2006 amendment to the Income Tax Act ensures companies that migrate from NZ pay tax on the worldwide income they earned while resident in NZ.
Sections CD 18, CD 32, FCB 1 to FCB 3, ME 6, MG 2, MI 2, MI 10, NF 4, NG 11 and OB 1 of the Income Tax Act 2004; sections 49 and 51 of the Tax Administration Act 1994
The Income Tax Act 2004 has been amended to ensure that companies that migrate from New Zealand pay tax on the worldwide income they earned while resident in New Zealand. The changes are intended to remove incentives for companies to migrate for tax reasons.
A company resident in New Zealand is liable for New Zealand tax on its worldwide income. However, a company was previously able to migrate without having necessarily paid tax on all the income that was earned while it was a New Zealand resident.
Under the amendments, a migrating company will be treated as if it had realised all its assets, liquidated, and fully distributed the proceeds to shareholders before migration. The distribution will be subject to tax as a dividend under the usual rules.
Clarifying technical amendments have also been made to the dividend withholding payment and conduit rules. For consistency with current imputation rules, a company that ceases to be resident in New Zealand will also cease to be a dividend-withholding payment account company and a conduit tax relief company.
Applying the liquidation rules
A company has migrated from New Zealand if it is no longer a New Zealand-resident company under the Income Tax Act 2004. This generally happens when companies transfer their place of incorporation overseas.
Under the Income Tax Act 2004, a company is a nonresident company if:
- it is not incorporated in New Zealand;
- it does not have its head office in New Zealand;
- it does not have its centre of management in New Zealand; and
- control of the company by its directors is not exercised in New Zealand. 1
A company resident in New Zealand is liable for New Zealand tax on its worldwide income. However, before the new amendments, a company was able to migrate without necessarily paying tax on all the income that was earned while it was resident in New Zealand.
For example, any increase in the value of property situated outside New Zealand that accrued when a company was resident in New Zealand was previously not subject to New Zealand income tax if the company migrated and the property was then sold. 2 Income tax deductions may have been previously allowed in relation to the property on the assumption that there would be a resulting income stream that would be taxable in New Zealand.
Similarly, other income generated when a company was resident in New Zealand may not have been subject to New Zealand income tax until a distribution was made to the company's shareholders. However, when a company had migrated, distributions made to nonresident shareholders were not taxed in New Zealand at all as the company was no longer a New Zealand-resident company. Distributions to resident shareholders were still subject to New Zealand tax, although offset to some extent by credits for tax paid on the distribution in the company's new country of residence.
The Companies Act 1955 required the liquidation and discontinuation of the legal personality of a company before it could be removed from the New Zealand register of companies. Distributions made to shareholders on the liquidation of a New Zealand company are treated as a dividend.
In contrast, the Companies Act 1993 allows a company to transfer its place of incorporation offshore and become a non-resident company without the need to liquidate, make a distribution and pay New Zealand income tax. This created a tax incentive for companies to migrate rather than liquidate.
Applying the same tax treatment to both liquidating and migrating companies removes the existing tax incentive to migrate rather than liquidate, and increases the neutrality of the tax system.
Dividend withholding payment and conduit tax relief accounts
In most cases, a New Zealand-resident company must have an imputation credit account. When a company ceases to be a New Zealand resident, its imputation credit account must close and a debit adjustment made to bring any credit balance to nil.
A New Zealand-resident company may elect to maintain a dividend withholding payment (DWP) account to record credits for the amount of DWP paid by the company on foreign dividends it receives. These DWP credits are available for allocation to its shareholders. The company may also elect to be a conduit tax relief (CTR) company to obtain New Zealand tax relief on its foreign-sourced income based on its foreign shareholding.
The company may subsequently elect to cease to be a DWP account company (and a CTR company). An election may not necessarily be made when a company migrates from New Zealand. If an election is made, the company's DWP accounts will close and a debit adjustment made to bring any credit balance to nil. To recover the amount of CTR provided while the company was resident, a CTR company is also required to pay additional DWP of the amount of any credit balance in its CTR account.
