New tax rules for certain debt offerings
Concessionary rules are being introduced to the taxation of certain corporate securities. Interest paid to non-residents is currently subject to non-resident withholding tax (NRWT) or approved issuer levy (AIL) where the AIL rules apply and the security is registered with Inland Revenue (IR). AIL is a 2% levy on the gross amount of interest payable by the issuer. It applies where the borrower and lender are not associated and is typically beneficial in situations where the lender would otherwise seek to recover the NRWT cost from the issuer. Given that withholding tax rates are usually 10% or 15% depending whether there is a tax treaty in place, which is higher than a 2% levy, AIL helps reduce the borrowing costs to the issuer.
The new rules reduce AIL to nil for certain widely held securities. The aim of the reform is to help grow the domestic corporate bond market through making it cheaper to attract offshore funds. Currently the majority of business debt is raised through local banks or directly from offshore while the domestic bond market remains largely underdeveloped. An exemption from AIL and NRWT was considered by the Jobs Summit and the Capital Market Development Taskforce, and received “in principle” recommendations from both groups. Concerns have been raised that AIL and NRWT may be one factor hindering the development of New Zealand’s corporate bond market.
The proposed rules, however, are narrowly drafted which potentially limits their application to a small part of the bond market. The criteria the securities need to meet are as follows:
- Securities need to be New Zealand dollar denominated.
- They need to be listed on the New Zealand stock exchange.
- If not listed they need to be held by at least 100 non-associated investors with no person holding more than 10%. An exception to the associated investor rules is made for a beneficiary of a trust established for protecting and enforcing the beneficiary’s rights.
- Securities cannot be issued through a private placement that is limited to a select group of investors (for example, syndicated loans) and need to be offered to the public.
- They are not an “asset-backed” security where the interest payments are financed by cashflows from a pool of financial assets, such as mortgages.
- The registrar or paying agent must be operating in New Zealand.
In addition, there is a set of compliance requirements imposed on the issuer. They will need to monitor the relevant investor thresholds and disclose information which is typically presented in AIL returns to the IR.
Considering the narrow set of circumstances in which bonds would qualify for the concession there is a risk that many existing corporate debt issues would not meet the requirements. For example, wholesale bonds (bonds issued to a small number of institutional investors) which make up over half of New Zealand’s existing corporate bond issues will not satisfy the proposed qualifying criteria and will continue to face a 2% rate of AIL.
Submissions on the rules sought to widen the exemption to bring it closer to a similar rule in Australia, where it applies to loans that satisfy one of the four public offer tests. The test is satisfied if the bonds are offered to 10 financiers who are unrelated to the issuer or 100 other potential investors, or are listed on a stock exchange or are quoted in a published source that is monitored by investors. The tests can apply to syndicated loans and closely held bonds. However the submissions were not favourably received by the officials out of concerns that related party loans and private placements can be structured to fit within the rules. It was emphasised that related party lending should continue to be taxed at a higher rate to reduce incentives to utilise tax-deductible interest payments to shift New Zealand profits offshore.
In our view, though the reform is clearly a positive step in the right direction, bolder tax measures will be required to make a visible difference to the way the domestic capital markets currently operate. As a minimum, serious consideration would need to be given to bringing the tax concession closer to the one that successfully operates in Australia. In the meantime, companies that have debt on issue should review whether the proposed rules apply to them and make necessary alterations to their compliance systems to secure the benefit of reduced AIL where it applies.