New Zealand

Graham Murray and Fiona King
Bell Gully
New Zealand

International tax reform and the first Supreme Court anti-avoidance verdicts were among key developments in the last year, explain Graham Murray and Fiona King of Bell Gully

There have been a number of significant developments in the New Zealand tax landscape during the past year.

Significant international developments include the New Zealand government signing a protocol to amend the New Zealand/US double tax agreement and entering into a new double tax agreement with Australia. The key domestic tax developments in the last year include reductions in personal income tax rates and thresholds, the repeal of the R&D tax credit regime and the introduction of measures intended to ease the tax compliance burden for small to medium-sized enterprises. The proposed reforms to the international tax and associated person rules, which were introduced in July 2008, are now expected to be enacted some time towards the end of 2009.

There have also been significant judicial developments in the past year. The Supreme Court, now New Zealand's highest appellate court, considered two cases concerning the application of New Zealand's general anti-avoidance rules. In both cases the court found against the taxpayer and it is expected that the approach adopted in those cases will be applied by lower level courts in future tax avoidance disputes.

International developments

On December 2 2008, the government announced the signing of a protocol that will significantly amend the existing New Zealand/US double tax agreement (the US DTA). The protocol provides for the following significant changes to the DTA:

A 5% withholding rate will now apply to dividends paid to companies that have 10% or more of the voting power of the company paying the dividend. Additionally, dividends can be paid free of withholding when a company holds 80% of the voting power in the company paying the dividend in the 12 months leading up to the date on which the entitlement to the dividend is determined, and it satisfies one of a range of tests which relate to the new limitation of benefits article. This change will allow qualifying New Zealand subsidiaries to freely distribute both tax paid and non-tax paid gains to their US parent companies without any New Zealand tax cost.
A 0% withholding rate will be available for interest paid to banks and financial institutions for loans to unrelated borrowers, unless interest is paid subject to a back-to-back lending arrangement. However, for the rate of New Zealand non-resident withholding tax to be reduced to 0%, there is an additional requirement that an approved issuer levy (AIL) of 2% be paid in respect of interest in circumstances where the AIL regime is able to be applied.
The maximum withholding rate on royalties will reduce from 10% to 5%.
The US DTA is to be amended to provide that income derived through a fiscally transparent entity by a resident of the US or New Zealand will be treated as having been derived by that resident under the US DTA, to the extent that the tax laws of either New Zealand or the US treat the item as income derived by the resident.

The changes to the US DTA will be effective once both countries have given legal effect to the protocol.

On June 29 2009 the government entered into a new double tax agreement with Australia (the new Australian DTA). The new Australian DTA incorporates similar features to those described above in relation to the US DTA.

The new Australian DTA also provides for concessionary treatment for pensions derived by a resident of one contracting state from the other contracting state, changes to the substantial equipment and dependent agent tests in the definition of permanent establishment, a revised employment income article that includes specific relief for seconded employees and special residence rules for dual listed companies (among other features).

The Australian DTA will come into force once both countries give legal effect to it.

Legislative developments

In December 2008, the newly-elected centre-right National (Party) Government passed urgent tax legislation effecting the following key changes:

The repeal of the R&D tax credit regime introduced by the previous centre-left Labour Government, with effect from April 1 2009. The R&D tax credit regime provided for a 15% tax credit for qualifying R&D expenditure and was in force for just one year.
A reduction in personal income tax rates and income thresholds (including a modest reduction in the top marginal tax rate from 39% to 38%), with effect from April 1 2009.

Further reductions in personal marginal tax rates were scheduled to occur on April 1 2010 and April 1 2011. However, as a response to budgetary pressures arising from the global economic slowdown, the government enacted urgent legislation in May 2009 that postponed these further reductions indefinitely.

The economic climate also prompted the government to enact a range of initiatives designed to help small and medium enterprises manage their cash flows and meet their tax obligations. The following were among the initiatives passed:

removing the 5% uplift rate that businesses pay in advance on provisional tax instalments throughout the year;
raising the goods and services tax (GST) payments basis threshold from NZ$1.3 million ($838,000) to NZ$2 million and raising the GST registration threshold from NZ$40,000 to NZ$60,000; and
raising various other thresholds relating to pay as you earn (PAYE) obligations and fringe benefit tax (FBT).

International tax and associated person reforms still not enacted

In July 2008 the government introduced proposals to reform certain aspects of New Zealand's international tax rules and the associated persons rules. The progress of these reforms was halted due to the general election in late 2008 and it is now expected that these proposals will not be enacted until late 2009 (with application from the 2010-2011 income year for most taxpayers). The main aspects of the proposals are summarised here.

Controlled foreign company rules

Income of a controlled foreign company (CFC) is attributed to the CFC's New Zealand resident shareholders in proportion to their income interest in the CFC, unless the interest is less than 10% or the CFC is resident in a grey-list country (that is, Australia, Canada, Germany, Japan, UK, US, Norway and Spain).

