For foreigners who want to make their taxes disappear, New Zealand can be an attractive destination. Chris Barton explains.
Secrecy and lack of transparency - they're the key features of a tax haven. "Those are simply not factors here in New Zealand," declared Revenue Minister Peter Dunne last month in response to concerns about New Zealand's possibly shady - definitely shrouded - world of foreign trusts. Labour's Revenue spokesperson David Clark was less sanguine about what was going on in this shadowy realm. "Peter Dunne's relaxed attitude to overseas tax avoidance and National's failed attempts to create a foreign funds hub shows the Government has no concerns about us becoming the Cayman Islands of the South Pacific." Green Party co-leader Russel Norman also called Dunne to account. "New Zealand's foreign trusts form part of a trillion dollar tax haven industry that should be transparent to help stop tax evasion."
The hoo-hah was sparked by a 60 Minutes item which strongly suggested New Zealand was indeed a tax haven. Dunne didn't help with his odd choice of words. "The term tax haven is a gross exaggeration because it implies illegality. It implies tax evasion rather that legitimate tax avoidance," he told Gyon Espiner.
Norman was not impressed: "Mr Dunne's repeated reference to legitimate tax avoidance was astounding. The tax system is being undermined by the minister in charge of it."
Legitimate tax avoidance - is there such a thing? "He got tangled up I think," says PwC partner Geof Nightingale. He should know. His breadth of experience in tax advice and tax policy development spans engaging with government, Inland Revenue and Treasury, including an 11-year stint with the New Zealand Institute of Chartered Accountants National Tax Committee.
"There is tax minimisation," he says, pointing to common tax rebate claims such as charitable donations, or being able to offset the loss made by one company against another that makes a profit in order to reduce tax. "Tax avoidance is where you use perfectly legal structures and legal transactions which have the net effect of reducing your tax bill in a way that Parliament didn't intend," explains Nightingale. "In that case we've got a general anti-avoidance law which says if that's the outcome, Inland Revenue can come in and ignore those legal transactions and recreate it in a way that restores tax."
An example of that was seen in a Supreme Court ruling in August last year which classified the actions of Christchurch orthopaedic surgeons Ian Penny and Gary Hooper as tax avoidance. Both had used "entirely lawful and unremarkable" company structures and family trusts for their practices, but had used those structures to pay themselves artificially low salaries - thereby avoiding paying the top personal income tax rate - which the court found constituted a tax avoidance arrangement. In other words tax avoidance, whether seemingly legitimate or not, is something the government normally discourages. In the world of tax such distinctions are important. Avoidance sits between minimisation and evasion - the criminal end of the spectrum which relies on non-disclosure, "telling lies, not telling anybody and hiding stuff."
If Dunne misspoke himself on avoidance, was he also wrong about New Zealand's tax haven status? Craig Elliffe, professor of Taxation Law and Policy at Auckland University Business School, says this country's foreign trust structure effectively provides a vehicle for foreigners not to pay tax and therefore, in a broad sense, we are a tax haven. But, he points out, New Zealand's foreign trust structure came about in 1988 through an entirely principled approach to taxation - namely to stop New Zealanders hiding their assets and income in overseas trusts to avoid paying tax.
To do this the government adopted a somewhat unique approach. It selected the residence of a trust's "settlor" as the basis for taxation. That is, the person who gives or "settles" property on a trustee to hold under the terms of a trust deed for a group of beneficiaries. In other words, if the settlor was a New Zealand resident, he or she would pay New Zealand tax. While the mechanism makes it difficult for New Zealanders to squirrel away their assets offshore, there is a flipside: settlors who live outside New Zealand, who settle trusts with New Zealand trustees, are exempt from New Zealand taxes. For foreign settlors that means a New Zealand trust, its trustees, trust assets and beneficiaries don't pay tax here.
"We have a regime which is fundamentally based on the residence of the settlor - a regime that deliberately ties up the taxation of the trust to the fact that the settlor probably has some sort of enduring economic connection with the trust," explain Elliffe. "So on that sort of principled basis the regime does comprehensively tax New Zealanders who set up foreign trusts. And it provides for the converse - foreigners who set up New Zealand trusts are not subject to [New Zealand] tax."
The result has been a burgeoning local trade. "The New Zealand Foreign Trust industry has been growing steadily since tax changes were introduced on 1 April 1988, but particularly since global settlors exited blacklist jurisdictions in the 1990s," says the International Funds Services Development Group (IFSDG) in its Exporting Financial Services report last year. The report estimated there were some 4500 foreign trusts registered in New Zealand in 2009, earning about $20 million a year in fees. Latest figures from the IRD indicate considerable growth. Since 2006, when registration of resident trustees of foreign trusts was introduced, 8261 have registered with Inland Revenue. Of those 675 have been terminated and 7586 remain active.
