Government issues paper on NRWT and related party and branch lending

On 7 May 2015 the Government issued an Officials’ issues paper “NRWT: related party and branch lending”.  Interest, dividends and royalties sourced in New Zealand and paid to non-residents (known as non-resident passive income or NRPI) is subject to non-resident withholding tax (NRWT).

This issues paper is focussed on strengthening the NRWT rules in relation to interest arising on related party debt and it also proposes material changes to the application of the Approved Issuer Levy (AIL) regime.

NRWT is levied on interest at the rate of 15% but is generally reduced to 10% when a double tax agreement is applied.  Officials consider that the NRWT rules sometimes have limited application due to the wide variety of transactions available to prevent or delay the payment of interest with a New Zealand source.  In certain cases, where interest is paid to a non-associated non-resident lender, NRWT is payable at a rate of 0% and instead the approved issuer pays a levy which is calculated at a rate of 2% on the interest paid.

While this issue is a New Zealand domestic law issue, it has been included as an item under the base erosion and profit shifting (BEPS) project in the Government’s Work Programme as the primary focus is on the appropriate taxation of income derived by non-residents from New Zealand.  The Minister of Revenue Todd McClay states “Acting to remedy this deficiency in our tax laws is part of New Zealand’s response to the issue of multinational tax avoidance”.   

As a starting point, the proposals are extremely wide-reaching.  It will be important for all arrangements to be tested under these proposals in order to identify any cases where the scope should be narrowed and unintended consequences addressed.

The proposals can be grouped in the following three categories:

Preventing arbitrage of NRWT rules with financial arrangement rules

Essentially under current law, NRWT is not payable to Inland Revenue until the income on which it is payable is distributed, credited or dealt with on the non-resident lender’s behalf.  However, from the New Zealand borrower’s perspective, the financial arrangement rules apply to determine the income or expenditure and timing of any interest deductions (typically on an accrual basis).  This potential mismatch of the tax rules can mean a deduction can be claimed by the New Zealand borrower under the financial arrangement rules, while the NRWT liability may be deferred.  It may also result in amounts that are essentially interest not being subject to NRWT.

The Government has decided that this is not the correct policy outcome.  The paper has three suggestions for addressing this mis-match and shoring up the tax base.  These changes will only apply to certain arrangements between associated persons.  These are to:

  • Broaden the kind of arrangements that give rise to NRPI by amending the definition of “money lent”  for the purposes of the NRWT rules so that there is better alignment between NRPI and financial arrangement expenditure
  • Widen the definition of “interest” to bring the rules for determining the amount of NRPI more into line with the financial arrangement rules
  • In certain cases, impose NRWT annually on an amount equal to the financial arrangement income that would have arisen if it were subject to the financial arrangement rules.  That is, imposing NRWT on accruing income calculated according to a YTM or expected value method, rather than on payments made where there is a more than immaterial element of deferral.   The detail behind this is quite complicated.

Preventing associated persons accessing the AIL rules

The effect of NRWT on the cost of capital for New Zealand borrowers was recognised back in 1991 when the AIL regime was introduced.  Under this regime, a person to whom money is lent, may elect to pay AIL in relation to a security for the purposes of the NRWT rules.  AIL can only be used where the borrower is not associated with the lender. The reason for this restriction is that related-party lending can be a substitute for equity from a parent and be used to increase interest deductions thereby reducing the taxable profit that would arise if the parent invested with equity.  AIL at 2% on related party interest would be inappropriately low when that interest deduction reduced the New Zealand borrower’s taxable income, which is generally subject to a 28% or higher income tax rate.  Officials consider that the current restrictions which prevent related parties from accessing the AIL regime are not robust enough and can be easily structured around.  Therefore the following changes are proposed:

  • That NRWT be paid (rather than AIL) on back-to-back loans and other forms of indirect funding
  • That NRWT be paid (rather than AIL) in situations where interest is paid to a non-resident who is not associated with the borrower but is part of a group of persons (including non-residents and New Zealand residents) who are acting together and would be associated with the borrower if they were a single entity.  This would significantly expand the associated person acting together concept for AIL purposes.
  • That AIL be limited to loans where it is expected that more than 75% of the total borrowings will be from a financial institution in the business of lending money to the public or raised from a group of 10 or more associated persons.  This test will not apply to a borrower who is a financial institution in the business of lending money to the public.

