41:D Inland Revenue Te Tan i Taake

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1 41:D Inland Revenue Te Tan i Taake Policy and Strategy Te Wahanga o te Rautaki me te Kaupapa 55 Featherston Street PO Box 2198 Wellington 6140 New Zealand T F February 2014 Mr Paul Goldsmith Chairperson Finance and Expenditure Committee Parliament Buildings Wellington Dear Mr Goldsmith Taxation (Annual Rates, Employee Allowances, and Remedial Matters) Bill At its meeting on Wednesday 12 February 2014, the Finance and Expenditure Committee asked officials for information on a number of issues as set out below. Employee Allowances Provide further information on the general approach in regards to the proposed test for employee accommodation including alternative frameworks considered. 1. The current law provides that where a payment is to cover a work expense it is not taxed. However where there is a private element to the expense, that private element is taxable. Likewise, accommodation provided directly is also taxable. This is on the basis that accommodation, like clothing and meals, is inherently private and can be in effect an alternative to salary and wages, which are also taxed. In a number of situations, however, the private benefit is either incidental to the business objective, or is minimal or hard to measure, and apportionment between the private and business elements is not practical, given the compliance costs. 2. Accordingly, the proposed rules set out in the bill, while not changing the existing legislative starting point that such expenses are taxable, apply the principles that the private amount should be ignored where it is low in value or hard to measure, and is not provided as a substitute for salary or wages. 3. Drafting legislation specifically on these principles would, however, provide too much interpretative uncertainty. For example, should "low in value" be some absolute amount or vary depending on the circumstances, and "hard to measure" is very much a subjective judgement. Therefore, the proposed accommodation rules instead include a range of pragmatic tests to determine the boundary between when an accommodation benefit is private (taxable), and work-related (not subject to tax). These tests take the form of time-limited exemptions for out-of-town secondments and projects, and an open-ended exemption where an employee works at multiple workplaces. When an accommodation benefit is taxable, it will continue to be generally valued at its market rental value, with some exceptions where historically there has been an alternative agreed practice.

2 4. As noted in the Regulatory Impact Statement, in coming to the approach proposed in the bill, other options and variations were considered One of those other options was that referred to by some submitters as the "net benefit test". Under this approach, when an employee maintains a home elsewhere for their use, it is argued there is no benefit from accommodation provided by the employer and, therefore, no tax should arise. Officials did not recommend such an approach for a number of reasons, including: If applied properly it would require an on-going subjective evaluation of an employee's personal affairs to determine the correct tax outcome, involving additional administration and compliance costs. Likewise, determining the correct tax outcome may not be possible at the time of payment meaning a retrospective assessment could often be necessary, with attendant compliance costs. It has no upper time limit so accommodation could potentially be tax-free for many years. Ultimately, there is a private benefit associated with the employer-paid for or provided accommodation, and the longer the payment/provision continues, the less tenable the argument that the retention of the other property is an extra cost created by the secondment and the more it is likely to be a personal choice of the employee. It would present significant fairness and equity issues with the potential for employees working side-by-side and incurring similar expenses having different tax and social assistance outcomes depending on personal circumstances and how these are assessed in determining the taxable element of any accommodation payments. The tax base risk, particularly given that allowances are in effect a form of cash. 6. For a number of years, many practitioners have applied a kind of net benefit test but, as the Commissioner of Inland Revenue's statement on accommodation of 6 December 2012 indicated, the test has no foundation in law. 7. Another approach that has been suggested by some submitters is that accommodation or accommodation payments should not be taxable if they are provided as a business imperative or treated as a business expense. Basing the taxability on the employer's position does not lead to a particularly meaningful outcome as on that basis salary and wages would not be taxable as it is imperative for a business to provide salaries and wages when they require staff. 8. Two variations on the recommended bright-line rules option were also considered: Exempting all accommodation where an employee is working temporarily away from their normal workplace, with no upper time limit. This would remove valuation issues (for temporary secondments) while recognising the significant private benefit to an employee in the long term. However, it carries a significant fiscal risk from permanent moves being labelled temporary, putting pressure on the salary substitution rule. Providing the Commissioner of Inland Revenue with the discretion to extend time limits in certain circumstances. This would allow for greater flexibility for any cases at the margin of the time limits. However, unless the discretion was very narrowly drawn, it would introduce administrative costs, uncertainty and potential fairness and consistency issues, as was found to be the case with the Commissioner discretion that applied before 1994.

