Commentary on parts of the act - H to L
Commentary on parts H to L of the Income Tax Act 2007.
Part H - Taxation of certain entities
Part H of the Income Tax Act 2004 contains groups of rules that modify the calculation of taxable income for a tax year for certain persons and entities.
Qualifying companies and loss-attributing qualifying companies (LAQCs) are dealt with in subpart HA.
Most of the trust rules are set out in subpart HC. These rules describe the taxation of distributions from trusts and the taxation of undistributed income derived by trustees. Trusts are classified as complying trusts, foreign trusts, and non-complying trusts.
The agency rules are set out in subpart HD. They describe the circumstances in which a person is treated as an agent for another person in relation to the other person's tax obligations for income tax and tax administration purposes.
Subpart HE sets out the rules that apply to transactions between a mutual association and its members. These rules describe the income tax treatment of income derived by a mutual association and also of distributions to members.
The rules for Maori authorities are contained in subpart HF. These rules set out the taxation treatment for income derived by a Maori authority and distributions made from these authorities. The relationship with other Maori authority rules is also identified, for example, in relation to tax credits, memorandum accounts, refunds, tax rates and administrative rules.
Subpart HL sets out the rules applying to portfolio tax rate entities. Subpart HR contains rules for a variety of entities, such as partnerships, joint ventures, group investment funds, the Government Superannuation Fund and airport operators.
Drafting improvements in Part H
The requirements that a company must meet to become and to continue as a qualifying company have been moved to subpart HA, primarily to sections HA 5 and HA6. Distributions from a qualifying company are treated either as fully imputed dividends or as exempt income. This effect is reflected in section CW 15.
The reference to "transitional capital amount" in section HG 13(1)(a)(i) of the 2004 Act has been removed. This reference is redundant as it related to unexpired 10-year bonus issues, which terminated in 1998.
Section HG 9(3) of the 2004 Act placed a restriction on the amount of deduction that a person is allowed for interest incurred. This restriction is now moved to section DB 9 as a limitation on the deduction.
Section HA 24(4), which rewrites sections HG 16(1) and HG 17(1)(a) of the 2004 Act, clarifies that the time at which the shareholder incurs an attributed loss from a loss-attributing qualifying company is subject to the balance date rule in section HA 26.
The defined terms "qualifying trust" and "non-qualifying trust" have been replaced with the terms "complying trust" and "non-complying trust" to reflect the underlying policy. The word "qualifying" is not very meaningful and has been omitted.
Section HC 2 (Obligations of joint trustees for calculating income and providing returns) also draws into subpart HC the rule from section HD 1 of the 2004 Act relating to the taxation obligations of trustees. This rule also makes it clear that the core provisions are to be read as if co-trustees were a single person. Each of the trustees is jointly and severally liable to satisfy the obligations imposed under section BB 2.
The definition of "beneficiary income" in section HC6 omits paragraphs (a)(iii) and (iv) of the definition in section OB 1 of the 2004 Act as they are no longer necessary.
The defined terms "distribution", "settlor" and "settlement" rely on the defined term "transfer of value". The drafting approach provides a general rule with specific exclusions, rather than producing a list of inclusions that extend a general term.
The 2004 Act definition of "distribution" is very extensive, with paragraph (a) applying to every vesting in interest in a beneficiary of property of a trust, any payment of property to a beneficiary of a trust, or the application for the benefit of a beneficiary of any property of a trust. In addition, this general concept is extended in paragraph (b) of the old definition to include transfers of property and service transactions between a trustee and beneficiary when the transfer value adopted benefits the beneficiary.
A number of provisions in the trust rules treat an amount derived as one of the categories of income of a person. Anumber of new provisions have been included in Part C, along with appropriate cross-referencing in subpart HC, to provide structural consistency with the core provisions. For example:
- Section HH 1(9) (which applies when a unit trust that is a superannuation scheme becomes a superannuation fund) is included in the dividend rules as section CD 12, with a cross-reference in section HC 1(5).
- The income aspects of sections HH 1(7), HH 3(1), HH 3(3), HH 3(5A) and HH 8 of the 2004 Act have been relocated to subpart CV (Income specific to certain entities).
- The "excluded income" provisions in sections HH 3(4), and HH 3A to HH 3F are now located in subpart CX (Excluded income). For example, a cross-reference from section HC 19 helps the reader identify its relationship with section CX 59 (Taxable distributions from non-complying trusts).
- Exempt income provisions in the 2004 Act have been moved to subpart CW (Exempt income).
Section CW 53 (Distributions from complying trusts) rewrites the rule in section HH 3(5) of the 2004 Act as "exempt income". This provision is necessary because a distribution from a trust (not being beneficiary income) could otherwise be treated as income for tax purposes. An example of a distribution to which this rule would apply is the payment of a pension from a superannuation fund.
Drafting this rule as an exempt income provision reveals the structural relationship of the rule to the deduction rules. By treating these distributions as exempt income, the beneficiary may not have a deduction for expenditure incurred in deriving a distribution from a superannuation fund. No change in outcome is intended.
