New Zealand was the first country in the world to introduce the concept of corporate territorial taxation through the Land and Income Tax Assessment Act of 1891.
It was, however, the 1990s before New Zealand had developed a comprehensive extraterritorial taxation regime. The 1990s’ regime was developed in the wake of the government’s 1991 paper ‘Taxing Income Across International Borders: A Policy Framework’, and was revised again in 2006.
A territorial tax system, also known as a “participation exemption” system, provides an exemption (either wholly or partially) from tax in the home country on income earned abroad by a foreign subsidiary.
For example, Company A, a resident of New Zealand has a subsidiary, Company B, a resident of Australia. Company A is not subject to New Zealand income tax on the active business income of Company B, derived in or from Australia, either at the time at which the income is derived or at the time that profits are repatriated to New Zealand.
Under New Zealand’s current controlled foreign corporation regime, which has been effective since 2009, this exemption applies only to ‘active business income’, as defined in the Income Tax Act 2007.
New Zealand, whilst it started off with this system of corporate territorial taxation, has switched from that to worldwide taxation with credits for foreign tax allowable, and back to corporate territorial taxation from 2009.
Since New Zealand taxes its individual tax residents on their worldwide income, the country has a hybrid system of taxation overall, consisting of both worldwide and territorial bases.
Between 1988 and 2008 the worldwide system of taxation was in effect in New Zealand. Income earned by a foreign subsidiary was, therefore, subject to New Zealand tax, with a credit for foreign income tax paid to foreign governments available in New Zealand.
Following a review of New Zealand’s international tax rules conducted in 2006, significant changes to the way in which New Zealand taxes offshore income were announced. One of those changes was the reinstatement of the territorial method for taxation of controlled foreign corporations on active income.
New Zealand is not the only country to have switched back and forth between these methods. Finland also commenced with a territorial system, changing to a worldwide tax system and then reinstating territorial taxation.
This came following concern that the level of New Zealand’s outbound foreign direct investment had fallen far below that of other OECD countries, which had risen from 10 per cent of gross domestic product in 1990 to around 30 per cent of GDP in 2002. In the same round of tax reform, rules were introduced to limit the amount of global interest deductible in New Zealand on funds that were used to derive offshore business income, in order to protect the New Zealand tax base (thin capitalization rules).
New Zealand is considering its response to the OECD recommendations made in the BEPS Action Plan and the Tax Policy Division of the Inland Revenue Department has added this to its work programme in 2016.
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