September 2009

 

WHAT YOU’LL FIND IN THIS ISSUE

1. TAX WORKING GROUP - SESSION TWO - CHANGES TO PERSONAL INCOME TAX RATES, WFF, GST RATES & NATIONAL SUPERANNUNATION

The Tax Working Group met for a second session on 31 July 2009 to address issues relating to change in personal income tax rates and transfers of tax such as Working for Families (WFF), change in GST rate and issues relating to National Superannuation.
The Group was formed in May 2009 to review the tax system and to investigate reforms in the future. The first session was held on 5 June 2009 and the business covered was of a general nature defining the objectives of the group and direction of future working group sessions. The second session considered specific issues of income tax, GST and National Superannuation. The third session will cover tax broadening options involving land and property tax and GST and capital gains tax, and the last session corporate tax and tax integrity.

Second Session

The Group agreed to six principles to guide the design of the tax system in the process of reform:

• growth and efficiency - including New Zealand’s need to compete internationally for highly mobile capital and labour;
• equity and fairness – how progressive is the tax system; how it affects the distribution of income tax liabilities; how far people with similar incomes pay similar taxes; and impacts on measures of economic hardship;
• revenue adequacy – that enough money is raised for government spending;
• revenue integrity – that the tax system and revenue will be sustainable over time, and minimise opportunities for tax avoidance and arbitrage
• simplicity of administration and compliance; and
• coherence – that the component parts of the over-all tax system form a coherent whole in the sense that they conform to the same principles (e.g. broad-based low-rate).

Specific issues of discussion:

• change to personal income tax and transfer of tax credits delivered through Working for Families (WFF) and the Independent Earner Tax Credit (IETC). The concern with the present system of using taxable income as a proxy for circumstances and wellbeing of a person is not always the best way to assess need and the ability of the present system to allow those not necessarily in need to qualify for WFF and IETC. The group considered five key objectives (efficiency and growth, equity and fairness, fiscal adequacy and integrity, simplicity of compliance and administration, and fiscal cost) of the current tax/transfer system and the trade-off between these five objectives when considering changes to those taxes. The Group will further investigate options involving a flat tax rate with a universal allowance or a targeted allowance to replace Working for Families (a scaled version of WFF).

• change to the rate of GST to provide extra revenue as part of a broader tax package. The Group looked at three possible rates: 15%, 17.5% and 20%. Any increase is likely to shift the mix of taxes away from income taxes to maintain a revenue-neutral position in the tax reform. The Group thought the avoidance risks were less at higher rates (17.5% or 20%); they also thought that any GST increase would be only slightly regressive but felt that this could in part be addressed by automatic compensation mechanisms for most of those on low incomes, and other tax changes for those on middle incomes. If the GST rate is to be changed, then compensation for those on lower incomes should be considered further as part of any tax reform package.

• the implications for personal income tax and GST revenues on population ageing in New Zealand. Without any change in policy settings for New Zealand Superannuation (NZS), significant tax increases will be required to meet the increasing cost of superannuation within 20 years. With current NZS settings, the cost of NZS is expected to approximately double over the next 40 years; and most of this will occur over the next 20 years. Measured in terms of personal income tax revenues, NZS expenditures rise from around 22% in 2010 to 36% by 2030 and 42% by 2050. This ‘pure ageing’ effect means that NZS cost will rise from $5.2 bn. to $9.9 bn.

The Tax Working Group will meet in September 2009 for the third session to discuss base broadening options and in October 2009 for the fourth session to discuss corporate taxes and tax integrity.

RECENT GOVERNMENT RELEASES

2. ASSOCIATED PERSONS AND LAND TRANSACTIONS

The new associated persons rules passed through the third and final reading in Parliament on 15 September 2009 and the Taxation (International Taxation, Life Insurance and Remedial Matters) Bill 2008 that contains the new rules will receive Royal Assent shortly and become law. The rules will have a significant impact on tax planning for those associated with certain persons involved in dealing and developing land and building. The association test for land apply to GST, disposal of land within 10 years of acquisition (or completion of improvements for builders) if the vendor is associated to a dealer, developer or builder, and where there is a transfer of land between associated parties. The new rules will apply to land acquired on or after the enactment date in the case of association to a dealer or developer, and improvements commenced after that date in the case of association to a builder.