Trustees and settlors are treated as tax agents for some purposes, and the obligations they are to comply with are more clearly signalled in the agency provisions in subpart HD.
Section HC 25 (Foreign-sourced amounts: non-resident trustees) is linked to section BD 1(4) and (5) in the core provisions, clarifying that section HC 25 overrides a core concept of the Act: taxation on the basis of both source and residence. This link is an illustration of the underlying theme of Part H, which is to modify the operation of Parts B to E in relation to a certain type of person or entity.
The main drafting improvement in subpart HD (Agents)isthe signposting of general tax agency obligations that a person declared to be an agent must satisfy. This signposting occurs in sections HD 3, HD 8 and HD 18. The rewritten provisions also draw together other agency provisions that are located in other parts of the 2004 Act.
Sections HF 1(1) and HF 1(5) of the 2004 Act relating to income derived by, respectively, a mutual association and a member of a mutual association, have been relocated to sections CB 33 and CB 34 respectively. This is signalled at the beginning of subpart HE.
Section HF 1(2) of the 2004 Act has been relocated to subpart DV (Expenditure specific to certain entities), again to provide structural consistency in the Act for the treatment of deductions.
The concept of "charitable trust" is defined for the purposes of the trust rules in section HH 1 of the 2004 Act. As this definition is virtually the same as the concept of "charitable trust" used in subpart CW, the
two terms have been rationalised. It is not necessary to retain a separate definition of "charitable trust" for the trust rules.
Intended change in Part H
Section HC 34(2) - Taxable distributions from non-complying trusts
Section HH 3(1) of the 2004 Act treats taxable distributions from a non-complying trust as a special
class of income that is not included in the beneficiary's annual return of income. These distributions are derived from trust funds when the trustees have not complied with their New Zealand tax obligations.
A taxable distribution of this nature is subject to a special tax rate, but the rules do not expressly contain a due date for payment of that tax. The current practice is to require payment of this tax by the terminal tax date of the person liable for the tax on the distribution. Section HC 34(2) makes this clear.
Part I - Treatment of tax losses
Part I contains the loss rules. Since these rules were first introduced, many additions have been made to them, including ring-fenced losses for mining, and for CFC and FIF holdings. Over time, the Act has also extended the way in which a tax loss is used for purposes other than as an offset against the net income for a future tax year. The new subpart IA (General rules for tax losses) now provides clear links to the core provisions, as well as signposts to specific rules setting out the different ways in which a tax loss may be used.
The Part is structured to ensure that persons with tax losses carried forward must first use those losses by subtracting them from their net income for the tax year before they can make use of the variety of elective uses for tax losses. New terms central to these rules are "tax loss component", "tax loss", and "loss balance".
Subpart IA is a key part of the restructured Part I. Thissubpart also contains the general rules for carrying forward a tax loss, which are located in subparts IE and IFof the 2004 Act.
Subparts IC to IE deal with the main company-related loss rules. The loss grouping rules for companies are in subpart IC. Subpart ID sets out how the loss grouping rules are applied to a consolidated group of companies. The loss rules that apply to companies in certain amalgamations are set out in subpart IE.
The rules in subpart IP set out how losses may be used when the general loss rules and loss grouping rules are breached part-way through an income year. A breach of these rules occurs through a loss of continuity or commonality.
Subparts IQ to IT deal with how ring-fenced tax losses may be used. These losses include attributed CFC net losses, FIF net losses, mining and petroleum mining net losses, and life insurance policyholder net losses. Subpart IV contains the rules restricting the amount of a tax loss that a supplementary dividend holding company may use. Subpart IW sets out the circumstances in which a tax loss may be used to satisfy shortfall penalties.
Drafting improvements in Part I
Subpart IA now identifies those tax loss components that have specific restrictions on their use as "ring-fenced tax losses". The tax loss components treated as "ring-fenced tax losses" are as follows:
- a net loss for a tax year of an LAQC (use determined under sections HA 24 to HA 27);
- a life insurer's policyholder net loss under section EY 43(10) (use determined under section IT 1);
- excess expenditure of investment funds (use determined under sections DV 5(4) and DV 7(2));
- an attributed CFC net loss under section DN 4(3) (use determined under subpart IQ);
- a FIF net loss under sections DN 8(3) and DN 9(3) (use determined under subpart IQ);
- the net loss of a mining company, a resident mining operator and a non-resident mining operator when it relates to mining activities (use determined under subpart IS);
- a net loss of a petroleum mining company if it relates to mining activities before the 1990-91 tax year (use determined under sections IS 5, IZ 2 and IZ 3);
- an amount remitted as a condition of a new start grant under sections CX 48 or EW 46; and
- a net loss of a portfolio tax rate entity (use determined under section HL 23).
Section IA 10 (Amended assessments) clarifies the effect on a person's tax loss, loss balance and tax loss components when the Commissioner makes an adjustment to the amount of a tax loss component for a tax year under section 113 of the Tax Administration Act 1994.
Intended change in Part I
Section IA 4(1) - Tax losses
The relationship between the tax loss carry-forward and the grouping rules was previously unclear. Under the 2004 Act, a potential ambiguity existed about whether losses carried forward by a person should be applied to the person's own net income before the grouping rules could be applied.
