Dialogue: Hidden costs of tax purity

By BRIAN FALLOW

New Zealand's international tax regime has sacrificed international competitiveness for economic purity.

That at least is the assertion of the Institute of Chartered Accountants in its first-round submission to the review of the tax system, being undertaken by a committee chaired by Arthur Andersen managing partner Robert McLeod.

The institute's overall view is that our tax system is balanced and robust. But the international tax system, it says, needs work.

Complaints about international tax, which feature in several of the submissions to McLeod, are underlaid by three considerations:

* New Zealand is heavily dependent on imported capital - $6 billion was needed last year to finance the current account deficit.

* Firms that outgrow the local market and want to expand overseas should not be hobbled by tax laws.

* Increasingly, individuals want to invest abroad and it is undesirable that their savings be ghettoised here by tax considerations.

Not surprisingly, many of the submissions from business organisations, invoking international competitiveness, call for a lowering of the company tax rate, now 33c in the dollar, to at least match the Australian rate of 30c.

The Business Roundtable, however, argues that with dividend imputation there is in effect no such thing as a separate company tax, at least for domestic shareholders.

"The thrust of recent tax reform has been to look through organisations such as companies ... and where feasible attribute tax to the ultimate owners or investors.

"In this way, double taxation is avoided and investors are more likely to be taxed at their appropriate marginal rates."

Consequently, cutting the company tax rate would do nothing for individual shareholders who are on the 33 or 39 per cent personal tax rates, or shareholders which are superannuation funds or other trusts (also taxed at 33 per cent).

It would change only how much of their grossed-up dividend was received as cash and how much as imputation credit; the tax they would pay on that dividend would be undiminished.

The Roundtable's solution is, of course, to cut personal taxes.

As for foreign investors, the Roundtable believes a case exists for taxing them at less than the present company tax rate of 33 per cent.

The grounds are pragmatic: to attract foreign investment, it says, New Zealand must be able offer after-tax returns that compete with other places where they might put their money.

The tax burden, in short, really falls on the New Zealand businesses in which they invest or to which they lend.

"In order to raise foreign debt finance New Zealand borrowers often have to agree that they will compensate the lender for any withholding tax imposed on that income," the Roundtable said.

"This is why New Zealand introduced the approved issuer levy regime; in effect it reduced the amount of non-resident withholding tax levied on the interest income of non-residents to 2 per cent."

As for the tax treatment of New Zealand investment abroad, PricewaterhouseCoopers calls it unfair, inefficient, complicated and a disincentive to saving.

The McLeod committee itself, in its invitation for submissions, highlighted anomalies in this area: "While our rules attempt to tax all New Zealanders on their worldwide income (even when that income is earned through offshore companies), this is not applied consistently. For example income earned through a company in the UK is not taxed as it accrues but income earned through a company in the Netherlands is taxed on an accrual basis under the tax rules relating to controlled foreign companies (CFC) and foreign investment funds (FIF)."

The United Kingdom is on the "grey list," along with Australia, the United States, Canada, Germany, Japan and Norway.

Income from CFCs (that is where the New Zealand resident owns at least 10 per cent of the company) in grey list countries is exempt from New Zealand company tax.

The exemption is given on the grounds that the tax levied in the foreign country would be almost certainly at least as great as would have been levied had the income arisen here.

PricewaterhouseCoopers contends that the list is out of date. Only one country, Norway, has been added to the list since 1988.

"Many of New Zealand's major trading partners are now in Southeast Asia yet there is a disincentive built into our tax system to put investment capital into these markets," it says.

In non-grey list countries, income must be calculated under New Zealand tax rules and tax is assessed as if the income was earned here. A credit is given for foreign taxes already paid, up to the limit of what would otherwise be the liability in New Zealand.

PricewaterhouseCoopers says this imposes high compliance costs, and puts New Zealand-based multinationals at a disadvantage to foreign-based competitors.

New Zealand is essentially the only country to tax the active business income of its resident multinationals' CFCs, it says.

In theory, the FIF regime applies to foreign-sourced income not covered by the CFC regime.

But again there is an exemption for the grey list countries.

"Officials have stated the grey list exemption covers roughly 80 per cent of foreign investment that would otherwise fall under the FIF regime," PricewaterhouseCoopers says.

"However, this begs the question. We consider that New Zealand investors are effectively forced to invest in grey list countries."

The main complaint about the FIF system is that it taxes capital gains, when supposedly New Zealand does not have a capital gains tax.

What is more, unlike most capital gains tax systems, which wait until assets are realised before taxing them, the FIF method taxes the gains as they accrue. This may mean that the taxpayer does not have enough cashflow and has to sell the asset to meet the tax liability, PricewaterhouseCoopers says.

"Whereas investment, especially foreign investment, used to be the preserve of those with considerable means, these days 'ordinary' investors seek diversified investment portfolios."

The Government is promoting saving for retirement, the lack of depth in the New Zealand sharemarket encourages investors to look overseas, and the internet has reduced the barriers to trading internationally.

But the FIF regime strips away some of the benefits of a diversified savings strategy, PricewaterhouseCoopers says.

It can deter desirable immigrants as well.

It can also deter desirable immigrants. "As a firm we are routinely briefed to advise high net worth individuals and entrepreneurs who have identified New Zealand as a desirable place to live.

"On numerous occasions the immigration has not proceeded when these people were advised that their substantial holdings overseas would be subject to the FIF regime."

* Tomorrow: Possible new taxes, capital gains and carbon.