"This can't stand, this is a really bad idea."
Prime Minister Jacinda Ardern said the U-turn was as a result of feedback from fund managers.
"It was clear to us that we had an uneven playing field in the way GST was being applied to fees and services. Ultimately, though, we thought we were fixing the system for those fund providers. We've heard very clearly from them, they don't believe that's what it would achieve," Ardern said.
Revenue Minister David Parker continued to defend the change.
He said that after the proposal was released, smaller KiwiSaver providers had made it clear they opposed the move.
"During extensive consultation views were mixed on the merits of the technical change. The large companies profiting from the current set-up were opposed to the change, while smaller providers were more supportive of the change. This was because these providers who did charge the full GST on their service fees faced unfair competition from the bigger players.
"However, since the announcement it has become clear that smaller providers now oppose it too," Parker said.
Parker said he was "proud" of Labour's history of introducing Kiwisaver.
"I am proud of Labour's role in introducing KiwiSaver and its role in securing the future of New Zealanders. We will never do anything to undermine it.
"By contrast, National will not commit to keeping KiwiSaver in its current form, and cannot be trusted to support this important scheme. When last in Government National ditched the Kick-Start payment and introduced a tax on employer contributions," Parker said.
Parker rejected that the tax was a tax on KiwiSaver - the tax was a tax on KiwiSaver fees, which regulators warned would result in lower KiwiSaver balances, he said.
"It was a proposal to even up GST of fees paid to KiwiSaver providers," Parker said.
Murray Harris, head of KiwiSaver at Milford Asset Management, said the Government's change of stance was "sensible".
"Clearly this has engendered a lot of debate."
He said adding GST to KiwiSaver fees would have been another disincentive for Kiwis to save for their retirement.
New Zealand's retirement scheme set-up means KiwiSaver members are already taxed on their income before contributions go into KiwiSaver and are also taxed on investment returns. Many other countries in the OECD provide tax exemptions for this.
An OECD report in 2018 found New Zealand had the second lowest tax gain on its retirement savings.
KiwiSaver industry body the Financial Services Council also welcomed the Goverment's decision.
"This is the right decision by the Government and one that will benefit the retirement savings of New Zealanders over the long term.
"At the heart of the issue are good retirement outcomes for all New Zealanders, and as an organisation with a vision to grow the financial confidence and wellbeing of New Zealanders, we believe that a GST tax on KiwiSaver fees was not conducive to this goal."
The Financial Markets Authority, the Government regulator, warned the fees would be passed on to consumers, and result in KiwiSaver balances being $103 billion lower by 2070.
The proposed tax bill was introduced to Parliament yesterday to change the way the tax is applied to service fees charged by managed funds, which currently are not subject to GST.
The Inland Revenue has calculated that the proposed change will add around $225 million a year to the Government's tax revenues.
Financial agencies and GST experts have warned the tax will hit KiwiSaver balances hard and be passed on in the form of increased fees, while the opposition has described it as "yet another tax grab ... to fleece New Zealanders of their hard-earned cash".
The Financial Services Council of New Zealand (FSC) also described the changes proposed in the Taxation (Annual Rates for 2022–23, Platform Economy, and Remedial Matters) Bill as legislative "overreaches" and a "suboptimal outcome" in the middle of a cost-of-living crisis.
The new rules would have lifted GST on fees for managed funds and KiwiSaver to the standard rate of 15 per cent. Currently the tax treatment of these funds varies.
Modelling from the Financial Markets Authority (FMA) warns the tax and its compounding effects would dent KiwiSaver balances by $103 billion by 2070.
This compares to total KiwiSaver balances which are expected to be $2196b in 2070.
Non-KiwiSaver funds will be hit by $83b. Total fund balances in 2070 would be $1757b. The figures were included in a Regulatory Impact Assessment (RIA) published with the rule change.
That amount of lost savings was equivalent to more than half the size of New Zealand's 2022 GDP.
Individual savers with balances of $100,000 could have lost about $20,000 over 25 years.
