Protocol to New Zealand-U.S. treaty: A New Zealand perspective

Transcription

1 Protocol to New Zealand-U.S. treaty: A New Zealand perspective The 2008 protocol updating the New Zealand-U.S. tax treaty came into force on 12 November The protocol provides for significantly more beneficial treatment of dividends, interest and royalties than under the current treaty, but adds a comprehensive limitation on benefits (LOB) article. Other amended provisions address information exchange and administrative assistance (with immediate effect); the taxation of former citizens and long-term residents; and the treatment of fiscally transparent entities. The protocol will apply: For withholding taxes, for amounts paid or credited on or after 1 January 2011 (for both countries); In the case of New Zealand for other taxes, for income years beginning on or after 1 April 2011; and In the case of the U.S. for other taxes, for taxable periods beginning on or after 1 January Dividends The protocol reduces the withholding tax rates that can be imposed on dividends derived by certain New Zealand and U.S. resident companies from the other state. In addition to the existing 15% withholding tax, the protocol provides for a 5% rate where the beneficial owner (investor) is a company that owns directly at least 10% of the voting power in the company paying the dividends. An exemption from withholding tax will be available where dividends are paid to a beneficial owner that is a company resident in the other state and that has owned directly or indirectly 80% or more of the voting interests in the company paying the dividends for a 12-month period provided certain LOB conditions are satisfied. The special LOB provision for dividends limits the exemption to dividends received by a company that: Meets the publicly traded test or is a qualifying subsidiary (i.e. at least 50% of the aggregate vote and value of the shares (and at least 50% of any disproportionate class of shares) in the distributing company is owned directly or indirectly by five or fewer companies meeting the publicly traded test provided that, in the case of indirect ownership, each intermediate owner is a resident of the U.S. or New Zealand); or Simultaneously meets both the ownership and base erosion test and the activity provision with respect to the received dividends; or Has received a certificate from the competent authority of the source state that it is eligible for treaty benefits. It is likely that the 0% rate will be available where the relevant entity is a subsidiary of a listed group of companies resident in the other state, or is a subsidiary of a privately held group of companies resident in the other state, provided the activities in each country are connected and relate to an active business. However, because of the strict and complicated LOB conditions, the base case should be to assume a 5% treaty withholding tax rate and then determine whether the criteria for the exemption can be met. From a New Zealand perspective, the LOB conditions in this treaty are unique and quite different to those in New Zealand s recently concluded tax treaty with Australia. U.S. Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs) are ineligible for the 0% and 5% rates and a REIT may receive the reduced 15% rate only if: the dividends are paid (i) to an individual or pension fund, neither of which may hold an interest in the REIT exceeding 10%; (ii) with respect to a class of stock that is publicly traded and the beneficial owner of the dividends is a person holding an interest of not more than 5% of any class of the REIT s stock; or (iii) the beneficial owner of the dividends is a person holding an interest of not more than 10% in the REIT and the REIT is diversified. It also should be noted that, subject to certain transitional rules, as from 1 February 2010, an exemption from New Zealand Nonresident Withholding Tax (NRWT) will apply to the extent a dividend paid by a New Zealand company to a shareholder with a 10% or more voting interest is fully imputed. In this case, it would not be necessary to resort to the tax treaty for relief. However if a dividend paid to a person resident in the U.S. is unimputed, it will, prima facie, be subject to a NRWT World Tax Advisor 1 of 5 Copyright 2010, Deloitte Global Services Limited.

2 rate of 30%, which can then be reduced under the new treaty (assuming the person is eligible to benefit under the treaty) to either 15%, 5% or 0%, depending on which qualifying criteria are met. In addition, as a consequence of the lower withholding tax rates, New Zealand has found it necessary to change the supplementary dividend regime (previously known as the Foreign Investor Tax Credit Regime or FITC). This regime can apply to allow a New Zealand resident company paying a dividend to a nonresident to pay a supplementary or additional dividend to effectively eliminate the cost of NRWT required to be deducted from the dividends. Supplementary dividends can no longer be paid to nonresident non-portfolio shareholders (i.e. shareholders that hold 10% or more of the direct voting interests). Interest The withholding tax cap on interest will generally remain at 10%, but the definition of interest is extended to include income from debt-claims of every kind, as well as any income that is subject to the same tax treatment as income from money lent under the relevant domestic tax legislation. There are three situations where the interest withholding tax cap of 10% may be reduced to zero: When the beneficial owner (i.e. the lender) of the interest is a contracting state or a statutory type body that is not subject to tax; When the interest relates to debt obligations guaranteed or insured by the paying state; and When the recipient is an unrelated bank or finance business (substantially deriving income from the active and regular conduct of a lending or finance business involving transactions with unrelated parties). However, a condition for this exemption requires that the New Zealand payer of interest to a U.S. lender must comply with the rules regarding the Approved Issuer Levy (AIL) regime; thus, the 2% AIL must be paid on New Zealand-source interest unless the payer is not eligible to elect to pay the AIL, and the interest may not be paid as part of an arrangement involving a back-to-back loan. (The AIL regime is a mechanism for the zero-rating of withholding tax that otherwise would be applicable to interest income derived by a nonresident from a source in New Zealand. The New Zealand resident borrower applies for Approved Issuer status, registers the security, and then pays a 2% levy. In this case, a zero rate of withholding tax applies. The AIL regime is not available for payments made to associated persons.) The concession for withholding tax on interest will benefit any New Zealand bank or financial institution that lends money to unrelated U.S. borrowers. Interest paid to the New Zealand lender in these circumstances will be free from U.S. withholding tax, unless the interest is paid in respect of a back-to-back loan arrangement. Royalties The withholding tax cap on royalties is reduced from 10% to 5% and the royalty definition has been amended. Of particular note is the fact that royalties no longer include payments for the use of industrial, commercial or scientific equipment. As such, payments for leased equipment should qualify for full treaty relief where the recipient does not have a permanent establishment in the relevant contracting state. Fiscally transparent entities The protocol updates the tax treaty with regard to fiscally transparent entities, i.e. entities where, under the laws of a country, the owners are taxed on their share of the entity s income and the entity itself is not taxed (i.e. it is looked through ). Common examples are limited liability companies (LLCs) and limited partnerships (LPs or LLPs). Where an entity is fiscally transparent in one country but not in another country it is referred to as a hybrid entity. Before 2005, there was a question as to whether these entities were considered liable to tax and, therefore, resident under the treaty. If not, income derived through hybrid entities would be ineligible for treaty relief. The position was clarified in 2005 in a mutual agreement between New Zealand and the U.S. World Tax Advisor 2 of 5 Copyright 2010, Deloitte Global Services Limited.

