Resident withholding tax rates on interest income

Section RE 12(5) and schedule 1, part D, tables 2 and 3 of the Income Tax Act 2007; sections 25A and 33A of the Tax Administration Act 1994

Resident withholding tax (RWT) rates on interest income have been aligned with recent changes to the company and individual income tax rates.

Background

RWT is a withholding tax based on the marginal tax rate of the recipient of interest income. Its purpose is to ensure that tax is paid at source on that income at a rate that closely approximates the recipient's marginal tax rate. Compliance and administrative costs are therefore minimised as recipients are less likely to request a personal tax summary or file a tax return if tax is withheld at the correct rate.

Previously the RWT rates were: 19.5%, 33% and 38% or 39%, which aligned with the former income tax rates. The default RWT rate where a person had provided a tax file number but had not elected a rate was 19.5%.

The legislation introduces new RWT rates to reflect recent changes to the company and individual tax rates.

Key features

Schedule 1, part D, tables 2 and 3 of the Income Tax Act 2007 introduces the following new RWT rates:

The amendments also allow Inland Revenue to instruct interest payers to change a person's RWT rate if the person's rate is inconsistent with their marginal tax rate.

Application dates

The changes generally apply from 1 April 2010.

The 30% RWT rate for companies applies from 1 April 2011 but is optional for interest payers from 1 April 2010.

Detailed analysis

Default rate

A new 21% RWT rate applies for those who were previously on the 19.5% default rate. Previously, the default rate of RWT that applied if the recipient of interest (not a company) did not elect a rate was 19.5%.

Consequently, row 5 of schedule 1, part D, table 2 provides that anyone who was on the 19.5% RWT rate before 1 April 2010 (either by default or by election) will have their rate changed to 21% from that date.

For people who open a new account with an interest payer after 31 March 2010 but do not elect a rate, row 2 of schedule 1, part D, table 2 introduces a new 38% default rate. This is to encourage people to elect the rate that aligns with their marginal tax rate.

Non-declaration rate

A new 38% rate applies from 1 April 2010 to persons who do not supply their tax file number to their interest payer. This new non-declaration rate aligns with the new highest marginal tax rate.

The 38% rate in row 1 of schedule 1, part D, table 2 therefore replaces the previous 39% RWT rate that applied before 1 April 2010 to those taxpayers who did not supply their tax file number to their interest payer.

New 12.5% rate

Row 7 of schedule 1, part D, table 2 introduces a new 12.5% RWT rate. A person may elect the 12.5% rate only if they have a reasonable expectation at the time of election that their income for the income year will be $14,000 or less and they provide their tax file number to their interest payer.

The 12.5% rate is not available to trustees other than those who receive interest as the trustee of a testamentary trust to which section HC 37 applies. Trustees of a testamentary trust do not need to satisfy a "reasonable expectation" test regarding their income but do need to provide their tax file number to their interest payer.

38% RWT rate

If a person has previously elected the 39% rate, it is intended that their interest payer will shift the person to the new 38% RWT rate from 1 April 2010.

Consequently, the 39% rate has been removed from table 2 and replaced with the 38% rate, in line with the reduction in the highest marginal tax rate.

RWT rates for companies (section RE 12(5) and schedule 1, part D, table 3)

Section RE 12(5) introduces an optional 30% RWT rate for interest paid to a company which may be applied for the 2010-11 income year.

Specifically, an interest payer may choose to apply an RWT rate of 30% if interest is paid to a company or a portfolio investment entity (PIE) in the income year when the RWT rate would have otherwise been 33%. The provision does not apply to companies that are trustees or Māori authorities, the rates for which are set out in schedule 1, part D, table 2.

The 33% RWT rate has been replaced in schedule 1, part D, table 3 by a 30% RWT rate from 1 April 2011. The 30% rate applies to companies that are not trustees or Māori authorities and which previously elected the 33% rate before 1 April 2011. The 30% rate also applies to companies that have supplied their tax file number but which did not elect a rate

For PIEs that are trusts, the 30% rate may be applied under section RE 12(5) for the 1 April 2010-11 income year and will apply from 1 April 2011 under schedule 1, part D, table 3.

Additionally, in schedule 1, part D, table 3, the 39% RWT rate has been replaced by a 38% rate, which also applies from 1 April 2010 for companies that elected a 39% rate before that date.

Inland Revenue may instruct interest payers to change an inconsistent RWT rate (section 25A of the Tax Administration Act 1994)

New section 25A adopts a similar approach to that used by Inland Revenue in relation to secondary tax codes, where it may instruct employers to use a particular PAYE tax code for an individual taxpayer.

Accordingly, if Inland Revenue considers that a person receiving interest income is on an RWT rate (whether by election or by default) that is inconsistent with their marginal tax rate, it may instruct the interest payer to change the person's RWT rate and provide the appropriate rate. The rate provided by Inland Revenue must be used by the interest payer as soon as reasonably practicable after the date that they are notified.

The interest recipient may subsequently elect a different rate, in which case the interest payer must use that rate. However, Inland Revenue may instruct the interest payer to change the person's rate the next year.