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Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Bill

Remedials

Home > Publications > 2021 > Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Bill > Remedials

Taxation (Annual Rates for 2020–21, Feasibility Expenditure, and Remedial Matters) Bill

Officials' report to the Finance and Expenditure Committee on submissions received on the Bill

February 2001

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Remedials

GENERAL COMMENTS

(Clauses 45, 59, 60, 76, 79)

Issue: General support

Submission

(Chartered Accountants Australia and New Zealand, EY)

The submitters expressed support for the proposals.

Recommendation

That the submission be noted.

Issue: Changes appear more than merely remedial

Submission

(Corporate Taxpayers Group)

We are concerned about changes being made to the schedules of eligible activities and expenditure types which are presented as “remedial” or as “clarifications.” While they may appear minor in nature, the R&D tax credit legislation is very prescriptive and even small changes can have a major impact on what is or is not eligible. Presenting these changes as “remedial” is disingenuous.

Comment

Officials consider that the changes to the schedules mentioned by the submitter are remedial in nature. These amendments are based on evidence and advice that the legislation is being interpreted, or could be interpreted, in a manner that is clearly beyond the original policy intent. The amendments seek to address these potential interpretation issues and ensure the legislation gives effect to the policy intent.

There is one change to the schedules that reflects a policy change (the carve-in for labour expenditure on core R&D that contributes to the cost of tangible depreciable property). This amendment is taxpayer-friendly in nature and explicitly supported by all submitters. Aside from this, officials believe all changes to the schedules do not alter the intent of the regime, but confirm and clarify it; as such, officials expect the effect on taxpayers filing within the policy intent will be minimal.

Recommendation

That the submission be declined.

Issue: Changes not based on evidence

Submission

(Corporate Taxpayers Group)

As most R&D claims for the 2019–20 income year have not yet been made, we do not believe that the changes are based on actual evidence of any issues with the application of the regime.

Comment

Many proposals in the Bill are based on operational experience from the R&D tax incentive’s pilot regime, which ran from November 2019 to June 2020. The pilot was intended to trial the in-year approval regime in advance of its deployment in the 2020–21 income year, but also to give officials advance indication of areas where issues may arise around interpretation before the majority of claims are filed for the 2019–20 income year (the first year of the regime), as it took place before applications for that year are due. This design meant that the scheme would evolve as new challenges came to light through the pilot. Officials consider evidence from the pilot justifies clarification in certain areas to ensure the original policy intent is being met.

Other proposals concern areas where officials have considered certain issues and received both legal advice and public feedback to the effect that the current legislation could be interpreted inconsistently with the original intent, or evidence from tax incentive regimes overseas that legislation similar to our own could be interpreted in ways contrary to the original intent.

Recommendation

That the submission be declined.

Issue: Changes decrease certainty

Submission

(Corporate Taxpayers Group)

We are concerned that there seem to be constant changes to the R&D tax credit regime, when returns have not yet been filed. This makes it hard for taxpayers who are claiming or wishing to claim, as the rules are being amended relatively often.

Comment

Evidence from the pilot regime (see Issue: Changes not based on evidence for more information) and from overseas jurisdictions has highlighted some areas of the regime where there are potential interpretations of the existing legislation that are inconsistent with those policy decisions. The amendments are primarily aimed at clarifying or tightening up the language around some of the activity or expenditure exclusions to bring them in line with the original policy intent.

We expect that applications should be made in good faith in line with the policy intent of those exclusions. Applicants acting in this way will not be affected by any of the proposed changes.

Recommendation

That the submission be declined.

Issue: Approach is counter to original intent

Submission

(Corporate Taxpayers Group)

The process being adopted in this Bill is counter to the process which was legislated via the Taxation (Research and Development Tax Credits) Act 2019. Section LY 9 of the Income Tax Act 2007 provides for an Order in Council process for making prospective changes to schedules 21 and 21B with effect from the tax year following the tax year in which the amendment is made (with a requirement to convert this to legislation within a period of three years). This approach is fairer than the proposed approach.

Comment

The mechanism provided for in section LY 9 is intended to allow officials to respond quickly to emerging areas of risk that might arise out of changes in the business R&D environment. The tax incentive is intended to be sustainable and provide certainty for businesses. To maintain this intent, the policy intent of the regime is to allow for minor amendments on a regular basis to address emerging areas of risk. This is key to ensuring a sustainable credit regime and avoiding the sudden major changes officials have observed in other jurisdictions. Overall, this provides more certainty for applicants in the long run.

The proposed changes are not responses to newly-identified risks or changes in the business R&D environment and do not represent a new policy decision. Instead, they address areas of the existing legislation where evidence shows there is potential for interpretations that are inconsistent with the original policy intent. Officials do not believe it is appropriate to generalise the intent of section LY 9 to cover all legislative changes to the R&D tax credit regime, regardless of their purpose.

Recommendation

That the submission be declined.

Issue: Retrospective application dates

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte)

  1. We support the retrospective application dates for the proposed amendments. (Chartered Accountants Australia and New Zealand)
  2. The proposed amendments should not take effect retrospectively, unless they are taxpayer-friendly, particularly where exclusions are broadened or definitions changed. Making the amendments fully retrospective increases the compliance burden on taxpayers who will have to reassess based on these changes (which may not be enacted prior to taxpayers needing to lodge R&D tax credit returns). This imposes an unfair burden on taxpayers. A prospective change would be fairer. (Corporate Taxpayers Group, Deloitte)
Comment

The fully retrospective application date of (most of) the amendments is intended to address areas where the effect of the legislation does not match the original policy intent of the regime. Officials do not believe the proposals alter the intended effect of the regime, but either close unintended gaps in the legislation or clarify certain aspects of the policy intent for the avoidance of doubt. As such, it is not anticipated that most taxpayers will need to re-evaluate their claims based on these amendments.

However, officials acknowledge that this is likely the last tax bill that will pass before the bulk of year one claims have been filed. Officials therefore concur that, after this Bill, any changes made to the regime ought not to be retrospective to the start of the regime (unless the change is to correct a major gap between the policy intent and the legislation), as this undermines the intent of providing certainty to applicants.

Recommendation
  1. That the submission be noted.
  2. That the submission be declined.

DEFINITION OF ELIGIBLE R&D EXPENDITURE

(Clause 45)

Issue: Support the amendment

Submission

(EY)

We support the intent of this amendment. The regime needs to remain robust. Identifying and addressing risks early will support the longevity of the scheme.

Recommendation

That the submission be noted.

Issue: Amendment may overreach

Submission

(Corporate Taxpayers Group, EY)

The Bill commentary suggests the proposed changes clarify existing requirements. We believe, however, that the changes go further and require a closer nexus between activity and expenditure than was originally intended. As the nexus appears to be tighter, some costs that were previously eligible will fall out of the regime. (Corporate Taxpayers Group)

While we acknowledge the Government is merely trying to protect the tax base, we are also concerned that the intended policy could overreach. Without robust guidance as to the intended scope of these words, the tests could be read too narrowly. (EY)

Comment

From the inception of the R&D scheme, it has always been a policy principle that in order for the scheme to be sustainable, it had to have strong integrity measures to prevent expenditure on activities unrelated to R&D being claimed. The intent therefore has always been that expenditure must have a close nexus with an R&D activity to be claimable for the incentive. However, the current legislative requirements require only a relatively loose nexus. Expenditure on R&D activities is claimable to the extent that it relates to an R&D activity (whether core or supporting), as long as it is not listed in the schedules of ineligible expenditure.

When the policy was being formulated, it was contemplated that activities that did not relate directly to the core R&D being conducted, such as cleaning, HR or payroll activities, or procurement, would only be eligible if they satisfied the supporting R&D activity test. The test stipulates that an activity be “integral to” or for the “only or main purpose of” supporting a core R&D activity to be eligible as a supporting activity and requires a close connection between a supporting activity and a core activity. As expenditure must be on an approved activity to be eligible, it was initially envisaged that expenditure on activities not directly related to core R&D would effectively be covered by the supporting activity tests (as the activity itself must first meet the requirements before expenditure on it can be claimed), and therefore no comparable test requiring expenditure to be closely related to core R&D was needed.

However, it has come to officials’ attention that the nexus requirement can be circumvented, and the policy intent defeated, by simply characterising indirect activities as “overhead” expenditure on core R&D activities rather than an activity at all. To remove this opportunity for exploitation, the proposed amendment effectively brings the supporting activity requirements into the definition of eligible expenditure. This will ensure that expenditure that is not directly related to R&D will be subject to the supporting activity tests, regardless of whether it is claimed as a supporting activity or as overhead expenditure on a core activity. This confirms the policy intent as these requirements were always intended to apply to this kind of expenditure. It is not proposed that the intended nexus test between activities and expenditure will change.

Officials understand the concern that, although they are intended to confirm the policy intent, the tests may be read more narrowly than intended. Officials agree that clear guidance is necessary to allay these concerns. Following enactment of the Bill, guidance will be provided in a Tax Information Bulletin, and Inland Revenue’s official guidance material will be updated to clarify the intended meaning of the tests.

Recommendation

That the submission be declined.

Issue: Potential for government interference

Submission

(EY)

The wording creates a risk that the government could narrow what expenditure will be considered eligible. Further consideration is required to ensure the wording does not open up an opportunity for officials to debate or influence how R&D is being conducted within a business. This includes references to expenditure being “required for” and “integral to” the activity. For example, some expenditure may make the R&D more efficient or may be linked to a business strategy, but if it cannot be directly related to the R&D activity and be considered integral and required, then it would not be eligible.

To address this risk, the provisions should make it clear that the taxpayer’s assessment of whether the expenditure is required or integral takes primacy. The onus should be on IR to argue the contrary.

Comment

Officials understand the concern, but do not believe the risk of this interference is high. The proposed tests simply reinforce the supporting R&D activity requirements already present in the regime, which do not force businesses to adopt a certain approach to their expenditure on R&D, but only require that the expenditure has a reasonably close connection with R&D. Guidance material on these existing tests makes it clear that they are not intended to tell businesses how to do their R&D or obligate them to carry out R&D in the simplest or cheapest manner possible; they only require that a supporting R&D activity has a certain degree of closeness to an approved core R&D activity. Officials fully intend this approach to be transferred to the proposed expenditure tests.

In keeping with New Zealand’s self-assessment system, the more efficient approach is for taxpayers to keep and provide records detailing the purpose of their expenditure and its connection with their R&D activities, rather than requiring the Commissioner to provide proof for any expenditure she considers not to meet the proposed tests. This is consistent with the design of the regime, which is that the taxpayer should have to keep records that adequately detail the particulars of their claim and demonstrate that it meets legislative requirements. It is also consistent with the general tax provisions in the context of resolving disputes.

Officials instead believe that this issue is best addressed by making the meaning of the proposed tests as clear as possible in supporting material. Following the enactment of the Bill, guidance will be provided in a Tax Information Bulletin and Inland Revenue’s official guidance material.

Recommendation

That the submission be declined.

MINING DEVELOPMENT ACTIVITY EXCLUSION

(Clause 59)

Issue: Support the amendment

Submission

(Chartered Accountants Australia and New Zealand)

We support the amendment.

