Reform plan leaves tax tangled as ever

Plans to tidy up the tax treatment of investment will just replace one set of distortions with another, tax experts say.

The area has become a tangled mass of complexity and inconsistency, with different rules depending on whether the investment is direct or through an intermediary, active or passive, in New Zealand or offshore and, if offshore, in which countries.

The Government's proposal to align the tax treatment of investment in New Zealand companies via managed funds with the way direct investment in the same shares is taxed removes one anomaly and has been widely welcomed.

But moves to impose a tougher tax regime on investment in overseas companies are liable to tilt the playing field towards more investment in New Zealand companies - with the risk of inflating local share prices and undermining prudent diversification of investment risk.

Abolishing the "grey list" of countries, where portfolio investment by individual investors and passive funds escapes capital gains tax, was recommended by Craig Stobo when he reviewed this vexed area of tax law last year.

But the Stobo report backed a different model for taxing offshore investment from the one the Government now proposes.

PricewaterhouseCoopers tax partner Paul Mersi said the proposed regime for foreign investment was too harsh.

For investors with more than $50,000 invested, it requires the investment to be marked to market and unrealised capital gains (which might reflect nothing more than exchange rate movements) taxed.

There would be a 6 per cent cap on the cash tax payment required in any one year, but if the tax liability was greater than that it would not be forgiven, just rolled over.

"It provides a very strong incentive to weight investments towards New Zealand or to evade tax through non-declaration," said Mersi.

Deloittes tax partner Thomas Pippos said that while investors could avoid the capital gains tax by investing in New Zealand, "it is not prudent to have all your eggs in New Zealand's small basket."

Institute of Chartered Accountants tax director Craig Macalister said the institute had yet to consider the discussion document but he suspected it would conclude the grey list should stay.