Restricting the branch exemption

Currently there are exemptions from NRPI for interest payments that are made by foreign branches of New Zealand companies or that are made to foreign companies with New Zealand branches.  These exemptions mean that certain interest payments are not currently taxed.  Officials now suggest this is not consistent with the policy intent.  The proposals therefore include:

  • Limiting the existing offshore branch exemption so that interest paid by the offshore branch of a New Zealand resident is subject to NRWT or AIL to the extent that the interest is paid on money which is lent to a New Zealand resident
  • Limiting the existing onshore branch exemption from NRWT so that it applies only to interest that is received by a non-resident in connection with a business carried on through a fixed establishment in New Zealand.  Where a non-resident operates a New Zealand branch, New Zealand-sourced interest income not connected with their New Zealand branch would be non-resident passive income (NRPI), subject to NRWT or AIL
  • Extending the AIL regime to allow members of New Zealand banking groups to access the AIL rules on interest payments to their non-resident associates.  The reasoning in the paper notes “this recognises that the owners of New Zealand banks are themselves margin lenders, whose funding in the main is sourced from unrelated lenders. The tax system would be improved by providing them with a transparent way to borrow from offshore with an appropriate level of tax, rather than leaving them to rely on the offshore and onshore branch exemptions, neither of which has a policy which supports its use in this context”.


The reforms proposed will increase the amount of tax that is imposed on borrowing by New Zealand residents from non-residents.  They will also have an impact on non-resident direct investment in New Zealand.   It will be very important for parties impacted by these changes to engage in the consultation process.  This includes both non-resident lenders and New Zealand borrowers.

The issue with taxing cross border lending is whether the non-resident is able to claim a credit in their home jurisdiction for the tax imposed.  If not, then that tax cost is likely to be priced into the interest rate they charge and effectively borne by the New Zealand borrower.  Given the potential negative effect this could have on New Zealand’s economic growth and international competitiveness we would expect that Officials have undertaken appropriate analysis to ensure that these proposals will not have a negative impact on the cost of funding to New Zealand businesses or the level of foreign investment in New Zealand.

These changes represent a radical shift in New Zealand’s long standing international tax policy settings which have been in place since at least the 1990s.  Inland Revenue is intimately familiar with the outcomes which to date have been blessed from a policy and operational viewpoint.  The current rules allow access to international finance markets without an additional tax cost for New Zealand borrowers.  It is quite possible that an additional AIL cost will at least in part be passed on to New Zealand borrowers.

The proposals seemingly run contrary to the changes in 2011 which provided limited exemptions from AIL for listed New Zealand dollar bonds.  The 2011 changes had their origin in the Capital Markets Task Force which recognised the barrier that AIL imposed on accessing international financial markets.  These proposals run contrary to that recognition and essentially seek to go further and limit the access to the AIL regime other than in the context of the banking sector.

In imposing a tax (albeit in some cases a 2% levy), New Zealand is out of step with a number of its trading partners (e.g. Australia, UK and the US) who provide various exemptions from withholding tax in similar circumstances to ensure that tax does not act as a barrier/cost to capital flows.

The proposals are to be introduced in a tax bill scheduled for late 2015.  The reforms will generally apply to financial arrangements entered into on or after enactment of the legislation (in the second half of 2016).  For financial arrangements entered into before enactment, taxpayers will be required to apply the new rules for the income years following enactment.

Submissions close on 16 June 2015.  For more information about these measures, please contact your usual Deloitte tax advisor.

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