Resident Withholding Tax and Offshore Unit Trusts

Sections LD 3, NF 2(1), NF 2(1A), NF 2(1AB), NF 2(1B), NF 2AA, NF 2A(1), NF 2A(3) and NF 4(9) of the Income Tax Act 2004 and the Income Tax Act 1994; sections 25(11), 26(1) and (2), 27(1), 33A(1)(b)(iv), 33A(1)(b)(x)(B), 50 and 51(6) of the Tax Administration Act 1994

The resident withholding tax (RWT) rules in the Income Tax Act have been amended to establish an RWT "proxy" for the payer and the recipient of the resident withholding income when the payer is non-resident. The "proxy" must pay to the Commissioner the RWT calculated in relation to the resident withholding income.

The use of the new RWT proxy mechanism is voluntary for both the RWT proxy and the recipient of the resident withholding income. In addition, the recipient can elect the correct marginal tax rate.

The amendments were introduced by Supplementary Order Paper 337 at the select committee stage of the legislative process.

Background

The Taxation (Venture Capital and Miscellaneous Provisions) Act 2004 enacted in December 2004 resulted in distributions from offshore unit trusts that were previously treated as "non-taxable bonus issues" for New Zealand tax purposes being treated as dividends and taxed accordingly.

As a consequence, individual investors in offshore unit trusts derive a dividend, from which no foreign or New Zealand tax has been withheld. These investors have a New Zealand income tax liability and may be required to file an income tax return.

Ideally the RWT rules should allow fund managers to withhold tax on behalf of investors. The RWT rules require the deduction of a withholding tax from interest and dividends paid to New Zealand residents. RWT is deducted at source at the time the interest or dividend income is paid, thus eliminating the need in many cases to file an income tax return because the correct amount of tax will have been withheld.

The income tax legislation did not previously allow New Zealand fund managers, who are not agents, to elect to be subject to the RWT rules in relation to investments in offshore unit trusts by New Zealand residents.

The amendments will make it easier for individuals to meet their tax obligations accurately, lowering compliance and administration costs. A key feature of the new arrangement is that it is voluntary. The decision to offer the withholding facility is a matter for each fund manager to consider.

Key features

The RWT rules have been amended to allow:

• New Zealand fund managers to elect to offer a withholding tax facility (to be an RWT "proxy");
• the correct marginal tax rate to be nominated when an investor elects to use the withholding tax facility; and
• the requirement that the investor files an annual income tax return to be removed.

Application date

The amendments apply from 21 December 2004.

Detailed analysis

Liability to pay resident withholding tax

Section NF 2(1A)(b) establishes a liability to pay RWT to the Commissioner if a person is an RWT proxy for the payer and recipient of the resident withholding income. It recognises that although the RWT proxy is not the payer of the resident withholding income, the proxy must, nevertheless, pay to the Commissioner the RWT calculated in relation to that income.

Section NF 2(1A)(a) preserves the existing position for all other instances where the person who makes the payment of resident withholding income must deduct the RWT from the resident withholding income and pay the RWT to the Commissioner.

New section NF 2(1B) prescribes the formula to work out the amount of RWT to be paid to the Commissioner by the RWT proxy when resident withholding income in the form of a dividend is paid. The formula ensures that the RWT is calculated in relation to the net amount that is paid to the recipient. The formula is:

Where:

1. is the appropriate rate of RWT, expressed as a percentage, specified in Schedule 14, clause 1
2. is the amount paid to the recipient of the dividend.

For example, if the recipient's marginal tax rate is 33% and the recipient receives 67 cents, then the amount of resident withholding income is $1. The formula calculates the amount of RWT as follows:

The formula therefore ensures that the correct amount of RWT is paid to the Commissioner.

Election to be an RWT proxy

New section NF 2AA has been inserted to prescribe how a person elects to be an RWT proxy.

• A person is an RWT proxy if: the proxy gives to the Commissioner a notice of election;
• the payer is a non-resident unit trust;
• the recipient is a natural person or a trustee of a qualifying trust;
• the recipient has asked the RWT proxy to act as a proxy;
• the proxy has agreed;
• the resident withholding income is a dividend; and
• the payment is made during the term of the election.

A notice of election must be in writing and contain:

• the election to be an RWT proxy for dividends distributed by the payer;
• the name and address of the payer; and
• the date from which the election is effective.

The election is effective from the date nominated in the notice until the Commissioner receives written notice from the proxy that the election is cancelled.

Election to apply appropriate rate of deduction

Section NF 2A(1) has been amended to allow a recipient to elect that an RWT proxy apply the appropriate RWT rate specified in Schedule 14, clause 1(a), (b) or (c).

Payment of resident withholding tax to Commissioner

Section NF 4, concerning the payment of RWT deductions to the Commissioner, has been amended to incorporate the RWT proxy mechanism.

Resident withholding tax deductions to be credited against income tax assessed

Section LD 3 has been amended to ensure that the payment of RWT by an RWT proxy in relation to resident withholding income can be credited against the income tax liability of the recipient of the resident withholding income.

Consequential amendments to the Tax Administration Act 1994

To ensure that the RWT proxy mechanism is subject to the administrative requirements in the Tax Administration Act 1994 relating to RWT, sections 25(11), 26(1) and (2), 27(1), 50 and 51(6) have been consequentially amended. In general, this has been achieved by ensuring the payer of the RWT- - either by the RWT proxy or the payer of the resident withholding income - is subject to these requirements.

Annual returns of income not required

Section 33A(1)(b)(iv) has been amended to provide that an annual income tax return is required when a taxpayer has not had the correct amount of tax withheld from interest or a dividend subject to the RWT proxy rules, where that amount is more than $200.

Section 33A(1)(b)(x) requires that an income tax return be filed when a taxpayer has, in effect, received more than $200 of foreign interest or dividends, irrespective of whether the correct amount of New Zealand tax has been paid on that income. This provision has been amended to ensure that it does not apply to resident withholding income subject to the RWT proxy rules.

In section 33A(2), paragraphs (cb)(ii) and (f) have been repealed because they are redundant. Their effect is already achieved in section 33A(1).