Transtasman tax reform

The CER birthday party is over. Do we still have something to celebrate? JO DOOLAN believes we do, and addressing tax problems associated with investments is an important move

At the 20th birthday party of the CER agreement, Australian Treasurer Peter Costello and New Zealand Finance and Revenue Minister Michael Cullen exchanged birthday presents in the form of a solution to a long-standing tax problem involving transtasman investment.

Accompanied by all the right oratory, Cullen and Costello emphasised: "These long-awaited reforms reflect the commitment of both governments to the continued strengthening of the Closer Economic Relations agreement between Australia and New Zealand and to promoting transtasman business.

"The reforms are aimed at what is known as the 'triangular tax' problem, where Australian and New Zealand shareholders investing through a company resident in the other country that earns income and pays taxes in their own jurisdiction, are unable to get imputation credits arising from the payment of such taxes.

"Under this reform, Australian and New Zealand shareholders of transtasman companies that choose to take up these reforms will be allocated imputation credits, representing New Zealand tax paid, and franking credits, representing Australian tax paid, in proportion to their ownership of the company. However, each country's credits will be able to be claimed only by its residents.

"These changes will remove an impediment to transtasman business. Therefore we are especially pleased to be able to announce them in this year of the 20th anniversary of the signing of CER."

They also noted CER was one of the most successful economic agreements in the world. Bilateral trade in goods had doubled in real terms since the treaty was signed in 1983, and the trade in services was also growing steadily.

The stage is set and the ministers are delighted with the triangular tax solution. A dampener on the celebrations is the apparent lack of enthusiasm from the business community.

In Australia they were indifferent; New Zealand considered it did not go far enough.

Given it has taken 10 years of discussions to get this far, the ministers had every right to be thrilled. Let's at least appreciate what has been achieved is heading in the right direction and will provide benefits for some companies.

Being able to use company tax paid in either country is a logical concept under the terms of the CER agreement. Actually agreeing to how it would work in practice is a great accomplishment.

Taxation has been a major impediment to transtasman shareholders. Aussie shareholders who invested in a transtasman company based in New Zealand could expect to pay up to 65 per cent tax on any dividends received, compared to a maximum of 48.5 per cent from the same company based in Australia. For a $100 dividend, the Aussie shareholder would receive $51.50 by investing in Australia, compared to $35 from investing in the New Zealand-based company.

Both countries have a system of taxation where tax paid by companies can be paid out to shareholders via a tax-paid dividend. The reality for transtasman investments is that, no matter how close we pretend to be, Aussies investing in New Zealand firms receive diminished returns and vice-versa.

Under the new proposal, New Zealand companies will be able to keep an Australian franking account and Aussie companies can keep a New Zealand imputation account.

Shareholders of transtasman companies will be able to be paid a portion of both franking and imputation credits with their dividends. Aussie shareholders will only be able to receive a tax credit for franking credits and New Zealand shareholders will only receive a credit for imputation credits sourced from New Zealand tax.

The new regime for taxation on transtasman investments may make life easier for investors. The estimated cost to the Australian Government is A$25 million and $10 million to the New Zealand Government.

Despite the groans of disappointment that triangular taxation represents a partial and limited solution, it is an important step forward s.

This agreement is a launching pad for future co-operation between the two countries. New Zealand might be about as important to Australia as Tasmania, but it is in New Zealand's interest to build on the momentum of CER and explore the potential to expand our economy with friendly partners.

Could this mean we adopt Australia's tax system as our own? Some aspects of this could be attractive. Low income earners would be better off, as Australia has a tax-free threshold of A$6000 and then taxes income between A$6000 and A$20,000 at a rate of 17 per cent. For top income earners a rate of 47 per cent is unlikely to be welcomed. Likewise medicare levies of 1.5 per cent and a capital gains tax. Active business exemptions for companies who operate in low- tax countries would be an attractive addition to New Zealand's controlled foreign company regime. At the company level, Australia is, on paper, already more competitive than New Zealand with its 30 per cent company tax rate.

What is needed in the future development of CER is not a merger of the two tax systems but a co-operative agreement that enables the two countries to attract capital and growth from the international market.

