In May 2016, the Government introduced the Taxation (Annual Rates for 2016–17, Closely Held Companies, and Remedial Matters) Bill (the Bill). Some of the key changes proposed in the Bill are outlined below.
Tainted capital gains
Capital gains derived by a company from the sale of a capital asset are able to be distributed tax free on liquidation. However, under the current legislation a capital gain derived from the sale of a capital asset to an associated person cannot be distributed tax free. Instead, the distribution of ‘tainted capital gains’ comprises a taxable dividend. The current rules date back to before the current imputation regime existed and arguably have no place today. In recognition of this, the Bill proposes to narrow the application of the dividend rules so that a tainted capital gain only arises if:
- the transaction is between two companies, and
- at the time of the transaction both companies have common ownership of at least 85%, and
- when the vendor company is liquidated and the capital gain distributed, the vendor company and the owner of the property have common ownership of 85% or more.
Related party debt remission
Taxable debt remission income can arise to a borrower if they are released from the obligation to repay a debt (i.e. the debt is forgiven). However, in specific circumstances these rules can lead to unusual outcomes. For example, if an insolvent company is propped up with loans from its shareholders and the company is liquidated or the debt is converted to equity, there is a risk of debt remission income arising.
The Bill proposes that debt remission income will not arise where:
- the borrower is a company or a partnership (including look-through companies and limited partnerships), and
- the lender is an owner of the borrower, and
- the debt forgiven is held and forgiven in proportion to ownership.
Accordingly, taxable income will not arise where the forgiveness of debt does not change the net wealth of a group of entities (e.g. in a wholly owned group). Instead the debt (and any unpaid interest) will be treated as being fully repaid on the date the debt is forgiven.
The Bill also proposes a separate amendment to prevent debt remission income arising for an LTC owner when that LTC owner remits a debt owed to them by the LTC.
RWT on dividends
Under current legislation, if a company pays a dividend to another company, resident withholding tax (RWT) applies at the rate of 33%, unless both companies are at least 66% commonly owned. Given companies pay income tax at 28%, payment of the additional 5% is arguably unnecessary. The proposed amendment will allow companies to opt-out of deducting RWT from fully imputed dividends paid to corporate shareholders, thereby eliminating the need to pay the additional 5%.
The above changes reflect common sense solutions to some illogical outcomes and are welcome.