Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill

  • enacted

Commentary

Recommendation

The Finance and Expenditure Committee has examined the Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill and recommends that it be passed with the amendments shown.

Introduction

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill introduces changes to many areas of the current tax laws. The bill provides for the reform of the international tax rules, among other measures introducing a tax exemption for the foreign active income of controlled foreign companies1 (CFCs), and exempting most foreign dividends received by New Zealand companies from tax. This reform aims to allow New Zealand residents with active businesses in overseas markets to compete on an equal footing with their competitors.

The bill would align life insurance taxation rules more closely with the actual profits of term life insurance business, and extend portfolio investment entity rules to life insurers’ savings products. It includes changes to the income tax rules for petroleum mining, such as ring-fencing deductions for petroleum mining undertaken in a foreign country through a branch, removing the distinction between onshore and offshore development, and introducing a reserve depletion method for deductions.

The bill would introduce a voluntary payroll giving scheme, which would allow employees to make regular payroll donations from their pay and to enjoy the relevant tax benefit immediately rather than at the end of the tax year. It contains specific tax rules for the treatment of honoraria and payments to reimburse expenditure incurred in voluntary activities. It would also clarify the tax treatment of relocation payments and overtime meal allowances for employees.

This bill would amend the Goods and Services Tax Act 1985 so that loyalty programme operators could defer the imposition of Goods and Services Tax (GST) until loyalty points were redeemed. The amendments to the Goods and Services Tax Act 1985 would also allow certain exported second-hand goods, which were not to be re-imported into New Zealand, to be zero-rated if the exporter had claimed a second-hand goods deduction.

The bill includes remedial amendments to the tax pooling rules in the Income Tax Act 2007, the tax rules for portfolio investment entities (PIEs), and the tax rules for offshore portfolio investment in shares. They aim to ensure that the legislation reflects the original intent of the rules.

Numerous other changes are also proposed in this bill. For example, the bill would reform the definitions of “associated persons” in the Income Tax Act, and provide for the taxation of emission units arising under the Climate Change Response Act 2002 and of grants made from the Screen Production Incentive Fund announced in Budget 2008.

In addition to these changes, the Minister of Revenue released Supplementary Order Paper 224 to the bill and asked us to consider it. Supplementary Order Paper 224 provides for new rules relating to stapled debt securities’ tax treatment, which would not apply to debt securities stapled before 25 February 2008. We agreed to consider this supplementary order paper alongside the main bill, and have incorporated in our recommended amendments those portions of the supplementary order paper with which we agree.

The depth and breadth of the bill

The proposals contained in the bill are significant and complex, and cover a wide range of taxation issues. The size of the bill, and the depth and breadth of the material it covers, have made our consideration more difficult than it might have been otherwise. In trying to meet the report due date for the bill, we and our committee consideration processes have been put under considerable pressure. We do not consider it desirable to put a number of very distinct and significant proposals into one bill simply because they relate to one area of law. In future, we would prefer to see such proposals introduced to the House as separate, more manageable bills. If such proposals are not divided sensibly, the House might wish to accord significantly more than the usual consideration time to committees charged with considering such bills. Ministers should remain mindful that if departmental advisers are appointed to advise committees on such bills, they will need to meet committee deadlines and information needs under pressure.

We wish to thank our independent specialist advisers for the significant role they have played in our consideration. We have relied heavily upon them for assurance about certain aspects of the bill and the amendments we are proposing.

Technical amendments and focus of our commentary

The bill proposes a raft of technical amendments, on which we make no comment in this report. We understand that tax practitioners and Inland Revenue Department field staff frequently propose such amendments as they recognise the need for them in the course of using tax legislation.

This commentary sets out only the key amendments we propose and addresses the main issues that we considered. It does not cover minor or technical amendments.

Application dates

We recommend amendments to change the application dates for provisions proposed in the bill. The bill as introduced sets dates that do not allow sufficiently for the progress of the bill through Parliament.

We considered this matter very carefully. We received communications from the Minister of Revenue, and sought advice and options from advisers on appropriate application dates for various provisions. We appreciate that there are trade-offs between the various options. On balance, we agree with the recommendations from the department.

The key changes we recommend to the application dates of specific provisions in the bill are set out below.

International taxation provisions

We recommend that the new international tax rules apply to all taxpayers from the 2010–2011 income year. We also recommend that, for the 2009–2010 income year, the new international tax rules apply to taxpayers with balance dates on or after 30 June, while the existing international tax rules continue to apply to taxpayers with balance dates before 30 June.

Our recommended application date for the new international tax rules would provide certainty for all taxpayers for the 2009–2010 income year, while allowing at least some taxpayers to benefit from the new rules at the earliest opportunity.

Life insurance

We recommend that the new rules on the taxation of life insurance business apply from 1 July 2010 generally. This application date is intended to allow all life insurers sufficient time to develop adequate systems to comply with the new rules.

We recommend that life insurers be given the option of applying the new rules on the taxation of life insurance business from the beginning of their income year, if that year includes 1 July 2010. This flexible arrangement would allow life insurers with balance dates earlier than 30 June 2010 to provide extended PIE benefits to their policyholders at an earlier date. It might also reduce the compliance costs for such life insurers.

To complement the previous recommendation, we recommend that a life insurer who elects to apply the new rules on the taxation of life insurance business from the beginning of their income year be permitted to choose to apply the new grandparenting provisions from the beginning of the same income year rather than from 1 July 2010.

