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Govt to close down managed fund tax loophole

Philip Macalister

Thursday 7th August 2003

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The Government made it clear yesterday that it wasn’t prepared to tolerate the use of tax-effective Australian unit trusts (AUTs).

In a speech delivered to the Institute of Chartered Accountants in Auckland, Finance Minister Michael Cullen said using AUTs instead of New Zealand based vehicles to get around paying tax was unacceptable.

"From the Government’s perspective this is unacceptable and, if necessary, we will change the law to ensure that this option is not available," he said.

The speech (delivered by Associate Revenue minister David Cunliffe) is a watershed for the funds management and financial planning community.

Russell Investment Group (formerly Frank Russell) pioneered the first AUTs for the ANZ, and many other managers have followed suit, including NZ Funds, Assure/Spicers, BT Funds Management, ING and more recently AMP and St Laurence.

While the government has made its intention clear, how far it will go and what it covers is less certain.

The speech (read what Cullen said here) gives an example of an investor who goes into an AUT which invests in New Zealand Government bonds. Cullen says by doing this the investment is virtually tax-free.

"An identical investment through a New Zealand vehicle would be clearly subject to New Zealand tax."

Some people have interpreted this to mean that the government is only interested in AUTs investing in New Zealand fixed income assets.

However, Cullen’s tax adviser, Helen Mackenzie, says the Government wants to look at the broader issue, which includes other tax effective funds such as United Kingdom-based Open Ended Investment Companies (OEICs).

However, she was unable to say how much revenue the government was missing out on by managers and investors using AUTs.

Cullen also noted there had been quite a lot of media comment in this area. Although he was not specific a speech made by PricewaterhouseCoopers tax partner John Shewan at the Financial Planners and Insurance Adviser conference and reported on Good Returns, has created much debate in the industry.

Shewan, yesterday, said that it was only a matter of time before the government moved to tighten up tax treatment of offshore unit trusts.

“There has been a general notion that Mum and Dad investors holding these investments on capital account won’t be taxed on the gains. That is not correct – and it’s never been correct, if they are acquired with the purpose of selling them.”

Despite the discussion period between now and whenever a decision is made on the October discussion document, Shewan suggests the government has given a clear steer which way it is thinking.

He points to Cullen’s comment that “it seems to me to be a mighty effort to argue that shares or units with no realistic dividend yield were purchased otherwise than for the purpose of sale. That would make all the gains taxable.”

The question is less whether the government will move to tighten up the rules, but rather how it will do it.

"Will we have the equivalent of the Springboks spitting in investors’ faces, or something more gentle than that?” Shewan says one of the positives is that managers have warned investors of the risks.

"The industry has been quite responsible in drawing attention to this, in investment statements and prospectuses. But I am amazed so little attention is paid to it. I’ve seen investors going into these Australian trusts with the intention of selling them a few weeks later.

“Frankly that is just dumb, because they will be taxed.” The government has not made any plans for how it will tackle this issue. It will release an issues paper in October that will raise options to deal with this problem and other issues that arise under the foreign investment fund rules.

One option is to implement a risk free rate of return regime as suggested last year by the McLeod tax committee. Another similar option, known to be favoured by some at the Inland Revenue Department, is a deemed dividend regime.

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