Inside this edition:
- Company Tax Residence
- Bright Line Test – Property
- Lump Sum Settlement Payments
- Individual Tax Residence post Diamond
- Look Through Companies – Proposed Changes
1. COMPANY TAX RESIDENCE
Often we are asked questions in relation to company tax residence, particularly in the context of individuals migrating to NZ that have established companies in foreign countries. More often than not they are under the impression that the transitional residency that applies to them also extends to their foreign companies. Whilst the transitional residency applies to individuals, it does not extend to foreign companies.
For a company to be considered tax resident in NZ it must meet any of the four residency criteria defined in YD2 of the ITA07. In order for a company to be tax resident of NZ it must either:
i) be incorporated in NZ
ii) have its head office in NZ (“Head Office Test”)
iii) have its centre of management in NZ, (“Centre of Management Test”) or
iv) be controlled in NZ by directors acting in their capacity as directors, even if the director’s decision making also occurs outside NZ (“Directors Test”)
The Head Office Test looks at the physical place of administration and management of the Company. In most cases determining whether the Head Office Test is met will be relatively simple. This may become somewhat more difficult in cases where the Company is a passive investment company in which case it may not even have an office at all.
The Centre of Management and the Directors Test are little bit more complex. Whilst the Centre of Management Test is similar to the Head Office Test, there is no requirement for physical place or an office. The Centre of Management test does not make a distinction between the various levels of management but rather it looks at the overall management of the company as a whole. It focuses on all areas of corporate management. The test is one of substance rather than one of form.
In contrast the Director Test focuses on strategic decisions at the Board level and specifically where the directors of a company as a whole exercise the control on an ongoing basis. It should be noted that the term director for the purposes of YA1 of ITA07 includes “de facto directors” that exercise the duties of directors. This test focuses on the place where the strategic and policy decisions are made.
Whilst it is quite common for a company to satisfy more than one test, the company will be considered NZ tax resident for the purposes of NZ domestic law as soon as one of these tests is satisfied.
Where a company is a subsidiary, the question may arise as to whether the company is controlled by its directors or by the parent company. If the parent company exercises control over the subsidiary, the subsidiary will most likely be tax resident in the country where the parent company is resident.
One must also be careful when considering a change to the composition of the board when the company is already deemed to be a NZ tax resident with the view to shift the tax residency of the company offshore. A company that ceases to be a NZ resident company is known as “an emigrating company” and is treated for the purposes of NZ income tax, as if it had immediately on the day prior to its emigration, disposed of its property at market value, liquidated and distributed its reserves as dividends. Obviously such changes may result in significant unforeseen income tax consequences.
Where a company meets the tax residency criteria under the domestic law of NZ and another country with which NZ has concluded a double tax agreement, the residency issue is resolved by application of the “tie breaker” provision in the applicable double tax agreement (DTA). NZ has concluded numerous DTA’s. Whilst the tiebreaker in most NZ DTA’s focuses on the “Place of Effective Management Test” which is similar to the “Centre of Management Test “ under the NZ domestic law there are some DTA’s which look at slight variations of this test such as “Day to Day Management test”, “Centre of Practical Management”.
Therefore we recommend that proper advice be sought in relation to the tax residence of foreign companies whether owned by transitional residents, or where there is a contemplated change in the board or management.
2. BRIGHT LINE TEST – PROPERTY
The legislative measures enacted in this first stage are as follows:
1. The following pieces of information are to be supplied to Land Information New Zealand (LINZ) by any person transferring any property as part of the usual land transfer process:
a. Their NZ IRD number; and
b. Their tax identification number from their home country if they are currently [also] tax resident overseas.
2. To ensure that NZ’s full anti-money laundering rules apply to non-residents, before buy a property in NZ,
offshore persons must have a NZ bank account number before they can get a NZ IRD number.
An offshore person is defined as anyone other than a person who is not an offshore person. A person is not an offshore person if:
1. They are a NZ citizen and have been in NZ within the last 3 years; or
2. They hold a NZ residency class visa and have been in NZ within the past 12 months.
All other individuals will be offshore persons.
A non-individual will be an offshore person if it is:
1. Incorporated outside NZ; or
2. 25% or more owned (legal or beneficial) or controlled by an offshore person.
There is an exemption from supplying the information to LINZ if the property being transferred is the person’s main home. This exemption however is not available to an offshore person, where the property is to be or was owned by a trust, or if the person is selling their main home for the third time in a two-year period.
For the main home exemption to apply to a transferee, the land must be intended to be used predominantly for a dwelling that will be the transferee’s main home. For the main home exemption to apply to a transferor the land must have been used predominantly, for most of the time the transferor owned the land, as a dwelling that was the transferor’s main home. The ‘most of the time’ requirement is a 50% or greater test. The ‘predominantly’ requirement is for evaluating the main use of the purchase of the property or land. For example, purchase of an industrial building with an adjoining apartment to be used as a main home does not meet the requirement that the land will be used predominantly as the transferee’s main home. Therefore the no-notification exemption will not be met.