Associated persons

To ensure that the amendments to the definitions of “associated persons” would not have a retrospective effect, we recommend that the general application date for these amendments (excluding those in the land provisions) be deferred to the 2010–2011 income year and the subsequent years. We recommend that the amendments in the land provisions, except for section CB 11, apply to land acquired on or after the date of enactment. We recommend that the amendments in section CB 11, which relates to disposal of land within 10 years of completing improvements, apply to land on which improvements started on or after the date of enactment.

Portfolio investment entity rules

We recommend amending clause 2 to defer the application date for the rewritten PIE rules from 1 April 2009 to 1 April 2010 generally. This would prevent these rules from being applied retrospectively.

Film production and Government funding

We recommend that amendments be made to defer the application date of the proposed changes to the tax treatment of the Large Budget Screen Production Grant payment. We recommend providing that the proposed changes apply if the final application for the grant is made on or after 1 October 2009, except when the project incurred at least $3 million of film-related expenditure by 1 July 2008. We believe that deferring the application date would give the film industry sufficient notice of the proposed changes, and would prevent an unnecessary erosion of the revenue base of film projects that have already incurred significant expenditure.

We recommend amending clause 2(18) to defer the application date of the scheme for deducting Screen Production Incentive Fund payments to 1 January 2010. This deferred application date would prevent existing film productions that have received such payments from being caught by the new tax deduction rules, giving them certainty about their tax treatment.

We recommend that the application date of the proposed information-sharing and secrecy provisions between the Inland Revenue Department and the New Zealand Film Commission be deferred from 1 July 2008 to the date of the enactment of this bill. We consider it inappropriate to apply these provisions retrospectively.

Payroll giving

We recommend that the application date for the proposed provisions for the payroll giving scheme be postponed from 1 April 2009 to three months after the enactment of the bill. We believe this would give employers and the Inland Revenue Department sufficient time to roll out the systems for implementing the scheme.

Other commencement dates

We recommend amendments to change the proposed commencement dates of other provisions in the bill, such as those relating to KiwiSaver, Niue development, recognised seasonal workers, tax pooling, and transitional ICA penalties, to ensure that these provisions would operate effectively and be applied appropriately. Most would come into effect on the date of Royal assent. We have not recommended changes to the commencement dates of provisions relating to stapled stock, petroleum mining, emissions trading, general insurance, banking continuity, charitable donee status, tax recovery arrangements, tax depreciation rules, relocation payments and overtime meal allowances, reimbursements and honoraria paid to volunteers, research and development tax credits, and GST and remedial amendments. We consider that the application dates contained in the bill as introduced are appropriate in respect of these provisions.

Raising certain tax thresholds

We recommend deleting provisions regarding changes to tax thresholds for small and medium-sized enterprises (SMEs) from this bill. We examined these provisions when considering the Taxation (Business Tax Measures) Bill, which was subsequently enacted in March 2009. The Taxation (Business Tax Measures) Act 2009 has rendered the similar provisions in this bill redundant.

Income Tax Act definitions of “associated persons”

The bill proposes changes to the definitions of “associated persons” in the Income Tax Act. The changes introduced in this bill are intended to address weaknesses in the current definition (which is used mainly in an anti-avoidance capacity), which primarily affect its application to land sales. The bill proposes the implementation of a tripartite test, which would associate two persons if they were each associated with the same third person. It also introduces new tests for the application of the definition in relation to trusts, and sets out new rules for aggregating the interests of associates to prevent the tests for associating two companies and a company and a person other than a company being circumvented by the fragmentation of interests and their distribution among close associates.

We recommend a number of amendments to reduce uncertainty and narrow the scope of the proposed tests. We are concerned that the tests contained in the bill as introduced could inadvertently capture those involved in truly arm’s-length transactions. The amendments we propose are meant to give effect to the policy intention of capturing non-arm’s-length transactions, whilst not applying more widely than necessary to protect the tax base. We examined these amendments in detail, and tested examples against the proposed amendments, to ensure that the policy intent of the provisions is being given effect without capturing circumstances or individuals that are not intended to be captured. The amendments we recommend would ensure, for example, that person A and person B would not automatically be associated persons where person B was a property developer and they both held a 50 percent interest in a company, but each person would be associated with the company itself (new section YB 14 in clause 414). An adult child would not be associated with a parent’s spouse or the spouse’s company under compliance cost savings provisions (new sections YB 3 and YB 4 in clause 414). The key amendments we recommend are described below.

Limitation of tripartite test

We recommend narrowing the scope of the tripartite test in proposed section YB 14 of the Income Tax Act (clause 414) to make it apply to two persons only if they are each associated with the same third person under different associated persons tests in clause 414. Furthermore, we recommend amendments to ensure that the tripartite test would not apply if two persons were both associated with the same third person under any of the companies-related associated persons tests in proposed section YB 2 or YB 3.

We note that narrowing the scope of the tripartite test would complement amendments we recommend to proposed sections YB 2, YB 3, YB 5, and YB 6 of the Income Tax Act (clause 414).

Limitation of the test associating relatives

We recommend amending proposed section YB 4(4) (in clause 414) to ensure that a person would not be associated with another person where that person could not be reasonably expected to have knowledge of the existence of the other party and/or their relationship to that party. We consider it undesirable for such people to be captured by the definition of “associated persons”.

