Cullen rethinks capital gains tax on overseas investments

Michael Cullen

Finance Minister Michael Cullen is back-pedalling rapidly from controversial plans to impose a capital gains tax on overseas share investments.

Some variation of an alternative, the deemed rate of return method, was likely to emerge from the select committee now considering the legislation, he said yesterday. "And I'm perfectly comfortable with that," Cullen said.

The finance and expenditure select committee has asked officials to look more closely at a proposal put by PricewaterhouseCoopers chairman John Shewan on August 30.

It is a variant of the risk-free return method (RFRM) advocated by the McLeod tax review.

It drops the plan to tax 85 per cent of unrealised capital gains on investments outside New Zealand and Australia and instead would tax either the dividends received or - as a proxy for dividends - 3 per cent of the average market value, the average of the value at the start and end of the year.

"There's an emerging consensus around some form of a deemed rate of return," Cullen said. "But I think the intrinsic problem with the full RFRM approach remains as it has always been - that is, that you end up with the individual taxpayer in particular paying tax even in the year of a loss. I've always felt that's a difficult issue to explain to the individual taxpayer."

Shewan says that is already the case, though, as dividends are taxable even when shares decline in value.

If the Government wished it could provide that the 3 per cent deemed rate would not apply when the market value of the investment fell over the course of a year.

But Cullen said: "Well, then it's a very one-sided thing, isn't it?"

He described Shewan's proposal as really just a variation on the theme of what was in the bill already.

Shewan said his proposal might also be labelled a capital gains tax or wealth tax insofar as it was calculated by reference to current market values.

"The logical response is that the Government's focus is on collecting tax on dividends and this is no more than a fair and reasonable back-stop in cases where people have significant investments [above $50,000] and no or minimal dividends are received."

National's finance spokesman, John Key, claims Cullen is isolated on the issue, with Prime Minister Helen Clark and many other ministers opposed to a capital gains tax.

"This U-turn is also an admission that Dr Cullen is in trouble with his support partners [New Zealand First and United Future]," Key said.

"Dr Cullen is at least finally admitting that his current proposal is a bureaucratic, compliance cost-ridden nightmare, and that it is unworkable."

Shewan said there was no point in designing a tax regime that was conceptually pure but not widely accepted as fair and reasonable.

The Government had made a policy decision not to tax capital gains on domestic investments.

"Following on from that, efforts to tax capital gains on offshore portfolio investments can only be justified on the basis that what the Government is seeking to collect in policy terms is either tax on dividends received or, if no or minimal dividends are received, on a proxy for those dividends."

But Deloitte managing tax partner Thomas Pippos said that if the legislation was to be changed so fundamentally a fresh round of scrutiny and submissions would be needed.

"Potentially you could be jumping out of the frying pan and into the fire."

- Additional reporting by Paula Oliver