’s list of donee organisations. To ensure public transparency and to strengthen the integrity of the tax system, it is proposed that organisations that want to qualify for donee status must be approved by the Commissioner of Inland Revenue under section LD 3(2)(a).
No changes are proposed for organisations registered under the Charities Act 2005 that are currently on the Inland Revenue’s list of donee organisations. Similarly, organisations with benevolent, cultural or philanthropic (but not charitable) purposes that are currently on the Inland Revenue’s list of donee organisations, will continue to have donee status.
A requirement for the Commissioner’s approval for donee status is also proposed for funds, public funds, and public institutions, under sections LD 3(2)(b), (c), and (d), for consistency.
The proposed amendment will apply from 1 April 2019.
Donee status – application to organisations with charitable purposes
At present, organisations with charitable purposes can obtain donee status without being registered under the Charities Act 2005.
The proposed amendment will require all entities with charitable purposes to be registered under the Charities Act 2005 in order to qualify for donee status. This will ensure that all charitable organisations that can issue donation receipts that qualify for a donation tax credit or gift deductions are subject to the same reporting and regulatory requirements.
Entities with charitable purposes that are not registered under the Charities Act 2005 but are on Inland Revenue’s approved donee list will be required to register under the Charities Act 2005 by 1 April 2020 if they wish to retain their donee status.
As noted above, this change will have no impact on organisations on the Inland Revenue’s approved donee list that have only benevolent, cultural or philanthropic (but not charitable) purposes.
The proposed amendment will apply from 1 April 2020.
Application of penalties, interest and avoidance provisions
Under the current law, use-of-money interest and some penalties cannot be applied when donation tax credit claims are overstated. Avoidance provisions also do not apply to overpaid donation tax credits. This is contrary to policy intent.
Amendments are proposed to the definition of “tax” in the Tax Administration Act 1994, as well as inserting a new anti-avoidance provision (section GB 53) in the Income Tax Act 2007, to ensure that relevant penalty, interest and avoidance provisions apply in relation to donation tax credits that are overpaid.
The proposed application date is 1 April 2019.