2010 Act restricts the use of debit balances in branch equivalent tax accounts to the extent that those balances arose from conduit tax relief.

The recently enacted Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010 restricts the use of debit balances in branch equivalent tax accounts to the extent that those balances arose from conduit tax relief. A taxpayer may elect to use debit balances to satisfy income tax liabilities that relate to attributed CFC income. However, the Act restricts use to cases in which the attributed CFC income arose in an income year beginning before 1 July 2009 and there is a timely election.

Background

Old international tax rules (BETA and conduit mechanisms)

Under the old international tax rules (replaced in the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009), a New Zealand taxpayer with an interest in a controlled foreign company was subject to two potential taxing events: firstly, when income was earned by the foreign company (tax on attribution); and secondly, when that income was repatriated to New Zealand by way of a dividend (tax on dividends). The purpose of the branch equivalent tax account (BETA) mechanism was to relieve this double taxation and ensure that, overall, a single layer of New Zealand tax was imposed on that income.

Normally a New Zealand company paid tax on attribution before dividends were paid. In this case, the company received BETA credits that it could use to offset subsequent tax on dividends. In the rarer event that dividends were paid before tax on attribution, say because of an interim dividend, the company received BETA debits which it could use to reduce the subsequent tax on attribution.

The conduit tax relief regime sat alongside the rules for BETAs. Under the conduit regime, New Zealand companies with non-resident shareholders were able to claim "conduit relief" from tax on controlled foreign company income. This meant that, to the extent of the non-resident shareholding, no tax was payable on either attribution or on dividends. That is, not only was there no double taxation, but (to the extent of the non-resident shareholding) no taxation at all.

However, BETA debits and credits were still generated in respect of income and dividends that had been conduit-relieved - as if tax had been paid. Accordingly, if a dividend was paid before the income was attributed, conduit tax relief would be provided on the dividend and a BETA debit would also be created. The BETA debit would then be used to relieve any tax when the income was attributed. This was done to avoid double counting of the amount of conduit relief (recorded as conduit credits). Such double counting of conduit credits would have been unfair to taxpayers if the number of New Zealand shareholders increased and a repayment of a portion of the conduit relief was required.

Transition to new international tax rules

The transition to the new international tax rules required decisions about how to dismantle the various memorandum accounts, including the BETA credit and debit accounts and the conduit credit accounts.

In the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009, the government introduced changes to the international tax rules that made BETA accounts for companies unnecessary in respect of foreign income that was earned under the new rules. In general, foreign dividends are now not taxable and so double taxation no longer occurs.

However, the government recognised there was a situation in which some double taxation could still occur if:

  • repatriated funds had been subject to tax on dividends prior to the changes; and
  • the income from which the funds were repatriated was subject to tax on attribution after the changes.

For this reason, the government announced that it would not cancel BETA debit balances for a period of two years.

Cancellation of some debit balances

It is apparent that the relief provided by non-cancellation of BETA debit balances is only required if tax was paid on the dividend that generated the BETA debits. If conduit tax relief was used to reduce or eliminate the tax liability, there is no possibility of double taxation and it is not appropriate to retain the BETA debits.

The Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010 therefore restricts the use of BETA debit balances to the extent that they arose from conduit tax relief on foreign dividends.

Key features

New sections OE 11B and OP 104B restrict the use of BETA debit balances that arise from conduit tax relief on foreign dividends.

The restriction is achieved by not allowing the relevant part of a BETA debit balance to be used to relieve tax on income attributed under the new international tax rules.

This approach allows taxpayers to continue, for a period of up to one income year, to use their BETA debit balances - whether or not resulting from the use of conduit tax relief - to offset tax that arose under the old international tax rules. The period of up to one income year is subject to restrictions to prevent manipulation of the new provision (essentially, to ensure the right amount of debits arising from both conduit-relieved and non-conduit-relieved dividends are used against pre-reform tax liabilities).

In contrast, outright cancellation of the relevant part of a BETA debit balance on entry into the new international tax rules would have resulted in simpler legislation, but would not have allowed continued use of debit balances against pre-reform tax liabilities. It was for this reason that outright cancellation was not pursued as an option.

