Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010

Distributions to co-operative company members

Taxation (Annual Rates, Trans-Tasman Savings Portability, KiwiSaver, and Remedial Matters) Act 2010 extends the law on distributions to co-operative company members.

The bill in effect extends the scope of sections DV 11 and CD 34 of the Income Tax Act 2007, which allow a co-operative company to deduct a distribution to a member if the distribution is in proportion to the sale and purchase of trading stock between the member and the co-operative. Amendments to section DV 11, and new section CD 34B, remove the requirement for strict proportionality by permitting a 20 percent differential. This flexibility is being introduced to reduce compliance costs for co-operative companies that pay dividends on a limited number of shares in excess of those held to match trading stock transactions.

Background

Previously, section DV 11 allowed a co-operative company to deduct a distribution to a member-shareholder if the distribution was one described in section CD 34. Such a distribution was required to:

be made by a resident co-operative company that requires members to hold shares in proportion to their trading stock transactions with the company (say, one share for each kilogram of meat sold to the co-operative); and
be in proportion to the member's supply of trading stock to the co-operative.

The distribution was taxable to the member under section CD 2.

Key features

Section CD 34 has been repealed and replaced by section CD 34B, which is slightly broader in scope.
Section CD 34B provides that a distribution by a co-operative company to a member on certain types of shares is not a dividend. This applies to shares held in proportion to actual or expected trading stock transactions between the member and the co-operative, and also to a limited number (20 percent) of other shares.
Section CD 34B(9) provides an exception to section 125(2) of the Companies Act 1993 for co-operatives that elect deductible dividend treatment for tax purposes, and that provide a copy of the election to the Registrar of Companies. Subsection (9) gives such companies some flexibility in fixing the date of entitlement which establishes members' rights to receive dividends.
Section DV 11, which currently provides for a co-operative company to deduct distributions to which section CD 34 applies, now refers to section CD 34B.

Detailed analysis

New section CD 34B applies to resident co-operative companies that pay dividends to resident members. It describes three types of shares - transaction shares, projected transactions shareholding and limited non-transaction shares. The distinction exists only for the purposes of tax rules relating to deductibility and dividends - the shares may be of the same or different classes for company law purposes.

Distributions in proportion to actual or estimated trading stock transactions

Under new section CD 34B, "transaction shares" are those that are held in proportion to trading stock transactions in a season. "Projected transactions shareholding" means shares held in proportion to estimated trading stock transactions in a season.

Distributions paid by a co-operative company on such shares are deductible to the co-operative (section DV 11) and are not a dividend to the member (new section CD 34B(2)(a) and (b)). However, they are taxable to the member (section CD 2).

Distributions on limited non-transaction shares

Non-transaction shares are shares that are not held in proportion to actual or estimated trading stock transactions but that nevertheless entitle the member to enter into trading transactions with the co-operative.

A distribution paid by a co-operative to a member on such a share is deductible to the co-operative, and is not a dividend to the member, if:

the member holds only a limited number of such shares; and
the constitution of the co-operative allows members to hold only a limited number of such shares.

The limit allowed under section CD 34B is the greater of 20 percent of the number of their transaction shares and 20 percent of their projected transactions shareholding.

If the constitution allows any member to hold more non-transaction shares than the 20 percent level, only distributions on transaction shares and projected transactions shareholding will be deductible to the co-operative and will not be a dividend. Distributions to any member on non-transaction shares will not be deductible.

Example
A is a member of a farmers' meat co-operative company. The company requires each member to hold one share for every 10 kgs of meat the member sells to the co-operative in a season. Members can also hold additional shares up to a maximum of 20 percent of shares held by the member to back their recent or estimated sale of meat to the co-operative. Shares held in excess of this are redeemed by the co-operative at the end of the season. A estimates that he will supply 1,000 kg of meat in the 2010-11 season so he purchases 120 shares. He only supplies 800 kg of meat in the season. After the end of the season, in addition to the amount it pays the member for the meat, the co-operative company distributes $1 per share to members for that season so A receives $120. A holds 100 projected transactions shares (80 of which are transaction shares) and 20 limited non-transaction shares for the 2010-11 season. The distribution of $120 is not a dividend under new section CD 34B and is deductible to the co-operative under section DV 11. It is income to the farmer under section CD 2. Variation The co-operative company changes its constitution so that an individual member may hold any number of non-transaction shares. A estimates that he will supply 1,000 kg of meat in the current season, and actually supplies 900 kg. He holds 200 shares. The company pays a $200 dividend on the shares. A holds 100 projected transactions shares and 100 other shares. The $100 paid on the projected transaction shares is deductible to the co-operative and excluded as a dividend. The remaining $100 is non-deductible and may be a dividend. In this case, section CD 34B(3)(b) also applies so that distributions on shares other than transaction shares or projected transactions shareholding held by any member (not just A) are not deductible and may be a dividend.

