Tax Traps For Lawyers. Disclaimer. First Message of the Day. Presented by nsatax Limited. Sir Issac Newton s law of motion. nsatax s law of motion

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1 Tax Traps For Lawyers Presented by nsatax Limited Disclaimer This webinar is of a general nature only. Please obtain specific advice on client situations as minor changes in facts may result in significantly different outcomes. This webinar does not purport to cover all aspects of tax law relevant to the topics covered. First Message of the Day Sir Issac Newton s law of motion For every action there is a reaction nsatax s law of motion For every transaction there is a tax consequence 1

2 Transactions Everything we or our clients do has a tax issue to consider Income tax GST FBT Errors Mistakes often arise due to an oversight or the advisor not anticipating there was a tax issue Generally IRD not concerned why an error arose If there is a tax shortfall interest and penalties apply End of story! Awareness We see many examples where the advice given was not wrong It just did not go far enough The issue is normally always about the thing nobody talked about 2

3 Common Traps Transfers of shares in a company always need to be approached with extreme caution Can lead to: Forfeiture of carried forward losses Loss of Imputation Credits ( ICs ) Loss of a particular tax status for the company Need to exercise care in this area Common Traps The reason for the transfer is irrelevant Eg transfer from individual to a trust or from husband to wife (unless under RPA) will be a problem Trace through any interposed company to end individual or trust shareholders Lawyers and accountants need to work together in this area Continuity Issues In order to carry forward tax losses a company must have 49% common shareholding from the time the loss was incurred until the end of the year in which the loss is used A breach of this will cause the losses to be forfeited Not a year by year test 3

4 Continuity Issues In order to carry forward IC s a company must have 66% common shareholding from the time the credit arose until when it is utilised Can have different continuity periods starting from each payment date A breach will mean loss of IC s Again not a year by year test Company Status A company may have special tax status which conveys certain benefits EG Look through company or qualifying company Shareholders required to make certain elections to achieve this status A change in shareholding can cause that status to be revoked Can lead to adverse tax consequences Associated Person Capital Gains 4

5 Associated Person Capital Gains No capital gains tax in NZ as such Need to be careful when restructuring so as to not create an latent tax obligation Many insurance cases in this area Often overlooked as restructure may be for non tax reasons so no one thinks tax Remember Everything our clients do has a tax consequence Associated Person Capital Gains Applies where a company derives a capital gain from a transaction with an associated person Gain not taxable to company BUT... capital gain will be taxable on distribution unless: Company is a close company Transaction is not with another company, and Gain derived in course of liquidation Associated Person Capital Gains Generally association is where 2 companies 50% or more commonly owned Company and a shareholder holding 25% or more of the shares Need to look through any interposed companies to end shareholder Associated persons are deemed to hold each others shares 5

6 Associated Person Capital Gains Generally arises due to need to sell assets at market value to avoid deemed dividend In some cases can overcome problem e.g using QC or LTC regime Related person definition traditionally a 20% test but from 1 April 2010 replaced by associated persons definition Very broad, virtually impossible to break Need to plan restructuring carefully Associated Person Capital Gains Capital gain effectively treated as a revenue reserve No ICA credits to attach so RWT liability RWT = 33% tax liability on dividend Tax only arises when dividend paid out so problem is deferred until dividend paid or company liquidated Associated Person Capital Gains If carrying out due diligence on share purchase and there is a capital gain in the balance sheet always ask How did the gain arise Was it a transaction with an associated person If the gain is an associated person gain your client has just acquired an inherent tax obligation 6

7 Associated Person Capital Gains If the gain is an associated person gain can the price be reduced? Maybe acquire the business instead of shares The key is to identify the issue and then advise the client correctly Example 1 Two unrelated companies merge by selling their businesses at market value to Newco Newco owned 50% by the vendor companies or their shareholders Value of goodwill = capital gain Vendor Coy A derives taxable gain of $4m Example 1 After sale Coy A balance sheet looks like this: Cash in Bank $4m Capital Reserves $4m If transaction with unrelated party, Coy A could liquidate and pay $4m cash to shareholder tax free Instead, $4m is a taxable dividend 7