Under the new rules, when a company ceases to be a New Zealand tax resident, the company will be treated as if it had been liquidated and paid a distribution to its shareholders.
This means that the existing tax rules that apply on the liquidation of a New Zealand company will also apply in the event of a company ceasing to be a New Zealand resident for income tax purposes.
The company will first be treated as disposing of its property at market value immediately before it ceases to be a New Zealand resident. Under the current tax rules, certain amounts (such as gains in the value of revenue account property and excess depreciation deductions) will be subject to tax. This is consistent with the current treatment of financial arrangements and interests in foreign investment funds when a company ceases to be a New Zealand resident.
The company will then be treated as having distributed all shareholder funds (which will include the proceeds of the deemed disposal) to its shareholders.
While realised capital reserves will generally be excluded from the distribution, a consequence of alignment with the liquidation rules is that they will be included for nonresident related company shareholders.
The amount of the deemed dividend will therefore vary between certain shareholders as shown in Table 1.
|Resident shareholder||Non-related non-resident shareholder||Related non-resident company shareholder|
|Dividend subject to RWT = shareholder funds, less available subscribed capital and realised capital reserves.||Dividend subject to NRWT = shareholder funds, less available subscribed capital and realised capital reserves.||Dividend subject to NRWT = shareholder funds, less available subscribed capital.|
In accordance with the usual tax rules applicable to dividends, a migrating company will be required to withhold tax from a deemed dividend distribution immediately before it ceased to be a New Zealandresident company, under the resident withholding tax (RWT) or non-resident withholding tax (NRWT) rules, as appropriate. The company is allowed to attach imputation credits to the deemed dividends arising on migration.
Under existing rules, RWT on dividends applies at the rate of 33%. A dividend distribution to a resident shareholder will be taxed at the shareholder's marginal tax rate, less imputation credits attached by the company.
A dividend distribution to a non-resident shareholder will be taxed at 30% if the shareholder is a resident of a non-treaty country and the dividend is not fully imputed or credited with dividend withholding payments. If the treaty allows, NRWT of 15% will apply to a dividend distribution to a shareholder from a treaty country or a shareholder from a non-treaty country if the dividend is fully imputed or credited.
Property will be treated as being re-acquired by the company at the same market value it was treated as being disposed of at the time of migration. For property that continues to be subject to tax in New Zealand after a company's migration (for example, standing timber situated in New Zealand), this will establish a new cost base to apply in the event of a subsequent disposal.
To remove the potential for double taxation in the event that, after its migration, a non-resident company pays a dividend to its shareholders, the amount of the distribution deemed to have been paid immediately before the company migrated is added to the company's available subscribed capital (which can be distributed tax-free to shareholders in certain circumstances).
A company that remains incorporated in New Zealand but moves its place of management to another country could also be treated as resident in the other country. In this type of situation, the company will not be considered to have migrated (because it remains a New Zealandresident company for New Zealand income tax purposes) and the new tax rules will not apply to it. It follows that if a dual resident company is treated under a double tax treaty as being resident in another country for the purposes of the treaty the new rules will similarly not apply. The corporate migration rules therefore apply only to companies that cease to be resident under domestic income tax rules. The new rules are consistent with New Zealand's double tax treaties.
Consequential technical amendments
If a New Zealand-resident company migrates, it will cease to be a dividend withholding payment (DWP) company and a conduit tax relief (CTR) company. Its accounts will close and a debit adjustment made to bring any credit balance to nil. To recover the amount of conduit tax relief provided while the company was resident, a conduit tax relief company is also required to make an additional dividend withholding payment of the amount of any credit balance in its conduit tax relief account.
