TO: FINANCE AND EXPENDITURE COMMITTEE CLERK OF THE COMMITTEE, SELECT COMMITTEE OFFICE

TO: FINANCE AND EXPENDITURE COMMITTEE CLERK OF THE COMMITTEE, SELECT COMMITTEE OFFICE ON: TAXATION (ANNUAL RATES FOR 2016 17, CLOSELY HELD COMPANIES, AND REMEDIAL MATTERS) BILL 29 JULY 2016 Chapman Tripp tax team contributing authors: Graeme Olding, David Patterson, Bevan Miles, Vivian Cheng, Simon Akozu, Helen Johnson, Robert Grignon, Rebecca Kennedy and Peter North

INTRODUCTION 1 This submission is from Chapman Tripp, PO Box 993, Wellington 6140. We wish to speak to the Committee in support of our written submission. 2 Should you require further information, please contact David Patterson on +64 4 498 6330 or david.patterson@chapmantripp.com. ABOUT CHAPMAN TRIPP 3 Chapman Tripp is a full service corporate law firm with offices in Auckland, Wellington and Christchurch. Thank you for the opportunity to make a submission on the Taxation (Annual Rates for 2016-17, Closely Held Companies, and Remedial Matters) Bill (the Bill). OUTLINE OF SUBMISSIONS 4 We make submissions on the following: 4.1 NRWT: related party and branch lending proposals. 4.2 Agreed apportionment methods for GST. 4.3 Related party debt remission. 4.4 GAAR override. 4.5 Time bar for ancillary taxes and the approved issuer levy. 4.6 LTC election. 4.7 RWT on dividends. 4.8 Tainted capital gains. 4.9 Taxable bonus issues. 4.10 RLWT certificate of exemption regime. NRWT: RELATED PARTY AND BRANCH LENDING PROPOSALS - (CLAUSES 5, 15, 55, 83, 246, 247, 248, 252, 253, 261, 262, 269, 270, 279, 294, 329, 330, 331, 332, 333) 5 The Bill proposes a number of changes to the withholding tax treatment of crossborder interest. The commentary on the Bill notes that the Bill addresses holes in the existing non-resident withholding tax (NRWT) regime and attempts to level the playing field. While we agree that some of the proposed changes are appropriate in addressing perceived holes, we are concerned that some do so in an overly PAGE 1

complicated manner. We are also concerned that other proposals go further than required to address holes and/or are not in New Zealand s interests. We expand on these points in our more detailed comments below. NRWT on related party lending Financial arrangements providing funding 6 The Bill proposes to extend the definition of money lent for the purposes of the NRWT rules to include circumstances where a non-resident provides funding to an associated New Zealand resident (where that funding gives rise to financial arrangement expenditure for the New Zealand resident). While we agree in principle that payments substantially the same as interest on a loan should be subject to NRWT in a related party context (to prevent the ability to structure around NRWT), we are concerned that the term funding is too broad and may capture commercial arrangements that should not give rise to NRWT. For example, it could be argued that swaps, or collateral provided in relation to swaps, provide funding, with the result that payments under a swap could become subject to NRWT. This is a significant departure from the current position and appears inappropriate. By way of example, if it can be argued that swaps provide funding, it seems difficult to take issue with the proposition that cashflows exchanged under a cross currency swap should not be treated as interest and should not be subject to NRWT (given that any gain or loss relates predominantly to foreign exchange movements). Correcting timing mismatch of NRWT and deduction 7 We are broadly supportive of legislative amendment to prevent mismatch in timing of payment of NRWT and interest deductions for related party lending. However, the proposals in the Bill, particularly the calculations required to determine whether a substantial deferral of payment of interest has occurred (so as to trigger earlier payment of NRWT and the first-year adjustment) seem an overly complex method of preventing mismatch. We submit that a simpler approach would be to defer the interest deduction for related party lending until NRWT has been paid. Back-to-back lending 8 The Bill proposes changes in relation to back-to-back lending and similar arrangements, which we understand are intended to prevent application of the approved issuer levy (AIL) rules in circumstances where lending is, in substance, between related parties (but provided via an unrelated party in order to access AIL). We support legislative amendment to require NRWT in these circumstances. 9 We are concerned that the legislation as drafted could have wider application and apply to genuine commercial arrangements that are not in substance related party lending. The mechanism for capturing back to-back loans and similar arrangements as related party lending is the definition of indirect associated funding in proposed section RF 12I(2) of the Income Tax Act 2007 (the ITA). The definition is in our view very broad, referring to the provision of compensation in any way in section RF 12I(2)(b). There is a risk that standard banking arrangements, such as working capital facilities provided to multi-national groups, could be captured. This is reinforced by the example provided in the commentary on the Bill that refers to cash pooling arrangements. We do not consider it appropriate for working capital facilities and PAGE 2

