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Flawed tax policy cheats Abano shareholders

18 April 2008

The Income Tax Act requires a 66% continuity of shareholding interests from the time that tax is paid until the time the imputation credits are distributed to shareholders.

In Abano's case, the change in shareholding was sufficient to ensure that "a significant value of imputation credits were lost', according to the earlier letter.

This continuity clause dates back to the tax reforms of the late 1980s.

Back then, non-residents could not use imputation credits in any way, whereas, in sharp distinction, New Zealand residents could use them to reduce their tax.

In the absence of a continuity rule it would be a straightforward matter to transfer the shareholding from non-residents to residents and to distribute imputation credits, which had no value to non-residents, to those residents who could use them.

It was, of course, completely logical to prevent this potential abuse and to marry up the requirement that the tax payments be distributed broadly to the same group of people that owned the shares of the company at the time the tax was paid.

It was also necessary to have certain concessionary rules for public companies so that where small and conventional shareholding changes had taken place in the ordinary course of market trading, then the continuity rules should not apply.

However, time moves on and tax regimes change. Non-resident shareholders now have a vital interest in whether a company can pay its profits to them together with imputation credits.

Both residents and non-residents have broadly the same desire to have their dividends fully imputed. There is no tax preference or arbitrage between non-residents and residents in their desire to channel imputation credits from one category of investor to the other.

This position may possibly be contrasted with the position of a company with losses that is required to keep a continuity of ownership to bring the losses forward to offset against future profits.

In this way, only the shareholders who have suffered that loss should have the right of using it against future earnings. However, where tax has been paid, that same logic does not apply.

It is simply not good tax policy when an unsolicited takeover offer results in the shareholders of Abano, having borne full New Zealand tax once, then being subject, through no fault of their own, or the management, to a second tax impost on their shares.

This impost arises as a result of the company's inability to allocate imputation credits in respect of those profits that have suffered this loss of imputation credit continuity.

In contrast to the New Zealand position, the Australian regime incorporates a set of various "integrity" measures. These include anti-streaming rules (also found in New Zealand) and a holding period and related payments rules which prevent trading schemes whereby a taxpayer might, for example, acquire shares cum dividend, collect the dividend and its franking credits, and then dispose of the shares at a loss.

The good news is that a review of who can use imputation credits is on the Government's current tax policy work programme.

It would indeed be helpful, although not for the shareholders of Abano, if that review could consider whether the original objectives in having a continuity rule applied to imputation credits are still valid, given the ability of both resident and non-resident shareholders to use those credits.

How taxpayers currently use imputation credits

 

Resident taxpayers

Non-resident taxpayers

Profits earned by a New Zealand company

100

100

Tax paid

(33)

(33)

Profits after tax paid as a dividend

67

67

Supplementary dividend paid to non-residents (sourced by a credit against corporate tax)

 

12

Non-resident withholding tax

 

(12)

Cash amount received

67

67

 

Imputation credit account

Resident taxpayers

Non-resident taxpayers

Tax paid

33

33

Debit arising from credit/refund of tax due to supplementary dividend

 

(12)

Credits attached to $67 dividend paid above

(33)

(21)

Final imputation credit balance

nil

nil

This article first appeared in the National Business Review.

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