Exemption for rights to benefit from employment-related foreign superannuation schemes

Section EX 36 of the Income Tax Act 2004, sections CG 14(3) and OB 1 of the Income Tax Act 1994 and sections 245R(1) of the Income Tax Act 1976

Amendments have been made to the foreign investment fund (FIF) exemption for rights to benefit from employment-related foreign superannuation schemes. The amendments extend the exemption to apply to returning residents and also give permanent exemption relief for all rights that were acquired in the first five years of each new period of New Zealand residence. These amendments apply retrospectively from the commencement of the FIF rules.

Background

Individuals working in Australia generally have compulsory contributions made on their behalf by their employers into a superannuation scheme (the Australian Superannuation Guarantee Scheme). This scheme is an employment-related foreign superannuation scheme for New Zealand tax purposes. In general, Australian and New Zealand citizens cannot access their superannuation entitlements until they reach retirement age. If they migrate or return to New Zealand they could be subject to tax on those entitlements, under New Zealand's FIF rules.

The FIF rules currently tax the income earned by a foreign entity (such as a foreign superannuation scheme) according to the rights held by New Zealand residents in that entity. They ensure that foreign income earned by a foreign superannuation scheme on behalf of New Zealand residents is subject to New Zealand tax.

Consultation with the private sector indicated that people who held rights to benefit from an Australian superannuation scheme are not complying correctly with their tax obligations under the FIF rules and, indeed, may not even be aware that they have to account for tax. It is likely that this non-compliance is not unique to people with Australian superannuation interests. For those people who are aware of their tax responsibilities, determining whether they are required to pay tax under the FIF rules can involve high compliance costs such as specialist tax advice. Although the current FIF exemptions provide some relief from the rules, the difficulty is determining which exemption applies and how to meet the continuing requirements of the exemption if a person wants to continue to contribute to a foreign superannuation scheme after moving to New Zealand.

In the course of reviewing the effects of the impact of the FIF rules on individuals with rights to benefit from a foreign superannuation scheme, an inconsistency was also identified in the way first-time residents and returning residents to New Zealand were treated under the rules. There were more exemptions available to firsttime residents than for returning residents, which raised concerns about equity and consistency.

For example, the previous exemption for rights to benefit from an employment-related foreign superannuation scheme applied to those rights that were held by firsttime residents only and that were acquired by the person before he or she became a New Zealand resident for tax purposes.

The amendments specifically address the inconsistency in the FIF treatment of first time residents and returning residents. They also increase the level of exemption for rights to benefit from an employment-related foreign superannuation scheme, thereby improving the overall equity of the FIF rules and decreasing the tax burden and the associated compliance costs for those people affected.

Key features

The exemption in section EX 36 of the Income Tax Act 2004 applies to the rights of an individual to benefit, as a beneficiary or a member, from an employment-related foreign superannuation scheme. These rights must have accrued during the period:

• for which the person is not a New Zealand resident; and/or
• for which the person is a New Zealand resident and that
  • begins when the person becomes a New Zealand resident; and
  • ends before the first day of the fifth income year following the income year in which the person becomes a New Zealand resident.

The extent to which these rights have accrued during the period as described above is calculated using the following formula:

The result of this formula is the value of the rights that are permanently exempt from the FIF rules. If there is more than one period that meets the description above, the rights accruing to each of these periods will be permanently exempt from the FIF rules.

Consequential amendments have also been made to the corresponding provisions in the Income Tax Act 1994 and the Income Tax Act 1976.

Application date

The amendments to the exemption for rights to benefit from employment-related foreign superannuation schemes apply from the commencement of the foreign investment fund rules, being the 1991–92 income year for taxpayers with a corresponding non-standard accounting year ending after 2 July 1992, or the 1992–93 and subsequent income years for other taxpayers.

