ABA Tax Section, Foreign Lawyers Forum Report 2013
NEW ZEALAND DEVELOPMENTS OF INTEREST TO INTERNATIONAL TAX LAWYERS – TO DECEMBER 31 2013
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 2013 and the proposed legislation introduced into the New Zealand parliament for discussion and enactment in 2014:
(a) Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 – This Act received Royal Assent on 17 July 2013. The major legislative change in the Act is the tightening of the deductibility rules for assets used for both private and income-earning purposes (so-called “mixed-use assets”). Other changes include further changes to the livestock valuation regime, and GST changes to enable cross border business to business neutrality.
(b) Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill – This Bill was introduced into Parliament on 20 May 2013. The Bill proposes significant changes for New Zealand residents who have interests in, and income from, foreign superannuation schemes. The Bill proposes a significant overhaul of the tax regime that applies to specified mineral miners. The Bill also introduces some minor changes to the tax rules relating to bad debt deductions.
(c) Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill – This Bill was introduced into Parliament on 22 November 2013. The Bill contains an assortment of legislative amendments related to employer provided accommodation, accommodation allowances and payments, an extension of the inbound thin capitalization rules, land related lease payments and changes to the deductibility rules for black hole expenditure.
2.1 Mixed-use assets
The Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 introduced new rules relating to the apportionment of indirect costs relating to mixed use assets. From the 2013/14 income year, expenses that are not directly attributable to either private use or taxable use of a mixed-use asset (such as interest) will need to be apportioned. The exception is where the expenditure delivers no private benefit. The apportionment formula is based on the number of days (or other relevant measure) that the asset is used privately and to generate income.
The asset will come within these new rules if:
· It is used privately by the owner or a close relative, and associates; and
· Is used to generate income; and
· There are more than 62 days where the asset is not actively used; and
· The asset is land or costs more than $60,000 (this includes private boats and aircraft).
Mixed use assets held by individuals, trusts, partnerships and close companies will be subject to the new rules.
2.2 Cross-border business to business neutrality
The Taxation (Livestock Valuation, Assets Expenditure, and Remedial Matters) Act 2013 contains changes to enable a non-resident business to register for GST and claim input tax deductions even if the non-resident does not make any taxable supplies in New Zealand. Non-residents will be able to register for GST if they are registered for a consumption tax (like GST or VAT) in the jurisdiction in which they are resident.
2.3 Foreign superannuation interests
The Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill proposes new rules for taxing New Zealanders’ foreign superannuation interests (i.e. amounts in foreign superannuation schemes built up when working overseas prior to settling in New Zealand). In summary, from 1 April 2014:
· Foreign superannuation interests will be taxed on withdrawals (i.e. lump sums) only using a new “schedule method”, or alternatively the “formula method”. Pensions, annuities and social security payments will however be taxable in full.
· The schedule method will tax a percentage of the withdrawal (between 0 and 100 percent) based on how long the holder of the interest has been NZ resident. The period a person is a transitional resident will not be counted and withdrawals during the transitional residence exemption period will not be taxed.
· The formula method will tax the actual investment gains derived while a person is NZ resident (again, excluding any transitional residence period). However, certain conditions will need to be met to use this method and it is information intensive.
· As a transitional measure, if a person has previously applied the Foreign Investment Fund (FIF) rules they can continue to apply those rules. However, a person cannot start using the FIF rules to avoid the new rules.
· Transfers between foreign superannuation schemes and transfers on death (to another NZ resident) will receive rollover relief.
· Transfers from an Australian superannuation scheme to KiwiSaver will not be taxed under the NZ-Australia Double Tax Agreement and trans-Tasman superannuation portability agreement now in force.
· If a person transfers their foreign superannuation interest to KiwiSaver, they can access their KiwiSaver funds to pay any tax owing.
· Withdrawals of contributions made while NZ resident (if contributions are compulsory and from after-tax income) will also not be taxed.
· Those who have not previously paid tax on their foreign superannuation interests must either pay tax on 15 percent of past withdrawals (in their 2013/14 or 2014/15 return), or under the tax rules that should have applied at the time (e.g. the available subscribed capital rules if this would result in less than 15 percent of past withdrawals being taxable).
