Stapled stock

Sections CD 22(9), DB 10B, DP 8(3), EX 5(5)(c), EX 9(6)(c), EX 30(6)(c), FA 2(4)(b), FA 2(5)(c), FA 2B, FE 15(1) and (2), FE 21(4B), HD 14(2)(a), and YA 1 of the Income Tax Act 2007; sections CD 14(9), DB 8B, DP 7(3), EX 5(5)(c), EX 9(6)(c), EX 31(6)(c), FC 1(4), FC 2(4B), FC 2B, FG 4(2)(b), FG 8G(1), HK 13(1), LF 2(3), and OB 1 of the Income Tax Act 2004

Under the new rules, certain debt securities stapled to shares are to be treated as shares for most tax purposes.

Background

The amendments are intended to bring tax rules up-to-date with developments in financial markets and prevent a potentially serious loss to the revenue base. Previously, using stapled stock instruments with debt components, companies could 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. The amendments 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.

The amendment was added to the bill post-introduction through Supplementary Order Paper No. 224.

Key features

• Debt securities “stapled” to ordinary shares will generally be treated as shares rather than debt for most tax purposes.
• The debt security component of the stapled stock instrument continues to be treated as debt under the thin capitalisation rules unless it is stapled in proportion to the available subscribed capital of all participating shares.
• Key exclusions include debt securities stapled to the share before 25 February 2008, debts stapled only to fixed-rate shares, and debts of a non-widely held company stapled under a shareholders’ agreement.

Application date

The new rule applies if the debt security was stapled to the share on or after 25 February 2008.

Detailed analysis

Debt securities stapled to shares are treated as shares for most tax purposes (sections FA 2B and DB 10B of the Income Tax Act 2007 and sections FC 2B and DB 8B of the Income Tax Act 2004).

New section FA 2B of the Income Tax Act 2007 (new section FC 2B of the Income Tax Act 2004) applies to a debt security stapled to a share, if the share is not a fixed-rate share. This debt security is treated as a share for most tax purposes. For example, interest payments will be treated as dividends under the Act.

For the purposes of the rule, a debt security is defined as a financial arrangement that:

• provides funds to the company;
• would give rise to a deduction but for the new rule; and
• does not arise only from a movement in a currency exchange rate or a non-contingent fee.

As a result of this limited definition, debt securities issued by a non-resident are not caught by the new rule unless the issuer has New Zealand income against which it could deduct the interest on the security.

What is “stapled”?

Under the new rule, a debt security is “stapled” to a share if it can, or ordinarily can, be disposed of only together with the share. Arrangements to which neither the company that issued the debt security nor the company that issued the share is a party are excluded.

The rule is also designed to exclude conventional “shareholder agreements” that limit separate trading of debt and shares in companies with small numbers of shareholders. A shareholder agreement is defined as an arrangement between shareholders of a company that is not a widely held company. The arrangement cannot be the company’s constitution, the terms of a debt security, or the terms of the company’s shares.

What type of shares?

The rule is only intended to apply to debt securities that are stapled to participating or ordinary shares. This is achieved by excluding debts stapled to a share that is a “fixed-rate”. A new definition of “fixed-rate share” is provided for this purpose.

Debt security and share aggregated for certain purposes

Under current rules, in certain situations, such as a share repurchase, a taxpayer is required to consider whether a share is a non-participating redeemable share, fixed-rate share, or fixed-rate foreign equity. When considering whether the stapled stock instrument meets one of these definitions, taxpayers are required to consider the stapled stock instrument as a whole. The two parts, when considered as one instrument, usually have the characteristics of an ordinary participating share, and so will not meet the definitions.

The debt security under the thin capitalisation rules

The debt security component of the stapled instrument will continue to be treated as debt under the thin capitalisation rules, except when it is stapled to shares in a proportional-stapling company or issued to a non-resident. This is to prevent taxpayers using the new rule to circumvent the thin capitalisation rules.

A proportional-stapling company is defined as one in which:

• each participating share is stapled to a debt security; and
• the available subscribed capital of each participating share and the amount payable for the issue of the debt security are in the same proportion for every participating share.

Effects of “stapling” and “de-stapling”

The available subscribed capital of a company needs to be adjusted appropriately for debt securities treated as shares under the new rule. The “stapling” of a debt security to a share is equivalent to issuing a share and the “de-stapling” of a stapled debt security is equivalent to cancelling a share. The definitions of “cancellation” and “consideration” have been amended to ensure that the same tax effects occur.

Relationship to rules treating certain debentures as shares

The new rule is similar to existing sections relating to “profit-related” and “substituting” debentures. An arrangement could, in theory, meet the conditions for both the new rule and one of the older rules. The older sections have been amended to clarify that only the new rule applies in such cases.