ABA Tax Section, Foreign Lawyers Forum Report 2007
NEW ZEALAND DEVELOPMENTS OF INTEREST TO INTERNATIONAL TAX LAWYERS – TO DECEMBER 31, 2007
This report is made for the purposes of the Tax Section of the American Bar Association’s Foreign Lawyer’s Forum. It summarizes a number of developments in New Zealand tax law and practice that may be of interest to lawyers assisting clients doing business with entities or individuals in New Zealand, or lawyers wishing to be informed generally of tax developments in New Zealand.
The report is divided into the following sections:
(a) Legislative changes
(c) Determinations, Rulings and Statements
(d) International Agreements
2. Legislative changes
This section of the report summarizes the major legislative tax changes which were enacted in 2007. In addition to the annual income tax rate setting legislation three main Amending Acts were passed. They were:
(a) Taxation (Kiwisaver and Company Tax Rate Amendments) Act 2007 – This introduced new rules for what is known as “Kiwisaver”, a broad-based public savings and investment initiative which is administered in part through the tax system by the deduction of contributions from wage and salary earners and other participants.
(b) The Income Tax Act 2007 – This was assented to on 1 November 2007 and completed a longstanding program for the rewriting and reorganization of income tax legislation. The Act commenced with effect from 1 April 2008 (or equivalent balance date). It was not meant to make substantive changes in the tax law except in limited and specific cases even though different language was used in most areas of the law. The 2007 Act represents the final stage of the rewrite of the New Zealand Income Tax Act.
(c) Taxation (Business Taxation and remedial Matters) Act 2007 – This enacted a new tax credit for Research and Development expenditure, made for the adoption of International Financial Reporting Standards and various administrative changes dealt with in more detail below.
2.1 Kiwi Saver
The Taxation (Kiwisaver and Company Tax Rate Amendments) Act 2007 resulted in several important changes to KiwiSaver. The changes include a tax credit for contributions paid by members of a KiwiSaver scheme or a complying superannuation fund. This means that from 1 July 2007 people who contribute to a KiwiSaver scheme (or a complying superannuation fund) will be eligible for a member tax credit that matches the amount of their contribution to the scheme up to $1,042.86 a year. The tax credit will be available to employees, the self-employed and other people who are not employees, such as beneficiaries. The member tax credit will be treated as excluded income for income tax purposes and as a non-taxable grant or subsidy for GST purposes.
The Taxation (Annual Rates, Business Taxation, KiwiSaver, and Remedial Matters) Bill also introduced further changes to KiwiSaver. These changes include an employer tax credit and compulsory employer contributions.
Changes to KiwiSaver regulations by Order in Council in 2007 include the introduction of a facility that allows KiwiSaver contributions to be withdrawn from a KiwiSaver scheme and applied towards a mortgage over a member’s own home.
2.2 Company tax rate
The tax rate for companies and certain savings vehicles has been reduced from 33% to 30%. The top rate for portfolio investment entities has been capped at 30%, instead of the previous 33%, while the tax rate for certain widely held savings vehicles has also been lowered to 30%. The new tax rates are intended to encourage savings and implement a more neutral tax treatment of different savings entities. The new tax rate comes into effect from the beginning of a taxpayer’s 2008/09 income year.
2.3 Research and Development (“R&D”)
New tax rules have been introduced which provide a tax credit for New Zealand businesses that perform R&D on their own behalf or that commission others to perform R&D for them, provided the R&D is performed predominantly in New Zealand. The new tax credit applies to the development of new or improved products or processes in a variety of industries. A maximum of $3 million of internal software development expenditure will be eligible for an R&D tax credit in any year. The new tax rate comes into effect from the beginning of a taxpayer’s 2008/09 income year. However, it should be noted that New Zealand elected a National government in November 2008 which proposes to now abolish the research and development credit.
2.4 Compliance and penalties
Amendments have been made to the compliance and penalties rules in the Tax Administration Act 1994. Changes have been made to the rules relating to late filing penalties, late payment penalties and shortfall penalties.
In particular, the amendments provide that:
• Inland Revenue will notify a taxpayer the first time their payment is late rather than imposing an immediate late payment penalty.
• The shortfall penalty for not taking reasonable care, taking an unacceptable tax position or having an unacceptable interpretation will not be imposed when a tax shortfall is voluntarily disclosed before notification of a pending tax audit or investigation.
• A shortfall penalty for not taking reasonable care can only be imposed in specific circumstances when taxpayers have used a tax advisor.
• The threshold for imposing the abusive tax position shortfall penalty has been repealed. Before this amendment, for an abusive tax position shortfall penalty to be imposed the tax shortfall had to be greater than $20,000.