Recommendation

That the submission be noted.

Issue: Changes not necessary

Submission

(Deloitte)

We do not consider that a mining development exclusion is necessary. There is no evidence of taxpayers in these industries taking aggressive approaches to making R&D tax credit claims.

Comment

The objective of this exclusion is not to address any perceived exploitative behaviour but to address an inconsistency between the policy intent of the tax credit and the legislative treatment of assets used in the petroleum and mineral mining industries.

The upfront cost of capital assets should, in most cases, be ineligible for the credit. These assets come with high associated costs that threaten the sustainability of the regime, but they also generally have a long lifetime and commercial uses beyond R&D. The objective of the credit is to incentivise R&D expenditure, not to subsidise high-cost capital assets that the claimant can then use in their commercial activities.

Aside from industry-specific activity exclusions in Schedule 21, this is largely addressed by excluding expenditure on most tangible depreciable assets. However, officials do not consider that the present legislation adequately gives effect to this intent when it comes to the petroleum or mineral mining industries. The existing exclusions are tied to depreciable property, but the tax rules affecting the petroleum and mineral mining industries do not use the depreciation rules. Instead, they have separate treatments for their assets in part D of the Income Tax Act, and are thus not technically depreciable.

While an activity exclusion exists for some phases of the mining lifecycle, assets used in the development phase (essentially the production phase of mining) are not caught by the existing exclusions, and the upfront cost of these assets may be claimable for the credit. This is counter to the policy intent and the intended treatment of the upfront cost of capital assets within the regime. It could lead to unintended and inequitable outcomes between different sectors within the regime and could reduce the sustainability of the regime. Amendments to remove this risk and bring the treatment of mining assets closer to the treatment of other assets are therefore necessary.

Recommendation

That the submission be declined.

Issue: Further clarity needed on amendment’s scope

Submission

(Corporate Taxpayers Group, Deloitte)

It needs to be made clear that the exclusion only targets development activity itself, and R&D related to the development activity may still be eligible.

Comment

Officials agree that it is important that taxpayers have clarity around the intended effect of the amendment. Following enactment of the Bill, guidance will be provided in a Tax Information Bulletin and Inland Revenue’s official guidance material.

Recommendation

That the submission be noted.

Issue: Amendment may impact New Zealand’s emissions targets

Submission

(Corporate Taxpayers Group)

The industries affected by this change need R&D investment to help New Zealand move towards its goal of being carbon-neutral by 2050. Making this exclusion casts doubt for the industry as to what support will actually be available to make the transition.

Comment

The intent of the proposed amendment is not to cut out expenditure on R&D to do with mining development, but only expenditure on development activities themselves. If a mining business is performing R&D that will assist its transition to carbon-neutral status, it will still be able to claim a credit for this R&D (provided it meets the legislative criteria).

Recommendation

That the submission be noted.

Issue: Amendment should be aligned with existing tax treatment

Submission

(Matter raised by officials)

  1. The exclusion on petroleum and mining development should be redrafted to exclude development as eligible expenditure rather than as an eligible activity, using language which aligns with the petroleum and mining tax regimes that already exist in the Income Tax Act 2007 (the Act). This should be achieved by refocussing the exclusion to exclude expenditure or loss by a “petroleum miner” or “mineral miner” (as defined in section YA 1 of the Act).
  2. The new exclusion should include exceptions for labour costs that contribute to core R&D and for prototypes (parallel to the treatment of tangible depreciable property).
  3. The new exclusion should also include miners of “minerals” (as defined in section YA 1 of the Act) and geothermal energy.
  4. As its intent will be covered by the new exclusion, clause 5 of schedule 21 parts A and B of the Act (which excludes “prospecting for, exploring for, or drilling for, minerals, petroleum, natural gas, or geothermal energy”) should be repealed.
Comment

Clause 59 seeks to exclude mining development activities in relation to minerals, petroleum, natural gas, or geothermal energy from the tax credit as activities. This would prevent a taxpayer from seeking approval for such activities, meaning they also cannot claim a credit for any expenditure associated with the activities. The purpose of this exclusion is to ensure that the upfront costs of assets used in the mining industry, which are not covered by the depreciation rules and which are therefore not currently covered by the expenditure exclusions in the R&D tax credit regime, are not inappropriately eligible for the credit.

Assets used in petroleum and mineral mining have their own tax regimes in the Act. These regimes centre on the terms “petroleum miner” and “mineral miner,” as defined in the Act. These terms are linked to a number of expenditure-related defined terms, such as “mining development expenditure” and “petroleum development expenditure,” which provide for the alternative tax treatment of assets created and used by miners when undertaking mining activities. Anchoring the amendment to these pre-existing definitions by refocussing the exclusion on petroleum and mineral miners would provide further certainty for taxpayers around what is covered by this exclusion. As these pre-existing definitions centre on expenditure, it is conceptually simpler to align the proposed exclusion with these definitions by targeting it towards expenditure rather than activities.

Excluding expenditure incurred by a miner is also more targeted than excluding mining development as an activity, as currently proposed in the Bill. Any R&D activities performed by a business involved in mining that meet the other legislative requirements could potentially be claimed for the credit, so long as it is not performed by the business in their capacity as a miner. This is more in line with the policy intent, which is to exclude the cost of assets used in the mining industries from the tax credit while still allowing a credit for R&D performed in these industries (see Issue: Changes not necessary for rationale).

The clause should be redrafted as an expenditure exclusion rather than an activity exclusion, with wording that incorporates the petroleum miner and mineral miner definitions for consistency within the Act. As its intent and function would be similar to existing exclusions on tangible depreciable property, the new expenditure exclusion should contain similar exceptions for labour costs that contribute to core R&D and for prototypes only used in R&D (see Tangible depreciable property expenditure exclusion, Issue: Scope of amendment should be expanded and Issue: Prototype exemption amendment for more information on these exceptions). This will bring the treatment of expenditure on assets in the affected industries fully into line with the treatment of expenditure on depreciable tangible property in other industries.

However, the term “mineral miner” and the terms associated with it in the Act (for example, “mining prospecting expenditure,” “mining exploration expenditure”) refer only to “listed industrial minerals,” rather than minerals in the broader sense. The definition of “listed industrial minerals” in the Act does not cover some minerals intended to be covered by the exclusion, such as coal. Geothermal energy, which is also covered by the present exclusion, would not be covered. To achieve the policy intent, the new clause should also deem miners of “minerals” (as defined in the Act) and geothermal energy to be “miners”.

The mining regimes in the Act include terminology that covers the intent of clause 5 of schedule 21 parts A and B (which excludes “prospecting for, exploring for, or drilling for, minerals, petroleum, natural gas, or geothermal energy”). If the amendment proceeds in the form proposed by officials, this clause should be removed.

Recommendation
  1. That the submission be accepted.
  2. That the submission be accepted.
  3. That the submission be accepted.
  4. That the submission be accepted.

TANGIBLE DEPRECIABLE PROPERTY EXPENDITURE EXCLUSION

(Clause 60(2))

Issue: Support the amendment

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, EY, KPMG)

We support the proposed amendment to include expenditure on employees performing core R&D activity that contributes to the cost of an item of tangible depreciable property as eligible expenditure for the tax credit.

Recommendation

That the submission be noted.

Issue: Scope of amendment should be expanded

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, EY, KPMG)

  1. While we support the amendment, we believe its scope needs to be expanded. External labour costs that are capitalised should also be eligible for the regime. R&D work lends itself to having more outsourced labour costs, particularly in asset-heavy industries, and excluding these costs from the regime disadvantages these industries. The proposal as drafted creates a bias against using contractor labour and will lead to arbitrary outcomes. (Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, EY, KPMG)
  2. Additionally, we do not agree with restricting the amendment to only include capitalised expenditure on core R&D activities. Allowing only capitalised core R&D costs while excluding capitalised supporting R&D costs will create arbitrary outcomes. The amendment should include capitalised labour expenditure on both core and supporting activities. (EY, KPMG)
  3. To achieve the above proposals, we suggest the amendment be redrafted as follows: “Expenditure or loss, other than for amounts for employees or services provided by contractors in relation to research and development activities, to the extent to which…” (KPMG)
Comment
  1. The amendment as proposed only allows capitalised expenditure on employees performing core R&D activity to be claimed for the credit. Officials acknowledge that excluding contracted labour costs may disadvantage asset-heavy industries. The original intent behind only allowing employee expenditure was a concern about having less visibility over contracted expenditure, which might allow other costs unrelated to labour included in contractors’ invoices to be claimed for the credit. However, officials have talked to industry experts (advisors and businesses) about this issue, and agree that these risks can be addressed through disclosure requirements (for example, claimants requiring that their contractors separate out their labour costs from other costs when submitting invoices in order to provide clear records for their tax incentive claim). Officials therefore accept that contracted labour costs should be included, and will recommend an amendment to the legislation on this basis.
  2. Officials do not accept that labour on supporting R&D activities should also be eligible. Restricting the amendment to labour costs that directly contribute to core R&D activities (that is, activities that resolve scientific or technological uncertainty) allows genuine R&D that contributes to the cost of tangible depreciable property to be recognised by the regime, while minimising fiscal risks associated with the high construction cost of these assets. Allowing all labour on an asset that involves R&D to be claimed brings in a significant amount of these costs and may reduce the integrity of the regime.
  3. Officials believe the proposed wording to incorporate contractor costs (“services provided by contractors”) is too broad and may allow costs beyond labour expenditure (such as materials provided by contractors) into the regime, contrary to the policy intent. This is covered in (a) above. Officials will recommend an amendment to the legislation that ensures clarity and maintains the policy intent.
Recommendation
  1. That the submission be accepted.
  2. That the submission be declined.
  3. That the submission be declined.

Issue: Prototype exemption amendment

Submission

(Corporate Taxpayers Group, KPMG)

  1. We agree with the prototype exemption amendment, as it confirms what was initially intended when the law was enacted. (KPMG)
  2. We agree with the intent of the prototype exemption. Expenditure on prototypes should be eligible for the credit. However, one of the proposed requirements for the prototype exemption (that the property never be intended for any purpose other than R&D) seems like a very high test to meet. It is not in line with the policy intent of the R&D tax credit regime to exclude legitimate R&D expenditure based on a (potential) later use of the property when the initial activity qualified. (Corporate Taxpayers Group)
Comment

The policy intent of the exclusion on expenditure that contributes to the cost of tangible depreciable property is to keep the cost of large capital assets out of the regime (see Mining development activity exclusion, Issue: Changes not necessary for rationale). An exemption exists for expenditure that contributes to an asset that is solely used in R&D. The intent of this is to allow the credit for assets solely used for R&D throughout their lifetime (that is, prototypes). As these assets would only be used for R&D and have no subsequent commercial use, the cost of producing them is plainly R&D expenditure and falls within the intent of the credit.

The amendment in the Bill clarifies this intent, as the current wording of the prototype exemption could be read as only requiring that the asset be used solely for R&D during the relevant income year, but not for any subsequent years. As the exemption allows an applicant to claim the incentive on the entire upfront cost of such an asset, officials believe it is appropriate that the threshold for accessing it be correspondingly high.