The proposals effectively clarify a misunderstood area of the New Zealand tax law which has, inadvertently, often not been complied with. They also offer an opportunity to remedy past non-compliance.
2.4 Employee benefits
The Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill proposes changes to the taxation of employee benefits. In summary, the proposals:
· Allow tax free employer provided accommodation, accommodation allowances and payments while an employee is working away from their normal workplace for up to 2 years (this time limit can be extended under certain circumstances). However, there must be a reasonable expectation that the employee will be away for 2 years or less.
· Treat accommodation related payments to employees with more than one workplace on an ongoing basis as tax-free, with no time limit.
· Provide that taxable accommodation related payments will generally be valued at their market rental value. However, there will be special valuation rules for Ministers of religion and New Zealand Defence Force personnel. Overseas accommodation can be taxed based on the New Zealand equivalent value of the accommodation.
· Allow meal payments linked to work related travel to be provided tax-free for up to three months.
2.5 Extending thin capitalization
The Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill proposes to extend the inbound thin capitalization rules to companies owned 50% or more by non-residents where:
· Debt in the company is held in proportion to equity; or
· There is a shareholders’ agreement that sets out how the company should be funded and the company is not widely-held (i.e. has less than 25 shareholders); or
· The shareholders are effectively co-ordinated by a person, such as a private equity manager or managers.
The Bill also extends the inbound this capitalization rules to New Zealand trusts settled 50% or more:
· By a single non-resident; or
· A group of non-residents acting together; or
· Another entity that is subject to the inbound this capitalization rules.
The other thin capitalization changes proposed in the Bill are to exclude shareholder debt from an entity’s worldwide group debt levels. Shareholder debt does not have to be excluded if the worldwide group has publically traded debt and the shareholder owns less than 10% of the company. The Bill also proposes to exclude an increase in asset values as a result of internal restructuring from being counted in “assets” (unless allowed under GAAP or as part of a post purchase restructure) when calculating the New Zealand debt ratio.
3. Case law
The following is a sample of tax-related case law was decided in 2013 which is of interest:
3.1 Financing structure using OCN’s tax avoidance confirmed
In Alesco v Commissioner of Inland Revenue the Court of Appeal dismissed an appeal by the taxpayer, Alesco NZ, against IR determinations that an intercompany financing structure involving Optional Convertible Notes (“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 OCN’s 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 appealed the High Court decision that the arrangements were void under the anti-avoidance provisions.
The primary issue before the Court of Appeal was whether the OCN arrangement had tax avoidance as its purpose or effect. Central to the judgment was the Court’s assessment of the purpose and effect of Determination G22. Under G22, which has now been replaced with Determination G22A, the taxpayer was required notionally to split the OCN’s into a debt component and an equity component and attribute values to each. This is because the financial arrangement rules, to which the determination related, treat the components differently for tax purposes. The calculations under G22 and the financial arrangement rules, which the Commissioner accepted were technically compliant, resulted in the notional interest payments, which had no economic or legal substance, being deductible to the taxpayer.
The Court’s main focus was whether Parliament intended for taxpayers to be able to claim under the financial arrangement rules expenditure that it was not liable to pay and would not ever suffer in an economic sense. The Court said that the financial arrangement rules were intended to operate as a net regime to bring to tax the amount yielded by a taxpayer after deducting the entire economic cost from a taxpayer’s entire economic benefit. That does not include notional transactions. The Court accepted that notional interest can be treated as expenditure for the purposes of the financial arrangement rules and G22 but that did not translate into a deduction for tax purposes. The Court said G22 does not operate to turn “a pretence into a reality”. In other words, the notional interest amounts were fictitious and the taxpayer did not as a matter of fact incur the liability for which it was claiming a deduction. The Court reinforced this concept when it said that “the underlying premise for the statutory deductibility rules is that they are to apply only when real economic consequences are incurred”. On that basis, the Court was satisfied that the taxpayer used the financial arrangement rules and G22 to claim deductions in a way that was outside Parliament’s contemplation. Accordingly, it dismissed the appeal on that point.
This decision has been subject to significant criticism and is scheduled for appeal to the Supreme Court.
