Tax Update by runout

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									                                                                                                                   April 2009


                          Tax Update
                          New direction for New Zealand’s
                          tax treaties
                          The revised NZ/US tax treaty heralds a major shift in NZ’s tax treaty landscape. The NZ/US treaty
                          is likely to become NZ’s new standard form for double tax agreements. In particular, the NZ/US
                          treaty gives a clear insight as to what can be expected in the soon-to-be-agreed NZ/Australia
                          tax treaty.
                          The main feature of the new treaty is the reduction in withholding tax rates on interest,
                          dividends and royalties. This policy change has generally been welcomed by the business
                          community. However, there are some subtleties in accessing the lower rates of withholding tax.
                          The detail of the new treaty and expected domestic law changes mean that in many cases, the
                          status quo for inbound investors will be unchanged. However, NZ residents investing into the
                          US are likely to benefit, particularly NZ companies with US operations, which will benefit from
                          the reductions in dividend and interest withholding rates.


                          Dividends
                          Withholding tax on dividends is currently capped at 15% under the NZ/US treaty (and most
                          of NZ’s other tax treaties). Under the revised treaty, that cap will be reduced to 5% if the
                          recipient is a company that directly owns at least 10% of the company paying the dividends.
                          No withholding tax will be imposed if the recipient is a company that directly or indirectly
                          owns 80% or more of the company paying the dividends (subject to satisfaction of technical
                          requirements concerning the recipient, which generally require that the recipient of the
                          dividends be listed, or owned 50% or more by residents of the same contracting state in which
                          it is resident, or has obtained a specific determination that it is entitled to benefit under the tax
                          treaty).
                          Foreign shareholders of a NZ company already have the benefit of, in effect, no withholding
                          tax on fully imputed dividends under the foreign investor tax credit (FITC) regime. The Inland
                          Revenue has signalled that it will repeal or reduce the scope of the FITC regime (probably by
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scrapping FITC on dividends paid to shareholders with a 10%            Given that royalties are tax deductible and it is difficult to
or greater holding in the NZ company), as in its current form          accurately determine an arm’s length value for intellectual
FITC may otherwise allow such foreign investors to reduce              property, the reduction in withholding on royalties may
their overall NZ tax rate to less than 30%. These domestic             see an increase in the number of groups which seek to take
law changes are likely to mean that US shareholders of a NZ            advantage of low withholding on royalties by setting up
company are unlikely to be subject to a lower rate of tax on           centralised intellectual property holding companies in low
distributed earnings than at present (taking into account              tax countries. The Inland Revenue is likely to be alert to these
corporate tax on underlying earnings and withholding tax on            structures as they can allow groups to transfer profits between
dividends).                                                            countries tax-free or with very low withholding.
Currently, withholding on unimputed dividends is capped                Currently, payments for the use of industrial, commercial or
at 15% under most treaties, and is not reduced by the FITC             scientific equipment are deemed to be royalties under NZ’s
regime. As the withholding liability for major investors (over         tax treaties. However, under the revised NZ/US treaty, these
10%) will be capped at 5%, irrespective of whether or not              equipment payments are no longer included in the definition
the dividend is imputed, the distribution of capital gains and         of royalties. Instead of being subject to 10% withholding tax
other earnings not subject to corporate tax other than on the          as royalties, they will now be subject to the general business
liquidation of the company may become more palatable to                profits article, which means that they will not be subject to
foreign shareholders.                                                  tax in the source jurisdiction at all, unless they relate to a
                                                                       permanent establishment. This is an effective reduction in
                                                                       withholding tax on equipment payments from 10% to 0%, and
Interest                                                               increases the body of transactions which are not automatically
Withholding tax on interest will generally continue to be              subject to withholding tax in the source country. This change
capped at 10%. However, no withholding tax will be imposed             is also likely to feature in the new NZ/Australia tax treaty.
if the recipient of the interest is a tax-exempt Government
body, or is in respect of debt that has been guaranteed or
insured by the Government in which the recipient is resident,
                                                                       Comment
or is received by a bank or a lending or finance business              The trend around the world is to lower withholding taxes
unrelated to the payer of the interest.                                under international tax treaties. This is a trend led by large
                                                                       nations (such as the US and the UK) which see themselves
However, interest paid from NZ to an unrelated US bank or
                                                                       as beneficiaries of lower withholding as their residents have
financial institution will only be exempt from withholding tax if
                                                                       significant amounts invested overseas and are generally
the approved issuer levy (AIL) of 2% is paid by the NZ resident.
                                                                       owners of intellectual property. NZ is not actively leading this
For NZ residents borrowing from foreign lenders and already
                                                                       trend, but is having to follow our major trading partners as
paying AIL rather than grossing up 15% NRWT, the changes in
                                                                       they move towards lower rates of withholding tax.
the revised treaty will not provide any tax relief – this is a large
proportion of offshore borrowings from banks.                          Intuitively, the reduction in withholding taxes would be
                                                                       expected to benefit business. However, it is not clear that
NZ banks have an advantage over foreign banks in that they
                                                                       this will be the case. This concern arises from the argument
are not subject to withholding tax on their gross interest,
                                                                       that where a person is allowed a credit in their home country
and are not subject to the 2% AIL. The new NZ/US treaty
                                                                       for NZ tax paid, NZ tax does not impact on the total amount
retains this status quo, and leaves NZ banks with their current
                                                                       of tax paid by the person and therefore does not affect the
advantage over foreign lenders.
                                                                       return on their investment. In this case, the tax is essentially
                                                                       a “free tax” for NZ, as it generates revenue without detracting
Royalties                                                              from NZ’s attractiveness as a place to invest. However, foreign
                                                                       investors are not always entitled to tax credits for NZ tax
The reduction of the maximum rate of withholding on royalties          paid, in which case the rate of NZ tax does have an impact on
from 10% to 5% is a major change to NZ’s tax treaty policy, and        their effective rate of return from their NZ investments, and
reflects worldwide trends (which are generally tending towards         consequently NZ’s attractiveness as an investment destination.
0% withholding on royalties). Withholding tax on royalties is          It is impossible to tell to what extent foreign investors in NZ
likely to be reduced to 5% under NZ’s future tax treaties (and         are allowed a tax credit for NZ tax paid, and as a result, how
given that the OECD provides for no withholding on royalties,          beneficial the reduction in withholding rates will be for NZ
may even reduce to 0%).                                                business.
  3                                                                                                                                                            TAX UPDATE APRIL 2009



contacts
                                  Andrew Ryan - Partner                                                                          Amanda Somers - Senior Associate
                                  T +64 9 353 9950                                                                               T +64 9 353 9994
                                  M +64 21 606 170                                                                               M +64 21 440 842
                                  E andrew.ryan@minterellison.co.nz                                                              E amanda.somers@minterellison.co.nz




                                  Joanne Dunne - Partner                                                                         Vivien Cheng - Senior Associate
                                  T +64 9 353 9990                                                                               T +64 4 498 5079
                                  M +64 21 610 874                                                                               M +64 21 610 863
                                  E joanne.dunne@minterellison.co.nz                                                             E vivien.cheng@minterellison.co.nz




                                  John Peterson - Partner
                                  T +64 4 498 5028
                                  M +64 21 895 559
                                  E john.peterson@minterellison.co.nz




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 Disclaimer
 The information contained in this update is intended as a guide only. Professional advice should be sought before applying any of
 the information to particular circumstances. While every reasonable care has been taken in the preparation of this update, Minter
 Ellison does not accept liability for any errors it may contain.
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