The policy intention is that, when a person is allowed to carry forward a "loss balance", they must first use the "loss balance" to offset against their own net income (subject to the restrictions on "ring-fenced tax losses").
New section IA 4 (Using loss balances carried forward to tax year) clarifies that a person who carries forward tax losses from one tax year to the next tax year must first use the carried-forward loss balance to reduce net income for that next tax year. It also clarifies that a person can apply the elective loss rules only to losses carried forward from the previous tax year if the balance of carried-forward tax losses exceeds the net income of the current tax year.
Part L - Tax credits and other credit
The rewritten Part L contains the rules relating to tax credits that may be used to satisfy a person's income tax liability, and includes the core tax credit rules that were placed in sections BC 8, BC 9 and BC 10 of the 2004 Act. Part L also lists most of the rebates that were located in Part K of the 2004 Act, other than the family income assistance scheme (now the Working for Families or WFF tax credit) and the KiwiSaver tax credit.
Under the rewritten Part L, a person who has received a tax credit during a tax year includes the total amount of their credits in the assessment of their income tax liability and terminal tax for that year. However, the tax credits for housekeeping and for a payment of a charitable or public benefit gift may not be used to satisfy a person's income tax liability, as these continue to be paid separately under section 41A of the Tax Administration Act 1994.
Subpart LA contains the general rules relating to the use of tax credits and includes aspects of the rules contained in sections BC 8 to BC 10 of the 2004 Act. In particular, subpart LA identifies when a tax credit arises, and sets out how the Act applies a tax credit to satisfy a person's obligations under section BB 2. It also sets out how WFF tax credits are used.
The provisions describing the amount and time at which a person has a tax credit for PAYE, provisional tax, RWT, NRWT, for families, and for caregivers are listed in subpart LB.
The tax credit rules relating to amounts that were rebates in subpart KC of the 2004 Act are now in subpart LC (Tax credits for natural persons). This subpart describes the amount and when a person can use the tax credit, as well as the adjustment rules for part-year residency and change in balance date.
Tax credits for donations or "charitable or public benefit gifts" are dealt with in subpart LD. The use of imputation credits as a tax credit is dealt with in subpart LE, and the use of FDP credits for tax credit purposes is set out in subpart LF.
Subpart LJ contains the rules that determine the tax credit a New Zealand resident can use for foreign taxes paid on income sourced outside New Zealand. These rules more clearly identify the segmental approach to the calculation of the maximum tax credit for income from a particular source or of a particular nature.
Subpart LK contains rules covering a variety of tax credits, including tax credits relating to attributed CFC income, consolidated companies and companies that have amalgamated.
The underlying foreign tax credit rules are set out in subpart LL. Subpart LO sets out when Maori authority tax credits arise and when they can be used. Subparts LP and LQ contain the tax credit rules for supplementary dividends and conduit relief. Policyholder tax credits for life insurers are dealt with in subpart LR.
Subpart LS contains the rules for the tax credits relating to certain zero-rated or exiting investors for their investment through a portfolio tax rate entity. It also contains the rules for the tax credit payable to a portfolio investor tax rate entity for the entity's positive rate investors.
Intended changes in Part L
Sections LA 1 to LA 10 - Tax credits
The rewritten Parts K and L consolidate the concepts of "rebate" and "tax credit". The rationalisation of these terms and restructuring of these rules gives rise to a minor adjustment in the use of rebates and tax credits.
The 2004 Act takes an inconsistent approach to the time at which tax credits arise and the tax year in which those tax credits are used to satisfy an obligation under the Act, particularly in a business context. The restructuring of the tax credit rules achieves a matching of the income year in which the tax credits arise to the corresponding tax year. This change overcomes timing problems inherent in some of the tax credit rules and better reflects the policy intention behind the rules.
This change relates to the time at which a tax credit may be used to satisfy an income tax liability. The rule applies only if a person has a tax credit. It does not apply if a tax credit is anticipated but not received.
For example, section LB 3 (which rewrites section LD3(2) of the 2004 Act) allows a person a tax credit "equal to the amount of tax withheld and paid in relation to the person's resident passive income for the tax year". Under section LD 3(2), the person was allowed a tax credit for all RWT paid in relation to the resident passive income derived during the tax year. This change ensures that only the part of the tax credit that relates to income included in the return of income for the tax year is included in a person's "total tax credit".
However, the clarification does not apply to tax credits that arise under subparts KC (Individual rebates) or KD (Tax credits for family support and family plus) of the 2004 Act, as these credits can only arise and be used in relation to a tax year.
Section LC 9(2) - Apportionment for housekeeper and low-income tax credit
An apportionment is necessary to determine the amount of entitlement to these credits when a person is absent from New Zealand during a tax year. The policy is to apportion the tax credit on the basis of absence or presence in New Zealand.
In the 2004 Act, two methods applied, with a weekly basis of apportionment applying to persons having regular pay periods and a daily basis to all other persons. The 2007 Act simplifies the apportionment calculation by providing one method - the daily basis - for all situations.