Zero rate of AIL on retail bonds

Sections 86I and 86IB of the Stamp and Cheque Duties Act 1971

The approved issuer levy (AIL) is imposed on interest payments made by New Zealanders to foreigners. The levy is 2% of the interest paid, and is paid to the Government by the borrower. AIL is an alternative to paying non-resident withholding tax (NRWT), which applies at a rate of 15%, or 10% with treaty countries, on the interest. The option to pay AIL is available only when certain requirements are met, such as the borrowing being from an unrelated party.

When AIL was introduced in 1991, the central aim was to substantially reduce the tax imposed on loans from unrelated parties on the basis that NRWT raised the cost of capital to the New Zealand borrower in these circumstances. The basic operation of the approved issuer levy is explained in Tax Information Bulletin Vol 3, No 2, August 1991, pp 7-8.

Unlike the 1991 reform, the measure in the Taxation (International Investment and Remedial Matters) Act 2012 aims to remove a potential tax impediment to the development of New Zealand's traded bond market, rather than reducing the cost of unrelated debt across the board.

The Act amends the Stamp and Cheque Duties Act 1971 by providing a zero rate of AIL for bonds that are traded in New Zealand. Strict criteria are used to prevent ordinary loans, syndicated lending, private placements and other forms of closely held or non-traded debt from qualifying for the zero rate of AIL.

The 2% rate of AIL is retained and AIL will be considered to be paid when either the existing 2% rate is paid, or the new nil rate applies.

Application date

The changes apply to interest payments made on or after 7 May 2012. This means that the zero rate can be used in respect of future interest payments on bonds issued before enactment of the legislation.

Key features

To qualify for AIL generally, the debt security must first comply with the existing AIL registration requirements in section 32M of the Tax Administration Act 1991 and section 86H of the Stamp and Cheque Duties Act 1971.

In cases where these requirements are met, the borrower can pay a 2% rate of AIL.

Section 86IB of the Stamp and Cheque Duties Act 1971 sets out the additional requirements that a registered security must meet to qualify for the zero rate of AIL. These are:

• that the security is denominated in New Zealand dollars;
• that the security was offered to the public for the purposes of the Securities Act  1978;
• that the security was not issued as a private placement;
• that the security is not an asset-backed security;
• that the registry and paying agent activities for the security are conducted through one or more fixed establishments in New Zealand; and
• that the security is listed on an exchange registered under the Securities Market Act 1988 (the NZDX) or alternatively, the security is traded in a market that brings together buyers and sellers of securities and satisfies a widely held test.

The main test is the NZDX test, with a widely held test as a back-up option for bonds that are traded in New Zealand but not listed on the NZDX.

The widely held test is outlined in new section 86IB(2). A bond must satisfy the widely held test at, or before, the time of the interest payment. This means that if the test has been satisfied on one previous occasion, it is not necessary to re-apply the test a second time.

There are two parts to the widely held test:

• The securities must be held by at least 100 separate persons whom the issuer could not reasonably expect to be associated with the issuer or with one of the other bond-holders. Bond-holders that are associated with each other count as one person for the purposes of this test. Persons who would be associated with the issuer due to the existence of a trust which is established for the main purpose of protecting or enforcing beneficiaries' rights under the class of securities can still be counted, so long as they are not associated with the issuer in some other way.
• No person or group of associated persons can hold more than 10% of the value of the securities at the time the test is applied.

Regardless of whether they pay AIL at 2% or 0%, the approved issuer will need to file an AIL return/payment slip.

Detailed analysis

In order to access the zero rate of AIL, the issuer of the security must first register to pay AIL. The issuer of the security must be an approved issuer under section 32M of the Tax Administration Act 1991 and must have registered the security under section 86H of the Stamp and Cheque Duties Act 1971. This allows them to pay AIL at a rate of 2%.

Section 86I of the Stamp and Cheque Duties Act 1971 has been amended so that AIL is considered to be paid when either the existing 2% rate is paid, or the new nil rate applies. When AIL is considered to be paid, a nil rate of non-resident withholding tax will apply under section RF 12 of the Income Tax Act 2007 as long as the borrower and lender are not associated, and as long as the interest is not jointly derived with a New Zealand resident.

Section 86IB of the Stamp and Cheque Duties Act 1971 sets out the requirements that a registered security must meet to qualify for the zero rate of AIL.

Issued in New Zealand

The objective of the zero rate of AIL is to remove a potential obstacle to the further development of the New Zealand bond market (bonds issued in New Zealand and denominated in New Zealand dollars) rather than reducing taxes on foreign debt funding more generally.

Two requirements are used to limit the zero rate of AIL to bonds which are issued in New Zealand.

The first requirement is that the securities are denominated in New Zealand dollars (section 86IB(1)(a)).

