Friday 19th December 2003
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The McLeod Report highlighted the inconsistent treatment of different types of offshore portfolio (or non-controlled) investments.
This week, releasing the new paper, Revenue Minister Michael Cullen said, "the main weakness of the present rules is that they tax similar offshore investments differently, depending on the country that is invested into. This creates distortions in how and where New Zealanders invest."
He went on: "The rules also create problems of tax-base maintenance. This occurs, for example, when New Zealanders invest in Australian unit trusts that in turn invest in instruments like New Zealand government stock, achieving virtually tax-free returns."
The discussion paper also includes an account of work carried out by officials and the New Zealand savings industry on applying the risk-free rate of return method to domestic investment vehicles.
Two alternatives are presented the "standard return rule" and the "offshore portfolio investment rules."
Both apply to investments through entities resident in all foreign jurisdictions. This means the distinction between non-controlled grey list investments (investments in Australia, Japan, US, UK, Germany, Canada and Norway) and other countries will be removed.
The proposals are targeted at non-controlled and non-business offshore investments. They apply to individual investors ("mums and dads") and entity investors who are not in the business of investing. For example, passive funds tracking offshore indices will be subject to the proposals.
The "standard return rule" is a modified version of the original "risk-free return method" (RFRM) proposed in the McLeod review. RFRM will be commonly remembered for the furore caused by the suggestion it should be applied to housing.
Under the "standard return rule," investments would be taxed on an imputed 4% standard return rate (distributions such as dividends would not be taxed when derived). It would broadly apply to non-business investments in foreign companies, unit trusts, foreign superannuation schemes and life insurance otherwise known as "qualifying assets."
The standard return rate would apply to the opening market value of qualifying assets (if available, otherwise approximated market values). Acquisitions and realisations of qualifying assets during an income year would be accounted for in the income tax calculation as part-year adjustments. The standard return rate would be reduced to reflect part-year holding periods.
The "offshore portfolio investment rules" are a modification of the existing foreign investment fund (FIF) rules and would apply to holdings of non-controlled offshore equity investments which cost more than $15,000.
Broadly, portfolio investors with non-controlled interests in foreign companies would be taxed using one of four income calculation methods prescribed.
The issue paper is welcome but the proposals fail to address the primary problem of the taxation of savings in New Zealand being out of step with many other countries. The proposals endeavour to address the symptoms, not the actual underlying problems. These are two-fold: most gains made by the collective investment vehicle are taxed under the company tax model at the company rate (rather than the marginal tax rate of the investor); and most returns are taxed as business profits that is, gains that would be capital if made by the investors directly are taxed as revenue in the hands of the collective investment vehicle.
Our view is that any review of the taxation of savings in New Zealand should start with a broader focus. In addressing the narrow issue of foreign uncontrolled investments by non-business taxpayers, the proposals in the paper put the cart before the horse.
Of concern with the proposals is that the original attraction of RFRM as proposed in the tax review was its simplicity. The proposals are overly complex and do nothing to reduce compliance costs.
In fact, a lot more individual investors, who previously may have been exempt under the rules, will be brought into the tax net.
Given the inherent complexity of these proposals, it is hard to resist the thought that the government's objectives in addressing the specific issues could be achieved within the existing rules.
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