New tax rates for companies and savings
2010 legislation introduces new tax rates for companies and savings; changes to the thin capitalisation rules ensure tax rates apply to foreign-controlled entities.
Sections CS 1, FE 5, FE 6, FE 12, FE 18, HM 47, HM 58, HM 60, LP 2, OZ 7 to OZ 17, RZ 3 to RZ 5 and schedules 1 and 6 of the Income Tax Act 2007 and section 140C of the Tax Administration Act 1994
The Taxation (Budget Measures) Act 2010 introduced changes to the tax rules for business and investments.
- The company tax rate is being reduced from 30% to 28%.
- The top tax rate for people saving through portfolio investment entities (PIEs) - including KiwiSaver funds - and other managed funds will also be reduced from 30% to 28%.
- Other tax rates that apply to KiwiSaver funds and other PIEs are being reduced in line with the changes to personal income tax rates.
- The safe harbour in the thin capitalisation rules that apply to foreign-controlled entities is being reduced from 75% to 60%.
Together, these reforms are intended to improve the competitiveness of New Zealand's company tax system and to encourage saving. The changes to the thin capitalisation rules support this objective by ensuring that tax rates apply effectively to foreign-controlled entities.
The company tax rate will be reduced from 30% to 28%. This change also applies to unit trusts, which are taxed as companies. The resident withholding tax rules for interest paid to companies are being amended accordingly.
The top rate for people saving through PIEs and other managed funds will also be reduced from 30% to 28%. The other tax rates that apply to multi-rate PIEs will be reduced in line with changes to personal income tax rates. Tax rates for investors in multi-rate PIEs will shift automatically from the old rates to the new rates when the changes take effect on 1 October 2010. The rates of retirement scheme contributions tax will be reduced in line with the changes to personal income tax rates.
The thin capitalisation rules deny interest deductions to the extent that the debt percentage (essentially, the debt-to-asset ratio) of a person's New Zealand group exceeds a specified "safe harbour" threshold and is also more than 110 percent of the debt percentage of that person's worldwide group. The safe harbour applying to foreign-controlled entities will be reduced from 75% to 60%. This will reduce the scope for foreign multinational enterprises to reduce the amount of New Zealand tax they pay by loading debt against their New Zealand operations.
A number of transitional arrangements accompany the reduction in the company tax rate. These are based on similar arrangements that accompanied the previous
- allow companies to continue to pay out imputation credits at the current 30/70 credit-to-dividend ratio until 31 March 2013, provided the credits arose when the company tax rate was 30% or 33%;
- allow shareholders - other than those eligible for the new 28% tax rate - to use these additional imputation credits to offset their tax; and
- allow companies that pay provisional tax using the uplift method or the GST ratio method to have immediate access to the tax cut.
For investments through multi-rate PIEs, including most KiwiSaver funds, the reduced tax rates - including the new 28% top rate - will apply from 1 October 2010.
For companies, and for investments through other managed funds, the reduction in the tax rate to 28% will apply for the 2011-12 and subsequent income years. The changes to the thin capitalisation rules will also apply for the 2011-12 and subsequent income years.
Unless otherwise stated, the following references to sections and schedules relate to the Income Tax Act 2007.
The reduction in the company tax rate and changes to the tax rates that apply to investments through PIEs and other managed funds are achieved through amendments to a number of provisions.
Clause 2 of schedule 1, part A has been amended to reduce the company tax rate to 28%. Since the definition of "company" in section YA 1 includes unit trusts, this reduction also applies to unit trusts. The lower company tax rate will automatically affect the maximum imputation and FDP crediting ratio under section OA 18, which will change from 30/70 to 28/72. A consequential amendment has been made to the formula in section LP 2(2) for calculating tax credits for supplementary dividends.
Clauses 5 and 6 of schedule 1, part A have been amended to similarly reduce the tax rate for group investment funds deriving category A income, approved unit trusts to which the Income Tax (Exempt Unit Trusts) Order 1990 applies, widely held group investment funds, and widely held superannuation funds. Clause 8 of schedule 1, part A has been amended to reduce the rate for life insurance policyholder income.
In schedule 1, part D, table 3, rows 1 and 2 are amended to reduce the rate of resident withholding tax applicable to interest paid to companies when the payer of the interest has been supplied with the tax file number of the company and has either not received a payment rate election or has received a payment rate election choosing the 28% payment rate. Rows 3 and 4 have been amended in line with the changes to personal income tax rates, reducing the rate of resident withholding tax from 38% to 33% for interest paid to a company when the recipient of the interest has either elected for the top personal rate to apply or has not supplied their tax file number to the interest payer.
Changes to the prescribed rates for multi-rate PIEs are contained in schedule 6, table 1.
