ABA Tax Section, Foreign Lawyers Forum Report 2011
NEW ZEALAND DEVELOPMENTS OF INTEREST TO INTERNATIONAL TAX LAWYERS – TO DECEMBER 31 2011
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 2011. Legislation passed in 2011 included the following:
(a) Taxation (Canterbury Earthquake Measures) Act 2011 – This legislation was enacted on 24 May 2011 and gave effect to measures to deal with tax issues arising from the Canterbury earthquakes on 4 September 2010 and 22 February 2011. Most notably these included tax relief for employers’ welfare contributions to employees, amendments to New Zealand’s Working for Families Scheme and tax relief for the donation of trading stock.
(b) Taxation (Annual Rates and Budget Measures) Act 2011 – This legislation was enacted on 24 May 2011 and gave effect to tax reforms announced in Budget 2011 to reduce the fiscal costs of KiwiSaver and Working for Families tax credits. The Act also set the annual rates of income tax for the 2011-2012 tax year.
(c) Taxation (Tax Administration and Remedial Matters) Act 2011 – This legislation was enacted on 29 August 2011 and brought into effect changes to the tax administration system, abolished gift duty, made changes to the tax disputes process and clarified the tax-pooling rules. It also reduced tax for non-residents investing through New Zealand portfolio investment entities.
(d) Taxation (Annual Rates, Returns Filing and Remedial Matters) Bill – This Bill was introduced into Parliament on 14 September 2011. Most notably, the bill set the annual rates of income tax for the 2012-2013 tax year, contained amendments designed to simplify the return-filing requirement for individuals and Working for Families tax credits, allowed the capital costs of unsuccessful software development to be tax-deductible and increased the KiwiSaver employer default and minimum employee contribution rates from 2 to 3 percent as announced in Budget 2011.
2.1 Canterbury earthquake measures
The Taxation (Canterbury Earthquake Measures) Act 2011 provided relief to individuals and businesses affected by or that made contributions in the aftermath of the two devastating Canterbury earthquakes. The first was in relation to payments made from employers to employees and fringe benefits. Generally, under the existing law, payments made to employees and benefits provided were taxable as either monetary remuneration or by way of fringe benefit tax. This Act exempts from taxation ex gratia welfare contributions made by employers to employees for the purpose of relief from the earthquakes. In addition, the Act amended the definition of “other payments” in the definition of “family scheme income” for the purposes of the Working for Families tax credit scheme to ensure payments given to support people affected by events such as the Canterbury earthquakes in September 2010 and February 2011, and other similar events in the future, are excluded from the definition of family scheme income for up to 12 months. The legislation also provided relief for businesses that made donations (or supplies for less than market value) of trading stock for relief from the earthquakes. The changes ensure that the anti-avoidance rules applying to disposals of trading stock did not apply and gifts did not constitute dutiable gifts.
2.2 Foreign Investment PIEs
The Taxation (Tax Administration and Remedial Matters) Act 2011 introduced new rules for foreign investment portfolio investment entities (“PIE’s”) to align the tax treatment of non-resident investors in PIE’s with the tax treatment of direct investors. The Act introduces two new categories of PIE’s. “Foreign investment zero-rate PIE’s” (referred to as “zero-rate PIE’s”) and “foreign investment variable-rate PIE’s” (referred to as “variable-rate PIE’s”). Resident investors in a foreign investment PIE will continue to be taxed as if they were in an ordinary PIE. Zero-rate PIE’s are generally only able to invest offshore, however de minimis levels of New Zealand-sourced income are allowed. This allows such a PIE to finance its day-to-day operations with a New Zealand bank account. Zero-rate PIE’s are taxed at zero percent on all PIE income attributable to certain non-residents. Variable-rate PIE’s can invest into both New Zealand and offshore assets. Variable-rate PIE’s face a variety of different tax rates on income attributable to non-residents, depending on the type and source of the income. The purpose of the legislation is to move New Zealand closer to becoming a “financial hub” providing back office services to international managed funds.
2.3 Disputes process
The Taxation (Tax Administration and Remedial Matters) Act 2011 brought into effect changes to the tax administration regime and disputes process. The Act relaxed the evidence exclusion rule (“EER”). When a tax dispute reaches a hearing authority, the EER previously limited the parties to the issues, propositions of law, facts and evidence contained in their respective Statements of Position (“SOP”). The relaxation of the rule means that the parties are now only limited to the issues and propositions of law contained in their SOP. The Act has widened the circumstances in which the Commissioner of Inland Revenue (“Commissioner”) can accept documents filed out of time by the taxpayer in the disputes process. Circumstances now include where the Commissioner considers that the disputant has a demonstrable intention to enter into or continue the disputes process at the relevant time. This test is now more in line with the test that applies to taxpayers accepting the Commissioner’s documents. In addition the Commissioner’s refusal to accept late documents is now challengeable in the Taxation Review Authority (“TRA”).
