Clerk of Committee Finance and Expenditure Committee Select Committee Services Parliament Buildings WELLINGTON July 2016

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1 Ernst & Young Limited Tel: Twigger Street Fax: Addington ey.com Christchurch 8024 New Zealand PO Box 2091 Christchurch 8140 Clerk of Committee Finance and Expenditure Committee Select Committee Services Parliament Buildings WELLINGTON July 2016 Uploaded via online submission form Dear Sir/Madam s on Taxation (Annual Rates for , Closely Held Companies, and Remedial Matters) Bill 2016 (130 1) We refer to the Taxation (Annual Rates for , Closely Held Companies, and Remedial Matters) Bill 2016 (130 1) ("the Bill") and attach our submissions for the Committee's consideration. We appreciate the opportunity to make submissions and wish to appear before the Committee in their support. Please contact David Snell of our Wellington office (mobile: (021) ; david.snell@nz.ey.com) in that regard. General comments Many of the proposals contained in the Bill are welcome in terms of general principle. New Zealand's tax system is a major national asset, which requires regular maintenance. We appreciate the Government's efforts to make tax law clear, accessible and comprehensive. To that end, we support many of the remedial changes contained in this Bill. It is not always possible to foresee all scenarios when law is first made. In addition, business process continuously evolves. The majority of our detailed submissions aim to ensure that the Bill enacts government policies into law in a workable way. At present, several of the Bill's measures may not operate completely or correctly as business practice is more varied than has been fully considered. Related party debt remission The related party debt remission proposals are an example of the issues we have in mind. These rules are intended to ensure that no debt remission income arises in circumstances where the debt remission causes no change in the net wealth of the economic group or dilution of ownership. We strongly agree with the intent of these proposals but some details appear inadequate as they currently stand: I. r r We understand the intent of the rules is for debt remission to cause available subscribed capital ("ASC"), which can later be returned tax free to shareholders if appropriate, but the drafting fails to link the deemed ASC to actual shares; The rules are intended to cover remission of debt within an economic group but the drafting appears not to cover remission within common situations such as where debt forgiveness occurs between companies owned by the same individual; and It is not clear how the rules deal with nominal shareholdings. Further development required for some measures In some cases, proposals may benefit from further development, including consultation with affected industries. Should this not be possible as part of the Committee's review, we anticipate that remedial legislation will be required in future years. Examples include the proposed aircraft overhaul provisions, especially in relation to helicopters.

2 2 Retrospective legislation overused We would like to draw the Committee's attention specifically to the number of proposals and amendments contained in the Bill which are expressly or effectively retrospective. In some cases, such as where the change to the taxation of related party debt remissions has been driven by a change in the Commissioner's interpretation of existing law potentially to the detriment of taxpayers reliant on her previous view, retrospectivity is justified. But taxpayers should generally be allowed to rely on the legislation in force to plan their conduct and transactions. Retrospective or retroactive tax legislation should be avoided where possible. Some of the measures which give us concern in this regard are: I. The transitional "catch up" adjustment proposed in the new "non resident financial arrangement income" ("NRFAI") rules, which will have a severe cash flow impact on taxpayers with long term funding arrangements already in place, notably forestry investments; p The valuation of look through company ("LTC") debts when LTC owners are treated as having disposed of all their interests in an LTC to a third party; and 0. The treatment of pre amalgamation tax losses. With regards to the valuation of LTC debts and treatment of pre amalgamation losses, there is no urgency or other factor which supports those changes applying retrospectively. At the very least, savings provisions should be included to protect taxpayers who have previously taken tax positions and filed returns on the basis of the legislation as enacted. structure We have structured our submission in the attached Appendix in two parts: o 10 A summary of issues raised: given the remedial nature of much of the Bill's content, there are inevitably many issues. in this summary, we have indicated our general level of support for the measures introduced. Even where we are not fully supportive, however, our submissions concentrate on ensuring that the provisions operate effectively rather than suggesting that the legislation be withdrawn; and A detailed analysis of references, anomalies and wording suggestions in support of the issues raised. Most of our submissions relate to very specific matters of drafting and we would be happy to work through them in detail with officials advising the Committee. Yours faithfully Ernst & Young Limited Aaron Quintal Director Tax Angela Williams Executive Director Tax Mob: (027) Mob: (027) angela.williams@nz.ey.com A member firm of Ernst & Young Global Limited

3 3 Building a bettar Appendix A 1 References used in these submissions 1.1 Abbreviations and references used in these submissions include the following. Reference used Refers to AIL Approved issuer levy ASC Available subscribed capital Bill Taxation (Annual Rates for , Closely Held Companies, and Remedial Matters) Bill 2016 (130 1) BPA Base price adjustment CIR Commissioner of Inland Revenue ary ary on the Bill, May 2016 DTA Double tax agreement ESCT Employer superannuation contribution tax FA Financial arrangement FDP Foreign dividend payment GST Act Goods and Services Tax Act 1985 IFRS International Financial Reporting Standards 1RD Inland Revenue Department ITA 2004 Income Tax Act 2004 ITA 2007 Income Tax Act 2007 LTC Look through company NRFAI Non resident financial arrangement income NRFAI rules Rules for the treatment of NRFAI as proposed in the Bill NRWT Non resident withholding tax PAYE Pay as you earn QC Qualifying company RWT Resident withholding tax SCDA Stamp and Cheque Duties Act 1971 TIB Tax Information Bulletin TAA Tax Administration Act 1994 TRA Taxation Review Authority 1.2 All statutory references are to the ITA 2007, as enacted at 20 July 2016, unless otherwise stated. References to clauses are to provisions in the Bill.