Under the proposed reforms, the grey-list exemption will be replaced with new exemptions for Australian resident CFCs and CFCs that meet an active business test. For the active business exemption, income of a CFC will not be required to be attributed if less than 5% of the CFC's gross income is passive income, such as rent, royalties, interest and dividends. Where a CFC is not exempt from the CFC rules, New Zealand resident shareholders will be attributed with the CFC's passive (but not active) income for tax purposes and must pay tax on that income accordingly.

The proposed reforms also include a new tax exemption for dividends derived by New Zealand residents from CFCs (whether the dividend represents a distribution of active or passive income of the CFC) and repeal the conduit tax relief regime.

Extension of the thin-capitalisation rules

It is also proposed that the thin-capitalisation rules, which apply to limit interest deductions from inbound investment by non-residents, be extended to apply to taxpayers with outbound CFC investments.

Under the revised thin-capitalisation rules there will be limits on interest deductions claimed by excessively geared New Zealand taxpayers that hold CFC investments. The thresholds for excessive gearing will be broadly based on the same thresholds for the inbound thin-capitalisation rules (that is, having a New Zealand group debt percentage in excess of 75% or 110% of the relevant worldwide group debt-to-asset percentage).

Extension of the associated persons rules

The proposed changes to the associated persons rules are also significant. The association of parties to a transaction or arrangement can have significant consequences under New Zealand tax law. The associated persons rules perform an important function by defining the circumstances in which two or more persons are associated.

It is proposed that a single comprehensive association test for companies, trusts, partnerships and individuals replace the existing four separate associated persons tests. The proposed test will be of general application, with some modifications made for the land tax rules, and represents a general broadening of the associated persons concept. A universal tripartite test is proposed to associate any two persons who are both associated with a common third party (with limited exceptions).

Government announces tax policy work programme

The government has released a tax policy work programme for the 2009-2010 income year. A broad range of projects have been given high priority, although the time-frames for enacting changes, if any, are not yet known.

Aspects of New Zealand's imputation system are under review, in particular whether imputation credits should be able to be streamed, and their refundability. Refundability of imputation credits would be particularly beneficial to tax exempt entities, which pay no tax on dividends but are unable to utilise imputation credits attached to the dividends.

New Zealand and Australia are also exploring the possibility of introducing a system of mutual recognition of imputation and franking credits. Credits attached to dividends in one country cannot be used to satisfy the tax liability of a person resident in the other country. Mutual recognition may remove certain investment biases from trans-Tasman investment decisions and reduce incentives for companies to stream imputation credits to New Zealand investors and franking credits to Australian investors.

Other high priority projects include:
designing a possible exemption from approved issuer levy and non-resident withholding tax for New Zealand bonds issued to non-resident investors; and
continuing work on developing tax incentives to encourage a culture of charitable giving in New Zealand. At present, charitable tax credits are only available to individuals or companies that gift money to a tax charity.

Supreme Court rules on tax avoidance for the first time

In late 2008, the Supreme Court released two decisions simultaneously on the application of general anti-avoidance rules to transactions conferring tax advantages. These decisions were the first of their kind issued by the Supreme Court since its establishment.

In Glenharrow Holdings Limited v the Commissioner of Inland Revenue the Supreme Court considered the application of the general anti-avoidance rule in a goods and services tax (GST) context. The court held that the taxpayer was not entitled to an input tax credit of one-ninth of the NZ$45 million ($29 million) agreed purchase price of a mining licence. The court took the view that the economic burden of the NZ$45 million purchase price had not been incurred and that, viewed objectively, the purchase price had been inflated to benefit from the GST input tax credit (even though this was not a subjective purpose of the parties).

In Ben Nevis Forestry Ventures Limited and Ors v the Commissioner of Inland Revenue, the Supreme Court disallowed tax deductions claimed in relation to a forestry investment scheme on the basis that the scheme constituted a tax avoidance arrangement. The approach of the majority in Ben Nevis confirmed that a taxpayer may rely on specific tax provisions when structuring a transaction. However, if use of a particular provision (or combination of provisions) alters the incidence of tax beyond that which the court considers was contemplated by Parliament, then the transaction is at risk of being struck down on avoidance grounds. The use of specific provisions to structure a transaction may fall outside of Parliament's contemplation when a taxpayer obtains benefits by relying on specific provisions in an artificial or contrived way.

New Zealand's lower courts can be expected to adopt the approach applied in Glenharrow and Ben Nevis in determining future tax avoidance cases due to the combination of the high authority of those decisions and their currency.

Graham Murray (graham.murray@bellgully.com) and Fiona King (fiona.king@bellgully.com) are solicitors with Bell Gully