similar commercial arrangements to be treated as indirect associated funding and submit that proposed section RF 12I(2) should be amended to ensure an appropriate outcome. AIL registration proposals 10 The Bill proposes changes that will restrict the ability to register for AIL purposes. We understand the changes are intended to prevent taxpayers from registering for AIL and applying AIL in circumstances where the borrower and lender are associated. As the commentary on the Bill notes, current law does not permit application of AIL for lending between associated parties. This is the case regardless of whether or not the relevant instrument is registered for AIL. The proposals are, therefore, solely intended to reduce the possibility of deliberate non-compliance. 11 We understand that the number of AIL registrations per year is not large and assume that a large proportion would be from financial institutions (for whom deliberate noncompliance with the AIL rules should not be a concern). The proposed AIL registration requirements introduce additional compliance costs that we consider are unwarranted. Deliberate non-compliance with the AIL rules should be dealt with in the same manner as other taxes, with audit and enforcement action undertaken by Inland Revenue. 12 If the proposed registration requirements are considered necessary, proposed section 86G(2) of the Stamp and Cheque Duties Act 1971 (the SCDA) should be amended to include a registered bank (and any of its wholly owned group members) in the list of borrowers able to register for AIL. Without such an amendment, registered banks would need to meet one of the other criteria to register when borrowing. This does not appear to be in line with the policy intent of the proposed changes, particularly given that proposed section 86G(3)(b) specifically permits a borrower to register for AIL in cases where a financial institution is the lender. It is also contradictory to proposed section RF 12(1)(a)(ii) of the ITA, which permits the application of AIL for related party borrowing by members of a New Zealand banking group, so the question of whether the lender is associated with a borrower from a banking group should be irrelevant. Branch lending proposals should not proceed 13 The Bill proposes changes to what is described in the commentary as the offshore branch exemption. It is relevant to note that there is no such exemption; the current law simply reflects standard source-based taxation principles, with the relevant interest income having no New Zealand source currently. 14 The changes applicable to offshore branches will have the effect of deeming interest paid by those branches to non-residents as having a New Zealand source and, as a result, becoming subject to NRWT (to the extent the branch lends money to New Zealand residents). In practice, these changes are likely to impact mainly (if not solely) on registered banks who currently raise wholesale funding from the UK and European money markets through London branches. 15 We submit that the offshore branch changes are not in New Zealand s interest and should not proceed for the following reasons: PAGE 3

15.1 The terms of the relevant funding programmes will require the New Zealand banks to bear the cost of any NRWT or AIL. As a result, the cost of funding for New Zealand banks will increase. It can be expected that this increase in cost of funding will be passed on to New Zealand borrowers, with a resulting increase in cost of capital, negative impact on economic growth and/or reduction in tax payable by those borrowers. This outcome is inconsistent with the Government s Business Growth Agenda. If the increased cost of funding is not passed on by the banks, this will result in a reduction in taxable income for the New Zealand banks and reduced tax payable by them. 15.2 To the best of our knowledge, few (if any) other jurisdictions impose a withholding tax in similar circumstances, i.e. banks in those jurisdictions can raise wholesale funding offshore without the bank s home jurisdiction imposing withholding tax. We cannot see a good rationale for New Zealand taking a contrary approach to other jurisdictions. If branch lending proposals are to proceed, amendments should be made to allow the 0% AIL regime to work in practice 16 We understand Inland Revenue considers the current treatment of offshore branches to be inconsistent with the wider NRWT rules. If there is a desire to address this inconsistency, we submit that a better approach that does not harm New Zealand s interests and is consistent with international norms is to amend the 0% AIL regime contained in section 86IB of the SCDA to apply more broadly, so that current constraints preventing the application of AIL at 0% in practice to offshore funding programmes (of the New Zealand banks and other New Zealand corporates) are removed. We consider that this should be possible with relatively minor changes to section 86IB, such as permitting: 16.1 the security to be denominated in a currency other than NZD; and 16.2 an offer for the security to be made under relevant UK or European securities law. Notional loans 17 The branch lending proposals also include changes that apply to notional loans from a foreign bank to a New Zealand branch of that foreign bank (proposed new subpart FG of the ITA). The effect of these proposals is to impose AIL on interest arising on the notional loan, in addition to New Zealand tax payable on the net interest income earned by the New Zealand branch from on-lending the relevant funds. We are concerned that these proposals will encourage foreign banks to lend directly to New Zealand from offshore, rather than through their New Zealand branch. In that case, AIL would apply to interest income received by the foreign bank but otherwise New Zealand would not be entitled to tax the net interest margin made from the lending transaction. This would result in a reduction in New Zealand s tax revenue. In that context, we submit that the increased revenue that might arise from imposing AIL on notional branch lending does not justify the risk to the revenue base. PAGE 4