3 9. The approach selected was recommended as it provides clarity and certainty for employers, minimises compliance and administration costs, and is unlikely to lead to salary substitution. Provide comment on the specific circumstances raised in submissions - boarding schools, offshore oil rigs, ships, and mining. 10. We note that the approach proposed in the bill does not differ significantly from the current law. Rather it is aimed at providing greater clarity and certainty by introducing bright-line rules as to when accommodation is, or is not taxable, based on time limits. 11. With regards to the specific examples raised in submissions before the Committee, we consider they can generally be grouped into two issues, which we address in turn below: 3 situations where the employer requires the employee to live on or near the employer's premises due to business need (for example Dilworth); and situations where the employee normally works shifts at a distant workplace for regular periods from which they cannot return home on a daily basis (for example ships, offshore oil rigs). Employer requires employee to live on or near premises 12. The treatment of employees in this situation was considered in the course of the allowances review, and discussed in the officials' issues paper, Reviewing the tax treatment of employee allowances and other expenditure payments, released for public consultation in November The paper considered that taxing the accommodation benefit in such situations at its market value would be appropriate, on the basis that even though there may be some significant drawbacks to "living on the job", an employee for whom the work premises are their permanent residence will still obtain a substantial private benefit, even if there is a work need for them to live on the property. 13. Other options that were considered for the treatment of such accommodation were: Taxing the full market value adjusted for a range of factors. Capping the taxable element at a benchmark value. Capping the taxable element at a proportion of salary. 14. These three options were not preferred because they risked not capturing the full private benefit, leading to risks of salary substitution. They each also had administrative and compliance cost issues for example benchmark values require reference properties to be identified meaning differences between properties are not captured, and capping at a proportion of salary would mean that employees with variable reward structures (such as overtime or performance pay) would likely need an end-of-year adjustment to the taxable amount. 15. The preferred option, and that contained in the bill, is to tax the market rental value. While this type of accommodation may be impacted by a number of factors that make it less attractive than a similar property nearby, factors that are specific to the property would impact on the market rental value and should be able to be factored in by a valuer.

4 4 16. There may also be factors linked to the employee and their job, such as the obligation to live in a particular property not of their choosing. These factors are unlikely to be reflected in the market value of the property as they can vary between individuals, depending on their perceptions and personal circumstances. However, an employee will often take into account the provided accommodation in their decision to take a job. An employer will also often factor this in when setting the overall remuneration package. 17. One of the policy criteria for the treatment of allowances is ensuring the overall private benefit to the employee is recognised. A market rental value should take account of the value of the particular property (including factors specific to that property) and the wider remuneration package should reflect any disadvantages particular to the employee. Therefore, no further adjustment should be necessary to the market value of the property or to the taxable amount of any accommodation payment. 18. For these reasons, officials do not consider it is necessary to include a special rule to deal with employees who are provided with accommodation on or near the workplace, due to a business need of the employer. If the property is subject to particular factors or restrictions on the employee's use or enjoyment of the property, these factors and restrictions should impact on the market rental value and be able to be factored in by valuers. How to provide further clarity in this area is discussed in the answer to the next question. Employees who normally work shifts at distant workplaces for regular periods from which they cannot return home on a daily basis 19. The issue of employees who are working on a ship or oil rig and cannot return home at the end of each shift is one we consider is likely to be confined to a small number of employees. While the general approach of the legislation has not changed, the amended wording has highlighted this potential issue. Officials are considering whether such situations would be taxable under the proposed legislation and if so what the appropriate response might be, for example a specific exemption. We will include our full response to this issue and any recommended changes in the officials' report. Provide clarity on how to assess market rental value. 20. As we have noted above, we consider that market rental value should take into account factors specific to the property for example, the condition of the property, its location (e.g. attached to a hostel as opposed to stand alone), and certain restrictions imposed on the tenant's use and enjoyment of the property. 21. In order to assist with understanding what sorts of factors and restrictions might impact on market rental value assessments, Inland Revenue is considering issuing operational guidance. Foreign account information-sharing agreement Is a person that has renounced their US citizenship still a "US person" for FATCA IGA purposes? 22. Under the IGA, in order to be identified as a "US person" by a New Zealand financial institution, an individual must have certain "US indicia" on their records. US indicia are: being identified as a US citizen or resident; have provided unambiguous indication of a US place of birth; a current US mailing address;

