Transitionals, consequentials and repeals
2009 provisions dealing with transitional and consequential matters resulting from new rules for CFC income and foreign dividends.
Sections EX 22, GZ 2, IQ 2B, LK 5B, LQ 1 to LQ 4, RG, OC 4, OC 5, OC 6, OC 8, OC 9, OC 10, OC 30 to OC 34, OD 4 to OD 8, OD 11, OD 23, OE 12 to OE, 16B, OP 56, OP 61, OP 62 and OP 105 to OP 108B of the Income Tax Act 2007
Provision has been made to deal with various transitional and consequential matters arising from the new rules for CFC income and foreign dividends. The changes are discussed below.
CFC net losses and foreign tax credits
Sections IQ 2B and LK 5B set out transitional rules to deal with attributed CFC net losses and foreign tax credits. In broad terms, the effect of these rules is that attributed CFC net losses and foreign tax credits accrued under the old rules can be carried forward into the new system, but will continue to be reduced by reference to total CFC net income (including non-attributable income).
Repeal of foreign dividend payments
Subpart RG has been repealed to remove the liability for resident companies to pay foreign dividend payments on dividends they receive from foreign companies.
Sections OC 4, OC 5, and OC 30 to OC 34 have been amended to replace "further FDP" with "further income tax".
Sections OC 6, OC 8, OC 9, OC 10, OP 56, OP 61 and OP 62 have been repealed to prevent new FDP credits from being generated.
Branch equivalent tax accounts
Sections OE 12 to OE 16 and OP 105 to OP 108 have been repealed to prevent branch equivalent tax accounts (BETA) debit balances from increasing under the new rules.
Sections OE 16B and OP 108B provide a BETA debit to extinguish any existing BETA credit balances as BETA credits are no longer required to relieve FDP once FDP has been repealed.
Repeal of the grey list exemption for CFCs
The exemption for CFCs resident in eight grey list countries available under the previous rules has been replaced with an exemption for a CFC resident in Australia. This is achieved by a modification to section EX 22.
Repeal of conduit tax relief
Sections LQ 1 to LQ 4 have been repealed to prevent further conduit tax relief (CTR) arising.
Section OD 4(3) has been amended so that a CTR company that elects to cease being a CTR company stops being a CTR company the day after the election is made (rather than at the beginning of the next tax year).
Sections OD 5 and OD 8 have been repealed to prevent new conduit tax relief credits from arising from conduit tax relief on attributed income or dividends.
Section OD 11 has been repealed as this square-up is obsolete now that FDP is no longer paid when a CTR credit is generated.
Section OD 23 has been repealed to remove the tax liability that can arise from CTR debits. In other words, CTR credits will cease to be a contingent liability unless the anti-avoidance rule in section GZ 2 applies.
Section GZ 2 claws back conduit tax relief from conduit arrangements that previously provided a tax benefit to New Zealand-resident shareholders (aside from the CTR company or a CTR holding company for that company).
Transitional loss carry-forward rules
A net loss incurred by a CFC is attributed to holders of non-portfolio income interests under subpart DN. FIF losses are likewise attributed to interest holders under subpart DN. A person may set an attributed CFC loss or a FIF loss from a given jurisdiction against attributed CFC income or branch equivalent FIF income from the same jurisdiction. Any excess becomes an attributed CFC net loss or a FIF net loss, which may be carried forward and used against future profits. Losses attributed from CFCs and branch equivalent FIFs are ring-fenced by jurisdiction, which means that a loss which arose in a given jurisdiction may only be set against CFC income or branch equivalent FIF income from the same jurisdiction.
Transitional rules are needed to deal with attributed CFC net losses and FIF net losses carried forward from the previous rules. This is because the measure of attributable income against which those losses can be set is narrower than that which applied at the time the losses accrued. The value of these historical losses should therefore be restricted under the new rules. This is achieved through section IQ 2B.
Subsection (1) provides that the amount of attributed CFC net loss or FIF net loss from a jurisdiction that a person has carried forward from the previous rules is the person's available BE loss for that jurisdiction. Subsection (2) provides that each year, some or all of this available BE loss is converted into an equivalent CFC loss, which is effectively an ordinary attributed CFC net loss under the new rules. The amount of available BE loss converted each year is the converted BE loss.