Companies as associated persons

We recommend creating an additional exception to the test in proposed section YB 2 of the Income Tax Act (clause 414), which determines whether two companies are associated persons. This exception would provide that the test would not apply to a company that is a PIE or that is eligible to become one, for the purposes of the land provisions in the Income Tax Act. This amendment would prevent a widely held fund from being adversely affected by the test in proposed section YB 2 because of the personal land dealings of the directors of the fund.

Trustee-for-relative test

We recommend that the associated persons test in proposed section YB 5 of the Income Tax Act (clause 414), known as the “trustee-for-relative test”, not apply for the purposes of the land provisions. This would align it with the other beneficiary-related associated persons tests in proposed sections YB 6 and YB 9, neither of which would apply for the purposes of the land provisions.

We recommend that energy consumer trusts established under the Energy Companies Act 1992 and unit trusts administering bonus bonds be excluded from the trustee-for-relative test in proposed section YB 5 of the Income Tax Act (clause 414), and the trustee-and-beneficiary test in proposed section YB 6 (clause 414). These trusts are public in nature and do not pose a risk to the tax base. The tests in proposed sections YB 5 and YB 6 are aimed at private rather than public trusts.

Charitable purposes

We recommend not treating “charitable organisations” (as defined in section YA 1 of the Income Tax Act) as beneficiaries for the purposes of proposed sections YB 6 and YB 9 (section YB 16(2) in clause 414). This would ensure that trustees and settlors of trusts would not be treated as associated persons simply because the same charity was a beneficiary of their trusts. We recommend that proposed section YB 7 of the Income Tax Act (clause 414) be amended to treat two persons who are in a marriage, a civil union, or a de facto relationship as the same person for the purpose of identifying a common settlor. We consider this amendment necessary to preclude the possibility of circumventing the proposed definition of “associated persons” by the use of “mirror trusts”. A “mirror trust” is a family trust settled by one spouse for the benefit of his or her spouse while the latter settles another family trust for the former.

We recommend that an exception be created exempting charitable trusts from the associated persons test for a trustee and a settlor in proposed section YB 8 of the Income Tax Act (section YB 8(2) in clause 414). This would prevent donors to charitable trusts from being treated as being associated with each other. We consider such an assumption of association would be impractical and inappropriate, and do not consider that excluding charitable trusts from the test would pose a risk to the tax base.

Employee trusts

For consistency, we recommend amending proposed section YB 15 of the Income Tax Act (clause 414) so that the test in proposed section YB 11, which provides that a trustee of a trust and a person who has the power of appointment or removal of the trustee are associated persons, is subject to an exception for certain employee trusts. We note that the other trust-related associated persons tests in clause 414 are subject to similar exceptions.

Partnerships

We recommend that proposed section YB 13 of the Income Tax Act in clause 414 be deleted to ensure that, in general, a partner could not be associated with the associates of the other partners in the partnership. However, we note that an associate of a partner, such as the spouse of a partner, would still be associated with the partnership under the tripartite test in proposed section YB 14 (clause 414), which associates two persons if both of them are associated with the same third person. For example, a partner’s spouse, who was associated with the partner under the proposed section YB 4, and the partnership, which was associated with the partner under YB 12, would be associated under the tripartite test.

We recommend that proposed section YB 12(2) of the Income Tax Act (clause 414), which creates an exception to the primary test for associating a partnership and a partner in proposed subsection (1), be amended to limit the exception to limited partners only and not general partners in a limited partnership. We consider that this would render proposed section YB 12(2) consistent with current section YB 16(1B) of the Income Tax Act.

We recommend that the proposed removal of the associated persons requirement from the dividend and fringe benefit tax rules, as set out mainly in clauses 11, 41, and 183 of the bill as introduced, not proceed. We are concerned that such a removal could have far-reaching consequences for various arrangements that are neither shareholding nor employment relationships, such as an agreement between a plumber and a bricklayer to use each other’s tools without making payments. Under existing rules, if a person is not a shareholder or associated with a shareholder, he or she does not need to be concerned with the dividend rules. Conversely, the proposed amendment in clause 11 would make it uncertain whether a person would have tax obligations in relation to dividends if he or she received free services from an unassociated person. We consider that this uncertainty outweighs the potential advantages of the proposed amendment.

International tax rules

The bill introduces a new approach to taxing foreign companies that are controlled by New Zealand residents. The key features of the new approach include an active income exemption for controlled foreign companies (CFCs), interest allocation rules for CFCs, repeal of the grey list exemption, and repeal of the conduit rules, which exempt from tax the proportion of a CFC’s income that is attributable to foreign shareholders.

Signposting provision

We recommend the inclusion of new clause 116B, which would insert new section EX 18A into the Income Tax Act. Our recommended amendment would ensure that key provisions relating to the CFC rules (including the application of formulae for the calculation of “attributable CFC income” and of “attributed CFC income or loss”, and the rules for determining whether a CFC is a “non-attributing active CFC”) were set out clearly in one place in the legislation.

The provisions in the bill relating to CFCs are complex, and would be contained in a number of separate sections in the Income Tax Act. Our amendment is intended to make the CFC rules more accessible by providing clear guidance on where relevant rules can be found. We encourage the use of such “sign-posting” provisions in any legislation that proposes the introduction of a complex set of rules located in multiple provisions.