18 If the notional branch lending rules are considered necessary, it appears to us that proposed subpart FG contains a number of drafting errors or points that should be clarified. We expect that other submitters (particularly the banks) will address these points but would be pleased to discuss them with officials if that would be helpful. Remedial amendment required to section 86IB of the SCDA 19 In addition to, and independent from, our submission above that section 86IB of the SCDA should be amended to broaden the circumstances in which AIL can be applied at the rate of 0%, an issue has been identified with the current wording of section 86IB that is producing an unintended result. 20 One of the requirements to apply AIL at 0% is that the relevant security is issued under: 20.1 a regulated offer for the purposes of the Financial Markets Conduct Act 2013 (the FMCA); 20.2 an offer referred to in clause 19 of Schedule 1 of the FMCA; or 20.3 an offer to the public for the purposes of the Securities Act 1978 (section 86IB(1)(b)(i) of the SCDA). 21 Going forward, we expect that offers for debt securities will generally be made under the FMCA. Clause 19 of Schedule 1 of the FMCA will often not be relevant because this clause requires the offer to be of a product highly similar to one already made. As a result, the requirement most often relevant will be that the security is issued under a regulated offer for the purposes of the FMCA. 22 Section 41 of the FMCA provides that a regulated offer means an offer of financial products to 1 or more investors where the offer to at least 1 of those investors requires disclosure under [Part 3 of the FMCA] (regardless of whether or not an exclusion under Schedule 1 applies to an offer to 1 or more other investors). 23 Clause 21 of Schedule 1 to the FMCA provides an exclusion for certain offers of debt securities made by registered banks. Offers that qualify for this exclusion are not regulated offers as defined in the FMCA (and use a streamlined offer document called a limited disclosure document (LDD), as opposed to the usual PDS required for regulated offers). 24 The consequence is that, as currently drafted, an offer of a debt security made by a registered bank under the FMCA cannot qualify for the 0% AIL regime (assuming clause 19 of Schedule 1 cannot apply). This is clearly an unintended outcome in our view. We submit that section 86IB of the SCDA should be amended with retrospective effect to ensure the 0% AIL regime remains available for debt securities offered by registered banks. PAGE 5

GST AGREED APPORTIONMENT METHODS SHOULD BE PUBLISHED - (CLAUSES 314(3), (4), (5), 315(2)) 25 We are concerned that there does not seem to be any requirement for Inland Revenue to publish alternative input tax apportionment and adjustment methods agreed with the Commissioner. 26 In our view, there is a public interest in these agreed methods, because they alter taxpayers tax liabilities. We submit that the statute should require Inland Revenue to publish methods agreed under the new provision in anonymous form. Publishing these methods in anonymous form will help to preserve the integrity of the tax system as defined in section 6 of the Tax Administration Act 1994 (the TAA). RELATED PARTY DEBT REMISSION - (CLAUSES 16, 22(1) AND (9), 39, 41(1) AND (6), 57, 58, 59, 262(17) TO (19) AND (75), 337, 338, 342 AND 343(2) TO (5)) Proposed legislation does not work as intended; there should be separate provisions for debt remissions within wholly owned groups and for debt remissions in proportion to ownership interests 27 We are generally supportive of the policy intent of the proposed related party debt remission amendments. As explained in the commentary to the Bill, the proposed amendments are intended to eliminate debt remission income (and thereby the tax asymmetry that can arise under current law when a creditor remits a debt owed by a related party) where the debt remission causes no change in the net wealth of the economic group of the debtor/creditor or dilution of ownership of the debtor. 28 In particular, the amendments are targeted at the following two scenarios involving related party debt: 28.1 first, where a debt is remitted between members of the same wholly owned group of companies; and 28.2 secondly, where debt owed by a company or partnership to its shareholders or partners is held and remitted pro rata to ownership so that the remission causes no dilution or change to the ownership of the debtor. 29 The key operative provisions for eliminating related party debt remission income in the two scenarios described above are proposed section EW 46C of the ITA and proposed section EW 46B of the Income Tax Act 2004 (the ITA 2004) (clauses 57 and 342). However, as currently drafted, they do not achieve their intended objective. 30 The provisions rely on the concept of pari passu debt (and incorporated within that the concepts of creditor group, creditor s associates and creditor s interest ) to address both targeted scenarios. In its attempt to cover both scenarios, the definition of pari passu debt is in our view unnecessarily complex and difficult to apply. Furthermore, it does not work well for debt remissions within a wholly owned group, with situations that are clearly intended to be within the ambit of the related party PAGE 6