Recommendation
  1. That the submission be noted.
  2. That the submission be declined.

OTHER EXPENDITURE EXCLUSIONS

(Clause 60)

Issue: Support the amendments

Submission

(Chartered Accountants Australia and New Zealand)

We support the proposed amendments.

Recommendation

That the submission be noted.

Issue: Unclear why amendments are required

Submission

(Chartered Accountants Australia and New Zealand, Deloitte)

The stated intent of clauses 13B, 20B, and 20C (which exclude expenditure on corporate governance costs, decommissioning, and remediating land) is to clarify areas already excluded under current legislation. If these areas are already excluded, it’s unclear why the amendments are needed. (Corporate Taxpayers Group)

We do not consider clauses 20B and 20C necessary. (Deloitte)

Comment

The purpose of clauses 13B, 20B, and 20C is to clarify that certain types of expenditure are ineligible for the credit for the avoidance of doubt. Officials believe it is arguable that the areas covered by these clauses are already excluded from the credit, as was the original policy intent. However, experience from the pilot suggested that some taxpayers were unsure about whether corporate governance costs were eligible or not, while clauses 20B and 20C are intended as a response to recent overseas experience that suggests legislation similar to our own does not effectively keep out these costs.

As none of these costs are intended to be eligible, the proposals make it clear for the avoidance of doubt that a taxpayer cannot claim them, ensuring the integrity of the regime and improving certainty for applicants.

Recommendation

That the submission be declined.

Issue: Better fit as activity exclusions

Submission

(Corporate Taxpayers Group)

New clauses 13B, 20B, and 20C may fit better as activity exclusions, rather than expenditure exclusions.

Comment

The intention of the proposed clauses is to provide more certainty about areas meant to be ineligible under the existing policy intent. As the pre-existing definitions of remediation and decommissioning in the Income Tax Act 2007 are predicated on expenditure, rather than activity as such, officials consider that aligning the exclusions with these existing definitions by using the expenditure schedule is conceptually simpler and provides more certainty for taxpayers.

While corporate governance could be excluded as an activity rather than as expenditure, officials believe the intent of the exclusion is better served as an expenditure exclusion. Officials do not consider that corporate governance costs should be eligible as they would have been incurred regardless of whether the R&D took place. Excluding these costs as an activity would have left it ambiguous as to whether they could be claimed as overhead expenditure on an eligible activity, contrary to the policy intent.

Recommendation

That the submission be declined.

Issue: Further clarity needed

Submission

(Corporate Taxpayers Group, Deloitte)

The concepts of “decommissioning” and “remediating land” are very broad. Further clarity is required on what this relates to, as some legitimate R&D exists in this space.

If new clauses 20B and 20C proceed, it’s important that the intention stated in the commentary (that R&D on decommissioning and/or remediating land should still be eligible) be reflected in guidance. (Deloitte)

Comment

Officials agree with the submitters. More clarity on the intended meaning of the exclusions will be provided in a Tax Information Bulletin and Inland Revenue’s official guidance material. The intention that R&D in these areas remain eligible will be preserved.

Recommendation

That the submission be noted.

ADMINISTRATION

(Clauses 76, 79)

Issue: Criteria and methodologies application due date change

Submission

(Corporate Taxpayers Group, EY)

Support the amendment to bring the due date for applying for criteria and methodologies (CAM) approval to six months before the end of the first income year to which the approval relates.

Comment

The proposal amends the due date for applying for CAM approvals to six months before the end of the first income year to which a CAM approval relates (CAM approvals can be obtained for up to three years).

The earlier due date ensures businesses have the correct R&D processes and methodologies in place during the relevant income year and reduces the need to retrospectively amend their processes to ensure their claims are correct. In addition, an earlier due date means businesses have more time to seek general approval should their CAM approval application be declined or only cover part of their R&D.

Recommendation

That the submission be noted.

Issue: Important that responses are timely

Submission

(Corporate Taxpayers Group)

It is important that responses to CAM approval applications are provided in a timely manner. Many of our members will need this to satisfy their auditors on their tax positions.

Comment

Officials agree that it is important that applications be completed in a timely manner. CAM approval applications are likely to take longer than general approval applications, as they involve the taxpayer and the Commissioner agreeing on a bespoke set of criteria and methodologies which the taxpayer will use to determine the eligibility of their R&D activities and expenditure. Requiring the application to be submitted earlier will allow the taxpayer and the Commissioner to agree on these criteria sooner, so that tax positions can be taken in the annual and supplementary returns with much greater confidence. This should also assist in any future audit process.

Recommendation

That the submission be noted.

Issue: Discretion for companies with balance date changes

Submission

(EY)

The amendment should allow for adjusted timeframes for a taxpayer who has a transitional tax year due to a change in their balance date. The Commissioner could be given a discretion to allow a different timeframe for these taxpayers on an application basis.

Comment

The intent of this amendment is defeated if a taxpayer becomes unable to apply for CAM approval in a timely manner due to their balance date being brought forward. In such cases, officials believe it is appropriate that the Commissioner have discretion to allow a different timeframe for the taxpayer to submit their application.

Recommendation

That the submission be accepted.

Issue: Example should be provided in the legislation

Submission

(EY)

It is not clear which income year is being referred to in the CAM due date amendment as currently drafted. An example should be included in the legislation to help clarify this for taxpayers.

Comment

Officials agree that further clarification would be useful for taxpayers. However, the R&D tax credit already has comprehensive guidance material for taxpayers seeking to understand how the regime operates in practice. Officials believe that the appropriate place for an example of how the proposed change will work is in the official guidance material, rather than the legislation.

Recommendation

That the submission be declined.

Issue: Timeframe for completing disputes process

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte)

We support the amendment around the timeframe for completing the disputes process.

Comment

The legislation currently requires a section 113 request to increase an R&D tax credit claim to be initiated and processed within a year of the relevant taxpayer’s income tax return due date. This is contrary to the policy intent, which is simply that the person must initiate the disputes process within that timeframe.

The proposed amendment would remove the requirement that the request be fully processed within that timeframe, while still requiring the request to be initiated within a year of the relevant taxpayer’s income tax return due date.

Recommendation

That the submission be noted.

OTHER R&D SUBMISSIONS

(Clause 76)

Issue: Drafting corrections

Submission

(EY, matter raised by officials)

  1. There is a drafting error in clause 76 of the Taxation (Annual Rates, Feasibility Expenditure, and Remedial Matters) Bill, which states that section 68CC(3) of the Tax Administration Act 1994 currently reads “before the end of the first income year.” However, the legislation actually reads “after the end of the first income year.”
  2. There is a drafting error in section 68CC(2)(iv) of the Tax Administration Act 1994. This section is intended to require that a person applying for criteria and methodologies approval must submit an R&D certificate to the Commissioner with their R&D supplementary return. However, the words “the person” are missing from the section, making 68CC(2)(iv) effectively meaningless.
Comment

Officials agree that these should be corrected.

Recommendation
  1. That the submission be accepted.
  2. That the submission be accepted.

Issue: Growth Grant exclusion – association test should be removed

Submission

(Corporate Taxpayers Group, Deloitte)

  1. The association test should be removed from the Callaghan Innovation Growth Grant exclusion rules. We do not support the outcome that shareholders in a Growth Grant recipient or two or more companies who share a common 50% shareholder(s) will be ineligible for the credit. The rule makes it difficult for Growth Grant recipients to obtain capital needed to expand. (Corporate Taxpayers Group, Deloitte)
  2. There are already rules in the R&D tax credit regime that prevent a person from “double-dipping” on Government R&D funding. These rules make the association test unnecessary. (Deloitte)
Comment

The policy intent is that a person can only claim either the credit or the Growth Grant, because the credit is intended to replace the Growth Grant regime. The association test was introduced at the Select Committee stage of the Taxation (Research and Development Tax Credits) Act 2019 to prevent Growth Grant recipients from artificially structuring their businesses so that they could claim both the credit and the Growth Grant at the same time.

During the Select Committee phase of the Taxation (KiwiSaver, Student Loans, and Remedial Matters) Act 2020, the Corporate Taxpayers Group and Deloitte raised an essentially identical submission to this one. Officials’ response at the time was that the association rule is necessary to prevent businesses deliberately structuring themselves so that they can claim both the credit and the Growth Grant. Officials’ position on this matter is unchanged. The association rule is still vital for preventing artificial restructuring in order to claim both the credit and the Growth Grant; no other part of the legislation fulfils a similar purpose.

At the time, as the association test was not one of the measures contained in the Taxation (Research and Development Tax Credits) Bill as introduced, officials proposed a grandfathering approach. This would allow claims submitted before the report-back date by the Select Committee to use the rules without the association test, while those submitted after that date would have to use it. This approach, and the taxpayers’ suggestion that the test be removed altogether, were both rejected by Select Committee on the grounds that a business can decide to return its Growth Grant, including its subsidiaries’ Growth Grants, if it wishes to be eligible for the credit.

The intent is that a business must choose between the Growth Grant and the credit. The provisions in the legislation that prevent taxpayers from claiming multiple forms of government R&D funding for the same expenditure are more limited in scope and would not prevent taxpayers from claiming the credit for some R&D activities and the Growth Grant for others. If the association test were to be removed, nothing would prevent a company from structuring itself to claim both the Growth Grant and the credit at once, contrary to the policy intent.

Recommendation

That the submission be declined.

Issue: Partnerships and receiving the credit

Submission

(KPMG)

We recommend an amendment to ensure the tax credit is received by a limited partnership or general partnership (rather than by the partners). This will ensure the R&D tax credit is available for the partnership to use in its R&D, rather than being diverted to the partners, and will also reduce the risk of abuse, as the credit will be claimed in a single return rather than across multiple partners’ returns. Additionally, administering the pass-through of the credit from the partnership to its partners is administratively cumbersome. This is important as limited partnerships are a common vehicle for start-up R&D.

Comment

Currently, while certain entity eligibility requirements can be met collectively by a partnership, most eligibility and filing requirements must be met by the individual members of the partnership. This includes filing applications for pre-approval and submitting returns to claim the credit.

In the cases of partnerships with a high number of members, this may be administratively onerous. However, officials do not consider that this justifies allowing partnerships to claim the credit at the partnership level. Requiring members of a partnership to claim at the individual level is an integrity measure that prevents ineligible entities (such as non-resident partners) or partners who are not eligible for refunds in their own right from claiming refundable credits. Allowing refunds to be claimed at the partnership level would remove this oversight and create an integrity risk.

Officials believe, however, that work could be done to streamline the pre-approval application process for partnerships. Allowing partnerships to submit a joint pre-approval application poses far fewer integrity risks than partnership-level refundability and would significantly reduce the compliance burden on taxpayers conducting R&D through a partnership. Officials will consider this further.

Recommendation

That the submission be declined.

Issue: Meaning of “acquire” in R&D expenditure exclusions

Submission

(Matter raised by officials)

A remedial amendment should be made to clause 2 of schedule 21B part B of the Income Tax Act 2007, clarifying that “acquiring depreciable property,” in relation to clause 2, does not include making depreciable property.