Exemptions from requirement to attribute (active business test)

We recommend some technical amendments to the accounting-based active business test for CFCs in proposed section EX 21E of the Income Tax Act (clause 123), to reduce the cost of applying the test. We note that accounting information would have to be adjusted before it could be used in the test proposed in the bill as introduced, and are concerned that such adjustments might not be straightforward in certain circumstances. In our view, if our recommended amendments were made, taxpayers would be able to make more use of unadjusted summary financial reporting information when applying the test.

We recommend amendments to sections EX 21C(9) and EX 21E(13) (clause 123) to ensure that taxpayers are able to rely upon detailed information taken from a financial report prepared in accordance with International Financial Reporting Standards (IFRS) or their equivalent (IFRSE) or Generally Accepted Accounting Principles (GAAP) as correct for the purposes of the accounting-based active income test. We recommend that an unqualified audit opinion be taken as evidence of compliance with the applicable accounting standards, unless there is a reasonable suspicion of fraud, intent to mislead, auditor incompetence, or lack of auditor independence. We also recommend that the accounting-based active business test be allowed to be used only for accounts that have received an unqualified audit opinion. The combined effect of these recommendations would be that taxpayers using the accounting-based active business test should normally be able to rely on accounting information that had been used to prepare audited financial reports. These recommendations are intended to reduce the compliance costs for taxpayers who use the accounting-based active business test, as they would not normally have to undertake detailed calculations to ensure that detailed information taken from the audited accounts indeed complied with the applicable accounting standards.

We recommend that an anti-avoidance rule be introduced and apply only to prevent taxpayers from manipulating the accounting-based active business test. We recommend that this rule apply only when an arrangement was entered into with a purpose, not merely incidental, of enabling a CFC to satisfy the accounting-based active business test (section EX 21E of the Income Tax Act (clause 123)). The proposed amendment reflects language linked (through the definition of “tax avoidance arrangement”) to the general anti-avoidance provisions in section BG 1 of the Income Tax Act. The amendment we propose is general and would capture, for example, situations where taxpayers use loans (or make financial arrangements) between related parties with different functional currencies to shelter passive income.

Consolidation in the active business test

Under proposed section EX 21D of the Income Tax Act (clause 123), taxpayers would be allowed to consolidate certain CFCs for the purpose of the tax-based active business test. In the bill as introduced, consolidation would be permitted only when the taxpayer had a voting interest of more than 50 percent in each of the CFCs that were to be consolidated. However, we consider that the term “income interest” would be more appropriate than “voting interest” in this context because it is income interest that gives rise to attribution of CFC income, not voting interest. We therefore recommend that, for the purpose of the tax-based active business test, consolidation be permitted only when the taxpayer has an income interest of more than 50 percent in each of the CFCs to be consolidated (section EX 21D of the Income Tax Act (clause 123)).

We recommend that proposed sections EX 21D(1)(a)(ii) and EX 21E(2)(b)(ii) of the Income Tax Act (clause 123) be removed. This amendment would ensure that consolidation for the purposes of the active business test would be allowed only for CFCs that were liable to tax in the same jurisdiction.

We also recommend amending proposed section EX 21D(1)(c) of the Income Tax Act (clause 123) to clarify that taxpayers would not be required to produce consolidated financial accounts in order to group CFCs for the purpose of the tax-based active business test.

Personal services income

We recommend amendments that provide that income from personal services which are not essential support for a product supplied by the CFC are attributed, but then disregarded for the purposes of the active business test (clauses 25, 66, 119, and 123). These amendments would ensure that entities that were set up to shelter personal services income earned by New Zealand residents from New Zealand taxation would always be subject to attribution on that income, but would still be able to qualify as a non-attributing active CFC in respect of their other income. We considered recommending that a CFC fail to pass the active business test if it received any income from personal services, but considered that the cost for businesses to comply with such a measure would be too great.

Currency rules for the active business test

We recommend that proposed section EX 21 of the Income Tax Act (clause 122) be amended so that the currency conversion rules in existing section EX 21(4) would also apply to section EX 21D. The effect of this recommendation would be that, for the purposes of the tax-based active business test, taxpayers would be given the option of calculating the gain in a foreign currency and converting it into New Zealand dollars in accordance with the rules applicable to section EX 21. In the bill as introduced, taxpayers would instead be required to use the functional currency of the CFC concerned, but we consider that more flexibility is desirable. This amendment would also reduce fiscal risk and ensure more consistency between the calculation of passive income in the tax-based active business test and in attribution of income.

Attributable income

Under the proposed rules, if a CFC failed the active business test, its passive income must be attributed to the New Zealand shareholders.

We recommend that a royalty payment received by an upper-tier CFC from a lower-tier CFC be treated as active income, as long as the royalty payment was derived from a non-related third party (section EX 20B(5)(d), clause 119). We acknowledge that there might be valid commercial reasons for using a CFC as a vehicle for repatriating the third-party royalty payments to the New Zealand resident company, for example, where a company had structured itself in such a way that its intellectual property was held in a separate subsidiary.

We recommend amending proposed sections EX 20B(5)(c), (7)(c), and (12)(a) of the Income Tax Act (clause 119) and the definition of “associated non-attributing active CFC” under proposed section YA 1 (clause 408). These amendments would allow an active CFC to pay royalties, interest, and rent to an associated CFC (such as a holding company) without the associated CFC having to recognise any passive income only if the CFC and the associated CFC were liable for tax in the same jurisdiction. This would prevent the possibility that income of an active business might not be taxed in any jurisdiction. For the same reason, we recommend amending proposed section EX 20B(7)(a) and paragraph (b) of the Income Tax Act (clause 119) to ensure that the exemption for rent from property in the CFC’s jurisdiction would be available only to CFCs that were liable to tax in the same jurisdiction.

