KEY POINTS:
NZX is proposing a change to the tax laws which it says will lift the level of local ownership of New Zealand companies and boost the tax take.
It is outlined in its submission to an IRD discussion document on imputation credits - the mechanism which New Zealand, Australia and almost no one else use to avoid the double taxation of distributed company profits.
The current tax system, NZX says, provides a clear incentive for overseas majority owners to acquire 100 per cent of a New Zealand company and increase its debt funding to the maximum level the thin capitalisation rules allow, thereby minimising the amount of tax they have to pay in New Zealand.
The company tax rate is 30 per cent. For local investors in a company which pays its full whack of tax, imputation means they will only be liable for another 3c or 9c in the dollar, if anything, on the dividends they receive, depending on which tax bracket they are in. They get a credit for their share of the company tax paid.
But for a foreign investor, the only advantage gained from paying that tax and generating imputation credits is to obtain shelter from non-resident withholding tax of 15 per cent, NZX says.
"It does not take an astute business person to know that paying $2 to save $1 is not a good deal."
And it will only get worse if the renegotiation of the double tax agreement with Australia underway leads as expected to a reduction in withholding tax rates.
Better to gear up the New Zealand company to the utmost and use all those deductible interest charges, leaving equity at the foreign parent level.
All of this entrenches the tendency of New Zealand to be an importer of capital and an exporter of profits, NZX argues.
"New Zealand investors have reduced equity investment options as foreign companies have a tax incentive not to offer quality equity opportunities to the New Zealand public."
This, it suggests, runs counter to Government policies to foster savings and investment and strengthen capital markets.
What it proposes should be done is to provide a tax credit to majority overseas owners, the size of which would depend on how much of the company is owned by New Zealand residents.
The overseas majority shareholder would receive a tax credit equivalent to 50 per cent of the total imputation credits distributed to New Zealand resident shareholders.
It would be limited to locally listed companies - this is NZX's proposal after all. And there would be a cap to ensure the credits did not reduce the overseas shareholder's tax liability below 15 per cent.
The tax credit is intended to reduce on a sliding scale the effective tax rate for the non-resident majority shareholder on equity invested from 30 per cent (if the non-resident owns 100 per cent of the New Zealand company) to 15 per cent (if it owns 50 per cent and all the other shareholders are New Zealand residents).
The exchange says this should not cut the Government's overall tax take. The revenue forgone by the tax credit would be less than what is lost when the foreign shareholder takes 100 per cent and then highly gears the balance sheet.
In the longer run it believes the effects would be fiscally positive as a result of more of New Zealand companies being owned by New Zealanders and taxed at their marginal tax rate.
The tax credit would only be available to non-resident majority shareholders. Foreign portfolio or minority shareholders would not benefit.
NZX justifies this bias on the grounds that majority or cornerstone shareholders bring skills as well as capital to New Zealand companies. Passive or portfolio investors do not, and can quit their holdings more readily if the economy suffers a downturn.
All of this is a radically different approach to the Government's preferred one, which is to try to persuade the Australian Government to agree to mutual recognition of imputation or franking credits.
When Finance Minister Michael Cullen raised the issue at the Australia New Zealand Leadership Forum in June, the response from Australian Finance Minister Lindsay Tanner was non-committal and guarded but nevertheless a marked contrast to the peremptory dismissal of the idea from the former Treasurer Peter Costello.
Tanner encouraged New Zealand to make a submission to the review of the Australian tax system being headed by Treasury Secretary Ken Henry. It has.
However strong the theoretical and CER-related case New Zealand makes for mutual recognition, they cannot get around the fact Canberra has more revenue to lose than Wellington. As at March this year, Australian direct and portfolio investment in New Zealand at $59 billion was 2.7 times larger than New Zealand investment in Australia.
Even if they succeed in persuading the Australians - a tall order - the time it would take to implement mutual recognition would be too long, NZX believes.
"By choosing mutual recognition over other initiatives New Zealand is choosing not to compete," it says.
Indeed it has another, more radical proposal up its sleeve: slash the company tax rate and forget about imputation altogether.
In the Mark II version of its draft strategy, jointly with the New Zealand Institute, for confronting the challenges of the credit crisis - "Swan Dive Or Belly Flop?" - it argues that the imputation regime creates growth-limiting distortions for New Zealand-owned companies.
It discourages them from expanding overseas since it is only the New Zealand tax they pay which can give rise to imputation credits. In addition, firms which cannot offer fully imputed dividends are generally less popular with local investors, which weighs on their share prices.
"For growth companies (think Nasdaq-type companies) paying dividends is not a sensible strategy as cash is better reinvested in growth to create capital value. Yet our tax structure is less favourable to growth companies than those that pay yield," NZX and the New Zealand Institute say.
If we want to keep companies here and attract new ones we need to drop our obsession with Australia and stop fiddling at the margin on corporate tax.
They propose to slash the corporate tax rate to around the 15 to 17.5 per cent level, and scrap the imputation system entirely.
Such a radical plan would have to be carefully thought through.
There are complex trade-offs. A return to the "classical" (but internationally normal) double taxation of dividends would encourage firms to retain earnings - which might be positive for capital deepening and productivity.
But it would also be unpopular with investors accustomed to value dividend yield.
And what would be the fiscal implications? In times as perilous as these, there is no shortage of special pleading which involves shrinking the tax base.
The status quo hardly warrants complacency, however, and suggestions like the exchange's, radical as they may be, are worthy of serious debate.
