Share Repurchase or Sherry Purchase

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Share Repurchase or Sherry Purchase Powered By Docstoc
					April 2007

In this issue Keith Turner highlights potential tax issues with the acquisition of an exiting shareholder’s interest in a
company. This will be of interest to both litigation and corporate lawyers. In addition, a brief outline of the NZ tax
treatment of foreign superannuation schemes highlights the need for specific advice for recent immigrants.

If you have any comments on this or previous articles, or wish us to cover a particular topic in future newsletters
please feel free to email Keith at keitht@nsa.co.nz or call us on 09 309 6505 or fax on 09 309 6506.



                           Share Repurchase or Sherry Purchase?

 Two recent situations involving the acquisition of                    the shareholding and the judgment provided
 shares potentially gave rise to unintended tax                        that the Company should pay the exiting
 implications whereby an otherwise capital transaction                 shareholder the agreed amount for his
 was treated as a share repurchase. Lawyers need to                    shares.
 be aware of the potential implications of a transaction
 being classed as a share repurchase.                                  For tax purposes this is a share repurchase
                                                                       and the tax rules outlined above apply. In this
 With a share repurchase, or share buy back, there                     case there was very little original capital
 are two tests to be satisfied for the repurchase not to               subscribed, with the result that approximately
 be treated as a dividend.                                             98% of the payment had to be treated as a
                                                                       dividend.
 Briefly these tests are the “bright line” tests.
 Essentially the buyback has to be of at least 10 or                   The company has the option to decide
 15% to avoid being a dividend. Also there is an                       whether to attach imputation credits or pay
 overriding requirement that the buyback cannot be in                  resident withholding tax to the IRD. If the
 lieu of a dividend.                                                   company pays the RWT to the IRD the exiting
                                                                       shareholder will receive 33% less in cash and
 Once these tests are satisfied the existing                           if the shareholder is an individual there will be
 shareholder can extract the “available subscribed                     an extra 6% liability if the dividend is over
 capital” tax free. This is basically the original capital.            $60,000 (the shareholder gets a credit for the
 Capital gains can however only be extracted tax free                  RWT deducted).
 on a liquidation, unless the company is a qualifying
 company, hence any amount over the original capital                   The company is more likely to choose not to
 will be a taxable dividend. Imputation credits can be                 impute the dividend as it would have to gross
 attached to the dividend at 33%, or if no imputation                  up the net sum payable and there is:
 credits are available, resident withholding tax
 (“RWT”) is deducted at 33%.                                              (i) an extra cash cost; and

 The two scenarios involved the following facts:                          (ii) it would leave the company with
                                                                               unimputed retained earnings which
 1. A shareholders dispute ended up in Court. The                              would be taxable on a future
    dispute concerned the valuation of the exiting                             liquidation.
    shareholders interest in the company.
                                                                          (iii) There is the potential for a debit
     The Court decided on an appropriate value for                              balance to the imputation credit


              Directors:   Phillip Walker        Phone:       09 309 6505           Address:   Level 5, 345 Queen Street
                           Philip Bell           Fax:         09 309 6506                      Cnr Mayoral Dv & Queen St
                           Bruce Watt            Email:       nsa@nsa.co.nz                    PO Box 3697
                           Graeme Carruthers     Web:         www.nsa.co.nz                    Auckland
                           Keith Turner
              Associate:   Lisa Murphy
            Share Repurchase or Sherry Purchase? (Continued)


          account.                                         It was intended to be a capital transaction.

   Compare this result to the alternative of the           However,     the   remaining     shareholder
   continuing shareholders themselves being                nominated the Company itself to purchase the
   ordered by the Court to purchase the exiting            shares. This meant the share repurchase
   shareholder’s shares rather than the company.           rules had to be applied to the acquisition of
   This would likely be a non taxable transaction          shares.
   assuming the shareholder held their shares on
   capital account. The purchasing shareholder             Needless to say the nomination caused some
   would likely get a deduction for any interest           initial dismay for the exiting shareholder, who
   incurred on borrowings to fund the purchase.            had by this time resigned as a director.
   What are the lessons from this situation?               Consideration was given to the ability to
                                                           prevent such a share buyback via the
   In framing their claim against the company, the         shareholders’ rights under the Companies Act.
   exiting shareholder could have included the
   existing shareholders as parties, and                   As it happened the buyback/dividend was able
   requested/directed the Court as to the manner           to be fully imputed and as the shares were
   in which the share could be acquired so as to           owned in trust there was no tax impost for the
   avoid a taxable share buyback and a tax                 outgoing shareholder. However, it had the
   effective result for both parties.                      potential to be a costly situation.

