Tax changes a boost for New Zealand investors

During 2006 more change to the taxation regime of investments owned by New Zealander’s was vigorously debated, amended, further amended and then passed into law than in many a previous year.

On 12 December (earlier than expected), the Government passed the Taxation (Annual Rate, Savings Investment, and Miscellaneous Provisions) Bill, included in which were provisions to change the taxation of investment income of direct and collective investment vehicles in New Zealand. The result will be most investors (other than portfolio investment, and to pave the way for non-taxpayers) being taxed at their marginal tax rate roughly coincidental with the introduction of the new ‘KiwiSaver’ plan.

The main objective of the ‘Bill was removal of the taxation, and hence return, distortions between direct investment and those via a managed fund entity, with both New Zealand and international investments considered.

However, rather than satisfy a levelling of the playing field the proposals were regarded as little more than an imposition of a new capital gains tax regime by many,  hence the wide debate.

The forthcoming Dr Cullen supported, KiwiSaver regime also carries its own impetus to attempt a levelling of the investment and taxation playing field before July 2007. The big question is just how does all this impact on us, the investor public.

The Bill effectively removes the current grey list concessions which exempts investors in the eight grey list countries (Australia, UK, US, Germany, Japan, Spain, Canada and Norway) from the foreign investment fund regime (FIF). The benefit of the FIF concession is that investors in most cases only paid tax on any dividends received (with a credit for tax paid in country of investment domicile). Gains on disposal were not taxable if the shares were held as capital assets.

Among the key features, the Bill does not apply to shares in New Zealand and Australian listed and resident companies. These continue to be taxed as per current.

The now proposed taxation of offshore investments is to tax on a fair dividend rate (FDR). This means investors will be taxed on 5.00 percent of the market value of their investments at the commencement of the year. Tax is payable regardless of the performance of the investment and whether dividends are received. The 5.00 percent cap is for individuals and if they can establish a lower return they only pay tax on the value of the actual return.

These rules take effect from April 2007 for individuals and October for managed funds. They will impact funds and superannuation funds and family trusts with offshore investments and individuals with similar investments having cost $50,000 or more. The ‘passive fund’ non trader advantage is also now torpedoed.

There are exemptions; in particular those with less than $50,000 invested offshore and the so called GPG exemption, (which has been extended to several other investments) means the FDR will not apply to them.

There has also been material change to the way listed property vehicles (LPV’s) are treated. The changes have an impact on net of tax income. Effectively, the benefit of tax allowances, such as depreciation, will pass through to investors. Any capital gains derived by the LPV that are distributed will pass through to investors with no further tax liability.

Local investors will now benefit from ‘tax shields’ within LPVs, resulting in an effective tax rate to the holder equal to the effective tax rate of the LPV. Under the current taxation regime, investors in property vehicles do not benefit from tax shields; the shareholder is fully taxed at their marginal tax rate on distributions.

Additionally, investors’ tax liability will now be capped at 33%, further benefiting investors at the top 39% tax rate.

The proposed changes effectively remove the tax distortion that previously existed between direct property investment (which can fully access tax shields - for example depreciation) and investment though collective investment vehicles (which currently cannot). Also, the proposed changes tilt the ground in favour of the new Portfolio Investment Entities (PIE’s) as the rate is capped at 33.00%. LPV’s can participate as PIE’s from 1st Octobert 2007 and it is believed most will qualify from this date.

There is no impact on non-taxpayers (charities) and there is minimal impact on offshore investors, likely to be neutral or marginally better-off. The new tax treatment of LPV’s will bring New Zealand into alignment with international peers, including Australia, UK, USA, Japan, Hong Kong, and Singapore.

Original Article published January 2007