Cullen 'strong' on advice to lower tax

By BRIAN FALLOW

The McLeod tax review's recommendation of a lower corporate tax rate for new foreign investment in New Zealand seems to have found favour with the Government.

Finance Minister Michael Cullen said he would refer the review's "extremely interesting" ideas on the tax treatment of both inbound and outbound investment to officials for more work.

He added that describing the proposals as "well worth pursuing" should be seen as strong words from a Finance Minister.

The review, chaired by Rob McLeod, recommends a corporate tax rate of 18c in the dollar for investment by non-residents in "new" activities.

It also proposes tidying up the mishmash of tax treatments of savings and investment vehicles.

On the taxation of overseas investment by New Zealand multinationals, the review comes to no conclusion but recommends a dialogue between the Government and business on whether the rules employed in other countries, which distinguish between active and passive investment, should be adopted here.

Dr Cullen greeted all those suggestions positively - unlike the review's call for a cut in the top personal tax rate, a switch from excises to GST, and a cap of $1 million on the tax any individual paid annually.

Overall, the review concludes that the mix between taxes on personal and company income on the one hand, and expenditure taxes on the other, is about right.

It acknowledges that the global mobility of capital and skilled labour puts downward competitive pressure on the rates at which corporate and personal incomes can be taxed, but does not call for a fundamental rebalancing towards lower direct and higher indirect taxation.

"Our judgment is that we can still tax capital to a material extent," says Mr McLeod. "And indirect taxes [GST and excises] already impose a reasonable burden on the New Zealand public."

The review regards more foreign direct investment as essential if New Zealand is to lift its economic growth significantly.

It also notes that multinational companies effectively pay tax at a much lower rate than the statutory 33c in the dollar because they can finance their New Zealand operations largely through debt, with the interest very lightly taxed.

The present average effective tax rate for non-residents is likely to be between 15 and 20 per cent.

Mr McLeod says it is better to make that rate transparent rather than surreptitious, and use it to "stand out from the crowd" competing for international capital.

The review recommends that, taking account of the extent a company is overseas-owned, it should pay company tax at 18c in the dollar, with a 2 per cent withholding tax on distributions.

The question then is whether this should apply to existing foreign investment or be targeted at investment that constitutes new growth in the economy.

The cost of the former would be about $460 million a year, which the McLeod committee concludes would be unacceptably high. (Dr Cullen agrees.)

So it recommends the latter option, which would cost about $50 million a year but raises difficult issues about defining the boundary between new activities and existing ones.

Underlying the proposal is the recognition that taxing inward foreign investment too hard merely pushes up the pretax return the investor requires, increasing costs (including the cost of capital) within New Zealand.

"It's important to identify how much of the tax actually sticks to the non-resident and make that transparent," Mr McLeod says.

Taking any more just pushes the economic burden of the tax on to New Zealand.

Though a differential company tax rate seems to put New Zealand companies at a competitive disadvantage, they already face that problem, Mr McLeod argues.

A company from a low tax rate jurisdiction such as Hong Kong or Singapore can invest here and bring their home tax rate to bear by borrowing the money.

Regarding foreign investment by local firms, the committee had to grapple with a dilemma.

In theory investment should face the same tax whether it is in New Zealand or overseas.

That includes taxing overseas income as it accrues, regardless of when it is repatriated to New Zealand.

But other OECD countries have adopted a system, at least for "active" investments, in which profits are taxed only when they are repatriated.

The review puts the dilemma like this: "On the one hand New Zealand does not want to induce our most mobile taxpayers to consider moving from New Zealand.

"On the other, New Zealand does not wish to adopt a built-in tax incentive that causes people who remain in New Zealand to see a tax advantage in investing offshore rather than in New Zealand. But it is precisely this type of system, that produces an incentive to invest offshore, which is the international standard."

Mr McLeod says the Government and business need to discuss whether to adopt the theoretically inferior but internationally normal regime.

He suspects that when confronted with some of the detailed issues, business may lose some of its enthusiasm for change. For example, would the grey list exemption, from which 80 per cent of investment overseas now benefits, survive?

Deloittes tax partner Thomas Pippos said it was positive that the committee recognised a problem in this area. Business would be keen to debate the issue.

The review rejects tax concessions to encourage retirement saving.

It notes that a lot of the cost of cutting income tax rates in the 1980s was offset by removing tax concessions on saving. One result is that a substantial percentage of the company tax take is now collected from financial intermediaries.

But the review recognises a lack of consistency in the way different savings and investment vehicles are taxed.

It proposes taxing them all as if the funds were invested in risk-free Government bonds, minus an allowance for inflation. At present the rate would be about 4 per cent.

Links


Tax Review