4 4 2 Summary of submissions 2.1 Our main submissions (other than a number of miscellaneous and minor drafting points) are summarised as follows. Closely Held companies Paras 2.2 We support reforms that make the LTC rules more workable and provide some improvements for closely held companies which are neither LTCs nor QCs. 2.3 Continuation of existing QCs 3.1 to 3.6 The proposed new s HA 6(4) definition of "minimum QC interest" should be revised so that it aligns with the "effective interest" concept defined in s HA 43 and measured under s HA 44 for Subpart HA purposes or should be expressed similarly to the criteria in ss IA 5(2) and (3) and OA 8(7). Section HA 6 as amended should be included in the s YA 1 definition of "continuity provisions". References to "continuity period" in the "minimum QC interest" definition should consistently refer to "QC continuity period". LTCs 2.4 The proposed new para (bb) of the s YA 1 definition of "look through counted owner" should be revised so that distributions sourced from pre year assets or funds are also disregarded. 4.1 to The proposed amendments to the s YA 1 definition of "look through interest" in cls 4.5 to (59) and (60) are too restrictive and should be revised to allow LTCs to have shares carrying no, or disproportionate, voting rights on any matter, so long as all shares carry equal rights to receive distributions. 2.6 The proposed amendments to the LTC definition in relation to foreign LTC holders 4.9 to 4.13 and foreign sourced income should be revised. Clarification of the intended meaning of a non resident settlor is needed while revision of the reference to "foreign sourced income" would be desirable. Debt remission for LTCs and partnerships 2.7 The proposed cl 56 changes to s EW 31 need revising to ensure they operate as 4.14 to 4.19 intended and exclude any net taxable income arising to LTC owners or partners who remit debts owed to themselves by their LTC or partnership ("self remission"). An explicit deduction provision is needed for LTC owners and partners in their capacity as creditors for relevant BPA amounts. 2.8 Application of the proposed amendments to s HB 4 relating to the market value of 4.20 to 4.26 third party debt should not be retrospective and cl 119 of the Bill, which proposes a new s HZ 8, should be deleted. RWT on concurrent cash and non cash dividends 2.9 The proposed new s RE 14B option for determining RWT liabilities on concurrent 5.1 to 5.6 cash and non cash dividends should not be limited to non cash dividends subject to s RE 14 but should also be available when non cash dividends subject to s RE 15 A fl, ifi i ii S L'utnicij L

5 5 are provided. Paras 2.10 The wording of s RA 9 should be clarified to remove any uncertainty as to what gross amounts shareholders are taxable on in each cash and non cash dividend situation The CIR should undertake to provide appropriate examples of calculations of the "cash dividend amounts" which would be required to satisfy the RWT cash liability when a non cash dividend (of whatever type) is provided An amendment similar to the proposed s RE 14B option should also be provided in the NRWT rules in respect of non cash dividends of all types. PAYE on shareholder employee salaries 2.13 The proposed options for treating shareholder employee remuneration as partly 6.1 to 6.13 subject to PAYE or as not subject to PAYE are too limited. Elections should not be irrevocable or made on a "once only" basis. Elections could be irrevocable for a limited period, say, three income years Clarification is required as to how the changes would start applying. The Bill should refer to the first income year for which any relevant election may be made and should provide some saving provisions for situations where amounts may already have been paid but not treated exactly as required under the current or proposed new provisions. NRWT: Related party and branch lending 2.15 These proposals have been subject to extensive consultation over the last year. We expressed concerns that the proposals as originally consulted would increase the cost of capital in New Zealand and potentially defer inbound investment. Measures included in this Bill are more targeted and so will have a lesser impact. We remain unconvinced that some of the measures are required. Our submissions assume, however, that they will proceed and are intended to make them more workable in practice. NRFAI 2.16 The NRFAI proposals should be revised to resolve matters including the following: 7.1 to 7.12 The difficulties in terms of mixed and inconsistent concepts, which are likely to cause uncertainty and add to compliance, particularly in relation to foreign currency FAs. For pre enactment FAs, the application of the proposed NRFAI rules, including any transitional "catch up" adjustment should be limited to post enactment income, with a wash up calculation on maturity. Interaction with New Zealand's transfer pricing rules, particularly, s GC and The transitional "catch up" adjustment proposed in the new "non resident financial 7.13 to 7.18 arrangement income" (''NRFAI") rules is effectively retrospective as it will require NRWT to be paid on existing financial arrangements in the first year in which NRFAI is treated as derived by the non resident lender. Those NRWT liabilities may result in substantial cash flow issues for some taxpayers. We are aware of taxpayers in the forestry sector, for example, which entered into long term funding arrangements a number of years ago to finance their investments in New Zealand

