Practical Company and Tax Law Issues

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Leslie Bond
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1 Practical Company and Tax Law Issues 1. CHOICE OF ENTITY 1 A: Company and Commercial Law Considerations 2 Deciding on a business entity 2 Key characteristics of each entity 2 General partnership 2 Special partnership 3 Trading trust 4 Company 5 Unincorporated joint venture 7 B: Taxation Considerations 8 Key tax characteristics of each entity New Zealand businesses owned by New Zealanders Sole trader 8 Partnership 8 Unincorporated joint venture 9 Special partnership 9 Trust (excluding unit trusts) 10 Unit trust 10 Company 11 Qualifying company 12 Loss attributing qualifying company 14 New Zealand businesses with non-resident owners 14 Branch 14 Subsidiary 15 Example of the application of the Foreign Investor Tax Credit: 17 Non-residents investing with New Zealanders into a New Zealand business 18 Foreign investment by New Zealand residents 18 GST treatment of different entities 18 Companies 19 Partnerships/Joint Ventures 19 Trusts 19 QUESTIONS SHAREHOLDER AND OTHER OWNERSHIP AGREEMENTS 31 A: Company and Commercial Law Considerations 32 Why should a company adopt a constitution? 32 Is a shareholders agreement required in addition to a constitution? 33 Considering appropriate exit strategies for shareholders 33 Pre-emptive rights 34 Issue of redeemable shares 34 Options 35 8

2 Agreed winding up mechanisms or agreed sale of assets 36 Drag along and tag along rights 36 Deciding on appropriate dispute resolution procedures 37 Resubmittal 37 Escalation 38 Mediation 38 Arbitration 39 Independent expert 39 Dealing with voting deadlocks between shareholders 39 Casting vote 39 "Swinger" 40 Put and call options 40 Russian roulette 41 Liquidation/termination 42 Joint sale 42 B: Taxation Considerations 43 Continuity of ownership issues 43 Tax losses 43 Imputation credits 43 Measurement rules 43 Consequences for shareholder agreements 44 Loss of QC or LAQC status 45 Exit strategies 45 Supplementary dividends/foreign investor tax credit (FITC) 46 Valuation of tax benefits 46 QUESTIONS RAISING CAPITAL 51 A: Company and Commercial Law Considerations 52 Increased requirements for funds 52 Debt or equity please? 52 Issue of debt securities corporate law considerations 53 Securities Act must be considered 54 Subordinated debt 54 Shareholder approval 55 Issue of equity securities corporate law considerations 55 Pre-emptive rights 56 Legislative framework for offers of securities - Securities Act Requirements for an offer to the public 57 Who is a member of the public? 57 The development of a "need to know" test 60 Common misconceptions 61

3 Exemptions 61 Complying with the requirements of the Securities Act 62 Penalties for breach of the Securities Act 63 Impact of the Fair Trading Act 64 Companies Act requirements for issuing of shares and other securities 65 Pre-emptive rights 65 Directors to certify 65 Concern where options are issued 65 Share options for employees 66 B: Taxation Considerations 67 General aspects of the distinction between debt and equity 67 Should shareholders provide funds by debt or equity? 68 Mismatching 68 Repayment of capital 68 Debt funding 69 Application of "accrual rules" 69 Deduction available for interest 69 Easier to establish deductibility since Pre-2001 law change situation: can be still relevant 70 Thin capitalisation 71 Transfer pricing 71 Hybrid instruments 71 Floating interest rate loans 71 Loans pro-rata to shareholding 72 Loans convertible to shares 72 Withholding taxes 73 Qualifying companies 73 Consequences of raising equity on continuity of ownership 73 Cross-border transactions and payments 73 Dividends 74 Interest 74 QUESTIONS BUYING AND SELLING BUSINESSES 79 A: Company and Commercial Law Considerations 80 Deciding whether to buy assets or shares 80 Most common mode of acquisition 80 Due diligence 81 Factors to consider in deciding whether to acquire assets or shares 81 Process for amalgamating companies 83 Why are warranties important? 85 Who should provide warranties? 85