Comment

Schedule 21B part B of the Income Tax Act 2007 lists types of expenditure that are ineligible for the tax credit. Clause 2 renders “expenditure or loss incurred in acquiring depreciable property” ineligible. The intent of clause 2 is to exclude expenditure or loss incurred on obtaining depreciable property through any method other than making the property.

However, “acquire” is defined in subpart YA 1, in the context of depreciable property, to include “make”. Clause 2 thus has a much greater reach than intended, effectively cutting all expenditure on depreciable property out of the regime. This is contrary to the policy intent, which is that some expenditure incurred on making depreciable property should be eligible (provided it is not covered by any other exclusion in schedule 21B part B), and should be corrected.

Recommendation

That the submission be accepted.

Issue: Scope of grant-related expenditure exclusion should be narrowed

Submission

(Matter raised by officials)

A remedial amendment should be made to clause 21 of schedule 21B part B of the Income Tax Act 2007, allowing R&D expenditure not supported through other government funding sources to be claimed for the credit.

Comment

Schedule 21B part B of the Income Tax Act 2007 lists types of expenditure that are ineligible for the tax credit. Clause 21 renders “expenditure or loss that is a precondition to, subject to the terms of, required by, or otherwise related to a grant made by the Crown or a local authority” ineligible, except where the expenditure relates to loans under the R&D loan scheme. The intent of this exclusion is to prevent a person from claiming multiple forms of government R&D funding for the same expenditure.

However, officials have become aware of circumstances where the exclusion means that expenditure can become ineligible where the R&D performer receives some government funding, such as a Callaghan Innovation Project Grant, even if the expenditure in question is not itself supported through that funding. A person claiming a Project Grant provides an estimate of the total project expenditure to Callaghan Innovation, and can receive up to 40% of that estimate as a grant (with the remaining 60% being required co-funding). Should the actual expenditure on the project exceed this estimate, any cost overruns are not eligible for further Grant funding. However, they are also not eligible for support through the tax incentive under the exclusion as currently written; the Grant funding agreement requires the person to complete their project, and as the cost overrun is technically required for the completion of the project, it is covered by the funding agreement (and therefore excluded by clause 21).

This outcome is contrary to the broader policy intent of the tax incentive, which is to incentivise and support businesses to increase their expenditure on R&D. Officials consider that the exclusion should be clarified to allow genuine R&D expenditure that is not being supported through other government funding to be eligible for the credit.

Recommendation

That the submission be accepted.

HYBRID RULES REMEDIALS

A submitter raised a number of issues in relation to the hybrid and branch mismatch rules in the Income Tax Act 2007, which do not relate to any specific amendments currently included in the Bill. These submissions are summarised below, alongside officials’ recommendations on them.

Issue: Non-resident group members should be able to group surplus assessable income

Submission

(PwC)

The submitter proposes that the New Zealand residency requirement in section FH 12(10) of the Income Tax Act 2007 should be removed. As a result of this requirement, currently only New Zealand-resident companies are able to group their surplus assessable income (SAI), non-resident companies paying tax in New Zealand are not. As a consequence of this limitation, the SAI of a non-resident company may go unused, while another non-resident in the same group is denied New Zealand deductions (where the non-resident company’s SAI could have otherwise been used to offset the denied deductions). This could result in over-taxation of the group as a whole.

Comment

The policy intent of the SAI grouping mechanism in section FH 12(10) of the Income Tax Act 2007 is to ensure that the right economic outcome is reached for the group as a whole (that is, if one group company has more SAI than it can use, it can make its SAI available to another wholly owned group member who has a hybrid or branch mismatch for which a deduction would otherwise be denied). Officials agree that the current limitation, which prevents non-resident companies paying tax in New Zealand (such as a non-resident company with a New Zealand branch) from grouping SAI with other group members, is inconsistent with the policy intent of this section.

Officials recommend that section FH 12(10) be amended to remove the requirement that companies eligible to group SAI must be resident in New Zealand.

The amendment is a taxpayer-friendly measure that ensures the provision does not result in over-taxation for a corporate group. Although officials are not aware of the number of taxpayers affected by the amendment, it is an issue raised by a tax adviser based on a real-life example faced by at least one of their clients. To ensure the provision applies appropriately, the amendment should be retrospective to the application date of the provision. That is, it should apply for income years beginning on or after 1 July 2018. Taxpayers who have taken a tax position under the existing law would, if relevant, be able to request the Commissioner amend the assessment in order to take advantage of the recommended change. The rationale above for retrospective law change is equally applicable to the other recommended changes to the hybrid and branch mismatch rules below.

Recommendation

That the submission be accepted.

Issue: Payments made within a consolidated group should be included in SAI calculation

Submission

(PwC)

The submitter proposes that section FH 12(4)(c) of the Income Tax Act 2007 should be amended so that excluded payments between members of a New Zealand consolidated group that are taxable to a non-resident group parent are included in the calculation of SAI.

Currently, the SAI calculation formula includes an exempt item, which covers exempt dividends between two New Zealand members of a 100% commonly owned group that are taxable to a foreign owner. The inclusion of these dividends in the formula is to reflect that the hybrid nature of an entity may cause a payment to be taxable in another jurisdiction, with no corresponding deduction for the payer in New Zealand.

This same hybridity issue can arise in relation to payments made within a New Zealand consolidated group. Such a payment will be excluded income in New Zealand and no deduction will be permitted for the payer. However, if the payee is fiscally transparent in another country, income may be recognised in that country in relation to the consolidated group transaction. Currently, such a payment would not be captured in the SAI calculation formula, despite the same income potentially being subject to tax in two jurisdictions: first in New Zealand to the consolidated group on recipient of a third-party payment, and second in the parent jurisdiction, as a regarded transaction between New Zealand companies in the same consolidated group.

Comment

Officials recommended that the SAI, calculation formula be amended to include payments made within a New Zealand consolidated group, where certain conditions are satisfied. To be included as SAI officials consider that a payment would need to meet the following conditions:

  • is both excluded income and non-deductible in New Zealand, due to being paid between consolidated group members (that would have been assessable income in New Zealand in the absence of consolidation), and
  • is taxable and non-deductible in the jurisdiction of a non-resident group parent of the consolidated group.

For the same reasons as those discussed above (in relation to Issue: Non-resident group members should be able to group surplus assessable income), officials recommend the amendment be retrospective to the application date of section FH 12 of the Income Tax Act 2007. That is, it should apply for income years beginning on or after 1 July 2018.

To ensure that this change operates as intended, officials also recommend that amendments be made to address remedial issues in section CX 60 of the Income Tax Act 2007. (Section CX 60(1) currently contains an incorrect cross-reference to section FM 8(3), and it is not necessary to have both section CX 60(1B) and section CX 60(2), as both provisions are expressing the same concept.) Section CX 60 is intended to have the effect of treating payments made between companies in consolidated groups as excluded income, so this section should be referenced as part of the amendment to the SAI calculation formula to achieve the outcome outlined above.

Officials recommend the amendments apply for the 2019–20 and later income years, this being the application date for the previous amendments to section CX 60, which resulted in the current errors. It is not anticipated that many taxpayers will be impacted by this change, nor that it will have a fiscal impact. Taxpayers who have relied on the current law are not expected to be advantaged or disadvantaged as a result of correcting the current legislative errors.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Hybrid financial instrument rule should not apply to income fully taxed in New Zealand

Submission

(PwC)

The submitter considers that the hybrid financial instrument rule (section FH 3 of the Income Tax Act 2007) should be amended, so that it does not apply where any country or territory (including New Zealand) recognises the relevant payment as giving rise to ordinary income (that is, income taxed at the recipient’s full applicable tax rate).

As currently drafted, section FH 3 does not apply where a country or territory outside New Zealand recognises the income. However, the section could still apply to deny a deduction where New Zealand taxes a payment received by the payee at the full applicable tax rate.

Comment

As there is no deduction/no-inclusion hybrid mismatch if a payment is taxed as ordinary income of the payee in New Zealand, this is not a situation that should be captured by the hybrid rules. Therefore, officials recommend section FH 3 be amended so that the section does not apply to a payment taxed at a payee’s full applicable rate in any country or territory, including New Zealand.

For the same reasons as those discussed above (in relation to Issue: Non-resident group members should be able to group surplus assessable income), officials recommend the amendment be retrospective to the application date of the provision. That is, it should apply for income years beginning on or after 1 July 2018.

Recommendation

That the submission be accepted.

Issue: Transfer pricing deemed arm’s length amount – exception should be extended to deductions denied under the hybrid rules

Submission

(PwC)

The submitter proposes that the exception to the deemed arm’s length amount rule in section GC 8(2) – which currently applies where an amount would be deductible but for the application of the thin capitalisation rules – should be extended to cover deductions denied under the hybrid rules.

The submitter notes that, as section GC 8(2) currently does not take into account the hybrid rules, section GC 8 would deem a non-resident payee to have transfer pricing taxable income in New Zealand in relation to an interest free loan where the payer would be denied a deduction for any interest that was paid under the hybrid rules.

Comment

Where inadequate consideration is received under a transfer pricing arrangement, section GC 8(1) deems an arm’s length amount to have been received by the payee for income and withholding tax purposes. Section GC 8(2) contains an exception to this rule, where the general rule in section GC 8(1) will not apply and the below arm’s length consideration will stand (non-resident’s exemption: deduction to the payer).

Section GC 8(2)(b) currently does not account for the hybrid rules, meaning section GC 8(1) could deem a taxpayer to have income taxable in New Zealand under the transfer pricing rules, in circumstances where the hybrid rules could then deny or limit deductions for expenses arising in relation to that income. This is an issue for interest-free loans, where if a deemed arm’s length amount of interest were to be substituted under section GC 8(1), then the hybrid rules could apply to deny a deduction for the deemed amount (that is, non-resident withholding tax would be payable on a deemed interest payment, with the payment not being deductible to the payer). This is an unintended outcome.

In relation to interest-bearing loans, section GC 8(2) also currently does not take into account disallowances under the hybrid rules where, from a policy perspective, the focus of the rule is on deferring – not permanently denying – a deduction, as is the case under sections FH 5, FH 8 and FH 9 (in these cases, the interest may still be deductible in future if there is sufficient “surplus assessable income”). As a deduction may become available for the interest payment in these instances, the original policy rationale for section GC 8(2) outlined above would apply and section GC 8(1) should not apply.

For the same reasons as those discussed above (in relation to Issue: Non-resident group members should be able to group surplus assessable income), officials recommend the amendments be retrospective to the general application date for the hybrid rules. That is, they should apply for income years beginning on or after 1 July 2018.

Officials recommend the above amendments.

Officials have also identified an error in section GC 8(2)(b) in the reference to deductions being denied under “subpart FE (Interest apportionment on thin capitalisation)”. The thin capitalisation rules do not deny deductions but rather deem additional income. It is likely that this reference was missed when the thin capitalisation regime moved from a deduction denial mechanism to the current income deeming method. Officials recommend this omission be corrected.

Recommendation

That the submission be accepted.

Issue: Reverse hybrid rule should be clarified in how it applies to hybrid entities and branches

Submission

(PwC)

The submitter considers that, under section FH 7, deductions may be denied to hybrid entities in circumstances where the relevant income is received, but is not taxable due to the application of exemptions (and not the non-recognition of income) in the recipient jurisdiction.