6 6 forests on the basis that interest would be paid at the end of the production cycle, once revenue had been realised from completed harvesting, with NRWT applying at that point. We understand any need to provide additional cash in the near future to fund payment of NRWT in accordance with the proposed NRFAI transitional "catch up" adjustment may adversely affect their working capital in that year and, more broadly, their ability to invest further in New Zealand. Paras 2.18 There needs to be further consideration of DTA implications relating to the NRFAI 7.21 to 7.34, proposals and publication of detailed explanations as to when and how any DTA 7.42 and 7.43 relief or limitations will apply to any NRWT payable under the NRWT amendments for related party debt and the NRFAI rules. Particular DTA issues include: Whether or not NRFAI income deemed derived under New Zealand's domestic law will be treated as payments of interest to which the Interest Articles of all New Zealand's DTAs may apply to limit the rate of any New Zealand NRWT. The need for clarification of the intended relationship of the proposed s RF 121(3) to the NRWT provisions. Whether or not any DTA relief may apply and, if so, how, if s RF 121(3) is intended non resident to apply to the effect that some or all interest paid to a direct lender (or NRFAI deemed to arise in any such situations) has to be treated as received on behalf of some other non resident party and subject to NRVVT. Confirmation that non resident entities which are deemed to derive NRFAI income will be able to claim appropriate foreign tax credits in their home jurisdictions The calculation of any excess interest paid in terms of the proposed new 7.35 to 7.41 transitional adjustment provision, s RZ 12(2), needs clarification and some revision in respect of: The period of accrual and payments covered. The impact of any foreign currency variations Taxpayers should be able to have any AIL paid in respect of interest which becomes 7.44 to 7.46 subject to NRWT under the proposed new s RZ 12(2) transferred on account of NRWT rather than being refunded. GST current issues 2.21 Generally we welcome the GST reforms as being useful improvements to GST law consistent with existing principles, with a good level of advance consultation. Our biggest reservation is in connection with the unnecessarily high turnover threshold for CIR agreement to a method for apportionment of input costs between taxable supplies and other uses. Sales under a power of sale 2.22 The proposed replacement of s 51B(1)(b) of the GST Act should be revised to enable the proposed amendment to operate appropriately. It should treat those selling the goods (the creditors) as registered if they are required to furnish returns under s 17 or make default in that regard, with the debtors being treated as registered if they have provided inadequate or incorrect notices as to non taxable status to the creditors. 8.1 to 8.7

7 7 Pa ras Consideration not known 2.23 The wording of the proposed replacements 9(6) of the GST Act should be revised 8.8 to 8.11 to achieve its objective effectively. Transactions relating to leases of land 2.24 Savings provisions should be included to protect tax positions taken by taxpayers, 8.12 to 8.17 the issuing of GST tax invoices and GST returns filed up to the date the Bill is enacted in relation to lease surrenders, novations and the exclusion of zero rating for commercial leases of land affected by the Bill's proposed retrospective amendments. Services directly in connection with land 2.25 Clarification, more detailed explanation and examples would be desirable as to the 8.18 to 8.21 use of the phrase "a parcel of land" and as to the types of services that are expected to be treated as being in connection with a parcel of land or improvement "intended to enable or assist a change in the physical condition, or ownership or other legal status, of the land or improvement". Zero rating of financial services 2.26 Clarification may be needed or desirable as to the amounts of "consideration" which GST registered taxpayers who carry on taxable activities should be showing as zero rated supplies of debt or equity securities or related payments in their GST returns to 8.27 Six monthly return filing basis 2.27 Availability of the new six monthly filing basis for seasonal suppliers should not be 8.28 to month restricted to those whose supplies mostly fall within the second six months of a period. The words "that ends with or near the end of the 12 month period" should therefore be deleted. Methods of apportionment and subsequent adjustments of input tax claims 2.28 The proposed $24 million annual turnover threshold for being able to seek the CIR's agreement to an apportionment or adjustment method for making input tax claims is too high. Ideally there should be no threshold. If some threshold is considered necessary, we suggest $3 million as a more reasonable threshold to 8.38 It should be clarified and confirmed that the $24 million (or any revised) annual turnover threshold would apply on a group basis if taxpayers are registered as part of a group for GST purposes. Adjustments 2.29 Clarification of the aim of the proposed amendment to s 20(3D) of the GST Act is 8.39 to 8.44 needed. GST on non deductible entertainment expenditure 2.30 The proposed amendment to s 211(4) of the GST Act should be expressed as first 8.45 to 8.50 applying in respect of taxpayers' returns of income for the tax year (or a later year if enactment of the Bill may be delayed), rather than simply applying