Previously, if a company ceased to be a New Zealandresident company it was required to file a DWP account return but it was not clear whether it automatically ceased to be a DWP account company and a CTR company. The DWP and conduit rules have been clarified to ensure that the same treatment that applies to an imputation credit account company ceasing to be a New Zealand resident also applies to DWP and CTR companies. Therefore, if a company ceases to be a New Zealand-resident company, it will automatically cease to be a DWP account company and a CTR company and may be required to pay additional DWP. These amendments are in line with the policy intent of the DWP and conduit rules, and can be regarded as a clarification.
The amendments concerning corporate migration apply to companies migrating on or after 21 March 2005, the date of announcement of these amendments by the government.
A grandparenting provision applies to companies that had done everything within their control to migrate by 21 March 2005, but had not yet become non-resident. In particular, the new corporate migration rules do not apply to companies that, before 21 March 2005, completed the requirements in the Companies Act 1993 for migrating companies relating to public notification, shareholder approval, Inland Revenue clearance and solvency, and that applied for incorporation under the laws of another country or territory.
The amendments to the dividend withholding payment and conduit rules apply from 1 April 1997.
Deemed liquidation rules
New subpart FCB contains the tax rules for migrating companies. Section FCB 1 is the purpose provision for the subpart. It refers to a company resident in New Zealand that ceases to be a New Zealand resident for the purposes of New Zealand income tax. The company will be subject to the tax rules that apply when it:
- disposes of its property at market value;
- is liquidated; and
- distributes shareholder funds (including the deemed disposal proceeds) to its shareholders.
Under new section FCB 2, a migrating company is treated as if, immediately before it became a nonresident company, it had paid as a cash dividend to its shareholders, the amount that would be available for distribution if the company had disposed of its property at market value and gone into liquidation.
Section CD 18, which defines dividends on liquidation, has been amended to also apply if an amount is treated as being paid under section FCB 2 to shareholders of a migrating company. Therefore, the amount in excess of the available subscribed capital per share and the available capital distribution amount will be a dividend. In relation to amounts treated as being paid to shareholders that are non-resident related companies, paragraph (c)(ii) of the definition of “dividend” in section OB 1 provides that the amount in excess of available subscribed capital per share will be a dividend.
Under the existing section ME 6(1), a migrating company is entitled at the time of emigration to attach existing imputation credits to distributions made under subpart FCB. Amendments have been made to section ME 6 to allow a migrating company to retrospectively attach imputation credits to a dividend arising under subpart FCB. Tax paid that is attributable to income derived before the migration or to the migration itself (from the deemed disposition of property) will be treated for imputation purposes as being paid immediately before the company ceases to be a New Zealand resident. A migrating company will therefore be able to attach the amount of the imputation credits treated as being available immediately before the company ceased to be New Zealand-resident to a deemed dividend arising under subpart FCB.
The amount that is treated as being paid to a resident shareholder will be resident withholding income to which the RWT rules in subpart NF apply. New section NF 4(6B) provides that a migrating company must pay the RWT deductions to the Commissioner by the date that is three months after its migration. Section 51 of the Tax Administration Act 1994 has been amended to give the company the same three-month period for providing related information to the Commissioner.
The amount treated as being paid to a non-resident shareholder will be non-resident withholding income to which the non-resident withholding tax rules in subpart NG apply. New section NG 11(4B) provides that a migrating company must pay the NRWT deductions to the Commissioner by the date that is three months after its emigration. Section 49 of the Tax Administration Act 1994 has been amended to give the company the same three-month period for providing related information to the Commissioner.
New section CD 32(15B) removes the potential for double taxation in the event that a migrating company subsequently pays a dividend to its shareholders. The amount of the dividend a migrating company is treated as having paid to shareholders immediately before the company migrated from New Zealand is added to the company's available subscribed capital that may be returned to shareholders tax-free in certain circumstances.
New section FCB 3(a) provides that a migrating company is treated as disposing of all its property at market value immediately before it ceases to be a New Zealand resident. Accordingly, gains in value of revenue account property will be subject to tax under existing legislation (for example, section CB 3 or CB 4) and excess depreciation deductions will be recovered under existing section EE 41.