The amount of losses converted each year, and the rate of conversion, is determined under subsections (4) to (7). Separate calculations are required for each relevant jurisdiction. The rate of conversion depends on the relationship between a person's jurisdictional attributed income and the person's jurisdictional BE income. These terms are defined in subsection (9). The key difference is that jurisdictional attributed income only includes income from CFCs which is attributed under the new rules, whereas jurisdictional BE income includes the full branch equivalent income from CFCs that would have been attributable under the old rules. (Full branch equivalent FIF income is included under both terms.)
Subsection (4) deals with the typical scenario, in which a person's jurisdictional BE income is greater than jurisdictional attributed income. In that case, the converted BE loss is equal to the person's jurisdictional BE income (or to the available BE loss if this is lower). The equivalent CFC loss is equal to the person's jurisdictional attributed income (or the amount calculated under paragraph (b)(ii) if this is lower). What this means in practice is illustrated by the following example.
Subsection (5) deals with the less common situation in which jurisdictional attributed income exceeds jurisdictional BE income. In that case, the equivalent CFC loss is equal to the converted BE loss (giving $1 of historical loss an effective value of $1). The available BE loss to be converted is the amount needed to offset the person's jurisdictional attributed income for the year, assuming there are sufficient losses available.
Subsections (6) and (7) make equivalent provision for interest holders who are members of wholly owned groups that include other resident members. For a member of a wholly owned group, the conversion of historical losses to an equivalent CFC loss is done by reference to the jurisdictional income ratio of the group.
A person or a wholly owned group may elect, under subsection (8), to fix the jurisdictional income ratio using the average ratios over a two-year period, provided they had jurisdictional BE income in each of those years. A person may also elect, under subsection (3), not to carry forward historical losses from a given jurisdiction.
To minimise compliance costs, subsection (10) allows a person or a wholly owned group to use the net profit or loss from financial accounts as a proxy for the branch equivalent income or loss of a CFC for the purposes of calculating their jurisdictional BE income.
Transitional rules for foreign tax credits
Subpart LK makes provision for tax credits relating to attributed CFC income. A person who has attributed CFC income for an income year is allowed a tax credit for income tax and foreign income tax paid in relation to that income by the person or by the CFC. Surplus credits may be carried forward or transferred within the same wholly owned group, subject in both cases to jurisdictional ring-fencing. The tax credit rules for CFCs in subpart LK are applied to branch equivalent FIFs by section EX 50(8) and (9).
Equivalent transitional issues arise for subpart LK credits carried forward from under the previous rules as losses. These credits are therefore subject to similar restrictions, in this case under section LK 5B.
Subsection (1) provides that the credit relating to a jurisdiction carried forward from under the previous rules is the available BE credit for that jurisdiction. Subsection (2) provides that each year, some or all of this available BE credit is converted into an equivalent tax credit, and is effectively treated as an ordinary credit under subpart LK. The amount of available BE credit converted each year is the converted BE credit.
The credits converted each year, and the rate of conversion, is determined under subsections (4) to (7). The approach is the same as that taken for losses under section IQ 2B. An election to fix the jurisdictional income ratio using the average ratios over a two-year period under section IQ 2B(8) will also apply for the purposes of this section.
As for losses, a person may elect not to carry forward historical credits from a given jurisdiction (subsection (3)). Likewise, there is the same scope for a person to use net profit or losses from accounts, instead of BE income or loss, when determining the jurisdictional BE income (subsection (10)).
Repeal of foreign dividend payments
As a result of the exemption for most foreign dividends received by companies, foreign dividend payments (FDP) have been repealed and foreign dividend payment accounts will be gradually phased out.
Subpart RG has been repealed to remove the liability for resident companies to pay foreign dividend payments on dividends that they receive from foreign companies. As a result, most foreign dividends received by companies will be wholly exempt, but in some cases, income tax will be payable (see the section on "foreign dividend exemption" for details and examples).