8 8 Building bi better from the date of enactment. Paras Changes to supply of secondhand goods 2.31 The time for returning any excessive input tax in relation to supplies of secondhand 8.51 to 8.53 goods acquired should depend on when the change becomes apparent or known to the registered taxpayer, rather than on when the change occurs. Other policy matters Related parties debt remission 2.32 We welcome the recognition that application of the financial arrangement rules in anti avoidance conjunction with the current Inland Revenue interpretation of the general over taxation. provisions in New Zealand's income tax legislation may result in Many corporate groups would have been at risk of over taxation on past restructuring carried out on a commercial basis had the Government not included this retrospective measure. The legislation as introduced, however, does not cover a sufficiently wide set of circumstances so, at a detailed level, fails to meet the Government's policy objectives. Increase of ASC 2.33 The proposed increase to a debtor company's ASC for debt remitted under the 9.1 to 9.13 proposed new s EW46C of the ITA 2007 or s EVV 46B of the ITA 2004 is inadequate to allow appropriate tax free returns of that ASC to shareholders and should be revised to ensure such outcome is possible. Bad debt write off deductions 2.34 Clarification is needed as to the intended scope of the proposed amendment to s 9.14 to 9.19 DB 31(2) of the ITA The proposed amendment should be re worded so that the limitation on any bad debt write off deduction applies only if the person is a member of the debtor's creditor group. Debt forgiven within economic group 2.35 Various aspects of the proposed new s EVV 46C of the ITA 2007 and s EW 46B of the ITA 2004 need to be clarified or re worded, including: 9.20 to 9.29 r. The para (1)(a) reference to a debtor who "has a capacity different from the creditor". The para (1)(d) reference to the debt being "forgiven". The references to "natural love and affection" in subpara (4)(b)(ii). I The proposed definition of "creditor's associate", which is currently inadequate to cover a number of situations of debt within an economic group when relief for remission would fall within the stated policy intent of the proposals. The para (4)(d) definition of "pan i passu debt". Cost of investment for creditor (or creditor's associate) 2.36 Additional legislative provision is required to ensure that the cost of the equity 9.30 to 9.32

9 9 investment for a creditor (or creditor's associate) in a debtor company is treated as increased by the amount of any debt remission treated as repaid under the proposed new s EW 46C of the ITA 2007 or s EW 46B of the ITA Pares Amalgamation 2.37 The debt remission relief proposals also need to be incorporated into the Subpart 9.33 to 9.36 FO provisions of the ITA 2007 (and the ITA 2004 equivalents) for the treatment of financial arrangements on amalgamation. Debt guarantees 2.38 Clarification is needed as to the intended scope of application of the proposed new 9.37 to 9.40 s EW 49B of the ITA 2007 and its reference to "the creditor's interest". Loss grouping and imputation credits 2.39 We are in agreement with the policy behind this change The wording of the proposed s OB 83(5)(d) and (e) should be revised to refer to the 10.1 to 10.7 income years for which the tax loss is made available and the election to transfer imputation credits is made, rather than to the income years in which such events happen. Clarification is also required as to whether irrevocability of elections and agreement of all relevant companies is intended, as the ary refers to such features but the Bill does not appear to include provision accordingly Clarification is required as to the intended application of the proposed new ss OB 10.8 to (1)(c), 06 72(2)(c) and OB 72B, including their references to "company A" and to the circumstances relevant to trigger application of the provisions. Remission income, tax losses and insolvent individuals 2.42 We are in agreement with the policy behind this change The wording of the proposed news IA 33 should be revised to ensure that bankrupt 11.1 to individuals' pre discharge tax losses remain available for use in relation to any shortfall penalties which may relate to the period before the 'loss cancellation date" (as that term is proposed to be defined) or to any income which may be derived before that specific date The commencement of application of the new s 42C of the TAA should be clarified by reference to the tax year for which it would first apply Legislative clarification is still required as to the extent to which a bankrupt individual is treated as deriving income, can claim any related deductions and is required to file returns of income post adjudication or Court approval of any relevant procedure under Part 5 of the Insolvency Act Aircraft overhaul expenses: deductibility and timing 2.46 While these changes are welcome, we consider they need additional development, particularly in respect of their application for helicopter operators. Transitional arrangements, accounting issues and treatment of spare parts need further consideration.

10 10 Building a bettor 2.47 Application of the proposed new rules should be expressed by reference to a taxpayer's first income year commencing after enactment of the Bill, rather than by reference to their income year. Pares 12.1 to Clarification is required, particularly in relation to helicopter owners, to distinguish 12.6 to between the income tax treatment of aircraft engine components (as proposed to be defined) which are acquired and held for repairs and maintenance outside regulatory overhauls and those which are acquired for or as part of such overhauls Clarification is needed or desirable in relation to: to The process for making relevant elections and agreeing methods and adjustments under the IFRS alternative method. The CIR's expected approach to approving apportionments of consideration on disposal. o. Whether or how the proposed transitional adjustment provisions (the new ss DZ 22 and EZ 23BA) apply if taxpayers elect to use the IFRS alternative method or the proposed s EJ 26 single aircraft owner method Clarification is required of the proposed new ss DZ 22 and EZ 23BA provisions, especially in relation to "unpriced aircraft engines" and in relation to situations where taxpayers have previously capitalised all aircraft overhaul costs Amendments are also needed to a number of related depreciation provisions, including ss EE 29(2), EE 37, EE 56 to EE 60, EE 61(3) and ss VA 1 and EE 67 definitions of "international aircraft" to to There should be further review to ensure the proposed aircraft overhaul provisions to will interact appropriately with the existing income tax provisions relating to finance and operating leases with clarification and revision as necessary, particularly in relation to: IN The interaction between ss CC 11 and CC 12, CG 9, EJ 27 and FA 9 and FA 10 where aircraft or aircraft engines have been leased under finance leases. Ideally, cross references should be included to ensure that any disposal consideration for an aircraft (or aircraft engine as a whole) cannot be taxed twice, once by reference to ss CC 11 and CC 12, secondly by reference to the proposed new ss CG 9 and EJ 27. The treatment of post lease disposals by associated persons of lessees. anti avoidance Relationship between New Zealand's DTAs and the domestic general provision 2.53 Further clarification is required as to the intended interaction between s BC 1 and 13.1 to 13.8 any given DTA provisions. Land tainting and council controlled organisations 2.54 The business premises exclusions to taxation under the various land sale provisions 14.1 to 14.8 in Subpart CB should be revised more generally as soon as possible to ensure the exclusions can apply to all land which is used within the normal scope of a taxpayer's business activities, as distinct from arguably being limited to buildings and their immediate surrounds.