4 What warranties should be included? 85 Practical considerations 86 Restraints of trade 86 What is a "major transaction"? 87 What is the "value of the company s assets"? 88 Does the term "liabilities" include contingent liabilities? 88 Practical issues 89 What if a special resolution is not passed? 89 Minority buy-out rights 90 Licensing arrangements 90 Misuse of corporate opportunities 91 When is a director "interested" in a transaction? 92 Notice of a director s interest 92 Voidable Transactions 92 When are directors obliged to disclose share dealings? 93 What is a "relevant interest"? 93 Relevance of price sensitive information 94 B: Taxation Considerations 96 New Zealand investors buying assets 96 New Zealand investor buying shares in a New Zealand company 97 Tax liabilities for pre-acquisition period 98 Interest deductions 98 Tax due diligence 98 Clauses in sale and purchase agreements 98 Tax representations / warranties / covenants 98 Indemnity clauses 99 Accrual rules 99 Lowest price clauses 99 Restraint of trade 100 Tax issues on amalgamation 101 Goods and Services Tax Act 101 GST can be charged at zero percent on going concerns 102 QUESTIONS OPERATING ISSUES 117 A: Company and Commercial Law Considerations 118 The paperwork 118 Statutory records 118 Interests register 119 Annual report 120 Financial statements 121 Requirement for an auditor 123

5 Accounting records 123 Share register 124 Register of Charges 124 Annual meetings 124 Annual returns 125 Contracting by the company 125 Notice of changes in company particulars 126 Authorisation of distributions 127 Removing companies from the Register 127 Other obligations and requirements 127 Management of a company 127 Directors duties 128 Requirements under other legislation 131 B: Taxation Considerations 133 Income Tax 133 Employers 134 Withholding tax obligations 135 Fringe benefit tax 136 Entertainment Tax 136 Records 136 Dispute resolution 136 Time Bar 137 QUESTIONS GETTING INTO DIFFICULTY 141 A: Company and Commercial Law Considerations 142 Getting into difficulty 142 Insolvent trading 142 Reckless trading - s Duty in relation to obligations- s Common law duty to creditors 145 Duties are enforceable against directors who breach them 146 Voidable transactions 147 When is a company unable to pay its due debts? 148 Ordinary course of business 148 Voidable charges s Transactions at undervalue s Transactions for inadequate or excessive consideration with directors (or 151 nominee of, trustee for or trustee for a relative of) - s 298 B: Taxation Considerations 152 Remission of deductible items 152 Remission of financial arrangement debt 152 Debt "parking" 153

6 Liquidation 155 Capitalisation of debt 155 Amalgamation or consolidation 156 Commissioner s rights of recovery 156 General priority 156 Liability of shareholders and directors 157 Qualifying companies 157 QUESTIONS 158 Question 1: Duties before incurring obligations 158 Question 2: Risk of trading while insolvent 158 Question 3: Rights against delinquent directors 159 Question 4: Voidable preference 159 Question 5: Settlement with trade creditors 160 Question 6: Debt forgiveness DISTRIBUTIONS AND SHARE REPURCHASES 161 A: Company and Commercial Law Considerations 162 What is the "solvency test"? 162 First limb - "able to pay its debts as they become due" 163 Second limb - value of assets exceeds liabilities 163 When are solvency certificates required? 164 Distributions to shareholders 164 What is a "distribution"? 164 How is a distribution authorised? 165 Dividends 166 Restrictions 166 Power to waive entitlement to dividends 166 Shares in lieu of dividends 167 Bonus shares 168 Shareholder discounts 168 Repayment of distributions and other unauthorised payments 169 Personal liability of directors 169 Liability for unauthorised shareholder discounts 169 Distributions of reduced amounts 170 Liability for unauthorised remuneration 170 Deemed distributions 170 Share buy-backs 170 Why would a company repurchase its shares? 170 Options for buying back shares 171 Pro rata offer to all shareholders (off market) 171 Offer to some but not all shareholders (off market) 172 What is a "disclosure document"? 172