debt remission rules falling outside the definition. This can be illustrated with some simple examples: Example 1 Multiple debts owed to 100% parent 30.1 In Example 11 of the Related Parties Debt Remission issues paper (the Issues Paper), Parent Ltd had advanced two loans totalling $900 (a $500 loan, followed by a further $400 loan) to its wholly-owned company, Sub Ltd. The Issues Paper is clear that if Parent Ltd remitted the $900 owed by Sub Ltd, the intention is that the tax outcome should be symmetric. 30.2 However, neither the $500 loan nor the $400 loan is within the current definition of pari passu debt. This is because the relevant member debt (i.e. the $500 loan or the $400 loan, as the case may be) expressed as a fraction of the total member debt of Sub Ltd is 500/900 or 400/900, while Parent Ltd s creditor s interest in Sub Ltd expressed as a fraction of total creditor s interests held by all creditor group members is 100/100. Example 2 Creditors with indirect ownership interests 30.3 Parent Ltd is the sole shareholder of Sub 1 and Sub 1 is the sole shareholder of Sub 2. Parent Ltd loans $100 to Sub 2 and Sub 1 loans $200 to Sub 2. Sub 1 remits the $200 loan owed by Sub 2. 30.4 Again, in this scenario, the $200 loan by Sub 1 to Sub 2 appears not to be a pari passu debt as currently defined. The member debt (i.e. the $200 loan from Sub 1) expressed as a fraction of the total member debt of Sub 2 is 200/300. In the circumstances where a creditor (i.e. Parent Ltd) has an indirect ownership interest in the debtor through another creditor (i.e. Sub 1), it is unclear what Sub 1 s creditor s interest expressed as a fraction of total creditor s interests held by all creditor group members is. But in any case, it does not correspond to 200/300. Example 3 Debts owed to sister companies 30.5 Parent Ltd has three wholly-owned subsidiaries, Sub 1, Sub 2 and Sub 3. Sub 1 and Sub 2 each loan $500 to Sub 3. The group decides to remit all intra-group debts. 30.6 For Sub 1 s loan to Sub 3, the relevant member debt expressed as a fraction of the total member debt of Sub 3 is 500/1000. Sub 1 is treated as having the creditor interests of its creditor s associates (i.e. members of the same wholly owned group) to the extent to which they are not creditors of Sub 3. This means that Sub 1 is treated as having the 100% ownership interest of Parent Ltd. Sub 1 s creditor s interest expressed as a fraction of total creditor s interests held by all creditor group members is therefore 100/100 (because Sub 2 does not have any creditor s interests as defined), which does not correspond to 500/1000. The same analysis applies for Sub 2 s loan to Sub 3. 31 Accordingly, we submit that proposed section EW 46C of the ITA and proposed section EW 46B of the ITA 2004 each be replaced with: PAGE 7