11 There should be an extension of the s CW 39 exemption from income tax for income derived by local authorities from transactions with unrelated council controlled organisations, port companies or energy companies. Such exclusion should apply to land sales, other income from land use and other types of income more generally. Pa ras Time bar and ancillary taxes 2.56 Clarification of the proposed extension of s 108 of the TAA to ancillary taxes and AIL is needed in respect of situations where no return has been filed to Consideration should be given to re writing s 108 of the TAA to align more appropriately with the current formal self assessment regime, the taking of tax positions in relation to ancillary taxes and AIL by not filing returns, just as much as by filing them, and the ongoing move to electronic filing which focuses simply on providing numbers in boxes. Other remedial amendments Life insurance Shareholder base and policyholder base treatment of fees for managing policyholder investments 2.58 The scope of the changes proposed in cls 61 to 63 and 66 is too narrow and not 16.1 to 16.7 consistent with tax positions taken by some life insurers. The proposed changes to ss EY 2 and EY 3 and proposed new ss EY 16B and EY 19B should be changed to relate to "management and administration services provided to policyholders by the life insurer". The proposed "investment services provided to policyholders by the life insurer in managing policyholder fund" approach is too narrow and may not validate tax positions taken by some life insurers to date. The linkage between the existing s EY 16 and the proposed s EY 16B needs to be considered, with a change to one or both sections. A savings provision should also be included in relation to the proposed changes to ss EY 2 and EY 3 to protect taxpayers who have taken tax positions in previous income years that are consistent with the proposed changes. Description of future amounts 2.59 We support the changes proposed in cls 64, 67, 70 and 71 but submit a savings provision should be included to validate tax positions taken in previous income years that are consistent with the proposed changes and 16.9 Available capital distribution amount and capital losses 2.60 The proposed amendments to ss CD 44(9) of the ITA 2007 and s CD 33(9) of the 17.1 to 17.4 ITA 2004 need revising to apply appropriately where the deficit between the cost of the property and its sale price is less than the depreciation deduction losses. The capital loss amount should be the greater of zero and any positive balance resulting from reducing the difference between the cost and the sale prices by the depreciation deductions Sections CD 44(14B) and CZ 98 should be repealed or their application limited to 17.5 to 17.10

12 12 working word amounts distributed before enactment of the Bill. Paras Pre amalgamation losses 2.62 The proposed changes to s IE 3 of the ITA 2007 should not be retrospective but should apply only for income years commencing after enactment of the Bill. Alternatively, a saving provision should be included to protect the position of taxpayers who have taken tax positions, used losses and filed returns based on the legislation as it has stood since enactment of the ITA to 18.3 Limits on refunds for ICA companies 2.63 Clarification of the proposed replacement s RM 13(3) of the (TA 2007 is required, 19.1 to 19.4 including confirmation that taxpayer companies may continue to obtain refunds based on the credit balances shown in: lb Annual ICA returns to the latest 31 March filed before, but separately from, their returns of income for the equivalent income year. Part period returns up to a current date under s 70(3) of the TAA. FBT and specified insurance premiums 2.64 Clarification is required as to the intended scope of the proposed new definition of 20.1 to 20.5 "specified insurance premium" for FBT purposes, especially as to the nature and extent of any employee benefits required to bring a policy within the definition. The scope of the "specified insurance premium" definition should be expressly limited to situations where employees have enforceable direct or contractual rights to benefit under a policy. Mere inclusion as an insured or covered life does not necessarily provide any benefit to an employee. Clarification would also be desirable as to any different treatment between policies taken out by employers and those taken out by the trustees of employment related superannuation schemes Miscellaneous drafting and minor typographical matters 21.1 to 21.32