If a company had an FDP debit at the end of the tax year (section OC 30) or when it migrates offshore (section OC 31) "further FDP" was payable under the previous rules. Under the new rules, this liability has been replaced with a liability to pay further income tax. Consistent with this change, section 140B of the Tax Administration Act has been amended so that imputation penalty tax is payable when further income tax is payable under section OC 30.
Several sections in subpart OC that give rise to FDP credits have been repealed as these sections are redundant with the repeal of the FDP liability in section RG. The repealed provisions are: section OC 6, which provided an FDP credit for FDP being paid, sections OC 8 and OC 10, which provided FDP credits when FDP was payable as a result of a CTR debit or CTR debit balance, and section OC 9, which allowed companies to convert any imputation credits earned on attributable foreign income into FDP credits. The repeal of section OC 6 only applies to dividends received after the new international tax rules came into force.
Companies will have five years to distribute their existing FDP credit balances to shareholders before any remaining balances are converted into imputation credits. This will be legislated for as part of a subsequent tax bill.
Branch equivalent tax accounts
The exemption for most foreign dividends received by companies means that branch equivalent tax accounts (BETA) for companies will be phased out. As income tax will continue to apply to foreign dividends received by non-companies, BETA accounts will be retained for non-companies.
Companies with BETA debit balances will be able to continue to use these debits to relieve any double taxation on attributed income for a two-year period. Any remaining BETA debits will then be extinguished. This will be legislated for as part of a subsequent tax bill.
The transitional period for BETA debits is intended only to prevent double taxation in the rare cases in which dividends have been paid significantly in advance of attributed passive income arising.
Repeal of the grey list exemption for CFCs
Taxpayers with a greater than 10 percent interest in a CFC that is resident in a grey list country will have to calculate their attributable CFC amount from the CFC unless it qualifies as a non-attributing active CFC under section EX 21B or is a non-attributing Australian CFC under section EX 22B.
The eight-country grey list for 10 percent or greater interests in FIFs in section EX 35 will be retained for the time being, while the possibility of extending the active income exemption to these entities is considered.
Repeal of conduit tax relief
Under the new rules, no further conduit tax relief will arise under the conduit mechanism. The conduit mechanism removes income tax on income that a New Zealand company receives from its CFC interests to the extent that the New Zealand company is owned by non-residents.
Section OD 23 has been repealed to remove the tax liability that can arise from CTR debits. In other words, CTR credits will cease to be a contingent liability. An exception to this is if the anti-avoidance rule in section GZ 2 is found to apply.
Section GZ 2 is intended to claw back conduit tax relief from arrangements that were entered into in anticipation of the repeal of section OD 23 that had the effect of reducing the tax liabilities of New Zealand shareholders. This reflects the fact that conduit tax relief was designed to relieve tax on non-residents investing through New Zealand into CFCs. Conduit tax relief was not intended to apply to income that was ultimately owned by New Zealand residents. Section GZ 2 applies to arrangements that generated conduit tax relief credits between 4 December 2008 (when an issues paper announcing this policy was released) and the date from which conduit tax relief was repealed. Section GZ 2 does not apply to conduit tax relief received by the conduit tax relief company itself, or by a CTR holding company for the CTR company.
CTR companies will be able to continue to attach CTR credits to any dividends they distribute to their non-resident shareholders, for a period of two years. This provides time for conduit-relieved income (represented by CTR credits) to be channelled to non-residents and any CFC income on which New Zealand tax has been paid (represented by FDP credits) to be channelled to New Zealand residents.
CTR companies that do not wish to distribute their foreign income in this way, can, under the new rules, elect to cease to be a CTR company under section OD 4 and have their CTR credits extinguished with no liability. Subsection OD 4(3) has been amended to make it so this election will take effect from the day after the election was made as this allows companies to convert FDP credits into imputation credits (under the previous rules, these companies would have had to wait until the next tax year before the election took effect).
Another option is for CTR companies to simply retain their CTR credits for the two-year transitional period, after which these credits will be extinguished with no tax liability.
The legislation for this final repeal of CTR accounts will be introduced as part of a subsequent tax bill.