Revenue constraints and the perception of the integrity of the tax system being maintained will be cited as reasons why something cannot be achieved. But they don't take into account the total economic growth that could come from making our countries more attractive.

TWENTY years ago the CER agreement was imperative for New Zealand. Britain was in the honeymoon phase of its entry into the European Community and the pressure was on. Who better to get into bed with than our nearest neighbour Australia?

After years of hard work and endless negotiations, CER is now celebrated as a closer alignment of our two economies, removing trade barriers and providing a platform to develop a very important trading relationship.

The capital market remains the least aligned part of the transtasman market, and taxation disincentives continue to impede the flow of transtasman capital.

Addressing the problem of triangular taxation is a step towards improving the ease of transtasman capital flows.

It is time,too, to use CER as a platform to looking beyond our pleasant shores to the global market. A starting point could be the clear tax bias towards investing in the domestic market; the converse being the tax impediments to our attractiveness to international investors.

The next round should include an option to allow dividend streaming of foreign-sourced income. Or we could adopt a policy of mutual recognition, with pro-rata revenue sharing.

Under mutual recognition, company tax paid in New Zealand would be allowed as a franking credit in Australia and vice-versa. The complexities arise in needing to record how much each government owes the other and compensation would be paid.

Mutual recognition in practice is complex in the light of existing double tax agreements and the loss of tax revenue - a scary concept that is not impossible, as we have a similar mechanism in place for social welfare.

Streaming is my favourite, as tax paid in New Zealand could be paid to New Zealand shareholders via imputed dividends, and tax paid in Australia paid to Australian shareholders via franked dividends. This type of concept has the huge plus that it is consistent with the idea that imputation being tax paid by companies can be paid to shareholders in the form of tax-paid dividends.

TO PROMOTE our countries as a part of the global network we need to see ourselves as the investors would. Barriers to investment should be removed to whatever extent our budgets allow.

Multinationals are reluctant to base themselves in a market where foreign- sourced income is taxed. Current measures like conduit relief provide a partial solution, but have limited benefits for joint ventures and branches.

Taxing entities based on existing residency tests that do not take into account the electronic age are antiquated and problematic.

Evidence is available to establish regional headquarter locations that can be driven by tax considerations as well as improved access to world markets and investors.

The trend is for company tax rates to decline. Countries such as Ireland are heading towards a 12.5 per cent rate. Singapore is aiming for 20 per cent by 2005 and Canada 21 per cent by next year. One may ask why the tax take from companies has not diminished. The answer is clever advertising: the reduction in tax rates is often accompanied by broadening the tax base. Add to this surtaxes, state taxes and provincial taxes and the effective rate is normally much higher than the advertised rate.

Tax is an important influence in the choice of where global investments are made. This encompasses tax rates, transparency, simplicity and administration. As net capital importers, we must ensure tax does not drive away the much-needed international investment.

So is the solution similar to the World Cup rugby scenario? Do we need to learn to present things in a way that blurs reality or start a campaign of pointing out where others are blurring reality?

If we are to enjoy the benefits of the global economy and achieve high economic growth, increase our productivity and export sales, then ensuring we eliminate impediments to Australian or New Zealand entities expanding or attracting capital are critical to our future success. Given the size of our combined economies to other countries, to do this in a c-co-operative, rather than competitive way, will provide added benefits to both.

As advisors and business people working under strict timeframes, it is often very difficult for us to appreciate how much time it takes to sort differences out at a political level and to provide workable solutions.

Cullen and others have achieved positive results against the odds and against a history of others not managing to crack this difficult nut. Starting with small steps in the right direction, pausing to celebrate the success and moving on to the next goal.

Global markets, global capital and global mobility mean continuing the progress of what CER has achieved is crucial.

Will an economic union ever be achieved? At present, adopting a common currency, a common government, a common tax system or similar proposals are concepts that are as foreign as Kiwis being taxed on their homes. Yet the small steps of progress could see us move towards this.

* Jo Doolan is a tax partner at Ernst & Young specialising in transtasman taxation. The views expressed are her own and do not necessarily represent those of Ernst & Young.

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