13 13 Closely held companies Continuation of existing qualifying companies 3.1 It is proposed that existing qualifying companies ("QCs") may continue to exist subject to meeting at least 50% shareholder continuity requirements from the date of enactment of the Bill to the end of each relevant subsequent income year (from the income year). Clause 98 proposes amending s HA 6 to that effect. 3.2 We submit: (i) (ii) (iii) The proposed new s HA 6(4) definition of "minimum QC interest" should be revised so that it aligns with the "effective interest" concept defined in s HA 43 and measured under s HA 44 for Subpart HA purposes. Section HA 6 as amended should be included in the s YA 1 definition of "continuity provisions". References to "continuity period" in the "minimum QC interest" definition should consistently refer to "QC continuity period". 3.3 As presently drafted, the proposed s HA 6(3) will require that, at all times in an income year, a group of persons holds minimum QC interests for the OC continuity period adding up to at least 50%. The proposed s HA 6(4) definition of "minimum QC interest" refers simply to the lowest voting interest or market value interest a person has in the company during the continuity period. 3.4 The proposed interest measurement test is based on alternative types of interest which may be held by each shareholder. It would involve possibly having to compare different types of measurement for different shareholders. The test would appear to differ from the existing "effective interest" concept in ss HA 43 and HA 44, which measures a QC shareholder's liability under s HA 8. The proposed "minimum QC interest" definition would also differ from the continuity tests which have applied for many years in relation to company tax losses and imputation credits (ss IA 5(2) and (3) and OA 8(7) respectively). On that basis, the proposed test could result in additional complexity and possible confusion. 3.5 We suggest the proposed "minimum QC interest" definition be revised to incorporate or align with the s HA 43 "effective interest" concept. Alternatively, we suggest it be expressed similarly to the criteria in ss IA 5(2) and (3) or OA 8(7). 3.6 We also suggest: p. Any references to "continuity period" in the "minimum QC interest" definition should be expressed as "QC continuity period" to ensure consistency with that defined term and remove any uncertainty. Section HA 6 be included in the s YA 1 definition of "continuity provisions" to ensure, for instance, that s YC 8 can apply in relation to death of a shareholder and s YC 9 in relation to trustee holders.

14 14 4 Look through companies Look through counted owner definition 4.1 Clauses 262(57) and (58) propose amending the s YA 1 definition of "look through counted owner" to widen the range of situations when beneficiaries of trustee owners may be counted in determining whether or not the maximum of five "look through counted owners" for LTC status is exceeded. Relevant distributions will no longer be limited to distributions of trust income as "beneficiary income" for each income year but will include any other distributions, whether of retained earnings, capital gains or corpus. A phasing in of the new criteria over the to income years is proposed, depending on whether or not distributions are sourced from pre year income. 4.2 We submit there should be some revision of the wording of the proposed new para (bb) of the s YA 1 "look through counted owner" definition so that distributions sourced from pre year assets or funds are also disregarded. 4.3 Limiting the transitional measure to situations where the only distributions received by individuals from the beginning of the income year are "sourced from income derived by the trust before the income year" does not take account of the fact trusts may have derived capital or other gains or income excluded from being taxable' in the pre period, as well as retaining income treated as "trustee income" for income tax purposes in those earlier years. The proposed income sourcing qualification therefore appears to be too narrow. 4.4 The ary (at page 7) refers to the fungibility of money as justifying the change to refer to all trust distributions. It also states that the new rule should apply only prospectively. We consider both these aspects should support amending the wording of the proposed new para (bb) of the s YA 1 definition of "look through counted owner" so that distributions consisting of, or sourced from, pre assets and funds, are disregarded, not just pre year income. Look through interest definition classes of shares 4.5 Clauses 262(59) and (60) propose amending the s YA 1 definition of "look through interest" so that LTCs may have shares carrying different voting rights, so long as all shares have the same rights to distributions. All shares would still have to have equal rights to vote on distributions and capital variations. 4.6 We submit the proposed amendments are still too restrictive and should be revised to allow LTCs to have shares carrying no, or disproportionate, voting rights on any matter, so long as all shares carry equal rights to receive distributions. Such as attributed PIE income in some circumstances A :11C11111EI!in

15 15 king a better 4.7 The proposed cl 262(59) amendment to para (a) of the s YA 1 definition of "look through interest" would still require any separate class of shares to have proportionate voting rights in relation to decision making on any distributions and on any variation of the capital of the entity or LTC. 4.8 We suggest that restriction is unlikely to provide the flexibility desired in terms of the legitimate commercial structuring or generational planning acknowledged in the ary (at pages 7 8). For the proposed amendment to be really effective, we submit it should be possible for shares to have no, or disproportionate, voting rights on any of the matters listed in para (a) of the current definition, so long as all shares retain equal rights to receive distributions. LTC and foreign LTC holder definitions 4.9 One of the amendments proposed in cl 262(56) to the LTC definition is a limit on the amount of foreign sourced income that an entity can have each year to become or remain an LTC, if more than 50% of the total ownership interests are held by foreign LTC holders. Clause 262(43) proposes inserting a definition of "foreign LTC holder" into s YA 1. One situation where it is proposed a trustee will be regarded as a "foreign LTC holder" is if the trust has a non resident settlor" We submit: (i) The reference to having "a non resident settlor" should be clarified or revised. (ii) The reference to "foreign sourced income" in the proposed para (eg) of the s YA 1 definition of an LTC should be revised to refer to a "foreign sourced amount". "Non resident settlor" 4.11 New Zealand's income tax law contains a very broad concept of "settlor" which generally applies for the purposes of the income tax rules relating to trusts. In broad terms, a settlor may include any person who provides financial assistance or the use of any property on less than market value terms. In traditional trust law terms, however, the settlor concept is generally restricted to those who create a trust over items of property wide reaching. We submit application of the extended New Zealand income tax definition may be too In any event, clarification is needed as to what "settlor" concept is intended to apply in this context. Foreign sourced income 4.13 Section YA 1 of the!ta 2007 contains definitions of several similar phrases: "Foreign source income", which applies for the purposes of s EG 1; "Foreign sourced amount", which applies generally for income tax purposes and refers to income which is not treated as having a source in New Zealand; and "Segment of foreign sourced income", which is used in the process of determining the extent of any foreign tax credits which may be claimed.

