Commentary on parts of the act - A to B
Commentary on parts A to B of the Income Tax Act 2007.
The broad purpose of the Income Tax Act 2007 is to define and impose tax on net income, to impose obligations concerning tax and to set out rules for the calculation and satisfaction of those obligations (section AA 1).
Section AA 2 reinforces the legislative principles of the Interpretation Act 1999 by highlighting how readers' aids to interpretation are to be used.
Section AA 3(1) has been omitted, as defining "this Act" to include the Tax Administration Act 1994 is no longer necessary. The drafting approach taken in the rewritten Act is to state clearly when the Tax Administration Act is being referred to.
Section AA 3(2) identifies the relationship of the Income Tax Act with the Interpretation Act, with particular reference to the defined term "person" in the Interpretation Act.
The Income Tax Act now provides that it applies to the Crown (section AA 4) to provide a better relationship with Part 4 of the Interpretation Act. Explicitly or not, the Income Tax Act has always applied to the Crown, as shown, for example, by the exemption given for government agencies in section CW 38 (Public authorities).
The scheme and purpose of Part B remains the same as in the 2004 Act - to impose income tax and other tax obligations and to set out how those obligations must be satisfied. As the core provisions are intended as an enduring framework, it is not expected that these rules will be altered in the future, unless fundamental changes are made to the policy underlying the scheme, its purpose and structure.
Overall, little substantive change has been made to the core provisions. However, some structural changes have been made to improve the relationship of the core provisions to Part I (Treatment of tax losses), Part L (Tax credits and other credits), and Part R (General collection rules).
Changes to the following core provisions have been made in rewriting Parts F to N of the 2004 Act:
- section BB 2(3) has been moved to section RA 4 (Provisional tax obligations);
- section BC 4(4) has been moved to subpart IA (sections IA 2 and IA 3);
- sections BC 8 and BC 10 have been moved to subpart LA (sections LA 4, LA 5 and LA 7);
- section BC 6(2) to (4) has been omitted as the restructuring of the tax credit rules means these particular rules are no longer necessary;
- a clear linkage has been made between section RB 3 and section BC 7 (relating to schedular income); and
- section BC 9 has been renumbered as section BC 8 in the 2007 Act, and explicit linkages developed between that provision in subpart LA (sections LA 2 to LA 5, LA 9, and LA 10).
While Part B was rewritten in the 2004 Act, it is useful to restate the scheme and purpose of Part B at this time. This enables readers to see the relationship of the various Parts of the Act to the core provisions and Part B in particular.
The overall purpose of the core provisions is to establish:
- a statutory scheme for the calculation and satisfaction of taxation obligations; and
- the structural relationships of the core provisions.
Subpart BB sets out the obligations that the 2007 Act requires a person to satisfy. Any of these obligations may be modified by the general anti-avoidance rule (section BG 1) and New Zealand's obligations under its double tax agreements (section BH 1).
The main obligations listed in section BB 2 are:
- the calculation and satisfaction of the income tax liability for each tax year (section BB 2(1) and subpart BC);
- the calculation and payment of provisional tax for a tax year (section BB 2(3) and the provisional tax rules);
- the calculation and satisfaction of withholding liabilities (section BB 2(4) and subpart BE); and
- the calculation and satisfaction of a variety of other taxes and payments (section BB 2(5) and subpart BF).
There is no intended change in outcome associated with the minor drafting improvements to sections BB 2(5) and BF 1. A new term "ancillary tax" has been introduced as a consequence of rewriting the definition of "income tax", to draw attention to the types of tax obligations imposed under the core provisions through the previous definition of "income tax".
Sections BB 3, BG 1 and BH 1 continue to provide an override for:
- the general anti-avoidance rule in sections BG 1 and GA 1; and
- bilateral relief under a double tax agreement entered into by New Zealand.
Subpart BC is linked to sections BB 1 and BB 2 through its subject matter. Subpart BC sets out the detailed process that must be followed to meet the obligation to calculate and pay income tax for a tax year.
The concept of "schedular income" in section BC 7 takes on greater importance as some provisions in Part H (Taxation of certain entities) provide for a scheme-based approach to the calculation of an entity's income tax liability, rather than using the core provisions' global gross approach. An example is the rules relating to portfolio tax rate entities.
