New Zealand: Proposed reform of interest withholding tax rules

Rhonda Gregory

Inland Revenue and the Treasury have released an issues paper proposing to reform the way non-resident withholding tax (NRWT) applies to interest. Generally, under existing law, where New Zealand-sourced interest is paid to a non-resident lender that does not have a New Zealand branch, the borrower must withhold NRWT at the rate of 15% (although this is usually reduced to 10% under any applicable double tax agreement). In the case of interest paid to a lender that is not associated with the borrower, the rate of NRWT can be reduced to 0% by the borrower paying an approved issuer levy (AIL) of 2%.

Currently, the only substantive limitation to applying the AIL regime is that the borrower and lender cannot be associated. There are various tests for determining when two parties will be associated. For companies, the main test is whether the two companies have common ownership to the extent of 50% or more.

The following proposals would further limit the scope of the AIL concession:

• Amounts would be deemed to be paid to an associate in the case of a back-to-back arrangement under which a non-resident associate of the borrower provides funds directly or indirectly to a third party lender, so that those funds can be provided to the borrower.

• The test for determining association between the borrower and lender will be broadened to include the concept of a group of (non-associated) persons acting together to lend to a New Zealand borrower, where that group would be associated with the borrower if the group were treated as a single entity. One consequence of this change will be to remove the AIL concession in the case of most lending by shareholders, even if the shareholder holds less than 50% of the borrower.

• The AIL concession would be available only where it is expected that more than 75% of the borrowing will be from non-associates who are either financial institutions in the business of lending money to the public, or by 10 or more persons who are not associated with each other.

In one respect, the proposals would expand the scope of the AIL concession. Members of a banking group would be permitted to pay AIL (in lieu of NRWT) even if the interest is paid to an associated lender.

NRWT obligations are currently triggered by payment of interest in respect of money lent. However, whether a borrower is entitled to a tax deduction, and the amount of that deduction, is generally determined on an accruals basis in accordance with the financial arrangements rules.

Where the borrower and lender are associated, a number of proposals are made to link the imposition of NRWT to the concept of financial arrangements income and expenditure, as opposed to strict concepts of payment and money lent. Such proposals are not to apply in respect of New Zealand-registered banks.

This could result in NRWT being payable where no cash interest is actually paid.

A number of proposals are made to change the impact of branches on the application of the NRWT rules. Broadly:

• Interest paid by an offshore branch of a New Zealand borrower would be treated as sourced in New Zealand, except where paid on money borrowed for the purpose of a business carried on outside New Zealand which does not involve lending to New Zealand residents. Now, withholding tax would not generally be applicable.

• Interest sourced in New Zealand and paid to a non-resident lender with a New Zealand branch would only be exempt from NRWT where it is received in connection with the New Zealand branch. At present, such interest is not subject to NRWT regardless of whether the non-resident lender is acting through its New Zealand branch.

Rhonda Gregory (rhonda.gregory@russellmcveagh.com)

Russell McVeagh

Tel: +64 9 367 8020

Website: www.russellmcveagh.com