Example 1: Foreign hybrid in non-grey list country (NZ company) 10% interest Tax rate 33% NZ Co Singapore LP (CFC) Tax rate 30%       Total of $1,000 income
Singapore tax paid by NZ Co
Profit	$100
Tax @ 20%	$20 (paid directly by NZ Co not entity)
Singapore LP profit available for distribution = $100 (because the tax is paid by NZ Co.)
NZ attributed foreign income (AFI)
AFI	$100
NZ tax @ 33%	$33
LC 4 Credit	($20)
NZ tax to pay	$ 3
Distribution (without section CD 10C) (dividend of $100: Singapore LP profit)
UFTC to 100	x 200 1000
= 20
FDWP = $100 + 20	= $120.00
FDWP @ 33%	= $39.60
UFTC credit	= (20)
Beta credit	= (13)
Net FDWP	= $6.60
Total tax paid by NZ Co	= $39.60
Total effective tax rate is 39.6%
With section CD 10C – dividend reduced
Tax paid in Singapore $ 20
Dividend received	$100
Dividend reduced	(20)
Net dividend	$ 80
FDWP = 80 + 20	= $100
FDWP @ 33%	= $ 33
UFTC	= (20)
Beta	= (13)
Net FDWP	= 0
Total tax paid by NZ Co = $33
Total effective tax rate is 33%

Example 2: Foreign hybrid in non-grey list country (NZ individual)
10% interest Tax rate 39% Individual Singapore LP (CFC) Tax rate 30% Total of $1,000 income
Singapore tax paid by NZ individual
Profit	$100
Tax @ 20%	$20 (paid directly by NZ individual)
Singapore LP profit available for distribution = $100 (because the tax is paid by NZ individual)
NZ attributed foreign income (AFI)
AFI $100
NZ tax @ 39%	$ 39
LC 4 Credit	($ 20)
NZ tax to pay	$ 19
Distribution (without section CD 10C)
Dividend received	$100
NZ tax @ 39%	$ 39
Beta credit	$ (19)
Tax	$ 20
Total tax paid by NZ individual = NZ $39 + Singapore $20 = Total $59
Total effective NZ tax rate on the post-foreign tax dividend of $80 is 48.75%
With section CD 10C – dividend reduced
Tax paid in Singapore	$ 20
Dividend received	$100
Dividend reduced	$ (20)
Net dividend	$ 80
Dividend received	$ 80
NZ tax @ 39%	$ 31.20
Beta credit	$ (19)
Tax	$ 12.20
Total tax paid by NZ individual = NZ $31.20 + Singapore $20 = Total $51.20
Total effective NZ tax rate on the post-foreign tax dividend of $80 is 39%

Example 3: Foreign hybrid in grey list country (NZ company)
10% interest Tax rate 33% NZ Co US LLC (CFC) Tax rate 33% Total of $1,000 income
US tax paid by NZ Co
Profit	$100
Tax @ 35%	$35
US LLC profit available for distribution = $100 (because the tax is paid by NZ Co)
Distribution
UFTC =	100 x 0.33 0.67
=	49.25
FDWP = 100 + 49.25 =	$ 149.25
FDWP @ 33% =	49.25
UFTC =	(49.25)
Net FDWP =	$ 0
Total tax paid by NZ Co =	$ 35
Therefore no need for section CD 10C
However no issues with double taxation arise if section CD 10C is applied.

Example 4: Foreign hybrid in grey list country (NZ individual)
10% interest Tax rate 39% Individual US LLC (CFC) Tax rate 35% Total of $1,000 income
US tax paid by NZ individual
Profit	$100
Tax @ 35%	$ 35 (paid directly by NZ individual)
US LLC profit available for distribution = $100 (because the tax is paid by NZ individual)
Distribution (without section CD 10C)
Dividend received	$100
NZ tax @ 39 %	$ 39
Total tax paid by NZ individual = NZ $39 + USA $35 = Total $74
Total effective NZ tax rate on the post-foreign tax dividend of $65 is 60%
Distribution (with section CD 10C)
Tax paid in US	$35
Dividend received	$100
Dividend reduced	$ (35)
Net dividend	$ 75
Dividend received	$ 65
NZ tax @ 39%	$ 25.35
Total tax paid by NZ individual = NZ $25.35 + USA $35 = Total $60.35
Total effective NZ tax rate on the post-foreign tax dividend of $65 is 39%