Lin – New Zealand Court of Appeal finds that Chinese tax spared on Chinese CFC income and attributed under a CFC regime to a New Zealand shareholder was not “in respect of” income derived by that shareholder from China

As a result of having a 30% interest in four companies which were resident in China, the taxpayer had the active business income of those companies of $4.6 million attributed to her in New Zealand under the New Zealand controlled foreign companies (CFC) regime. The New Zealand income tax payable by her on that income was reduced by the Chinese tax actually paid by those companies, but not by approximately $0.6 million of tax that the Chinese companies were spared from paying due to tax concessions granted to them under Chinese domestic law.

Art. 23 of the China- New Zealand Double Taxation Agreement provided in relevant part that “Chinese tax paid … in respect of income derived by a resident of New Zealand from sources in the [PRC] … shall be allowed as a credit against New Zealand tax payable in respect of that income,” and that for such purposes, such Chinese tax “shall be deemed to include any amount which would have been payable as Chinese tax for any year but for an exemption from, or reduction of tax granted for that year … under [specified] provisions of Chinese law.”

In finding that Art. 23 did not require the Commissioner to grant a foreign tax credit for the spared Chinese tax, Harrison J stated:

[W]e are satisfied that art 23(2)(a) requires the tax to have been paid by a New Zealand resident on income derived by him or her in China, not by a third party CFC; that is the essential precondition to a credit in New Zealand. …

The fact that the ultimate source is income attributed to Ms Lin from the Chinese CFCs does not justify treating the two income streams, earned separately by the CFCs and Ms Lin, as one for revenue purposes, and ignoring the plain foundation of art 23(2)(a) on the source of “the income derived by a resident of New Zealand”, Ms Lin.

In commenting on this case, Brian Arnold suggests that it accorded with the literal meaning of Art. 23, but went on to suggest that it is strange that the taxpayer did not raise the issue of whether the Treaty prevented the application of New Zealand's CFC rules, which were introduced after the Treaty and, by extending to business income of CFCs, were very broad in scope:

[T]here is a strong argument - based on a broad purposive interpretation of tax treaty, the unusually broad scope of New Zealand's CFC rules, the OECD Commentary as it read at the time the treaty was signed, and the absence of any specific provision in the treaty allowing New Zealand to apply its CFC rules - that the treaty should have been interpreted to prevent New Zealand from applying its CFC rules and imposing tax on the taxpayer with respect to the income of the Chinese CFCs. The Lin case is significantly different from the Canadian case [Canada-Israel Development] in this regard because the Canada-Israel [Treaty] contained an explicit provision to the effect that nothing in the treaty prevents Canada from applying its CFC rules.

Neal Armstrong. Summary of Commissioner of Inland Revenue v. Lin, [2018] NZCA 38 under Treaties – Income Tax Conventions – Art. 24 and of Brian J. Arnold, “The Relationship between Controlled Foreign Corporation Rules and Tax Sparing Provisions in Tax Treaties: A New Zealand Case,” Bulletin for International Taxation July 2018, p. 430 under Treaties – Income Tax Conventions – Art. 24.