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Tax Toolkit: Tax reforms to NZ controlled foreign company rules

China General Interest

“The aim in developing this comprehensive reform has been to devise flexible rules that are consistent with the realities of the business environment and that help New Zealand businesses to expand their operations but keep their head offices in New Zealand” Finance and Revenue Ministers Dr Cullen and Peter Dunne.

As the celebrations for the New Zealand China Free Trade Agreement continue we also honor a New Zealand hero, Victor Percival.

Victor’s vision and foresight saw him start his journey into a trading relationship with China in 1956. His China experience is shared in the book “The Kiwi Pathfinder – Opening Mao’s China to the West” by Bruce Kohn.

The pioneering spirit displayed by Vic is exactly what we need today to ensure the benefits of the FTA are translated into economic wealth for our nation.

Governments establish platforms and it is up to businesses to build on these. In the area of platform building we have on the table tax reforms to our controlled foreign company rules that are set to apply from 1 April next year.

These fundamental and radical changes will be welcomed by New Zealand businesses operating offshore.

The upshot is that active businesses operating offshore will generally not be taxable in New Zealand.

This puts us on an even footing with most of our competitors and helps remove the incentive for our businesses to migrate to countries like Australia or Singapore.

Most dividends paid by a foreign company will be exempt from income tax when received by New Zealand companies. The exceptions to this are dividends that are deductible for tax in a foreign jurisdiction and those paid on fixed rate shares, which will also be taxable.

Other measures will introduce interest allocation rules that will restrict the amount of interest that will be deductible by the New Zealand entity.

Even so, there are several safe harbour provisions that will minimise the impact of this.

There are also changes that will remove what is termed as the “conduit relief mechanism”, which exempts from tax the foreign-sourced income of New Zealand companies owned by non-residents. There is, however, a two-step transition mechanism.

These changes will bring our tax rules into line with the practice in other countries. It will also help New Zealand-based business to compete more effectively in foreign markets by freeing them from a tax cost that similar companies in other countries have not had to endure.

They also mean New Zealand businesses need to review the way they are operating in countries such as China to make sure they are tax effective.

A critical part of this review must include the relevant tax rules in the offshore jurisdiction.

The recent tax changes in China will more than likely result in increasing the tax that is payable by New Zealand enterprises in China. Consideration needs to be given to your holding company structure and the impact of withholding tax being payable on dividend distributions. An example would be that if these dividends are payable back to New Zealand then your withholding tax rate is 10%, whereas, the rate under the China-Hong Kong double tax agreement, is only 5%.

From a withholding tax perspective, it could be beneficial to use Hong Kong as a holding company jurisdiction for a PRC entity. The added fishhook is equity transfers could attract a capital gains tax in China, which is a feature New Zealand businesses need to take into consideration.

Given the changes to the dividend withholding tax, other methods need to be explored. Charging fees from your New Zealand company to your China entity for services, trademarks, technology or pushing down interest bearing loans to China are just some of the issues to be considered. All this needs to be done in accordance with the new and existing transfer pricing rules in China and New Zealand.

Even if you do not do this any related party transactions need to be disclosed to the China Tax Bureaus. Penalties and interest charges will apply if you do not have the required documentation and evidence that these are based on arms length rates.

With the corporate tax rate in China moving to 25% for both foreign-owned and domestic enterprises, consideration needs to be given to the incentives still available and how you can qualify.

China has self-imposed restrictions on deductions of certain expenses such as advertising and sponsorship costs.

We fully appreciate not everyone loves that three letter word ending in “x” as much as we do. Despite this, tax is a critical part of the equation in ensuring your offshore activities are successful.

Over fifty years ago Victor Percival believed China would replace Britain as New Zealand’s principal trading partner. Today we are reaping the benefits of this type of foresight.

Ernst & Young are pleased to give away to five lucky readers a copy of the book. Please email your application to wendy.byrne@nz.ey.com

Joanna Doolan is a Tax Partner and Florence Wong is a Senior Tax Manager with Ernst & Young.


Tags: tax