Taxation (Base Maintenance and Miscellaneous Provisions) Bill

Taxation (Base Maintenance and Miscellaneous Provisions) Bill

Officials’ Report to the Finance and Expenditure Committee on Submissions on the Bill

2 May 2005

Prepared by the Policy Advice Division of the Inland Revenue Department

and the Treasury

CONTENTS

Thin capitalisation rules for foreign-owned banks 1

Overview 3

Income not fully tax free 4

Selective consultation contrary to GTPP 5

Impact of IFRS 6

The New Zealand banking group 7

Issue: Inadvertent exclusion of certain non-residents 7

Issue: Reporting bank confusion where there is more than one registered bank 8

Issue: SOP – exclusion of non-resident life insurance business 9

Equity of the New Zealand banking group 10

Issue: Definition of New Zealand net equity 10

Issue: Scope of AEQI 11

Issue: Grey list shares excluded from EOI 12

Issue: Consistency of debt and equity treatment throughout Act 13

Issue: Removal of fixed-rate shares from definition of net equity 14

Issue: Subsequent review of legislation 15

Issue: SOP – regulatory power to amend the definition of “net equity” for thin capitalisation purposes 15

Issue: SOP – grandfathering 17

Issue: Calculation of New Zealand net equity 17

New Zealand net equity threshold using risk-weighted exposures 18

Issue: Calculation of net equity threshold 18

Issue: Treatment of deferred tax 18

Issue: Valuations where denominated in foreign currency 19

Interest denial 20

Issue: Clash between accounting and tax concepts 20

Minor drafting issues 22

Issue: Drafting issues raised by NZBA 22

Issue: Drafting issues raised by Russell McVeagh 22

Issue: Use of “contribute to” 23

Changes to the tax depreciation rules 25

Overview 27

Patents 28

Issue: Commencement date of depreciation 28

Issue: Useful life of patents 30

Issue: Transitional issues 32

Issue: Patents granted in other jurisdictions 32

Issue: When ownership of patent applications change 33

Issue: Patent renewal fees 34

Issue: Drafting 34

Issue: Costs associated with obtaining a design registration 35

Issue: Commencement date for intellectual property rights generically 36

Plant variety rights 37

Issue: Plant variety rights granted in other jurisdictions 37

Issue: Deductibility for plant variety development costs 37

Issue: Application date of the changes 38

Issue: Application of clauses 20 and 21 to plant variety rights 39

Losses on destruction of buildings 41

Issue: Losses on disposal of buildings should be wider 41

Issue: Dredging costs 43

Issue: Losses when a building is no longer used/required to be demolished as the result of a qualifying event 44

Issue: Application date of changes 46

Issue: Definition of “qualifying event” 46

Issue: Losses on sale of a temporary building 47

Special tax depreciation rates 49

Issue: Special tax depreciation rates for classes of depreciable property 49

Issue: Guidelines for issue of special tax depreciation rates 50

Issue: The six-month deadline for issuing special tax depreciation rates 51

Issue: Estimated useful life under the special tax depreciation rate rules 53

Issue: Special tax depreciation rates part way through an asset’s life 54

Issue: Special tax depreciation rates for excluded depreciable property 56

Issues: Drafting 56

Other 58

Issue: Deductibility for resource consents that are not granted or are withdrawn 58

Death and asset transfers 61

Overview 63

Support for amendments 64

Rollover relief 65

De minimis 68

Cost base for depreciable property 69

Use-of-money interest 70

Application date 71

Publicity 72

Drafting 73

Imputation credit shopping 81

Overview 83

That the measures in the bill to counter imputation credit shopping are
unnecessary or inappropriate 84

That the measures preventing share splits from becoming taxable bonus issues
are inappropriate and should not proceed 86

Ability to make taxable bonus issues in excess of reserves capitalised which
could have inappropriate outcomes 87

The proposed anti-imputation credit shopping rules in sections ME 9B and
ME 9C should only apply when the dominant purpose is to obtain an imputation
or refund advantage 88

Any proposed further income tax payable should be creditable to future income
tax payments and to the imputation credit account 89

That clear rules on the timing and form of elections available under proposed
ME 9B are required 90