2.4 Provisional Tax pooling
The Taxation (Tax Administration and Remedial Matters) Act 2011 also brought into effect changes to the provisional tax pooling regime. The Act extends the time limit available to satisfy an obligation to pay provisional or terminal tax to 75 days and the time limit for meeting provisional or terminal tax no longer applies to the use of a taxpayers own deposited funds (provided the return is filed on time). Additionally, the Act allowed members in a group of companies to use pooling deposits made or purchased by any member of the same group in certain circumstances and extended the use of pooling funds to voluntary disclosures for certain non income tax revenues where there has been no previous assessment.
3. Case law
The following case law was decided in 2011 and is of interest:
3.1 Still New Zealand tax resident despite five year absence
Case 12/2011 considered whether a New Zealand citizen, who had lived and worked in Fiji for a period of almost five years, was solely a tax resident in New Zealand or Fiji under the New Zealand – Fiji Double Tax Agreement (“DTA”). The TRA held that the taxpayer was resident in New Zealand under the tie-breaker provisions in Article 4(2) of the DTA for the following reasons:
· The taxpayer had a “permanent home” in New Zealand despite the house being uninhabitable due to renovations for a substantial portion of the time in question. The taxpayer’s accommodation in Fiji was rented and paid for by his employer.
· The taxpayer’s “centre of vital interests” and personal and economic relations remained closest to New Zealand as his wife and family continued to be based in New Zealand and there was also a lack of clarity around his employment ties (for example, his remuneration was borne partly by the New Zealand operations of his employer).
· The taxpayer’s “habitual abode” was New Zealand as he had lived in New Zealand for most of his working life and intended to return to New Zealand.
At first glance, the decision is surprising as the taxpayer was living and working in Fiji for almost five years. It is noteworthy that the taxpayer conceded the existence of a permanent place of abode in New Zealand. In addition, the taxpayer was not aided by the lack of clarity around his intention for the family home and the availability of a second property in New Zealand owned by a family trust. The case emphasizes the need to ensure that evidence and actions are consistent with the tax positions taken and that a taxpayer’s intentions must be able to be discerned from his, or her, overt actions. Despite specific factual nature of the case, there is a clear risk that Inland Revenue may interpret this decision as raising the hurdle to becoming non-resident.
Case 12/2011 (2011) 25 NZTC 1-012
3.2 Tax Avoidance – personal services income
In CIR v Penny & Hooper the Supreme Court held that the sale by two surgeons of their private practices to companies was tax avoidance. The companies were owned by family trusts whose beneficiaries were members of the surgeons’ respective families. Each surgeon’s practice was sold into the relevant company, and the purchase price was left outstanding as a debt due to the surgeon from the company. From 2001, when the Government increased the top personal tax rate from 33% to 39%, and left the company rate at 33%, the companies paid the surgeons salaries that were substantially less than the amounts they had received when they were self-employed. The incidence of tax on the income previously derived by the surgeons personally was altered because tax was payable by a different taxpayer (a company) and the tax rates applicable to that taxpayer were lower than the top personal marginal tax rate.
The Supreme Court determined that if income is set at a less than commercial level, motivated by tax outcomes to more than an incidental degree, avoidance will be involved in the setting of the income level. That one step will taint an otherwise acceptable structure. The Court accepted that there is no such concept under New Zealand tax law of a “commercial salary” and accepted that family transactions are not always based on commercial values. However, it said that the law expects that one will not structure one’s affairs with a more than merely incidental purpose of obtaining a tax advantage not contemplated by Parliament.
The implication is that Parliament has contemplated that salaries will generally be commercially set because without that there is no tax advantage to be addressed. The practical effect of this seems to be that unless an uncommercial level of remuneration is justifiable by reference to non-tax drivers, the anti-avoidance regime may well now incorporate a Parliamentary expectation that shareholder employees of companies must usually be remunerated (and taxed) at commercially acceptable levels. Accordingly, this decision may have enormous implications for all incorporated family businesses, not just incorporated professional practices.
Penny and Hooper v Commissioner of Inland Revenue (2011) 25 NZTC 20,073
3.3 Voting interest requires registered shareholding
In BHL v CIR the High Court dismissed efforts to have losses of one company used by another. The key issue was whether the companies had the required commonality of shareholding for them to be within a group for the purposes of offsetting losses and profits. The commonality test requires that the companies have common shareholdings to the extent of 66%. The problem was that, although the two companies were owned by the same husband and wife shareholders, they held the shares 50/50 in one and 99/1 in the other.