The major changes are summarized as follows

• The two company test (sYB2 of the Income Tax Act 2007 (ITA07)) and the company and non-corporate test (sYB3 of the ITA07) use an aggregation rules. The aggregation rule sums common control where two persons are themselves associated when applying the test of >50% and >25%, respectively for association. The persons maybe relatives (sYB4 to sYB6 of the ITA07) or trusts (sYB7 to sYB11 of the ITA07) or partners in a partnership (sYB12 of the ITA07).

• Two trusts are associated where there is a common settlor, a trustee is associated with the settlor where the settlor settles that trust (settlor includes any person that transfers value to the trust, is a nominee, lends money to the trust at less than market rates of interest or by agreement that includes a Marshall Clause), a trustee and a person who has the power of appointment or removal of trustees’ are associated, and a partnership and a partner in the partnership are associated.

• Tripartite test where if two persons A and B are associated by the above tests (sYB2 to sYB12 of the ITA07) and one of the persons are associated to person C then the other is also associated with person C. The Tripartite test is the final test if all other tests of association fail.

The testing Process involves the following steps

1. Identify the parties to be tested.
2. Identify the direct tests used to associate the parties (eg two company test of sYB 2 or company and non-company test of sYB 3 for aggregation).
3. Identify the wider indirect tests used to associate the parties (eg two company test and company and non-company test for aggregation of associated secondary parties which may include use of the Tripartite test).
4. Test for deemed association using the sYB14 Tripartite test.

Note, when using the tripartite test the same direct test cannot be applied twice to associate two parties (eg If A & B are unrelated partners in the same partnership, A & B are not necessarily associated for that reason). That rule does not apply to the direct tests (ie vica versa rules apply).
The new rules make the process of breaking association between related parties and companies with common shareholding an almost impossible task. The focus of tax planning for land ownership will be on the application of the exemption provisions of the land taxing provisions of sCB6 to sCB 15 of the ITA07.

3. RWT INVESTMENTS ALIGN WITH TAX RATES & OTHER PROPOSED TAX CHANGES

The Government tabled the Taxation (Consequential Rate Alignment and Remedial Matters) Bill in Parliament on 21 July 2009.

Major change proposed:

The major change proposed by the Bill is to the Residential Withholding Tax (RWT) rates.
The new legislation will align RWT rates on interest and portfolio investment entities (PIE) tax rates to the personal income tax rates and the 30% company tax rate with recent changes to those rates.
New RWT rates will be 12.5%, 21%, 33% and 38%, depending on the personal tax rates of individual recipients. The new RWT rates will generally apply from 1 April 2010. It is proposed that a transitional period apply for people who have a bank account at 1 April 2010 and who are on the current RWT default rate of 19.5%. They will automatically shift up to a 21% rate for a year from 2010. They will then have a year in which to either confirm with their bank that 21% is their correct rate or to select one of the other RWT rates. If they neither confirm the 21% rate nor elect another rate, their RWT default rate will then go up to 38% from 1 April 2011.
The default rate for individuals who do not specify their tax rate to their bank will rise from 19.5% to 38%. This will apply from 1 April 2010 for new bank accounts.
The use of a new 30% RWT rate on interest for companies that invest in financial institutions will be optional for financial institutions for a year from 1 April 2010, and compulsory thereafter.
Tax rates on PIEs will also reflect the new personal tax rates, with rates ranging from 12.5% to 30% for income over $70,000. Once enacted, the new PIE rates will apply from 1 April 2010.
The Bill is expected to be enacted by December 2009.