Definition of ultimate owners 91

Technical issues 92

Drafting issues 93

Privilege – right of non-disclosure for tax advice 95

Overview 97

Support for the amendments 98

Legal professional privilege 99

Complexity 100

Whether statutory declarations should be automatic 101

Tax advisor 102

Tax advice document 106

Tax advice documents given to other persons 108

Tax contextual information 109

Illegal or wrongful acts 113

Process for claiming privilege 114

Third parties 119

Definition of “document” 120

Inland Revenue requests for information 121

Inland Revenue guidelines 122

Disclosure of information to approved advisor groups 123

Drafting 124

Tax deductions for business environmental expenditure 129

Overview 131

Revision of section DB 37 132

Format of deduction 133

Definition of deductible business environmental expenditure 136

Links to other environmental legislation and projects 143

Links to the depreciation regime 144

Drafting 147

Need for the environmental restoration account 149

Design of the ERA 150

Interest rules 154

Transitional issues 157

Drafting 158

Removal of the word industrial 160

Other policy matters 161

Tax exemption for petroleum exploration and development 163

Issue: Extending the exemption to include income from related activities 163

Issue: Exemption should be automatically given 165

Issue: Note that because the amendment is retrospective Inland Revenue should amend affected assessments 166

Issue: Application date in the Explanatory Note to the bill is erroneous 167

Issue: Whether the exemption should apply to New Zealand-residents 167

Issue: It is not clear when exploration and development starts and finishes 168

Issue: Reference to the earth’s crust is confusing 168

Cook Island National Superannuation Fund 169

Issue: Residual issues relating to New Zealand-sourced income 169

Tax recovery provision: application to civil penalties and interest 170

Issue: Amendment should not be made 170

Issue: Consideration of overall level of penalties 171

Issue: Application date of proposed amendment 171

Excess imputation credits of individuals 173

Issue: Treatment of excess imputation credits of individuals 173

Issue: Extinguishing of carried-forward imputation credits 173

Issue: Numbering of provision on use of imputation credits 174

Publication of tax offenders’ names 175

GST and the Fire Service levy 176

Issue: Support objective 176

Issue: Scope of the proposed amendment 176

Issue: Treatment of penalties and interest 178

Issue: Deduction of input tax 180

Issue: Zero-rating levies paid by non-residents 181

Non-residents and GST deregistration 182

Issue: Scope of the amendment is incorrect 182

Issue: The amendment is not required because provisions already exist to deal with the perceived mischief 183

Issue: The proposed amendment will result in commercial uncertainty for multi-national groups with New Zealand operations 184

RWT on dividends paid to New Zealand investors in offshore unit trusts 185

Issue: Application date 186

Issue: Type of recipient 186

Issue: Type of dividend subject to proxy treatment 187

Issue: Taxable bonus issues not “dividends” for purposes of RWT proxy rules 188

Other amendments proposed by officials 189

Offshore unit trust – consequential amendments to the Income Tax Act 2004 191

Shortfall penalty for employers of non-resident contractors 192

Minor drafting changes 193

Issue: Allocation deficit debit rules for life insurance companies 193

Issue: Sale and leaseback of intangibles 194

Issue: Refund of excess tax 195

Issue: Research or development 195

Issue: Months for payment of provisional tax 196

Issue: Use-of-money interest for income statement recipients 197

Issue: Reduction of penalties for previous behaviour 197

Remedial amendments for the rewrite of the Income Tax Act 199

Rewrite Advisory Panel – retrospective amendments to Income Tax Act 2004 201

Post-assent changes to Income Tax Act 2004 205

Thin capitalisation rules for foreign-owned banks

15

Overview

Proposed thin capitalisation rules for banks are a systemic response to the problem of excessive debt funding by banks. The fundamental objective is to measure more accurately the income associated with the New Zealand activities of banks, ensuring that excessive debt cannot be allocated to the New Zealand operations of a multinational bank.

The new thin capitalisation rules for banks compare the equity associated with the New Zealand banking business (net of certain outbound investments) with a prescribed level of required equity based on 4% of the banks’ New Zealand risk-weighted exposures, and deny interest expenses where there is a deficiency. The measurement of equity is based on accounting and regulatory concepts of equity, which enables verifiability and minimises compliance costs. The objective of the new rules is not to regulate the amount of equity in New Zealand per se, but the use of equity as a benchmark for achieving an appropriate allocation of interest expenses.

Officials have worked closely with the banking industry to develop these rules. These rules will be monitored to ensure that they are operating in a way that reflects the policy intent.

Proposed thin capitalisation rules for foreign-owned banks operating in New Zealand are summarised in figure 1.

Figure 1: Thin capitalisation rules for foreign-owned banks

Income not fully tax free

Submission

(35W – Deutsche Bank, 23 – Russell McVeagh)

In some circumstances income from an offshore investment could be subject to New Zealand tax. In that case costs incurred to earn such income should be deductible. The new thin capitalisation rules could act to deny a deduction for interest on debt funding the investment.

Comment

The submissions suggest that some interest should be deductible because the income is subject to non-resident withholding tax of 15% in New Zealand under either the conduit rules or the dividend withholding payment (DWP) rules.