The IFSDG, which was established by Cabinet in 2010 to look at financial services opportunities for New Zealand, concluded that this country could build on its capability as "an exporter of financial services". A number of tax and regulatory changes were proposed for New Zealand to become a financial services hub, but the initiative has since stalled amid concerns about the level of taxpayer support required and the risks of transferring wealth to offshore financial institutions.
On the face of it, the New Zealand companies offering foreign trust services to foreigners seem keen to highlight New Zealand's good reputation, and the fact that it's not viewed as a tax haven, as the key selling point. Some examples:
* "While New Zealand is NOT an offshore haven, it is nonetheless recognised among informed practitioners as a first rate jurisdiction for certain financial structures. It provides all the advantages of traditional 'offshore' financial centres, but is regarded as a true 'onshore' financial centre which is NOT blacklisted by any jurisdiction or authority in the world. - Capital Conservator.
* "Many low tax jurisdictions are blacklisted by OECD nations, who have implemented a wide range of regimes, rules and other measures aiming to prevent citizens from using them. As a result of this attitude, many practitioners and wealth holders are looking at other jurisdictions, with less scrutiny attached. One such country is the Southern Pacific nation of New Zealand." - RLA Trustee Services.
* "Whilst New Zealand is not generally regarded as tax haven, it is just that, when it comes to Offshore Trusts." - Covisory Partners.
* "The direct ownership of the US investments exposes the individual to substantial US estate tax upon his or her death. ... Indirect ownership of the account through a corporation established outside of the United States avoids the US estate tax ... The structure described below, utilising the NZ trust, is designed to provide equivalent benefits through the use of trusts and entities established in non-blacklist jurisdictions." - ATC.
* "... the country can provide all the advantages of traditional 'offshore' jurisdictions and even more because it is not blacklisted by any jurisdiction or authority in the world and has no connotations as a tax haven." - Equity Trust New Zealand.
* "New Zealand is not seen as a 'tax haven' country so the use of a New Zealand trust is generally not perceived as a means to avoid tax or as being tax aggressive." - McVeagh Fleming.
The tax haven that isn't called a tax haven. A rose by any other name. "It's partly due to lax foreign tax systems. Or it could be due to dishonest foreign taxpayers," says Elliffe. Which raises a key question: "Is it really appropriate to paint New Zealand in a very negative light in respect of either of those two things?"
Nightingale asks a similar question: "If someone in Mexico uses New Zealand as a tax haven, they are breaking Mexico's laws. So what degree of care does New Zealand have as an international citizen? We can't be the tax police for the world." Rather than shut down foreign trusts, Nightingale argues New Zealand does enough to meet its international responsibilities through its disclosure arrangements - the double tax agreements it has with 38 countries and the tax information exchange agreements it has with 18 other nations. As well, New Zealand this week signed the Convention on Mutual Administration Assistance in Tax Matters, as amended by the 2010 Protocol.
The multilateral treaty, formulated jointly by the OECD and the Council of Europe, will give Inland Revenue the ability to request help from other tax authorities in detecting and preventing tax evasion, and collecting outstanding tax debts from absconding taxpayers. "This is an important step and consistent with New Zealand's approach to tax matters, and frankly, makes a mockery of tax haven assertions," said Dunne making the announcement.
The valid debate, says Nightingale is whether we collect enough information and how much we should collect. As he points out, under the Tax Administration Act, New Zealand trustees are required to hold detailed records which can be requested by Inland Revenue. That includes the trust deed, details of the settlor, the assets, liabilities, income and expenses of the trust, and details of the beneficiaries and what distributions have been made.
However the actual information Inland Revenue collects about foreign trusts is scant. All that is required on the IRD disclosure form is the name of the foreign trust - or, if no name is available, some other identifying particular - plus contact information for the New Zealand-based trustee. No information about the settlor or the beneficiaries is gathered - the only exception being a question asking whether the settlor is a resident of Australia.
Which creates a fundamental problem: "They [Inland Revenue] won't know what they don't know," says Elliffe. So while the government of a foreign country might suspect some of their citizens of employing foreign trusts to hide their wealth and avoid tax, unless they know the specific name of the trust in New Zealand, a request to Inland Revenue here is not going to get them very far. Elliffe paints a troubling scenario. "Say the Mexican government sends a request to the New Zealand government and says: 'Can you please tell me how many foreign trusts you have with Mexican settlors and who they are?' At that point in time we are in big trouble. We know there are Australian settlors, but we don't know anyone else."
