Temporary exemption for transitional residents
Sections FC 23, FC 24, KD 3, KD4, NF 1, NF 2, OB 1 and OE 1 of the Income Tax Act 2004 and section 87(2) and (3) of the Taxation (Savings Investment and Miscellaneous Provisions) Act 2006
The rules for the temporary exemption for transitional residents have been amended to correct certain technical difficulties identified after the original legislation introducing the exemption had been enacted.
The Taxation (Depreciation, Payment Dates Alignment, FBT, and Miscellaneous Provisions) Act 2006 introduced a tax exemption for transitional residents (see Tax Information Bulletin Vol. 18 No. 5 June 2006, from page 103). The exemption is available to people coming to live in New Zealand on or after 1 April 2006 for the first time or after an extended absence. It lasts for four years after migration and covers most types of foreign income.
The legislation has been amended to deal with various technical issues that came to light after enactment. The timing and eligibility rules for the exemption have been changed to avoid a potential mismatch with the tax residence rules for individuals. Facility for a person to elect not to be a transitional resident has been introduced and changes have been made to clarify that resident withholding tax does not have to be deducted from interest and dividends - covered by the exemption.
Changes to the timing and eligibility rules for the exemption
There are two ways a person can become tax-resident in New Zealand under section OE 1 of the Income Tax Act 2004: by acquiring a permanent place of abode here or by being present in the country for more than 183 days in a 12-month period. Where the 183-day rule applies, a person becomes tax-resident from the first of those 183 days.
Under the previous legislation, a person qualified for the exemption only after they acquired a permanent place of abode in New Zealand. Focusing on permanent place of abode was intended to avoid situations where people qualified for the exemption "too soon" - for example, where a temporary visit to New Zealand before actual migration triggered tax residence under the 183-day rule. However, this approach allowed for a potential mismatch between the rules for the exemption and the general tax residence rules: in certain circumstances, a person could become tax-resident in New Zealand without qualifying for the exemption. The timing and eligibility rules for the exemption contained in sections FC 23 and FC 24 of the Income Tax Act 2004 have therefore been amended as follows:
- To avoid the possibility that a person may become resident for tax purposes without qualifying for the exemption, the eligibility and timing rules for the exemption have been aligned with the general tax-residence rules.
- To resolve issues associated with people qualifying for the exemption too soon, any backdating under the 183-day residence rule is ignored for the purposes of the eligibility rules and time-limit for the exemption.
Opting out of the exemption
In certain circumstances, a person may be better off not receiving the exemption - for example, if they have foreign losses, wish to claim family assistance, or have little or no foreign income and prefer to defer their claim. It was therefore always intended that people should be able to choose whether or not to receive the exemption. The original legislation did not allow people to make this choice. A mechanism has been introduced in section FC 4 to allow taxpayers to opt out of the exemption if they wish.
Resident withholding tax
Resident withholding tax is required to be deducted from interest and dividends paid to New Zealand residents. Resident withholding tax applies to "resident withholding income", as defined by sections NF 1 and OB 1 of the Income Tax Act 2004. Under the original legislation, there was nothing that removed foreign-sourced interest and dividends accruing to a transitional resident from this definition. In certain circumstances - such as when an agent received such income on behalf of a transitional resident - this could mean that withholding tax had to be deducted, notwithstanding that there was no underlying liability. To avoid this, the definition of resident withholding income has been amended to exclude income covered by the exemption. In addition, section NF 2 now makes it clear that an agent is normally able to rely on a statement by a client that income is covered by the exemption for the purposes of deciding whether or not to deduct resident withholding tax.
The changes apply retrospectively, for the 2005-06 and later income years. Transitional provision has been made to ensure that people are not disadvantaged as a result.
Section FC 23 of the Income Tax Act 2004
Section FC 23 sets out the general requirements for being a transitional resident. A number of changes have been made to this section.
The requirement, in paragraph (a), that a person must have a permanent place of abode in New Zealand has been replaced. The requirement now is to be tax-resident in New Zealand.
Paragraph (b) limits the exemption to people who have not lived in New Zealand for at least 10 years (the nonresidence period). This provision has been amended so that the test is now applied by reference to the date a person satisfies the requirements in section OE 1(1) or (2) - that is, the date on which the person obtains a permanent place of abode or their 184th day of presence within a 12- month period, whichever is the earlier. Applying this test by reference to the date on which section OE 1(1) or (2) is satisfied rather than the date from which tax residence begins, ensures that people are not disqualified under the 10-year rule merely because of backdated residence under section OE 1(2). This could happen, for example, if a person returned to live in New Zealand after the required non-residence period, but had visited New Zealand for a holiday a few months before doing so.
There are two limbs to paragraph (b). Sub-paragraphs (i) and (ii) are independent tests and a person can satisfy the required non-residence period provided they meet one, both, or a combination of the tests for at least 10 years.
Sub-paragraph (i) focuses on whether a person satisfied the requirements of section OE 1(1) or (2). This avoids the problems associated with backdated residency.
Sub-paragraph (ii) focuses on whether a person was resident in New Zealand. It is possible for a person to be non-resident by virtue of section OE 1(3) even while they satisfy section OE 1(2) (see Public Information Bulletin 180, June 1989). Sub-paragraph (ii) ensures that deemed non-residence under section OE 1(3) can be counted towards the required non-residence period.