Other changes proposed

Other changes proposed by the Bill include the following:

• Secondary tax code and extra pays: introduction of a new 12.5% secondary code and a new 12.5% withholding tax rate for extra pays that brings the withholding rate on employment income into line with new personal tax rates.

• Personal tax summaries: removal of the current requirement for the Commissioner to issue personal tax summaries (PTS) to give the Inland Revenue Department (IRD) flexibility in selecting who PTS should be issued to. Taxpayers will continue to be able to request PTS.

• Electronic communications: the current requirement that a person must consent to the IRD communicating electronically will be replaced with a requirement that the IRD can provide information electronically if there are no reasonable grounds to believe that the communication will not be received by the person.

• Tax returns: changes to allow the IRD to accept corrections of minor errors in subsequent returns, to reduce compliance costs for taxpayers.

• Trusts: changes to allow tax agents who administer trusts more time, if needed, to allocate beneficiary income. Currently, beneficiary income must be allocated within six months of a trust’s balance date.

4. RESIDENTIAL INVESTMENT PROPERTIES IN AUSTRALIA NRWT ON INTEREST

The Inland Revenue Department has recently outlined its tax position on Non-Resident Withholding Tax (NRWT) on the interest paid by New Zealand residents to Australian financial institutions on borrowings used to purchase residential investment properties in Australia.

In general terms

• If the Australian financial institution has a branch in New Zealand the NRWT rules will not apply because the financial institution has a fixed establishment in New Zealand.

• It is important to note that some Australian financial institutions that operate in New Zealand do so through subsidiaries rather than through branches (eg National Australia Bank through the BNZ). The NRWT rules will apply if the Australian financial institution from which the money is borrowed in Australia operates in New Zealand only through a subsidiary, i.e. it does not also have a branch in New Zealand. If the money is borrowed from a New Zealand subsidiary of an Australian financial institution no NRWT issues will arise, however, because the interest is not paid to a non-resident. Financial institutions that operate as branches in New Zealand can be sourced to the Reserve Bank website (www.rbnz.govt.nz/nzbanks).

• If the Australian financial institution does not have a branch in New Zealand, the outcomes will be affected by deemed residency through management of the property.

Self management of the property

If the owner manages the property from New Zealand, the NRWT rules will apply because there is no fixed establishment or a permanent establishment in Australia. If the owner has more than one residential investment property in Australia, then there may be a fixed establishment in Australia, and in that situation the owner will not have to pay NRWT on the interest.
Property manager in Australia manages the property
If owner employs a property manager who:
- works as a property manager only for the owner; and
- has and habitually exercises the authority to enter contracts on the owners behalf
then the NRWT rules will not apply because the property manager will be a dependent agent and the owner will be deemed to have a permanent establishment in Australia.
If the property manager acts for the owner in the ordinary course of their business and is able to act independently of the owner, it is likely the property manager will be an independent agent and in that case the NRWT rules will apply because the owner will not have a permanent establishment in Australia.

Transitional residents

There are transition provisions where the owner becomes a New Zealand tax resident after 1 April 2006 and was a non-resident for a continuous period of at least ten years prior to change of residency. Transitional residents qualify for NRWT at 0% for four years after becoming a tax resident of New Zealand, and after that period, NRWT must be at the generally applicable rate (currently 10%).

Penalties and interest

The owner is required to withhold the NRWT and pay it to the Commissioner of Inland Revenue. There is use of money interest, late payment penalties and/or shortfall penalties ranging from 20% to 150% imposed for failing to account for NRWT.

Approved issuer levy

Liable owners can apply to the Inland Revenue Department to become an approved issuer and have the loan treated as a registered security. The approved issuer levy of 2% is paid in substitution of NRWT at 10%. The owner will be granted approved issuer status if the owner has complied with requirements under all of the Inland Revenue Acts during the two years before application date.

5. NEW AUSTRALIA - NEW ZEALAND TAX TREATY

The new double tax agreement between Australia and New Zealand was signed on 27 June 2009 and when in force later this year, it will replace the existing 1995 agreement.

