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IRD guidance on withholding tax for non-resident directors fees

Tax Alert - September 2018

By Veronica Harley

Inland Revenue has issued a draft interpretation statement which sets out when withholding tax is required to be withheld from fees paid to directors who are not resident in New Zealand. When finalised, it will complete the guidance on the treatment of directors’ fees. Guidance was released in 2017 on payments of fees to resident directors (refer IS 17/06) which left the issue of how to deal with fees paid to non-resident directors hanging. This is an area where it is necessary for the business engaging a non-resident director to know and understand when it has a withholding tax obligation.

The draft interpretation statement does provide some clarity however, far from being a straightforward issue, the rules are technically very complex and highly dependent on the facts and circumstances of the particular scenario. It’s also become apparent that recent changes as a result of BEPS concerns, which were mostly targeted at multinational companies, are starting to bite in other, unexpected, areas. We have set out a high level explanation below of the draft guidance and the factors that will need to be established in determining whether a New Zealand company has an obligation or not to withhold tax.

Identify who you have contracted with

The first step is to identify who you have contracted with because both individuals and entities (such as partnerships and companies) can provide directorship services. While it may be more common to contract with an individual, it is possible to contract with an entity to provide directorship services via an entity, for example, an employee of a non-resident company. This fact will have a bearing on whether the fees have a New Zealand source. It is important to know where your director (or entity providing directorship services) is resident, as the rules may apply differently if the residence is in a Double Tax Agreement (DTA) or non-DTA country; or if the director is from the United States (which does not have a specific DTA article on directors’ fees).

Determine the source of directors’ fees

Withholding tax will only need to be withheld if the directors’ fees are determined to have a New Zealand source, and this is where it starts to get complicated.

In the case of non-resident individuals, the Commissioner concludes (after several pages of analysis), that all directors’ fees payable to a non-resident individual have a New Zealand source. This is either under sections YD 4(4) and (18) of the Income Tax Act 2007 (the Act) or under the new section YD 4(17D) of the Act if applicable (i.e. the individual is tax resident in a country which has a DTA with New Zealand and that DTA has an article on directors’ fees). This is regardless of whether the services are performed physically in New Zealand or from overseas.

In the case of a non-resident entity resident in a DTA country, it is first necessary to determine whether the directors’ fees are attributable to a “permanent establishment” in New Zealand. If so, the new section YD (17D) will apply here as well to treat the fees as New Zealand sourced.

If the fees are not attributable to a permanent establishment, then it is a matter of determining the extent to which the non-resident entity physically performs directorship services in New Zealand (and this may require apportionment). The example in the draft considers that in the case of monthly meetings, of which six are attended in person and six are attended via videoconference, that those attended in person will have a New Zealand source and so the fees are apportioned on this basis. It is then necessary to determine what would have been paid to an independent third party for carrying out the non-resident entity’s New Zealand directorship activities and therefore the directors’ fees apportioned may differ from the amount the New Zealand company has contracted to pay. However, if it is concluded that the directorship services are entirely performed from overseas, there is no New Zealand source (and no withholding tax). Significantly, in this regard it therefore makes a difference as to whether directors attend meetings physically in New Zealand or “from overseas” i.e. via videoconference.

Section YD 4(17D) is a new source rule which deems an item of income to have a New Zealand source under our domestic legislation if New Zealand has a right to tax that item of income under a DTA. Whether section YD 4(17D) applies will depend on the country concerned and terms of the DTA. This section was inserted into the Act as part of the recent BEPS reform and will apply to income years beginning on or after 1 July 2018.

Further explanation on the new source rules can be found in draft BEPS guidance recently published.


Applying the schedular payment rules

Having determined that directors’ fees paid to either a non-resident individual or entity have a New Zealand source, the next step is to consider how the schedular payment rules apply. The outcome will depend on whether the person is considered to be a non-resident contractor or not. If so, there are certain relief provisions and de minimis rules that could apply so that withholding tax need not be withheld. Further, if the non-resident individual or entity holds an exemption certificate, then the New Zealand company is not required to withhold tax.

Withholding tax at the correct rate

Having determined that tax should be withheld, the New Zealand company has an obligation to withhold at the time of payment. Broadly, it is likely to be one of 5 rates:

  • No notification rate of 45% (if the non-resident does not provide you with an IR330C form).
  • Standard withholding rate of 33% (if the non-resident provides you with the IR330C form but does not self-elect a rate).
  • Elected withholding rate (a non-resident can elect their own rate via the IR 330C, but it cannot be less than 15%).
  • Special rate (if the non-resident presents you with a special rate certificate which means they have applied for a special rate which is below 15%).
  • Prescribed rate (only if Inland Revenue determines and notifies you of the requirement to withhold at a prescribed rate).

When do the rules apply?

This is also a curly one to work through, as it depends on which source rule applies. For example, if withholding tax will only be payable because of the new source rule (i.e. s YD 4(17D)), this section only applies to income years commencing on or after 1 July 2018, which for many non-residents will not yet have started. For others, these rules will already have been technically applying, albeit the Commissioner’s guidance has been lacking until now. It is highly likely there are some companies who have not been withholding tax on non-resident directors’ fees historically. On this point, the Commissioner is considering whether to issue an operational statement which specifies that if there is a change in interpretation, this guidance should have prospective application.

As noted above, the rules are complex and we would be happy to discuss your particular circumstances and how the rules may apply to your business. Submissions on the draft statement close on 5 October 2018.

 

Section YD 4(17D) is a new source rule which deems an item of income to have a New Zealand source under our domestic legislation if New Zealand has a right to tax that item of income under a DTA. Whether section YD 4(17D) applies will depend on the country concerned and terms of the DTA. This section was inserted into the Act as part of the recent BEPS reform and will apply to income years beginning on or after 1 July 2018.

Further explanation on the new source rules can be found in draft BEPS guidance recently published.

Section YD 4(17D) is a new source rule which deems an item of income to have a New Zealand source under our domestic legislation if New Zealand has a right to tax that item of income under a DTA. Whether section YD 4(17D) applies will depend on the country concerned and terms of the DTA. This section was inserted into the Act as part of the recent BEPS reform and will apply to income years beginning on or after 1 July 2018.

Further explanation on the new source rules can be found in draft BEPS guidance recently published.

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