We recommend amending proposed section EX 20B(3)(k) of the Income Tax Act (clause 119) to clarify the policy intent, which is that passive income should include income derived from the disposal of revenue account property held by a CFC that is used to derive attributable income.

We recommend amending proposed section EX 20B(3) so that income from the disposal of share options held on revenue account would be treated as an attributable CFC amount. We note that this would be consistent with the treatment of income from the disposal of shares held on revenue account, as provided for in proposed section EX 20B(3)(i).

Net attributable CFC income or loss

We recommend allowing a full deduction for the interest paid by a CFC for a loan that is on-lent to associated CFCs (clause 119). Without this amendment, the rules on interest expenditure incurred by CFCs (sections EX 20C to EX 20E) would mean that multinational companies controlled from New Zealand could be liable for more tax if they borrowed loans for the group and on-lent them to operating subsidiaries than if their operating subsidiaries borrowed directly.

We recommend amendments to the rules for excessively debt-funded CFCs in clause 119 (proposed sections EX 20D and EX 20E of the Income Tax Act), to reflect the policy intent of these provisions. It is intended that, when a CFC is excessively debt-funded, its interest deductions should be capped at the amount that would be determined by apportionment by reference to the assets of all the CFCs of the interest holder. Therefore, if a CFC with mainly attributable assets were excessively debt-funded, interest deductions would be limited by reference to the offshore asset mix of the group as a whole.

Interest allocation rules

In the bill as introduced, the proposed interest allocation rules have features intended to mitigate any adverse effects of the provisions on SMEs. For example, there is a minimum threshold of $250,000 for interest deductions, below which the interest allocation provisions would not apply (proposed section FE 5(1B)(b)(i) of the Income Tax Act, clause 158).

We recommend that the minimum threshold for interest deductions be raised to $1 million. We also recommend that the impact of the interest allocation rules be mitigated for firms that breach the 75-percent-debt-percentage safe harbour and have interest deductions of between $1 million and $2 million. These changes would be achieved by the proposed amendments to section FE 6 (clause 159). These extensions of the concessions are recommended as a result of discussions between our specialist advisers, the Inland Revenue Department, and accounting firms. We understand that they are designed to mitigate much of the adverse effect of the interest allocation provisions on SMEs as they expand overseas.

Foreign dividend exemption

We recommend that fixed-rate foreign dividends and deductible foreign dividends be treated as non-exempt dividends (clause 32), rather than as interest or financial arrangement income, as proposed in the bill as introduced. We consider that, if our recommendation is not adopted, compliance costs could be increased and existing commercial arrangements jeopardised.

Transitional and consequential matters

To reduce compliance costs and make the rules easier to apply, we recommend that the transitional rules for historical losses and historical foreign tax credits (clauses 220, 220B, and 253) be amended.

To reduce complexity, we recommend that there be no requirement for historical losses and historical foreign tax credits to be used first against non-attributable income or notional tax on such income. To reduce compliance costs, taxpayers would be allowed to elect to convert all historical losses and historical foreign tax credits into new losses and credits, using figures from the two preceding years, subject to certain constraints. Such an election would be irrevocable, would be made on a jurisdiction-by-jurisdiction basis, and would apply to all New Zealand companies in the same wholly-owned group.

At any time, a taxpayer would be allowed to elect not to carry forward historical losses and credits from a particular jurisdiction.

In addition, taxpayers would be able to use information from CFC accounts for the purposes of calculating the appropriate reduction in historical losses and credits, rather than being required to calculate the old measure of branch equivalent income for entities covered by the active income exemption. This would further reduce compliance costs.

Repeal of the grey list exemption

We support the repeal of the grey list exemption. We considered carefully whether this exemption should be retained, as on its face it is a simple and straightforward way of dealing with the passive income of CFCs. However, New Zealand and the eight grey-list countries all have different tax treatments for passive income. We are therefore concerned that, if the grey list exemption were retained, there would be a high risk of taxpayers using various structures or instruments to avoid tax on passive income. We do not consider it feasible for the Inland Revenue Department to allocate resources to keeping continuous watch on the tax arrangements of these other jurisdictions.

Regarding the repeal of the grey list exemption, we recommend only one minor amendment, to correct a drafting error in clause 425.

Taxation of life insurance business

This bill would introduce new rules for the taxation of life insurance business in New Zealand. These new rules are designed to tax life-risk business on actual profits in a manner similar to the way that other businesses are taxed, and extend the tax benefits of the PIE rules to all savers in life insurance products. Under the proposed new rules, life insurers would be taxed on two bases: a shareholder base (representing income derived for the benefit of shareholders), and a policyholder base (representing income derived for the benefit of policyholders).

We have considered issues arising from the proposed provisions for the taxation of life insurance business, such as the appropriateness of the application date, the allocation of life-insurance income and expenditure between shareholder and policyholder bases, the calculation of various reserves, the allocation of income in relation to participating policies, the use of actuarial concepts (particularly for the application of the premium smoothing reserve), and the coverage of the transitional rules. In view of these issues, we recommend a number of amendments to make the proposed provisions clearer and more flexible.

