Proposed Changes to the Non-Resident Withholding Tax & Approved Issuer Levy Rules
In May 2015, Inland Revenue released an "issues paper" which discussed various concerns about New Zealand’s NRWT and AIL rules. The paper is part of a consultation process aimed at updating and strengthening the withholding tax rules for related-party debt.
This issues paper suggests a number of changes are required to address concerns arising from the manner in which financial transactions have evolved and become more sophisticated since the NRWT rules were first formulated often resulting in the collection of NRWT being deferred or circumvented. These changes fall under three broad headings.
- Preventing arbitrage of NRWT rules with the financial arrangements rules
At present, a liability for NRWT on interest (defined in the income Tax Act as “non-resident passive income” ("NRPI")) is only triggered when the NZsourced interest is paid or deemed to be paid. The related definitions have not been changed since 1983 and the Officials consider the definitions contribute to the deferral of NRWT on accrued interest which has been claimed as an expense for income tax purposes.
The interest expense being calculated on an accruals basis having regard to the “financial arrangement rules” which apply to NZ tax-residents and require the interest or expense to be spread over the life of the financial arrangement.
This can result in a mismatch between the timing of the deduction for interest to a NZ resident borrower and the collection of NRWT on the NZ sourced interest earned by the non-resident lender where the interest has not been paid.
The financial arrangement rules also take into account the effect of foreign currency fluctuations on a foreign currency loan on an unrealized basis but no account is taking of the same fluctuations in calculating the interest (NRPI) to which NRWT applies.
The issues paper suggests that for certain related-party debt structures that would generate financial arrangement income if the non-resident party were subject to the financial arrangement rules, an NRWT liability should be triggered and determined by reference to the financial arrangement rules rather than the NRWT rules. This would be a significant change.
In order to prevent a mismatch between the NZ tax treatments of a resident borrower and the associated non-resident lender, the first proposal is to widen the definition of "money lent" to include an amount lent to a resident by an associated non-resident, and under which the resident incurs financial arrangement expenditure.
A second proposal would affect how the amount of interest (NRPI) is calculated, effectively bringing this more into line with how financial arrangement income is calculated.
A third proposal would bring the time of recognition of NRPI more into line with the financial arrangement rules, for arrangements that involve a deferral of payments as compared with income measured under the financial arrangement rules.
- Preventing associated persons accessing the AIL rules
NZ borrowers who meet the requirements of the approved issuer levy (“AIL”) rules can pay a levy on payments of interest that would ordinarily be subject to NRWT. The AIL regime can be particularly useful when the non-resident lender is not able to claim the NRWT as a tax credit in their home country.
One of the requirements is that the borrower and the lender are not "associated persons". However, there is a concern that associated persons can arrange certain funding structures that would provide access to the AIL rules when the policy intention is that the interest payments should be subject to NRWT.
Unlike some of the other tax rules, the AIL rules do not look through to the ultimate non-resident lender. This could allow a lender and borrower to interpose one or more third parties into what would otherwise be a loan from an associated person.
The proposed solution is that NRWT should be paid when NZ-sourced interest is paid to a third party, if it is part of an arrangement for that third-party lender to be provided funds by a non-resident who is associated with the resident borrower.
A second proposal is that NRWT should be paid when interest is paid to a non-resident who is not associated with the borrower under the normal association rules, but who is part of a "group of persons" who are acting together and would be associated with the borrower if they were a single entity. This rule would be similar to the changes recently introduced to the thin capitalisation rules.
A third proposal intends to deal with the improper substitution of AIL for NRWT on interest to related persons. The suggested solution is to limit AIL to loans which are either to or from a financial intermediary, or raised from a group of 10 or more non-associated persons.
- Restricting branch exemptions
The NZ income tax legislation currently has NRPI exemptions for interest payments that are made by foreign branches of NZ companies, or are made to foreign companies with NZ branches. The concern of officials is that the wide scope of both exemptions means that certain interest payments are exempted in a way that is not consistent with the policy intention.
The first proposed solution is to limit the existing offshore branch exemption so that interest paid by the offshore branch of a NZ resident is subject to NRWT or AIL to the extent that the interest is paid on money which is lent to a NZ resident.
The second solution is to limit the onshore branch exemption so that it only applies to interest that is received by a non-resident in connection with a business which is carried on through a fixed establishment in NZ. Where a nonresident operates a NZ branch, NZ-sourced interest income which is not directly connected with the business carried on through the NZ branch would be treated as NRPI, and therefore subject to NRWT or AIL.
The third solution applies to cross-border related-party borrowing by banks. Officials recognise that where a NZ bank is part of a wider worldwide banking operation, there are commercial reasons why the NZ bank would want to borrow funds from its parent or from another associated entity. The implementation of the suggested restrictions to the offshore and onshore branch exemptions could have an adverse effect on banking operations, and could in fact increase the cost of capital for all borrowers in NZ. Therefore, it is suggested that members of NZ banking groups be allowed to use the AIL on interest payments to their non-resident associates.
What happens next?
The submissions closed on 16 June 2015. Subject to consultation with interested parties, any amendments to the NRWT rules could be included in the next tax bill which is currently scheduled for introduction in late 2015.
The IRD officials have suggested that the reforms would apply to financial arrangements entered into on or after enactment of the legislation, and this is expected to be in the second half of 2016.
With regard to the AIL registration rules, it is proposed that Issuers of securities which were registered before the enactment date would have to reapply under the new requirements within two years of the enactment date. If they do not reapply, or do not meet the criteria, the registered security status would be lost and NRWT would become payable on interest after that date.
Once we learn the details of the legislation amendments, we will include an update in the next edition of Tax Today.