Capital gains provision dropped

The Government has dropped plans for a capital gains tax on overseas share investments and is now proposing a tax on up to 5 per cent of the shares' value instead.

The original plan to impose a tax on unrealised capital gains on share portfolios outside New Zealand and Australia above a $50,000 threshold provoked widespread opposition.

It is part of a tax bill, which also includes several investor-friendly changes, now before Parliament's finance and expenditure select committee.

Finance Minister Michael Cullen and Revenue Minister Peter Dunne will write to the committee recommending a suggested compromise, which they are calling the "fair dividend rate".

New Zealand First leader Winston Peters has assured Cullen he regards this approach as a better option for the select committee to pursue than the original proposal.

It would tax individual investors on 5 per cent of the value of their overseas share portfolio at the start of the year.

But if they made a return - including any dividends paid - of less than 5 per cent they would pay tax on that lower amount instead. If their returns were negative there would be no tax liability.

Unlike the scheme in the tax bill, if the return was more than 5 per cent the excess would not carry forward to subsequent years to be taxed when the shares were sold.

Cullen and Dunne do not propose to change the $50,000 threshold, below which only dividends are taxable, and are leaving to the select committee the question of what to do about the proposed five-year holiday for GPG shareholders.

The rules are sightly different if the shares are held through a managed fund. The fund would pay tax on 5 per cent of the value of their non-Australasian share portfolio regardless, even in a year when returns were less than 5 per cent or negative.

That would limit the fiscal cost, Cullen and Dunne said in a joint statement. As it is, the net cost to the Government revenue of the amended scheme and the other provisions already in the bill would be around $140 million, up from an estimated $110 million before the latest changes.

"We want to eliminate the tax advantages some investors have enjoyed for many years. A number of offshore vehicles pay no or very low dividends so that their investors avoid paying tax," Cullen and Dunne said.

The compromise plan bears a resemblance to the McLeod review's risk-free return method, and the deemed rate of return method proposed by PricewaterhouseCoopers chairman John Shewan to the committee two weeks ago.

Shewan said: "It is pleasing that the capital gains tax element has been removed.

"My main concern is that 5 per cent is too high. Our proposed 3 per cent was deliberately low so that it would be seen as concessionary and generate greater buy-in."

The ministers said the 5 per cent rate was realistic in light of historical returns on equity investment which had averaged 8 per cent over the latter half of the last century.

Shewan said the implementation date for the new regime should be put back a year to April 1, 2008, to allow time for adequate consultation on the new proposal.

While it was desirable to have the regime in place in time for the introduction of the KiwiSaver workplace savings scheme - which has itself been delayed by some months - it was not essential, he believed.

Deloittes tax partner Thomas Pippos said: "Ironically taxpayers would be incentivised to invest in products that pay as little tax as possible - those which offend officials the most - to maximise the opportunity to outperform the 5 per cent cap."

How it would work

Three fictional characters are used to show what the changes mean.

* John's overseas shares are worth $100,000 at the start of the year and $115,000 at the end. John also gets a $10,000 dividend. His total return is $25,000 but his taxable income for the year would be limited to 5 per cent of the opening value of his shares - $5000.

* Mary's overseas shares have a market value of $100,000 at the start of the year and $102,000 by year's end. She gets a $1000 dividend. Her total return is $3000 and she pays tax on that.

* Judy's shares were worth $100,000 at the start of the year but only $75,000 at the end. She did, however, get a $10,000 dividend. Her net return is therefore a loss of $15,000. Because Judy has made a negative return on her overseas shares, no tax would be payable.