Unless a person is a non-filing taxpayer, this process contains a series of steps involving the calculation of net income, taxable income and the income tax liability for a tax year. A non-filing taxpayer's income tax liability for a tax year is, in general, determined by amounts of tax withheld at source.
To apply subpart BC (the calculation of the income tax liability for a tax year), a person must know the core concepts of annual gross income and annual total deduction.
These core concepts are defined in sections BC 2 and BC 3 respectively. The concept of "corresponding income year" ensures that the core provisions align the calculation of the income tax liability for a tax year to the tax balance date of the taxpayer. The tax balance date may be either the standard date (31 March) or an early or late balance date.
"Annual gross income for a tax year" is a global concept. Section BC 2 defines it as the "aggregate of all assessable income from all sources that is derived in or allocated to the corresponding income year". The concepts of "assessable income" and "allocation" are explained further in subpart BD.
"Annual total deduction for a tax year" is also a global concept, and section BC 3 defines it as the "aggregate of all deductions that are incurred in or allocated to the corresponding income year". The concepts of "deduction and allocation" are explained further in subpart BD.
Section BC 4 now reflects the wide range of uses to which a net loss may be put.
Sections BC 6 to BC 10 of the 2004 Act provide a framework for determining the income tax liability of a person and how the Act uses tax credits to satisfy this liability. As this framework has been more closely integrated with the detailed tax credit rules in Parts L and M, these core provisions have been simplified and harmonised with Part L. As a result, sections BC 6 to BC 8 and subpart LA now cover the same subject matter as sections BC 6 to BC 10 of the 2004 Act.
The rewrite of Parts F to N of the 2004 Act highlights the importance of the concepts of "schedular income" and "schedular income tax liability" in section BC 7 as part of the framework of the core provisions. These two terms provide a framework for:
- classes of income with unique tax rates or a final liability - for example, non-resident withholding income subject to final withholding; and
- an entity-based calculation of the entity's income tax liability for a tax year - for example, portfolio tax rate entities in subpart HL (Portfolio investment entities).
The intention is that the more specific rules will state how the schedular rule relates to section BC 7. For example, section RB 3 (Schedular income tax liability for filing taxpayers for non-resident passive income) states that, for the purpose of section BC 7, the schedular income tax liability for a person with schedular non-resident passive income subject to final withholding is determined under section RB 3 and not under the rules in sections BC 1 to BC 6.
The flowcharts in the core provisions have also been updated to highlight the interaction of Part L with the core provisions in section BC 8.
Subpart BD has an important role to supplement the operation of subpart BC, as it explains the core concepts of assessable income, deduction, and allocation. It also defines the extent of New Zealand's income tax base.
The concept of "assessable income" is a calculated amount, and is defined in section BD 1. Assessable income is a person's income that remains after excluding any part of that income that comprises exempt income, excluded income or non-residents' foreign-sourced income. An amount of assessable income may be spread or allocated across more than one tax year.
To use this concept, the reader also needs to know the meaning of "income", "exempt income", "excluded income" and "non-residents' foreign-sourced" income.
The concept of "income" is described in section BD 1. This definition is supported by all of the provisions in Part C through the explicit linkage in section BD 1(1). That section identifies that Part C is a code in relation to its role of determining whether an amount arising from a transaction or event is income.
Gains and profits that are not treated as income under Part C are not subject to income tax. Examples of this category are capital profits and windfall gains.
The only exclusions from income are found in subsections BD 1(2) (exempt income), (3) (excluded income) and (4) (non-residents' foreign-sourced income). These subsections represent a series of exclusions from what is income under section BD 1(1).
After applying these restrictions, the amount (or apportioned amount) that arises from a transaction is termed "assessable income". Assessable income under section BD 1(5) represents the amount of income that is included in the determination of a person's income tax liability for a tax year, subject to any allocation of that income between different tax years. This amount may be allocated across more than one tax year.
The category of exempt income (section BD 1(2)) is reserved for amounts of income that Parliament determines should not be subject to income tax. An example of exempt income is found in section CW 41 (Charities: non-business income).
Falling within the concept of "excluded income" (section BD 1(3)) are amounts of income that are not included in income because they are generally subject to tax in another way.
For example, life insurance premiums derived by a life insurer (and reinsurers) are treated as excluded income (section CX 39). The exclusion arises because the life insurance rules in subpart EY separate the income (underwriting) and savings elements of those premiums and include the underwriting elements in income.