Then there is the wider context. New Zealand's foreign trusts are essentially legal structures in a large virtual network, behaving as intermediaries or conduits for wealth located in some other offshore bank account or destination. As Tax Justice Network senior adviser James Henry points out, the term "offshore" refers not so much to the actual physical location of private assets or liabilities, but to "nominal, hyper-portable, multi-jurisdictional, often quite temporary locations of networks of legal and quasi-legal" entities and arrangements. "A painting or a bank account may be located inside Switzerland's borders," says Henry. "But the all-important legal structure that owns it - typically that asset would be owned by an anonymous offshore company in one jurisdiction, which is in turn owned by a trust in another jurisdiction, whose trustees are in yet another jurisdiction (and that is one of the simplest offshore structures) - is likely to be fragmented in many pieces around the globe."
The key aspect of foreign trusts, says Nightingale, is that none of the assets or income and none of the beneficiaries or ultimate original owners are anywhere near New Zealand. "It's just the administration that happens in New Zealand." An example might be a Mexican family with shares in Australia owned and managed by a New Zealand foreign trust. "The foreign income, such as dividends from the shares, comes through the New Zealand trust and out to the beneficiaries," says Nightingale. "The only reason we don't tax it is because it conduits right through. That's a legal conduit, probably not a physical flow."
Elliffe points out a perhaps unintended consequence of foreign trust arrangements - that by virtue of having a New Zealand resident trustee, they give foreigners the benefit of New Zealand's double tax agreements. In a paper - The Inconvenient Problem with New Zealand's Foreign Trust Regime - Elliffe and co-author Jeremy Beckham argue they shouldn't. "When you have a New Zealand resident deriving foreign sourced income, there are normally lower rates of withholding tax on that foreign income," says Elliffe. "So if we have a share investment in Australia, then the tax on certain dividends that the Australians would normally deduct would be resident withholding tax of 30 per cent. But under the double taxation treaty the maximum tax is either 5 per cent or 15 per cent under the rules of the treaty."
Elliffe asks what should happen when a New Zealand trustee managing Australian assets is acting for someone from Brazil, which doesn't have a double tax treaty with Australia. Should they get the benefit of paying just 5 per cent tax? "It's incorrect as a matter of technical law for the Australians to be thinking that they are dealing with New Zealanders," he says.
The paper points out that it remains unresolved as to whether New Zealand trustees must be recognised as valid parties in New Zealand's network of double tax treaties. "New Zealand is silent on the issue in its treaty negotiations and the topic of trusts has not, to my knowledge, been the subject of a direct OECD inquiry."
Secrecy, subterfuge or turning a blind eye? The big picture issue with new Zealand's foreign trusts is that nobody really knows what they represent. Inland Revenue knows there are 7586 active trust registered, and of those 126 have declared Australian settlors. But it doesn't know much else - certainly not the scale of the wealth the trusts contain.
In a global context, estimating such things is an exercise in night vision says Henry. "The subterranean system that we are trying to measure is the economic equivalent of an astrophysical black hole." But the Tax Justice Network has gone to considerable efforts to try to find out. In The price of offshore revisited: New estimates for "missing" global private wealth, income, inequality, and lost taxes, it estimates that at least US$21 to US$32 trillion, as of 2010, "has been invested virtually tax-free through the world's still-expanding black hole of more than 80 'offshore' secrecy jurisdictions."
The report makes the point that the scale of this "offshore economy" has a major impact on estimates of inequality of wealth and income and on estimates of national income and debt ratios. Most importantly, it has "significant negative impacts on the domestic tax bases of key 'source' countries' - that is, countries that have seen net unrecorded private capital outflows over time.
Henry says the core capabilities of today's "offshore" system are secrecy, tax minimisation, access, asset management, and security. "This 'pirate banking' system now launders, shelters, manages and if necessary re-domiciles the riches of many of the world's worst villains, as well as the tangible and intangible assets and liabilities of many of our wealthiest individuals, alongside our most successful mainstream banks, corporations, shipping companies, insurance companies, accounting firms and law firms."
While there is no doubt New Zealand plays a part in this labyrinthine black hole economy, it can be argued that not everything about our foreign trusts is automatically bad. Henry notes such havens might for example, "help people dodge noxious government rules and regulations, provide escape hatches for the victims of oppressive regimes". And the reason for using them may not necessarily be tax related but more to do with having "the need for discretion and a safe bolthole" as tax consultant Terry Baucher argues. Then there is the issue that New Zealand foreign trusts generate significant revenue in fees - in the order of $50 million per year - for New Zealand professionals. One can't help wondering if Inland Revenue collected a little more information about these entities - such as the country of residence of all settlors - whether that revenue might suddenly dry up. If it did, you'd have to ask why.
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