5 5 a current US phone number; standing instructions to transfer funds to a US account; an effective power of attorney granted to a person with a US address; or the sole address on file is a "care of" address in the US (unless the account balance is below US$50,000). 23. If none of these indicia are present, the financial institution is not required to report on the account. 24. It is possible that a person that has renounced their US citizenship may have one or more of these indicia. For example, they may have provided the financial institution with "unambiguous indication of a U.S. place of birth". However, the person can displace the presumption that they are a US person by: self-certifying that they are not a US citizen or resident; providing evidence of their nationality of another country (for example, a New Zealand citizenship certificate); and providing a copy of their "Certificate of Loss of Nationality of the United States". 25. It is anticipated that a person that has renounced their US citizenship will have all of the necessary documentation, so will effectively have the option of not be treated as a "US person" for IGA purposes. Is a person with a US green card, even an expired one, still a "US person" for FATCA IGA purposes? 26. Officials consider a person that has a green card to be in a similar position to someone that has renounced their US citizenship. In other words, there might be instances when a person is deemed to be a "US person" because they have some of the relevant "US indicia", but this presumption is rebuttable. A green card holder is unlikely to have a US place of birth but might, for example, have provided the financial institutions with a US address or have a standing order to a US bank account. The institution is required to treat such a person as a US person, but the person can rebut this presumption by: self certifying that they are not a US citizen or resident; and presenting a form of ID issued by a New Zealand Government body that is typically used for identification purposes (an example would be a New Zealand driver's licence). 27. Again, officials consider that has a green card holder, particularly the holder of an expired green card, will be in a position to provide this documentation. What are the tax consequences of renouncing US citizenship? 28. The following explanation of "expatriation tax" is located on the US Internal Revenue Service website.1 Expatriation tax applies to "US citizens who have renounced their citizenship and long-term residents (as defined in IRC 877(e)) who have ended their US resident status for federal tax purposes": 1

