Tax options unveiled for overseas portfolio investments

By BRIAN FALLOW

Eagerly awaited proposals from officials to tidy up the tax treatment of portfolio investment in overseas equities were unveiled yesterday.

PricewaterhouseCoopers tax partner John Shewan said the existing rules were a shambles that caused distortions and high compliance costs.

Officials are proposing a variation on the risk-free return method proposed by the tax review headed by Rob McLeod for the taxation of offshore portfolio (non-controlling) equity investments.

Under the "standard return rule" regime, one of two options suggested, tax would be payable on a standard return of 4 per cent of the value of the investment at year's start. This fixed rate departs from the McLeod review's proposal for a rate which would rise and fall with Government bond yields, adjusted for inflation.

It would abolish the distinction between favoured or "grey list" countries and non-grey list ones.

But it would preserve the distinction between actively managed investments (essentially funds entrusted to fund managers) and investments held by individuals directly or through "passive" or "tracker" funds.

The two-thirds of the $35 billion in offshore portfolio equity investment handled by fund managers would continue to be taxed as it is now, which includes a tax on unrealised capital gains as they accrue.

The standard return regime is open to the same objection as McLeod's risk-free return method: that investors would be taxed regardless of whether they received any dividend from the investment.

Nevertheless officials justify the regime as being a rough approximation of the treatment the same investors would get if they invested in shares within New Zealand - paying tax on the dividends they receive (except to the extent they are covered by imputation credits).

The other option, "offshore portfolio investment rules", resembles the more onerous existing foreign investment fund (FIF) rules for non-grey list countries.

It encompasses several options but for smaller investors the most likely would include a tax on 70 per cent of their unrealised capital gains as well as any distributions. For that reason it is unlikely to find favour.

"This is such a radical departure from the Government's commitment not to introduce a tax on capital gains that it is highly unlikely to gain any significant traction," Shewan said. "It has obviously been dreamed up by someone with a strong desire to tax all capital gains.

"One of the big advantages of the standard rate of return method is certainty. Investors will know in advance that they will be taxed at their personal marginal rate on a deemed return of 4 per cent. In contrast, investors wrapped up in the unpopular FIF regime have literally no idea until shortly after year end what they are likely to be taxed on. This routinely leads to severe underpayments of provisional tax and resulting exposure to use of money interest," Shewan said.

He welcomed ending the distinction between the grey list countries (Australia, UK, United States, Japan, Norway and Canada) and other countries. "It also does away with the very unpopular (and widely evaded) foreign investment fund regime."