Increasing mobility of capital, cross-border investments and international trade have all necessitated the need for ‘Double Taxation Avoidance Agreements’ between countries, aimed at eliminating ‘double jeopardy’ and facilitating global partnerships.
New Zealand has such agreements with many countries including Australia, UK, European Union and India (to mention a few) but the increasing Trans-Tasman trade and investment has necessitated a better understanding of the financial impact and more importantly, filing appropriate tax returns. While the importance of tax compliance cannot be undermined, individuals and companies must ensure that they are not burdened beyond their taxable limits.
New Zealand Double Tax Agreement with Australia does not allow tax credits received on Australian dividends in tax returns filed in New Zealand.
Double taxation
The New Zealand and Australian Governments actively encourage Trans-Tasman investment, trade and capital flow, envisaged in the Closer Economic Relations, formally established in 1983.
Since then, institutional and individual investments in listed and other shareholding companies have accrued dividends in either country. These dividends are taxable in the country of its occurrence and stand the risk of being taxed twice.
For instance, an individual or a company in New Zealand receiving dividends accruing from an investment in Australia will be taxed at source in that country in the first instance; and since such income should be included in the tax returns filed in New Zealand, the individual or company will be liable for tax in this country.
Imputation Credits
Inland Revenue Department (IRD) has in place a system called, ‘Imputation Credits’ which aims to avoid double taxation.
Imputation is a mechanism that a company can use to pass on credits for tax it has paid on profits to its shareholders, when it pays them dividends. These Imputation Credits offset the amount of tax that the resident shareholders would otherwise be liable to pay on those dividends, in order that they do not have to pay ‘double tax.’
New Zealand introduced the scheme in 1988 to avoid (double) taxation on already taxed income. The dividend declared by a New Zealand Company is reported in an individual’s tax return as income and the imputation credit attached with that dividend is used as tax credit to avoid double taxation.
The following example may be illustrative.
An example
Mr A received $100 gross dividend from ‘Space City Group,’ which he will report in his tax return. This amount will increase his tax liability by $33 (the highest rate). However, this income was already taxed and 28% tax was paid by the company. Therefore, to avoid double taxation, Mr A will receive $28 Tax Credit and pay only $5 ($33-$28) as tax.
Section LA5 (4) of the Income Tax Act 2007 permits imputation credits to be used as credits to settle one’s income tax liability.
Franking Credits
Australia introduced its own version of double taxation avoidance in 1987, terming it ‘Franking Credits.’
These are a type of dividend imputation and a way to reduce or eliminate double taxation of dividends. Franking Credits are also calculated for mutual funds that hold Australian based companies, which are then passed through to investors at the end of the financial year.
The relief of double taxation is provided to local taxpayer and taxes paid in a foreign country are not permitted as imputation or Franking Credits.
This denotes a single layer of taxes on local investment but double layer of taxes on foreign investments. Therefore, if you are a New Zealander who has invested in Australian equities receiving dividend and Franking Credits, these credits are of no use, since you cannot claim credits in your tax returns filed in New Zealand.
The New Zealand Government is working on this issue and will hopefully resolve it soon, enabling use of Franking Credits of Australia as tax credits in your tax returns filed in New Zealand.
Saurav Wadhwa is a Charted Accountant and Principal of IBBZ Accounting Limited based in East Auckland. Phone 027-5555458; Email: Saurav@ibbz.co.nz