Alesco New Zealand Limited v Commissioner  NZCA 40
3.2 Limited recourse to judicial review in tax cases
The High Court declined an application for judicial review of an Inland Revenue decision not to reopen default assessments under section 113 of the Tax Administration Act 1994 (“TAA”).
The taxpayer, Arai Korp Limited, had taken no steps at all to dispute or challenge default assessments issued by the Commissioner for the 2004 and 2005 income years. Those assessments had been made in late 2006. Only in mid 2011, when the company was about to be wound up, did it request the Commissioner to accept new returns for the relevant years and allow a challenge out of time. The Commissioner treated this as a request for the assessments to be reconsidered under section 113 of the TAA, which permits the Commissioner to amend assessments at any time to ensure their correctness.
There was no dispute that the original default assessments contained manifest errors. Land sales had been brought to account as giving rise to income but no allowance had been made for the cost of acquiring the land or for interest on known borrowings. Despite this an IRD official refused to exercise the section 113 discretion and did not consider the merits of the taxpayer’s assertion that clear errors had occurred.
The High Court held that the Commissioner was permitted in these circumstances to refuse to exercise the section 113 discretion. The decision is based essentially on the view that judicial review ought not to provide a back door avenue for the assessments in issue to be challenged when the strict time requirements of the disputes process had apparently been ignored. The Court also upheld the fact that the IRD official exercising the delegation to consider this matter was entitled to take into account the fact that an earlier investigation would have to be reopened and would require IRD resources to be committed and also to take account of the background leading up to the request.
The Court noted that the merits of the taxpayer’s case were not considered by the relevant officer yet that omission was not fatal to the decision to refuse to reopen matters. The other factors, principally the costs to the IRD and the background of the taxpayer having taken no steps trumped the fact that the merits had not been considered. The fatal element for the taxpayer was a combination of very unhelpful facts which, if not present in another case, could see the need to consider the merits of the taxpayer’s case given far greater prominence.
Arai Korp Limited v Commissioner (2013) 26 NZTC 21-014
3.3 Resource consent costs deductible
The High Court decided in favour of a power generation company’s claim to deduct the costs of obtaining resource consents for what the company called its ‘development pipeline’. TrustPower kept its generation options open by setting up the possibility of being able to build capacity in a variety of way. It sought and obtained resource consents, often well in advance of any development activity. There was no assurance that any particular development project would proceed because they were regularly and often reassessed, one against the other.
The Commissioner’s argument was essentially that the resource consents became assets of the company and so the costs were on capital account and non-deductible. But the Court did not agree and preferred an approach that determined the nature of the expenditure having regard to what it was calculated to effect from a practical and business point of view. On that basis it concluded that obtaining consents was a crucial and integral part of TrustPower’s business and so should be treated as a revenue account expense.
The consents were not related necessarily to particular assets actually created but were part of a process undertaken by the company to advance a number of potential initiatives so that they could then be evaluated as TrustPower considered generation activity alongside the purchase of electricity.
This case does not conclude that the costs of all resource consents are deductible. Those that are linked inevitably to a particular asset or development are likely to be part of the capital costs of that project. The singular facts of TrustPower’s business made the case different because TrustPower was really investing in possibilities which might or might not come to fruition.
The impact of the decision in other areas such as the treatment of “black hole” expenditure, including feasibility costs, means it is highly likely to be appealed by Inland Revenue.
TrustPower Limited v Commissioner  NZHC 2970
4. Determinations, Ruling and Statements
The following interpretation statements are of interest:
4.1 Tax avoidance and the interpretation of sections BG 1 and GA 1 of the Income Tax Act 2007
This interpretation statement (“IS”) outlines the Commissioner's view of the law on tax avoidance in New Zealand. It sets out the Commissioner's view of the principles to be applied and provides a framework within which those principles will be applied. The Commissioner applies the approach to sections BG 1 and GA 1 established by the Supreme Court in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue  NZSC 115. This statement replaces the Commissioner's statement on section 99 of the Income Tax Act 1976 (Appendix C to the Tax Information Bulletin, Vol 1, No 8, February 1990).
