Application to non-residents with no fixed establishmen

Subsections FE 13(3) and FE 6(1B)

Changes have been made to the thin capitalisation rules to limit their application when non-resident companies do not carry on business through a fixed establishment in New Zealand. Those companies will no longer be subject to the rules if all their New Zealand-sourced income that is not relieved under a double tax agreement is non-resident passive income.

Application date

The change applies to income years beginning on or after 1 July 2011.

Detailed analysis

The thin capitalisation rules currently apply to non-resident companies that have New Zealand-sourced income that is not relieved under a double tax agreement, even if the company has an insignificant physical presence in New Zealand.

This is to ensure that such non-residents are not artificially lowering their taxable income by debt-funding their New Zealand activities or investments.

However, the inclusion of such companies causes difficulties with the definition of the
"New Zealand group" under the rules, and may bring in non-resident entities that should not logically be included.

When the New Zealand-sourced income is "non-resident passive income", it is subject to a withholding tax in New Zealand which is typically a final tax. That is, no interest deductions may be taken against the income. In such a case, it is not necessary to apply the thin capitalisation rules.

Accordingly, the thin capitalisation rules are modified to exclude non-resident entities that do not have a fixed establishment in New Zealand and whose only New Zealand-sourced income is non-resident passive income. If the non-resident entity has a mixture of non-resident passive income and other income that is sourced from New Zealand, they will still be included in the New Zealand group to the extent that their New Zealand-sourced income qualifies for relief under a double tax agreement.