After five years of reform of the tax rules for outbound investment, Inland Revenue officials are now proposing changes to an important inbound tax regime.
Inland Revenue released a paper on 14 January 2013 proposing to broaden the thin capitalisation regime. The regime limits interest deductions claimed by foreign-owned New Zealand companies with debt to equity ratios exceeding certain thresholds.
The proposal is aimed at both widening the application of the regime and limiting the application of the existing safe harbours.
Submissions on the Inland Revenue’s Issues Paper are due by 15 February 2013.
For inbound investment the thin capitalisation regime in effect denies interest deductions to the extent that a New Zealand group’s debt to asset ratio is more than the greater of:
• 60%, and
• 110% of its worldwide ratio.
Wider application of the thin capitalisation regime
The rules are proposed to apply where there is a group of non-residents investing together, whereas the current rules are focused on entities controlled by a single non-resident investor. The group of non-residents must be able to collectively determine the level of debt the company holds in the same way as an individual controlling shareholder can, and so will affect some private equity investment.
Inland Revenue is seeking comment on how the test for whether there is a group should be determined. The proposals are for a bright line threshold (i.e. a 50% foreign ownership threshold, with an exception for listed companies) or a test of whether the group of investors is “acting together” – a test that is likely to be somewhat vague and would need to be teased out to know what it would mean in practice.
The current thin capitalisation regime covers only complying trusts where a single foreign investor makes more than 50% of the settlements on the trust. Inland Revenue has proposed to extend this to all trusts where a group of non-residents or another entity covered by the rules makes more than 50% of the settlements.
Restricting the regime’s existing safe harbours
The paper proposes to exclude related-party debt when determining the worldwide group debt percentage. The current rules do not work where the worldwide group is nearly the same as the New Zealand group because the 110% safe harbour is always available. This allows the group to use as much New Zealand debt as it wants and still claim interest deductions because the New Zealand debt percentage falls below the 110% threshold.
Increased asset values are proposed to be ignored where they result from internal sales.
In the case of outbound groups, it is proposed that an individual owner’s interests would be consolidated with those of the outbound group, rather than considered separately.
Capitalised interest is proposed to be excluded from the value of a group's assets for the calculations if a tax deduction for that interest has been taken in New Zealand.
Inland Revenue believes that these changes, aimed at increasing tax collected from foreign investors, will not significantly affect the level of inbound investment into New Zealand.
Submissions close on 15 February 2013.