16 16 Bubdir,q a Letter workin Some uncertainty may therefore arise from the use of another similar, but undefined, phrase, "foreign sourced income", in the proposed new para (eg) of the s VA 1 definition of an LTC. We suggest clarification of the intended meaning and revision of the wording accordingly. Debt remission for LTCs and partnerships 4.14 Two significant changes are proposed in relation to the treatment of debts, both to apply retrospectively from 1 April 20112: (i) (ii) To ensure that net taxable remission income does not arise to LTC owners or partners who remit debts owed to themselves by the LTC or partnership (including a limited partnership) (described as "self remission"). For LTCs, to include credit impairment adjustments in the market value of LTC owners' interests as debtors in debts owed to third parties We submit: (i) (ii) Revision of each of the above proposed changes is required to achieve the intended effect. Application of the changes relating to the market value of third party debt should not be back dated and cl 119 of the Bill should be deleted. Self remission 4.16 Clause 56 proposes amending s EW 31 so that "self remission" amounts will reduce the "amount remitted" item in the base price adjustment ("BPA") formula by the amount owed by LTC owners or partners as debtors to themselves as creditors We do not consider that change will be sufficient to overcome the acknowledged taxable remission income problem. In their capacity as debtors, the LTC owners or partners will still have a full amount of taxable income under the usual application of the BPA rules to them in their capacity as debtors. The "amount remitted" item in the BPA formula is irrelevant to that calculation in their debtor capacity At present, LTC owners or partners who are the creditors are unable to claim any deduction against such income because the BPA formula treats them as having received the amount remitted so there is no BPA loss amount. The proposed alteration to that formula may leave LTC owner or partner creditors with negative BPA amounts (representing the portions of debt owed by other LTC owners or partners). Negative BPA amounts, however, do not necessarily ensure deductibility for creditors or offset against their taxable BPA income as debtors. The usual interest deductibility rules would apply We submit revision of the cl 56 proposal is required. Ideally there should be explicit statutory provision to allow a deduction to LTC owners or partners as creditors for the amounts of their BPA remission income as debtors from a self remission event. 2 See ary, pages 16 18

17 17 working word Debtor's interest in debt owed to third parties 4.20 Section HB 4 treats LTC owners as having disposed of all their owner's interests in an LTC to a single third party for a payment equal to the interests' market value in certain circumstances. Clause 104 proposes inserting a new s HB 4(7) which would require LTC owners to take "the amount of any adjustment for credit impairment" into account in the market value of their owner's interests in any financial arrangement as debtors in those situations Clause 119 proposes inserting a news HZ 8 which would treat taxpayers as having taxable income amounts in their income years reflecting the additional income they would have had for previous years if s HB 4 had applied then as it is now proposed to be amended It is not totally clear what the proposed amendment is intended to achieve. If it is intended to ensure BPA income arises for LTC owners on third party debt which they are unable to pay at all or in full, we do not consider it would necessarily be effective The wording of the proposed s HB 4(7) is not restricted to third party debt, although the ary refers to financial arrangements "with a third party" 3. If the proposed amendment is intended to cover all financial arrangements owed to LTC owners as well as to outside parties, we suggest there should be clarification as to how it should operate in relation to the proposed "self remission" income amendments and confirmation that there would be no inconsistency or conflict in their application nor any untoward outcomes We assume the "certain interpretations" referred to in the ary are based on the fact that, from a debtor's perspective, the market value of a liability to be taken over by a third party would generally be the full amount of that liability, as a third party would not generally take over a legal liability for any lesser payment We would not expect a debtor LTC to have made any adjustments for credit impairment to any financial arrangement liability it (and its owners under the LTC rules) owes. On that basis we consider the proposed s HB 4(7) would not seem to effect the change apparently desired by officials. Proposed new 5 HZ The proposed s HZ 8 introduces a retrospective element, even if any resulting tax liability is payable on a "prospective" basis for taxpayers' income years. The proposed s HZ 8 would require taxpayers to recognise income under the new rule in their income year in relation to events which occurred in prior years and to tax positions taken on an arguably legitimate basis of the tax law as then enacted. We consider such retrospective taxation is unreasonable and unwarranted. On that basis cl 119 of the Bill should be deleted. 5 RWT on concurrent cash and non cash dividends 5.1 Clauses 240 to 242 of the Bill propose amendments to the RWT rules to enable combined cash and non cash dividends to be treated as a single dividend for RWT calculation purposes, with effect from 1 April ary, page 17