6 6 "If you expatriated after June 16, 2008, the new IRC 877A expatriation rules apply to you if any of the following statements apply. Your average annual net income tax for the 5 years ending before the date of expatriation or termination of residency is more than a specified amount that is adjusted for inflation (US$147,000 for 2011, US$151,000 for 2012, and US$155,000 for 2013). Your net worth is US$2 million or more on the date of your expatriation or termination of residency. You fail to certify on Form 8854 that you have complied with all U.S. federal tax obligations for the 5 years preceding the date of your expatriation or termination of residency. If any of these rules apply, you are a "covered expatriate." A citizen will be treated as relinquishing his or her U.S. citizenship on the earliest of four possible dates: (1) the date the individual renounces his or her U.S. nationality before a diplomatic or consular officer of the United States, provided the renunciation is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State; (2) the date the individual furnishes to the U.S. Department of State a signed statement of voluntary relinquishment of U.S. nationality confirming the performance of an act of expatriation specified in paragraph (1), (2), (3), or (4) of section 349(a) of the Immigration and Nationality Act (8 U.S.C. 1481(a)(1)-(4)), provided the voluntary relinquishment is subsequently approved by the issuance to the individual of a certificate of loss of nationality by the U.S. Department of State; (3) the date the U.S. Department of State issues to the individual a certificate of loss of nationality; or (4) the date a U.S. court cancels a naturalized citizen's certificate of naturalization. For long-term residents, as defined in IRC 7701(b)(6), a long-term resident ceases to be a lawful permanent resident if (A) the individual's status of having been lawfully accorded the privilege of residing permanently in the United States as an immigrant in accordance with immigration laws has been revoked or has been administratively or judicially determined to have been abandoned, or if (B) the individual (1) commences to be treated as a resident of a foreign country under the provisions of a tax treaty between the United States and the foreign country, (2) does not waive the benefits of the treaty applicable to residents of the foreign country, and (3) notifies the IRS of such treatment on Forms 8833 and IRC 877A imposes a mark-to-market regime, which generally means that all property of a covered expatriate is deemed sold for its fair market value on the day before the expatriation date. Any gain arising from the deemed sale is taken into account for the tax year of the deemed sale notwithstanding any other provisions of the Code. Any loss from the deemed sale is taken into account for the tax year of the deemed sale to the extent otherwise provided in the Code, except that the wash sale rules of IRC 1091 do not apply. The amount that would otherwise be includible in gross income by reason of the deemed sale rule is reduced (but not to below zero) by US$600,000, which amount is to be adjusted for inflation for calendar years after 2008 (the "exclusion amount"). For calendar year 2013, the exclusion amount is US$663,000. For other years, refer to the Instructions for Form 8854.

7 7 The amount of any gain or loss subsequently realized (i.e., pursuant to the disposition of the property) will be adjusted for gain and loss taken into account under the IRC 877A mark-to-market regime, without regard to the exclusion amount. A taxpayer may elect to defer payment of tax attributable to property deemed sold. For more detailed information regarding the IRC 877A mark-to-market regime, refer to Notice Form 8854, Initial and Annual Expatriation Information Statement, and its Instructions have been revised to permit individuals to meet the new notification and information reporting requirements. The revised Form 8854 and its instructions also address how individuals should certify (in accordance with the new law) that they have met their federal tax obligations for the five preceding taxable years and what constitutes notification to the Department of State or the Department of Homeland Security. Note. If you expatriated before June 17, 2008, the expatriation rules in effect at that time continue to apply. See chapter 4 in Publication 519, U.S. Tax Guide for Aliens, for more information." How does the US tax retirement savings held offshore? 29. Officials are not in a position to provide a definitive answer to this question. This is because the question relates to a matter of substantive US tax law, which the IGA, FATCA and the proposed legislative amendments do not propose to alter in any way. In other words, if a US taxpayer has an interest in such a scheme, and the US imposes tax on that interest, that imposition already exists as a matter of law and FATCA will not change that (that is, it is fact specific). 30. However, officials do note that KiwiSaver schemes and other funds registered under the Superannuation Schemes Act are likely to be excluded from FATCA reporting, on the basis that the model IGA (Annex II, paragraph II. A.) treats funds entitled to benefits under the double tax agreement between New Zealand and the United States as "non-reporting financial institutions". 31. The submitter (Mr Richardson from Canada) expressed the view that KiwiSaver accounts may be a "Passive Foreign Investment Company" (PFIC) under the US tax law. The IRS website describes such entities as:2 "A foreign corporation is a PFIC if it meets either the income or asset test described below. 1. Income test. 75% or more of the corporation's gross income for its taxable year is passive income (as defined in section 1297(b)). 2. Asset test. At least 50% of the average percentage of assets (determined under section 1297(e)) held by the foreign corporation during the taxable year are assets that produce passive income or that are held for the production of passive income. Basis for measuring assets. When determining PFIC status using the asset test, a foreign corporation may use adjusted basis if: 1. The corporation is not publicly traded for the taxable year and 2