The main features of the new double tax agreement are:

• Lower withholding taxes on dividend and royaltypayments between Australia and New Zealand. The standard withholding rate on dividends will stay at 15%, but will reduce to 5% for an investing company that has at least a 10% shareholding in the company paying the dividend. The rate will reduce to 0% if the investing company holds 80% or more of the shares in the other company and meets certain other criteria.

• Pensions that are exempt in the home country will be exempt in the other country where the taxpayer has emigrated from the home country, and lump sum pension benefits will be taxed only in the country in which the pension is sourced, not in the country to which the pensioner has retired.

6. USE-OF-MONEY INTEREST RATE CHANGES

The UOMI rates and the method for calculating the underpayment rate changed from 1 July 2009. The UOMI underpayment rate reduced from 9.73% to 8.91% and the UOMI overpayment rate reduced from 4.23% to 1.82%.
The method used for calculating the UOMI underpayment rate has been changed from using the Reserve Bank of New Zealand 90-day bank bill rate, plus 450 basis points (4.5%), to the floating first mortgage new customer housing rate, plus 250 basis points (2.5%). The overpayment rate is reset using the existing method. This method uses the Reserve Bank of New Zealand 90-day bank bill rate, minus 100 basis points (1%).

7. FBT RATE FOR LOW-INTEREST LOANS CHANGE

From 1 July 2009, the prescribed rate used to calculate fringe benefit tax on low-interest, employment-related loans will fall from 8.05% to 6.41%.

8. TAX DEDUCTABILITY OF FINES & PENALTIES

The Inland Revenue Department released a draft interpretation statement on the deductibility of fines and penalties on 8 July 2009.
The statement considers leading cases on the issue of fines and penalties to determine the correct test or tests that apply in a New Zealand context and tax legislation on the issue of relationship with the income-earning process. The statement concludes that irrespective of whether statutory nexus is met, fines and penalties are not deductible in New Zealand because of the application of public policy considerations.

9. DEPRECIATION OF RESIDENTIAL PROPERTIES

The Inland Revenue Department maintains its position outlined in interpretation statement IS0064 on splitting out of buildings component for depreciation. The issue is an ongoing subject of debate on access to higher depreciation rates.
The statement directs that if an item in a residential rental property is distinct from the building it can be depreciated separately from the building. It lists the following items with a ‘x’ to indicate that the item is not depreciable property that can be separated from the building for depreciation purposes and a ‘√’ for those that can.

• Plumbing and piping x
• Electrical wiring x
• Internal walls x
• Doors x
• Garage doors x
• Wardrobes and cupboards (built in) x
• Carpets √
• Curtains √
• Blinds √
• Water heaters and hot water cylinders √

10. GST ON SECOND HAND GOODS

The Inland Revenue Department has indicated a further change to second hand goods claims. It is proposed that all second hand goods claims will apply the same rules to those that apply to the purchase of secondhand goods from an associated person. Currently the GST claim for a purchase from an unregistered and unassociated party is 1/9 of the transaction price, and the claim for a purchase from an unregistered and associated party is the lesser of:

• The GST (if any) included in the sellers original cost;
• 1/9 of the transaction price; and
• 1/9 of the market value of the goods.

The change will significantly limit the GST recovery on purchases from unregistered vendors.

CLIENT QUERIES - TAX

11. LIMITATION ON INPUTATION CREDITS AVAILABLE TO COMPANY SHAREHOLDERS

Company shareholders are limited in the application of imputation credits attached to dividend income to 30% of the gross dividend from 1 April 2009. The change is a consequence of the change in the company tax rate from 33% to 30% from that date. Dividend income will be disclosed in returns of income from 1 April 2008 at the gross value (imputation ratio of 30/70 or 33/67 as stated on the dividend statement) and only 30% of the value of the gross can be used in the calculation of tax. In effect 3% of imputation credits attached to distributions of reserves dated prior to the 2008 tax year will be lost.