Section HM 58, as amended, operates to adjust automatically notified investor rates for multi-rate PIEs, unless the investor advises the PIE that a different rate should apply. Section HM 60(6) has been amended so that, if an investor does not notify a multi-rate PIE of their notified investor rate, the rate applied will be 28%.
Section HM 60(3) has been replaced by a new subsection (3) so that multi-rate PIEs can calculate tax for the 2010-11 income year using current notified investor rates for each day in the year up to and including 30 September and the new lower rates for remaining days in the income year. The new lower rates that the multi-rate PIE will apply from 1 October is the rate automatically adjusted on that date under the revised section HM 58 or another rate notified by the investor on or after that date. Consequential amendments to the PIE multi-rate calculation provisions in section HM 47(4)(a)(i) support this treatment.
Section HM 47(4)(ii) has been amended so that, if the PIE is treated as the sole investor, the rate applied will be 28%.
Retirement scheme contributions tax has been reduced by amendments to schedule 6, table 2.
Note that section CS 1, which deals with fund withdrawal tax on superannuation funds, is amended as a consequence of the alignment of the top rate of employer superannuation contribution tax with a taxpayer's marginal rate. This is discussed further in the TIB item that deals with the changes to personal income tax rates.
Provisional tax rules for companies
Provisional tax involves payments being made during an income year, in anticipation of an income tax liability for that year. Section RC 5 sets out various methods of calculating provisional tax.
The "standard method" of determining provisional tax liability, under section RC 5(2) and (3), looks to a person's residual income tax for a previous year, uplifting that amount by a specified percentage - normally either 5% or 10%, depending on the circumstances. In view of the reduction in the company tax rate, section RZ 3 has been amended to reduce temporarily the amount of that uplift for persons subject to the new company tax rate of 28%.
- Where the 5% uplift method applies, section RZ 3(1)(b) and (2)(b)(ii) modifies section RC 5(2) to eliminate any uplift for the 2011-12 income year.
- Where the 10% uplift method applies, section RZ 3(1)(b), (3)(b)(ii) and (c)(ii) modifies section RC 5(3) to reduce the amount of the uplift to 5% for the 2011-12 and 2012-13 income years (in this case, the modification applies for two years, because section RC 5(3) looks to a person's residual income tax for the tax year before the preceding tax year).
Corresponding modifications to section RC 10 have been made by section RZ 5.
Some provisional taxpayers can choose to calculate their provisional tax payments using the "GST ratio method" under section RC 8. The GST ratio is normally calculated by dividing residual income tax for the preceding year by taxable supplies in that year, although in certain circumstances amounts from earlier years may be used instead. Section RZ 4 modifies section RC 8, reducing the income tax amounts used for the purposes of calculating the GST ratio to reflect the reduction in the company tax rate. For the 2011-12 and 2012-13 income years, section RZ 4(1)(b) and (2)(b) provides that the income tax amount for a new company tax rate person is to be multiplied by 0.95.
Thin capitalisation rules for foreign-controlled entities
For a person falling within their ambit, the thin capitalisation rules deny interest deductions to the extent that the debt percentage of that person's New Zealand group exceeds the higher of two thresholds specified in section FE 5. One threshold is a "safe harbour". The other threshold is determined as being 110% of the debt percentage of the person's worldwide group (this threshold does not apply to individuals).
The scope of the thin capitalisation rules was recently extended by the Taxation (International Taxation, Life Insurance, and Remedial Matters) Act 2009. Previously, the rules only applied to New Zealand taxpayers if they were, or were controlled by, a non-resident (section FE 2(1)(a) to (d)). They now also apply to New Zealand residents with an income interest in a controlled foreign company (CFC) or with control of a resident company with such an interest (section FE 2(1)(e) to (g)).
Section FE 5 has been amended to reduce the safe harbour for taxpayers that are, or are controlled by, a non-resident from 75% to 60%. This lower safe-harbour is set by section FE 5(1)(a)(i) and (3)(a). The safe harbour for New Zealand residents with CFC interests remains at 75% (section FE 5(1)(b)(i) and (3)(b)). The 110% threshold is also unchanged (section FE 5(1)(a)(ii) and (b)(ii)). Consequential amendments have been made to section FE 6(3)(e) and section FE 12(2).
Section FE 18(5) sets the default percentage for the worldwide group of an excess debt entity. Currently, the default percentage is 68.1818, an amount that when multiplied by 110% is equivalent to a 75% safe harbour. This section has been amended so that, for taxpayers subject to the reduced safe harbour, the default percentage becomes 54.5454: multiplied by 110%. This matches a 60% safe harbour.
The special thin capitalisation rules for banks are not affected by these changes.
