Inside This Edition
• Dividends Paid to 31 March 2010
• Limited Partnerships
• Business Dealing in Financial Arrangements
• Deductibility of Loan Break Fees
• Changes to the FITC Regime
Dividends Paid to 31 March 2010
This is an area which is still causing some confusion.
In the 2007 budget the Government announced a reduction in the corporate tax rate. From the 2008/09 income year the company tax rate was reduced from 33% to 30%. Companies are able to allocate credits at a maximum tax credit ratio of 33/67 for a transitional period from the beginning of the 2008/09 income year to 31 March 2010, to the extent that the company has 33% tax credits. From 1 April 2010 the transitional period ends and the maximum tax credit which can be attached to a dividend from that date is 3/7ths.
All information in this newsletter is to the best of the authors’ knowledge true and accurate. No liability is assumed by the authors, or publishers, for any losses suffered by any person relying directly or indirectly upon this newsletter. It is recommended that clients should consult a senior representative of the firm before acting upon this information.
During this transitional period companies need to keep track of their 33% credits. It is quite common for companies to have excess credits owing to non-deductible items. These excess credits can in fact be used to impute post March 2008 after tax profits. For example, if a company has retained earnings at 31/03/08 of $67,000 and $34,000 of 33c credits, it could make a distribution before 1/04/2010 of $69,030 (34,000 x 67/33) and attach $34,000 of imputation credits to the dividend.
A dividend may also be paid in the same income year with a 30% credit attached without breaching the benchmark dividend rules.
As a result of the reduction in the tax rate, where a company has 30% credits available and they are paid to shareholders there is still a requirement to “top up” those credits with RWT.
Section RE 13(2) states:
The amount of tax for the payment that the person must withhold and pay to the Commissioner is calculated using the formula—
(tax rate × (dividend paid + tax paid or credit attached)) – tax paid or credit attached.
where the tax rate is set out in schedule 1, part D, clause 5 which says:
“The payment rate for a payment of passive resident income that consists of a dividend… is 0.33”.
Where a dividend is imputed to 30%, an IR4K needs to be filed and the RWT paid to the Commissioner on the 20th of the month following the payment.
This can create problems where taxpayers regularly draw cash out of their companies over and above the level of shareholders salaries and there are inadequate credit balances in shareholder advance accounts to cover such drawings. In the past, fully imputed dividends could be declared to eliminate the resulting over- drawn current accounts and, for FBT purposes, such dividends were treated as credited at the earlier of the date the current account went into debit or the date of the dividend. This does not apply to dividends which are subject to RWT. At the very least, we recommend that the state of current accounts be reviewed in March every year and the dividends be declared to tidy these up with the RWT being paid on 20 April.
Last year the Limited Partnership Act 2008 (the Act) came into force introducing into New Zealand the limited partnership legal structure. This replaced the previous special partnership regime.
A Limited Partnership is a separate legal entity from the limited partners thereby giving them protection against creditor’s claims from business activities of the partnership.
Under section 8 a limited partnership must have at least one general partner and at least one limited partner. A person may not be both a general partner and a limited partner in the same partnership. By using a limited liability company as the general partner, added protection can be obtained for the individuals behind the company. Limited partners are required to be passive investors in the partnership and are not allowed to take part in the day to day operation of the partnership. The general partner is appointed by the limited partners in accordance with the partnership agreement. Should a limited partner be involved in the day to day operation of the business they could become personally liable as an effective general partner.
The limited partnership is required to use the abbreviation LP after its name to designate that they are a limited partnership.
A limited partnership is required to be registered with the Ministry of Economic Development via the Companies Office website. The Companies Office maintains a list of limited partnerships, but limited partners have anonymity as they are not required to be listed on the website.
From a tax point of view the main advantage of limited partnerships is the flow through tax status while maintaining limited liability for investors (limited partners). This is especially so for international investors investing into New Zealand who previously had to rely on the FITC regime to alleviate some of the impacts of the double taxation on dividends being remitted to overseas shareholders.
Another benefit of Limited Partnerships is that unlike Loss Attributing Qualifying Companies (LAQCs), where fresh shareholder elections are required to be made if new shareholders come in during a tax year to ensure that the company remains a LAQC, interests in a limited partnership can be transferred to a third party without any need to file paperwork at the Inland Revenue. This increased flexibility comes at an increased cost. Limited Partnerships will be more expensive than a LAQC to establish as a partnership agreement has to be drafted and agreed on between the partners.
The Income Tax Act contains anti-avoidance provisions to prevent the streaming of income, expenses, losses, credits or rebates to the partner who can utilise them best. They must be allocated pro-rata to each partner’s share in the partnership.