The Commissioner argued successfully that the test of common voting interest required that a person be a registered shareholder.
The taxpayers argued that because the shareholders were husband and wife they were presumed to hold relationship property 50/50. The Court held that the mere classification of shares as relationship property could not be relied upon to say that a spouse was presumed to be a 50% owner of the shares in the absence of an order made in respect of that property.
Next the Court concluded that because orders of the Family Court were said to be binding on the Crown, that did not mean that the Commissioner of Inland Revenue was required to abide by one when he had not been a participant.
Finally the Court was asked to address the argument that a share transfer form had been entered into but not registered and that this was enough to establish share ownership and the necessary voting interest. The Court chose to resolve this by saying that registration was required (which ended the point) but also found as a fact that the form had not been completed.
BHL v CIR (7 October 2011 HC Napier, Courtney J)
3.4 Financing structure using OCN’s tax avoidance
In Alesco v CIR the High Court held that an intercompany financing structure involving OCN’s amounted to tax avoidance. The case involved the purchase of two New Zealand businesses by the Australian Stock Exchange listed Alesco Corporation. The Corporation determined that its wholly owned subsidiary Alesco NZ would effect the purchases. Alesco Corporation raised approximately $85 million through debt and equity financing to complete the deals. In order to lessen its transaction costs, Alesco Corporation was keen to ensure that the inter-company financing arrangements were structured in the most tax-effective way. Alesco Corporation decided to use a form of optional convertible note to record payments totaling $78 million to Alesco NZ. Each of the notes contained debt and equity components.
Alesco Corporation was advised that this type of financial instrument would allow Alesco NZ to claim interest deductions in New Zealand. However, the Commissioner disallowed interest deductions and loss offsets and imposed shortfall penalties totaling more than $23.6 million under the general anti-avoidance provisions in section BG 1 of the Income Tax Act 1994. Alesco NZ and other subsidiary companies challenged the High Court proceedings and the commissioner's decision that the arrangements were void under the anti-avoidance provisions.
The Court held that tax avoidance had been established because there was an absence of any match between expenditure incurred and income to be returned. The terms of the agreement were not negotiated but were designed to enable Alesco NZ to claim interest deductions without any corresponding return of taxable income.
The arrangement was accordingly held to be an artificial device designed only to secure a tax advantage in New Zealand that could not otherwise have been obtained. No real interest expense had been incurred and the notional interest claimed did not represent a real economic cost.
Alesco New Zealand Ltd v CIR (No 2) (2011) 25 NZTC
4. Determinations, Ruling and Statements
The following interpretation statement is of interest:
4.1 Meaning of “obsolescence” in the definition of “estimated useful life” for depreciation purposes
This Interpretation Statement (“IS”) sets out the Commissioner’s view on the meaning of the term “obsolescence” for the purpose of determining the estimated useful life of an item of depreciable property (“an item”). The estimated useful life of an item is used to set the depreciation rate for that item and there is a timing advantage in having a shorter, rather than longer, estimated useful life. Section EE 63 of the Income Tax Act 2007 provides that certain factors must be taken into account when determining the estimated useful life of an item. One of the factors is “obsolescence”.
In the context of s EE 63, obsolescence involves a reduction in the period for which an asset might be expected to be useful in deriving assessable income for reasons (other than physical deterioration or wear and tear) such as economic, technological or other external causes that affect the estimated useful life of the item. Obsolescence will cause an item to no longer be useful in deriving assessable income before the end of its physical life. However, an obsolete item will not necessarily be completely useless. Whether an item is affected by obsolescence is a question of fact to be judged objectively. An item will be obsolete if causes external to that item, and outside the control of the taxpayer, will result in it being no longer useful in deriving assessable income before the end of its physical life.
Obsolescence is not contributed to by the presence of a business failure or market forces of supply and demand that do not impact on the item. Or by the mere fact that an item is abandoned, demolished or scrapped or that there is a decision to do so.
An item can become obsolete in many different ways and the IS does not provide an exhaustive list.