New section FCB 3(b) treats the company as re-acquiring the property for the same market value for which it was treated as having been disposed of at the time of migration. This will establish a new cost base for property that will continue to be subject to tax in New Zealand.
Section EE 26, which allows for a 20% depreciation loading on New Zealand-new assets, has been amended to disregard the deemed disposition and reacquisition under section FCB 3. This amendment ensures that a migrating company is still eligible for this 20% loading on its assets, which is the appropriate treatment as actual ownership of the relevant property does not change at the time of migration.
Equivalent amendments have been made to the Income Tax Act 1994.
Amendments to the dividing withholding payment and conduit rules
New section MG 2(6) provides that a migrating company ceases to be a dividend withholding payment (DWP) account company. New section MG 2(7) provides that the company must furnish a DWP return and pay any further DWP payable under section MG 9.
New section MI 2(8) provides that a migrating company also ceases to be a conduit tax relief company and must furnish an imputation return and, under section MI 10(3), pay DWP of the amount of any credit balance in its conduit tax relief account.
Equivalent amendments have also been made to the Income Tax Act 1994.
|Example: Migration of a New Zealand company|
S Ltd was incorporated in New Zealand in 1995 and issued 140,000 ordinary shares at $2 each to resident shareholders and 60,000 ordinary shares at $2 each to non-resident shareholders (40,000 of those shares are held by related non-resident companies).
The shareholders resolve to transfer S Ltd's place of incorporation and its directorial and managerial functions offshore. S Ltd has a realised capital profit of $150,000 and revenue reserves of $300,000. S Ltd also owns shares held on revenue account in a company that owns commercial rental property in Wellington. The market value of these shares is $500,000. They were purchased for $450,000. S Ltd also owns a New Zealand-registered patent worth $250,000. The cost of the patent was $200,000, and depreciation deductions of $50,000 have been claimed.
S Ltd's imputation credit account has a credit balance of $100,000. 3
Under section FCB 3, S Ltd is treated as disposing of all its property at market value immediately before ceasing to be a New Zealand resident.
The taxable amount from the disposal of the patent is $100,000 (market value less cost (reduced by the amount of depreciation already claimed)). 4 The taxable amount from the disposal of the shares is $50,000 (market value less cost). 5 Under the proposed amendments, S Ltd's tax liability on the deemed disposal of its revenue account property is $49,500, and the tax paid is credited to S Ltd's imputation credit account.
The company that owns the commercial property will remain in New Zealand, and the patent is registered in New Zealand. Therefore, future income derived from the shares and the patent will continue to be subject to New Zealand tax. 6 Under section FCB 3, S Ltd will be treated as re-acquiring the shares at $500,000 and the patent at $250,000, which will establish new cost bases for those assets.
Under section FCB 2, S Ltd is treated as if it had been liquidated and distributed all available amounts (being shareholder funds and the disposal proceeds) to its shareholders immediately before it became a non-resident company.
The total amount deemed to have been distributed by S Ltd to its shareholders is $4.75 per share. 7
In calculating the amount of the dividend paid by S Ltd it is first necessary to exclude capital amounts from total funds. For these purposes, capital amounts comprise the amount of available subscribed capital (ASC) per share and, for shareholders that are not related non-resident companies, the available capital distribution amount.
Applying the formulae in the legislation, ASC per share is calculated as $2, and the available capital distribution amount is 75 cents. Therefore, the tax-free capital component of the amount distributed by S Ltd for each share held by a shareholder that is not a related non-resident company is $2.75, and the remaining $2 per share (representing revenue reserves) is taxable to each shareholder as a dividend.
S Ltd may attach imputation credits of 70 cents per share 8 to dividends paid to its shareholders.
The total amount received per share by resident shareholders on S Ltd's migration is $4.75, of which $2.75 (being $2 + $0.75) is tax-free. The remaining $2 per share is taxable to each shareholder as a dividend. The attached imputation credits of 70 cents per share can be used to satisfy the shareholder's income tax liability.
