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Overview

The Taxation (International Investment and Remedial Matters) Act 2012:

  • allows the controlled foreign company (CFC) rules (active income exemption) and the portfolio foreign investment fund (FIF) methods (fair dividend rate and cost methods) to be used by investors with interests of 10% or more in foreign companies that are not CFCs;
  • introduces a zero rate of approved issuer levy for interest paid to non-residents in respect of retail bonds;
  • introduces an alternative thin capitalisation method for firms with high-value intangible assets; and
  • includes a number of technical amendments relating to the earlier reform of the CFC rules in 2009.

The new legislation builds on and extends earlier international tax reforms. The main change is that it allows an investor with a shareholding of 10% or more in any foreign company to apply the active income exemption (provided they have sufficient information to perform the necessary calculations). Previously this exemption was limited to investors with a shareholding of 10% or more in a CFC.

In 2009 an active income exemption was introduced for foreign companies that are controlled by New Zealand investors. The reform was designed to ensure that New Zealand businesses that expand offshore by operating subsidiaries in foreign countries can compete on an even footing with foreign competitors operating in the same country. This means that a New Zealand-owned manufacturing plant in China would generally face the same tax rate as other manufacturers operating in China.

An "active business test" is used to reduce the tax and compliance costs associated with calculating and attributing small amounts of passive income. The test is passed, and no income is attributed, if less than 5% of the gross income of the CFC is passive. If the test is failed, only the passive income (that is, highly mobile income such as interest, rent or royalties) is attributed to the shareholder.

In 2007 new methods were introduced for calculating income from less than 10% shareholdings in foreign companies (portfolio foreign investment funds). As a consequence, these investors generally calculate income based on an assumed 5% rate of return (fair dividend rate method), although natural persons and trustees of trusts for the benefit of loved ones or charities can choose to be taxed on the actual returns of all of their foreign portfolio investments. However, if there is an overall loss across all holdings this is reduced to zero.

The 2007 and 2009 reforms did not apply to interests that are between 10% and 50% in companies that are not controlled by New Zealanders (non-portfolio FIFs). Within this tranche there are some investors who take an active role in managing the foreign company or who invest in companies that are strategically aligned with their own business (akin to a CFC). Others will enter an investment based mainly on expected dividends and share gains (akin to a portfolio shareholding).

The new Act provides consistency in the tax treatment between similar types of foreign investment by extending the active income exemption and active business test (with some small modifications) to non-portfolio FIFs. It also extends and rationalises the portfolio FIF reforms so those investors who are unable, or who prefer not to use the active income exemption will generally be deemed to have FIF income equal to 5% of the value of their investment.

The main exception to the rules is for foreign companies that are located in Australia. The new legislation replaces the grey list for non-portfolio FIFs with an exemption for non-portfolio FIFs that are resident and subject to tax in Australia. This is consistent with earlier reforms that replaced the eight-country "grey list" exemptions with an exemption for CFCs that are resident and subject to tax in Australia and with an exemption for ASX-listed companies.

Thin-capitalisation

As part of the 2009 CFC reforms, interest allocation rules were introduced for New Zealand-based groups with offshore investments. These rules limit the deductions that New Zealand companies can take for borrowings used to fund offshore investment, because earnings from most CFC investments will be exempt from New Zealand tax. Consistent with extending the active income exemption to FIFs, the interest allocation rules have been extended to apply to New Zealand residents who have non-portfolio holdings in FIFs for which they use the active income exemption or the Australian exemption.

The way these interest allocation rules work can produce harsh results for firms with high value intangible assets such as brands. The Act mitigates this effect by providing an alternative mechanism for calculating the limit on deductions for New Zealand-based groups that invest in CFCs or active FIFs.

Memorandum accounts

As a result of the 2009 reforms, branch equivalent tax accounts and conduit tax relief accounts became obsolete. In 2009 it was announced that these accounts would be repealed after a two-year phase-out period. The new Act therefore repeals these accounts.

Approved issuer levy

In 2009 the Capital Market Development Taskforce recommended that the approved issuer levy be reduced from 2% to nil for some public issues of debt by New Zealand residents. The new Act amends the Stamp and Cheque Duty Act 1971 in order to provide a zero rate of AIL for bonds that are traded in New Zealand.

Application dates

The changes to the FIF rules apply to income years beginning on or after 1 July 2011.