8 8 2. The corporation is (a) a controlled foreign corporation within the meaning of section 957 (CFC) or (b) makes an election to use adjusted basis. Publicly traded corporations must use fair market value when determining PFIC status using the asset test. Look-through rule. When determining if a foreign corporation that owns at least 25% (by value) of another corporation is a PFIC, the foreign corporation is treated as if it held a proportionate share of the assets and received directly its proportionate share of the income of the 25%-or-more owned corporation. CFC overlap rule. A 10% U.S. shareholder (defined in section 951(b)) that includes in income its pro rata share of subpart F income for stock of a CFC that is also a PFIC generally will not be subject to the PFIC provisions for the same stock during the qualified portion of the shareholder's holding period of the stock in the PFIC. This exception does not apply to option holders. For more information, see section 1297(d)." 32. We are unsure if this classification is correct but, assuming it is, it appears that income and capital from such funds is taxable only if the average distribution in a given year is greater than 125% of the historical average distributions. Again from the IRS website :3 "Shareholders of a section 1291 fund are subject to special rules when they receive an excess distribution (defined below) from, or recognize gain on the sale or disposition of the stock of, a section 1291 fund. A distribution may be partly or wholly an excess distribution. The entire amount of gain from the disposition of a section 1291 fund is treated as an excess distribution. Excess distributions. An excess distribution is the part of the distribution received from a section 1291 fund in the current tax year that is greater than 125% of the average distributions received in respect of such stock by the shareholder during the 3 preceding tax years (or, if shorter, the portion of the shareholder's holding period before the current tax year). No part of a distribution received or deemed received during the first tax year of the shareholder's holding period of the stock will be treated as an excess distribution. The excess distribution is determined on a per share basis and is allocated to each day in the shareholder's holding period of the stock. See section 1291(b)(3) for adjustments that are made when determining if a distribution is an excess distribution. Portions of an excess distribution are treated differently. The portions allocated to the days in the current tax year and the shareholder's tax years in its holding period before the foreign corporation qualified as a PFIC (pre-pfic years) are taxed as ordinary income. The portions allocated to the days in the shareholder's tax years (other than the current tax year) in its holding period when the foreign corporation was a PFIC are not included in income, but are subject to the separate tax and interest charge set forth in section 1291(c). Exempt organizations. If a shareholder of a PFIC is a tax exempt organization, the rules of section 1291 will apply only if a dividend from the PFIC would be taxable to the shareholder under subchapter F." 3 ibid.

9 33. There are also various elections that a person that has an interest in such a company can make to provide different tax treatment. We are unsure on the exact scope of how these elections operate (in particular, whether they are advantageous) and the impact they may have on a person' tax position. Provide assurances from the banks that their IT systems are able to perform the necessary due diligence and subsequent reporting requirements on joint bank accounts, such that non-us persons are not reported on by virtue of accounts they hold with US persons? 34. Officials have consulted with the New Zealand Bankers' Association, who have confirmed that: 9 "...the four large banks that they are all taking the approach that for joint accounts (where only one of the parties is an American) they are only reporting details of the American party for FATCA purposes. I am confident that this reflects practice across the industry as a whole." 35. In addition, officials make the following observations: The United States has provided a 'schema' setting out the information that it expects to receive as part of the IGA reporting. That schema provides for the name of the US person and the account number, but it does not contain a field for the account name. Given our understanding that each customer with a bank has a unique customer number, this significantly reduces the risk of the details of a non-us taxpayer being transmitted in error. Inland Revenue has established an IT working group with the financial services sector to ensure that only the necessary and correct information is transferred (noting that the first transfer of data to Inland Revenue is not due until the end of May 2015). Inland Revenue's proposed technology solution for IGA information will result in data transferred from financial institutions being electronically screened to ensure it complies with minimum requirements. From the 2017 year, one of the required data fields will be the US social security number (called a TIN for tax purposes and essentially an IRD number equivalent) of the relevant person. A person that is not a US taxpayer will not have a social security number. So, even if a financial institution did try to report on a non-us person, the data would be rejected by Inland Revenue systems as being incomplete. 36. The legislation before the Committee (clause 158, proposed section 1851) is designed to reduce the cases of 'over-reporting'. For example, the wording on "excluded choices" in clause 185 (proposed sections 185F(6) and (7)) is intended to prevent a financial institution from reporting on a US person if an account they have an interest in has a balance below the US$50,000 threshold set out in the model IGA. Of immediate relevance is the fact that draft legislation only authorises financial institutions to transmit data to Inland Revenue "...if that information and its providing and obtaining is described or contemplated in the agreement...". The model IGA does not contemplate the passing of information of anyone that is not a US person. Therefore, if a financial institution transmits data on any other person it will not be able to rely on the protections offered by the legislation if the relevant person made a complaint to the Privacy Commissioner under the Privacy Act.