IS 11/01 – Income tax – depreciation: meaning of “obsolescence” in the definition of “estimated useful life”
The following standard practice statements are of interest:
4.2 Installment arrangements for payment of tax
This Standard Practice Statement (“SPS”) sets out the Commissioner’s practice when considering applications for financial relief by way of an installment arrangement under section 177 of the TAA. The SPS applies to applications made on or after 16 February 2011. Upon application, the Commissioner requires the relevant information about the arrangement and will also generally require the filing of any related outstanding returns. The Commissioner may accept the request, seek further information from the taxpayer, make a counter offer or decline the request. The Commissioner’s authority to enter into an installment arrangement is supported by the requirement to maximise the recovery of tax debt from a taxpayer and where the Commissioner is likely to recover more through an installment arrangement than from bankruptcy or liquidation action, an installment arrangement will generally be entered into.
If an arrangement is agreed, monthly incremental penalties will not be charged provided that the taxpayer complies with the terms of the arrangement, however, use of money interest will continue to accrue.
The taxpayer may renegotiate an arrangement at any time, however, the Commissioner may only do so after two years have elapsed from the date the installment arrangement was entered into. The Commissioner may cancel an installment arrangement if the taxpayer has provided false or misleading information, or if the taxpayer is not meeting their obligations under the arrangement.
SPS 11/01: Installment arrangement for payment of tax (February 2011)
4.3 Compulsory deductions from bank accounts
This SPS sets out the Commissioner’s practice on the use of statutory notices (referred to in the statement as “deduction notices”) which are issued to banks requiring them to make deductions from the bank account of a taxpayer who has arrears. The SPS applies to deduction notices issued from 29 April 2011.
A number of legislative provisions grant the Commissioner the power to require a third party to make deductions from amounts that are payable, or will become payable by that third party, to a taxpayer who has tax arrears. Amounts payable includes all monies deposited with a bank to the credit of the taxpayer, including funds on term deposit even though that term may not be due to mature.
Inland Revenue does not require deductions from a bank account that would put the taxpayer into, or further into, overdraft. However, if Inland Revenue issues a deduction notice for an account which is in credit and the taxpayer attempts to avoid complying with that notice by transferring funds from that account so that it will go into overdraft, then the deduction notice will take priority. The notice will continue to apply until a deduction is made by the bank in respect of a notice requiring deduction by lump sum, or in respect to an on-going notice, until the amount required pursuant to the notice has been deducted or the notice is either revoked or withdrawn by Inland Revenue.
If the deduction is not made by the bank, the amount required to be deducted is recoverable by Inland Revenue from the bank as if it were tax payable by that bank. Furthermore, Inland Revenue has the power to prosecute the bank for not complying with the terms of the deduction notice under section 157A of the TAA. The bank does not however, incur liability in this manner if they fail to comply with a deduction notice for child support arrears under section 168(2) of the CSA.
SPS 11/04: Compulsory deductions from bank accounts
4.4 Disputes resolution process commenced by the Commissioner of Inland Revenue
This SPS sets out the Commissioner's rights and responsibilities to a taxpayer in respect of an adjustment to an assessment when the Commissioner commences the disputes resolution process. The SPS applies from 13 October 2011 and incorporates legislative changes to the disputes process enacted in the Taxation (Tax Administration and Remedial Matters) Act 2011. The most significant change to the disputes process outlined in the SPS is that the “evidence exclusion rule” was replaced by the “issues and propositions of law exclusion rule” for disputes or challenges relating to a disclosure notice issued on of after 29 August 2011. In these disputes, the disputant and the Commissioner are only confined in challenge proceedings to the issues and propositions of laws disclosed in their respective Statement’s of Position. In other words, additional facts and evidence not originally disclosed in the disputant’s or Commissioner’s SOP may be introduced in challenge proceedings.
SPS 11/05 Disputes resolution process commenced by the Commissioner of Inland Revenue (October 2010)
4.5 Disputes resolution process commenced by a taxpayer
This SPS discusses a taxpayer's rights and responsibilities in respect of an assessment or other disputable decision when the taxpayer commences the disputes resolution process. This SPS applies from 13 October 2011 and incorporates the legislative changes to the disputes process enacted in the Taxation (Tax Administration and Remedial Matters) Act 2011. The changes are discussed above at paragraph 4.4.
SPS 11/06 - Disputes resolution process commenced by a taxpayer
5. International Agreements
New Zealand has a comprehensive regime of double tax agreements. On 9 November 2011 the double tax agreement between New Zealand and Hong Kong came into force. The agreement makes investment between the two countries more attractive, and will bring withholding tax rates into line with rates currently in operation with the USA and Australia.
 The advice contained in this report is of a general nature only. Every effort has been made to ensure that it is accurate but it should not be relied upon without being verified in the context of specific facts and circumstances. The author accepts no responsibility or liability for loss or damage occasioned by reliance on the content of this report. The author acknowledges the assistance of Andrew Tringham, Barrister, in preparing this report.