Changes to the taxation of overseas investments, as indicated by Finance Minister Michael Cullen in his Budget speech, could have major implications for investors and domestic asset prices.

Cullen has signalled the introduction of a tax on the unrealised gains on all overseas equity investments.

This will bring us into line with most other countries with one notable exception - investments in New Zealand equities will not be subject to a capital gains tax.

As most investment decisions are strongly influenced by tax considerations, the proposed changes could lead to a flood of money coming back into the country.

If implemented, they should have a positive impact on the sharemarket and property prices.

These four questions need to be answered:

* Why is the Government proposing a capital gains tax on overseas equity investments only?
* What is the existing tax regime?
* What are the proposed changes and when will they be implemented?
* What are the implications for investors and financial markets?

As the accompanying table illustrates, the managed funds industry has experienced low growth since 1996, particularly when compared with Australia.

Total funds under management have risen by only $20.3 billion, with $12.1 billion going overseas and just $8.2 billion staying in New Zealand (the figures include equities, fixed interest securities and other investment assets).

By comparison, managed funds in Australia have increased by A$489 billion over the same period, with A$391.4 billion staying at home and only A$97.7 billion going offshore.

Looking at it another way, 60c of every additional $1 of managed funds in New Zealand since March 1996 has gone overseas, compared with only 20c in $1 in Australia.

The strong New Zealand bias towards foreign investments has become more exaggerated since December 1999.

In that five-year period, a staggering 97c of every additional $1 of managed funds in New Zealand has gone overseas, whereas only 13c of every extra $1 of managed funds in Australia has been invested overseas.

A joint December 2003 study between the Inland Revenue Department and the Treasury, called "Taxation of non-controlled offshore investment in equity - An officials' issues paper on suggested legislative amendments", estimated that $22.6 billion was invested in foreign equities at the time.