A supporting requirement is that the activities of the registrar and paying agent for the security are conducted through one or more fixed establishments in New Zealand (section 86IB(1)(d)). This means that these activities occur in New Zealand. Bonds will be registered with a registrar whose role is to check that the bonds comply with relevant legal obligations and that the amount of bonds on issue matches the amount of bonds authorised by the company. A paying agent is an agent who accepts payments from the issuer of a security and then distributes the payments to the holders of the security.

Issued publicly

Two requirements are used to limit the zero rate to bonds that are issued publicly.

First, the securities must be an offer of securities to the public under the Securities Act 1978 (see section 86IB(1)(b)(i) of the Stamp and Cheque Duties Act 1971). The Securities Act does not expressly define an offer of securities to the public, but section 3 of the Act provides guidance on how the phrase should be interpreted. Section 3 of the Act lists people who are not considered to be members of the public. These include associates, institutional investors, underwriters and investors who pay a minimum subscription price of at least $500,000 before allotment of the securities. The Securities Act requires the preparation of an investment statement, a registered trust deed and (generally) a registered prospectus before a debt security can be issued to the public.

Secondly, the securities cannot be issued as a private placement (section 86IB(1)(b)(ii)). A "private placement" is not a formally defined term in the Income Tax Act 2007 so this exclusion relies on the ordinary commercial meaning of a private placement. For example, securities that were exclusively issued to a group that were pre-selected by the issuer would probably be considered to be a private placement.

Not an asset-backed security

The securities cannot be asset-backed securities (section 86IB(1)(c)). Again, an "asset-backed security" is not formally defined so would be interpreted using the ordinary commercial meaning of this term. For example, securities whose interest payments were directly financed out of cashflows from a pool of financial assets such as mortgages or other loans could be considered to be asset-backed securities.

In cases where a company issues bonds and then on-lends all of the funds to a related party, the bonds will not usually be an asset-backed security. With an asset-backed security, the interest payment on the bond is dependent on the performance of the underlying assets. This is not the case when the funds are simply on-lent to a related party.

The purpose of this requirement is to deny the zero rate of AIL in cases when a group of loans have been bundled together and securitised into a bond. The concern is that such securities could be used to effectively shift the profit margin earned on closely held loans (such as mortgages) outside the New Zealand tax base.

Traded in a market

The securities must either be listed on an exchange registered under the Securities Market Act 1988 (see section 86IB(1)(e)(i) of the Stamp and Cheque Duties Act 1971), or alternatively, must be traded in a market that brings together buyers and sellers of securities and also satisfy a widely held test (section 86IB(1)(e)(ii)). This means that non-traded instruments such as bank term deposits will not qualify for the zero rate of AIL. Currently, the NZDX is the only debt exchange that is registered under the Securities Market Act.

Securities listed on the NZDX will not need to apply the widely held test and are expected to generally satisfy the other requirements listed above.

Widely held test

The widely held test is outlined in section 86IB(2). A bond needs to satisfy the widely held test at, or before, the time of the interest payment. This means that, if the test has been satisfied on one previous occasion, it is not necessary to re-apply the test a second time.

The securities must be held by at least 100 separate persons whom the issuer could not reasonably expect to be associated with the issuer or with one of the other bond-holders. Bond-holders that are associated with each other count as one person for the purposes of establishing if there are at least 100 separate bond-holders. Persons who would be associated with the issuer due to the existence of a trust which is established for the main purpose of protecting or enforcing beneficiaries' rights under the class of securities can count toward the 100 persons, so long as they are not associated with the issuer in some other way. See the next section, "AIL and associated persons remedial", for a discussion on why this exclusion for bond trusts is necessary.

Note that the securities need not all be issued on the same date so long as the debt securities are identical (that is, they are fungible). This means that issuers can build up to 100 investors over time, although they will only get the nil rate of AIL in respect of interest payments made on or after the first day that the securities satisfy the test.

If the number of persons who hold the bonds subsequently drops below 100, the test will still be satisfied so long as this threshold was not met simply because of an arrangement (that the issuer could reasonably be expected to be aware of) that was intended to temporarily increase the number of persons holding the bonds.

The second part of the widely held test is that no person or group of associated persons holds more than 10% of the value of the securities at the time the test is applied. If a person subsequently comes to hold more than 10% of the bonds, the test will continue to be satisfied. Note that both parts of the widely held test (requiring 100 persons and that no person holds more than 10% of bonds) must be satisfied on the same date.

Filing requirements

Regardless of whether they pay AIL at 2% or 0%, approved issuers will need to continue to file an AIL return/payment slip by the 20th day of the month following the month in which the interest payment was made (sections 86I and 86K). This slip will now require the approved issuer to record the total amount of interest payments which have been zero-rated. A person will not generally be able to use the zero rate of AIL in respect of any interest payments for which they fail to provide this information by the 20th day of the following month. However, there is scope for the Commissioner to provide a later deadline in a notice given to the approved issuer (section 86I(b)(ii)). Alternatively an approved issuer that is late at supplying this information would still be able to get a 2% rate of AIL (section 86I(a)(ii)) if they pay AIL at a later date, along with any interest and penalties.