Paul Mersi and Mark Russell: Don't panic over tax changes ... yet

New tax rules have chilled investors, but there's a long way to go before they become law. Picture / Daily Post

The proposed changes to the taxation of foreign shares have had emotions running high, so interest in the Tax Bill introduced by the Government last Wednesday was much more intense than 117 pages of tax legislation would usually generate. It's ironic, then, that the biggest news story is not about the content of the bill. Instead, most attention was directed towards the humble Government media release that followed an hour later.

THE GPG EFFECT

That media release showed the Government had given in to pressure from GPG and its shareholders and was sending them on a five-year holiday from the new tax. This is somewhat surprising considering the Government earlier claimed most GPG shareholders would get a lifelong holiday from the tax because their shares cost less than $50,000.

The manner in which this holiday was achieved should give heart to other aggrieved investors, and is a boost to the power of clever media coverage and the email equivalent of text-bombing politicians.

If the change is policy-driven rather than political, why aren't the thousands of New Zealanders with interests in NZX-listed UK investment trusts equally deserving of a five-year break? The fat lady hasn't yet sung her song.

OTHER DEVELOPMENTS

Other than the GPG tax holiday, the key changes and clarifications are:

* No tax on historic gains: For most investors, increases in the value of shares prior to the new tax coming into effect on April 1, 2007, will not be taxed. Only increases in the value of shares from that date are taxable.

* Australian exemption: The carve-out from the tax on Australian investments applies to ASX-listed companies that are Australian tax-resident. Australian unit trusts miss out, as do investments in true-blue Aussie institutions such as James Hardie and News Corp, which are tax resident outside Australia. How investors are expected to know if an ASX-listed company is tax-resident in Australia is not clear - hopefully the IRD will list qualifying entities on its website ahead of next April 1.

* Small investor exemption: It will be a great relief to many that the exemption for investors with overseas shares costing less than $50,000 now covers all foreign shares, not just listed shares in countries with which New Zealand has a tax treaty. But the exemption does not apply to investments in a NZ managed fund that, in turn, invests in foreign shares. Investors in these funds will be taxed under the new rules based on the fund's foreign share portfolio.

* Tax deferral: The "5 per cent cap" mechanism that restricts the tax payable on investments in any one year is now available to family trusts as well as individuals. Tax on gains over the 5 per cent threshold are deferred to later years, provided the proceeds of any sales of foreign shares are reinvested in other foreign shares by year end. Investments made via NZ managed funds qualify for a watered-down cap.

WHERE ARE WE?

A couple can now hold unlimited listed investments in NZ and Australia together with up to $100,000 of investments in all other countries without being subject to the rules. On the face of it, this significantly narrows the ambit of the new tax.

However, since the small investor exemption does not apply to investments made via NZ managed funds, many small investors (some with substantially smaller portfolios than the $50,000 concession) will effectively be subject to the new tax. This will include very low-income earners investing through a KiwiSaver scheme and whom the reforms are intended to benefit. This dilutes the potential impact of the concession significantly.

There are few positive messages for those investors with substantial foreign portfolios in the existing "grey list" countries not saved by the Australian or small investor exemptions. For this group, the proposals continue to have the potential to increase their existing tax burden significantly.

PANIC STATIONS?

Despite incorrect claims from some that the new tax will whittle away the retirement nest eggs of hard-working Kiwis, our message is: "Don't panic." Well, not yet anyway. Many investors will not be subject to the new tax. For those who are, your capital investment is not jeopardised: The tax only impacts the returns on that capital.

There is a long road to travel before the new tax is implemented, with opportunities for lobbying around concessions and submissions. We suggest deferring decisions about exiting investments until the rules are finalised later this year, at which stage there should be plenty of time to take action before the tax kicks in.

* Paul Mersi (partner) and Mark Russell (director) are in the tax practice at PricewaterhouseCoopers.