Taxation (Annual Rates, Venture Capital and Miscellaneous Provisions) Bill

Taxation (Annual Rates, Venture Capital and Miscellaneous Provisions) Bill

Officials’ Report to the Finance and Expenditure Committee on Submissions on the Bill

August 2004

Prepared by the Policy Advice Division of the Inland Revenue Department

and the Treasury

CONTENTS

Venture capital

Eligible investment

Issue:Widening the concept of eligible investment to include assets other than shares

Issue:Extending the exemption to cover dividends

Issue:Exemption for manager’s carried interest

Issue:Property development, royalties and lease payments as excluded activities

Issue:Holding companies – ownership requirement of subsidiaries

Issue:Residence of holding company subsidiaries

Issue:Redrafting the 12-month rule

Issue:Redrafting the listing requirement

Issue:Definition of “recognised exchange”

Eligible investors

Issue:Expanding the list of preferred countries for FFOFs

Issue:Targeting of non-residents that would not receive a credit for any New Zealand tax imposed

Issue:Timing requirements

Issue:Exemption should apply to all non-residents

Issue:Accommodating foreign funds of funds that are structured as limited liability partnerships that have separate legal entity status

Issue:Accommodating foreign funds of funds that are structured as limited liability companies

Issue:Disqualification of FFOFs

Issue:Targeting investors with a 10% or less tax rate

Issue:Residence of QFEI in a DTA country

Issue:Exempt investors in a foreign fund of a fund structured as a partnership

Issue:Introduction of eligible investment vehicles and a registration system

Issue:Countries in which a direct QFEI can be resident

Issue:Redrafting of CB 2(4)(a)(iii)

Issue:The scope of the associated persons test

Issue:FFOFs established under State laws

Miscellaneous items

Issue:Extending the removal of the loss ring-fencing to release losses accumulated under the old rules

Issue:Tax position of investors not subject to the regime

Issue:Mutual recognition of regimes between Australia and New Zealand

Issue:Introduction of an internationally recognised limited partnership regime and the tax treatment of foreign hybrid entities

Issue:Drafting in CB 2(4)(b)(iv) and (c)(v)

Issue:The description of flow through tax treatment

Issue:Redrafting of CB 2(6)

Issue:Redrafting of cross-referencing

Issue:General partners of a special partnership – section HC 1

Issue:Section 57 of the Partnership Act

Disputes resolution

Overview

Completing the process

Issue:The legislation should be clarified to ensure that “completing the process” means consideration of the taxpayer’s SOP

Issue:Lack of time-frames on the Commissioner

Alternative proposal: There should be a statutory time limit requiring Inland Revenue to start and complete audits within a time-frame to ensure that the disputes process is completed

Issue:Reference to adjudication should be inserted into the legislation

Issue:Adjudication should be legislatively provided for and a time limit placed on the issue of the adjudication report

Issue:Other parts of the disputes process must be completed at least six months prior to the four-year time bar to allow for adjudication

Issue:New section 89N – what constitutes a “failure to provide information requested”

Issue:New section 89N – what constitutes a “request under a statute for information”?

Issue:New section 89N – the ability to apply to the High Court should be removed

Issue:New section 89N – in what circumstances can the Commissioner apply to the High Court for an order to either issue an assessment, or complete the process?

Issue:New section 89N(3) – the time bar should be suspended when the Commissioner applies to the High Court for an order to either issue an assessment, or complete the process

Issue:New section 89N – incorrect reference to associated person provision

Issue:New section 89N – reference to “criminal matter” should be defined

Issue:New section 89N – judicial review proceedings

Issue:New section 89N – the word “delay” should be removed

Issue:Provision should be made to allow taxpayers to unilaterally opt out of the disputes process

The documentation required as part of the disputes process

Issue:The amount of detail required in the taxpayer NOPA should not be more than the detail required in a Commissioner NOPA

Issue:Detailed amendments to taxpayer NOPA if preceding submission not addressed

Issue:To provide all material documentary evidence in a taxpayer NOPA is unnecessary

Issue:Clarify that a taxpayer NOPA must identify the adjustment or adjustments made to a disputable decision