2. The second situation involved a shareholder             Where there is an agreement for one
   dispute where after much negotiation an                 shareholder to buy another shareholders
   agreement was reached that the remaining                shares, and there is a desire to nominate a
   shareholder (or their nominee) could purchase           purchaser, good practice suggests the exiting
   the exiting shareholders shares at an agreed            shareholder should insist that it is not possible
   value.                                                  to nominate the company itself as a purchaser.




                               Associated Persons Changes


The Government has issued a discussion                  (trading trust and investment trust as beneficiary)
document proposing an overhaul of the associated        would no longer be effective to break association.
persons provisions in the Income Tax Act 2004. It
is proposed to take effect from 1 April 2008.           It is likely there will be a multitude of submissions
                                                        because the discussion document does not really
This      would     affect    a      multitude     of   provide any meaningful reasons for making the
structures/transactions involving land transactions,    changes, and the effects are wide ranging.
sales of businesses to related parties, provisions of   Submissions must be in by 11 May 2007.
benefits to certain associates of companies etc.
The amendments suggest imposing “tripartite”            It would appear to be the case that the current
tests (for associating dealers and developers of        structures for non association in a land transaction
land to other entities of which they have an            situation should continue to be available until 1
interest). This would mean the two trust structure      April 2008.




Newsletter for Lawyers                                                                            Page 2
                           Foreign Superannuation Schemes


 With the influx of UK and US migrants into New         choose one of four methods to account for FIF
 Zealand, lawyers who act for new residents can do      income or loss on an annual basis. Various
 their clients a service by suggesting they check the   conditions apply to be able to use each method.
 tax status of any pension or superannuation            The most common method is the comparative
 schemes they hold.                                     value method, which taxes the annual increase in
                                                        value. Three out of four of these methods of
 Residents new to this country (from 1 April 2006)      calculations bring annual capital gains to tax.
 have a four year exemption from any foreign
 sourced income which is not employment income.         Many immigrants are not aware of the fact their
                                                        superannuation schemes could be subject to the
 However, on the expiry of that period, taxpayer’s      FIF regime. We have acted for a number of
 should have classified any interests in foreign        executors of estates in liaising with IRD regarding
 superannuation schemes to ensure they correctly        previously non disclosed FIF gains and losses, and
 account for the tax treatment on an annual basis.      the penalty and interest costs in these cases have
 Don’t assume that because the taxpayer is not yet      been substantial, let alone the core tax.
 receiving the pension or annuity there are no
 ongoing New Zealand tax implications.                  If the superannuation schemes are not FIF’s by
                                                        virtue of the above exemptions applying, the
 A foreign superannuation scheme that provides          taxpayer is taxed on a pension received basis, and
 retirement benefits will be subject to the foreign     any lump sum withdrawals are subject to either the
 investment fund (“FIF”) regime, unless any of the      unit trust rules or trust rules.
 exemptions apply. We have traditionally taken the
 view that US IRA’s and 401K plans are FIF’s,           Different tax treatment applies under these
 although each plan will need to be analysed in         regimes and it is beyond the scope of this article to
 terms of its documentation.                            comment in detail. Note there are time frames that
                                                        need to be satisfied under the trust regime to
 Two main exemptions exist (in addition to the four     obtain certain benefits.
 year period outlined above):
                                                        Note that interests in certain Australian
 1. The Immigrants Accrued Superannuation               superannuation funds are now no longer subject to
    entitlement exemption. If the interest in the       the FIF regime (following the extensive changes
    scheme is acquired via employment and               introduced from 1 April 2007), and previously
    certain other restrictions on assignment or         reported FIF income may be able to be refunded.
    conversion are present, the exemption applies.
                                                        Foreign superannuation schemes are not thought
 2. Non resident’s pension or annuity exemption.        of as giving rise to tax issues, however invariably
    Similar to 1 above there must be restrictions on    most migrants have them and are often ignorant of
    the ability to receive a lump sum payment.          any tax liability. With the multitude of products
                                                        issued out of the UK in particular, each scheme
 Assuming the exemptions do not apply, and the          needs to be examined closely to classify it
 super scheme is subject to the FIF regime at the       accurately.
 expiry of the four year period, it is necessary to




This newsletter is not intended to provide an exhaustive or comprehensive statement of tax law
and it should not be relied on or used as the basis for any decision or legal action. Detailed
professional advice should always be sought in order to verify the applicability of the relevant
legislation to the specific case.




Newsletter for Lawyers                                                                           Page 3
                          SEMINAR REGISTRATION 2007
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 CURRENT TAX ISSUES
 Looking at new overseas investment rules as they                                  8/05/07                                10/05/07                     25/5/07                  27/04/07
 impact on portfolio investors and other                                          10am-12pm                              10am–12pm                    10am-12pm                11am – 1pm
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 TAX RETURN ADJUSTMENTS
 For intermediate level accountants who prepare
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                                                                                   22/05/07                               24/05/07                     4/05/07                  11/05/07
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 tips, traps and benefits of both.


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