Foreign investment taxes under review

Tax rules governing investment by New Zealand companies in overseas subsidiaries could be loosened up.

The Government is considering relaxing a regulatory framework that generally claws back tax breaks such companies derive in other countries for foreign direct investment.

Revenue Minister Peter Dunne told a conference of tax practitioners in Rotorua yesterday that the main matter under consideration was whether there should be an active/passive distinction in the treatment of those subsidiaries - "in other words whether substantive economic activity such as manufacturing should be treated differently from passive income such as dividends, interest and royalties".

Australia makes such a distinction.

Deloitte tax partner Thomas Pippos said it was interesting the Government was suggesting a more liberal treatment of foreign direct investment at the same time as it was planning a tougher regime for foreign portfolio investment (where stakes of less than 10 per cent are involved) at least into countries other than Australia.

Dunne said the Government was also reviewing the withholding tax rates covered in bilateral international tax treaties, including that with Australia.

Australia has reduced withholding tax rates on interest, dividends and royalties in its double tax agreements with the United States and Britain and has raised the issue with New Zealand as well. In their briefing paper to the incoming minister late last year, tax officials noted concerns that New Zealand's relatively high withholding tax rates could be an impediment to international investment.

But they said such taxes were important in helping to sustain taxation on a source, rather than residence, basis "which is especially important if New Zealand wants to maintain a significant company tax base".

Dunne said the review of business taxation would yield proposals for consultation by the middle of the year.

He was strongly committed to ensuring the outcome was significant and beneficial. Finance Minister Michael Cullen has already spoken of "very bold" measures.

But whatever changes emerge would not take effect until April 2008.

Pippos said that by contrast the Australians were expecting further tax reform this year.

He said the longer and louder the drum roll ahead of the business tax review's outcomes, the greater the risk of another anti-climax like the "chewing gum" Budget.

People should be wary of speculation about "straw men" like a payroll tax, which was old-fashioned, distortionary and as a tax on employment unlikely to appeal to a Labour Government.