Paragraphs (c) and (d) together ensure that a person may only qualify once as a transitional resident. Paragraph (c) requires that a person must not have been a transitional resident before the non-residence period. New paragraph (d) focuses on the period after the non-residence period. It ensures that a person who ceases to be a transitional resident for any reason cannot subsequently satisfy section FC 23, even if they meet the other criteria. The usual application of paragraph (d) will be when a person elects to stop being a transitional resident under section FC 24 (3).
Sections FC 24 and KD 4 of the Income Tax Act 2004
Section FC 24 has been entirely rewritten. It deals, in particular, with the period of exemption and elections not to receive the exemption.
Subsection (2) provides that the period for which a person is a transitional resident begins on the first day of taxresidence in New Zealand and lasts for up to 48 months from the end of the month in which the person satisfies the requirements in section OE 1(1) or (2). The effect is that the starting point for the exemption is aligned with the start of a person’s tax-residence in New Zealand - including when the period of tax residence has been backdated by virtue of section OE 1(2) - but any backdating is ignored for the purposes of the time limit for the exemption.
Subsections (3) to (7) provide a mechanism whereby a person can elect not to be a transitional resident. The deadline for making an election is set out in subsections (6) and (7). This has been aligned with the deadline for making a return for the relevant tax year (a later deadline applies for 2005-06). Transitional residents and their partners are not eligible to receive family assistance. Accordingly, an application by a transitional resident for a tax credit under subpart KD is deemed by subsections (4) and (5) to be an election not to be a transitional resident by that person and any partner. This deeming provision has retrospective effect. However, subsection (5)(b) allows a person who applies for a subpart KD credit before 1 April 2007 to notify the Commissioner before 1 June 2007 that they do not want that application to be treated as an election not to be a transitional resident. Section KD 4(4B) ensures that a person exercising this right is not liable for a shortfall penalty.
Section 87(2) and (3) of the Taxation (Savings Investment and Miscellaneous Provisions) Act 2006 and section OE 1(2b) of the Income Tax Act 2004
As noted earlier, section FC 23(b) has been amended so that the requirement for a 10-year non-residence period is applied by reference to the date a person satisfies the requirements in section OE 1(1) or (2). An equivalent change has been made to the rule that limits the availability of the exemption to people who come to live in New Zealand on or after 1 April 2006.
Section 87(2)(a) of the Taxation (Savings Investment and Miscellaneous Provisions) Act 2006 specifies that to qualify for the exemption a person must begin to satisfy the requirements for tax-residence on or after 1 April 2006. Backdated residence under section OE 1(2) would not prevent a person from qualifying for the exemption, provided they had not established a permanent place of abode or been present for more than 183 days in a 12-month period before that date.
Under the previous rules, a person who became taxresident before 1 April 2006 may still have qualified for the exemption, provided they had not acquired a permanent place of abode in New Zealand before that date. Section 87(2)(b) allows these individuals to continue to qualify, while section 87(3) allows their exemption to be backdated to their first date of tax residence, as for other transitional residents. Section OE 1(2B) of the Income Tax Act 2004 is no longer required and has therefore been repealed, with retrospective effect.
The following examples illustrate how the new timing and eligibility rules for transitional residents are intended to operate in practice.
Robert visits New Zealand for an interview on 1 February 2006. He relocates here permanently and acquires a permanent place of abode on 1 May 2006. He is subsequently deemed to be tax-resident from 1 February under the 183-day rule. He has never been tax-resident in New Zealand before.
Robert would qualify for the exemption. Although he is treated as tax-resident from 1 February 2006, he does not begin to satisfy the requirements of section OE 1 for being a resident until 1 May. His exemption would run from 1 February 2006 to 31 May 2010.
Roger first arrives in New Zealand on 1 June 2005. He stays for three months (92 days). He comes back to New Zealand on 1 March 2006 and stays for another three months (92 days). By the time he leaves, on 31 May 2006, he has been in New Zealand for more than 183 days in a 12-month period and is deemed to be tax-resident from 1 June 2005. Roger relocates to New Zealand and establishes a permanent place of abode here on 1 January 2007. He has never been tax-resident in New Zealand before.
Roger would qualify for the exemption. Although he is deemed to be tax-resident from before 1 April 2006, he does not begin to satisfy the requirements of section OE 1 for being a resident until after that date. His exemption would run from 1 June 2005 to 31 May 2010.
Rachael leaves New Zealand and ceases to have a permanent place of abode here on 30 September 2006. She returns on holiday from time to time to visit friends. Each time, she is only present in New Zealand for a couple of weeks a year. Her last holiday here is from 1 to 14 August 2016. On 1 December 2016, Rachael decides to move back to New Zealand to live. She acquires a permanent place of abode on that date. She was last resident on 30 September 2006, just over 10 years ago. On 19 May 2017, when she has been present for 184 days, she is deemed to be tax-resident from 1 August 2016.
Rachael would qualify for the exemption. She began to satisfy the requirements of section OE 1 for being a resident on 1 December 2016 when she reacquired a permanent place of abode in New Zealand. At that time, she had not been resident in the preceding 10 years. Her exemption would run from 1 August 2016 to 31 December 2020.
Sections NF 1 and NF 2 of the Income Tax Act 2004
Section NF 1(2) has been amended, taking interest and dividends covered by the exemption outside the definition of resident withholding income. This clarifies, in particular, that agents receiving such exempt income on behalf of transitional residents are not required by section NF 3 to deduct resident withholding tax. Section NF 2(7B) ensures that agents will normally be able to rely on a notice given by a client that income is exempt.