Diana Clement: Taxing times over capital gains

Don't panic, Captain Mannering" is the advice to investors about the new tax rules on overseas investments.

But as those who saw the hit UK TV series Dad's Army will recall, Corporal Jones, famous for his advice to Captain Mannering, was always in a state of panic. And some of the best tax, legal and financial planning brains in the country are in a fervour trying to work out how the rules will affect up to 20,000 investors.

The rules are complex and haven't even been spelled out in full. But in essence, the Government is scrapping the exemption from capital gains tax in all foreign countries except Australia. Investors with money overseas directly, or via New Zealand-domiciled collective funds, in shares, will need to pay capital gains tax on 85 per cent of the rise in the fund or share price over the previous 12 months - whether or not they have sold.

If you've bought those shares directly in an overseas market, then each year 5 per cent of the gain will be taxed and the rest rolled over until the investment is sold when you pay capital gains tax on the remainder of any gain. Any losses cannot be claimed against your income tax, just rolled forward.

Individuals are exempt if the original purchase price was less than $50,000 for an individual or $100,000 for a couple. But family and other trusts get no such exemption.

The proposals appear to encourage investors to repatriate their money and, as a result, fly in the face of the golden rule of investing - diversify, diversify, diversify. Yet investors will find that their returns from foreign shares are going to be diminished while the risk remain the same, says Select Asset Management's director Mike Newton. "That has quite a structural importance for all investors."

Yet Peter Riley, investment adviser at Spicers Wealth Management, says although investors will be better off in tax terms in Australia (and New Zealand), they should temper the desire to sell off and put all their eggs in one basket.

Even those with less than $50,000 to invest overseas need to keep an eye on these changes. Potentially, Newton said, they could be better off by investing directly into overseas investments than via locally offered funds.

That's because locally offered funds investing in overseas shares do not get the benefit of the $50,000 limit exemption and investors in these funds will effectively pay tax on 85 per cent of any capital gains and on 100 per cent of any income from those assets each year.

Investors who invest directly into international shares will also have the advantage of being able to defer the majority of the tax on any capital gains until they repatriate those gains into New Zealand. It is possible, though unlikely, that direct investors may never bring these proceeds back to New Zealand and, in the event they become non-New Zealand tax residents or should they die, they may never need to pay the liability.

There are, without a doubt, some nonsensical outcomes from the proposals. Ethical investing specialist David Yates, of Integrate Financial Services in Takapuna, points out that investors in socially responsible investments will be hit with capital gains tax thanks to the lack of suitable products here. "[Even in Australia] there is only one true deep green fund, which is Australian Ethical, but that doesn't give investors sufficient international exposure," he says.

Some gobsmacking complexities of the proposals:

* They are selective and only cover equities and funds, not property.

* Capital gains tax may mean returns on wise investments that spread investors' money will make them uneconomic.

* The Superannuation Fund, run by the Government, has 77 per cent of its money invested overseas.

* Should the Kiwi dollar dive you instantly have a capital gain on your foreign-based investments - meaning a tax liability.

* Investors who have bought into funds and foreign equities for capital gains, not income, could run into cashflow problems. If their annual dividends are small, they will have to raise cash - possibly by selling shares or units, to pay the tax.

If the bill is passed, investors will have to learn to live with it. But bringing all your money back to New Zealand just when the economy and sharemarket have been through a bull run and might be on their way down may not be prudent, suggests Robert Oddy, director of International Financial Planners.

You might not find the outlook for other asset classes here such as residential and commercial property all that great either.

What's more if you still plan to hold a balance of New Zealand and overseas investments (invested directly), you're going to need a degree in accounting or maths to keep your records straight or a good accountant and financial adviser with appropriate software.

Although financial planners say "stay calm", the reality is that if you are thinking of selling your overseas shares and investing in foreign commercial or residential property, you need time - and April 1, when the regulations are due to come into force is less than a year away.

It's not surprising that ways to avoid the new tax legally are already emerging, including one suggested by law firm Bell Gully, that involved pooling offshore investments in a New Zealand holding company, or as some have suggested, investing in property through syndicates that are correctly structured to avoid capital gains tax.

The announcement last week of the new investment rules was coupled with details of other investment changes including the removal of capital gains tax from New Zealand-based actively managed funds - removing a bias towards passive funds such as FONZ and MOZY. The Government also fleshed out details of the Kiwisaver proposal.

At a disadvantage

One recent immigrant who runs the New Zealand division of a global company in which he holds shares, now finds himself at a huge tax disadvantage if he leaves his money overseas where he believes it to be invested wisely.

His shares in the global company are not listed on any stock exchange, which makes them difficult to value for tax purposes.

"The most prohibitive part of the tax increase is that there appears to be no inflation adjustment," he says.

"Aside from voting National, which we did, what can we do to preserve our retirement investments and remain in New Zealand without becoming a burden to the state in our old age?"