18 18 Buildine a better worecini world 5.2 We submit: (i) (ii) (iii) (iv) The proposed new s RE 14B option should also be available when non cash dividends subject to s RE 15 are provided, not just when non cash dividends subject to s RE 14 are provided. The wording of s RA 9 should be clarified to remove any uncertainty as to what gross amounts shareholders are taxable on in each cash and non cash dividend situation. The CIR should undertake to provide appropriate examples of calculations of the cash non cash dividend amounts which would be required to satisfy the RWT cash liability when a dividend (of whatever type) is provided. An amendment similar to the proposed s RE 14B option should also be provided in respect of non cash dividends of all types in the NRWT rules. 5.3 We welcome the proposed changes but consider they need some extension to be completely effective. As presently drafted, they would not apply when shares are issued under a bonus issue in lieu or a profit distribution plan (as those terms are defined in the ITA 2007). Yet cash must also be used to meet any RWT liabilities (after imputation credits are taken into account) on such distributions, technically resulting in similar gross up and potential double taxation issues, even if not always treated fully in that way in practice. We therefore suggest application of the s RE 14B option should also be available for s RE 15 non cash dividends. 5,4 We consider the wording of s RA 9 is not best suited to ensure all elements of non cash dividends and cash payments of RWT are treated as taxable by shareholders, because of the references to amounts withheld from payments. We suggest the wording be revised to ensure that the dividend amounts which may be taxable to shareholders include amounts of tax paid on a shareholder's behalf in relation to any distribution, as well as to amounts withheld from monetary payments. 5.5 We think the proposed s RE 146(2) formula should work appropriately but it assumes the "cash dividend" amount is known. We expect that the key question in practice may be "What amount of cash dividend is required simply to satisfy the RWT liability?" We suggest considering the inclusion of an appropriate formula in the legislation. If that is not pursued, however, we hope the CIR will provide appropriate examples to show how that amount is arrived at, as well as illustrating the relevant amounts to be included in dividend statements for shareholders. Need for similar option in the NRWT rules 5.6 The Bill does not currently include any amendment similar to the proposed s RE 14B option in relation to non cash dividends provided to non resident shareholders when NRWT is payable. Yet non cash dividends the same issues must arise when a company pays cash to IRD to satisfy NRWT liabilities on of all types provided to non resident shareholders. We therefore submit a similar amendment should be included in the NRWT rules. 6 PAYE on shareholder employee salaries 6.1 Clauses 235 and 236 of the Bill propose amending s RD 3 and inserting new ss RD 3B and RD 3C so that shareholder employees of close companies or companies with up to 25 shareholders may elect either: 1,1

19 19 To treat payments of regular amounts as salary or wages subject to PAYE while any further income that may be allocated to them as employees would not be subject to PAYE (under the proposed new s RD 3C, if an election is made under the proposed new s RD 3(3)); or To have no amounts of their employment income from their company treated as subject to PAYE (the proposed new s RD 35, if an election is made under the proposed new s RD 3(2)). The proposed new s RD 3(4) and (5) provide that any elections made under the new s RD 3(2) or (3) are irrevocable and can only be made once. 6.2 We submit the proposed options are too limited and should not be irrevocable or made on a "once only" basis. Instead, we suggest elections could be irrevocable for a limited period, say, three income years. 6.3 The default position is that salaries, wages or other employment remuneration paid by companies to shareholder employees are, and would continue to be, subject to PAYE in the same way as employment remuneration paid to any other employees. The income tax legislation has, however, provided possible relief from PAYE treatment for shareholder employees in "close companies" as defined for those purposes for many years. 6.4 The current s RD 3 allows shareholder employees in close companies (including companies with up to 25 shareholders) to choose not to have PAYE apply to their employment remuneration from their companies where their pay meets the prescribed criteria (essentially, if they are not receiving mostly regular amounts for frequent and regular pay periods or they receive amounts, which may be allocated later as income, as a variable element). 6.5 The current rules therefore provide for PAYE or non PAYE treatment of such remuneration on an all or nothing basis, without the possibility of having a portion treated as subject to PAYE (such as any basic amounts which are regular amounts paid in each pay period) and any variable amounts allocated later in the income year as not being subject to PAYE. A choice that remuneration not be subject to PAYE is technically irrevocable once made, as the current s RD 3(3) removes PAYE treatment for the income year in which the individual makes that choice and the current s RD 3(4) states that all amounts paid to the person in later income years in their capacity as employee of the company will also be treated as not subject to PAYE. 6.6 The proposal to allow a combination of PAYE and non PAYE treatment was raised in para 9.35 of the September 2015 issues paper, Closely held company taxation issues. That proposal was one of several "Initiatives to simplify and reduce the compliance and administration costs associated with closely held companies that are neither LTCs nor QCs". We welcomed the proposal on the basis it should allow reasonable flexibility and cash flow management while ensuring at least some level of taxation would be paid periodically through the income year. 6.7 We acknowledge para 9.35 also stated that any such combined approach "should be applied consistently from year to year so that a shareholder employee should not be allowed to swap in and out of the provisional tax regime." Nevertheless we consider the proposed limitation of any such election to a single, irrevocable election to maintain the same combined or non PAYE treatment for the current and all subsequent income years is too restrictive. 6.8 We submit some ability to change elections or treatment should be provided to allow for changing circumstances, such as those affecting the company's profitability and solvency as well as those affecting the nature and extent of shareholder employees' individual roles in the company, which may change over time. As an alternative, we suggest elections could be irrevocable for, say, a three year period.