Groups of resident companies that have 100% common ownership may elect to be subject to the consolidated group regime. The group is effectively treated as a single company, and transfers of assets, dividends, interest, and management fees among members of the group are generally disregarded for tax purposes. The group files a single return and is issued a single assessment. Group members are jointly and severally liable for tax purposes, unless an election is made to limit the liability to one or more companies in the group.
Outside of the consolidated group regime, companies that are 66% or more commonly owned constitute a ‘group’. Group companies are able to offset losses by election as well as by subvention payment. A subvention payment is a payment made by the profit company to the loss company and cannot exceed the amount of the loss company’s loss. The payment is deductible to the profit company and assessable to the loss company.
Companies that are more than 66% commonly owned may transfer imputation credits as part of loss grouping (i.e. loss offsets or subvention payments). This allows the company receiving the benefit of the loss grouping to pay a fully imputed dividend despite engaging in loss grouping and allows the company to retain the benefit of the loss transfer.
Certain companies subject to special bases of assessment (e.g. mining companies other than petroleum extraction companies) are excluded from the grouping provisions. Branches of non-resident companies may be included, provided they continue to carry on business in New Zealand through a fixed establishment.
Losses incurred by a dual-resident company are not available for offset by election or subvention payment.
The transfer pricing rules are based on OECD principles and require taxpayers to treat all cross-border transactions with associates as having been made for an arm’s-length consideration.
The transfer pricing rules apply to arrangements for the acquisition or supply of goods, services, money, intangible property, and anything else (other than non-fixed rate shares) where the supplier and acquirer are associated persons. Similar rules apply to the apportionment of branch profits.
Various methods are available for determining the ‘arm’s-length consideration’. The taxpayer is required to use the method that produces the most reliable measure of the amount that independent parties would have paid or received in respect of the same or similar transactions. Inland Revenue has published guidelines that make it clear that documentation is required to support a taxpayer’s transfer prices. While there is currently no legal requirement to maintain transfer pricing documentation in New Zealand, where a transfer pricing adjustment is made to a taxpayer’s tax position, a 20% penalty will be imposed if no (or insufficient) transfer pricing documentation is in place at the time the relevant tax return was filed.
Significant changes to the transfer pricing rules have been enacted as part of a series of BEPS-related measures. This includes an extension of the transfer pricing rules to New Zealand companies owned by non-associated investors who ‘act together’ to control the New Zealand taxpayer. Those who are captured under the extended transfer pricing regime will be subject to a number of additional requirements in order to demonstrate that:
- the legal form and substance of its cross-border associated party transactions align, and
- the policies in place in support of these transactions achieve an ‘arm’s-length’ outcome that unrelated parties would be expected to agree to.
The changes apply with respect to income years beginning on or after 1 July 2018.
Country-by-country (CbC) reporting requirements
The CbC reporting requirements have been published by the OECD in order to address BEPS. In New Zealand, the first reporting of CbC data took place during the 2017 calendar year.
Each year, the New Zealand Inland Revenue will contact the New Zealand headquartered corporate groups required to file the CbC report and provide templates and guidance.
‘Inbound’ thin capitalisation rules apply to New Zealand taxpayers controlled by non-residents, including branches of non-residents. The aim of the rules is to ensure that New Zealand entities or branches do not deduct a disproportionately high amount of the worldwide group’s interest expense. This is achieved by deeming income in New Zealand when, and to the extent that, the New Zealand entities in the group are thinly capitalised (i.e. excessively debt funded).
The inbound rules include situations where non-residents are 'acting together' and include trusts where the majority of settlements have come from non-residents or from entities subject to the thin capitalisation rules.
The ‘outbound’ thin capitalisation rules are intended to operate as a base protection measure to prevent New Zealand residents with CFC investments and certain FIF investments from allocating an excessive portion of their interest cost against the New Zealand tax base.
To reduce taxpayer compliance costs, the outbound thin capitalisation rules do not apply when the New Zealand taxpayer has 90% or more of their assets in New Zealand.
Further concessions are available under the ‘outbound rules’ to taxpayers who do not fall below this threshold. If the taxpayer’s interest deduction and dividends paid for fixed rate shares (the finance cost) is below NZD 1 million, no apportionment of deductible interest is required. If the finance cost is above NZD 1 million, but below NZD 2 million, the interest apportionment may be reduced.
An apportionment of deductible interest is required under the thin capitalisation rules when the debt percentage (calculated as the total group interest bearing debt/total group assets net of non-debt liabilities of a New Zealand entity or group) exceeds both:
- 60% (for ‘inbound’ thin capitalisation) or 75% (for ‘outbound’ thin capitalisation) and
- 110% of the worldwide group’s debt percentage.
The use of the debt-to-net-asset ratio differs from most thin capitalisation models that apply to an entity’s debt-to-equity ratio. All interest (both related and unrelated party) is subject to apportionment.
Foreign-owned banks operating in New Zealand are subject to specific thin capitalisation rules that deem income if the bank does not hold a level of equity equivalent to 6% of their New Zealand banking risk-weighted assets. In addition, banks are required to have sufficient equity to equity fund offshore investments that do not give rise to New Zealand taxable income in full.