Bases of taxation

We recommend an amendment to section EY 20 of the Income Tax Act (clause 143) and the inclusion of new section DR 2 (clause 68) to clarify that all direct and indirect expenditure incurred by a life insurer would be deductible in the shareholder base. In our view, new section EY 20 as introduced could be taken to imply that some expenditure incurred by the life insurer but not directly incurred in relation to the gross income on the shareholder base might not be deductible. This would be contrary to the policy intent.

Reserves

We recommend amendments to proposed sections CR 4 and DW 4 of the Income Tax Act (clauses 29 and 79 respectively) to provide that, in relation to non-life insurance policies (such as insurance policies for disability income protection), life insurers are able to claim a deduction for movements in the outstanding claims reserve. Under the bill as introduced, life insurers could make such a deduction in relation to life insurance policies, and general insurers could also do so in relation to general insurance policies. Our recommended amendment would ensure consistent tax treatment of all life insurance and general insurance policies.

Transitional rules

We recommend amendments to ensure that, under section OA 7(1) of the Income Tax Act, where a life insurer has overpaid tax on the life office base under the existing rules, the overpayments would be carried into the new rules and could be used to satisfy tax liabilities arising on both shareholder and policyholder bases, whether or not there was a balance in the company’s imputation credit account. In particular, we recommend amendments to clause 225 to provide that the new rules would not apply to old credit balances; to clause 372 to ensure that policyholder credits would be brought forward correctly (as imputation credits) into the new rules; and to the transitional part-year rules contained in clause 140. In our view, it would be equitable to allow these overpayments to be used to satisfy both shareholder-base and policyholder-base tax liabilities. These amendments are also intended to address concerns raised by some members of the industry.

We recommend an amendment to clause 143 to ensure that the rules for the transitional tax treatment of term insurance products, as contained in section EY 30 of the Income Tax Act, apply to life insurance policies that are reinstated after the application date of the proposed life insurance provisions, provided that they were originally entered into before that date, had lapsed for no more than 90 days before their reinstatement, and the insurer concerned did not treat the reinstated policy as a new policy. We consider that such reinstated policies should not be treated differently from policies that were entered into before the application date of the proposed life insurance provisions and had never lapsed. In addition, we recommend an amendment to section EY 30 (clause 143) which provides that transitional rules would apply to master policies on a look through basis, as they apply to other policies.

General insurance and risk margins

The bill introduced amendments to clarify that general insurers could claim a tax deduction for movements in the outstanding claims reserves calculated under the New Zealand International Financial Reporting Standards (IFRS). We recommend further amendments to make the provisions in question clearer and more taxpayer-friendly.

We recommend amendments to clauses 29(2) and 79(2) to allow an insurer to opt not to apply the proposed provisions for movements in its general insurer’s outstanding claims reserve retrospectively from the 2009 income year. The bill as introduced does not provide such a choice. We were advised by the Inland Revenue Department that allowing these provisions to be applied retrospectively is intended to benefit the taxpayers, as they clarify that movement in reserves calculated for the purposes of IFRS could be deducted for tax purposes. However, we are concerned that applying these provisions retrospectively might not be taxpayer-friendly where a general insurer has filed income tax returns adopting a different approach for tax purposes than for accounting purposes. Therefore, we consider it desirable to allow taxpayers to choose whether to apply these provisions retrospectively.

Payroll giving

We recommend an amendment to clause 447 to make it clear that payroll donations would be held in trust for employees until those donations were transferred to the relevant recipient organisations. This amendment addresses our concern about the risk that employers might fail to transfer employees’ payroll donations for any reason. Our recommended amendment would give employees the right to claim compensation or redress from their employer for any payroll donations that had not been transferred.

Tax treatment of petroleum mining

The bill includes provisions to amend the tax treatment of petroleum mining. They seek to ensure that New Zealand receives its proper share of the benefits from New Zealand petroleum resources, and to remove disincentives to investment in oil and gas exploration and development in New Zealand. We recommend some amendments to clarify the new rules, such as an amendment to new section DT 1A(2) of the Income Tax Act in clause 71 to clarify that petroleum mining losses incurred through a foreign branch could be offset against petroleum mining income from any country other than New Zealand.

Issues not leading to amendments

We considered whether there should be any change to the law for offshore branch operations of petroleum mining companies, especially when such a change would compromise the operations of existing offshore branches. In the bill as introduced, the proposal to ring-fence foreign branch expenditure would apply only to expenditure incurred on or after 4 March 2008, so the tax treatment for expenditure incurred before that date would not be changed.

However, we understand that the proposal would affect the tax treatment of future foreign branch expenditure incurred pursuant to binding contracts entered into before 4 March 2008. While grandparenting provisions could be introduced to exempt such expenditure from the proposed tax rules, we were advised that this would not be desirable, as the fiscal costs involved could be very large since contracts for petroleum exploration are often open-ended.

We therefore recommend that the proposal to ring-fence foreign branch expenditure proceed without exempting future foreign branch expenditure incurred pursuant to binding contracts entered into before 4 March 2008. We note that some petroleum mining companies might have difficulty fulfilling their obligations under these binding contracts when this bill is enacted, but emphasise that this should be an issue only where expenditure is incurred pursuant to a binding contract entered into before 4 March 2008. The Inland Revenue Department has assured us that it intends to monitor this situation, and may consider recommending legislation in future to remedy any unintended consequences.