Issue:Detailed amendment to NOR

The four-month taxpayer NOPA period

Issue:Support for proposal

Issue:Four-month NOPA period not long enough

Issue:Ensure that the self-assessment date is clear

Time bar waiver provisions

Issue:Agreement must be in writing

Issue:Clarify that the Commissioner must not raise new issues in the waiver period

Issue:The taxpayer should be able to further extend the waiver period

Exceptions to the four-year statutory time bar

Time-frames for refunds of excess tax

Alternative submission: The amendments should refer to “mistake or oversight”

Issue:The refund section needs to clarify that a refund claimed, but not received, before the end of the period can be issued to the taxpayer

Claiming GST input tax credits

Issue:The status quo should remain

Alternative proposal: Provide for a two-year period for claiming an input tax credit with restrictions placed after that period

Alternative proposal: Ability to claim input tax credit outside of the two-year period

Alternative proposals: 12-month time period to claim input tax credit or specify when a credit cannot be claimed

The application of the Commissioner’s discretion to amend assessments – section 113

Issue:Practical application of section 113 of the TAA

Issue:If the preceding submission is not accepted, section 89D(5) should be amended to accept a late NOPA

Issue:The inability of taxpayers to amend their self-assessment at any time

Miscellaneous issues

Issue:Changes to the definition of “disputable decision”

Issue:Exceptional circumstances – section 89K

Issue:Section 114 – validity of assessments not affected by failure to comply with section 89N

Issue:Minor amendment to the challenge procedures – section 138B(3)(b)

Issue:Test cases

Issue:Self-assessment of GST and section 108A of the TAA

Other policy issues

Deductibility for costs associated with patent and resource management consent applications that are not granted or are withdrawn

Issue:Resource management consents that are not fixed life intangible property

Issue:Application date of the proposed changes

Issue:Tax treatment of patents and resource management consents that are granted

Issue:Deductibility for all costs that do not lead to a depreciable asset

Issue:Carry-back of losses

Horticultural plants

Issue:General support for changes

Issue:Higher yearly deductions for replacement plants

Issue:Factors in determining a plant’s useful life

Issue:Amortisation rates

Issue:Leasing horticultural businesses

Issue:Whether horticultural replacement planting rules should apply more broadly

Issue:Defining horticultural plants

Issue:Specify method of election

Issue:Extra immediate deduction for storm damage

Issue:Terminology – “vines and trees” and “horticultural plant”

Issue:Definitions of “plot” and “planting”

Issue:Other drafting concerns

Issue:Exclusion for wine growers

Sale and leaseback of intangibles

Issue:Rely on anti-avoidance rules instead of proceeding with reform

Issue:Review of finance lease rules instead of proceeding with proposed amendments

Issue:Concern over scope of proposed amendments

Issue:Replacing substantive rights-based test with more targeted test

Issue:Arrangement-based test

Issue:Limiting amendments to leases of intangible property

Issue:Non-exclusive licences to use intangible property

Issue:Technical error in paragraph (c) of the finance lease definition

Issue:Application of accrual rules to “in substance” principal

Early payment rebate

Issue:Support for the proposal and advertising the rebate

Issue:Rate of the early payment rebate

Issue:Application of the rebate regardless of business structure

Issue:Availability of the early payment rebate

Issue:Application date of the early payment rebate

Issue:Rebate be available for all of the first three years in business

Issue:Index the early payment rebate rate

Issue:Payment date for rebate

Issue:Applying for rebate

Issue:Not withdrawing early tax payments

Issue:Terminology change

Imputation credits and transfers

Issue:Elevation of issues to the Policy Advice Division

Issue: Consolidated groups

Issue:Drafting issue (section MD 4(3))

Issue:Drafting issue (section MD 4(2))

PAYE by intermediaries

Issue:Minimum number of employers

Issue:Definition of “officer”

Reduction of non-declaration rate for non-resident contractors who are companies

Issue:Support of lower non-declaration rate

Issue:Application date for lower non-declaration rate

Issue:Lowering the rate of non-resident contractors’ withholding tax

RWT on use-of-money interest

Issue:Commissioner should be subject to the same rules as others

Issue:Provisional tax threshold

Incorporated societies

Issue:Support for proposal

Issue:Application date – defining incorporated societies as a “special corporate entity”

