Profit distribution plans

The tax treatment of profit distribution plans has been amended from 1 Oct 2012 so that bonus shares issued under a PDP are treated as a dividend for tax purposes.

Sections CD 7, CD 7B, CD 8, CD 23B, CD 43, RE 14, RE 15, RF 10 and YA 1 (definition of "bonus issue", "profit distribution plan", "taxable bonus issue") of the Income Tax Act 2007

A profit distribution plan (PDP) is a scheme offered by companies whereby the company advises all its shareholders that they will be issued with bonus shares on a particular date. The shareholders are asked if they would like to have the company repurchase those bonus shares immediately after the shareholder receives them. If the shareholder does not elect to have some or all of their bonus shares repurchased, the default option is for the shareholder to retain the bonus shares.

The tax treatment of PDPs has been amended so that bonus shares issued under a PDP are treated as a dividend for tax purposes. These changes were necessary to ensure that the tax treatment of PDPs is consistent with the current policy around imputation credit streaming and the taxation of bonus issues.

Background

Under the previous tax treatment, the bonus issue of shares under a PDP were treated as a non-taxable bonus issue meaning that if a shareholder retained the bonus shares they were not subject to tax. However, if the shareholder elected to have the bonus shares repurchased by the company, the repurchase proceeds were treated as a taxable dividend. Imputation credits could be attached to the cash dividend by the company and used to credit the tax payable by the shareholder.

The previous tax treatment of PDPs was the subject of a specific Inland Revenue product ruling in 2005 (BR PRD 05/08). The ruling held that a distribution of shares under a PDP is treated as a non-taxable bonus issue and consequently does not constitute a dividend in the hands of the shareholder. The ruling was made subject to certain conditions, including that the company making the bonus issue had sufficient credits in its imputation credit account to have fully imputed a cash dividend equal to the bonus issue not redeemed for cash.

After this product ruling, the tax treatment of PDPs was further reviewed and in 2009 the Government announced its intention to amend the tax treatment of PDPs. Later that year, officials released an issues paper, The taxation of distributions from profit distribution plans, for public consultation.

In 2009 the Capital Market Development Taskforce specifically considered the tax treatment of PDPs and made the following recommendation:

  • The Taskforce considers it important that the tax system treats substitutable transactions neutrally. If PDPs are substitutable for ordinary dividend payments with optional reinvestment, the tax treatment should ideally be identical in both cases. The same goes for other close substitutes. Otherwise, there is a danger that investment decisions will be biased towards companies that offer PDPs, and that there could be significant loss of tax revenue from normal dividend taxation.

    At the same time, the Taskforce considers it desirable that the tax system does not impede the supply of capital. A decision on the tax treatment of PDPs should, therefore, take into account the fact that PDPs are an effective way for companies to raise capital.

    Recommendation: We recommend that changes to the tax treatment of PDPs should be made as part of a broader review of tax settings and take into account any adverse impacts on capital-raising costs.

In 2011 Inland Revenue officials consulted seven interested parties on draft legislation based on the proposal to treat distributions from a PDP as a taxable bonus issue in lieu.

Detailed analysis

Several amendments have been made to achieve the policy intent. The key amendments are as follows.

Taxation of bonus shares

New section CD 7B treats as a dividend bonus shares issued under PDPs. The amount of the dividend is the amount offered by the company for the repurchase of the shares.

Repurchase of shares under a PDP

New section CD 23B is intended to prevent cash amounts under a PDP from being taxed twice. If a shareholder elects for their bonus shares to be repurchased under a PDP, section CD 23B ensures that the repurchase proceeds are not taxable under the ordinary dividend rules. That is, it is only the bonus issue under a PDP that is the taxable event.

For clarification, there are a few points to note:

  • Section CD 23B is not intended to apply to on market repurchases. This section is only intended to apply to shares that are repurchased under PDPs and not to share repurchases generally.
  • Section CD 22 is not intended to apply to section CD 23B. Section CD 22 generally applies when a company pays an amount to shareholders, other than on liquidation, because of the off->market cancellation of shares in the company. This section allows the available subscribed capital of the company (which is generally equal to the amount paid to the company to subscribe for its shares) to be returned to shareholders tax-free if certain criteria are met. New section CD 7B states that section CD 22 does not apply in relation to a share issued under a PDP and repurchased by the company under that plan. If section CD 22 applied to new section CD 23B this could potentially result in double taxation; first when the company issues the bonus shares under a PDP, and secondly when the off-market share cancellation takes place.
  • If shares are repurchased by the company outside of the PDP scheme, the ordinary tax rules regarding share repurchases will apply.

Application date

The application date of the changes is 1 October 2012.