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Opinion: Tax changes on investments introduce new distortions

By Simon Louisson of NZPA

Thursday 13th April 2006

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The Government appears to have swapped one set of tax distortions for another when it announced a long-anticipated overhaul of tax rules on investments this week.

Managed funds will no longer have to pay capital gains on holdings in Australasia. But a capital gains tax will be imposed on investments over $50,000 (or $100,000 per couple) outside Australasia, capped at 5% per year.

As well, those on the 19.5% income tax bracket will no longer have to pay a 33% rate on investments in a managed fund.

There are definite winners and losers out of these changes, as with all tax reforms. Critics argue the distortions created are worse than the fences fixed.

Rubbing hands in anticipation of the changes are those in the funds management industry together with the local stock exchange.

Local stocks will be more sought after because of their favoured tax treatment.

The funds industry said the removal of capital gains tax on investments in Australasia means the playing field viz-a-viz direct investors has been evened up.

"This means better long-term returns for investors in managed funds," said Fisher Funds Management managing director Carmel Fisher.

Indeed, one new investment fund, Aspiring Asset Management, has been set up specifically because the managers believe the tax changes make such funds much more attractive, particularly to the wealthy investors it is targeting.

AMP Financial Services savings and investment general manager Roger Perry believes this week's announcements, together with the Kiwi Saver initiative, will be seen in 20 years as "very, very significant for New Zealand - maybe not so significant for what they do right now, but for what they will do the future"

In an emotional outburst, British based Guinness Peat Group, which has 28,000 of its 33,000 shareholders in New Zealand, attacked the capital gain tax as "un-New Zealand". But the changes could easily be countered by GPG by changing its main domicile to New Zealand.

The harshest critic of the changes is economist and commentator Gareth Morgan, a man who plans to give away the proceeds of a $47 million windfall he made through investing in his son Sam's start-up, Trade Me.

Morgan slams institutional investors as talking their books because they are favoured by the changes.

"It's going to steer money back into New Zealand and we are going to get over-investment in New Zealand," he told Radio NZ.

He compares the situation to subsidised private pensions before the 1987 sharemarket crash, that saw many nest eggs wiped out.

"The key to secure people's savings is diversification. Therefore, it is absolutely essential that they are able to spread their money around the world," said Morgan.

A capital gains tax outside Australasia means people will sacrifice diversification to follow tax breaks - just as they did when there were breaks for investing in forestry, resulting in a lot of lost shirts.

"You have to separate the vested interests here from the interests of New Zealanders."

"While (NZX chief executive officer) Mark Weldon and the stock exchange will be ecstatic about it, that is not New Zealand. What we are really concerned about is the security of New Zealanders' savings."

Institutions will over-invest in New Zealand and Australia which are "high beta economies" - commodity plays that are very exposed to strong cyclical swings.

Morgan said Finance Minister Michael Cullen and Revenue Minister Peter Dunne had "fallen victim to the insurance industry lobby yet again".

While the tax changes are projected to cost the Government $100 million, Morgan believes that may reverse to a gain as people look through the capital gains tax costs and continue to invest elsewhere.

However, he also fears people will say "what a load of cobblers this is" and put more money into housing - the opposite message that Cullen is attempting to send.

Thomas Pippos, managing tax partner at accountants Deloittes, fears the capital gains tax on foreign investments outside Australasia could be the thin end of the wedge.

"There is now a new paradigm in the Tax Act which is a recognition that in certain instances it's okay to tax economic gains as opposed to real gains.

"Economic gains are what they are now taxing in relation to international equities. There will be pressure to extend it."

Classically, Inland Revenue taxes income or dividends, not capital gains. Pippos said many property investments are structured in such a way there is no taxable profit. The gain comes when the property is sold and mostly that is not taxable.

The argument in favour of the capital gains tax was that investors were avoiding tax by investing in foreign companies that did not pay dividends, unlike most Australian and New Zealand companies.

However, Pippos said such investments were no different to investing in a local company that chose to retain profits. Such a company's share price could be expected to appreciate as a result of accrued wealth, and the investor would not pay tax if he or she sold the shares at a profit.

He is concerned future Treasury officials or a new government will apply the principles of the new rules to local investments such as property or shares.

Although not opposed to the concept of a broad capital gains tax - indeed he believes the broader the tax base the better - he believes there must be quid pro quo of a reduced tax elsewhere.

"What we could be seeing is a broadening of the tax base but with no corresponding reduction in the tax rate."

He is deeply sceptical of Treasury estimates of a $100m reduction in overall taxes as a result of the changes. Previous forecasts have proved inaccurate, he said.

"What we have ended up with is an erosion towards the introduction of a more widespread capital gains tax without any quid pro quo in terms of a reduction in the rate."

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