S Ltd is required to withhold resident withholding tax (RWT) from the dividends paid to resident shareholders. S Ltd's RWT amount per share is 19 cents. 9 S Ltd's total RWT amount is $26,600.10
Under section CD 32(15B), the amount of the distribution treated as a dividend is included in the subscriptions amount that S Ltd could return to shareholders tax-free.
Non-related non-resident shareholders
The total amount received per share by non-related non-resident shareholders on S Ltd's migration is $4.75, of which $2.75 (being $2 + $0.75) is tax-free. The remaining $2 per share is taxable to each shareholder as a dividend.
S Ltd is required to withhold NRWT from dividends paid to non-related non-resident shareholders. S Ltd's NRWT amount per share held by these shareholders is 30 cents.11 S Ltd's total NRWT amount in relation to these shareholders is $6,000.12
Related company non-resident shareholders
The amount of the dividend to the related non-resident company shareholders subject to NRWT is the amount paid in excess of ASC per share.
The total amount paid to related non-resident company shareholders on S Ltd's migration is $4.75, of which $2 is tax-free. The remaining $2.75 (representing revenue reserves and capital profits) is taxable to the company shareholder as a dividend subject to NRWT. S Ltd's NRWT amount per share held by these shareholders is 41 cents.13 S Ltd's total NRWT amount in relation to these shareholders is $16,400.14
These calculations are summarised in Table 2.
Operational implications of new legislation For a company to migrate, an application by the company for removal from the New Zealand register of companies must be accompanied by written notice from the Commissioner of Inland Revenue that the Commissioner has no objection to the company being removed from the New Zealand register. This is as per section 351(c) of the Companies Act 1993.
Inland Revenue's current practice is that a company wanting to migrate will not receive such a notice if the Commissioner cannot be sure that tax debts, that may arise or need to be collected once the company has migrated, will be met.
To mitigate this concern, taxpayers have in the past offered Inland Revenue a letter of guarantee from, for example, a related New Zealand company that has the means to satisfy the migrated company's tax liability, or a bank in other circumstances. With the letter of guarantee in place, Inland Revenue is then able to provide written notice to the Registrar of Companies that the Commissioner has no objection to the migration.
While Inland Revenue's practice will not change with the new legislation there is now a greater likelihood of a tax debt, due to the additional income tax and withholding liabilities arising from this legislation, than was previously the case. Thus, companies should be aware that, on a case by case basis, some form of guarantee may need to be offered to ensure that the Commissioner has no objection to the migration.
Previously, when a notice was given that the Commissioner had no objection to the migration of a company, it had been implicit that such a notice applied only to the company at the date of the notice. The notice did not apply should any other company or companies be subsequently amalgamated into the company.
For clarity in future, Inland Revenue practice will be that, when written notice is given that the Commissioner has no objection to a company being removed from the New Zealand register, the notice will explicitly state that it applies only to the company on the date of the notice and not in the event other companies are amalgamated into it.
1Section OE 2 of the Income Tax Act 2004.
2Unless the property is a financial arrangement or a foreign investment fund interest.
3A company could make use of the foreign investor tax credit rules by paying a fully imputed dividend and a supplementary dividend to its non-resident shareholders before it ceases to be a New Zealand-resident company.
4 See sections CB 26, DB 29 and DB 31.
5 See section CB 1.
6 Assuming that there are no tax treaty implications.
7 (400,000 + 150,000 + 300,000 + 150,000 – 49,500)/200,000. Note that all figures in this example have been rounded to two decimal places.
8 Existing imputation credit rules require the same imputation credit ratio to apply to all distributions within an income year. Applying this rule to the total imputation credit account balance of 149,500 allows dividends to resident shareholders to have 70 cents per share of imputation credits attached.
9 ((2+.70) x .33) – .70
10 .19 x 140,000
11 15 x 2 (assuming that the standard NRWT treaty rate of 15% applies).
12 .3 x 20,000
13 .15 x 2.75
14 .41 x 40,000