The intended scope of this provision in Inland Revenue’s Special Report (page 41) on the hybrid and branch mismatch rules provides that the appropriate application of the rules depends on whether a branch or hybrid entity is involved in the transaction.

Comment

Section FH 7 is intended to deny a deduction for a payment in two separate situations:

  • where the payment is not taxable because of a branch mismatch
  • where the payment is not taxable because it is made to a reverse hybrid.

A payment will be non-taxable because of a branch mismatch if paragraphs (a), (b)(i), (c), (d) and (e)(i) are met. A payment will be non-taxable because it is made to a reverse hybrid if paragraphs (a), (b)(ii), (c), (d) and (e)(ii) are met.

There are three issues with the section.

  • As drafted, the section can apply if paragraphs (a), (b)(i), (c), (d) and (e)(ii) are met, or if paragraphs (a), (b)(ii), (c), (d) and (e)(i) are met. This was not intended.
  • With respect to (b)(ii), it should only apply if the amount is treated under the law of the payee country as being income of a person who is in the same control group as the payer and is not the payee. If the income is income of the payee, the payment will not be to a reverse hybrid. However, the subparagraph currently could apply if the income is income of the payee.
  • Also with respect to paragraph (b)(ii), it should be met if: (a), the person treated as deriving the income under the law of the payee country is a person in the payer’s control group who is not the payee; or (b), the arrangement is a structured arrangement (regardless of whether or not that last mentioned person is in the same control group as the payer).

For the same reasons as those discussed above (in relation to Issue: Non-resident group members should be able to group surplus assessable income), officials recommend the amendments be retrospective to the application date of the provision. That is, they should apply for income years beginning on or after 1 July 2018.

Officials recommend the above amendments.

Recommendation

That the submission be accepted.

Issue: The disregarded payments rule should not apply where the end investor is exempt from tax

Submission

(PwC)

The submission proposes that there is a risk that section FH 5 could deny deductions where the income would not be subject to tax in the hands of the recipient due to jurisdiction-specific tax exemptions (for example, due to the source of income or an exemption for pension funds).

The hybrid rules should only operate to deny deductions for payments that are not subject to tax as a result of a hybrid mismatch. The rules should not deny deductions where the hybridity of an entity has no overall impact on the tax outcome of the payment (that is, where the income is not taxable due to specific legislation in the recipient jurisdiction).

Comment

Officials understand that the issue raised by the submitters relates to a specific structure that involves an intermediary foreign entity between the ultimate investor and the New Zealand payer. In this scenario, the investor elects to treat the intermediary entity as “disregarded” for tax purposes in the payee jurisdiction, meaning that, for tax purposes, the intermediary is not treated as a separate person from the investor.

Officials understand the technical issue raised, but consider that the issue could be resolved by removing the intermediary entity from the particular structure, or inserting an entity that New Zealand would not see as fiscally transparent for tax purposes.

Recommendation

That the submission be declined.

Issue: Definition of “hybrid mismatch” should clarify the payee

Submission

(PwC)

The definition of hybrid mismatch in section FH 15(a)(ii) should be amended to clarify that the relevant amount need only be recognised by a person or entity as ordinary income (and not a person or entity “in the payee jurisdiction”).

Comment

As the provision is currently drafted, a payment will fall outside the definition of hybrid mismatch if the relevant amount is recognised as ordinary income of a person or other entity in the payee jurisdiction. It is possible that this definition could cause a hybrid mismatch to arise for payments that are recognised as ordinary income, but are attributable to branches. Therefore, the definition of hybrid mismatch may be met even if the payment is subject to tax as ordinary income in the branch jurisdiction, because it will not be subject to tax in the payee jurisdiction. However, further work on this matter requires prioritising and resourcing as part of the Government’s tax policy work programme.

Recommendation

That the submission be noted, subject to officials’ comments.

Issue: Reverse hybrid rule should only apply where a mismatch in tax outcome arises due to differences in tax treatment of relevant entities

Submission

(PwC)

The submission suggests that section FH 7 should be amended so that it only captures branch mismatches (where relevant), and not mismatches that happen to involve a branch.

The risk identified is that the provision might apply to deny deductions in relation to structures that involve a branch and produce mismatched tax outcomes, despite those outcomes not arising from a branch mismatch. For example, the provision may apply due to the tax regime of the branch jurisdiction (in which case there should be no hybrid mismatch), or due to the payer being disregarded in the branch jurisdiction (in which case section FH 5 should apply). From a policy perspective, it is suggested that section FH 7 should be limited to situations where the mismatch arises due to differences in: (a) the characterisation of the branch (disregarded branch structure), or (b) the attribution of profits to the branch (diverted branch payments), and not merely because a structure includes a branch.

Further work on this matter requires prioritising and resourcing as part of the Government’s tax policy work programme.

Recommendation

That the submission be noted, subject to officials’ comments.

Issue: Domestic transactions should not be denied by the imported hybrid mismatch rule

Submission

(PwC)

The submitter has raised an issue that may arise where both a New Zealand resident company and a non-resident company (through a New Zealand deducting branch) claim New Zealand deductions in relation to a payment that funds a mismatch higher in the global chain. In this situation, it is considered that section FH 11 could apply to deny the New Zealand deductions from both the New Zealand resident company and the New Zealand-deducting branch of the non-resident company. Only one of these deductions should be denied.

It would be preferable to have legislative certainty that only one deduction will be disallowed. It is suggested that the deduction denial in this scenario should be for the deduction claimed by the non-resident company with the New Zealand-deducting branch. Officials expect that at an operational level, only one deduction would be allowed.

Further work on this matter requires prioritising and resourcing as part of the Government’s tax policy work programme.

Recommendation

That the submission be noted, subject to officials’ comments.

BRINGING KIWISAVER EMPLOYER CONTRIBUTIONS INTO THE PENALTIES, RECOVER AND USE-OF-MONEY INTEREST REGIMES

(Clauses 67(4), 68, 80 and 83)

Issue: General support for reform

Submission

(Chartered Accountants Australia and New Zealand)

We support the reform. The amendment would bring voluntary employer contributions within the same penalty and debt collections rules as compulsory contributions. This is appropriate.

Comment

Clause 67 in the Bill is intended to ensure that compulsory and voluntary employer KiwiSaver contributions are treated consistently under the penalties, recoveries and Use-of-Money-Interest (UOMI) regimes.

In March 2019, Cabinet agreed that Inland Revenue would pay an amount of employer contribution to a KiwiSaver scheme in advance of the contribution being received by Inland Revenue. This payment would be based on the employer information filed with Inland Revenue which stated that an employer contribution had been made. This meant that the Crown would provide a limited guarantee to recipients of compulsory and voluntary KiwiSaver employer contributions.

However, the Crown’s provision of a limited guarantee exposes it to fiscal risk. While, in the case of compulsory employer KiwiSaver contributions, this risk is mitigated by the application of the penalties and recoveries regimes, these regimes do not currently apply to voluntary employer contributions. Additionally, the UOMI regime currently does not apply to either category of employer contribution (that is, compulsory or voluntary).

It is not intended that the KiwiSaver funds which are received by an employee’s scheme provider be used to satisfy a tax obligation owed by the employee to the Commissioner. The intention of the amendments is to allow the Commissioner to ensure that employers meet their obligations to pay contributions which the Crown has guaranteed.

Additionally, under section 73 of the KiwiSaver Act 2006, once the Commissioner has received employment income information relating to an employee or employer KiwiSaver contribution, they must enter this amount into the Inland Revenue KiwiSaver Holding Account. This amount must then be transferred to the KiwiSaver member’s scheme provider. This means the Commissioner does not have the ability to apply KiwiSaver contributions to another purpose (for example, an individual taxpayer’s tax liability). It was not considered necessary to consult the Ministry of Justice on this item as it is remedial in nature.

Recommendation

That the submission be noted.

CONFIRMING HOUSING NEW ZEALAND BUILD LIMITED SUBJECT TO INCOME TAX

(Clause 63)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand)

That the remedial proposal to confirm that Housing New Zealand Build Limited is subject to income tax is supported.

Recommendation

That the submission be noted.

CHANGING THE DUE DATE FOR LOCKED-IN PORTFOLIO INVESTMENT ENTITIES

(Clauses 70, 71, 72 and 75)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand)

The submitter supports the proposals to bring forward the date of reporting to the Commissioner by a portfolio investment entity (PIE) that is a superannuation fund or retirement saving scheme, which will align reporting by locked-in and non locked-in funds.

Recommendation

That the submission be noted.

(Clauses 70, 71, 72 and 75)

Issue: Discretion when applying late filing penalties on income information filed by locked-in portfolio investment entities

Submission

(Deloitte)

The legislation proposes bringing forward the filing date by which multi-rate PIEs with locked-in funds are required to file detailed income information for their investors to 15 May. This relates to multi-rate PIEs that are a superannuation fund or retirement saving scheme. Some PIEs may not be able to meet the proposed amended date, and in these situations a longer time period may be needed. Appropriate discretion must be applied to late filing penalties in these situations.

Comment

The filing date was brought forward from 30 June to 15 May for locked-in PIE funds to align information reporting on investors with non-locked-in PIE funds. This is to allow Inland Revenue to undertake the PIE end-of-year square-up process as part of the auto- calculation process for individual income tax assessments. In further correspondence, the submitter noted that there are alternatives available, such as allocating PIE income and deductions. Officials note that late filing penalties may be waived if there is reasonable cause to do so.

Recommendation

That the submission be declined.

APPLICATION OF THE MINORS’ INCOME TAX EXEMPTION TO MINOR BENEFICIARY INCOME

(Clause 12)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand)

We support the amendment.

Comment

Section CW 55BB provides school children with an income tax exemption on up to $2,340 of income. This is a compliance cost measure preventing them from having to a file a return. The exemption is not intended to apply where there is someone in a position to pay tax on behalf of the child – for example, it does not apply where tax has been withheld at source such as on investment income or salary and wages.

Beneficiary income up to $1,000 paid to a minor is taxed at the beneficiary’s tax rate. Under current law, this $1,000 distribution would be eligible to be exempt under CW 55BB. This is contrary to the policy intent as the trustee is in a position to pay tax on behalf of the beneficiary.

The proposed amendment therefore provides that income derived by a minor beneficiary does not qualify for the income tax exemption in section CW 55BB, and is taxed at the beneficiary’s marginal rate.

This amendment is retrospective to 29 May 2012 (the date the minors’ income tax exemption was introduced), with a savings provision for people who took a tax position relying on the current law in a return filed before the Bill was introduced into Parliament. The savings provision allows taxpayers who filed a return before the Bill was introduced into Parliament to rely on the current law. It is limited to the date the Bill was introduced because from that point taxpayers will be aware of an impending amendment. The provision only applies to those who have already filed a return, in order to prevent taxpayers from amending a previous return and getting a windfall gain.

