This bill proposes alterations to the rules about what type of entity can be an LTC and who can hold LTC interests. It is primarily focussed on strengthening the rules around the requirement for an LTC to have no more than five counted owners.

As a result, some LTCs may lose their status and need to become an ordinary company during the 2017–18 tax year. Should this happen, the parties would pay tax on unrealised gains held on revenue account. We propose inserting a transitional rule (new section HZ 4E of the Income Tax Act 2007) in clause 118B to enable the tax book values to be rolled over to the ordinary company.

The bill proposes to grandparent current Māori authorities that acquired interests in look-through companies before the introduction of the bill (3 May 2016). However, the current wording of this provision provides wider concessions than intended.

We recommend amending subclauses 262(48) and 262(56) so that the grandparenting provision in the bill for Māori authorities would be tightened. This would mean that it would only apply to interests held before 3 May 2016.

The bill also proposes that charities should not be owners of an LTC. Some submitters expressed concern with this proposal and that existing structures would be affected. They suggested that the proposed amendment should not apply to existing charities with LTC interests. This would align with the amendment proposed for Māori authorities. We agree, and propose to grandparent charities’ LTC interests as at 3 May 2016.

We recommend amending subclauses 262(47B) and 262(56) to reflect this.

We recommend amending clause 262(58) to confirm that the trustees of a trust will be a single look-through counted owner if no distribution of income has been made. This will ensure that an LTC has at least one counted owner, and when an LTC is owned by multiple trusts that make no distributions to beneficiaries, that each trust is recognised as an owner.

Debt remission refers to the extinguishing of a debtor’s (borrower’s) liability by operation of law or forgiveness by the creditor (lender). It results in taxable debt remission income to the debtor. The amendments proposed by the bill aim to provide relief in certain situations. We support the aim, but consider that the rule, as proposed, needs to be made clearer. We also feel there would be value in extending the rule to cover liquidations and cessations of entities.

We therefore recommend inserting clauses 38B and 56B, and amending clause 56, to provide that creditors of look-through entities that are also owners or partners automatically have a right to a deduction for a base-price adjustment as a result of a self-remission.

We also recommend amending the definition of “self-remission” in clause 262(97).

The bill introduces a continuity of ownership test for qualifying companies. Under the proposed rule, qualifying company status would be lost if there is a greater than 50 percent change in the ownership of the shares in the company.

We recommend inserting new subclause 98(3B) to give an exception for sales of shares to close relatives. This would allow for intergenerational planning.

The bill proposes a rule that would restrict the foreign income able to be earned by an LTC that is controlled by non-resident shareholders. Such entities would be restricted to a maximum foreign income threshold that is the greater of $10,000 or 20 percent of the LTC’s gross income. We agree that when determining whether a trust that is an LTC owner is non-resident, the trust should only be counted as non-resident to the extent that non-resident settlors have provided settlements to the trust. Accordingly, we recommend amending the definition of foreign LTC holder in clause 262(43).

The bill would introduce a new concept of non-resident financial arrangement income (NRFAI) as a new category of non-resident passive income under certain financial arrangements between associated parties.

We recommend refining the definition of NRFAI so that amounts paid to parties other than the non-resident related party lender should not be included in the calculation of NRFAI. This would amend clause 253, section RF 12D, which describes how to calculate NRFAI. We recommend making equivalent modifications to the general rules relating to expenditure (subsection (1C)), spreading method (subsection (1D)), and forex movements (subsection (1E)).

We recommend amending clause 248, section RF 2B(5), to further define items in the formula for the deferral calculation of NRFAI which is proposed in section RF 2B(4). The numerator and denominator should be the same; they should refer to all payments and accruals.

We recommend amending clause 247 to insert new section RF (2B) to specify an interest exception. It would exclude from interest that is non-resident passive income an amount that has given rise to NRFAI under clause 253, section RF 12E.

We recommend further amending clauses 247 and 248 to exclude amounts from NRFAI for onshore branch exemption. NRFAI should not be derived when the lender is a non-resident acting through their New Zealand branch, as this is a valid use of the onshore branch exemption.

We also recommend amending clause 5(4) to insert new paragraph 5(4)(c) to extend onshore branch grandparenting to certain securitisation vehicles.

Non-resident withholding tax is required to be deducted from payments of interest on loans between a New Zealand borrower and an offshore lender where the two parties are associated persons. The bill proposes to treat the interest being paid by the New Zealand borrower to the direct lender (for example a bank) as agent for the indirect lender (the offshore associated person).

We recommend amending clause 253 to insert new sections RF 12J(2) to RF 12J(5) to clarify “as agent” treatment of indirect associated funding, and add an intention test to prevent application to genuine commercial arrangements. We further recommend amending clause 253 to insert new sections RF 12I(2)(b) and (c) to clarify the application when a borrower and direct lender are associated. We also recommend amending section RF 12H (1)(a)(ii), deleting section RF 12I(5), and adding new section RF 12H(3) to restructure the “acting together” provisions.

Where a person is an “approved issuer” and the security under which they are making interest payments is a “registered security”, the borrower is able to pay approved issuer levy (AIL) at 2% rather than deducting NRWT from the interest payments.

The proposal under the bill is to limit the availability of AIL to three categories of people. The first two categories are people whom the Commissioner of Inland Revenue has determined are highly unlikely to treat a payment to an associated person as being eligible for AIL when it should be subject to NRWT. The third category is New Zealand borrowers who make interest payments of at least $500,000 per annum to non-residents.

We are concerned that these proposals would impose compliance costs on many borrowers who are already compliant.

We therefore recommend that clauses 246(3), 294, 330, 331, and 332(2) be deleted from the bill.

We recommend inserting subclause (64B) into clause 262 to refer to the definition of nominal shareholdings in section EW 46C. This would ensure that nominal shareholdings are ignored when calculating ownership and debt percentages.

Available subscribed capital is share capital of a company that, in appropriate circumstances, can be returned tax-free to shareholders.

We recommend amendments to clauses 22, 23, 41B, 338, 339, and 340B, so that when available subscribed capital is created, the owner would receive an uplift in the carrying cost of their shareholding in the debtor. If a debt remission does not result in available subscribed capital, it should also not result in the debtor receiving a capital profit as this could lead to the artificial conversion of retained earnings into capital gains.

We recommend that available subscribed capital be attributed to the class of shares that the shareholder owns that carries the most rights in the company.

We consider that the remission of debt owed by a foreign shareholder in a New Zealand creditor company should continue to be taxed as a dividend. We therefore recommend an amendment to clauses 16 and 337 so that the proposed exception applies when the dividend is derived by a company that is resident in New Zealand, or that is a subsidiary of such a company wheresoever resident, and is derived from a company that is in the same wholly-owned group of companies as the recipient at the time the dividend is derived.

The bill proposes that no dividend will arise if a wholly owned New Zealand company remits a debt owned by another wholly owned company. This would make section CW 10(4) of the Income Tax Act 2007 redundant, and we therefore recommend that it be repealed by amending clause 29C

We recommend amending clause 41 to ensure that the bad debt rule would be limited to situations when the debtor has obtained a tax deduction in New Zealand for the financial arrangement expenditure.

We recommend amending clause 59 to ensure that the creation of a new debt is limited to guarantees with recourse to the debtor.