Detailed analysis

Structure of cancellation rules (sections OE 11B and OP 104B)

If a company has a BETA debit balance on entry into the new international tax rules or at a later date, it must apply the restriction on use of BETA debit balances.

To apply the restriction, the company firstly identifies the individual BETA debits that make up the beta debit balance at a particular time. This is done with the aid of an ordering rule (subsection (3)).

Then, to the extent that the identified debits arose from the use of conduit tax relief to reduce an FDP (foreign dividend withholding payment) liability, they form part of the "CTR-relief amount" at that time (paragraph (1)(b)).

In general, the CTR-relief amount is not able to be applied to reduce tax on attributed foreign income. However, there is an exception (subsection (2)). For a defined period, the CTR-relief amount may be applied to reduce tax on attributed foreign income that arose under the old international tax rules. The exception is subject to limitations to prevent manipulation.

Rules for ordinary BETA accounts (section OE 11B)

Definition of affected year (subsection OE 11B(1))
An "affected year" is an income year in which the taxpayer applies the new international tax rules. The first "affected year" is the first income year beginning on or after 1 July 2009 (see the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009).

Definition of CTR-relief amount (subsection OE 11B(1))
Paragraph (b) defines the "CTR-relief amount". At any particular time, this amount is a portion of a debit balance that exists in the BETA account of a BETA company.

The CTR-relief amount is determined by identifying the BETA debits that have arisen to create the debit balance. This is determined with the aid of an ordering rule (see the explanation of subsection (3) below).

Once the BETA debits that created the debit balance have been identified, they are classified. To the extent that each debit arose from a conduit-relieved liability to pay FDP on a foreign dividend, it is part of the CTR-relief amount. Conversely, to the extent that each debit did not arise from a conduit-relieved liability, it is not part of the CTR-relief amount. Sections OE 12 and RG 7 (or the corresponding sections in the Income Tax Act 2004) are the sections that would have applied in the case of such a conduit-relieved liability. Note that sections OE 12 and RG 7 have since been repealed.

Example 1: Calculating the CTR-relief amount

NZCo, a standard balance date company which has always been 70% New Zealand owned, received foreign dividends on 30 September 2007, 21 May 2008 and 30 September 2009. FDP was payable on these dividends (liabilities of $1.2 million, $1.5 million and $0.7 million respectively). NZCo claimed conduit tax relief to the extent it was able and paid the rest of the FDP at the time dividends were received. NZCo had tax liabilities for attributed CFC income of $1.8 million in the 2007-08 income year, $0.5 million in the 2008-09 income year and $0.2 million in the 2009-10 income year. The company used all available debit balances to relieve tax on attributed foreign income. No foreign tax credits were available because no foreign tax was paid.

BETA account

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend   1.2m -1.2m 1
21/5/08 Dividend   1.5m -2.7m 2
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend   0.7m -1.6m 3
28/3/10 File tax return (attr. income) 0.5m   -1.1m  
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES
30/3/11 File tax return (attr. income) 0.2m   -0.9m  

On 1 April 2010, the debit balance included $0.4 million of debit number 2, being the remainder after application of BETA credits for use of BETA debit balances. The debit balance also includes $0.7 million of debit number 3. In each case, 30% of the debit arose from the application of conduit tax relief. Therefore, the CTR-relief amount on 1 April 2010 is $0.33 million (being 0.4 x 30% + 0.7 x 30%). On 31 March 2011, following another BETA credit, the CTR-relief amount is $0.27 million (0.2 x 30% + 0.7 x 30%).

Restrictions on use of CTR-relief amount (subsection OE 11B(2)).
A BETA company has historically been able to make an election to use all or part of a BETA debit balance to satisfy a liability for tax on attributed foreign income (subsection OE 7(3)).

Section OE 11B(2) restricts this election. The CTR-relief amount may not be used to satisfy a liability except in strictly defined circumstances, effectively reducing the available debit balance in all other cases to:

  • total debit balance - CTR-relief amount

More than "total debit balance - CTR-relief amount" may be used to satisfy a liability only if four conditions are met.