The amendment will prevent minors from reopening returns and claiming an exemption on the up to $1,000 of beneficiary income already allocated, as well as preventing them from claiming the $1,000 exemption going forward. This is expected to affect approximately 9,000 minor beneficiaries – 2,675 beneficiaries who paid tax and would be prevented from reopening a return, and 6,258 who previously did not pay tax on distributions received but who would be required to do so going ward.

Recommendation

That the submission be noted.

NOMINEE TREATMENT FOR TRUSTEE OF EXEMPT EMPLOYEE SHARE SCHEME (ESS)

(Clauses 2(1) and 10)

Issue: Support for amendment

Submission

(Chartered Accountants Australia and New Zealand)

We support the clarification that a trustee of an exempt employee share scheme can be treated as a nominee of a company providing the scheme. We also support the amendment applying from the date of enactment.

Recommendation

That the submission be noted.

Issue: Transitional effects of section CE 6 (trusts are nominees)

Submission

(Russell McVeagh)

The consequences of the existing section CE 6 are uncertain in various respects, and may result in unexpected tax liabilities.

  1. There is a question as to whether section CE 6 is intended to apply to a trustee of a taxable ESS that is grandparented under section CZ 1. The application of section CE 6 to a taxable ESS – including a grandparented ESS – and an exempt ESS should be optional, as taxpayers may have taken, or wish to take, different approaches.
  2. There is a question as to the transitional consequences for the trustee of becoming a nominee. For example, it is unclear whether the trustee is treated as disposing of any unallocated shares to the company. It is also unclear whether the trustee is treated as being relieved of any financial arrangements liabilities it owes, such that debt remission income arises. A taxpayer should be entitled to elect to treat assets or liabilities as transferred at cost, or otherwise on a basis that does not give rise to an income tax liability for the trust purely by virtue of the application of section CE 6. This could be similar to the approach adopted for a solvent company under a resident’s restricted amalgamation, for example.
  3. Where section CE 6 applies, unallocated shares held by the trust are treated as treasury stock of the company. If shares remain unallocated after one year, the company has a reduction in available subscribed capital (ASC), under section CD 25(4). It should be clarified that if the trust subsequently allocates or disposes of the shares, an amount the trust receives is included in “subscriptions” (in section CD 43), increasing the company’s ASC. Otherwise the reduction in ASC under section CD 25(4) would be permanent.
Comment
  1. Section CE 6 applies to a person who is a trustee of an employee share scheme. An employee share scheme is defined in section CE 7. This definition includes a scheme that provides benefits which are, by virtue of section CZ 1(2), subject to section CE 2 before its amendment in 2018. In officials’ view, it is employee share scheme benefits that are grandparented, not particular schemes. Therefore, section CE 6 applies to a trustee of an employee share scheme that provides benefits; some or all of which are grandparented by section CZ 1. Officials consider it is simpler for nominee treatment to apply to all ESS/exempt ESS trustees, rather than for trustees to have to determine their own status.
  2. Officials have discussed with the submitter and others the effect of deeming trustees to be nominees to the extent provided for by section CE 6. The purpose of this deeming provision was to simplify compliance for employee share schemes. Officials appreciate that, in the absence of detailed provisions, such as those that apply to amalgamations in subpart FO of the Act, there may be a slightly untidy transition for trustees of some schemes. However, given that the issue is very technical and is not a recurring one, officials at this stage do not believe that it is a good use of resources to give detailed consideration to the development of a suite of rules for this purpose. As a general proposition, and in the absence of any firm evidence to the contrary, we believe that any difficult issues should be resolvable on an administrative basis.
  3. An issue of treasury stock by a company is included in available subscribed capital simply because it is an amount received by a company from the issue of shares (section CD 43(2)(b)). However, officials recommend amending the definition of “subscriptions” to clarify that consideration received by the company for the issue of shares as a result of the application of section CE 6 is included.
Recommendation
  1. That the submission be declined.
  2. That the submission be declined.
  3. That the submission be accepted.

Issue: Typo in section CW 26C(7)(a)(ii) should be corrected

Submission

(Matter raised by officials)

There is a typographical error in section CW 26C(7)(a)(ii), which deals with the period of restriction for the exempt ESS rules. The word “employer” (the eighth word of the subsection) should be “employee”, as it is the date of the employee’s acquisition of the shares that is relevant to the period of restriction.

Comment

Officials recommend this error be corrected.

Recommendation

That the submission be accepted.

DISPOSAL OF COMPANY’S OWN SHARES BY EMPLOYEE SHARE SCHEME TRUSTEE

(Clauses 2(1) and 13)

Issue: Support for amendment

Submission

(Chartered Accountants Australia and New Zealand)

We support the clarification that income derived by a trustee of an ESS from disposing of the company’s own shares (treasury stock), while acting in its capacity as nominee of the company, is exempt. We also support the amendment applying from the date of enactment.

Recommendation

That the submission be noted.

GST COMPULSORY ZERO RATING OF COMMERCIAL LAND LEASES

(Clause 88)

Issue: Supports proposal

Submission

(Chartered Accountants Australia and New Zealand, KPMG)

Support the changes as they ensure that the compulsory zero rating rules achieve the intended policy outcome in relation to land leases, and validates how these rules have been applied by many (if not most) taxpayers and practitioners. (KPMG)

Recommendation

That the submission be noted.

Issue: One of the proposed amendments is unnecessary

Submission

(Chartered Accountants Australia and New Zealand)

One of the proposed amendments, which would zero-rate business assets where a business sale that includes a zero-rated supply of a land lease is unnecessary as the legislation already provides this outcome.

Comment

Officials consider that the proposed amendment is a useful clarification that the relevant supply will still be zero-rated if it includes a lease assignment or surrender and other business assets.

Recommendation

That the submission be declined.

WHEN INCOME IS DERIVED FROM A CASH DIVIDEND

(Clause 9)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte)

The submitters support the proposed change.

Recommendation

That the submission be noted.

Issue: Replace “received” with “paid”

Submission

(Chartered Accountants Australia and New Zealand)

The use of the term “received” does not align with concepts in the Inland Revenue Acts.

The concept of “pay” or “paid” is the correct approach and should be adopted in the amendment. The term “pay” is defined in section YA 1 of the Income Tax Act 2007. The salient part of the definition relevant for the purposes of the proposed amendment is, broadly, an amount that is distributed, credited, or dealt with on a person’s behalf. It is generally well understood by practitioners and taxpayers.

The objective that the amendment is seeking to achieve is to change the timing of when a cash dividend will be assessable, effectively overriding accrual treatment. This can be done under current concepts by a “pay” or “paid” approach.

Comment

Officials note that the term “received” is not a defined term in the Income Tax Act 2007. However, it is a well-understood term and is defined in case law. “Received” is the standard term used in the timing rules where income is to be returned on a cash basis, which is the policy intent of this clause. The term “received” is used multiple times throughout the Income Tax Act 2007, for example in sections CC 2, CG 5, CG 5B, and CG 6 when describing the timing of income from superannuation schemes and insurance.

The policy intent is to simplify the process for accrual-based taxpayers to be able to account for cash dividends on a cash basis. The issue identified was that taxpayers who accounted for their business income on an accrual basis would also have to accrue any business-related dividends, which officials understand is contrary to existing practice. The simpler approach is for taxpayers to allocate the income when they receive the dividend, rather than having to determine when the dividend has been accrued.

Officials consider the use of that the term “paid” could also create further confusion, as the person receiving the dividend may not know the date the dividend was paid by the payer if they have yet to receive the amount. Officials therefore prefer the use of “received”.

Recommendation

That the submission be declined.

Issue: Clarify application to company paying dividend by resolution

Submission

(Chartered Accountants Australia and New Zealand)

The proposed amendment should clarify how the rule would apply to small-to-medium sized companies that resolve to pay a dividend before year-end, where the amount of the dividend is quantified after year-end.

Comment

The proposal in the Bill clarifies that a person who receives a dividend is treated as deriving it on a cash basis. This means that a dividend cannot be treated as derived if a company resolves to pay a dividend but does not pay it – if it is not paid, it cannot be received. Officials therefore consider it unnecessary for amendments that address the circumstances where a company makes a resolution to pay a dividend, but that dividend is not paid until a later time. In that situation, the dividend cannot be treated as “received” by the recipient.

Officials acknowledge the matter raised in this submission, but note that further clarification would require prioritising and resourcing as part of the Government’s tax policy work programme.

Recommendation

That the submission be noted, subject to officials’ comments.

Issue: Clarify interaction with investment income reporting rules

Submission

(Chartered Accountants Australia and New Zealand)

The legislation should clarify how the investment income reporting rules apply to a payment of a dividend that is deemed to be paid in an earlier income year.

It is timely to clarify in the Income Tax Act 2007 how the investment income rules apply to a dividend paid by resolution before the end of an income year but quantified after that date.

Comment

Officials acknowledge the matter raised in this submission, but note that it would require prioritising and resourcing as part of the Government’s tax policy work programme.

Recommendation

That the submission be declined.

Issue: Availability of tax credits should be confirmed

Submission

(Chartered Accountants Australia and New Zealand)

The legislation should confirm that the associated imputation credits and resident withholding tax credits will be available to the shareholder in the income year that the dividend is assessable.

The availability of imputation credits and resident withholding tax credits on dividends that are paid with retrospective effect can be uncertain.

Comment

Officials consider that the law is clear regarding this practice and therefore does not need further clarification. However, officials will look to provide some confirmation of the position in a future Tax Information Bulletin following the enactment of this Bill.

Recommendation

That the submission be noted.

Issue: Amendment more appropriate in Part E of the Income Tax Act 2007

Submission

(Chartered Accountants Australia and New Zealand)

The amendment may be more appropriate in Part E of the Income Tax Act 2007. The intention of the amendment is to change the timing of the assessment of a cash dividend. Therefore, the amendment may be more appropriately placed in Part E of the Income Tax Act 2007 (timing and quantifying rules).

Comment

Officials note that the Income Tax Act 2007 contemplates the fact that the provisions dealing with the timing of income are included in Parts C and E to I. This is reflected in section BD 3(2), which deals with the allocation of income to particular years, and states: “An amount of income is allocated to the income year in which the amount is derived, unless a provision in any of Parts C or E to I provides for allocation on another basis”. On this basis, it would not be unprecedented for a provision in Part C to contain a timing rule, such as the case proposed in the Bill and the amendments proposed to section CD 1.

Recommendation

That the submission be declined.

Issue: Assurance that the Commissioner will not seek to review prior tax positions taken on basis of previous law

Submission

(Chartered Accountants Australia and New Zealand)

The Commissioner should assure taxpayers that resources will not be employed to review the tax treatment of dividends derived before the 2020–21 income year. Although we broadly support the policy intent of the amendment, it would be helpful if the Commissioner assured taxpayers that resources will not be employed to review the past tax treatment of dividends derived before the 2020–21 income year.

Comment

Inland Revenue will consider this operational matter.

Recommendation

That the submission be noted.