Tax pooling rules

The bill introduces changes that would extend the tax pooling regime to additional tax payable as a result of a reassessment for all types of tax. We recommend some amendments regarding access to funds in tax pooling accounts, the depositing of funds, the transfer of funds, interest on deposits, and the application date of the tax pooling provisions.

We recommend that proposed section RP 17B of the Income Tax Act in clause 405 be amended so that a taxpayer who owed additional tax as a result of the resolution of his or her dispute with the Commissioner of Inland Revenue could access funds from a tax pooling intermediary within 60 days of the date of the resolution. We believe this would provide sufficient time for taxpayers who initiated dispute proceedings against the Inland Revenue Department to make financial arrangements for any additional tax payable as a result of the resolution of their disputes.

We recommend amending new section RP 17B(1) of the Income Tax Act in clause 405 to reflect the extension of the tax pooling rules to reassessments of all taxes, and to enable any person, not just provisional taxpayers, to deposit money into a tax pooling account. We also recommend amending proposed section RB 17B(1) of the same Act to clarify that the amount held in a tax pooling account on behalf of a person might be refunded to the person, or used to satisfy the person’s liability for terminal tax, provisional tax, or an increased amount of tax resulting from a reassessment, voluntary disclosure, or the resolution of a dispute.

We recommend that clause 406 be amended to enable an intermediary to instigate the transfer of tax pooling funds between intermediaries when one of them starts or ceases its business. The clause as drafted would incur an unnecessary compliance cost because intermediaries would have to arrange for each taxpayer who had money invested in the pool to request separately a transfer to another intermediary. For clarification, we recommend that section 120 OE(1) of the Tax Administration Act 1994 be amended to specify that interest is payable on deposits in a tax pooling intermediary’s account from the date on which the deposits were made to the date on which the amount is refunded or transferred.

Issues not leading to amendments

We considered at length whether taxpayers should be allowed to access tax pooling funds to make tax payments, such as regular GST payments, other than provisional tax payments. We concluded that taxpayers should not be allowed to access tax pooling funds to make regular tax payments, where the amount of tax payable is certain. We consider that if tax pooling were allowed in these circumstances, the Crown would have to bear all the risk of taxpayers defaulting on tax payments. Under the tax pooling regime, if a taxpayer failed to pay the tax pooling intermediary concerned within a certain period, the intermediary would be entitled to withdraw from the tax pool the amount of tax payable on behalf of the taxpayer, and therefore would not bear the risk of the taxpayer’s default. The Inland Revenue Department would then have to begin recovery action for the overdue amount. In our view, it would not be prudent for the Government to carry all the risks of non-payment of tax.

Income tax treatment of emissions trading units

The bill contains provisions for the income tax treatment of transactions under the Emissions Trading Scheme, which was introduced by the Climate Change Response (Emissions Trading) Amendment Act 2008. We recommend some changes to improve the operation of these provisions.

Issues not leading to amendments

We considered whether the legislation should be amended to provide expressly for deductions for emissions liability accruals. We were advised that it is clear that a properly calculated amount for an emissions liability at the end of an income year is deductible, even when the requirement to surrender the relevant emissions units arises in a subsequent year. While we accept, on advice, that the legislation does not need to be amended to clarify this point, we believe it would be useful for the Inland Revenue Department to give taxpayers some guidance on deductibility for emissions liability accruals. We expect the Inland Revenue Department to issue guidance to taxpayers on this matter, and have received assurance that it will be addressed in a Tax Information Bulletin shortly after this bill is passed.

GST treatment of transactions relating to emissions units

We recommend deleting provisions regarding the GST treatment of transactions relating to emissions units (clause 524). These provisions have been superseded by the GST amendments introduced by the Climate Change Response (Emissions Trading) Amendment Act 2008.

GST treatment for non-Kyoto emissions units

We recommend that the existing zero-rating GST treatment of Kyoto emissions units be extended to include non-Kyoto emissions units with effect from 1 April 2010. We consider that it would be confusing to apply different GST treatments to different types of emissions units.

Non-disclosure right

We recommend amendments to clauses 437 to 441 to provide that the new provisions for non-disclosure rights would apply to current disputes that had not advanced to the first conference required under the High Court rules or the Taxation Review Authority regulations as at the date of Royal assent, as well as future disputes as provided for in the bill as introduced. We consider that, where a challenge has not yet advanced to conference stage, the non-disclosure right can be applied effectively, regardless of the date upon which the challenge was filed. We see no reason that the new non-disclosure right should not be applied in these conditions.

However, we consider it desirable for taxpayers to be subject to similar non-disclosure rights in similar circumstances. We therefore recommend amendments to clauses 437 to 441 to provide that the non-disclosure right will not apply to challenges that raise substantially similar issues already being considered by the courts.

Tax treatment of reimbursements and honoraria paid to volunteers

Proposed section CW 62B of the Income Tax Act in clause 39 provides that reimbursement payments that are based on actual expenses incurred by volunteers in undertaking voluntary activities will be treated as exempt income, if they are made separately from honoraria, which are treated as schedular payments subject to the PAYE rules.