31.1 a provision that applies when debt is remitted between members of the same wholly owned group of companies; 31.2 a separate provision that applies when debts owed by a company or limited partnership to its shareholders/limited partners are remitted in proportion to the shareholders/limited partners ownership interest in the company or limited partnership; and 31.3 an additional provision that eliminates debt remission income if, on application to the Commissioner, the taxpayer can demonstrate that debt has been remitted pro rata to ownership when the interests of wholly owned group members and persons for whom the creditor has natural love and affection are taken into account (this is to cover off the creditor group concept that is in the current pari passu debt definition). 32 Separating out the three scenarios as described above should enable the legislation to be drafted in a simple and straightforward way. Clarification required on when a debt is considered to be forgiven for purposes of the related party debt remission rules 33 Proposed section EW 46C of the ITA and proposed section EW 46B of the ITA 2004 apply when a debt is forgiven. The commentary to the Bill states that the means of debt remission does not matter and this is reflected in subsection (3) of the provisions which state that the means by which the debt is forgiven is immaterial. 34 In our view, the related party debt remission amendments should apply in all circumstances where a base price adjustment is required for a qualifying financial arrangement (i.e. a financial arrangement between members of a wholly owned group or held in proportion to ownership) and a positive base price adjustment arises for the debtor because of inadequate consideration paid for or under the financial arrangement. The proposed legislation should clarify that this is within the scope of what is meant by debt forgiveness in proposed section EW 46C. Clarification required on grandfathering provision 35 The commentary to the Bill states that positions taken before the commencement of the 2014-15 income year are final and reassessments would not be permitted. This appears to be inconsistent with clause 57(2), which provides that proposed section EW 46C does not apply to income years before the 2015-16 income year for which a taxpayer has taken a tax position that is inconsistent with the amendment. Clarification on this would be appreciated. For example, we believe this could be done be referring to debt being extinguished rather than forgiven. Proposed denial of bad debt deductions should not be proceeded with 36 Clause 41(1) proposes to amend section DB 31(2) to deny a bad debt deduction for interest receivable in respect of debt that could be remitted tax free under the proposed related party debt remission provisions. This is achieved by inserting a new paragraph (bb). The commentary to the Bill states that the proposal is intended to ensure a symmetric outcome as between the debtor and creditor. PAGE 8

37 Following discussions with Inland Revenue officials, we understand that the proposed amendment to section DB 31(2) is directed at cross border debts and is intended to protect the New Zealand tax base against excessive interest deductions by a New Zealand taxpayer in circumstances where the debt is owed to a group of non-resident owners but the thin capitalisation, transfer pricing and other cross border base maintenance regimes do not apply because the non-resident creditors interests in the New Zealand taxpayer are below the requisite thresholds. This has not been explained in the commentary to the Bill and is not obvious from proposed new paragraph (bb). 38 Proposed new paragraph (bb) is drafted in unacceptably broad terms and there is no reference to the cross border scenario which we now understand the provision to be targeted at. If it is added to section DB 31(2) in its current form, proposed new paragraph (bb) would have the effect that a person is allowed a bad debt deduction for previously recognised interest income only to the extent to which it meets the requirements in paragraphs (a) to (c) and: the person is a member of the debtor s creditor group and the assessable income is derived from a financial arrangement that is not a pari passu debt 39 If proposed new paragraph (bb) is enacted, a creditor who has no ownership interest in the debtor (i.e. a genuine third party lender) and who has been required under the financial arrangements rules to recognise interest income which it has no prospect of recovering from the debtor would be denied a bad debt deduction to reverse out the interest income which it has not actually received. That outcome is not appropriate as a policy matter and cannot have been intended. 40 If, as we understand from Inland Revenue officials, the true intention of the proposed amendment to section DB 31(2) is to act as a disincentive for excessive interest deductions in cross border related party lending scenarios, in our view the proposed amendment should not be proceed with. We do not consider it appropriate for that issue to be addressed by limiting the scope of section DB 31, because it is a blunt solution that will have unintended adverse consequences for taxpayers outside the target zone which are not sound from a policy perspective. If Inland Revenue considers that the issue merits a legislative response, it should be addressed by a review of the current cross border base maintenance regimes. 41 If, contrary to our submissions, section DB 31 is to be amended, at the very least any restriction of the circumstances under which a person is allowed a bad debt deduction for previously recognised interest income should be limited to the narrow class of intended target transactions. GAAR OVERRIDE MUST BE CLARIFIED TO CONFIRM TREATY RELIEF APPLIES TO A RECONSTRUCTED AMOUNT - (CLAUSE 6) 42 The Bill proposes to amend section BH 1(4) to say (emphasis added): PAGE 9