The second stage introduced a new easy to enforce, objective bright-line test to tax gains from the disposal of residential land acquired and disposed of within two years of acquisition, subject to some exceptions. The Taxation (Bright-line Test for Residential Land) Act 2015 received Royal asset on 16 November 2015 and the rules apply from 1 October 2015.
The start and end dates are specifically defined and may differ depending on the nature of the transaction. The following tables give a summary of the start and end dates for purposes of the bright-line test:
|Type of acquisition||Start date of bright-line test|
|Standard purchase of land||Registration under LTA1952|
|Sales without registration of title||Latest date property acquired (ordinary rules)|
|Sales “off the plan”||Date of entry into a contract to purchase|
|Subdivided land||The original date of registration for the undivided land|
|Converting a lease with a perpetual right of renewal into freehold title||Date the lease with a perpetual right of renewal is acquired|
|Type of disposal||End Date of bright line test|
|Standard purchase of land||Date of entry into agreement for sale|
|Gift||Date of gift (generally registration of title)|
|Compulsory acquisition||Date of compulsory acquisition|
|Mortgagee sale||Date land disposed of by mortgagee|
|Other disposals where no contract to sell||Date of disposal according to ordinary rules|
Only residential land is caught by the new bright-line test. Residential land is land that either has a dwelling on it, the seller of the land is a party to an arrangement that relates to erecting a dwelling on it, or is bare land that is zoned for residential purposes. However, if the land is used predominantly as business premises or is farmland then the land is not residential land.
The bright-line test also has a main home exemption whereby a sale of a main home within two years of purchase will not be subject to tax. However, to qualify the land must have actually been used predominantly, for most of the time the person owns the land, for a dwelling that was the main home of the person or a beneficiary of a trust that owns the property.
A person can only have one main home at a time (some overlap may be permitted in certain situations such as a pending sale of a prior main home when a person has already moved into a new main home) and habitual sellers cannot use the main home exemption. A person is a habitual seller if they have either used the main home exemption twice in the previous two years or have engaged in a regular pattern of buying and selling of residential land.
There is a limitation for trusts selling residential land that want to use the main home exemption. For tax purposes, a settlor of a trust is anyone who has transferred value to the trust for an inadequate consideration. A trust cannot use the main home exemption when a principal settlor of the trust has another main home. This rule is to ensure that people cannot use the main home exemption multiple times through the use of a trust. A principal settlor is the person who has made the greatest transfer of value to the trust. However, if the person providing the most value to the trust has made the provision with no strings attached and is not a beneficiary, trustee, appointor, a person with a contingent interest in the trust property or a decision maker under the trust, then their settlements are disregarded.
Other exemptions from the bright-line test are:
- Inherited properties – Transfers from the deceased to the estate and from the estate to beneficiaries are deemed to be at cost (no gains arise) and the on-disposal within two years of receipt by the beneficiaries of the inherited property is exempted.
- Relationship properties – transfers between the parties pursuant to a relationship property agreement are deemed to be at cost and therefore no gain arises. However the on-disposal of the transferred property within two years by the recipient party will be subject to the bright-line test.
- Resident’s restricted amalgamation – the existing rollover relief, where a transfer of property as a result of an amalgamation (held on revenue account by virtue of application of sections CB 9 to 11 and CB 14) is treated as transferred at cost, is extended to include property that is revenue account property of the amalgamating company due to the application of the bright-line test.
Other key aspects of the new bright-line test are that:
- The cost of the property is tax deductible, including expenditure related to the acquisition and cost of capital improvements made after acquisition. Other holding costs may be tax deductible if sufficient nexus exists with income. Interest costs may be automatically deductible if the property is owned by a company.
- Losses from deductions claimable solely against bright-line income are ring-fenced so they can only be offset against gains on other land sales that are taxable under any of the land sale provisions.
- Specific anti-avoidance provisions have been included to defeat the use of land-rich companies and trusts to circumvent the intent and purpose of the bright-line tests, such as disposal of 50% or more of shares in the company that owns residential land, which will be subject to the anti-avoidance provisions.
The third stage is contained in introductory legislation. The bill has passed its first reading as of 8 December 2015. The bill proposes that offshore property speculators pay a withholding tax on profits from sales of residential land under the bright-line test which is the lower of:
- 33% of the vendor’s gain on the that property and
- 10% of the total purchase price of that property.
This withholding tax will be known as the Residential Land Withholding Tax (“RLWT”). The obligation to withhold the RLWT will be on the purchaser not the vendor. The RLWT is scheduled to come into effect from 01 July 2016.
3. LUMP SUM SETTLEMENT PAYMENTS
IRD has recently released a Draft Interpretation Statement PUB00246 Income Tax – Treatment of Lump Sum Settlement Payments. This document was released as there is a growing trend for taxpayers to treat lump sum settlement amounts as capital receipts and therefore not taxable. Taxpayers who enter into settlement agreements without specifying the apportionment between the capital and revenue portion of the settlement may run into a problem.