Section HG11 also limits partner’s deductions to the book value of the amount that they invested in the partnership.
Following is a comparison of the LAQC and Limited Partnership regimes:
Comparison of LAQC and Limited Partnership
|1. Maximum number of investors||5||Unlimited|
|2. Flow through of losses||P||P|
|3. Limited Liability of Investors||P||P|
|4. Anonymity for Investors||O||P|
|5. Ease of disposal of interest||P||O|
|6. Ability of international investors to use tax credits||O||P|
|7. Ease of administration||P|
Business of dealing in Financial Arrangements
In the current economic climate, the inability to collect monies owed from a debtor is more prevalent. A recent case decided on 13th
nuary in the Taxation Review Authority (“TRA”) was fought over what constitutes a dealer in financial arrangements.
Under section DB31(3) in order to claim a deduction for bad debts in relation to financial arrangements, the person must carry on a business for the purpose of deriving assessable income that includes dealing in or holding financial arrangements that are the same as, or similar to, the financial arrangement in relation to which a deduction is sought.In that case the taxpayer had made several loans which all turned out to lose money for the taxpayer.
The TRA held that even though the taxpayer had only made several loans, because they ‘involved serious risk of lending significantsums to seek high profits’ and because there was significant work required on behalf of the trust (active management of the loans because they were short term) the taxpayer was in the business of dealing in financial arrangements.
Furthermore the taxpayers claimed that they would have made further loans, except that they now lacked the funds required to do so. TheTRA agreed with the taxpayers.
The case, although only at the TRA level, represents quite a low bar to cross in order to be a ‘dealer in financial arrangements’. The Tribunal’s findings seem to mostly relate to the situation where a taxpayer makes significant advances to a small number of borrowers at a high interest rate for a short period of time. Because of the combination of all these factors the tribunal found the business was not a passive one saying that “there was activity to seek profit at, just, a sufficient level and organised extent to amount to a small business.”
Deductibility of Loan Break Fees
The IRD recently issued PUB0160 which is a draft public ruling on the deductibility of break fees paid to exit a fixed term mortgage early.
A “break fee” is charged where a landlord enters into a fixed interest rate mortgage with a lender, and prior to the end of that fixed term seeks to exit that fixed term (by re-financing with another lender, or with the same lender).
Cash basis persons will be able to deduct the amount of the break fee when it is incurred under the general permission, provided the money was borrowed to purchase a property from which rental income is derived.
A Cash basis person is:
- A person who has less than $40,000 difference between their cash and accrual income and either:
(i) Their income and expenditure in the income year under all financial arrangements to which they are a party is $100,000 or less; or
(ii) Who on every day in the income year, the absolute value of all financial arrangements to which they are a party added together is
$1,000,000 or less.
Where a taxpayer is not a cash basis person, they must spread the break fee over the remaining term of the loan where the loan is varied. Where the loan is moved to another lender, or a new loan is entered into, the full amount of the break fee will be deductible immediately.
Changes to the FITC Regime
On Friday 17 February NZ signed an order in council incorporating the new NZ/Australia double tax agreement (“DTA”) into New Zealand law. One of the key changes to note in the new DTA is lower withholding tax rates on dividends. As a consequence the changes to the Foreign Investor Tax Credit (“FITC”) and Non-Resident Withholding Tax (“NRWT”) regimes will come into effect for all dividends paid to Australian residents when Australia ratifies the treaty.
Under the new treaty, dividends will be taxed at a rate which does not exceed “5% of the gross amount of the dividends if the beneficial owner of those dividends is a company which holds directly at least 10 per cent of the voting power in the company paying the dividends”.
To enable the implementation of the new NZ/Australia DTA significant changes were required to the FITC and NRWT regimes. These changes were made in the Taxation (Consequential Rate Alignment and Remedial Matters) Act which was passed on 26 November 2009. The key changes are that from 1 February 2010 NRWT on dividends is 0% where a foreign shareholder has a 10% or greater direct voting interest in the NZ company paying the dividend, or a DTA reduces the tax on dividends to less than 15%, and the dividend is fully imputed. Where NRWT is taxed at the new 0% NRWT rate, the FITC rules will not apply.
It is expected that the NZ/USA tax treaty will be amended shortly to reduce withholding tax rates in a similar manner.
We also note that where shares are held solely by non-residents it does not make a difference for FITC purposes whether the dividend is paid prior to 1 April 2010 or after as the FITC credits attached are the same amounts under each scenario so loss of 33% credits for non-resident owned companies is irrelevant.