Despite anything in this Act, except subsection (5) or (5B) or section BG 1, or in any other Inland Revenue Act or the Official information Act 1982 or the Privacy Act 1993, a double tax agreement has effect in relation to (a) (b) income tax: any other tax imposed by this Act 43 On this wording, double tax agreements arguably have no effect if section BG 1 applies, i.e. no treaty relief is available if section BG 1 applies. The intended outcome is that a treaty should be applied to the reconstructed income under a tax avoidance arrangement, with the effect that the tax on the reconstructed income is subject to the limits in the treaty. In our view, this outcome cannot be easily achieved by amending section BH 1(4). A new provision is required to make clear that where section BG 1 applies, the treaty should be applied having regard to the reconstructed income and any treaty relief should be available with respect to that reconstructed income. TIME BAR AMENDMENTS MAY NOT BE EFFECTIVE - (CLAUSE 295) 44 We are concerned that the amendments to section 108(1) to make ancillary taxes and AIL time barred taxes may not be effective because the Bill does not address section 108(2). We will be making detailed submissions on this issue (to follow). CLOSELY HELD COMPANIES: THE PROPOSED DRAFTING OF NEW SECTION HB 13(6) DOES NOT GO FAR ENOUGH (CLAUSE 106) 45 As regards the amendment to section HB 13, the proposed drafting incorporates problematic language and does not go far enough to provide clarity to shareholders: 45.1 By definition, the phrase superseded company suggests that the effect of an LTC election is to replace the existing company with a new entity, being the LTC. This is not correct as the company is the same company as has always been there and the shareholders are treated as owning its property after the LTC election. 45.2 The current proposals do not clarify whether or not the existing company s acquisition dates and status, intention or purpose are also attributed to the shareholders along with the existing tax book values. 46 We suggest that the current wording of section HB 13(6) in clause 106 of the Bill be substituted with another provision which is broadly as follows: HB 13(6) LTC election does not affect underlying company On and from the date at which the LTC election becomes effective: (a) the LTC shareholders are treated as having acquired the assets and assumed the liabilities of the company at existing tax book values; and PAGE 10

(b) (c) where the LTC shareholders acquisition date is relevant to the application of any provision in this Act, the LTC shareholders are treated as having acquired the assets of the company on the same date as the company acquired them; and if at any point the application of any provision in this Act makes relevant the status, intention or purpose of the LTC shareholders prior to the effective LTC election date, the LTC shareholders are treated as having the same status, intention and purpose as the company had at those dates. Supplementary analysis 47 The following sections demonstrate why the suggested language in subsections HB 13(6)(b) and (c) is necessary, especially in the context of land and buildings which will likely have tax book values that equal the assets acquisition costs: 47.1 A different acquisition date may result in the application of various time sensitive revenue deeming provisions, such as the bright-line provisions (two years from acquisition) in sections CB 6A or land dealing business provisions (ten years from acquisition) in sections CB 9 CB 12: Example 1 2000 Rental property purchased for $100,000 by Company A as a long-term open-ended investment on capital account. 2016 Company A elects into the LTC regime, LTC shareholders are deemed to acquire the rental property at a tax book value of $100,000. Current market value is $300,000. 2017 LTC disposes of the rental property for $350,000. Analysis Our new subsection HB 13(6)(b) makes it clear that the bright-line test could not apply in this scenario, as the legislation would treat the LTC shareholders as having acquired the rental property in 2000 rather than within the two years before 2017. Therefore, the disposal in 2017 would be treated as a capital gain of $250,000 instead of assessable income. This result is logically consistent with the proposition that shareholders take the company s existing tax book value because the LTC shareholders first acquired a beneficial interest in the rental property when it was purchased by the company in 2000. 47.2 A different status, intention or purpose may result in the application of one or more of the business, schemes for profit or land disposal provisions, as contained in sections CB 1, CB 5 and CB 6: Example 2 2000 Land acquired by Company B for $1,000,000 for farming use as part of a long-term open-ended investment on capital account. PAGE 11