Significant changes to the thin capitalisation rules have been enacted as part of a series of BEPS-related measures. These changes come into effect for income years beginning on or after 1 July 2018. Specifically, the changes include:
- An anti-avoidance rule to ensure that taxpayers do not repay loans just before year-end for thin capitalisation purposes.
- Measuring total assets net of non-debt liabilities (as discussed above), excluding any interest-free shareholders loans.
- A ‘restricted transfer pricing rule’ within the transfer pricing regime, which would require inbound related-party loans greater than NZD 10 million to be priced as plain vanilla senior debt with a rebuttable presumption of parental support, unless the foreign parent has substantial third-party debt that includes those terms.
Controlled foreign companies (CFCs)
The CFC regime imposes New Zealand tax on the notional share of income attributable to residents (companies, trusts, and individuals) with interests in certain CFCs.
Central to the regime is the definition of a CFC. When five or fewer New Zealand residents directly or indirectly control more than 50% of a foreign company, or when a single New Zealand resident directly or indirectly controls 40% or more of a foreign company (unless a non-associated non-resident has equal or greater control), that company is a CFC. For interests that do not meet the definition of a CFC, the investment may be taxed under the FIF regime (see below).
Note that a person with an income interest in a CFC does not have attributed CFC income or losses if:
- the Australian exemption applies or
- the CFC passes an active business test.
If the exemptions do not apply, only the CFC’s passive (attributable) income is subject to tax on attribution (on an accrual basis). However, no income attribution is required if a New Zealand resident has an income interest of less than 10% in the CFC.
Active business test
A CFC passes the active business test if it has passive (attributable) income that is less than 5% of its total income. For the purposes of the test, taxpayers measure passive and total income using either financial accounting (audited International Financial Reporting Standards [IFRS] or NZ GAAP accounts) or tax measures of income.
CFCs in the same country may be consolidated for calculating the 5% ratio, subject to certain conditions.
A person with an interest in a CFC does not have attributed CFC income or a loss if the CFC is a resident in, and subject to income tax in, Australia and meets certain other criteria.
Passive (attributable) income
Attributable, or passive, income is income that is highly mobile and not location-specific (i.e. income where there is a risk that it could easily be shifted out of the New Zealand tax base).
The broad categories of attributable income are as follows:
- Certain types of dividend that would be taxable if received by a New Zealand resident company.
- Certain interest.
- Certain royalties.
- Certain rents.
- Certain amounts for financial arrangements.
- Income from services performed in New Zealand.
- Income from offshore insurance business and life insurance policies.
- Personal services income.
- Income from the disposal of revenue account property.
- Certain income related to telecommunications services.
Taxpayers must disclose interests in CFCs in their annual tax returns. Failure to disclose CFC interests can result in the imposition of penalties.
Foreign investment funds (FIFs)
The FIF regime is an extension of the CFC regime, which subjects persons with interests in certain foreign entities (which are not CFCs) to New Zealand tax. It also applies when the investor does not have a sufficient interest in a foreign entity to be taxed under the CFC regime.
Common examples of investments classified as FIFs include foreign companies, unit trusts, and life insurance policies issued by foreign entities not subject to New Zealand tax.
The FIF rules can be split into two regimes:
- The portfolio FIF rules, which apply to interests of less than 10% in an FIF.
- The non-portfolio FIF rules, which apply to interests of 10% or more that are outside the CFC rules.
Portfolio FIF rules
The portfolio FIF rules apply to interests of less than 10% in foreign companies, foreign superannuation schemes, and foreign life insurance policies issued by non-resident life insurers (if the CFC rules do not apply). However, a New Zealand resident does not generally have FIF income when:
- the total cost of FIF interests held by the individual does not exceed NZD 50,000
- the income interest is in certain Australian Stock Exchange (ASX) listed companies or certain Australian unit trusts, or
- the CFC rules apply.
There are also exemptions for interests in certain foreign employment-related superannuation schemes. These include interests held by returning residents and new migrants acquired before the person became a New Zealand resident or within the first five years of New Zealand residence.
When an interest is exempt from the FIF rules, distributions are subject to tax on a receipts basis in accordance with normal principles.
The taxable income of a New Zealand resident with an interest in an FIF that does not qualify for one of the exemptions is calculated using one of the following methods:
- Fair dividend rate (FDR).
- Comparative value.
- Deemed rate of return.
- Attributable FIF income.
The nature of the interest held and the availability of information restrict the choice of method.
Taxpayers must disclose interests in certain FIFs in their annual tax returns. Failure to disclose can result in the imposition of penalties.
Non-portfolio FIF rules
The active business exemption (which applies for CFCs) also includes certain non-portfolio FIFs. If the FIF fails the active business test, passive income will be attributed to the New Zealand shareholders. There is also an exemption for shareholders with a 10% or greater interest in an FIF that is resident and subject to tax in Australia.
When investors do not have sufficient information to perform the calculations required under the active business test (or choose not to apply the active business test), they will be able to use one of the attribution methods for portfolio FIF investments (see above).