NRFAI DEFERRAL CALCULATION FORMULA – HYBRID DEDUCTION ITEM

Issue: Amendment may result in formula producing an undefined outcome

Submission

(PwC)

The submitter proposes that the amendment could result in the non-resident financial arrangement income (NRFAI) formula producing an undefined answer where the accumulated accruals figure is reduced to zero for a reason other than by operation of the hybrid rules (such as transfer pricing). The submitter recommends that the proposed amendment to section RF 2C(6)(a) of the Income Tax Act 2007 (which would specify if “the item accumulated accruals is equal to the item hybrid deductions” then NRFAI would not arise) should be changed to read: “the item accumulated accruals is equal to the item hybrid deductions, or zero”.

Comment

In the situation the submitter is referring to, where the hybrid deduction item is not the cause of the accumulated accruals item being reduced to zero, the hybrid deduction item must itself be zero. This would mean that the accumulated accruals item would be equal to the hybrid deduction item (that is, they would both be zero). Therefore, officials are of the view that the proposed amendment would not produce an undefined answer in situations where the accumulated accruals figure was reduced to zero for reasons outside of the hybrid rules.

Recommendation

That the submission be declined.

THIN CAPITALISATION REMEDIALS

(Clauses 34 and 35)

Issue: Support for carve out

Submission

(Chapman Tripp, Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte)

Submitters supported the insertion of proposed section FE 2(4B).

Recommendation

That the submission be noted.

Issue: Scope of carve out should be extended

Submission

(Chapman Tripp)

Sections FE 6 and FE 7 of the Income Tax Act contain interest apportionment rules. Section FE 2(1)(d)(i) states that these may apply to a trust settled by a non-resident or an associated person of a non-resident. Proposed section FE 2(4B) should be amended so that it carves out from the meaning of “associated person” for the purpose of section FE 2(1)(d)(i) all associations between a New Zealand-resident settlor of a trust and a non-resident that has not made a settlement on the trust.

Due to the breadth of the association rules in subpart YB, there are many other scenarios in which a resident settlor of a trust would be associated with a non-resident but it is not intended that the trust be brought within the ambit of the thin capitalisation rules solely by reason of that association because the non-resident is not itself a settlor of the trust.

Examples of trusts that would not be saved from inadvertent/unintended application of section FE 2(1)(d)(i) by the current drafting of proposed section FE 2(4B) include:

  • where a New Zealand-resident company settlor of a trust has a non-resident sister company that it is associated with under section YB 2 but the sister company does not make a settlement on the trust; and
  • where a beneficiary of a trust, who is associated with the New Zealand-resident settlor under section YB 9, moves overseas and becomes a non-resident but the beneficiary does not make a settlement on the trust.
Comment

Officials agree that the proposed carve outs do not cover all possible scenarios where certain trusts with a New Zealand resident settlor should not be subject to thin capitalisation.

Section FE 2(1)(d)(i) was intended to cover settlements by a non-resident as well as any New Zealand resident associates of that non-resident. However, the current provision is much wider than this. It includes a trust settled by any New Zealand resident who is associated with a non-resident, unless that associate is specifically carved out.

Points of difference

Officials agree with the submitter’s proposal with the following adjustment.

Rather than further extending the scope of the carve outs, officials recommend section FE 2(1)(d)(i) is narrowed so that it only covers settlements by a non-resident, or an associate of that non-resident and that proposed section FE 2(4B) be removed.

It would also remove the need for existing section FE 2(4)(b), as a non-resident relative would only be covered by the revised section FE 2(1)(d)(i) if they had also made a settlement on the trust, in which case section FE 2(4)(b) would already not apply to them.

Recommendation

That the submission be accepted, subject to officials’ comments.

Issue: Resident and non-resident trusts

Submission

(Chapman Tripp, Russell McVeagh)

References to resident/non-resident trusts in proposed section FE 2(4B) should be consistent with existing terminology in the Income Tax Act for trusts and trustees.

Comment

Officials agree that the terms used in this provision should be consistent with the existing terminology and concepts used in the trust rules that describe the relationship of trusts, trustees, and settlors with tax residence.

However, the recommendation above to remove proposed section FE 2(4B) deletes the issue.

Recommendation

That the submission be noted.

Issue: Application date of section FE 2(4B)

Submission

(Chapman Tripp, Chartered Accountants Australia and New Zealand)

  1. Proposed section FE 2(4B) should have retrospective effect from the 2015–16 income year. This is because it is a remedial amendment to correct a mistake in the current drafting of section FE 2(1)(d)(i), which arose when the section was amended in 2014 by the Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Act 2014 with effect from the 2015–16 income year. If desired, a savings provision could be added to preserve tax positions taken under the existing provision. (Chapman Tripp)
  2. It is appropriate that section FE 2(4B) should apply to income years beginning on or after the date of enactment. (Chartered Accountants Australia and New Zealand)
Comment

A prospective application date was considered appropriate, as proposed section FE 2(4B) would extend the scope of carve outs from section FE 2(1)(d)(i) in a way that had not previously been contemplated, rather than correcting a previous error.

However, officials’ recommendation above, to narrow the scope of section FE 2(1)(d)(i) rather than proceed with proposed section FE 2(4B), reflects that the original scope of section FE 2(1)(d)(i) brought trusts with a New Zealand settlor within the thin capitalisation rules in a way that was not intended.

Officials do not support a savings provision, as this would provide a benefit to trusts that had not complied with the current rules over trusts that had applied thin capitalisation consistent with the current rules. Instead, officials recommend that the revised position is applied effective from 1 April 2015 to align with the original amendments.

Recommendation
  1. That the submission be accepted.
  2. That the submission be noted.

Issue: Support for new apportionment formula

Submission

(Chartered Accountants Australia and New Zealand, Corporate Taxpayers Group, Deloitte, Powerco)

Submitters supported the introduction of a new formula for calculating apportionment of interest by an excess debt entity that is controlled by a non-resident owning body or trustee.

Recommendation

That the submission be noted.

Issue: “Group world debt percentages” higher than 60%

Submission

(Corporate Taxpayers Group, Deloitte, EY, Powerco, PwC)

The proposed formula should be amended to work in situations where the “group world debt percentage” is higher than the 60% threshold, as the deemed income is overstated under the proposed formula.

Comment

The formula proposed in the Bill includes:

(group NZ debt percentage – 60%) / (group NZ debt percentage – group world debt percentage)

Provided that the group world debt percentage is below 60%, this will result in a fraction between zero and one, so the taxpayer derives an amount of income that is a fraction of their total interest expenditure that would be excluded from their worldwide group (essentially related party interest). However, when the group world debt percentage is greater than 60% the fraction will be greater than one meaning the taxpayer could derive an amount of income greater than their total interest expenditure that would be excluded from their worldwide group. Officials recommend that this should be corrected.

Recommendation

That the submission be accepted.

Issue: Negative total assets

Submission

(KPMG)

The introduction of the non-debt liabilities adjustment for income years commencing on or after 1 July 2018 can, in rare cases, result in the denominator of the thin capitalisation safe harbour calculation being negative (for example, a company has non-debt liabilities exceeding its total assets).

It is unclear what a negative debt percentage means for interest limitation under the thin capitalisation rules. When the non-debt liabilities adjustment to total assets results in a negative debt percentage, for thin capitalisation purposes, the interest limitation should be the total interest expense for the year.

Comment

Under the current law, when there is a negative debt percentage, two possible interpretations are that interest-income arising due to breaching the thin capitalisation safe harbour could be either zero or larger than total interest expense. Neither of these outcomes are appropriate. The submitter is correct that when the debt percentage is negative, the amount of income derived by the taxpayer should be equal to their total interest expense for the year.

Officials recommend amendments to clarify this situation.

Officials note that this outcome should also apply to the restricted transfer pricing rules, so that a taxpayer with a negative debt percentage should be treated as having a debt percentage of greater than 40% for the purpose of applying the group credit rating and restricted credit rating.

Officials also recommend similar amendments be made to apply to the restricted transfer pricing rules.

Recommendation

That the submission be accepted.

TAX RULES RELATING TO CUSTODIAL INSTITUTIONS

(Clauses 56 and 73)

Issue: Extending the definition of custodial institutions

Submissions

(Chartered Accountants Australia and New Zealand, Deloitte, HSBC, KPMG)

The submitters support the proposals that the definition of a “custodial institution” be extended to include a New Zealand operation that is a fixed establishment of a non-resident entity. The amendment would apply from 1 April 2020. This aligns the date of the amendment with the commencement date of the investment income reporting rules, in particular the rules for custodial institutions. The amendment is taxpayer friendly.

Recommendation

That the submission be noted.

Issue: Clarifying the withholding obligations of custodial institutions

Submissions

(Chartered Accountants Australia and New Zealand, Deloitte)

The submitters support the proposals that the requirement for custodial institutions to withhold RWT be extended to include NRWT as applicable.

Recommendation

That the submission be noted.

Issue: Foreign currency and resident withholding tax

Submissions

(Deloitte)

The submitter suggests that there should be further alignments of the options for converting foreign currency for investment income payers and investors, which refers to subsections RE 4(5), (6) and (7) of the Income Tax Act 2007. This submission was made in relation to custodial institutions but relates to all investment income payers.

The option for investment income payers to use the foreign exchange conversion rate on the date the payment of income is received is not matched with the conversion rate with the options for RWT credits.

Investment income payers may not be able to use the exchange rate for the day the income is received, as their systems process conversions on a different date.

Comment

Officials acknowledge the matter raised in this submission; however, further work requires prioritising and resourcing as part of the Government’s tax policy work programme.

Recommendation

That the submission be noted.

Issue: Amending the definition of “end investor”

Submission

(KPMG, HSBC NZ)

The exclusion of a non-resident custodial institution which carries on business in New Zealand through a fixed establishment in New Zealand should be removed from the definition of an “end investor”. The requirement prevents custodians caught by the exclusion from being able to withhold and report investment income on an aggregated basis. This is contrary to the policy intention.

The fixed establishment requirement should be modified to permit foreign custodians to be treated as end investors, to the extent that the underlying clients of the custodian are not clients of the foreign custodian’s New Zealand fixed establishment. This should apply retrospectively from 1 April 2020. (HSBC NZ)

Comment

Officials agree that the policy intention was to allow reporting and withholding on an aggregated basis where a payment of investment income passes to a non-resident custodian. It was not intended that a non-resident custodian’s New Zealand business model should affect reporting and withholding requirements.

The normal reporting rules require detailed information which is used to pre-populate New Zealand investors’ myIR account. Aggregation is intended to relax the normal rules where a New Zealand custodial institution passes a payment of investment income to a non-resident custodial institution. This means that information in respect of non-New Zealand resident individual investors (who may be many steps further along an investment chain) is not required by Inland Revenue.

Officials note the difficulties that have arisen with definitions involving non-resident custodial institutions, and ensuring that obligations are clear and unambiguous. In consequence, officials’ view is that the proposed amendment would benefit from further work.

Recommendation

That the submission be noted.

BENEFICIARIES AS SETTLORS

(Clause 43)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand)

We support the amendment.

Recommendation

That the submission be noted.

Issue: Beneficiaries owed money by a trust should not be deemed settlors where they have no knowledge of the debt

Submission

(PwC)

A beneficiary owed more than $25,000 by a trust should not be deemed a settlor where they have no knowledge of the debt. This could have significant tax consequences – for example, if the beneficiary acquires land during a period in which the trust is in the business of developing land, that land may be subject to tax if sold within 10 years.

