Good and bad in Cullen plan - tax expert

By BRIAN FALLOW economics editor

New tax rules proposed by Finance Minister Michael Cullen for private superannuation schemes would eliminate some distortions of the present regime, but raise problems of their own, says PricewaterhouseCoopers tax partner John Shewan.

Under existing rules, a superannuation fund receives contributions out of the after-tax income of savers and the fund itself is taxed at 33 per cent like a company. But when the savings are paid out they are tax-free.

"This is essentially the banking model. You put money into the bank, the earnings are taxed within the bank, and you withdraw the principal and tax-paid interest without further tax," said Mr Shewan.

But Dr Cullen says that while this approach is neutral in terms of short-term savings, it is far from neutral when compared with other forms of long-term saving.

Mr Shewan said: "He also rightly points out that savers are sceptical that when they finally retire, in perhaps 20 or 30 years, the rules which protect from tax the amounts paid out will remain intact."

The big problems include the over-taxation of savers whose marginal rate is less than 33 per cent and the taxation of capital gains derived by the superannuation fund when New Zealand supposedly does not have a capital gains tax.

Those distortions would be eliminated under the Cullen proposal. The earnings of superannuation funds would be exempt from tax. When pensions or lump sums were finally paid out, the earnings components would be taxed, yet the saver's own contributions would not.

But Mr Shewan said a superannuation fund's exemption from tax would be largely negated if the companies into which it invested paid tax and the fund was not able to benefit from the imputation credits attaching to the dividends paid.

"The obvious answer would be to allow the imputation credits to be cashed out. If a superannuation fund received a fully imputed dividend from, say, Telecom - a gross dividend of $100 including $33 of imputation credits - the fund would get $67 cash from Telecom and apply to the Inland Revenue for a cash refund of $33 for the imputation credit."

The fiscal cost would be significant, Mr Shewan said, but without it superannuation funds would have a bias towards investments such as bonds which delivered pre-tax returns.

Secondly, it was not obvious why the new tax rules should stop at superannuation funds and not apply to other long-term savings, such as unit trusts.