Issue:Application date – the offsetting of losses between commonly owned incorporated societies

Issue:Shares in deemed companies should be deemed to carry all shareholder decision-making rights

Confirmation of annual income tax rates

Issue:Reduction in the tax-to-GDP ratio and in overall tax rates

Issue:Need for empirical international evidence to support New Zealand’s current tax rates

Issue:Inflation-adjustment of tax rate thresholds

Penalties applicable to non-resident contractor if total double tax relief applies

Issue:Support for the lower penalty contained in the proposal

Issue:Section 141AA should not be enacted

Issue:Filing requirement imposed as an alternative to the penalty

Issue:Reference to “contract payment” or “withholding payment”

Issue:Reference to non-resident contractors’ income tax liability

Issue:Limitation of application to double tax agreements

Tax shortfalls – loss attributing qualifying companies

Issue:Tax shortfalls – shareholders acting in good faith

Issue:Tax shortfalls – penalise the company in the first instance

Issue:Drafting clarification

Issue:Tax shortfalls – drafting issue

Issue:Tax shortfalls – application date

Issue:Tax shortfalls – application date inconsistency

Issue:Tax shortfalls – voluntary disclosure of shortfalls

Supplementary Order Paper – offshore unit trusts

Issue:Over-taxation of New Zealand investors investing through pooled investment vehicles

Issue:Uncertainty with the vesting rule

Issue:Vesting rule is unnecessary and should be repealed

Issue:Potential double taxation when amount that vests is issued as a bonus issue

Issue:Bonus issue rule is flawed and should be repealed

Issue:Unintended consequences of bonus issue rule

Issue:Expenditure incurred by a company in deriving exempt dividends

Issue:Rules necessary to determine value of the bonus issue

Issue:Potential double taxation if units held on revenue account

Issue:Changes to section CF 3(2)(c)

Issue:Limit provision to situations where there is a reduction of foreign tax

Issue:Application date – grandparenting existing investments

Issue:Application date should be 1 April 2005

Issue:Application date should be 1 July 2004

Supplementary Order Paper – February storm issues

Issue:Taxation (Disaster Relief) Act 2004, destroyed buildings, destroyed farming land improvements, and donated trading stock

Issue:Extending section EG 19(3)

Issue:New start grants

Issue:Use-of-money interest and restoration grants

Issue:Bay of Plenty storm event

Remedial issues

Branch equivalent tax accounts and losses – remedial issues

Issue:Consequential drafting issues

Trans-Tasman imputation – remedial issues

Issue:Late elections

Issue:Common ownership of a consolidated group

Issue:Recording of debits and credits by a resident imputation subgroup

Issue:Transfers of credits between imputation credit accounts and policyholder credit accounts

Issue:Australian imputation credit account companies

Issue:Imputed dividends paid in a foreign currency

Issue:Consequential drafting issues

Allocation deficit debit rules for life insurance companies

Issue:General support for amendments

Issue:Earliest DWP reference period

Issue:Clarify that section MG 8B(2) conditions are cumulative rather than disjunctive

Issue:Application date provisions

Issue:Guidance on reduced deficit debit calculation

Issue:DWP reference period definition

Issue:Policyholder DWP ratio definition

Issue:Conduit tax relief companies

Issue:Application of reduced deficit debit formula

Issue:Consequential amendments

Fund withdrawal tax

Issue:Drafting suggestions – clause 7

Issue:The term “other contributions” should be clarified

Issue:Drafting suggestions – clause 8

Issue:Uncertainty on application of provision

Issue:Redefining “employer”