12. DEDUCTION FOR LEGAL

Taxpayers are entitled to deduct legal expenses incurred in their business activity or in deriving taxable income without need to exclude part not normally allowed as a deduction because of capital limitation rules (eg legals relating to purchase of rental property) provided total legal expenses are less than $10,000 in the income year. Legal expenses means fees for legal services (as defined in the Lawyers and Conveyancers Act 2006) provided by a person who holds a practicing certificate issued by the New Zealand Law Society or an Australian equivalent. If total legal fees for the year exceed $10,000 then the expense needs further analysis to exclude that portion that is of a capital nature.

13. PREPAYMENTS – EXEMPTIONS

Determination E12 replaced E11 on 4 March 2009 with few changes to the exemption amounts and term of availability of the exemption for adds back of the unexpired portion of the expenses in determination of taxable income. As a general rule unexpired prepayments at the end of the tax year need to be added back in the determination of income. Determination E12 lists expenses incurred that are excluded from the prepayments provisions. There are three components of the determination:

• column 1 describes the expenditure potentially exempted from the prepayments provisions

• column 2 provides for a maximum amount of theunexpired portion for some of the expenses, if the exemption is to be available

• column 3 provides for a maximum term for some of the expenses, if the exemption is to be available.

Where there is a gap that signifies no limitation.

14. GST TRAPS INVOLVING SALE & PURCHASE OF LAND

GST issues of recent months:

• The time of supply for land transactions betweenassociated parties is the date on which the land is made available subject to the proviso regarding earlier of payment or invoice. Payment or invoice prior to possession would trigger time of supply.

• Purchasers of second hand goods (whether associated or not) require payment to be made to claim GST on cost. Payment cannot be by journal entry to the general ledger even where the transaction is supported by Deed of Acknowledgement of Debt.

15. ACC COVERPLUS EXTRA

ACC CoverPlus Extra provides income cover to self employed and shareholder employees (excl. PAYE income) at an agreed value negotiated with ACC at the time of entering the contract. The contract prescribes the level of cover so in the event of a claim the amount of compensation is predetermined and guaranteed. The value can be negotiated between 40% to 120% of the average of three prior year’s earnings. The cover provides certainty to those in first year of business, and although the level of cover still needs to be negotiated, ACC have indicated that the indicative level is 60% of the labour cost index in the applicant’s industry. It also provides certainty of compensation in a low income year. Shareholder-employees that purchase ACC CoverPlus Extra are treated as self-employed for the calculation of weekly compensation entitlements and they pay levies at self-employed rates.
ACC CoverPlus is the standard injury cover and provides income protection based on the prior year’s income for loss of earnings. The level of cover is not predetermined, and is negotiated after incapacity and that is often the cause of delays in payment and disputes relating to full entitlement.
The premium cost of ACC CoverPlus and ACC CoverPlus Extra are similar. Both have a maximum cover of $85,178 and a minimum fulltime cover of $19,968. Both also pay compensation 5 years after death of the claimant to the spouse and children.
The point of difference of ACC CoverPlus Extra to CoverPlus is the ability to negotiate the level of cover while healthy, and that amount is predetermined and guaranteed where there is a loss of earnings caused by accident.

RECENT CASE

16. BNZ INVESTMENT LIMITED & ORS V C OF IR

The High Court held that each of six similar finance transactions entered into by the Bank of New Zealand (“BNZ”) was a “tax avoidance arrangement”.

Background

The BNZ made an equity investment in an overseas entity on terms requiring an overseas party to repurchase that investment when the transaction terminated. The transactions were structured to enable the BNZ to deduct expenses relating to earnings from its investment, while receiving those earnings free of tax. That mismatch made the transactions highly profitable for the BNZ.