Non-residents' foreign-sourced income
This category of income establishes the role that the source of income and a person's residence play in determining whether an amount of income is subject to taxation in New Zealand (section BD 1(4)). It also enables New Zealand to identify what deductions a non=resident may or may not be entitled to.Source and residence
The concepts of "source and residence" are fundamental to determining the scope of New Zealand's income tax base. This is achieved through the operation of section BD 1.
Section BD 1(1) defines the subject matter by reference to the amounts listed as income in Part C. As explained later in this article, the concept of income under Part C does not depend on the concepts of time, residence or source.
Section BD 1(5) provides that the concept of "assessable income" does not include income derived by a non-resident that is not treated as being derived from New Zealand at the time that person is non-resident. The overall effect of section BD 1(1) gives the following outcomes:
- Income that a resident of New Zealand derives from anywhere in the world is treated as assessable income, provided that income is neither exempt nor excluded income (section BD 1(2) or (3)).
- Income that a non-resident derives from New Zealand is treated as assessable income, provided that income is neither exempt nor excluded income (section BD 1(2) or (3)).
- Income that a non-resident derives from sources outside New Zealand falls within non-residents' foreign-sourced income and is not assessable income (section BD 1(4)).
Allocation of income (timing)
Section BD 3 explains the basis on which the legislation allocates income to a particular income year. In this context, the term "income year" was chosen because allocation applies to both the standard (31 March) and non-standard tax balance dates.
The general rule is that the Act allocates income to an income year on the basis of when it was derived or credited in the account of a person, or dealt with in their interest or on their behalf. Common law principles are also to be taken into account when considering the sometimes divergent tax accounting results that arise between business and cash-basis taxpayers (section BD 3(3)).
It is important to note that the allocation made is of the income, not just the assessable income. Therefore, the method of allocating an amount of income applies also to any part of that income that is exempt income, excluded income, non-residents' foreign-sourced income and assessable income. Allocation of the income on a consistent basis for all categories of income is necessary because of the nexus tests under the general permission which link deductibility with assessable income (section DA 1).
For example, an amount of income derived by a non-resident may be apportioned between non-residents' foreign-sourced income and assessable income. The allocation of both the non-residents' foreign-sourced income and assessable income across income years will be proportionate to how the income is apportioned.
Assuming that deductions in deriving income are allowed under the general permission, this allocation of income can be expected to influence the amount of deduction allowed in each tax year.
The general rule may be overridden by any rule that allocates the income on another basis.
Sections BD 2 and BD 4 explain the core concept of deduction and the timing of a deduction.
The concept of "deduction" in section BD 2 is a key link or signpost between the core provisions in subpart BC and the operative rules found in subpart DA (previously located in section BD 2 of the 2004 Act). This relocation reflects the intention that all deductions should be located in one Part.
Section BD 2 identifies that Part D is a code for determining whether an amount arising from a transaction or event is a deduction. This means that a person may not have a deduction unless it is listed in Part D - see, for example, section HF 1(2) (Profits of mutual associations in respect of transactions with members) of the 2004 Act.
Allocation of deduction (timing)
A deduction is always allocated to an income year (section BD 4). Again, the term "income year" is used to signal the application of the allocation provisions to persons with non-standard tax balance dates.
The general rule is that a deduction is allocated to an income year on the basis of when it was incurred. Again, common law principles must be taken into account when considering any possible divergent treatment that exists in tax accounting between business and cash-basis taxpayers.
This general rule of allocation may be overridden by any rule that allocates the deduction on another basis.
Section BB 2(3) imposes the obligation to pay provisional tax. It also points to the details of the provisional tax rules in subpart RC which set out the process for calculating and paying provisional tax.
Sections BB 2(4) and BE 1 continue to provide the obligation to comply with various tax payment systems such as PAYE, RWT, NRWT, FBT, ESCT and FDP.
Section BE 1 also provides a link to the detailed provisions that a person needs to know in order to comply with these obligations.
Ancillary tax obligations
An ancillary tax is defined in section YA 1, as being any of ESCT, FBT, FDP, FDP penalty tax, further FDP, further income tax, imputation penalty tax, NRWT, PAYE, penalty tax for a Maori authority payable under section 140DB of the Tax Administration Act 1994, provisional tax, qualifying company election tax, RWT and withdrawal tax.