The Government wants input on how best to tax distributions to shareholders under a profit distribution plan (PDP). It is proposing that they be treated as a taxable dividend, in the same way as distributions to shareholders under a dividend reinvestment plan (DRP).
The proposal is contained in an issues paper released last week by the Inland Revenue Department. The IRD wants submissions by 7 August 2009.
Distributions to shareholders under a DRP are taxable. Under a DRP, shareholders have the option of reinvesting their cash dividends (with any attached imputation credits) in shares of the company. The cash dividend paid to all shareholders is taxed under the standard dividend rules.
However, distributions of shares to shareholders under a PDP can be structured to be a non-taxable bonus issue that does not constitute a dividend in the hands of the shareholder, and therefore may not be taxable.
Inland Revenue has previously ruled on a PDP scheme and included a number of conditions to its confirmation that the initial issue of shares qualified as a non-taxable bonus issue; one of which was that the company needed to have sufficient imputation credits to have fully imputed an equivalent dividend.
PDPs can provide tax benefits to shareholders who could not utilise the imputation credits that would have otherwise been attached to a cash dividend. Such a shareholder may be able to realise the value of the dividend in a more tax-effective way by selling the shares it has received on the share market.
The proposed solution
To reach the same tax treatment for distributions from DRPs and PDPs, the Government proposes to include within the definition of “bonus issue in lieu” the issue of shares where shareholders can opt for the company to repurchase those shares. This would result in distributions of shares under a PDP being taxable as a dividend.
However, this raises issues with the subsequent repurchase of those shares by the company, which currently would also be treated as a taxable dividend where the re-purchase does not satisfy the bright line tests.
A further amendment to eliminate the share repurchase from the dividend definition is therefore proposed. However, this solution in itself may have wider implications and the paper calls for submissions on these issues.
It is arguable that the current rules, which contain various anti-avoidance provisions, adequately deal with the position and that the different tax outcomes between PDPs and DRPs are simply a reflection of the different factual context.
We recommend that companies with existing DRPs or PDPs, or contemplating these plans, consider the possible impact of these proposals.
If you wish to make a submission or would like further information, please contact Graeme Olding.