The objective of the IS is to publically state the Commissioner’s view of the interpretive principles that control the application of sections BG 1 and GA 1, which are the general anti-avoidance avoidance (“GAAR”) provisions of the Income Tax Act 2007. The Commissioner uses as its base a detailed consideration of the Supreme Court’s decision in Ben Nevis. The Commissioner sees this as a unifying judgment that settles a number of interpretive issues and sets the foundation for future interpretation. Also important in this context is the Supreme Court decision in Penny and Hooper v Commissioner  NZSC 95.
In many respects, the IS is uncontroversial, providing a comprehensive summary of the relevant case law on particular points of interpretation. However, it does provide controversial aspects in its emphasis on the ‘commercial reality and economic effects’ of an arrangement and outlining the ‘Parliamentary contemplation’ test.
The IS advocates that when determining whether an arrangement involves tax avoidance, it is necessary to identify whether the tax outcomes of a particular transaction are what Parliament would have intended for those provisions. The outcome is what a “hypothetical Parliament” would have contemplated, not the actual Parliament of the day when the legislation was introduced. It must also be considered whether Parliament would have contemplated the outcome using the combination of any sections involved in a transaction.
The first step under the Parliamentary contemplation test and main emphasis of the Commissioner’s statement under this test is to consider the commercial reality and economic effect of an arrangement. This involves going beyond the legal form of an arrangement to identify the real outcomes of an arrangement. The statement suggests that this involves a close examination of cash flows, changes in the parties’ economic position, the rights and obligations of the parties and the risks assumed by them. It also requires a consideration of the profitability and the viability of a transaction when tax is ignored. It follows that where there are steps in the arrangement that disguise the actual consequences of the parties and the risks assumed by them, that this would not have been within the contemplation of Parliament.
The publication of the Commissioner’s draft statement on tax avoidance is generally welcomed by New Zealand tax practitioners, however the IS is not considered by all commentators to set out accurately the legal approach to tax avoidance. Given the decisions that have been made so far on the application of the anti-avoidance regime to cross border funding structures which delver New Zealand tax benefits, the IS is likely to be important lawyers advising on such matters.
IS 13/01: Tax Avoidance and the interpretation of sections BG 1 and GA 1 of the Income Tax Act 2007
4.2 Draft interpretation statement on the meaning of Permanent Place of Abode
IRD issued a draft interpretation statement (“IS”) on the meaning of Permanent Place of Abode (“PPOA”). The concept of PPOA is central to that of tax residence. Even if a person is absent from New Zealand for a sustained period, if they retain a PPOA here they remain tax resident. If that is so, they remain liable for New Zealand tax on worldwide income unless a double tax agreement (“DTA”) applies to prevent that. It does not matter that you may also have a PPOA in another country. As long as you have one in New Zealand you are at risk of New Zealand taxation.
This is an obvious concern for the expat community, many of whom live and work in countries with which NZ does not have a DTA. If they retain a PPOA in NZ, their income from overseas activities may still be taxed here even if they are away from NZ for many years. It may also be of concern to persons who regularly visit New Zealand and own property here which is available to them.
The IS addresses the elements that make up a PPOA and in particular the concept of there being a dwelling in New Zealand which is available for use. The concept of PPOA is based on a broad consideration of the factors that make up one’s family, professional, business and economic life but an important element, and one without which it is arguably difficult to assert the existence of a PPOA, is that there must be somewhere that a person can physically abide in the country that is available to them with sufficient frequency and continuity and certainty to be regarded as permanent.
The obvious issue that this has always raised is how the retention in NZ of a holiday home might figure in an assessment of PPOA. But the IS is being seen to raise other risks as well, namely that more informal arrangements for accommodation during any return to New Zealand could signal a PPOA here, even the ability of an expat to have accommodation here with relatives.
The essential change concerning holiday homes is that the IRD is suggesting that temporary rental arrangements which prevent an expat using the holiday home while they are out of New Zealand will not necessarily mean that the home is not available to them so as to trigger a PPOA. The statement seems to say that because the home is or may be available at some future time, it is available throughout the relevant absence from NZ. There are number of observations that might be made about that:
1. Residence has to be determined year by year. That is because the tax system applies periodically. Circumstances have to be considered and may change year by year.
2. If a home is unavailable to you because it is subject to a tenancy to someone else for the whole of a tax year, it is difficult to see how it is available for a PPOA consideration in and for that year.
