Back in the 1980s, New Zealand had a company tax rate of 48%. At the end of that decade two things occurred. Firstly, the company tax rate was reduced to 33% - where it remained until just a few years ago. Secondly, a system of imputation was introduced.
As part of moving to a policy of a “broad base low rate” tax system, the company tax rate was reduced to 30% with effect from the 2009 tax year. More recently, the rate has been reduced to 28% - lower than the comparable Australian rate.
Such reductions are often accompanied by cries of contempt for the tax cuts afforded to “big corporates”. However, the reality for companies owned by New Zealand resident shareholders is that, ultimately, any change to the company tax rate makes no long term difference. Our system of imputation means that for Kiwi shareholders, company tax is effectively only an intermediate withholding tax.
A simplified example shows how this works. Say a company makes a profit before tax of $1,000. When the company tax rate was 33%, the company would pay tax of $330, leaving $670 to pay to the shareholder as a dividend. Without imputation, the shareholder would pay tax on the net amount received. At a 33% personal rate, that's another $221 of tax, bringing the total tax paid on the original $1,000 of income to just over 55%.
With imputation, the shareholder is taxed on the gross income earned by the company, and then given a credit for the tax paid by the company. In the above example, the shareholder is taxed on $1,000 ($330 at 33%). With imputation credits for the company tax, the shareholder has nothing further to pay.
With the company tax rate now at 28%, a shareholder who is on a personal rate of 33% will have to top up the tax payable but, overall, the effect is still the same; the company’s profits are taxed at whatever the shareholder’s personal tax rate is.
The rate at which companies can pass on tax credits to their shareholders is tied to the company tax rate. With the reduction in the company tax rate, it means that companies can only pass on credits as if they had paid tax at 28% - even if the company tax was actually paid at a higher rate. There is a transitional period during which credits can be passed on at a level reflecting the rate it was paid at. For company tax paid at 30%, this period ends on 31 March 2013. Companies should be reviewing their imputation accounts before then to ensure that credits are used at their full value.
For resident shareholders, the main advantage of the lower company tax rate is one of timing. For so long as the company profits are retained in the company, the effective rate is that of the company - 28%. It is not until the profits are distributed as dividends that any “top up” for the shareholder's personal tax has to be paid.
Despite all of that, the company tax rate is not totally irrelevant. It also drives the rate of tax for Portfolio Investment Entities (PIEs) where 28% can be the effective final rate of tax, even for wealthy investors. And the company tax rate is also the final effective rate for non-resident investors.
New Zealand and Australia are amongst the last countries in the OECD to continue with an imputation system. How long that will be the case remains to be seen.
Geordie HooftPartner, Tax
Grant Thornton New Zealand Ltd
T +64 (0)3 379 9580
E geordie.hooft@nz.gt.com