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A hidden Budget gem

-Donal Curtin

Friday 3rd August 2007

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What do you remember about the Budget? All the KiwiSaver stuff, very likely, and the cut in the corporate tax rate, that was nice, and then there were assorted odds and sods that weren't half bad - the R&D tax credit, and for the philanthropically minded you can now give as much as you like to charity (well, up to your annual income, anyway) and get a tax rebate on all of it instead of the piddling $1,890 limit that used to apply before.

That it?

Thought so. In which case something rather important may have slipped under your radar, and that's the huge improvement proposed for the tax treatment of New Zealand-owned overseas operations.

First, the facts. Today, you set up a manufacturing operation in, let's say, China (and here I'm pilfering the example handed out amidst the rest of the Budget bumph). You make $100,000 profit.

Your friendly Chinese tax inspector takes $10,000, because they've got a low tax rate to attract firms like you, but your friendly New Zealand IRD then wants another $20,000.

That extra $20,000 comes about because New Zealand currently taxes all your worldwide income, so the IRD wants 30% (at the new corporate tax rate), which is $30,000, but it credits you with the $10,000 you've already paid to the Chinese, hence the $20,000 bill.

And the proposal? You pay the Chinese their $10,000, and that's it. You can keep your gains in China, or you can repatriate your $90,000 home as a dividend, whatever, but the dividend won't be taxed. You're home free.

Now, tax lawyers being the sort of people they are, and tax chisellers being the sort of people they are, there are provisos and qualifications and definitions to stop rorts of the new system, but the only one that matters to honest folk is that the new provisions apply to 'active' operations. In plain English, you need to be making or doing something. No biggie.

This is likely to be a big advance on the current scheme of things for many New Zealand exporters. At the moment, it's true that you're treated okay if you've got operations in what are called the 'grey list' countries: you don't pay New Zealand tax if you're based in Australia, Canada, Germany, Japan, Norway, Spain, the UK or the US.

In practice, though, that's not where many New Zealand firms are likely to be looking these days.

Two other places are likely to be much more front of mind: cheaper cost bases in the developing economies (recall Fisher & Paykel Appliances' impending move to Thailand), and places like Ireland that offer attractive low tax packages to greenfield investors. There wasn't a lot of point in setting up in Ireland and paying the Irish sweetheart tax rate of 12.5%, if the New Zealand IRD then topped it up back to 30% again. Now, there is.

Or will be, at any rate. Even if things go well, businesses probably won't see the benefits till the 2009-10 tax year. Sure, aspects of it get very technical, and there'll need to be parliamentary space found for the legislation, but when you tune in to pretty much any session of Parliament, you'll quickly wonder about priorities. Pull finger, folks!

Timing aside, there's another point. It's not so much that your new plant in Waterford is now paying only 12.5% tax on its profits. That's nice, obviously, but there's something else that's maybe more important.

It's the levelling of the playing field against your competition. Up to now, you got no benefit from the Irish deal - but your competitors, in all probability, do. They typically don't pay tax on their worldwide income the way you do. Now, it's all on. You can access the same cost or tax benefits, whereas beforehand only they could.

And that's going to be an exceedingly important point to keep in mind from a political point of view. Because sooner or later some populist idiots are going to stumble across this tax proposal, and they won't like it very much. What's likely to get up their noses (as we saw with the Fisher & Paykel kerfuffle) is the encouragement to create jobs overseas rather than here at home.

Never mind that these are the same sort of jingo types who bemoan that 'foreigners' own so much of New Zealand, while we own half of five-eighths of sod all of their economies.

And that's true enough as far as the statistics go: New Zealanders have only $18.1 billion of overseas direct investments ('direct' meaning factories and offices and other physical stuff, as opposed to shares in BHP), while foreign investors own $89.4 billion of physical assets here.

But you can't have it both ways. If you think we don't own enough investments of our own, then you'd better welcome this policy, because it increases the attractiveness of setting up shop on the ground overseas. And if that still doesn't do it for you politically, then recall the level playing field aspect. Do you really want the Aussie firm to be able to tap into benefits you won't let a Kiwi firm access?

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