2.5 Charitable giving and tax credits
New rules have increased tax incentives for making donations to charitable organizations. The changes include removing the maximum limit on the tax credit for donations made by individuals, removing the 5 percent deduction limit on donations made by companies and Maori authorities, and extending the company deduction to apply to close companies not listed on a recognised stock exchange.
Further, the Charities Commission and the Inland Revenue Department now work together to provide information on the tax status of charitable entities following the opening of the Charities Commission register on 1 February 2007.
2.6 Finance lease amendments
Changes to the taxation of leases means that certain lease arrangements involving assets used overseas will be classified as finance leases, or that lessors will have allowable depreciation deductions for lease assets reduced. The changes are aimed at preventing depreciation losses being claimed on overseas assets in which the New Zealand taxpayer has no real economic interest.
The definition of "finance lease" has been widened to include certain lease arrangements that satisfy three conditions:
• they involve use of the lease asset wholly or mainly overseas; and
• they involve income of a person other than the lessor that is not subject to New Zealand income tax; and
• substantially all the risks and rewards incidental to ownership of the lease asset lie with a person other than the lessor.
Operating leases entered into before 20 June 2007 may continue as operating leases. However, allowable depreciation deductions will be reduced by one-sixth, with one-sixth of any previously claimed depreciation recognised as additional assessable income in the income year beginning after 20 June 2007.
2.7 New tax rules for offshore portfolio investments in shares
The main features of the new rules affect the Foreign Investment Fund (“FIF”) rules. Those rules have attributed income to the holder of an income interest in a FIF, using several available methods so that it is taxed in New Zealand. The main changes are:
• Previously the FIF rules exempted from New Zealand taxation FIF’s in a so-called “grey list” of countries generally considered to have tax regimes compatible with New Zealand’s expectations for the taxation of investments. The grey list was made up of Australia, Canada, Germany, Japan, Norway, Spain, the UK and the USA. The grey list has been abolished.
• Investments made in Australian resident companies listed on an approved index of the Australian Stock Exchange are exempt from the FIF rules. Orthodox income tax rules apply to these investments: dividends are taxable if the shares are held on capital account and both dividends and gains realized on the sale of shares will be taxable if the shares are held on revenue account. Listed shares in Australian resident companies that are held by so-called “Portfolio Investment Entities” (“PIE’s”) will generally only attract New Zealand tax on dividends.
• An individual taxpayer will be exempt from the application of the FIF rules if the original value of his or her portfolio investments does not exceed NZ$50,000. This threshold does not usually apply to trust holdings.
2.8 Introduction of Limited Partnerships
New rules introduce a limited partnership business structure in New Zealand. Limited partnerships are a form of partnership involving general partners who are liable for all the debts and liabilities of the partnerships and limited partners who are only liable to the extent of their distribution to the partnership. The Limited Partnerships Bill was introduced into the house on August 2007. It should also be noted that the Taxation (Limited Partnerships) Act 2008 received Royal assent on 13 March 2008 and amended the Income Tax Act 2007, the Tax Administration Act 1994 and the Goods and Services Tax Act 1985.
Key tax implications include:
• all partnerships will be subject to flow-through treatment for tax purposes with partners deriving income, expenses, tax credits, rebates and losses (subject to some loss limitation rules applicable to limited partners in limited partnerships) in proportion to their share in partnership income
• each partner’s share of partnership income will be as determined in the partnership agreement, or in the absence of such an agreement, by operation of the Partnership Act
• subject to specific carve outs, partners will be required to account for tax on their exit from a partnership in some circumstances, if the amount of disposal proceeds from the partnership interest exceeds the total net tax book value of the partner’s share of partnership property by more than $50,000
• tax losses will only be able to be claimed by limited partners in limited partnerships to the extent of the tax book value of the limited partners’ investment. A “basis” concept will calculate the extent of a limited partners’ investment and the extent to which tax losses can be accessed by limited partners in a particular income year
2.9 Emissions trading scheme
The New Zealand government has proposed the introduction of an emissions trading scheme which will have income tax and GST implications for participants. The scheme will introduce a price for greenhouse gas emissions into the New Zealand economy.
The preliminary government stance to tax issues arising from the scheme was released in an issues paper entitled “Emissions Trading Tax Issues” in September 2007. For sectors other than forestry, the paper suggests that expenditure associated with meeting emissions trading scheme obligations should be a tax-deductible expense and recognised on an accruals or emerging basis over time. Income from the allocation of free emissions trading units should be recognised as taxable income on an emerging basis over time.