Under the conduit rules the 15% non-resident withholding tax is paid in respect of the offshore assets income when the New Zealand company ultimately distributes that income to its non-resident shareholders. However, the payment of this tax can be delayed indefinitely.

Likewise, under the DWP rules the offshore income will ultimately only be subject to 15% non-resident withholding tax.

Albeit 33% is initially paid with an 18% refund when these profits are distributed to the non resident shareholders of the NZ Bank.

Given that 15% non-resident withholding tax rather than 33% income tax is paid on the offshore income it does not seem appropriate to claim a full interest deduction. Apportionment calculations would be extremely complex to take account of the different rates of tax. Consequently officials do not recommend that any interest deduction be available in respect of this income. It should also be noted that when setting the prescribed level of capital required to support the NZ business of the bank, at 4% of risk weighed exposures it was acknowledged that in some cases the offshore income could be subject to some NZ tax. Consequently if an interest apportionment was considered in the future, the 4% rate would need to be reviewed.

Recommendation

That the submission be declined.

Selective consultation contrary to GTPP

Submission

(31 – Minter Ellison Rudd Watts)

The consultation of the proposals was selective and contrary to the Generic Tax Policy Process (GTPP).

Comment

The analysis leading to the introduction of the new thin capitalisation rules for banks involved base-maintenance of a significant size which needed a more timely response than would be possible under the full GTPP. Only a small number of taxpayers were directly affected. The issues involved were extremely complex and required a more intensive technical interaction with the taxpayers directly involved. Extending the consultations to individual firms would have diverted resources from these consultations. Accordingly it was decided to keep other taxpayers informed through meetings with general bodies such as the Institute of Chartered Accountants of New Zealand and the New Zealand Law Society.

Recommendation

That the submission be noted.

Impact of IFRS

Submission

(21 – Institute of Chartered Accountants of New Zealand)

The proposed rules should be considered in light of the effects of the new International Financial Reporting Standards (IFRS).

Comment

It anticipated that the key areas affected by IFRS will be: EQV, INTG and I. Lesser areas affected by IFRS are: REV, TXB, CEFA, NAFA, EOI, AEQ, AEQI and GFD. One difficulty in assessing the effect of IFRS is that the details of the change in standards are not yet known. The banks are likely to be in a better position to have considered and implemented the changes and are likely to raise issues themselves in the future. Officials will also monitor the IFRS changes and the need for consequential tax law changes.

Recommendation

That the submission be noted. That changes to IFRS be monitored to determine if there is any impact on the operation of the new rules.

The New Zealand banking group

A foreign-owned registered bank will be required to determine its “NZ banking group” under section FG 8C. This group will include all resident entities and fixed establishments (generally branches) operating in New Zealand that would be required to consolidate with the ultimate foreign parent of the registered bank for financial reporting purposes.

Section FG 8C also provides an option to exclude life insurance companies from the NZ banking group. Entities that are part of a life insurance company’s group can likewise be carved out, provided they do not have a main activity that is banking, financing or leasing, and they are not holding companies of banking, financing or leasing companies.

Issue: Inadvertent exclusion of certain non-residents

Submission

(23 – Russell McVeagh)

The provision which defines taxpayers who are subject to the thin capitalisation rules (section FG 2(1)) may inadvertently exclude non-resident companies, including registered banks, to which the thin capitalisation rules were intended to apply. Section FG 2(1) should be rewritten to be consistent with the language used in the present section FG 2(1).

Comment

The proposed section currently states that a non-resident company will be subject to thin capitalisation rules only if:

· no person who is resident in New Zealand has a direct ownership interest that is equal to or greater than 50%; and

· a non-resident has a direct ownership interest that, when aggregated with the direct ownership interest of persons associated with the non-resident, is equal to or greater than 50%.

If a non-resident company is widely held, the second requirement may not be satisfied and the company will therefore not be subject to the thin capitalisation rules.

Officials agree that FG 2 (1) should be rewritten to be consistent with the language used in the present thin capitalisation rules in section FG 2(1) in order to achieve the intended effect.

Recommendation

That the submission be accepted.

Issue: Reporting bank confusion where there is more than one registered bank

Submission

(23 – Russell McVeagh)

Section FG 8D should be amended and simplified to provide more certainty in its application. It is not clear how section FG 8D is intended to apply to a banking group which includes two registered banks, one of which carries on business in New Zealand as a New Zealand-resident subsidiary, and where the other carries on business in New Zealand as the branch of a non-resident bank. The submitters note that in this example, the wording as currently stands would not classify a branch as a registered bank for the purposes of section FG 8D.

Section FG 8D should be redrafted to the effect that:

· where a banking group only includes one registered bank (including a branch), then that registered bank is the reporting bank; and