Example

A is a member of a farmers' meat co-operative company. The company requires each member to hold one share for every 10 kgs of meat the member sells to the co-operative in a season. Members can also hold additional shares up to a maximum of 20 percent of shares held by the member to back their recent or estimated sale of meat to the co-operative. Shares held in excess of this are redeemed by the co-operative at the end of the season.

A estimates that he will supply 1,000 kg of meat in the 2010-11 season so he purchases 120 shares. He only supplies 800 kg of meat in the season. After the end of the season, in addition to the amount it pays the member for the meat, the co-operative company distributes $1 per share to members for that season so A receives $120. A holds 100 projected transactions shares (80 of which are transaction shares) and 20 limited non-transaction shares for the 2010-11 season. The distribution of $120 is not a dividend under new section CD 34B and is deductible to the co-operative under section DV 11. It is income to the farmer under section CD 2.

Variation

The co-operative company changes its constitution so that an individual member may hold any number of non-transaction shares. A estimates that he will supply 1,000 kg of meat in the current season, and actually supplies 900 kg. He holds 200 shares. The company pays a $200 dividend on the shares. A holds 100 projected transactions shares and 100 other shares. The $100 paid on the projected transaction shares is deductible to the co-operative and excluded as a dividend. The remaining $100 is non-deductible and may be a dividend.

In this case, section CD 34B(3)(b) also applies so that distributions on shares other than transaction shares or projected transactions shareholding held by any member (not just A) are not deductible and may be a dividend.

Review

As noted earlier, the government proposes to review the tax treatment of distributions from co-operative companies to shareholders later this year. This will enable full consultation on the appropriate treatment of such distributions.

Section 125(2) Companies Act 1993

A problem arises for co-operative companies with a particular capital structure that pay dividends to shareholders and have different financial years and trading seasons (for example, a trading year ending 31 March and a financial year ending 31 May).

Under section 125(2) of the Companies Act 1993, there is a maximum 20 working-day period between the time shareholders' entitlements to receive a dividend are determined (the "record date") and the date the company's board resolves to pay the dividend.

This creates a problem for co-operative companies that require shares to be held in proportion to trading stock transactions, pay dividends to shareholders and have a different financial year and trading season. If such companies pay a dividend in respect of a trading season after the end of the equivalent financial year, the record date can be in the new trading season. The appropriate record date should be in the trading season for which the dividend is paid.

Subsection CD 34B(9) therefore provides an exception to the 20 working-day rule, in relation to entitlements to receive distributions, for co-operative companies that have elected the tax treatment in section CD 34B. However, the exception applies in relation to all shares of the co-operative that entitle a member to enter into trading stock transactions. That is, the 20 percent limitation that applies for tax purposes does not apply for the purposes of the exception to the Companies Act 1993.

Example
A Co is a co-operative company whose members hold one share for each 10 kg of meat they supply to the co-operative. It has a trading season of 1 April to 31 March and a financial year of 1 June to 31 May. It intends to pay a dividend based on its 2010-11 trading season on 1 August 2011, after the end of its 2010-11 financial year. It wants to pay that dividend to members in relation to their shareholding in the 2010-11 trading season. It elects under section CD 34B to deduct the dividends paid on its shares and also gives a copy of the election notice to the Registrar of Companies. It resolves to fix a record date for all future distributions of 31 March, being the last day of its trading season. As this resolution was made before the end of the 2010-11 trading season, the board can resolve to pay a dividend on 1 August 2011, in respect of the 2010-11 trading season, based on shareholding at 31 March.

Example

A Co is a co-operative company whose members hold one share for each 10 kg of meat they supply to the co-operative. It has a trading season of 1 April to 31 March and a financial year of 1 June to 31 May. It intends to pay a dividend based on its 2010-11 trading season on 1 August 2011, after the end of its 2010-11 financial year. It wants to pay that dividend to members in relation to their shareholding in the 2010-11 trading season.

It elects under section CD 34B to deduct the dividends paid on its shares and also gives a copy of the election notice to the Registrar of Companies. It resolves to fix a record date for all future distributions of 31 March, being the last day of its trading season. As this resolution was made before the end of the 2010-11 trading season, the board can resolve to pay a dividend on 1 August 2011, in respect of the 2010-11 trading season, based on shareholding at 31 March.

Application date

The amendments will apply to distributions made on or after 1 April 2010.