Company tax: Transitional arrangements
Imputation and fair dividend payment crediting ratios
An immediate reduction of the crediting ratio allowed under section OA 18, which caps the ratio of imputation or fair dividend payment (FDP) credits to dividends, has the potential to disadvantage shareholders if the dividends to which it applies represent a distribution of income that was taxed at 30%. Therefore, the legislation allows this maximum ratio to be overridden for dividends paid during a transitional period, beginning on the first day of the company's 2011-12 income year and ending on 31 March 2013. During that period, companies can attach imputation and FDP credits to dividends up to a maximum ratio of 30/70, provided the underlying income was taxed at 30%. This is achieved by updating sections OZ 7 and OZ 8, which were introduced to deal with the previous company tax rate cut.
If a company imputes dividends using a 30/70 ratio after the 2010-11 income year to an extent that exceeds the credit balance in its imputation credit account relating to income taxed at 30%, a 10% transitional imputation penalty tax will apply under section 140C of the Tax Administration Act 1994. Penalty tax will only arise under section 140C if there is a debit balance relating to 30/70 credits on 31 March 2013. If penalty tax is also payable under section 140B because of an overdrawn balance at 31 March 2013, it will be reduced by any amount payable under section 140C.
Sections OB 61 and OC 28 provide that the amount of imputation or FDP credits attached to the first dividend paid by a company in a tax year (the "benchmark dividend") sets the imputation ratio for that year. The imputation ratio of subsequent dividends paid in the year must be the same as for the benchmark dividend, unless the company makes a ratio change declaration.
Section OZ 9 has been updated to modify the benchmark dividend ratios in sections OB 61(4) and OC 28(4). This allows companies to change their crediting ratio from 30/70 to 28/72 without making a ratio change declaration. If the benchmark dividend was paid before the start of the 2011-12 income year and credited using a 30/70 ratio, section OZ 9 allows subsequent dividends paid during the transitional period to be credited using a 28/72 ratio. In addition, if the benchmark dividend was credited using a 30/70 ratio under section OZ 8, section OZ 9 allows a 28/72 ratio to be used for subsequent dividends once credits accrued under the 30% tax rate have run out.
Shareholders' tax credits
If the amount of imputation credits or FDP credits exceeds the maximum ratio allowed under section OA 18, the tax credit available to the shareholder is normally limited to that maximum. Section OZ 10 has been updated to modify sections LE 8 and LE 9 and sections LF 6 and LF 7, allowing shareholders to benefit from additional credits during the transitional period, when these have been attached to dividends in accordance with section OZ 8.
However, if the shareholder is a person, including a multi-rate PIE, eligible for the new 28% rate, section OZ 11 limits the credit available against their tax liability based on a 28/72 ratio, even if the actual crediting ratio of the dividend was higher than this by virtue of section OZ 8. Since a new company tax rate person will only be subject to 28% tax on the dividend, it would be inappropriate to allow them to benefit from additional credits, which could be used to offset tax on other income.
Tax credits for non-residents
The formula in section LP 2(2) for calculating tax credits for supplementary dividends is amended, reflecting the new 28/72 crediting ratio. Section OZ 12 has been updated to maintain the existing formula for dividends imputed using a 30/70 ratio under the transitional rules.
Available subscribed capital
The concept of "available subscribed capital" is relevant when a company cancels its shares and pays consideration to compensate a shareholder for that cancellation. For the purposes of determining available subscribed capital, the extent to which a dividend is fully credited may be relevant. The extent to which a dividend is treated as credited is determined using the formula in section CD 43(26). Section OZ 13 has been updated to provide that a ratio of 28/72 should be used for the purposes of this formula even if a dividend has an imputation ratio up to 30/70 during the transitional period.
Dividends from qualifying companies
A dividend paid by a qualifying company is only taxable in the hands of the shareholder to the extent it is imputed: these dividends are therefore required to be imputed to the maximum extent possible under the imputation rules given the company's available credits. The formula for calculating the amount of a fully imputed distribution is set out in section HA 15(2). Section OZ 14 has been updated to modify this formula, to treat the tax rate as 30%, rather than 28%, for dividends paid during the transitional period to which section OZ 8 applies.
Statutory producer boards and cooperative companies
For a statutory producer board, the allocation of credits to cash distributions must be done according to the formula in section OB 73(4), while section OB 75(2) allocates credits to notional distributions. For cooperative companies, the equivalent provisions are sections OB 78(3) and OB 80(2). Section OZ 15 has been updated to allow these entities to use a 30/70 crediting ratio during the transitional period.
Branch equivalent tax accounts and conduit tax relief accounts
Sections OZ 16 and OZ 17 have been updated so that entries in the branch equivalent tax accounts or conduit tax relief accounts of companies or consolidated groups that relate to 2010-11 or earlier income years are adjusted in line with the proposed reduction in the company tax rate. This is because credit balances in these accounts will be used to offset tax liabilities calculated under the proposed new company tax rate.