2016 Company B elects into the LTC regime, LTC shareholders are deemed to acquire the land at a tax book value of $1,000,000. Current market value is $2,000,000. 2017 LTC disposes of the land for $3,000,000. Analysis Our new subsection HB 13(6)(c) makes it clear that sections CB 1, CB 5 or CB 6 could not apply in this scenario, as the legislation would treat the LTC shareholders as having also acquired the land as part of a long-term open-ended investment on capital account. Therefore, the disposal in 2017 would be treated as a capital gain of $2,000,000. This is the appropriate result. The shareholders are intended to have carryover tax basis and carryover status, intentions and purposes for the land. AMENDMENT TO RWT ON DIVIDENDS SHOULD GO FURTHER (CLAUSES 20 AND 239) 48 We encourage any amendments which reduce unnecessary compliance costs for taxpayers. Therefore, the amendment to section CD 39(9)(c) which removes an issuer s obligation to withhold RWT on fully imputed dividends paid to corporate shareholders is encouraging. However, in our view, the amendments could go further and fully align the RWT treatments of dividends with interest payments, i.e. as regards the unimputed portion of dividends paid to companies, the applicable rate of RWT should be 28% as it is for interest paid to companies. Where shareholders can prove to the satisfaction of the issuer that they are a company, there is no good policy reason that the shareholder should overpay tax by 5% on their earnings. TAINTED CAPITAL GAIN PROPOSAL WILL NOT WORK AS INTENDED UNLESS SECTIONS CZ 9B AND CD 44(14B) ARE REPEALED - (CLAUSE 23) 49 Existing sections CD 44 (10B) and (10C) apply to taint certain capital gain amounts and capital losses derived after 31 March 2010. Existing sections CZ 9B and CD 44 (14B) apply to taint certain capital gain amounts arising from 1 April 1988 to 31 March 2010. 50 There is no policy reason why the proposed sections CD 44 (10B), (10C), (10D) and (10E) should only apply to amounts derived after 1 April 2010. We submit that sections CZ 9B and CD 44 (14B) should be repealed. 51 The current tainted capital gain rules only take effect for capital gain amounts and capital losses derived after 1 April 1988. We also submit that the proposed section CD 44 (10B) should be amended to include the words, after 31 March 1988. For example, the proposed section CD 44 (10B) could read: An amount derived or incurred by a company (company A) on disposing of property (the property) to another company (company B) after 31 March 1988 is not a capital gain amount or a capital loss amount if PAGE 12

CLARIFICATIONS TO TAXABLE BONUS ISSUE RULES SHOULD APPLY RETOSPECTIVELY (CLAUSES 45 AND 22) 52 The Bill proposes two clarifications to the taxable bonus issue rules. The outcomes produced by these clarifications are orthodox tax results that apply under current law and we see no policy reason why the legislation should not apply retrospectively. URGENT REMEDIAL ACTION IS REQUIRED IN RELATION TO THE RLWT CERTIFICATE OF EXEMPTION REGIME 53 Although not addressed in the Bill, urgent remedial changes are needed to the recently enacted RLWT certificate of exemption (COE) rules as applying to New Zealand resident property developers/dealers/builders (we refer to these persons collectively as developers for this submission). 54 Additionally, the current COE rules do not apply appropriately in the case of transparent entities (e.g. limited partnerships and LTCs). 55 Following consultation on the Taxation (Residential Land Withholding Tax, GST on Online Services, and Student Loans) Bill, the Finance and Expenditure Committee recommended amending the Bill to provide for COEs in limited circumstances, noting in the commentary on the Bill: We gave careful thought to the compliance and administrative costs entailed in the bill, and its potential effect on the supply of new housing, which we would like to see encouraged and not constrained. [ ] We are concerned that [not having a COE regime] could lead to cash flow difficulties for developers of residential housing, additional compliance costs for vendors, and administrative costs for IRD. If there was any doubt about a vendor s offshore status, they would have RLWT deducted and would then have to file an interim tax return or wait for their end-of-year return for a refund. We are aware that finance can be tight for housing developers and believe that the delay entailed in this interim claim process could constrain residential development activity. We therefore recommend some amendments to allow the Commissioner, in specific circumstances, to issue a certificate of exemption from the RLWT. We propose that the exemption be limited to offshore developers and to offshore persons who are disposing of their main home. [emphasis added] 56 We are supportive of the FEC s rationale for introducing COEs for developers. However, the FEC s focus appears to have been on providing COEs for developers who are genuinely offshore but whom did not pose a revenue risk due to their demonstrating a willingness to comply with New Zealand s tax laws. 57 However, in our view the scope of the offshore RLWT person definition was not adequately considered, insofar as many large New Zealand tax resident developers may be offshore RLWT persons to which RLWT applies, given the breadth of that term. For these persons, the design of the COE rules simply does not work. PAGE 13

