Reforms for Non Resident Withholding Tax and Approved Issuer Levy
Tax Alert - February 2017
By Emma Marr
Proposals to amend the non-resident withholding tax (NRWT) and approved issuer levy (AIL) rules are a step closer to enactment, as the May 2016 Bill, which included extensive reforms to the rules, was reported back to Parliament in late 2016. Further details on the proposals can be found in our May 2016 Tax Alert article.
As we noted when the Bill was introduced, these proposals are particularly complex. Taxpayers with overseas borrowing, whether related party or not, should be getting in touch with their Deloitte tax advisor to ensure they are prepared for the reforms when they come in to force (either on the date of enactment, which is expected to be in the next couple of months, or from the start of the next income year after enactment).
Three main aspects of the reforms are discussed below. Limitations on the offshore and onshore branch exemptions are also incorporated in the Bill. Officials accepted a number of submissions suggesting drafting changes to these rules.
Removing timing mismatches
The Bill introduces new rules aimed at removing the ability for associated taxpayers to benefit from a mismatch between when income tax deductions are available for interest expenditure and when the associated NRWT liability arises. Currently the liability to pay NRWT on an amount of interest may arise later than the deduction for that interest payment. Under the proposed new rules, which introduce the concept of non-resident financial arrangement income (NRFAI), the ability to defer an NRWT liability on a related party debt will be limited and should more closely align with the income tax deduction (calculated under the financial arrangement, or FA rules) available to the borrower for that interest.
The NRFAI rules introduce a deferral calculation performed from the end of the second year of a FA. The calculation compares interest deductions available on that FA up to the end of the year immediately prior to the year the calculation is being performed with interest payments made on the FA in the years up to the end of the year of calculation, plus any interest payments made after the balance date but before the NRWT is due (being within the third month following balance date). This approach recognises that interest may often be accrued up to year end then paid shortly thereafter, and does not intend to alter that type of arrangement – more significant deferrals are targeted. If total interest payments divided by total deductions is less than 90%, NRFAI arises and NRWT will be payable.
In a simple example, say a loan was taken out in late 2018 with a non-resident related party, after the enactment of the Bill. The borrower has a 31 March balance date. At the end of the second income year following the creation of the loan (the 2020 income year) the New Zealand borrower must compare the interest deductions available on the loan for the 2019 year (the year immediately before 2020) with the interest payments made in the 2019 and 2020 income years plus any that might have been paid up to 20 June 2020 (the due date of the NRWT on the NRFAI if any is due). If the interest payments made exceed 90% of the interest deductions available then no NRFAI arises and NRWT will not be payable. However if the interest payments made are less than 90% then the shortfall to the 90% amount is deemed NRFAI and is liable to NRWT.
The Bill introduces a de minimis level of total expenditure under all related party debts of the borrower and any companies in the same group of companies in the prior year of $40,000. In this case no NRFAI can arise.
A number of submissions were made on the Bill, ranging from the popular submission that the reforms shouldn’t go ahead at all, to more detailed submissions on how the wording of the proposed legislation could be improved. Some comments in the Official’s Report, as well as changes made to the legislation as a result of these submissions include:
- Clarifying that the new NRWT rules are only intended to apply to arrangements that provide funding, not arrangements such as interest rate or foreign exchange swaps, or collateral held as security on a derivative.
- Clarifying and improving the terminology used in the new rules by referring to a “borrower” and a “lender” rather than “Person A” and “Person B”.
- Undertaking to clarify a number of aspects of the new rules by publishing examples in a Tax Information Bulletin after the legislation is passed. (It is always preferable that legislation can be understood on its own without extra explanation, but it appears these particular rules will not be).
Submissions that the new rules are overly complex were not addressed by Officials in the Report. Further, alternative suggestions to the proposals made by submitters, such as a targeted anti-avoidance rule or denying interest deductions until NRWT is paid were rejected by Officials (partially, and somewhat ironically, on the basis that they would be too complex).
Although taxpayers may not need to adjust their current practices following the enactment of the new rules, they will still need to understand them, perform the required calculations, and document the outcome of the calculations in order to support their tax position.
The deferral calculation can only create NRFAI after the end of the second year of a financial arrangement. In the first year the deferral calculation is deemed to be over 90%. The new rules will apply to existing arrangements on and after the first day of the borrower’s income year that starts after the date of enactment. For all other arrangements (i.e. new FAs) the rules will apply from the date of enactment.
Tightening AIL criteria by widening definition of ‘related parties’
The Bill also tightens the criteria that must be met in order to pay AIL (at a rate of 2%) rather than NRWT (generally 10% or 15%). AIL cannot be paid on loans between related parties and the changes address the concern that parties are structuring around the rules to pay AIL instead of NRWT. The Bill widens the definition of situations that are between related parties, to target back-to-back loans and multi-party lending arrangements interposing a third party to mask what would otherwise be an associated party loan. The AIL rules will also introduce the concept of non-residents “acting together”, who will now be related parties (a similar concept exists in the thin capitalisation rules).
The reported-back Bill makes some changes to these proposed reforms.
- The circumstances in which parties will be treated as creating a back-to-back loan are narrowed and the test now requires that the arrangement has the ‘purpose or effect’ of creating FA expenditure without any corresponding NRWT liability.
- Rules creating an “as agent” tax liability for the direct lender in a back-to-back loan arrangement (i.e. the bank) have been amended to allow lenders to reduce the likelihood that they would have any obligation to pay NRWT on behalf of a borrower.
- Other drafting changes are recommended, including moving the definition of a ‘non-resident owning body’ from the thin capitalisation rules to the general definition section of the legislation.
Reforms to the AIL rules will apply from the date of enactment of the Bill.
New AIL registration criteria abandoned
The major change to the NRWT/AIL proposals in the reported-back Bill is that strict new limitations on when a security can be registered for AIL have been scrapped. This is a welcome development, as the proposals were very restrictive and would have effectively closed the door to AIL to all but a few New Zealand borrowers.
For further information on these complex rules, please contact our usual Deloitte tax advisor.
February 2017 Tax Alert contents