The recent Government discussion document, Dividend integrity and personal services income attribution, proposes to tax majority (more than 50%) shareholders on the sale of shares in a non-listed company to the extent that historical profits are retained and/or reinvested in the company. 

CA ANZ New Zealand Tax Leader John Cuthbertson suggests that any proposed integrity measures should solely focus on aligning with the definition of the problem, that is, taxpayers specifically structuring to avoid the 39% top personal tax rate.

The proposal came from a concern that shareholders are avoiding tax by retaining profits in a company rather than paying dividends, and then selling the shares in the company for an increased price, reflecting the value of the undistributed profits. The increased sale proceeds are not subject to tax for the shareholder, while a dividend paid before the sale would have been taxable at their marginal tax rate. 

According to Cuthbertson, the proposal does not clearly address the stated problem definition. Instead, it has the effect of introducing a form of capital gains tax by re-characterising sale proceeds from a capital asset. 

CA ANZ acknowledges the existence of targeted anti-avoidance rules relating to dividend stripping. Cuthbertson highlights that the proposal focuses on controlling shareholders in a broad context, whereas the dividend stripping rules apply to all shareholders on a narrower but more targeted basis. In addressing the avoidance of the individual 39% tax rate, it would be sensible to review whether the dividend stripping rules are adequately enforced.

“Any legislative changes outside this scope are unnecessary.”

It should also be noted that the "sale of shares" rule is aimed at closely held (i.e. privately owned) New Zealand companies, where there is a share sale by the controlling (e.g., the majority) shareholder. The affected transactions are potentially quite broad – they will capture the sale of shares to related companies, unrelated companies, or an unrelated individual. For corporate groups, sales of subsidiaries and other majority-owned group companies may also give rise to a deemed dividend for the ultimate controlling shareholder. 

Cuthbertson says that this measure would result in significant overreach, impinge on normal commercial transactions, and does not align with Government policy.

Should this proposed measure proceed, it would introduce inefficiencies and complexities, resulting in inequitable outcomes. It arbitrarily distinguishes between publicly listed and non-listed companies and provides different outcomes for shareholders depending on whether they are considered to hold a controlling interest.

It especially negatively impacts the SME sector and may become a barrier to economic growth. It disproportionately targets small-medium enterprise companies.

This is unjustified and directly conflicts with the Government's stated objective to promote and support small businesses.

All business owners, including those who have adopted a corporate structure, should be able to reinvest in and grow their businesses.

Tax measures should not be attacking productive investment; instead, they should be encouraging such investment.

The use of companies and specifically the sale of shares is not prima facie evidence of income being ‘diverted’ to avoid a higher tax rate. The sale of shares in a company is a commercial decision with tax consequences.  Business owners (subject to satisfying company solvency requirements) typically distribute retained earnings to the extent covered by available imputation credits prior to a share sale to avoid forfeiture of credits. The proposed measures if they were to proceed would further push mergers and acquisition (M&A) transactions to the sale of assets rather than via share sale.

The discussion document also sets out two other options for consideration:

1. Requiring companies to maintain a record of their available subscribed capital and net capital gains so that these amounts can be more easily and accurately calculated on liquidation or share buyback. 
2. Broadening the scope of the personal services attribution rule so that the rule captures a wider array of scenarios. 

Again, this latter option would disproportionately impact the SME sector and unnecessarily impinge normal commercial arrangements. Greater alignment of the proposed measures with the problem definition is required. 

According to the latest update from Inland Revenue, these proposed measures will not proceed into the August Tax Bill. More work will be commenced, including engagement with key stakeholders (such as CA ANZ), to ensure the measures are appropriately scoped and fully considered.