Closely held companies bill reported back with significant changes
Tax Alert - December 2016
By Veronica Harley
The Taxation (Annual Rates for 2016-17, Closely Held Companies, and Remedial Matters) Bill (“the Bill”) was reported back to Parliament by the Finance and Expenditure Committee (FEC) on 25 November 2016.
As a reminder, the Bill includes over 70 different reforms, including changes in relation to the following areas:
- Review of the tax rules for closely held companies (e.g. look-through companies);
- Non-resident withholding tax (NRWT) and Approved Issuer Levy: related party lending;
- GST - technical issues;
- Related party debt remission relief;
- Interaction of loss grouping and imputation rules;
- Time bar application to ancillary taxes;
- Amending the empowering provision for New Zealand’s double tax agreements (DTA) to clarify that anti-avoidance rules still override the effect of a DTA;
- Aircraft overhaul expenses: deductibility and timing; and
- Various other remedial changes.
The FEC received 36 submissions. As a result, a number of amendments have been made in relation to the draft legislation which we previously reported on in our May Tax Alert. Below, we comment on the key changes to be aware of in relation to the main policy issues in the Bill.
Closely held companies
As the title of the Bill would suggest, the Bill includes a number of changes relevant to closely held companies, including look-through companies (LTCs) which will apply from the beginning of the 2018 income year. These are a mixed bag. On the one hand, the deduction limitation rule is being removed which is extremely positive, while on the other, the LTC regime’s entry criteria is being tightened which will cause some LTCs to convert to an ordinary company. There are also changes to limit the amount of foreign income that an LTC can earn before losing its LTC status.
Submitters were generally supportive of proposed changes in relation to closely held companies; however concerns were expressed about the proposed tightening of the LTC regime’s eligibility criteria and the resulting implications of transitioning to an ordinary company (i.e. that exit tax would be payable). A positive change is the inclusion of a transitional rule (to apply for the 2018 year only) which will allow the tax book values to be rolled over to the ordinary company. There have also been refinements in relation to the grandparenting of charities’ LTC holdings, clarifications to the proposed restrictions on an LTC earning foreign income and the rules for counting beneficiaries and trustees as LTC counted owners.
A welcome amendment following the Bill’s report back is a re-write of the draft legislation of the debt remission proposals. Broadly, these proposals sought to ensure that the tax rules do not produce income in circumstances where the debt remission causes no change in the net wealth of the economic group or dilution of ownership. However the first draft was problematic and it’s good to see that Officials have acknowledged that the original legislation was “trying to do too much too briefly”, was “unnecessarily complicated” and may not work as intended. As such, the rule has been rewritten to deal with each of the following scenarios:
- Where the debtor and creditor are in the same wholly-owned group as the debtor, and the debtor is a New Zealand resident company;
- Where the creditor is a member of the same wholly–owned group of companies as the debtor and, for the debtor, a group of persons who are New Zealand resident companies hold common voting interest which add up to 100%;
- Where the debtor is a company and the creditor is not a member of the same wholly-owned group of companies as the debtor, but the creditor has ownership interests in the debtor;
- If the debtor is a partnership, the creditor has a partner’s interest in the income of the debtor;
- If the debtor is a look-through company, the creditor has an effective look-through interest in the debtor.
A caveat to the above scenarios is that the relief rule will not apply if the creditor and debtor are members of the same wholly owned group of companies and the creditor is a non-resident and the debt has been held by a person that is not a member of the wholly owned group of companies.
The debt remission rule has been backdated to apply from the 2007 income year in order to provide certainty for taxpayers who have essentially taken this filing position in past returns. However if a taxpayer has taken an inconsistent tax position in a past year, then that tax return will stand and will not be able to be reopened.
It is important to note that to the extent the debt is remitted or forgiven after 1 July 2017, “debt” will be deemed to include any accrued but unpaid amounts, such as accrued but unpaid interest. Therefore the full amount of the debt (including any accrued but unpaid interest) will be deemed to be paid to the creditor. This denies the associated creditor a bad debt deduction for any accrued but unpaid interest as at 1 July 2017. This could have adverse implications for historic bad debt deductions claimed by the creditor in respect of accrued by unpaid interest with the effect that the creditor may be subject to tax on accrued interest income that it does not receive. We recommend you discuss this with your Deloitte tax advisor.
NRWT and AIL issues
The Bill includes significant changes to strengthen the NRWT rules in relation to interest arising on related party debt. Broadly, the proposals will remove the ability for related taxpayers to benefit from a timing mismatch between when income tax deductions are available for interest expenditure and when the associated NRWT liability arises. Most submitters were generally supportive of the need to have robust policy settings and accepted that some aspects of these rules needed strengthening. However submitters were critical of the overly complex method of achieving this. Submitters also had concerns about the potential increase in the cost of capital and impact on inbound investment. Although various alternative suggestions were made by submitters, Officials have mostly stuck to their guns, albeit they have refined and clarified some issues within the draft legislation. These rules will apply to existing arrangements from the beginning of the taxpayer’s first year after enactment of the bill and so the exact application date will depend on when the bill is enacted and the taxpayer’s balance date. The rules are still complex and taxpayers with related party cross border debt will need to take advice on the application of these new rules to their situation.
The first draft of the Bill included significant changes to the Approved Issuer Levy (AIL) regime as there was an initial policy concern that parties were structuring around the rules to pay the 2% AIL levy instead of NRWT. It is very pleasing to note that these measures have been removed on the basis that proposals would have imposed compliance costs on already compliant borrowers.
The Bill is likely to be enacted in early 2017 when Parliament resumes in the New Year. There is a need to get the Bill enacted and in force before 1 April 2017 when most of the measures will start to apply for most taxpayers. For further information on how these measures will apply or the other issues within the Bill, please contact your usual Deloitte tax advisor..
December 2016 Tax Alert contents
- Timely revised guidance on deductibility of certain earthquake related costs
- Closely held companies bill reported back with significant changes
- Charitable change to the FBT rules? Depends on your facts
- Business tax simplification measures are a step closer
- Calculating “market rental value” on employee accommodation – guidance finally released
- R&D tax credits – our experience to date
- IR’s Operational Guidelines: Pre-Litigation Settlements
- What’s on the Tax Policy Agenda?
- A snapshot of recent developments