8 Example 1 Coy A has no imputation credits as capital gain not taxable Coy must deduct RWT of $1.32m Shareholder receives net cash of $2.68m instead of $4m Example 2 Coy B owned 100% by trust Sells premises to family trust and leases back. Capital gain of $400k derived by Coy B Family trust & Coy B are associated persons Capital gain taxable on liquidation Tax payable of $132k Exception Associated person capital gain rules do not apply if: - Company is a "close company"; - Gain derived in the course of liquidation; - Associated person is not a company Close company = 5 or fewer natural persons own > 50% of voting interests in company with associated persons treated as 1 person 8

9 Other Examples Selling IP out of a company to a trust for asset protection reasons Selling land and building from a company to separate from business risk Selling land and buildings from company as wish to retain property but sell business eg child care center Alternative Options There are some options available to ensure no associated person gain problem The key is to identify the issue in the first place and then take appropriate advice There are no fixes once the associated person gain is derived Property Sale Often a client will develop a property for sale (so taxable) but wants to keep part as an investment eg Client develops 10 units with a view to selling 8 and keeping 2 Client subdivides coastal land and wishes to keep 3 sections for family 9

10 Associated Persons The land is on revenue account so sales are taxable Any sales to related entities must be at market value One issue to be aware of Associated Persons There is a provision (section CB 15) that applies where a person who is subject to tax on the sale of land sells that land to an associated person The associated person is subject to tax if land later sold to the extent the vendor would have been taxed No time limit Tainting Issues Development Company Taxable sale at MV Shareholder on sale also taxable. No exemptions available including residence 10

11 Associated Persons This is a real problem Previously could structure so no association between vendor and purchaser Change in definition from October 2009 makes this almost impossible No exemptions apply and no 10 year rule Share Repurchases Share Buy Backs Can be used to return capital to shareholders tax free without liquidating company Can be either a pro-rata offer to all shareholders or to selected shareholders Selected shareholders must suffer at least a 15% reduction in their interest in the company to avoid a dividend 11

12 Share Buy Backs Amount paid on account of share repurchase is tax free to the extent the amount does not exceed the available subscribed capital (basically the paid up capital) Any amount paid in excess of the paid up capital is taxable as a dividend Commonly see share buy backs used to purchase shares at market value Common Examples Coy with paid up capital of $1,000 20% shareholder exiting Market value of shares $200,000 Remaining shareholders don t want to use their own funds to purchase shares & suggest a share buy back $199,000 taxable as a dividend Exiting shareholder loses $65k in tax Common Examples Coy A has 2 shareholders 50/50 Acrimonious fall out A agrees to sell shares to B at MV B prepares S & P agreement recording purchaser as B or nominee B nominates Coy A to purchase shares Becomes a share buy back, any amount paid in excess of paid up capital dividend to A 12

13 Trust Resettlements & Relationship Property Transfers Resettlements Assets of one trust resettled on to another trust Can resettle entire trust fund or just certain assets and liabilities Tax Consequences Resettlements are a taxable event Tax rules apply equally to the distribution or sale or resettlement of assets 13

14 Income Tax - Shares A sale, distribution or resettlement of shares will be a transfer which impacts on continuity Note a change of trustee of the same trust on its own does not affect continuity Watch avoidance Income Tax - Depreciable Property A sale, disposition or resettlement of depreciable property is deemed to take place at market value for both parties Depreciation recovery/loss on sale rules Property Relationship Issues Seen many cases where separation is not on good terms and one party looking to shift a latent tax liability to the other party 14

15 Property Relationship Agreements Concessionary provisions in Part FB deal with transfers of property under relationship agreements If applicable transferee steps into shoes of transferor for tax purposes Generally transferred at cost and same date as acquired Agreements can apply where no relationship separation Common Areas Depreciation concession No depreciation recovered Transferee takes over any depreciation recovered liability Need to watch if acting for spouse taking over rental property where depreciation previously claimed Trusts & Property (Relationships) Act Transfers Income tax concessions only apply to the parties to a PRA, and only the couple can dispose of relationship property Conventional view is that this is not available to trustees even if a party to the agreement 15

