Taxation of outbound dividends
2009 changes to the taxation of dividends paid to non-residents, affecting the supplementary dividend regime and the non-resident withholding tax (NRWT) rules.
Subpart IV and sections LP 1, LP 2, LP 7 to LP 10, RF 9, RF 11B and YA 1 of the Income Tax Act 2007
New rules have been introduced for dividends paid by New Zealand companies to non-resident shareholders.
Various changes have been made to the rules concerning the taxation of dividends paid to non-residents. These changes affect the supplementary dividend regime and the non-resident withholding tax (NRWT) rules.
Tax treaties signed with Australia, Singapore and the United States in 2008 and 2009 provided the catalyst for these domestic law changes. The new treaties reduce the rate of New Zealand tax that can be imposed on non-portfolio dividends paid to non-residents from 15% to either 5% or zero, depending on the size of the shareholder's stake in the company paying the dividend, and certain other criteria. There is no zero rate under the Singapore treaty.
The supplementary dividend rules in subpart LP have been amended. From 1 February 2010, credits will no longer be available for supplementary dividends paid to non-residents in respect of non-portfolio interests in New Zealand companies, nor if the rate of tax applicable to the dividend is less than 15%.
Effective from the same date, a zero rate of NRWT has been introduced for non-portfolio dividends paid to non-residents, and for other outbound dividends for which the applicable rate of tax would otherwise be less than 15%. This zero rate applies to the extent the dividends are imputed.
From 1 April 2011, credits under subpart LP will cease to be available for distributions to supplementary dividend holding companies. Provisions supporting the supplementary dividend holding company regime are fully repealed for the 2013-14 and later income years.
Various application dates are relevant to these changes. These are outlined above and discussed in more detail below.
Changes to the supplementary dividend rules
The rules concerning credits for supplementary dividends are set out in subpart LP. Section LP 2 provides that, when a resident company pays a dividend and a related supplementary dividend to either a non-resident or a supplementary dividend holding company, it qualifies for a tax credit calculated under the formula in subsection (2).
Distributions to non-residents
Section LP 2(1)(a) deals with distributions to non-residents. It has been amended so that a credit is only available for a dividend and related supplementary dividend paid by a company to a non-resident if the non-resident has less than a 10% direct voting interest in the company and the rate of tax applicable to the dividend is 15% or more. This change applies from 1 February 2010.
The requirement in section LP 2(1)(a)(ii) that the rate of tax payable on the dividend must be at least 15% will ensure that credits under this subpart are also unavailable for dividends and related supplementary dividends paid to non-resident portfolio investors if a lower rate of tax applies. For example, under Article 10(4) of the new double tax agreement with Australia, dividends paid on portfolio interests held by a Contracting State, political subdivision or local authority will be exempt from source taxation.
Distributions to supplementary dividend holding companies
Section LP 2(1)(b) deals with distributions to supplementary dividend holding companies. It has been repealed, along with subpart IV, sections LP 1(2), LP 2(4) to (6) and sections LP 7 to LP 10, which make further provision for such holding companies. Consequential amendments have been made to sections LP 2(2) and YA 1.
The repeal of section LP 2(1)(b) applies from 1 April 2011, as do the related repeals of sections LP 1(2), LP 2(5) and (6), and the amendments to sections LP 2(2) and YA 1. It will therefore be possible to continue to claim credits for dividends and supplementary dividends paid to holding companies for a limited period after these credits cease to be available for distributions to non-residents.
This delayed application allows time for distributions to be paid up through a chain of holding companies and on to non-resident investors. It is intended to deal with the possibility that a lower-tier holding company has already received a dividend and a supplementary dividend before 1 February 2010 without having made a corresponding distribution by that date. Delaying the repeal of section LP 2(1)(b) and related provisions ensures that a higher-tier holding company can continue to receive supplementary dividends and correspondingly adjusted imputation credits, and therefore have a tax liability against which to claim a credit under subpart LP when making a distribution to a portfolio investor.
Note that, under section YA 1, a supplementary dividend holding company must have an ongoing purpose of enabling the payment of a supplementary dividend to a non-resident. Supplementary dividends will not be payable to non-residents for non-portfolio holdings after 1 February 2010. Accordingly, we would not expect supplementary dividend holding companies to be maintained beyond 1 February 2010, except when it is necessary to enable payment of supplementary dividends to non-resident portfolio investors. Holding company structures typically involve non-portfolio interests.
Other provisions relating to supplementary dividend holding companies will be left in place until they are no longer required. Accordingly, the repeal of subpart IV, section LP 2(4), and sections LP 7 to LP 10, and the related amendment to section YA 1, do not apply until the 2013-14 income year.
Remedial amendment to section LP 8(2)
The formula in section LP 8(2) has been amended, with effect for the 2008-09 and later income years (up to repeal). This corrects an unintended change made when the Income Tax Act 2007 replaced its predecessor.
The formula in section LP 8(2) specifies how the taxable income of a holding company is to be determined. Before its amendment, the section specified a lower amount of taxable income - and therefore liability to tax - than was needed to allow the holding company to use in full the credit it became entitled to when it paid a supplementary dividend. Under the Income Tax Act 2004, the missing income was brought into account by section LE 3(8), which provided that a supplementary dividend received by the holding company was not exempt income under section CW 10.
Section LE 3(6) of the Income Tax Act 2004 specified the amount of a dividend that was to be treated as exempt income (if any), while section LE 3(8) provided that the supplementary dividend was not exempt income. The Income Tax Act 2007 takes a different approach, with section LP 8(2) simply prescribing the amount of taxable income a holding company derives. It is therefore appropriate to correct the formula in section LP 8(2), rather than resurrect section LE 3(8) of the Income Tax Act 2004.
Changes to the NRWT rules
NRWT is imposed under subpart RF. New section RF 11B has been introduced, with a consequential amendment to section RF 9. These changes apply from 1 February 2010.
The effect of these amendments is to apply a zero rate of NRWT to dividends paid by a company to a non-resident that either has a direct voting interest in the company of 10% or more or (section RF 11B aside) would be subject to tax on the dividend at a rate below 15%. The zero rate applies to the extent the dividend is imputed, with this to be determined under section RF 9.
New section RF 11B is the corollary to the amendments to section LP 2 discussed above. If a dividend paid to a non-resident is outside the scope of section LP 2(1)(a) (as amended), either because it relates to a direct voting interest of 10% or more, or because it is taxed at a rate below 15%, then, to the extent the dividend is imputed, it becomes eligible for a zero rate of NRWT under subpart RF.