The Draft Interpretation Statement states that if there is no reasonable and objective basis of apportionment of the settlement amount between revenue & capital, the entire amount will be treated as revenue and therefore taxable. The burden of proof rests with the taxpayer that the apportionment is reasonable. It is clear that the Commissioner will no longer accept such payments as non-taxable.
Consequently it is advised that, where possible, the respective settlement agreements should state the apportionment between revenue and capital. As this stipulation may not always be possible the taxpayers should have supporting documentation in relation to the apportionment, keeping in mind that the basis for apportionment must be reasonable and objective.
What is reasonable and objective will often depend on the specific facts and circumstances surrounding your client. We will be happy to assist in cases where there is uncertainty in relation to the basis for apportionment.
4. TAX RESIDENCY – INDIVIDUALS
The Court of Appeal’s decision in the Diamond case has cleared the uncertainty around tax residency by upholding the High Court’s decision and dismissing the Commissioner’s “two step approach” in determining whether the Permanent Place of Abode (PPOA) test is satisfied. The PPOA test is important in determining whether an individual is NZ tax resident as it overrides the presence test (also known as the day count test).
The Commissioner’s argument/ case centered around the “two step approach”, that if a taxpayer owns a dwelling in NZ, which the taxpayer did not use as a permanent place of abode before leaving NZ, but is a place in which the taxpayer could abide on a permanent basis, that this dwelling can be construed as the taxpayer’s PPOA. This “two step approach” was put forward as the basis for determining whether the PPOA test is met in the Inland Revenue’s Interpretation Statement on Tax Residence published in March 2014.
Thankfully common sense prevailed and this “two step approach” was rejected by the Court of Appeal. In fact it was critical of the Commissioner’s preferred interpretation stating:
“ …once a dwelling that is merely available is identified extraneous factors establishing a connection or remote ties to NZ can be invoked to artificially assign to that dwelling the status of permanent place of abode.”
The Court of Appeal confirmed that PPOA means more than a place that is merely available to stay and that it implies actual usage of the property by the taxpayer for residential purposes. It looks at place where the taxpayer habitually resides from time to time even if the taxpayer spends periods of time outside of NZ.
The Court of Appeal considered that the correct interpretation of PPOA calls for ”an integrated factual assessment, directed to determining the nature and quality of the use the taxpayer habitually makes of a particular place of abode.” In this assessment mere availability to the taxpayer of a dwelling is clearly not sufficient by itself.
The Court of Appeal then set six various non-exhaustive factors that one should consider when determining whether PPOA exists, such as the continuity of the taxpayer’s presence in NZ and in the dwelling, the duration of that presence, the durability of the taxpayers association with the particular place, the closeness of the taxpayer with that dwelling, etc.
Another important finding was that the focus is on whether the taxpayer has a PPOA and not the members of his family. Accordingly the fact that the taxpayer concerned may provide a home to his family in circumstances where the taxpayer lives elsewhere would not necessarily be sufficient to establish that the taxpayer had PPOA in NZ.
The Court of Appeal has laid clear guidance on the application of the PPOA test in relation to a taxpayer. Whilst the Commissioner has pushed the boundaries, common sense prevailed and certainty in relation to the interpretation of the tax residency principles as opposed to science fiction has been restored.
In light of the Court of Appeal findings we anticipate that in due course the Commissioner’s Interpretation statement on tax residency will be amended.
5. PROPOSED CHANGES – LOOK THROUGH COMPANIES
A September 2015 officials’ issues paper on the taxation of closely held companies proposes a number of changes to the eligibility rules for LTCs:
- Charities and Maori authorities will not be allowed to be hold shares in an LTC or be beneficiaries of a trust shareholder in an LTC. The rule will apply to existing LTCs with the result that many LTCs will cease LTC eligibility unless trust deeds of trustee shareholders are amended to remove charities as beneficiaries.
- From the beginning of the 2017/18 year, a shareholder trustee of an LTC will not be able to make distributions to a non-LTC corporate beneficiary.
- More than one class of share will be permitted provided that class differences are in voting rights only.
- Where greater than 50% of LTC shares are held by non-residents, the LTCs annual foreign income cannot exceed the greater of $10,000 and 20% of the LTCs gross income.
- The rule of determining look through counted owners where a Trust is a shareholder will change so that a beneficiary will be treated as a ‘counted owner’ if they have received any distribution in the last six years, regardless whether the distribution is of Trust Capital or Beneficiary Income.
- Technical changes to calculating owners’ basis is also proposed so that the balance sheet can be used as the starting point for the calculating the owners’ basis when a company enters the LTC regime. Currently, the cost of the capital at the time the shareholder subscribed for the shares in the company is included as “investment” in the owners’ basis formula as opposed to the market value at the time the company enters into an LTC regime.
- Currently for many companies entering the LTC regime this amount at cost will be minimal relative to the market value of the net assets of the company and clearly can create problems when distributing reserves which have arisen pre-entry to the LTC regime.