You've got AIL
Tax Alert - September 2023
By Troy Andrews & Alex Kingston
These are often the words New Zealand borrowers are hoping to hear from Inland Revenue before paying interest to a foreign lender. But it’s important to make sure all the right boxes have been ticked to qualify for the Approved Issuer Levy (“AIL”), and that good governance is in place to ensure ongoing compliance with the regime. When it comes to AIL, there can be quite severe and unexpected outcomes for getting it wrong.
Outline of AIL regime
The AIL regime is available when interest is paid by a New Zealand resident to unrelated foreign lenders. Broadly, once Inland Revenue has confirmed (i) the borrower has approved issuer status, and (ii) the relevant loan/security (or class of securities) have been registered, a levy equal to 2% of the interest may be paid by the borrower, instead of the Non-Resident Withholding Tax (NRWT) that would usually otherwise be payable.
The AIL regime has been around since the early 1990s and was intended to lower the cost of foreign borrowing for New Zealand residents. Foreign lenders would typically pass on the cost of withholding taxes to New Zealand borrowers (where that withholding tax was not valuable/available as a tax credit offshore), so AIL was made available as an alternative to NRWT (where it has been agreed between borrower and lender that AIL is preferred). AIL of 2% effectively results in an after-tax cost to the New Zealand borrower of 1.44% of the interest amount (whereas NRWT would otherwise commonly apply at 10% to 15%). AIL may also be reduced to 0% for certain widely offered/widely held bonds denominated in NZD.
AIL is only available where the borrower and lender are not associated (except for within certain banking groups), and rules have been tightened since it’s introduction to make it more difficult to structure into the AIL regime where there is no genuine third-party lending relationship.
Common issues
While the concept of AIL is not complex, there are a number of issues that commonly arise in the application of the AIL regime by taxpayers and as mentioned above, the implications of getting it wrong can be significant. Examples of issues we’ve seen include:
1. Failing to register in time
There is a strict requirement that AIL registration (and registration of the relevant debt instrument) must have been made prior to an interest payment, in order to apply AIL instead of NRWT. There is no flexibility to simply register prior to the due date for AIL, the registration must be done before the interest payment. Inland Revenue generally considers the date it receives an application as the registration date. In our experience, Inland Revenue does not allow any flexibility with this, with the consequences being NRWT would apply to interest payments made up until the AIL registration date. Often foreign lenders will seek a “tax gross-up clause” in loan agreements, meaning that it is the New Zealand borrower that bears this NRWT cost.
It is therefore important to consider AIL compliance in the early stages of arranging any new foreign borrowing and (assuming the lender and borrower want AIL to apply and qualify) have a clear plan in place to undertake the necessary registrations. Some agreements will also include AIL registration as a condition precedent to being able to draw down funds.
2. Non-standard lending scenarios
The AIL rules (including Inland Revenue registration/application forms) do not always clearly contemplate some of the more complex or unique lending scenarios. We have found that early engagement with Inland Revenue is key, to ensure there is sufficient time to confirm whether AIL is available, prior to the first interest payment. For example, there can be complexity in how (or whether it is possible) to apply AIL in the context of certain cash pooling arrangements, syndicated loans, securitisations, peer-to-peer lending, amongst others. We have observed that Inland Revenue has been willing in some circumstances to allow AIL compliance to be undertaken on behalf of certain classes of borrowers, subject to certain conditions. It is essential to engage with Inland Revenue early to allow these discussions to take place.
3. Ongoing compliance
Approval to apply AIL is not always the end of the story for a particular loan or other debt instrument. For example:
- Changes in terms may be viewed as a new arrangement, which can trigger a need to re-register the security for AIL;
- Changes in lenders/the portions held by lenders in a syndicated loan scenario may also trigger a requirement to either re-register or update Inland Revenue’s records. In practice, this may depend on the manner in which the loan instrument has been registered in the first place.
- For widely-held bonds that qualify for a 0% rate of AIL, information still needs to be reported to Inland Revenue following each interest payment date, with the consequence of late filing being that 2% AIL will apply instead.
- Corporate re-organisations such as company amalgamations or the novation of loans to a new borrower may result in new registrations needing to be undertaken.
- AIL must be paid by the due date. Any errors in accounting for AIL on time will result in NRWT being payable, which is an expensive mistake to make. Inland Revenue will show no leniency when it comes to administrative errors.
Robust processes and controls therefore need to be in place to ensure filings are made on time. Changes in lending arrangements also need to be monitored, with regular communication between tax and treasury teams, to ensure AIL continues to apply (and at the correct rate of 0% or 2%).
Final comment
As a concessionary regime, electing to apply AIL to a loan from a foreign lender is optional, but can be an effective way of reducing the cost of borrowing for New Zealand borrowers. Overall, the regime is seen as positive from the perspective of NZ Inc., which is usually considered a net “importer” of capital.
For taxpayers, given the consequences of not getting AIL compliance right can be a significantly higher cost of borrowing than planned, it is essential to think about AIL early in the financing process, and have good governance procedures in place to ensure compliance. With Inland Revenue’s recent focus on Tax Governance, we would suggest that AIL (and withholding taxes more broadly) is thought about, in addition to other tax types that may be more front of mind.
If you have any questions about the AIL rules and how they may apply to you, please contact your usual Deloitte advisor.
September 2023 - Tax Alerts