3 Now the issue has now been codified and further addressed in the current protocol to clarify that treaty relief will be available in such circumstances to the extent the income of the entity is treated as income of a resident of the country. While this update largely resolves the treatment of these entities, there are still potential issues with a U.S. LLC, LP or LLP that is owned out of New Zealand and advice should be sought where this structure exists or is contemplated. Limitation on benefits article The concessional withholding tax rates in the protocol may provide non-u.s./new Zealand residents with incentives to structure investments through either country to obtain a tax advantage. To address this concern, the protocol introduces a comprehensive set of anti-treaty shopping rules in an updated LOB article. The new anti-treaty shopping rules establish objective tests that must be satisfied to benefit from the treaty and have the purpose of denying tax residents the benefits of the treaty in certain circumstances. The tests are drawn from the LOB rules in the U.S. model treaty and are now a standard inclusion in all U.S. tax treaties. The full benefits of the New Zealand-U.S. treaty are only available to a tax resident who is a qualified person. Individuals, the New Zealand and U.S. governments, pension funds and certain charitable/religious/education entities qualify, but other non-individuals such as companies, trusts and other entities must meet certain listing, ownership and base erosion tests, and the criteria are very prescriptive. As one example, it is fairly common for New Zealand discretionary trusts to be an ultimate shareholder and these entities appear to prove problematic under the rules. Persons that fail to be a qualified person as defined may still qualify for treaty relief on particular items of income if an active business test is satisfied. However, this test may not be straightforward to apply in practice, especially if there is income arising from different sources or activities. The key message is not to forget the importance of the LOB article in this treaty. It should not be assumed that all New Zealand and U.S. residents will qualify for treaty relief and benefits. Advice on each situation should be sought before undertaking any cross-border transactions. New Zealand officials have advised that they will not be seeking similar articles in future tax treaty negotiations with other countries unless they are requested by the other party to the negotiation. Bruce Wallace (Auckland) Partner Deloitte New Zealand brwallace@deloitte.co.nz World Tax Advisor 3 of 5 Copyright 2010, Deloitte Global Services Limited.

4 About Deloitte Deloitte refers to one or more of Deloitte Global Services Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see for a detailed description of the legal structure of Deloitte Global Services Limited and its member firms. Deloitte is the brand under which tens of thousands of dedicated professionals in independent firms throughout the world collaborate to provide audit, consulting, financial advisory, risk management, and tax services to selected clients. These firms are members of Deloitte Touche Tohmatsu Limited (DTTL), a UK private company limited by guarantee. Each member firm provides services in a particular geographic area and is subject to the laws and professional regulations of the particular country or countries in which it operates. DTTL does not itself provide services to clients. DTTL and each DTTL member firm are separate and distinct legal entities, which cannot obligate each other. DTTL and each DTTL member firm are liable only for their own acts or omissions and not those of each other. Each DTTL member firm is structured differently in accordance with national laws, regulations, customary practice, and other factors, and may secure the provision of professional services in its territory through subsidiaries, affiliates, and/or other entities. Disclaimer This publication contains general information only, and none of Deloitte Global Services Limited, its member firms, or its and their affiliates are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser. None of Deloitte Global Services Limited, its World Tax Advisor 4 of 5 Copyright 2010, Deloitte Global Services Limited.

5 member firms, or its and their respective affiliates shall be responsible for any loss whatsoever sustained by any person who relies on this publication. World Tax Advisor 5 of 5 Copyright 2010, Deloitte Global Services Limited.