7 Rights of shareholders 172 A company may hold its own shares 173 B: Taxation Considerations 174 General concepts 174 Broad definition of "dividend" 174 Range of specific exceptions 176 Qualifying companies 176 Withholding taxes 176 RWT 176 NRWT 177 Shareholder/employee issues 178 Distinguishing between dividend and salary or wages treatment 178 PAYE or not 179 Bonus issues 181 Bonus issue normally not a dividend 181 Bonus issue v dividend reinvestment 181 Bonus issues in lieu 182 Elective taxable bonus issues 182 Share repurchases 183 "Bright-line" tests 183 Available subscribed capital 185 Treasury stock 186 Liquidations 186 Amounts which are not "dividends" may still be taxable 187 QUESTIONS 188 QUESTIONS & ANSWERS CHOICE OF ENTITY 194 Question 1: Start-up joint venture business/company v partnership/tax 194 losses Question 2: Special partnerships and tax losses 198 Question 3: Some trusts are unit trusts 199 Question 4: Companies and the imputation regime 201 Question 5: Carry forward of losses by companies 203 Question 6: Loss offset between companies 204 Question 7: The qualifying company regime requirements for entry into 206 the regime Question 8: Flexibility on exit by being able to sell shares or assets 207 Question 9: Seeking further information 208 Question 10: Advising on a recommended structure SHAREHOLDER AGREEMENTS 212 Question 1: Constitutions and shareholders agreements 212 Question 2: Exit strategies 213

8 Question 3: Dispute resolution procedures 216 Question 4: Deadlock mechanisms RAISING CAPITAL 220 Question 1: Who is a "member of the public"? 220 Question 2: Equity or debt which do you want? 221 Question 3: Tax losses projected 222 Question 4: Individual shareholders have tax losses 222 Question 5: Setting interest rates 223 Question 6: Shareholder not resident in New Zealand 223 Question 7: Offering shares to employees 224 Question 8: Offering shares in a subsequent transaction BUYING AND SELLING BUSINESSES 228 Question 1: Purchase of a business by way of assets or shares 228 Question 2: Income tax treatment when accrued liabilities of a business are 231 assumed by a purchaser and paid Question 3: Due diligence 233 Question 4: Misuse of corporate opportunities 236 Question 5: Disclosure of Interests 237 Question 6: Representations 238 Question 7: Limiting exposure under warranties 239 Question 8: Income tax treatment of purchase price adjustment based on 239 future profits Question 9: Accrual rules and sale and purchase agreements 241 Question 10: Restraint of trade/restrictive covenants in the context of 243 purchase/sale of a business Question 11: Major transactions 246 Question 12: Deductibility of feasibility costs 247 Question 13: Deductibility of salary expense for employees engaged in 249 acquisitions (or installation of assets) Question 14: Share dealings by directors 250 Question 15: GST Zero rating of going concern 251 Question 16: Sale of a going concern to a nominee 252 Question 17: GST Sale of a partnership interest where partnership 256 registered for GST 5. OPERATING ISSUES 258 Question 1: Use of money interest 258 Question 2: Time bar waiver GETTING INTO DIFFICULTY 262 Question 1: Duties before incurring obligations 262 Question 2: Risk of trading while insolvent 263 Question 3: Rights against delinquent directors 265 Question 4: Voidable preference 267 Question 5: Settlement with trade creditors 268

9 Question 6: Debt forgiveness DISTRIBUTIONS TO SHAREHOLDERS 272 Question 1: Solvency test/dividends 272 Question 2: Shares in lieu of dividends 274 Question 3: Bonus shares 275 Question 4: Shareholder discounts 276 Question 5: Recovery of unauthorised distributions 277 Question 6: Share buy-backs 279 Question 7: Shareholder salaries 282 Question 8: Liquidation 283

Joint Ventures and Shareholders' Agreements

Joint Ventures and Shareholders' Agreements Written by ANDREW COMBEN Simmons & Simmons and specialist contributors Edited by CHRIS WILKINSON Simmons & Simmons Butterworths London, Charlottesville, Dublin,