58 There is no good policy reason why the RLWT COEs should not be issued on an enduring basis to New Zealand resident property developers, similar to certificates of exemption from resident withholding tax (RWT), provided they meet the desired criteria (e.g. New Zealand tax resident, turnover over a certain threshold, a good compliance history, etc). The existing transaction-by-transaction (or development-bydevelopment) approach is flawed, overly burdensome and unnecessary. 59 Moreover, the current approach of separately assessing the compliance history of every entity in a wholly-owned group for the purpose of each of their individual COE applications is misguided. This is particularly true in the case of LTCs and limited partnerships which are not liable for the underlying income tax. The commercial reality is that many developers undertake development activity via special purpose vehicles (SPVs) which may not individually have the requisite compliance history. However, on a group-wide basis, the Commissioner should be able to get comfortable that she is dealing with a good taxpayer and the use of a withholding tax to ensure compliance is unnecessary. 60 The disposal of residential property by property developers has always been taxable in New Zealand. The 2-year bright-line test in s CB 6A does not apply where a disposal is otherwise taxable under sections CB 6 to CB 12 (consequently s CB 6A is unlikely to ever apply to disposals by property developers). Nevertheless, the RLWT rules ignore this and apply if the vendor is an offshore RLWT person and the disposal would otherwise by taxable under s CB 6A, ignoring the other land taxation provisions. This outcome is what necessitated the introduction of the COE regime for developers. 61 The RLWT and bright-line rules are complex. To illustrate our concerns, we provide the following example of a situation (one of many) where the current rules are unnecessarily draconian and flawed. PAGE 14

Example Facts 62 NZ Trust, Developer Co, Partner Co and Housing LP are all New Zealand formed/incorporated entities and tax resident in New Zealand. However, NZ Trust (a family trust) has made a distribution last year of $8,000 to a family member who is overseas and has not been in New Zealand for the last 3 years. As a consequence, NZ Trust, Developer Co, and Housing LP are all offshore RLWT persons under s YA 1. 63 Developer Co is a large New Zealand residential property developer and the Commissioner has issued a number of RLWT certificates of exemption to Developer Co under s 54E(3) of the TAA, on the basis of Developer Co s clean 2-year compliance history. 64 Developer Co has entered into a joint venture (JV) with Partner Co (who is not an offshore RLWT person) to develop a residential block. The parties have formed Housing LP as a special purpose vehicle (SPV) for the purposes of their JV. Application of current rules 65 RLWT will apply to any disposals within 2 years of acquisition of interests in residential land held by Housing LP. 66 Although Developer Co has the underlying income tax liability (in respect of its 75% interest), it is not eligible to apply for an RLWT COE in respect of a disposal by Housing LP. 67 Instead, Housing LP must apply for a RLWT COE in order for RLWT not to be withheld from its sale. However, because Housing LP does not have 2+ years of tax compliance PAGE 15

history, it is not eligible for an RLWT COE under s 54E(3). It will only be eligible for a COE if it provides security to the Commissioner in accordance with s 54E(2). 68 In the recent Special Report on RLWT and related Tax Information Bulletin item, IR has referred to a bank bond as potentially being adequate security this is commercially an unsatisfactory outcome and we submit is extremely draconian to require in these circumstances. Comments/recommendations 69 This outcome is clearly inappropriate. Leaving aside the question or whether the RLWT rules should even apply to the disposal (an outcome of the broad definition of offshore RLWT person ), a COE should be available without having to resort to providing a security interest to IR. 70 Our primary recommendation is that a COE should be available to Developer Co on an enduring basis, provided it continues to satisfy the desired eligibility criteria (similar to the current RWT exemption certificate rules). That COE should also exempt any disposals by a limited partnership/ltc in which Developer Co is a partner/member, on the basis it has the underlying income tax liability that the RLWT is intended to shoreup. 71 If our recommendation to provide COEs on an enduring basis is not accepted, at the minimum we would expect that: 71.1 The compliance history of the partner/member in a limited partnership/ltc should be assessed in granting COEs, rather than the compliance history of the limited partnership/ltc. 71.2 A group s overall compliance history should be assessed by the Commissioner in deciding to grant a COE to a particular subsidiary/entity that is part of a commonly owned group. Large developers frequently utilise SPVs which themselves do not have 2+ years of compliance history, however the Commissioner should be able to get comfortable that the entity in question does not pose a revenue risk where the other companies in the group (under common ownership) have always paid their tax. PAGE 16