In relation to forests planted before 1990, the paper suggests that the receipt of free emissions trading units should be non-taxable, and expenditure associated with a change in land use should be non-deductible. In relation to forests planted after 1989, the paper suggests that income derived from the receipt of emissions trading units should be taxable, although there will be problems associated with the recognition and timing of income and expenditure. The paper suggests that emissions trading units should attract GST in the same way that any other good or service supplied by a register person is subject to the tax.
The Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill 2008 was introduced on 2 July 2008 and dealt with these issues.
2.10 Controlled Foreign Companies
Issues papers were released on 12 October 2007 and 4 December 2007 proposing major changes to New Zealand’s current international tax rules. The first issues paper proposes that New Zealand take an active/passive approach to the taxation of controlled foreign companies (“CFCs”). A taxpayer with an interest in a CFC that meets an active business test will not be required to attribute any income under the CFC rules. The active business test replaces the current exemption which applies in respect of CFCs resident in grey list countries.
The second issues paper focuses on a tax exemption for dividends received by New Zealand companies from their offshore subsidiaries. It also looks at other issues associated with the change to the CFC rules such as the repeal of the conduit relief rules and the treatment of existing foreign losses and foreign tax credits.
The Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill 2008 was introduced on 2 July 2008 and dealt with these issues.
3.1 GST tax avoidance
Ch’elle Properties (NZ) Ltd v CIR was decided on 6 September 2007 and represents a clarification of the tax avoidance provision in the GST Act 1985.
It was held in this case the taxpayer’s arrangement defeated the intent and application of the GST Act 1985, notwithstanding that separate items in the scheme technically complied with substantive taxing provisions. The arrangement was deemed tax avoidance because invoices issued were not going to be paid for 10 to 20 years, whereas the taxpayer was immediately entitled to input tax credits for the purchase of the properties, thereby defeating the intended balance between input and output tax. There was no purpose to the arrangement other than to exploit a tax advantage.
The GST Act 1985 permits a degree of mismatching in terms of accounting methods, but seeks to limit the nature and degree of such mismatching and contains explicit restraints on a taxpayer's ability to register on a payment basis.
Ch’elle Properties (NZ) Ltd v CIR (2007) 23 NZTC 21,653
3.2 Taxation Review Authority has all the powers, duties, functions and discretions of the CIR in hearing and making a determination on any objection or challenge.
The High Court has held that where a disclosure notice is issued and the taxpayer subsequently challenges the assessment, the matters in issue are limited to the legal and factual issues identified in the statements of position, but all of those issues are legitimate matters of dispute in the challenge proceedings.
It was held that the clear language of s 16 of the Taxation Review Authorities Act 1994 is that the Taxation Review Authority shall have all the powers, duties, functions and discretions of the CIR in hearing and making a determination on any objection or challenge.
It was further held that Parliament has made doubly sure of this power by making a similar provision in s 138P Tax Administration Act 1994 (“TRA”). That is, on hearing a challenge, the TRA may make an assessment which the CIR was able to make at the time the CIR made the assessment to which the challenge relates, or may direct the CIR to make such an assessment.
Max Beckham v CIR (2007) 23 NZTC 21,499.
3.3 Trustee liable for post bankruptcy tax debt
The Court of Appeal has held that a trustee may not continue to trade and incur debts after being bankrupted with impunity from liability for GST. If he chooses to do so he incurs a fresh liability that is not provable in his bankrupt estate.
The taxpayer could have avoided potential liability for output tax by resigning as trustee, or could have left the development in the hands of a financier. However he did not do so, and instead elected to trade through the trust after his adjudication. There was therefore no injustice in holding him liable for associated GST liabilities.
The onus was held to be on the taxpayer to show that the liabilities were provable in his bankruptcy, rather than for the CIR to show that they were not so provable. As the taxpayer failed to show that at the date of his adjudication he had an obligation to enter into the sales which triggered his GST liabilities, he was held personally liable for the GST.
CIR v Philip John Duncan  NZCA 235
3.4 Trinity Investors lose appeal
The Court of Appeal has upheld the finding that the Trinity Forestry arrangement is a tax avoidance scheme. Under the scheme investors claimed deductions against their other income for license and insurance premiums that were associated with the growing of a Douglas fir forest. Over the fifty year life of the forest investors had the potential to claim tax benefits in excess of $3 billion. The Court confirmed the Commissioner was correct in imposing a 100% shortfall penalty on the taxpayers for taking an abusive tax position.
Accent Management Ltd v CIR (2005) 22 NZTC 19,027
3.5 The Commissioner is entitled to settle tax cases commercially
The Court of Appeal has held that the Commissioner is entitled to settle tax cases commercially given his care and management responsibilities under the principles in section 6 and section 6A Tax Administration Act 1994 (TAA) and authority of cases such as Auckland Gas Co v The Commissioner of Inland Revenue  2 NZLR 409 (CA).
