Inside this edition:
1. Income Protection Insurance
2. Gifts of Food & Drinks
3. Taxable Gains – Rezoning Changes
4. Relationship Property Transfers
5. Debt Remission
6. Qualifying Companies & Continuity
7. Tainted Capital Gains
8. Horse Racing, Prizes & GST
9. Loss Grouping of Imputation Credits
1. INCOME PROTECTION INSURANCE & TAX IMPLICATIONS
In general there are two types of income protection policies that cover the insured for loss of earnings. The income tax treatment of premiums and payouts vary depending on the type of policy you have. The income protection policy can be either “Indemnity Value and Loss of Earnings Policies” or “Agreed Value Policy”.
The Indemnity Value and Loss of Earnings Policies tends to be offered to employees where the expectation is that the income is reasonably stable and it should increase over time. This policy type offers the ability to insure for up to 75% of the pre-taxed earnings of the insured. Premiums paid by the insured under this type of policy are deductible for income tax purposes and any payout received will equally be taxable as the aim of these policies is to provide replacement income for the insured.
The Agreed Value Policy on the other hand tends to be offered to self employed people where the income may fluctuate from year to year. This policy offers the ability to insure up to 55% of pre-tax earnings of the insured. Premiums paid under this policy are not deductible for income tax purposes and any payout received under this policy will equally not be taxable.
In addition to the differing income tax treatment of these two types of policies, there is a fundamental difference which should be considered by every person considering taking out income protection insurance. In case of the Indemnity Value Policy the income of the insured does not have to be proved until the time a claim is made. There is a possibility that the income of the insured may be very different at the time of claim than initially anticipated should the individual have taken a reduction in earnings, changed from full time to part time employment, or in the event of a redundancy.
In contrast with the Agreed Value Policy, the income of the insured has to be proved at the time the policy is taken out and not at the time of claim. Whilst self employed individuals would be advised by their insurance brokers to have an agreed value policy in place this may also be of interest to persons who are ordinary employees, as the Agreed Value Policy offers greater certainty at the time of a claim.
In terms of claiming premiums for income protection insurance, care should be taken to ensure that the premiums claimed are in fact deductible.
The IRD has recently released an operating statement in relation to deductibility of expenditure spent by taxpayers on client gifts consisting of items such as wine, chocolates, biscuits & food items.
The IRD’s position starting on 1 September 2016 is that such expenditure will fall within the entertainment provisions in subpart DD, which limits the available deduction to 50%, for expenditure on items such as chocolates, bottles of wine and other food items provided to customers as gifts.
The IRD’s rationale for this is that taking clients to a lunch would be expenditure which will be subject to the 50% limitation, whereas should the taxpayer chose to provide a gift basket to the client consisting of various food items such cost would be fully deductible. The IRD is of the view that this is inconsistent treatment.
Consequently, the IRD is of the view that gifts of food and drink, fall within the category of food and drink that the taxpayer provides off their premises that will provide a private benefit to the customer as well as a business benefit to the taxpayer. As there is no requirement by the subpart DD for the private benefit to arise to the taxpayer himself then such gifts provided off the taxpayer’s premises to its customers will be subject to the entertainment rules in subpart DD. Consequently such gifts will fall within s DD 2(5) and a deduction sought by the taxpayer will be subject to the 50% limitation.
Where gift baskets are provided to customers and such baskets contain a mixture of food and non-food items IRD is of the view that appropriate apportionment should be made.
The IRD’s operational position represents a major shift in the application of entertainment rules as they were initially introduced, as there is no private benefit to the taxpayer providing the gift of food to the customer. Nonetheless the IRD’s position is effective from 01 Sept 2016. Care should therefore be taken when considering a deductibility of expenditure incurred on customer’s gifts consisting of food items (including Christmas hampers), alternatively gift items other than food could be considered instead.
Section CB14 seeks to impose income tax on gains derived from the disposal of land within 10 years of acquisition, where at least 20% of the gain arises from rezoning changes or the likelihood of rezoning changes with a deduction being allowed for 10% of gain for each complete year of ownership.
If land that is subject to s CB14 is disposed off, an exclusion from these taxing provisions is available for residential land under s CB18 but only insofar as the land was disposed of by the person who used the land or intended to use the land mainly as residence and the land was disposed of to another person who acquired it for use as a residence including erecting a dwelling thereon.
The exclusion in CB 18 only applies to persons and members of their family living with them, who use or intended to use the land mainly as residence.
Consequently a person disposing of land to a property developer within 10 years of acquisition where at least 20% of the gain is attributable to rezoning changes or a possibility of rezoning, may be faced with unforeseen income tax consequences.
In addition to the above persons engaging in land banking activities often hold the land within company structures. In some cases the land is held for less than 10 years, in which case s CB14 will find application.
Pursuant to s CB14 the gain is a taxable gain, which is abated by 10% for each complete year of ownership. Consequently when the land is disposed of by a company, the untaxed gain will form part of un-imputed earnings and will be subject to dividend rules at the time of distribution to shareholders.
Relationship breakups are often associated with a division of relationship property. The Income Tax Act provides for rollover relief where relationship property is divided. The roll over relief provisions ensure that no adverse income tax consequences arise as a result of property that being transferred on “settlement of relationship property”. In essence the act treats the transferee as stepping in the shoes of the transferor. These provisions ensure that there is no depreciation recovered, that no income arises as a result of transfer of revenue account property, that the shareholder continuity is not affected for the purposes of imputation credits and loss carry forward rules.