  • The first condition is that all the conditions of section OE 7 are satisfied (this is implicit).
  • The second condition is that the liability relates to attributed CFC income that arose under the old international tax rules. More precisely, the liability must relate to attributed CFC income that is allocated to an income year that begins before the first affected year (as defined in subsection (1)). Allocation of attributed CFC income to a particular year is determined according to the existing rules in subpart BD.
  • The third condition is that when the election is made under OE 7, it must be made before any election under section OE 7 that is in respect of post-reform CFC income. More precisely, suppose that an election is made to use part of a BETA debit balance to offset the tax liability on attributed CFC income that is allocated to the first affected year, or to a later income year. Then, at or after the time of that election, it is not possible to make an election to use the CTR-relief amount.
  • The fourth condition is that the election made under OE 7 must be made before the end of the first affected year.

The third and fourth conditions prevent manipulation of the rule. This is in response to a concern that by making elections out of order, a company could manipulate the CTR-relief amount. In normal circumstances (filing occurring on time, elections made at time of filing) these conditions are unlikely to be an obstacle.

 

Example 2: Use of the CTR-relief amount (all conditions met)

BETA account from Example 1.

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend   1.2m -1.2m 1
21/5/08 Dividend   1.5m -2.7m 2
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend   0.7m -1.6m 3
28/3/10 File tax return (attr. income) 0.5m   -1.1m  
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES
30/3/11 File tax return (attr. income) 0.2m   -0.9m  

The CTR-relief amount on 29/3/11 is $0.33m and the total debit balance is $1.1m. The company makes an election on 30/3/11 to use 0.2m of its BETA debit balance to offset the tax liability on attributed CFC income that it has allocated to the 2009-10 income year. The election is in respect of income that arose under the old international tax rules and is made before any election that is in respect of post-reform income. The election is also made just before the end of the first affected (2010-11 income) year. All conditions of (2) are met, so the election is permitted. It reduces the total debit balance to $0.9m and the CTR-relief amount to $0.27m.

For the 2010-11 income year, the company has a tax liability relating to attributed CFC income of $0.8m. It files an income tax return for the 2010-11 year on 29/3/12 and makes an election to use available debit balances to offset the $0.8m liability. Because the election is in respect of a tax liability on attributed CFC income that arose in a post-reform year, the condition in paragraph (2)(a) is not met and the company can elect to use only $0.63m of the BETA debit balance, being $0.9m - $0.27m. The remaining balance of $0.27m is no longer able to be used under section OE 7.

Date Event Credit Debit Balance Debit number
29/3/12 File tax return (attr. income) 0.8m*   -0.1m  

* Made up of a $0.63m credit under section OE 7 and a $0.17m credit under section OE 6.

The total debit balance is reduced to $0.1m. In terms of the ordering rule, this credit reduces the debits that did not arise from conduit relief first, then other debits. This means that the CTR-relief amount on 30/3/12 is $0.1m, the same as the total debit balance. It will not be possible to use any of the remaining debit balance by making an election under section OE 7.

 

Example 3: Use of the CTR-relief amount (condition of exception not met)

Recall Example 2, but suppose instead that the tax return for the 2009-10 year is not filed on 30/3/11, and no election is made to use the BETA debit balance to satisfy the 2009-10 attributed CFC income tax liability.

BETA account

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend   1.2m -1.2m 1
21/5/08 Dividend   1.5m -2.7m 2
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend   0.7m -1.6m 3
28/3/10 File tax return (attr. income) 0.5m   -1.1m  
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES

As at 30/9/11, the CTR-relief amount is $0.33m.

In the 2010-11 income year, the company has a tax liability for attributed CFC income of $0.8m. It files an income tax return for the 2010-11 year on 1/10/11 and makes an election to use available debit balances to offset the $0.8m liability. Because the election is in respect of a tax liability on attributed CFC income that arose in a post-reform year, the company can elect to use only $0.77m of the BETA debit balance, being $1.1m - $0.33m.

Date Event Credit Debit Balance Debit number
1/10/11 File tax return (attr. income) 0.8m*   -0.3m  

* Made up of a $0.77m credit under section OE 7 and a $0.03m credit under section OE 6.

The total debit balance is reduced to $0.3m. In terms of the ordering rule, this credit reduces the debits that did not arise from conduit relief first, then other debits. This means that the CTR-relief amount on 30/3/12 is $0.3m, the same as the total debit balance.

