Brian Gaynor: Tax proposal rewards NZ investments

The proposed investment tax regime announced on Tuesday is positive for most investors. The clearest indicator of this is that the Government's annual investment tax revenue will fall by an estimated $110 million.

The proposals have negative implications for individuals who have invested in seven of the eight grey list countries: Canada, Germany, Japan, Norway, Spain, the United States and the United Kingdom.

The other negative group comprises companies that are domiciled outside Australasia but have a large number of New Zealand shareholders. These include BIL International, Guinness Peat Group and Richina Pacific. These companies will have to move to Australasia or lose some of their New Zealand shareholders.

There are three areas to look at when considering the changes.

* Are shares held individually or through a qualifying collective investment vehicle (pooled fund)?

* Are the investee companies based in New Zealand or offshore? Listed Australian-resident entities will be classified as NZ entities from April 1 next.

* The difference between tax on income (dividends) and capital gains.

Pooled funds

All pooled funds, whether they invest in New Zealand or offshore, are currently taxed at 33 per cent on both income and capital gains.

From April 1 next, pooled funds that invest in New Zealand or Australia will be exempt from capital gains tax. Income will continue to be taxed at 33 per cent except for individuals on a 19.5 per cent tax rate who may choose to have their income taxed at that rate.

The tax impost on pooled funds investing outside Australasia will remain the same.

The tax changes should encourage more New Zealanders to invest in the NZX and ASX through pooled funds. The proposals carry a slight incentive for individuals on the top tax rate to invest through pooled funds because dividends from their individually held shares will be taxed at 39 per cent whereas they will be taxed at 33 per cent in pooled funds.

The composition of the net $110 million annual tax revenue loss reflects the benefits to the managed funds sector. Approximately $110 million of tax revenue will be lost on NZ-orientated pooled funds and a further $40 million on Australian invested pooled funds and individually held investments in non-grey list countries.

On the other hand, the Government expects to collect an additional $40 million tax from individually held investments in existing grey list countries, excluding Australia.

Individually held investments

At present all individually held investments in New Zealand are not subject to a capital gains tax, unless the individual is a trader, and income is taxed at the individual's tax rate.

The same tax regime applies on both income and capital gains on investments in the eight grey list countries. Investments in all other countries are subject to a draconian unrealised capital gains tax regime, which has to be paid each year.

From April 1 next, there will be no tax on individually held investments in New Zealand and Australia, unless the investor is a trader, and tax on income will continue to be applied at the investor's personal rate.

There will be two main regimes as far as investments in all other countries are concerned.

1) Individuals with less than $50,000 invested offshore at cost will not be subject to a capital gains tax. For example, if an individual invested $20,000 in GPG in 1992, has no other offshore holdings and the GPG stake is now worth $210,000, then he or she will not be subject to a capital gains tax because the original investment cost less than $50,000.

2) Individuals with more than $50,000 invested offshore will be subject to a capital gains tax. It will apply to only 85 per cent of the capital gains, there is an annual 5 per cent cap as far as taxable gains are concerned, the carried-over tax only has to be paid when funds are remitted back to New Zealand, and the capital gains liability is completely removed when an investor dies.

The proposed offshore tax regime is complicated and best explained through the accompanying table.

An investor starts Year 1 with overseas investments worth $100,000 (column A). At the end of Year 1 these investments are worth $160,000 (B) and the investor received additional dividends of $6000 (C).

The total amount assessable for tax in Year 1 is $57,000 (E), made up of $51,000 (85 per cent of the capital gains of $60,000) plus the $6000 dividend.

As assessable income is the higher of 5 per cent of the opening investment and the dividends received, then the investor is only liable to pay tax on $6000 (I). At a marginal tax rate of 39 per cent, the total tax liability for Year 1 is $2340 (J).

The big difference between the old and new structure is that the investor will have to carry over taxable income of $51,000 (K) from Year 1 to Year 2.

In Year 2 this $51,000 (F) is added to the assessable income for that year but the taxable income is only $8000 (I) because that is the higher of the 5 per cent cap and dividends received. A capital loss (B-A multiplied by .85) in Year 3 doesn't reduce the tax paid, but it diminishes the assessable income carried over from Year 3 to Year 4.

Year 4 is a fantastic period for our hypothetical investor with the total value of the portfolio rising from $175,000 to $300,000 (A&B). The total tax payable that year is $4290 (J).

At the end of the year the investor has $169,800 of taxable income to carry over, but tax on this is only payable when the funds are remitted back to New Zealand. Offshore securities can be bought and sold without triggering the catch-up tax payment, but proceeds held in a foreign bank will be treated as money remitted back to New Zealand for tax purposes.

An important aspect of the proposals is that the carry-over obligation (K) will be completely abolished when the investor dies.

The actual tax paid in the four years is $13,260 (J), whereas under the existing grey-list regime the investor would pay tax of $13,182 on dividends (C). Thus the additional tax paid over the four year period is $78.

This tax structure is far less draconian than previously suggested and is clearly superior to the current non-grey list regime.

Non-Australasian companies

If non-Australasian companies are included in a New Zealand or Australian pooled fund then they will be subject to a capital gains tax, whereas the rest of the portfolio will not. This creates potential problems as fund managers may not want to hold a tax inefficient security in a pooled fund that is not subject to a capital gains tax.

GPG's Tony Gibbs is undertaking an intensive lobbying campaign to convince Government ministers that they should exempt his UK-based group and classify it as a New Zealand company. If Gibbs fails, GPG will have no option but to move the company to New Zealand or Australia.

* Disclosure of interest; Brian Gaynor is an investment strategist and analyst at Milford Asset Management.