We recommend amending proposed section CW 62B of the Income Tax Act (clause 39) to provide that, where a payer makes a combined payment of reimbursement and honorarium to a volunteer, the payer is not required to treat the whole payment as a schedular payment and withhold tax, as long as the payer can identify clearly which portion of the payment is honorarium and which portion is reimbursement. In this case, the portion of the payment that is reimbursement would be treated as exempt income, while the portion of the payment that is honorarium would be treated as a schedular payment and subject to withholding tax. The volunteer would have to include the honorarium in their tax return. We consider that this amendment would reduce the compliance costs for both the volunteers and the organisations that pay them, as it would allow organisations to arrange payments to volunteers more flexibly.

We recommend that the requirement for a “volunteer” to be a New Zealand resident, as defined in section CW 62B(4) of the Income Tax Act (clause 39), be removed.

We asked the Inland Revenue Department to clarify the tax status of people who are in New Zealand subject to the conditions of a temporary entry class visa. The department advised us that non-residents2 who earn New Zealand-sourced income are required to furnish a return of income for a tax year (sections 33A(2) and 33A(3) of the Tax Administration Act). At present, if a non-resident receives a reimbursement for voluntary services, the payment must be declared as income and the expenditure incurred claimed as a deduction. The amendment that we recommend would ensure that filing a tax return is no longer necessary in such circumstances, unless there is other income.

General recommendations regarding the bill

Special bulletin and Tax Information Bulletin

We consider it vital that tax law be clear and accessible for taxpayers, and considered whether further amendment for certainty and clarity would be desirable in particular areas of the bill. We were advised that, in some areas, it would not be possible to recommend amendments for clarity or certainty without posing a risk to the tax base.

We sought assurance from the Inland Revenue Department that it would provide clear guidance to taxpayers in these areas. The department assured us that it would publish a special report explaining some of the new rules introduced by this bill as soon as practicable after the bill is passed, and that this information would also be set out in a Tax Information Bulletin by the end of this year. The special report and the Tax Information Bulletin will be free and available on the department’s website.

We have asked the department to explain the following issues in the special report and upcoming bulletin as comprehensively as possible:

  • active income exemption for royalties

  • the interest allocation rules, particularly in relation to the measurement of debt and assets of associated persons

  • the non-prescriptive and voluntary nature of the payroll giving scheme

  • the donee organisation list for the administration of the payroll giving scheme

  • record-keeping requirements for payroll giving

  • the definition of “regularly engaged” in relation to the exemption for the development of intellectual property by a CFC

  • the definition of “linked to New Zealand” in relation to intellectual property acquired by a CFC

  • the definition of “person” in the context of partnerships

  • deductibility of emissions liability accruals

  • tax treatment of non-resident partners

  • process for correcting error in PAYE resulting from the extinguishment of the payroll giving tax credit

  • the application of the penalty and use-of-money interest rules to payroll giving

  • the new design costs rule for the research and development tax credits

  • corroborating material for the purposes of claiming overpaid tax on past allowances

We encourage the Inland Revenue Department to publish this explanatory material as quickly as possible, and expect the material to include working examples to demonstrate the operation of the new rules wherever possible.

Review of the PIE rules rewrite

We note that the bill would make remedial amendments to the tax rules for PIEs to ensure that they reflect the intended policy. It also rewrites the PIE rules in the plain-language drafting style that has been adopted for other parts of the Income Tax Act. As most of the amendments in the bill are technical in nature, we do not make any comment on them, but comment only on the general application date of the rewritten PIE rules.

However, we are concerned that unintended consequences could result from this rewrite of the PIE provisions. Such consequences occurred when most of the income tax legislation was rewritten in plain-language drafting style in the Income Tax Act. As a result, the Rewrite Advisory Panel was given the tasks of considering submissions on the unintended legislative changes, and recommending amendments to remedy them. We recommend that the panel be given the same tasks in relation to the PIE provisions contained in this bill.

Inland Revenue Department website

We note that the payroll giving scheme requires donations to be given to donee organisations. When we tested the accessibility of information about donee organisations, we were disappointed that this information did not appear to be readily available or easily accessible to the public.

We understand that changes are to be made to the Inland Revenue Department’s website to make this information more accessible. We encourage the department to complete this work as soon as possible, and to communicate the changes to employers and employees. We would like to see information on these changes also set out in the special report and the Tax Information Bulletin that the department has assured us it will be publishing regarding this bill.

Appendix

Committee process

The Taxation (International Taxation, Life Insurance, and Remedial Matters) Bill was referred to the previous committee on 6 August 2008. The closing date for submissions was 15 January 2009. We received and considered 78 submissions from interested groups and individuals. We heard 51 submissions.

We received advice from the Inland Revenue Department, the Treasury, our independent specialist adviser on tax issues, Therese Turner (Chartered Accountant), and an independent specialist adviser on legislative drafting, David McLay (Barrister). We would like to extend our thanks to all who provided assistance to us in our considerations on this bill.

Committee membership

Craig Foss (Chairperson)

Amy Adams

David Bennett

John Boscawen

Brendon Burns

Hon David Cunliffe

Raymond Huo

Rahui Katene

Peseta Sam Lotu-Iiga

Stuart Nash

Dr Russel Norman

Chris Tremain

Key to symbols used in reprinted bill

As reported from a select committee

text inserted unanimously

text deleted unanimously


  • 1  A controlled foreign company is a foreign company controlled by New Zealand residents.

  • 2  For tax purposes, a non-resident is a person who stays in New Zealand for 183 days or fewer in any 12-month period.