On 2/10/11, the company finally files its tax return for the 2009-10 income year and recognises its $0.2 million of attributed foreign income. It is unable to elect to use any of the remaining BETA debit balance because it is made up entirely of the CTR-relief amount, and because:

  • it has already made an election in respect of post-reform income (a day earlier); and
  • it did not make the election before the end of the first affected year.

This violates both conditions in paragraph (2)(b).

Date Event Credit Debit Balance Debit number
1/10/11 File tax return (attr. income) 0.2m*   -0.1m  

* A credit entirely under section OE 6.

Ordering rule for BETA accounts (subsection OE 11B(3))

The ordering rule is used to determine which of the BETA debits in the BETA account make up an overall debit balance.

The purposes of the rule are firstly to ensure that it is possible to identify the part of the overall debit balance that results from the application of conduit tax relief, and secondly to ensure that credits relating to post-reform income cancel out debits that have not arisen from conduit tax relief before other debits.

It is possible that a single debit could arise that results:

  • partly from the application of section RG 7 to reduce the required payment of FDP; and
  • partly from the actual payment of FDP, including a payment made under section RG 6 by reducing a loss.

Paragraph (a) requires that, for the purposes of applying the ordering rule, such a debit be split in two. One debit is equal to the reduction of FDP under section RG 7. The other is equal to the amount of actual FDP payment.

Paragraphs (b) and (c) then treat credits as cancelling out debits in two ways, depending on the type of credit.

  1. For a BETA credit that arises before the first affected year, paragraph (b) requires in almost all cases that the credit reduces BETA debits in the order in which the debits arise. When two debits arise at the same time and are not reduced to nil, they are reduced proportionately.

    The paragraph (b) treatment also applies to a credit that arises on or after the first day of the first affected year, if:
    • the credit arises as a result of an election under section OE 7; and
    • the election is one that qualifies for the exception in subsection (2).

    The paragraph (b) treatment does not apply to a credit that arises before the first affected year in one circumstance:
    • the credit arose because of an election under section OE 7; and
    • the election was made before the first affected year; and
    • the election is in respect of post-reform attributed CFC income (so the condition in paragraph (2)(a) is not met).

    It is doubtful that the legislation is intended to allow an election giving rise to such a credit. If it were possible for one to arise, is exceedingly unlikely to be seen in practice (if such an election does occur officials are likely to recommend a clarification to ensure it is ineffective). If one did nevertheless arise and was effective, it would use the treatment in paragraph (c).
Example 4: Ordering rule, paragraph (b) treatment debits before affected year

A standard balance date company has the following entries in its BETA account.

BETA account

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend   1.2m -1.2m 1
21/5/08 Dividend   1.5m -2.7m 2
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend   0.7m -1.6m 3
28/3/10 File tax return (attr. income) 0.5m   -1.1m  
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES

Each of the dividends was subject to FDP, which was reduced by 30% under section RG 7, with the remaining liability paid immediately.

The debit on 30/9/07 is treated as two debits. One is $0.36m, equal to the reduction under section RG 7, and the other is $0.84m, equal to the FDP actually paid. The debits on 21/5/08 and 30/9/09 are treated similarly.

The BETA account now looks like this.

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend (RG 7)   0.36m   1a
  Dividend (Other)   0.84m -1.2m 1b
21/5/08 Dividend (RG 7)   0.45m   2a
  Dividend (Other)   1.05m -2.7m 2b
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend (RG 7)   0.21m   3a
  Dividend (Other)   0.49m -1.6m 3b
28/3/10 File tax return (attr. income) 0.5m   -1.1m  
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES

The credit on 30/3/09 arises before the first affected year. It is the result of an election under section OE 7 and the election is in respect of pre-reform income (the condition in paragraph (2)(a) is met). Therefore, the credit is treated as described in paragraph (3)(b) and wipes out all debits in chronological order, with pro-rating for debits that arise simultaneously.

The credit is treated as reducing debits (1a) and (1b) to nil, then proportionately reducing debits (2a) and (2b) at the same time, to 0.27m and 0.63m respectively. The CTR-relief amount immediately after the reduction is 0.27m.