Issue:Increased compliance costs from exercise of Commissioner’s discretion

Issue:Overseas transfers

Issue:Credits from reserves

Issue:Defined benefit to defined contribution conversions

Deferred deduction rule

Issue:Deferral of losses

Issue:Exclusion for foreign company shares held on capital account

Issue:Application of deferred deduction rule too wide

Issue:Two drafting issues

Issue:Drafting issue

Issue:Technical issue

Write-off – date of measurement of net loss

Issue:Whether drafting achieves policy intent

Miscellaneous technical amendments

Issue:Dividend withholding payments by local authorities

Issue:Redundant commencement date provision

Issue:Timing of expenditure on leases of land and buildings

Issue:Matters that cannot be challenged

Issue:Transitional provision for supplies of imported services

Issue:Determinations in relation to financial arrangements

Regulatory impact and compliance cost statements

Number of remedial amendments

Issue:Care when amending legislation

Other amendments proposed by officials

Income from standard-cost household services treated as schedular gross income

GST on imported and financial services

Issue:Zero-rating under the reverse charge

Issue:Correction required to prevent GST double dipping

Minor drafting changes

Issue:Grammatical correction

Issue:Consequential effects of Income Tax Act 2004 on amendments to other Acts

Issue:Numbering and other errors and omissions in Income Tax Act 2004

Issue:Numbering of sections inserted in the Tax Administration Act 1994 by Schedule 22 and Part C of Schedule 23 of the Income Tax Act 2004

Venture capital

VENTURE CAPITAL

Clause 4

The venture capital proposals in the bill remove a tax barrier to unlisted New Zealand companies gaining access to offshore venture capital. The main change is to provide an exemption from income tax for certain non-residents that sell shares in unlisted New Zealand companies. Profits from the sale of such shares may currently be taxable if a non-resident has purchased them with the purpose of resale or the proceeds from the shares are a part of the non-resident’s business income.

Non-residents will generally be eligible for the exemption if they are resident in a country with which New Zealand has a double tax agreement and would not be eligible for a tax credit in their home jurisdiction for any New Zealand tax paid if the income were taxable in New Zealand. These criteria will generally be met by residents that are tax-exempt in their own jurisdiction. The new rules also provide that certain foreign funds of funds (FFOFs) will qualify as eligible investors. In a venture capital context, a FFOF pools funds on behalf of a number of international investors and invests the capital in local venture capital funds.

The changes will also see the repeal of section HC 1 of the Income Tax Act 1994. This section currently prohibits partners of special partnerships from offsetting special partnership tax losses against their other income.

Eligible investment

Issue:Widening the concept of eligible investment to include assets other than shares

Submission

(15 – PricewaterhouseCoopers, 19 – Minter Ellison Rudd Watts)

Under the current proposal, the rules will exempt gains from the sale of shares in an eligible New Zealand company.

PWC note that, for a number of commercial considerations, an investor may want to invest in instruments that have equity characteristics but are not shares. Examples of such instruments are options and profit-linked interest bearing debentures. For this reason PWC suggest that the exemption should apply to gains derived from the disposal of equity and debt.

MERW considers that the form of an investment should not determine whether the tax exemption should apply. It is suggested that the proposed exemption should be extended to include the sale of New Zealand business assets.

Comment

The purpose of the proposed changes is to remove tax barriers to venture capital investment. A key characteristic of venture capital investment is that the venture capital investor’s return is connected directly with the performance of the company into which the investment is made. Therefore a venture capital investment is generally an equity rather than a debt investment. This explains why the current proposals are limited to an investment in shares.

The current definition of “share” in section OB 1(a) encompasses investments that have both debt and equity characteristics. That is, in subparagraph (ii) of section OB 1(a) a debenture to which section FC 1 applies is included in the definition of “share”. A debenture of this type is one where the interest payable is determined by reference to the dividends payable or the company’s profits. As the return from such a debenture is linked directly to the performance of the company, it is appropriate that such an investment is included in the ambit of the proposed rules. Therefore the definition of “share” that should apply for the purposes of the new rules is that contained in paragraph (a) of the definition of “share” in section OB 1.

This definition would not encompass a share optionbecause a share option is not a direct “interest in the capital of a company”. However, the economic substance of a share option (the option to purchase shares in a company at a given price at some time in the future) is clearly akin to an equity interest in that company. Therefore officials consider that an option to purchase shares in a company at a given price at some time in the future should be encompassed as an eligible investment in the new rules.