Clarification of "dividend" definition

Sections CD29B and YA 1 (definition of "bonus issue") of the Income Tax Act 2007; sections CD 21BA and OB 1 (definition of "bonus issue") of the Income Tax Act 2004

The definition of "dividend" has been amended to make it clear that certain transactions should not be treated as dividends for tax purposes. The changes do not involve a change in policy but clarify the policy intent for the specified transactions.

Background

A dividend that is derived by a person is treated to be income. The current dividend definition is based on the policy that, in general, distributions from a company to a shareholder should be taxed if there is a transfer of value to the shareholder and the transfer is made in recognition of the shareholder's ownership interest in the company (instead of, for example, an employer/employee relationship between the company and shareholder).

Previously it was unclear whether certain transactions fell within the definition of "dividend". Amendments have therefore been made to clarify that certain transactions are not treated as dividends for tax purposes. The amendments do not involve a change in policy, nor do they imply that other arrangements fall within the dividend definition. The relevant transactions are described below: 

Rights issues

Companies can offer their shareholders rights to buy new shares, generally at a discount to the market value.

Legislative changes have been made to make it clear that the discounted amount is not a taxable dividend for shareholders that exercise the right, and that the right itself (which has value and may in some cases be traded or renounced) is not a taxable dividend.

The policy rationale for ensuring that rights and discounted shares issued under a rights issue are not treated as dividends is that the company does not give up anything of value. A rights issue involves the company raising new equity when the shareholders invest new funds in the company.

Premiums paid under bookbuild arrangements

Following a rights issue, a bookbuild can take place. A bookbuild involves the rights of non-participating shareholders (who chose not to participate or were not entitled to participate) being offered to other investors who pay a premium for them. The original shareholder is paid all or part of this premium for giving up their rights.

Legislative changes have been made to make it clear that premiums paid under bookbuilds are not dividends for tax purposes. From a policy perspective, a bookbuild should not be treated as a dividend because, like a rights issue, the company does not give up anything of value.

Share splits

A share split involves a company diluting its shareholding whereby the shareholding proportions are retained but the shareholding is split into a greater number of shares.

The definition of "bonus issue" has been amended so that share splits that involve a subdivision of shares (that take place under the Companies Act 1993) can be excluded from the dividend definition. Previously, only bonus issues that involved the issue of new shares could be excluded from the definition of "dividend" for tax purposes. However, a subdivision of shares does not necessarily involve the issue of new shares.

From a policy perspective, a share split should not be treated as a taxable dividend because the company does not give up anything of value. Furthermore, in a subdivision of shares, the shareholder is generally not involved in a transaction with the company.

Key features

Two key changes have been made.

New section CD 29B of the Income Tax Act 2007 and CD 21BA of the Income Tax Act 2004 ensure that:

• under a rights issue, the discounted amount is not a taxable dividend for those shareholders that exercise the right;
• under a rights issue, the right itself (which has value and may in some cases be traded or renounced) is not a taxable dividend;
• premiums paid under bookbuilds are not dividends for tax purposes.

The legislative definition of "bonus issue" has also been amended to include not only the issue of new shares, but the subdivision of shares. The existing tax rules for taxable bonus issues and non-taxable bonus issues will then apply to subdivisions of shares.

Application date

The changes apply from 1 April 2005. This is when the Income Tax Act 2004 (containing the dividend definition) came into effect. Similar changes have been made to the Income Tax Act 2007.