The credit on 28/3/10 is also treated as described in paragraph (3)(b). It further reduces debits (2a) and (2b) to 0.12m and 0.28m respectively. The CTR-relief amount immediately after the reduction, taking into account that debits (3a) and (3b) have also arisen, is 0.33m.


Example 5: Ordering rule, paragraph (b) treatment for credits arising in first affected year

The BETA account begins in the same way as Example 4.

BETA account

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend (RG 7)   0.36m   1a
  Dividend (Other)   0.84m -1.2m
1b
21/5/08 Dividend (RG 7)   0.45m   2a
  Dividend (Other)   1.05m -2.7m 2b
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend (RG 7)   0.21m   3a
  Dividend (Other)   0.49m -1.6m 3b
28/3/10 File tax return (attr. income) 0.5m   -1.1m  
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES

At the end of 28/3/10, the ordering rule treated 0.12m of debit (2a) and 0.28m of debit (2b) as remaining. If the income tax return for the 2009-10 year is filed on 30/3/11, and there are credits under OE 7 for 0.2m, the following entry occurs.

Date Event Credit Debit Balance Debit number
30/3/11 File tax return (attr. income) 0.2m   -0.9m  

The credit on 30/3/11 arises after the beginning of the first affected income year, but the credit arises as a result of an election made under section OE 7 that qualifies for the exception in subsection (2). Therefore, the credit is treated as described in paragraph (b). The credit further reduces debit (2a) to 0.06m and debit (2b) to 0.14m. The CTR-relief amount after the credit is 0.27m.

  1. All other BETA credits are treated by paragraph (3)(c) as:
  • firstly, reducing branch equivalent tax debits that did not arise from a reduction of an FDP liability under section RG 7, in the order they arose (with proportionate reduction of debits arising at the same time); and
  • secondly, to the extent that there is any remaining debit balance, reducing branch equivalent tax debits that did arise from a reduction of an FDP liability under section RG 7, in the order those debits arose (again, with proportionate reduction of debits arising at the same time).
Example 6: Ordering rule, paragraph (c) treatment for credit arising in affected year

The BETA account begins in the same way as Example 5.

BETA account

Date Event Credit Debit Balance Debit number
1/4/07       0  
30/9/07 Dividend (RG 7)   0.36m   1a
  Dividend (Other)   0.84m -1.2m 1b
21/5/08 Dividend (RG 7)   0.45m   2a
  Dividend (Other)   1.05m -2.7m 2b
30/3/09 File tax return (attr. income) 1.8m   -0.9m  
30/9/09 Dividend (RG 7)   0.21m   3a
  Dividend (Other)   0.49m -1.6m 3b
28/3/10 File tax return (attr. income) 0.5m   -1.1m    
1/4/10 ENTRY INTO NEW INTERNATIONAL TAX RULES
30/3/11 File tax return (attr. income) 0.2m   -0.9m  

After 30/3/11, the ordering rule treated the remaining part of debit (2a) as being 0.06m and the remaining part of debit (2b) as being 0.14m.

If the income tax return for the 2010-11 income year was filed on 29/3/12, and there was a tax liability for attributed CFC income of 0.8m, the following entry would occur.

Date Event Credit Debit Balance Debit number
30/3/11 File tax return (attr. income) 0.8m   -0.1m  

The credit arises after the entry into the new international tax rules. It does not arise from an election that qualifies for the exception under subsection (2), because it is in respect of post-reform income.

Therefore, the credit is treated under paragraph (c) as first reducing debits that did not arise from the application of section RG 7, the other debits. The credit wipes out the remaining 0.14m of debit (2b), wipes out debit (3b), wipes out the remaining 0.06m of debit (2a), and wipes out 0.11m of debit (3a), in that order. This leaves 0.1m of debit (3a) remaining. The CTR-relief amount, immediately after the application of the credit, is also 0.1m.

Rules for consolidated BETA accounts (section OP 104B)

Section OP 104B applies the same rules to consolidated BETA groups with BETA accounts that section OE 11B applies to BETA companies.

Application date

The new rules apply for all income years beginning on or after 1 July 2009. This was also the date of application of most provisions in the new international tax rules.