Comment

Section HC 27(2) provides that a person who transfers value to a trust is a settlor. A beneficiary can become a settlor when money is paid out to them but is retained in their current account with the trust. This is because they “transfer value” to the trust by leaving money in the trust interest-free.

A recent legislative amendment to section HC 27(6) aimed to ensure that beneficiaries with current account balances below $25,000, or on which the prescribed or market rate of interest has been paid, do not become settlors. This was a taxpayer-friendly amendment, ensuring that beneficiaries with modest current account balances do not because settlors. Being a settlor has implications in numerous areas, such as social assistance and student loan repayment obligations.

It has become apparent that this amendment may be ineffective because, from a legal point of view, a beneficiary’s knowledge as to the way the trustee is using the money is required for a transfer of value to occur. Therefore, a beneficiary could be owed any amount by the trust but not be a settlor if the beneficiary had no knowledge of the debt. The amendments in the Bill ensure the original policy intent is achieved by providing that a beneficiary of a trust who is owed money by the trustee and does not meet the requirements of subsection (6) is a settlor, regardless of knowledge.

Officials disagree with the submitter that a beneficiary should only be treated as a settlor where they have knowledge of the debt. It would be difficult for the Commissioner to ascertain the beneficiary’s level of knowledge. To introduce such a requirement would also be inconsistent with other aspects of the tax system, such as the bright-line test for residential property, which replaced a test that was based on the taxpayer’s purpose or intent.

As the trustee deciding on the use of a trust’s funds is often a family member, it is expected that the trustee would inform the beneficiary of the debt. The additional disclosure requirements to beneficiaries in the Trust Act 2019 may assist in keeping beneficiaries more informed. Alternatively, the beneficiary being deemed a settlor can be prevented by the trustee paying market interest or ensuring the amount owed to the beneficiary is not more than $25,000.

It was always intended that beneficiaries who owed more than $25,000 on which interest has not been paid would become settlors of the trust, regardless of knowledge. The Bill as currently drafted is consistent with this intent.

Recommendation

That the submission be declined.

MIGRATING SETTLOR OF A TRUST

(Clauses 41, 42, and 44)

Issue: Electing to pay New Zealand tax on world-wide trustee income

Submission

(Chartered Accountants Australia and New Zealand)

The proposed amendments to allow a distribution of tax-paid income to be exempt to the beneficiary, following a voluntary disclosure or an election to pay tax on world-wide trustee income, are supported.

Recommendation

That the submission be noted.

Issue: Distributions from trusts – terminology used inconsistent with policy purpose

Submission

(Wallis Tax Advisory Ltd)

That the reference to “a distribution from income” in clause 44 should refer to the term “a distribution of an amount”, to ensure that a distribution of a capital gain from a trust can be treated as being made from a complying trust.

Comment

A complying trust is a trust for which the trustee has paid tax on world-wide trustee income. However, such a trust may make a capital gain, which is not taxable under the Income Tax Act 2007, and the non-taxation of such a gain is not intended to affect the complying trust status. A distribution of a capital gain from such a trust is also intended to be exempt to the beneficiary. Officials recommend the submission be accepted.

Recommendation

That the submission be accepted.

Issue: Taxation of trusts and interaction with Double Taxation Agreements

Submission

(Wallis Tax Advisory Ltd)

That the provision allowing an election to pay tax on world-wide trustee income explicitly provide an override of the allocation of taxing rights under a double taxation agreement (DTA).

Comment

When a person makes an election for a trust to pay tax under section HC 33, the trustee is, by choice, agreeing to pay New Zealand tax at the trustee rate on their world-wide trustee income, without reference to any DTA. The purpose of this election is to permit the trust to be treated as a complying trust for distributions from the trust fund of amounts derived after the effective date of the election. These distributions are tax-exempt to the beneficiary.

Officials consider that this policy, and the associated legislative outcome, is supported by the general principle of the OECD commentary on tax treaties which states that countries are free to tax their own residents as they choose. Article 11 of the multilateral convention to implement tax treaty-related measures that address base erosion and profit shifting clarifies that a DTA generally does not restrict a country’s ability to tax its own residents, except in certain listed circumstances. Taxing a trust based on an election to pay tax on world-wide trustee income is not one of those listed circumstances.

Therefore, officials consider that the suggested change is unnecessary, as officials are concerned that a specific override in the election rules for tax treaties may create an adverse inference for other trust provisions that are intended to override tax treaties.

Recommendation

That the submission be declined.

RESTRICTED TRANSFER PRICING

(Clause 39)

Issue: Support for proposal

Submission

(Chartered Accountants Australia and New Zealand, EY, PwC)

Submitters supported replacing references to “associated persons” so that cross-border related borrowing is treated consistently with loans from an associated person.

Recommendation

That the submission be noted.

Issue: Cross-border related borrowing with terms greater than five years

Submission

(PwC)

The calculation to allow for exotic features seen in third-party debt to be “regarded” under the restricted transfer pricing rule should be simplified.

Where taxpayers have significant third-party funding arrangements with terms longer than five years, there is limited practical ability for such features to be regarded under the restricted transfer pricing rule. This is on the basis that, in order for this feature to apply, the rules effectively require related-party debt to be executed in tranches with differing loan terms. Specifically, the requirement to calculate and adjust for the threshold fraction prohibits the ability to recognise third-party debt with a threshold term longer than five years where a taxpayer only has one tranche of related party debt (which is common in order to manage compliance obligation). Effectively, where there is only one tranche of related-party debt, the taxpayer will never be able to apply the threshold term.

Comment

Section GC 18 removes terms of greater than five years from being included in pricing cross-border related borrowing unless the New Zealand group or the worldwide group has significant third-party debt with a term that is equal or greater than five years. These rules were explained on page 24 of the BEPS interest limitation special report and page 113 of Tax Information Bulletin Volume 31, No 3, April 2019.

The threshold fraction calculates third-party debt with a term over five years as a proportion of total third-party debt. This was intended to require a group to have terms for cross-border related borrowing that resembled their third-party funding. For example, if a group had 50% of its funding with a term of two years and 50% of its funding with a term of 10 years, it could also have 50% of its cross-border related borrowing with a term of 10 years. Although the rules operate correctly when a group structures itself in this way, as noted by the submitter, groups may prefer to have a single cross-border related borrowing rather than splitting it into below-five-year and above-five-year components. For example, instead of the two loans above, they could have a single loan with a term of six years for the same average maturity. When a group has a single cross-border related borrowing with a term of greater than five years, they will only satisfy the threshold term if they have no third-party debt with a term of less than five years.

Officials recommend that an alternative approach should be added to the restricted transfer pricing rules, so that cross-border related borrowing can have a term of greater than five years without having to satisfy the threshold term if:

  • the term is less than the weighted average of all third-party debt, and
  • total cross-border related borrowing is less than four times the third-party debt.
Recommendation

That the submission be accepted.

Issue: Notching for group credit rating

Submission

(EY)

We understand that section GC 16(10) was intended to provide for downward notching adjustments under both paragraphs (a) and (ab), rather than only under paragraph (a) as the section currently stands. This inconsistency should be addressed.

Comment

Section GC 16(10)(ab) was introduced by the Taxation (Annual Rates for 2018–19, Modernising Tax Administration, and Remedial Matters) Act 2019 to cover situations where the group credit rating could not be applied as the group had no external debt. As the submitter notes, it was not intended that a taxpayer relying on this provision would not be able to apply the same one- or two-notch adjustment that is already available for a taxpayer relying on section GC 16(10)(a).

Officials recommend correcting this error and the amendment should apply from 1 July 2018 to align with the start of the Restricted Transfer Pricing rules and the previous amendment.

Recommendation

That the submission be accepted.

NZ SUPERANNUITANTS AND THE END-OF-YEAR AUTO-CALCULATION PROCESS

(Clause 84)

Issue: Support for the proposal

Submission

(Chartered Accountants Australia and New Zealand)

The submitter supports the proposed change to clarify that recipients of New Zealand Superannuation and Veteran’s Pension are limited to a $50 write-off if they have used a tailored tax code.

Recommendation

That the submission be noted.

(Clause 84)

Issue: Clarification that clause 1(b) of Part B of schedule 8 is subject to the same limitation

Submission

(Matter raised by officials)

An amendment should be made to clause 84 to include clause (1)(b) of Part B of Schedule 8 of the Income Tax Act 2007 in order to effectively limit the proposed write off to New Zealand superannuation and veterans pension precipitants who use a tailored tax code.

Comments

Part B of Schedule 8 to the Income Tax Act 2007 outlines when the Commissioner must write off certain amounts of tax. The write off is available under both clauses 1(a) and 1(b) of Part B. The current proposal in clause 84 of this Bill aims to limit the write off available to taxpayers that use a tailored tax code and receive New Zealand superannuation or veteran’s pension through an amendment to clause 1(a). However, a write off is also available under clause 1(b). Accordingly, an amendment should also be made to clause 1(b) in order to also limit the write-off amount under that clause.

Recommendation

That the submission be accepted.

THE COMMITTEE’S ASSURANCE PROCESSES

Issue: The Committee’s assurance processes

Submission

(KPMG)

The submitter raised an issue in relation to withholding tax rules for custodians and a square-up mechanism for PIE tax contained in the Taxation (KiwiSaver, Student Loans, and Remedial Matters) Bill. The submitter expressed the view that a change to the proposals had not been fully considered by the Select Committee. The Committee should consider whether and when further assurance is required for changes to a tax bill before it is reported back.

Comment

Officials acknowledge the matters raised in this submission, being the development of:

  • amendments to the withholding and reporting rules for custodial institutions (“custodians’ rules”); and
  • refundability of overpaid portfolio investment entity (PIE) tax.

As the submitter notes, the development of the custodians’ rules was subject to external consultation. This consisted of an initial survey of issues facing custodians, targeted consultation to develop the solution and early-stage consultation on the draft provision. This was intended to provide an opportunity for subject matter experts to comment on the wording of the draft provisions. Officials acknowledge that the timeframe was short and that additional time for consideration may have enabled earlier identification and addressing of potential issues.

Officials have reviewed the process and confirm the change was made in response to feedback received from external stakeholders. When the errors were identified, administrative flexibility was used to enable those custodians who were inadvertently excluded from the rules to access them. This enabled the correction of the provision to be further consulted on as part of the current Bill.

The policy to allow for the refundability of overpaid tax on PIE income was developed quickly in response to data showing that a large number of individuals (approximately 950,000) overpay tax. The legislation did not allow for a refund of any overpayment. The policy development involved targeted consultation and the proposal was discussed with the Committee’s specialist advisor.

Implementation of the PIE tax square-up required embedding of the square-up calculation and refund process into existing income tax year-end processes provisions throughout the tax Acts. Due to the way the square-up calculation and definitions were drafted in the new legislation, a supplementary order paper at the Committee of the Whole House stage of the Taxation (KiwiSaver, Student Loan and Remedial Matters) Bill clarified that the calculation allowed a credit for PIE tax paid, which had been a part of the square-up policy from the start.

Recommendation

That the submission be noted.

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