Settlements entered into do not need to reflect the Commissioner's view of the correct tax position and it is not appropriate for the Court to review the litigation strategy adopted by the Commissioner in relation to the taxpayers who settled. The Court of Appeal also upheld the High Court's refusal to recall the judgment.
The basic background facts are those relating to the "Trinity" forestry investment scheme. The litigants unsuccessfully applied to recall the High Court judgment, essentially relying on inconsistency between the Commissioner's stance at trial and the terms on which he had settled with other taxpayers.
Accent Management Ltd v CIR (2005) 22 NZTC 19,027
4. Determinations, Ruling and Statements
The following standard practice statement is of interest:
4.1 Transfer of depreciable property between associated persons
This Standard Practice Statement ("SPS") sets out various factors that the Commissioner will consider in deciding whether the taxpayer should be permitted depreciation based on the taxpayer's cost when acquiring depreciable property from an associated person.
SPS 07/05 - Transfer of depreciable property between associated persons - section EE 33 of the Income Tax Act 2004 (September 07)
The IRD has issued the following binding public rulings:
4.2 Interest Deductibility
The IRD issued two rulings expressing the Commissioner’s view of the principles relating to interest deductibility in the Australian Full Federal Court decision in FC of T v Roberts; FC of T v Smith 92 ATC 4. The Ruling applies for the period beginning on 22 May 2007 and ending on 22 May 2010.
The arrangements involve borrowing to replace and repay amounts invested in an income earning activity or business. Examples of such arrangements are returns of capital to partners, share repurchases and payments of dividends.
Roberts and Smith is authority that there is a sufficient connection between interest and income when the interest is incurred on borrowed funds used to replace an amount previously invested in an income earning activity or business and to return the amount to the person who invested it. The link with income is through the new borrowings taking the place of funds that have a sufficient connection with assessable income or in respect of which interest was deductible.
Public Ruling BR Pub 07/04 – 07/09
4.3 Legal services provided to non-residents relating to transactions involving land in New Zealand are zero-rated
A public ruling has been issued that concludes that the supply of certain types of legal services relating to land transactions in New Zealand to a non-resident who is not in New Zealand at the time the legal services are performed are zero-rated under the GST Act 1985.
Supplies relating to the following are included:
• transactions involving the sale or purchase of land in New Zealand or the lease, licence, or mortgage of land in New Zealand, or
• easements, management agreements, construction agreements, trust deeds, guarantees and other agreements concerning land in New Zealand, or
• disputes arising in relation to land in New Zealand.
The Ruling applies for the period beginning on 22 May 2007 and ending on 22 May 2010.
Public Ruling BR Pub 07/03
4.4 No Fringe benefit in FICA payments confirmed
The New Zealand Inland Revenue refreshed its ruling that contributions from wages payable to employees that are deducted and paid with employer contributions to the US Federal Government under the Federal Insurance Contributions Act (“FICA”) do not attract Fringe Benefit Tax (“FBT”). This is essentially because a fringe benefit to which FBT applies is in the nature of a benefit provided to a particular employee. Neither do FICA contributions fall within specific categories of fringe benefit such as contributions to superannuation funds or sickness, accident or death benefit funds.
Public Ruling BR Pub 07/02
5. International Agreements
New Zealand has a comprehensive regime of DTA’s. During 2007 the following developments occurred:
• New DTA’s between New Zealand and Chile, Poland and Spain came into force in relation to withholding taxes from 1 January 2007 (for Chile and Poland) and 1 September 2006 for Spain. In relation to all other taxes, all three treaties are effective from 1 April 2007.
• The double tax agreement with Mexico entered into force on 16 June 2007. It has effect in both countries for withholding tax from 1 August 2007. For other taxes it generally takes effect from 1 January 2008 in Mexico and from 1 April 2008 in New Zealand.
• New Zealand and the Netherlands Antilles have signed a tax information exchange agreement on 2 March 2007. The bilateral agreement provides for full exchange of information on criminal and civil tax matters between the two countries.
• New protocols affecting the DTA’s between New Zealand and Australia and Singapore became effective. The protocol with Australia significantly widens the exchange of information article in the DTA so that it applies to all taxes. An “Assistance in the Collection of Taxes” Article has been added to the Australian DTA. The protocol with Singapore expands the DTA with that country to cover New Zealand entities providing consulting services in Singapore and vice versa.
• An amending protocol to the double tax agreement with the United Kingdom was signed on 7 November 2007. Once they are in force, the changes made will mean that the treaty will follow more closely the new OECD standard on exchange of information between tax authorities. In particular, the amended treaty will allow authorities to exchange information on other taxes besides income tax. Provision is also made for tax authorities in each country to request assistance from each other in the recovery of tax debt.