2006 changes to the GST Act to treat certain activities involving investments in equity securities and participatory securities as supplies of financial services.
Sections 3 and 20F of the Goods and Services Tax Act 1985
Changes have been made to section 3(1) of the Goods and Services Tax Act 1985 to treat certain activities involving investments in equity securities and participatory securities as supplies of financial services. The financial services may be zero-rated if supplied to businesses.
Background
Supplies of financial services in New Zealand are generally exempt from GST. Since 1 January 2005, however, supplies of financial services to GST-registered persons whose taxable supplies equal or exceed 75% of their total supplies may be zero-rated, when the financial services provider elects to do so.
The amendment recognises that, in its absence, certain activities involved with investments in the form of shares may not be treated as supplies of goods and services for the purpose of the GST Act. For example, entities, such as investment companies and equity funds, whose sole activity is to hold shares are generally unable to register for GST. Any GST incurred by these entities (investors) is therefore irrecoverable.
If the investor seeks to pass on the cost of the irrecoverable GST- for example, in the form of requiring higher returns from investments in other GST-registered persons (investees) - tax cascades may arise. The greater the activity associated with the management of the investment, the more likely it will be that the investor will seek to recover those costs from the investee.
The amendment seeks to resolve this problem by treating certain equity security or participatory security investments (such as the acquisition of shares) that allow the investor to influence the management of the investee as a supply of "financial services". If the investor acquires shares in an investee that is GST-registered and 75% of the investee's total supplies are taxable supplies, the investor may elect to zero-rate the investment (including such activities associated with maintaining the investment) and register for GST. Information on when the supply of financial services may be zero-rated can be found in Inland Revenue's GST guidelines for working with the new zero-rating rules of financial services.1
A consequential amendment has also been made to section 20F(1) so that it refers to a "person" rather than a "registered person". The change means that a person making GST-exempt supplies, and who is therefore unable to register for GST, can elect to zero-rate supplies of financial services under section 20F and register for GST.
| The income tax rates that will apply for the 2006–07 tax year are: | |||||||
| Policyholder income | 33 cents for every $1 of schedular taxable income | ||||||
| Maori authorities | 19.5 cents for every $1 of taxable income | ||||||
| Companies, public authorities and local authorities | 33 cents for every $1 of taxable income | ||||||
| Trustee income (including that of trustees of superannuation funds) | 33 cents for every $1 of taxable income | ||||||
| Trustees of group investment funds in respect of category A | 33 cents for every $1 of schedular taxable income | ||||||
| Taxable distributions from non-qualifying trusts | 45 cents for every $1 of taxable income | ||||||
Other taxpayers (including individuals)
| |||||||
| Specified superannuation contribution | |||||||
| Where the employee has made an election under section NE 2AA | 39 cents for every $1 of the withholding tax contribution | ||||||
Where the employer has made an election under section NE 2AB and the amount of salary or wages given by section NE 2AB is:
| |||||||
| Where no such election is made | 33 cents for every $1 of contribution | ||||||
| The income tax rates confirmed are the same as those that applied for the 2005–06 tax year. | |||||||
Key features
Section 3(1) has been amended by inserting new paragraphs (m) and (n).
New paragraph (m)
An investment in an entity will be treated as a supply of financial services if:
- the investment is in an equity security or participatory security that is equal to or greater than 10 percent of all the equity securities and participatory securities issued by the entity; and
- the investment allows the investor, or a person acting on behalf of the investor, to influence the management of the business of the entity.
The reference to influence over an entity that is exercised by a person other than the investor was changed from an "associated person" to "a person acting on behalf of the investor" at the recommendation of the Finance and Expenditure Committee. The change reflects that the investment sector commonly uses independent managers to influence the business of the investee.
New paragraph (n)
The bill initially included a definition of "actively managed investment". This definition was removed as part of the Finance and Expenditure Committee deliberation on the bill and the clause was re-written as new paragraph (n).
Activities, including on-going activities, that an investor undertakes to evaluate an investment meeting the requirements of section 3(1)(m), such as monitoring or holding the investment, will be treated as a supply of financial services under section 3(1)(n). Activities connected with influencing the management of the investee are also treated as a supply of financial services. The paragraph extends to pre-acquisition activities that are carried out for the principal purpose of acquiring an investment described in section 3(1)(m).
Application date
The changes apply from the date of enactment, 18 December 2006.
Detailed analysis
Active investment
The changes to the definition of "financial services" are directed at active investment in the share capital of another entity. The active nature of the investment is measured using two conjunctive tests.
The first test requires that the investment is equal to or greater than 10 percent of all the equity securities and participatory securities issued by the entity.
The second test requires that the investment allows the investor, or a person acting on behalf of the investor, to influence the management of the business of the entity. This test considers whether the investment allows the investor an active role in the management of the investee entity.
Consideration for the supply of goods and services
"Consideration" for the purposes of the GST Act is typically thought of in terms of discrete amounts or obligations, such as explicit fees. "Consideration" can also take the form of margins in certain circumstances - for example, the interest rate differential between borrowing and lending rates. In the case of equity investment, the consideration received by an investment company for its intermediation services would be the net difference between the dividends it receives and the dividends it pays to its own shareholders. Additional commentary on valuing supplies of financial services is set out in Inland Revenue's guidelines on the application of the zero-rating rules for business-to-business supplies of financial services.2
1See Tax policy or Tax Information Bulletin, Vol 16, No 10 (November 2004)
2As per 1.
Other sections in this legislation
| Offshore investment | Tax rules for PIEs | Tax on geothermal wells | Australian superannuation fund exemption | New rules for selecting SSCWT rates | Allowing documents to be removed for inspection | Military and police allowances | New rules for spreading income on the sale of patents | Organisations approved for charitable donee status | Consolidated groups and foreign losses | Assessments by the Commissioner | GST and financial services | GST on fringe benefits | GST grouping rules | Taxation of business environmental expenditure | Family assistance provisions | Rewrite amendments | Tax depreciation treatment of patents | Fringe benefit tax | Depreciation formula | Economic rate of depreciation | Calculating depreciation rates | Election to depreciate | Transitional residents | Death and asset transfers | New GST due date | Limit on refunds and allocations of tax | The imputation system and companies | Reverse takeovers | Changes in GST taxable periods | Miscellaneous technical amendments |