3. The fact that the tenancy may terminate at some stage in the future could be relevant if such termination meant that the holiday home came free for use at a future time but that does not mean that it is available at any other time.
4. It seems, therefore, that the analysis for the suggested change to include prospective availability of a holiday home during a period of absence from NZ may not be all that strong. But that does not mean that rental arrangements will always be a robust defense to a PPOA argument. Neither will trust ownership, if the holiday home in NZ is routinely available from trustees to expat beneficiaries.
There are clear risks to expats working without the protection of DTA coverage that the IRD will use the existence of retained connections with NZ such as a holiday home to assert a continuing right to tax expat income, despite it having been earned overseas and the expat being absent from NZ for many years.
There are also implications for persons who acquire property in NZ to use as a base for regular visits. Even though not physically present for more than 183 days, such persons may nevertheless acquire a PPOA and so become NZ tax residents.
Income Tax – Residence INS0117
The following standard practice statements are of interest:
4.3 Retention of business records in electronic format
This SPS Standard Practice Statement (“SPS”) applies to taxpayers who are required to keep business and other records under the Inland Revenue Acts and other third party data storage providers that hold business records for taxpayers offshore. It provides guidelines on the retention of business records in electronic format and sets out the Commissioner’s practice when considering an application to store business records offshore. The SPS also outlines the Commissioner’s practice when considering an application to keep records in M‚ori. This SPS applies from 11 March 2013.
The Tax Administration Act 1994 ("TAA") and the Goods and Services Tax Act 1985 ("GSTA") require taxpayers to keep business and GST records in New Zealand and in the English language. Under this SPS, the Commissioner has the discretion to authorize the offshore storage of records or to authorize records being kept in another language. Changes to the TAA allow applications to be made by a third party data storage provider, such as a cloud service provider, to store records offshore for their clients.
Records stored electronically, both inside and outside of New Zealand, and either on the taxpayer’s own electronic storage system or on an outsourced system, must meet the requirements of the Electronic Transactions Act 2002 ("ETA") that:
(a) the integrity of the information contained in the records is to be maintained, and
(b) the information is readily accessible so as to be usable for subsequent reference.
Further conditions for legal requirements to retain records under the Inland Revenue Acts are provided in schedule 1, clause 4 of the Electronic Transactions Regulations 2003 ("ETR").
Under this SPS, the Commissioner may authorize a taxpayer to store records offshore or a third party to hold records offshore for multiple taxpayers, if the storage of those records offshore does not impede the Commissioner’s compliance activities. In particular, the records stored offshore remain accessible by the Commissioner. An applicant may be required to demonstrate that the manner in which the records are to be stored offshore will meet the requirements of the ETA and the ETR. Each application will be considered on a case by case basis having regard to the merits of the case, including the compliance history of the applicant.
For a third-party application, the Commissioner will also consider whether the third party carries on business in, or through, an establishment in New Zealand; and the procedure that the third party has for dealing with client data should the third party no longer hold records for the client.
The Commissioner may authorize records to be kept in a language other than English. The Commissioner recognizes that M‚ori is an official language of New Zealand and those persons who wish to keep their records in M‚ori may apply to the Commissioner, in writing, to do so. The Commissioner will generally approve applications to keep records in M‚ori provided that the taxpayer uses certain English phrases specifically required by the GSTA and that numbers are recorded using Arabic numerals. Applications to keep records in other languages may be approved only in limited circumstances where there are compelling reasons to do so. These applications will be considered on the facts of each case.
SPS 13/01: Retention of business records in electronic format, application to store records offshore and application to keep records in M‚ori (January 2013)
5. International Agreements
New Zealand has formally ratified the OECD “Convention on Mutual Administrative Assistance in Tax Matters” effective 1 March 2014. Under the Convention, which 62 countries have signed to date, IR will be able to request information from other tax authorities and to seek assistance in collecting outstanding tax debts from taxpayers who move overseas irrespective of the existence of such provisions in Double Tax Agreements.
New Zealand has a comprehensive regime of double tax agreements. On 5 August 2013 a double tax agreement between New Zealand and Vietnam was signed. The agreement makes investment between the two countries more attractive, and will come into force once legal formalities between New Zealand and Vietnam are completed.
 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.