Cullen shuts banks' loopholes

By BRIAN FALLOW

Foreign-owned banks will have to put about $1.7 billion in extra capital into their New Zealand businesses under new tax rules, officials believe.

"The New Zealand tax payments of foreign-owned banks in recent times have not appeared to reflect their reported profits," Finance Minster Michael Cullen said yesterday.

New "thin capitalisation" rules will reduce the extent to which banks' holding companies can debt-finance New Zealand operations.

The Inland Revenue Department says some banks will have to commit more capital to their New Zealand operations - about $1.7 billion in all.

And the amount of interest for which they can claim tax deductions will reduce correspondingly.

Cullen said the changes, to be included in legislation introduced to Parliament in November, would result in the banks paying around $360 million a more a year in tax.

The financial sector, which includes insurance companies and banks, pays about $500 million in tax.

IRD deputy commissioner Robin Oliver said the normal thin capitalisation system for overseas-owned corporates, which requires a minimum 25 per cent equity, had never worked for banks.

Because of a rule for money that is on-lent, thin capitalisation effectively did not apply to them.

Under the new system, which is similar to that operating in Australia, banks will be denied interest deductions unless they hold a level of capital equivalent to 4 per cent of their risk-weighted New Zealand banking assets.

The figure now is effectively zero.

As well, the Government is moving to close off the use of New Zealand as a tax-efficient conduit for loans flowing from one country, say Australia, to another foreign destination, say the United States.

Present rules allow the New Zealand subsidiary of an overseas bank to borrow this money from its parent and claim an interest deduction.

But the transaction produces little or no taxable income in New Zealand.

Transactions which flow through New Zealand only for tax reasons and which erode the local tax base will not be able to be debt-funded at all and will therefore dry up.

Reserve Bank regulations for registered banks include the internationally standard capital adequacy requirement of 8 per cent of risk-weighed assets, including 4 per cent of "tier one" capital, effectively equity.

The tax problem arises where a highly-geared holding company is above the operational company which the Reserve Bank supervises but below the parent company, which for all the major retail banks is Australian.

Tax officials and banks have had extensive consultations over the past 18 months.

Robin Oliver said the banks were "not ecstatic about it", as they would be paying more tax, but the system was similar to what they were familiar with in Australia and they regarded it as "liveable".


"The minister has made it clear that if they find ways to play with these rules, we will react with new legislation," he said.

The major banks were coy yesterday about the implications.

"Whatever the cost is we won't attempt to pass it on to our customers," Bank of New Zealand spokesman Owen Gill said.

John Duncan of ASB Bank said: "We have a choice of injecting capital at the holding company level or repaying some liabilities. We will wait to see the final legislation before we make our choice.

"But it should result in more tax being paid to the New Zealand Inland Revenue."

Westpac's Paul Gregory said the rules were a reasonable response to the Government's concerns.

A requirement higher than Australia's 4 per cent would have been "unattractive".

Cynthia Brophy for ANZ and the National Bank said the organisation needed "a little more time to consider it".

Cause and effect

* Banks have been paying a lot less tax than their profits suggest they should.

* The Government will legislate to reduce the amount of interest they can claim tax reductions on.

* It is ending the practice of overseas-owned banks funnelling money through New Zealand for tax purposes.

* It believes the two measures will bring in a $360 million a year in tax.