Tax overhaul easier to swallow

Michael Cullen (left) and Revenue Minister Peter Dunne explain their changes at the Beehive yesterday. Picture / Mark Mitchell

The long-awaited overhaul of the tax treatment of investment, unveiled yesterday, has retained the bits people liked from the original proposal last June, while significantly watering down some of its harsher provisions on the international tax side.

People on lower incomes who invest in managed funds will no longer see the income from their savings taxed at a higher rate than their other income.

But the proposal to tax the savings income of those in the top income tax bracket at their marginal rate of 39c in the dollar has been dropped on pragmatic grounds, to the relief of fund managers. The top rate at which income from managed funds will be taxed remains 33c in the dollar.

The major concession remains of dropping the tax on capital gains from funds trading in New Zealand-listed company shares and has been extended to Australia.

Carving out Australia from the new regime for investors holding foreign shares directly - which had already been foreshadowed in February - is a large concession, since more than half of New Zealanders' offshore portfolio investment is in that country.

Only dividends from Australian-listed companies will be taxable.

Canberra remains resolute in refusing to countenance mutual recognition of imputation credits but, apart from that, New Zealand investors in Australian-listed companies, directly or through a fund, will be treated the same as those who invest in local companies.

Finance Minister Michael Cullen gave three reasons for giving Australia special treatment:

* The push for a single investment market between the two countries.

* The fact that Australian companies - like New Zealand ones - tend to pay out a high proportion of their profits as dividends.

* The close relationship between the Inland Revenue and the Australian Taxation Office should allow the tax authorities to close any loopholes that arise.

Criticism of the overall package, whose net fiscal cost is estimated at more than $100 million a year, is likely to relate to the treatment of direct share investments in the seven other countries which used to be exempt from the more draconian features of the foreign investment fund rules, notably Britain, the United States and Japan.

People who have invested more than $50,000 (at original cost not current market value) in equities in those countries will face a tax on 85 per cent of the average capital gain on those investments. The original proposal was 100 per cent.

But in any one year the taxable gain is capped at 5 per cent of the market value of the holdings at the start of the year. The original proposal was a cap of 6 per cent.

Any gain above that would be carried forward and can be offset by tax losses in subsequent years.

But if or when the investor cashes up and repatriates those profits, 85 per cent of them will be taxable.

PricewaterhouseCoopers tax partner John Shewan said that in practice and in a rising market most investors outside New Zealand and Australia, above the $50,000 threshold, would be paying tax on 5 per cent of the opening value of their portfolios each year.

He said the 5 per cent figure was a reasonable proxy for the dividend yield they would be earning if they invested locally.

And the rollover provisions (on gains above 5 per cent) would probably amount to an indefinite deferral of tax for most of the investors concerned.

"It takes a lot of heat out of the original proposal. I don't think you could say this is a comprehensive capital gains tax. It is substantially watered down," Shewan said.

But Institute of Chartered Accountants tax director Craig Macalister said the capital gains would still be taxed when the cash was brought home.

He said it was a shame moves to a more benign treatment of domestic investment was linked with a harsher treatment of offshore investment. International tax policy should not be driven by domestic savings policy.

Tax on investments in Asian countries (apart from Japan) and most of Europe and Latin America becomes less onerous under the planned regime.

The changes will be included in the next tax bill, to be introduced to Parliament next month. They are intended to come into effect on April 1 next year.


The main changes

In New Zealand

* Earnings in a managed fund will be taxed at 19.5 per cent if that is the investor's marginal rate or 33 per cent otherwise.
* Managed funds will no longer pay capital gains tax on their holdings of New Zealand and Australian listed shares.

Investments outside Australia

* Individual investors who hold shares directly in overseas countries other than Australia will be taxed on 85 per cent of their capital gains, even if unrealised.
* But it is capped. If the capital gain is more than 5 per cent in any one year, they will only pay tax on a 5 per cent gain. The rest will be carried forward but will only be taxed if the shares are sold and the proceeds repatriated.
* The capital gains tax only applies to investors with more than $50,000, on an original cost basis, invested outside New Zealand and Australia, or $100,000 for a couple.
* Passive or tracker funds invested outside Australia will be treated the same as direct investors.