IRD

The Commissioner invoked the avoidance provisions of the Income Tax Act because he considered the arrangements:

• substantially altered the incidence of tax for the BNZ and that was their only purpose or effect, and the purpose or effect was not a merely incidental

• they had no commercial purpose or rationale

• they were not within the scheme and purpose of the provisions applied to make the income tax-exempted

• the principal deductible expenses claimed by the BNZ (the fixed rate it paid on an interest rate swap) and the guarantee arrangement fee (GAF) or guarantee procurement fee (GPF)) were contrived and artificial, and
• the transactions were structured on a basis of a formula that had the artificial consequence that, the higher the transaction costs, the higher the tax benefits they generated.
  

The High Court’s decisions on tax avoidance

The High Court considered the findings of the Ben Nevis case on the issue of avoidance and in particular the two-step inquiry:

• Step 1 required the court, on an ordinary interpretation of the applicable specific provisions of the Income Tax Act, to decide whether the arrangements complied with those provisions.

• Step 2 required the court to decide whether the legislature would have contemplated and intended that the specific provisions be deployed as they were deployed by the taxpayer in the transactions in issue.

The court said that, at step 2, the focus shifted to the reason for the inclusion of the specific provisions in the context of the legislative scheme as a whole. This “scheme and purpose approach” requires the court to focus on “wider considerations”, than the Income Tax Act. The court said that the court should consider the use made of the specific provisions in the light of the commercial reality and economic effect of that use. The ultimate question was, viewed in a commercially and economically realistic way; does the arrangement make use of the specific provision in a manner consistent with Parliament’s purpose.

Tax avoidance

The High Court concluded that all six of the transactions at issue were caught by the avoidance provisions. They were arrangements falling on the avoidance side of the line referred to in Ben Nevis. The High Court reached this conclusion for the following principal reasons, which it listed in order of importance:

• The transactions had the purpose or effect of substantially altering the incidence of tax for the BNZ. This was not a “merely incidental” purpose or effect of the transactions.

• The transactions had no commercial purpose or rationale. Short of the tax benefits they were anticipated to generate, they involved the BNZ providing funds to the counterparties at a substantial loss. Their only purpose was to use the bank’s tax capacity to generate exempt income.

• The transactions did not make use of the provisions in the tax act in the manner contemplated by Parliament.
• The transactions generated the claimed deductible expenses in a contrived or artificial way:
  

• The 2.95% pa GPF was a contrivance. A guarantee from the parent of the counterparty would have been forthcoming for no fee, or for a fee of no more than 0.65% pa.

• The BNZ contrived to set the fixed rate on the interest rate swap at the highest rate it thought defensible, and in the case of some of the transactions, this was significantly outside market parameters.

• The returns on the transactions to the BNZ and counterparties alike were substantially in excess of what could have been expected from a risk-free (except for tax risk for the BNZ) investment via a structured finance transaction, negotiated at arm’s length.

Commissioner’s Treatment

The High Court was of the view that the Commissioner’s treatment of denying the BNZ of the following tax deductions was correct:

• its funding costs;

• its net swap costs, that is, the fixed payment it made, less the floating payment it received, under the interest rate swap;

• the GAFs or GPFs; and

• the risk participation fees.

The High Court held that all the deductions disallowed by the Commissioner were integral parts of the tax avoidance arrangement.
The High Court noted that approximately $416 million of tax hinged on the outcome of these proceedings. Challenge proceedings brought by the Westpac Banking Corporation began in Auckland on 30 June 2009 and proceedings brought by other New Zealand trading banks have yet to come to trial. The total amount of tax in issue is probably over $1.5 billion.
The BNZ confirmed that it has filed a notice on 12 August 2009 to appeal the High Court’s decision.
Ben Nevis Forestry Ventures Ltd v C of IR; Accent Management Ltd v C of IR (2009) 24 NZTC 23,188; [2009] 2 NZLR 289.

17. NEWS ABOUT THE OFFICE

Cynthia Gounder returned to work in August, three months after the birth of Nikita.
Michelle Oldfield recently passed her Diploma in Accounting with Certificates in Human Resources and Accountancy, and is continuing her studies for admission to the New Zealand Institute of Chartered Accountants.