10 10 Controlled foreign company amendments Can you provide a summary of the policy developments that led to the Whyte Group's submission on head office expenses incurred in earning exempt foreign dividends? 37. In general, expenses can only be deducted for tax purposes if they are incurred in earning taxable income. In other words, if the expenses relate to income which is exempt from tax, no deduction can be claimed. When a New Zealand company receives a dividend from a foreign company, the dividend is exempt from income tax. Section DB 55 allows deductions despite the fact that the dividends are exempt from income tax. The rationale for this, is that prior to 2009, the dividends were subject to a special levy, known as "foreign dividend payment" or "FDP" which was equivalent to income tax. 38. The FDP levy existed due to the fact that we had a 1983 tax treaty with the United States which prevented New Zealand from applying income tax to dividends paid by US companies. The FDP levy was a work-around which allowed New Zealand to effectively "tax" the foreign dividends. 39. In 2009 there was a major reform of New Zealand's international tax rules. This reform was designed to reduce tax barriers on New Zealand businesses that expand offshore. It did this by exempting most types of income that businesses earned through foreign subsidiaries. As part of this reform we also removed all tax on foreign dividends paid to New Zealand companies including FDP. This meant that after 2009, the rationale for having section DB 55 was no longer valid. In the course of implementing the 2009 reforms, the need to repeal section DB 55 was overlooked. We are now seeking to repeal it as part of the current Bill. 40. Maintaining section DB 55 in the absence of FDP would be contrary to general tax principles of not allowing deductions which relate to exempt income (now that the dividends are truly exempt). It would effectively be a tax concession or subsidy. However, in recognition of the fact that some taxpayers may have relied on section DB 55 when filing tax returns after 2009 we have included a "savings provision" which preserves any deductions taken under Section DB 55 that were included as part of tax returns filed before the Bill was introduced (November 2013). 41. The Whyte Group's main submission is on the effective application date of this savings provision. They have pointed out that the savings provision fails to accommodate taxpayers who have applied section DB 55 during their 2013 income year, but had not yet filed their returns for We are currently considering this submission and will report back on it as part of our official's report. The taxation of land-related lease payments Provide information on the impact of the proposals in respects of a tenure renewal for pastoral leases. 43. The bill taxes certain lease transfer payments that are substitutable for taxable lease surrender payments. A tenure review of a pastoral lease does not result in a transfer of a lease to a third party, and therefore officials consider that the bill does not affect the tax treatment of a transaction occurring under a tenure review. Officials agree with the point made in submissions that perpetual leases (including pastoral leases) are more akin to freehold land, and should be excluded from the ambit of the lease transfer provisions in this bill, as well as the recently enacted provision taxing lease surrender payments (section CC 1C of the Income Tax Act 2007)

11 11 I trust this information is of assistance. Yours sincerely S Graeme Morrison Senior Policy Advisor Bill Manager