14 June 2005

Key finally wakes up

“It has taken several weeks but it seems John Key has finally read the Budget Speech,” Finance Minister Michael Cullen said today.

He was responding to a statement by Mr Key on government proposals to reform the taxation of offshore investment.

“A full discussion of the options was included in the Budget Speech.

“There is no secret agenda. The objective is to introduce greater transparency into what has long been seen as an anomalous area of tax policy and – in the process – to remove an incentive for people to invest overseas rather than in New Zealand,” Dr Cullen said.

The relevant passage from the Budget Speech, pages 7 and 8, reads: Reform of the taxation of offshore investment is more difficult. Under current rules, offshore share investment is taxed differently depending on the country in which the investment is made. If direct investment is in what is called a “grey list” country, it is excluded from the foreign investment fund rules. If it is not, then foreign investment fund rules which tax accrued capital gains apply. The rules contain four methods for calculating investment for a foreign investment fund.

Consideration was given for some time to the use of a version of the risk-free rate of return method with respect to overseas investment by New Zealanders. In the end this has not been adopted. The main issue is the complexity involved in applying such a mechanism. The method is conceptually simple but quickly becomes complex in application, particularly for individual investors where investments are made at different points in a year. Moreover, the fundamental perception problem remains with respect to tax being applied even where losses had been incurred.

Instead, it is proposed to issue a discussion document within the next few weeks proposing to apply an income calculation method based on actual changes in value for investment funds, companies and individual investors. Under the proposal, the grey list will be abolished for portfolio share investment. Collective investment vehicles will be taxed on the basis of the change in their accrued value.

This would make for clearer rules, but in practical terms the results should be similar to the law as it currently applies for funds that are in the business of actively trading shares.

For individual and other investors it is even more difficult to find an approach that is reasonable without favouring direct offshore investment over investing in a fund. The approach being proposed is that individual and other investors will also be taxed on the change in value of their overseas shares, but with an annual cap so that tax is spread over a number of years to better reflect cash flow. The discussion document will propose a threshold so that those with small holdings of foreign shares continue to be taxed just on dividends received.

This will lead to accusations of extending the capital gains tax regime at present implicit in taxation on non-grey list investment. It is clear, however, that any reform of the current regime that does not penalise investment into New Zealand shares will lead to some such outcome.

The choice then is between a complex regime which tends to favour investment going offshore or a simpler regime which is more favourable to investment in New Zealand.

ENDS

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