Whilst the above is nothing new, the Taxation (Annual Rates for 2015 – 16, Research and Development, and Remedial Matters) Act 2016 which was enacted on 24th February 2016 has extended the scope of the application of the roll over relief by amending the definition of “Settlement of Relationship Property” to include associates of persons that are party to the relationship property agreement.
Historically the rollover relief was only available to property transfers between the parties to the agreement and not to the property that was owned by a family trust or a company. The amendment of the definition, which applies to the settlements of relationship property on or after 24 Feb 2016, has extended the rollover relief provisions to
a) transfers of property by a person who is a party to the relationship agreement or is associated with a party to the agreement
b) transfers by another person who is a party to the relationship agreement or is associated with a party to the agreement.
The amendment in the definition extends the rollover relief to trusts and companies provided however that these are associated with the persons who are party to the relationship agreement. The rollover relief also extends to property being transferred to relatives within a second degree relationship. As the transferee is stepping into the shoes of the transferor, it will be necessary to consider and take into account any deferred income tax liability.
The Taxation (Annual Rates 2016-17, Closely Held Companies, and Remedial Matters) Bill proposes amendments to current legislation which are aimed at preventing remission income from arising in certain circumstances in cases where a loan from a shareholder to a company is remitted. It should be noted that the debt remission rules are not disappearing completely. However remission income will not arise in certain circumstances.
Under current rules when the LTC owner or a partner in a partnership (incl. Limited Partnership) remits a loan, remission income will arise to the owner without a corresponding deduction to the owner. The position under the current law is inequitable given the fact that the remission arose from a transaction where the owner has forgiven the loan to himself, i.e. effective self-remission as LTC’s and Partnerships are transparent.
The proposals in the Bill are aimed at fixing this anomaly by introducing a concept of “self-remission” the purpose of which is to ensure that remission income will not arise to the LTC owner or a Partner where the LTC owner or a Partner has lent money to the LTC or Partnership.
The amendments for LTC’s will apply from the start of the LTC rules on 1 April 2011.
The Bill also proposes some changes to the treatment of debt remission other than through self-remission, where the borrower and the lender are associated.
Under the current rules when a loan owed to a shareholder is remitted, such remission gives rise to remission income to the company without the ability to claim a deduction for the shareholder of the bad debt. In essence taxable income arises even though there is no real economic gain.
The Bill proposes that the amount of debt remitted will be treated as repaid in full and consequently not give rise to remission income for the company (borrower) insofar as:
- The creditor (lender) is a member of the creditor group of the debtor (borrower), and
- The debt forgiven that is owed to the creditor is a pari-pasu debt (debt advanced in proportion of the creditor’s ownership interest in the company
The Bill further proposes that the remission of a company’s debt to an associated creditor will increase the available subscribed capital of the company with a corresponding increase to the cost of the creditor’s investment in the debtor. The outcome of the proposal is the same as debt capitalization, i.e. capital injections.
Whilst this is still in Bill form, remission other than pari-pasu debt remission may be problematic. The proposed amendments do not alter the tax treatment of debt remission by a company to its shareholders, which except for a wholly owned group of companies, still continues to be taxed as dividend.
The changes are proposed to be backdated to the beginning of the 2006/2007 income tax year to provide certainty to the taxpayers. However positions taken prior to the commencement of the 2014/2015 income tax year will not be available for re-assessment. Such positions will be considered final.
The Taxation (Annual Rates 2016-17, Closely Held Companies, and Remedial Matters) Bill also proposes that qualifying company (QC) status will cease if there is a change in control of the company.
The proposed new “Shareholder Continuity” requires a minimum continuity interest of 50% for the continuity period.
The minimum continuity interest is the lowest voting interest or the market value interest during the continuity period. A breach of this requirement will trigger the loss of QC status. Rollover relief will be available for changes in shareholding resulting from relationship settlements or death of a shareholder.
The Taxation (Annual Rates 2016-17, Closely Held Companies, and Remedial Matters) Bill proposes amendments to accounting for GST on race winnings.
Section 5 “Meaning of term Supply” will be amended by inserting s 5(11CB) which treats the prize winnings received by a racehorse owner as consideration for a supply of services provided to the racing club.
The new section will apply when a registered person is carrying on the racing in the course of a taxable activity. Its aim is to treat winnings paid to registered horse owners, who enter the race in the course or furtherance of a taxable activity, as consideration for a taxable supply. The new section is not meant to apply or alter treatment of non-registered persons or cause a non-taxable activity to become a taxable activity.
It is proposed that the amendments will apply from 01 April 2012.
Under the current rules when a loss is offset between a loss company and a profit company, a situation often arises that the imputation credits available do not match the retained earnings available for distribution. Consequently subvention payments are often preferred as an alternative to a loss offset.
The Taxation (Annual Rates 2016-17, Closely Held Companies, and Remedial Matters) Bill proposes amendments to the current legislation which will allow companies that are commonly owned (having at least 66% commonality of ownership, the standard company grouping) but not 100% to transfer imputation credits as part of loss grouping.
It is proposed that the imputation credits to the value of the tax effect of loss grouping be capable of transfer to the profit company by another member of the group, provided that the eligibility criteria are met.
It is proposed that these amendments will apply from the 2017/2018 income tax year.
Should you have any questions on the content of this newsletter, please do not hesitate to contact us. We will gladly provide clarification or assistance as the case may be.