The extension of the thin-cap rules to FIFs that use the active income exemption applies to income years beginning on or after 1 July 2011. Other thin-cap changes apply to income years beginning on or after 1 July 2009, or to income years beginning on or after 1 July 2011.

The repeal of branch equivalent tax accounts applies to income years beginning on or after 1 July 2012. The repeal of conduit tax relief accounts applies to income years beginning on or after 1 July 2011.

The zero rate of AIL for interest paid on bonds that are traded in New Zealand applies to interest payments made on or after 7 May 2012. A rule requiring revaluation of inherited grey-list shares also applies on 7 May 2012.

Most of the remedial changes apply to income years beginning on or after 1 July 2009.

FIF rules

The following terms are used throughout this item.

"This Act" and other legislative references

To improve readability, the Taxation (International Investment and Remedial Matters) Act 2012 is often abbreviated to "this Act".

The Act amends several core Taxation Acts:

  • the Income Tax Act 2007;
  • the Tax Administration Act 1994; and
  • the Stamp and Cheque Duties Act 1971.

These Acts are referred to by their full titles. Unqualified references to sections refer to the Income Tax Act 2007.

Person

"Person" is the term used in the Income Tax Act for the taxpayer. In the context of the CFC or FIF rules, the person will be the New Zealand resident with the interest in the FIF or CFC. This interest will generally be a shareholding.

Foreign investment fund

There are three types of foreign investment funds (FIFs):

  • foreign companies;
  • foreign superannuation schemes; and
  • foreign life insurance policies.

The Taxation (International Investment and Remedial Matters) Act 2012 mainly affects foreign companies, particularly interests of 10% or more in foreign companies that are not controlled foreign companies (CFCs).

Controlled foreign company

A controlled foreign company (CFC) is a foreign company that is controlled by five or fewer New Zealand residents or that is at least 40% owned by a New Zealand resident and has no single non-resident with a higher shareholding. CFCs are a subset of FIFs.

The controlled foreign company rules were reformed in 2009. See Part II of Tax Information Bulletin Vol 21, No 8, October/November 2009 for more detail on these reforms.

FIF interest

A FIF interest is an interest in a foreign company, foreign superannuation scheme or foreign life insurer. Unless an exemption from the FIF rules applies, a person with a FIF interest has to apply the FIF rules and attribute income under a FIF calculation method.

CFC interest

A CFC interest is used to describe an interest to which the CFC rules apply. The CFC rules apply to an income interest of 10% or more in a CFC, including any interests held by associated persons (see section EX 15 of the Income Tax Act 2007).

CFC rules

The CFC rules are used to calculate a person's net income from their CFC interests. They are found in sections EX 1 to EX 27 of the Income Tax Act 2007.

FIF rules

The FIF rules are used to calculate a person's income from their FIF interests. They are found in sections EX 28 to EX 72 of the Income Tax Act 2007.

Exemptions from the FIF rules

There are various exemptions from the FIF rules. For example, if a natural person's FIF interests have a collective cost of less than $50,000, the FIF rules will generally not apply (see section CQ 5(1)(d)). A similar exemption applies to some trustees of trusts for the benefit of a loved one or charity in section CQ 5(1)(e)). The other exemptions from the FIF rules are found in sections EX 31 to 43 of the Income Tax Act 2007.

FIF calculation method

A person is required to use a FIF calculation method to calculate the income that they derive from each of their FIF interests. The FIF calculation methods are listed in section EX 44 of the Income Tax Act 2007. For all income years beginning on or after 1 July 2011, the available FIF calculation methods are:

  • the attributable FIF income method;
  • the comparative value method;
  • the deemed rate of return method;
  • the fair dividend rate method; and
  • the cost method.

For income years beginning before 1 July 2011, the available FIF calculation methods were:

  • the accounting profits method;
  • the branch equivalent method;
  • the comparative value method;
  • the deemed rate of return method;
  • the fair dividend rate method; and
  • the cost method.

The FIF rules include rules which limit a person's ability to choose or change from a FIF calculation method.

Attributable FIF income method

The attributable FIF income method is a new method for calculating a person's FIF income under the FIF rules. The calculation is based on the CFC rules, with certain modifications. This means that active income is exempt from New Zealand tax. Active income is not exempt under the other FIF methods.