By BRIAN FALLOW
The McLeod tax review is considering a "carefully targeted" reduction in the company tax rate to between 15 and 20 per cent for foreign companies investing here.
"We want New Zealand to stand out from the crowd," the review says in its interim issues paper.
It has also put up proposals for overhauling the tax treatment of New Zealand investment abroad, which is generally seen as among the toughest regimes around.
At September 30 last year, there was $163 billion of foreign money invested here and $75 billion of New Zealand money invested abroad.
The case for lower taxes on inbound investment generally is that New Zealanders pay the tax anyway.
The foreign investor is interested only in the after-tax return; the higher the tax, the higher the pretax return required before the investment makes sense.
This is why the approved issuer levy taxes the interest foreign lenders earn at only 2 per cent. Since foreign lenders are the marginal source of debt finance, a higher tax on interest would only push up the cost of capital to New Zealand firms generally.
But cutting the tax on inward equity investment too far risks giving revenue away for no purpose.
"Providers of foreign direct investment will often invest in New Zealand precisely because they believe they can earn a higher return here than elsewhere. In these cases they may not be deterred by (reasonable) taxes and the tax will not have adverse consequences for New Zealand.
"In fact a reduction in taxes would not necessarily increase foreign direct investment from existing investors; it may instead only increase their return," the issues paper says.
Also, where companies can claim a tax credit in their home jurisdiction for tax paid here, reducing their New Zealand tax would not leave them better off, but would leave the New Zealand Government worse off.
Cutting the company tax rate for non-residents to 15 per cent would cost $855 million a year. A cut to 25 per cent would cost $380 million.
But instead of a blanket reduction, the review committee suggests targeting the reductions. One possibility would be to limit the concession to new investment; existing foreign investment would not qualify, nor would new investment into existing businesses.
Another option would be to limit the concession to investment in export industries, rather than those aimed at the New Zealand market, or to select industries or regions.
PricewaterhouseCoopers partner John Shewan said the proposal would be hard to sell on equity grounds. You could have a foreign-owned company getting preferential treatment over a New Zealand-owned competitor.
Many New Zealand subsidiaries of multinational companies pay little tax because they are largely debt-financed and interest is deductible. The committee recommends no change to the thin capitalisation rules or to the 10 per cent rate for non-resident withholding tax on interest paid between associated parties.
On the tax treatment of outbound investment, the committee puts up two broad approaches for consideration. Either would allow the abolition of the "grey list," which gives preferential treatment to investment in seven approved countries.
The less radical, "modified CFC approach" would introduce an active/passive distinction for foreign direct investment abroad (apart from a list of tax havens).
It would represent a move away from the policy that New Zealand residents' worldwide income should be taxed as if it was all earned in New Zealand, with a credit for foreign tax paid. This is widely seen as putting New Zealand-based companies at a disadvantage if they want to expand abroad.
Instead the idea would be to target the regime more narrowly at overseas investment designed to avoid New Zealand tax, consistent with the standard practice in other countries.
"We are concerned by recent developments involving the migration of New Zealand resident companies out of New Zealand, and also by the movement offshore of a significant number of New Zealand's wealthy individuals," the review says.
The alternative approach would be to adopt the risk-free return method, which involves taxing not the actual return on capital but what the real yield on it would be if it was invested in a risk-free instrument like Government stock.
The committee has also suggested it in the context of taxing savings and, controversially, a residential property.
"Someone must like it," said Deloittes tax partner Thomas Pippos. "They have obviously never owned shares.
"Suppose you own shares in Portugal and, as is increasingly common, they pay no dividend. If the shares go down in value you will not be happy paying tax, when you are looking at a capital loss. If they stay flat, you will not be happy paying tax on a notional gain that doesn't exist. And if they go up, you will still not be happy paying tax because the shares haven't thrown off any cash to pay it."
The committee also proposes a couple of options for attracting wealthy individuals here, or at least not repelling them for tax reasons.
One would be to put a cap of $1 million on the amount of income tax any individual pays.
The other would exempt from the foreign investment fund rules people who are resident but not domiciled in New Zealand. In other words if New Zealand was not their permanent home (with permanence defined perhaps as six or eight years) they would escape New Zealand tax on their overseas investments.
* People who want to express their views are encouraged to write to: The Secretary, Tax Review 2001, PO Box 3724, Wellington or by email to