Comprehensive reform of international tax rules to help New Zealand-based companies
compete more effectively overseas is the main feature of a taxation bill introduced
into the country's parliament on 2nd July, it has emerged.
“The proposed changes represent a fundamentally different approach to
taxing New Zealand companies that have offshore operations,” Finance Minister
Michael Cullen and Revenue Minister Peter Dunne announced upon the bill's introduction.
“The cornerstone of the reform is the exemption from tax of the offshore
active income of New Zealand’s controlled foreign companies, regardless
of where it is earned. That will bring our tax rules into line with the tax
systems of comparable countries, particularly that of Australia, and remove
a tax cost that similar companies in other countries do not face,” the
Ministers added.
At present, New Zealand taxes the active income – such as income from
manufacturing – from its offshore subsidiaries, whereas other countries
do not.
The change is designed to encourage businesses with international operations
to remain in New Zealand and enable them to compete on an equal tax footing
in foreign markets.
“Further important features of the proposed changes are an exemption
from tax of most foreign dividends paid to companies and measures to protect
the tax base as a result of adopting an active income exemption," the ministers
explained.
The changes introduced on Wednesday represent the first stage of the those
to emerge from the government’s review of New Zealand's international
tax rules and have been influenced by consultation with businesses and their
advisors.
“Most aspects of the reforms were signalled in a series of consultative
papers, although there has been further work to develop the detail in some areas,"
the ministers said.
Cullen and Dunne said that under the reforms, comprehensive attribution of
income from controlled foreign companies (CFCs) to New Zealand owners will be
replaced by attribution of passive income only. Passive income – such
as interest – will continue to be attributable.
There will be some exceptions to attribution of passive income, however, to
reduce compliance costs. For example, there will generally be no attribution
of passive income for CFCs in Australia, which is usually the first country
of choice for New Zealand's smaller businesses that want to expand overseas.
There will also be an exception for CFCs that pass an ‘active business’
test: no attribution of passive income will be required for CFCs whose passive
income is less than five percent of total income.
Passive income will consist mainly of interest, rent, royalties and dividends.
Certain services will also be classified as passive income, as will income from
speculative derivative instruments and derivatives that hedge passive income.
Most dividends paid by a foreign company will be exempt from income tax when
received by New Zealand companies, as was previously announced by the government.
Deductible dividends and dividends on fixed rate shares will be continue to
be taxable as interest, and fixed rate shares issued by foreign companies will
be treated as debt. This is designed to prevent double New Zealand taxation,
since a deduction will be allowed against the attributable income of the CFC.
As part of the exemption for ordinary dividends, there will be a change to
the qualifying company rules: a qualifying company may no longer hold an attributing
interest in a controlled foreign company or non-portfolio foreign investment
fund. This change is designed to prevent foreign dividends being passed through
to shareholders tax-free.
Interest allocation rules will be extended to cover New Zealand residents that
have outbound interests in a CFC. Several ‘safe harbour’ provisions
will, however, minimise the impact of the rules and permit much of the cost
of debt-funding for a foreign investment to be deducted against the New Zealand
tax base.
The present ‘grey list’ exemption from attribution of CFC income
is being replaced with the active business test for CFCs in all countries, with
one exception – Australian CFCs will generally continue to be exempt from
the requirement to attribute any income to New Zealand residents.
The existing conduit relief mechanism, which exempts from tax the foreign-sourced
income of New Zealand companies owned by non-residents, is being removed. Even
so, the active income exemption and the foreign dividend exemption provide the
same results as conduit relief for active income, Cullen and Dunne said.
The ministers added that companies’ foreign dividend payment accounts,
branch equivalent tax accounts and conduit tax relief accounts will become unnecessary
under the reform. It is the government’s intention that existing FDP credit
balances can be carried forward for five years and BETA debit balances and conduit
tax credits can be carried forward for two years, with legislation repealing
them to be introduced at a later date. BETA credit balances will be cancelled
from the beginning of the 2009-10 income year.
“The aim in developing this comprehensive reform has been to devise flexible
rules that are consistent with the realities of the business environment and
that help New Zealand businesses to expand their operations but keep their head
offices in New Zealand,” the Ministers concluded.
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