16 Trusts & Property (Relationships) Act Transfers Therefore, apply the normal rules to property transfers to and from trusts If sale or distribution/resettlement of property: Possible share continuity breach Depreciation recovery Revenue account property trigger Trust Distributions Need to be careful when making distributions from trusts Applies where there has been a previous debt forgiveness By deed Or on death If no gifting at time of distribution then no issue Trust Distributions Two tests If natural person forgives trust debt in consideration of natural love and affection for beneficiaries, deemed paid for purpose of financial arrangements rules Trust must be established mainly to benefit natural persons for whom creditor has natural love and affection 16

17 Debt Forgiveness If trust subsequently makes distribution to non-qualifying beneficiary e.g. company then distribution is income to trust to the extent of any previous debt forgiveness Not an issue if distribution made before any debt forgiveness May be able to distribute to another clean trust & then to company Debt Forgiveness Example Previous debt forgiveness totals $216,000 No issue at time of gifts due to natural love and affection for beneficiaries In year 9 a company is added as a beneficiary and receives a distribution of $300,000 Result is $216,000 income to the trust Debt Forgiveness Always confirm relationship of beneficiary if previous gifting to trust by way of debt forgiveness Also applies on debts forgiven under a will Maybe consider cash gifts Monies then used to repay loans No forgiveness of debt in this case 17

18 Debt Forgiveness Generally a forgiveness of debt creates taxable income to the borrower Unless debt forgiven in consideration of natural love and affection Individual = family and close friends Trust = look at beneficiaries Company = X Debt Forgiveness Be careful when drafting wills Have seen cases where the individual forgives all debts owing by family members, their trust and their company No issue for family members and the trust Taxable income to the company Leave the current account to someone; don t provide for forgiveness GST Zero Rating 18

19 Supplies of Land Between GST Registered Persons From 1 April 2011 CZR rules Compulsory zero-rating if: Taxable supply wholly or partly of land between GST registered persons and Recipient of the supply intends to use for making taxable supplies and Recipient NOT intending to use property as principal place of residence for themselves or a relative (to 2 nd degree) Zero Rating The compulsory zero-rating rules are not optional That s why called the CZR rules! Seen advice saying doesn t matter about the price because you can recover the GST Wrong if GST is 0 there is no claim so the price is the price Need to watch pricing in contract Question Client entered into an agreement to sell land on gst inc basis. Purchaser circled they are registered for GST. Before settlement the purchaser s solicitor advised sch 2 was completed in error and purchaser is not registered for GST and not using the property for GST taxable activity. 19

20 Zero Rating Land Sales The legislation does not deal with this situation The reverse charge provision does not apply as notification of the charge in registration status of the purchaser occurred before settlement On the face of cant zero rate and the vendor has a GST liability as GST inc purchase price Zero Rating Land Sales Our view is that the vendor should still zero rate IRD TIB states that where original treatment (ie zero rating) changes before settlement the parties can agree to alter that treatment However if parties don t agree then original treatment stands Zero Rating Land Sales The issue arises as the contract is inclusive of GST A plus GST if any contract would not have this issue If acting for the purchaser issues can arise where the contact is plus GST 20

21 Zero Rating Land Sales Client buying a multi unit site zoned as a rest home Vendor used the property for residential purposes Client going to use for long term residential; Contract is plus GST if any What are the issues? Drafting Agreements Important to understand tax consequences when drafting agreements Also important to be aware of law changes when drafting agreements Some things that were once tax free are now taxable eg: lease inducements Capital contributions Trade tie payments Land Related Payments 21

22 Inducements Lease Inducement Payments Taxable if derived on or after 1 April 2013 Not taxable if derived on or after 1 April 2013 but received in relation to lease entered into or renewed before that date Tax deductible to payer Income and deductions spread evenly over the term of the lease Inducements Lease Inducement Payments If lease terminates early, balance to be spread is taxable/deductible But spreading continues if the lease is transferred to an associated person Capital Contributions For payments received on or after 20 May 2010, tenant has the option of: Spreading amount as income evenly over 10 years, or Reducing cost for depreciation purposes Landlord spreads payment over term of lease 22

23 Surrender Payments Lease Surrender Payments Taxable if derived on or after 1 April 2013 Deductible if incurred on or after 1 April 2013 Taxable/deductible in the year derived/incurred No spreading rules (since paid to end land right) Questions 23