Govt to counter stapled securities revenue loss
Hon Dr Michael Cullen
Minister of Finance
Hon Peter Dunne
Minister of Revenue
6.30 pm 25 February 2008 Media Statement
Govt to counter stapled securities revenue loss
Cabinet today agreed to amend the law on certain types of stapled securities to bring the tax rules up-to-date with developments in financial products and to prevent a serious loss to the revenue base from the use of those instruments, Finance Minister Michael Cullen and Revenue Minister Peter Dunne said today.
“Stapled stock instruments are relatively common overseas but until recently have not been used much in New Zealand, and our tax rules have yet to catch up,” they said.
“The issue arises from the fact that by using stapled stock instruments with debt components, companies can pay tax-deductible interest to shareholders as a substitute for dividends. The issue becomes particularly acute if the instruments are issued to foreign investors in New Zealand companies.
“If those instruments were to become common in New Zealand the amount of debt deductions against our tax base could increase significantly.
“The government will therefore amend the Income Tax Act to ensure that when a debt instrument that would normally give rise to tax deductions is stapled to a share it will be treated as equity for tax purposes – meaning that no deductions for interest payments will be available.
“The change will be included in the next available taxation bill and, once enacted, will apply to stapled stock issued or stapled on or after today. Securities that have already been issued will not be affected by the legislative change.
“Today’s announcement is being made without prior consultation with interested parties because it is a matter of urgency, since some companies may be contemplating the issue of the type of stapled stock in question. An early announcement of what will be legislated for gives certainty of future tax treatment to companies and shareholders alike.
“Before legislation is introduced, tax policy officials will consult with interested parties on the details of the proposed changes,” the ministers said.
stapled securities announcement
1. What is the tax problem with stapled stock that consists of a debt attached to a share?
The government is concerned about companies’ ability to pay deductible interest to shareholders as a substitute for dividends by using certain stapled stock instruments. The stapled stock in question is a hybrid instrument which consists of debt attached to a share. These instruments can be regarded as perfect substitutes for equity. At present, the debt component of these instruments is treated as debt for tax purposes, and the interest is deductible. This has the potential to significantly erode the New Zealand tax base, particularly when the instruments are issued to non-residents. Treating these instruments in part as a debt instrument is also inconsistent with their treatment for commercial purposes, including accounting and regulatory purposes.
Current tax rules do not provide enough protection against the potential revenue loss posed by these instruments. Furthermore, the commercial constraints that operate to moderate the level of gearing are effectively removed with these instruments. That is because what is debt for New Zealand tax purposes is equity for accounting and other purposes, meaning that tax debt could be much higher than what commercial constraints would normally allow.
2. What does the change involve?
The tax rules have to be modernised to keep pace with what is evolving in the financial products world.
The legislative change will require that when a debt instrument for which an interest deduction would normally be allowed is stapled to a share it will be treated as equity for tax purposes.
Changes in the borderline between debt and equity for one purpose can have unintended effects on other areas of the tax system. As part of the technical development of the rules, the consequences for the imputation and thin capitalisation tax rules will need to be examined.
The change will apply to stapled stock issued or stapled on or after today. The government will consult on the technical development of the new rules following the announcement. The changes will be included in the next available tax bill.
3. Why the urgency to change the law?
The risk to tax revenue must be dealt with as a matter of urgency, since the government is aware that there is growing interest in using these instruments in the New Zealand market following on from their international popularity.
4. Is this a radical change in direction?
The proposed legislative amendment is not intended to be a radical change to the current tax rules, but instead a change at the margin, given that current tax rules already treat interest as dividends for some broadly similar instruments. New Zealand tax rules around the debt/equity boundary generally follow the legal form of the instrument concerned, irrespective of its commercial substance. That means when, for example, the legal form of the instrument is debt, the tax treatment will be debt. However, there are a few examples in New Zealand’s current tax rules where it has been necessary to specifically legislate to override legal form. One example is where a debt instrument is paying a return that is dependent on the profits of the company, that instrument is considered to be equity for tax purposes. The change we are recommending would just be a further example.
5. How will instruments that have already been issued be affected?
The law change will not apply to publicly held instruments that were issued or stapled before today.
6. Why did the government not consult beforehand on this change?
This issue is a base maintenance issue involving potentially large sums of revenue and the government has to proceed with urgency. The government will consult on the technical development of the new rules.
7. What are the next steps?
Following consultation with interested parties, the government will include amending legislation in the next available taxation bill. When the bill is referred to a select committee interested parties will have the opportunity to make a submission.