Mike Shaw: Intentions unclear on overseas equity tax

The Government is expected this week to release a discussion document on the taxation of foreign portfolio investments. This is portfolio investment into foreign shares made by New Zealand investors including individuals and savings vehicles.

Finance Minister Michael Cullen said in his Budget speech: "The changes I am foreshadowing are designed to remove the disincentives to save and invest, remove elements of over-taxation and lead to an outcome where investment is guided more by the returns on the investment than by the tax opportunities presented."

Two details have emerged so far:

* Of savings vehicles, Cullen said that "collective investment vehicles will be taxed on the basis of the change in their accrued value". This is likely to be a capital gains tax on realised and unrealised capital gains.

* Of individuals who have foreign share investments, "the approach being proposed is that individual and other investors will also be taxed on the change in value of their overseas shares but with an annual cap so that tax is spread over a number of years to better reflect cashflow".

Because the cap will bring complex calculations, it is also likely to act as a capital gains tax on realised and unrealised capital gains.

Even the minister acknowledges that this could be seen as a capital gains tax, stating in his Budget speech: "This will lead to accusations of extending the capital gains tax regime at present implicit in taxation on non-grey list investment."

Given that the vast majority of such investment is in grey-list countries (Australia, Canada, Germany, Japan, Norway, Britain, the US and soon Spain) such accusations would be totally accurate.

It is important to consider the Government's objective for these proposals.

Is it to remove disincentives to save? You don't remove disincentives to save by increasing taxes. There is no way this tax increase provides an incentive to make such savings.

Is a capital gains tax on foreign investment proposed to bring more investment in local companies? Clearly if the Government wanted to achieve this, it could simply require the Cullen Fund to invest some of the 75 per cent of its funds now invested overseas back into New Zealand equities

Perhaps the introduction of a capital gains tax on foreign shares is to ensure that local investors do not invest in foreign products that do not pay tax.

If this is the case, then the proposals have merit as New Zealand companies requiring capital will always find it difficult to compete with companies that pay no tax.

However, most foreign portfolio investment is in listed companies in grey-list countries.

The grey list was originally established as companies resident in those countries generally pay an equal or higher amount of tax than if they were resident in New Zealand.

There is generally no current tax advantage for local investors investing in companies resident in grey-list countries that pay tax.

It is, therefore, difficult to see how this proposed tax increase is justified for such investments.

There are a few companies, unit trusts and other entities that are resident in grey-list countries that do enjoy favourable tax treatment, therefore gaining a competitive advantage. These foreign entities can, and should, be targeted to ensure they do not attract local investors because of the tax savings.

However, there is little justification for introducing a capital gains tax for all foreign companies when only a few structures provide tax savings; this is a clear example of using a sledge hammer to crack a nut.

Finally, in terms of tax neutrality, perhaps providing a capital gains tax on all portfolio foreign investment is to ensure individuals do not enjoy a preferential tax treatment over New Zealand saving vehicles undertaking the same investment.

This is a valid concern of savings vehicles.

In the context of New Zealand share investment where this issue has arisen, the Government has sought to address this by announcing in the Budget a full tax exemption for gains made on the sale of domestic shares for New Zealand savings vehicles.

This is a positive move.

However, to achieve the same level playing field between individuals investing directly or via savings vehicles on the international equities market, the Government has announced a full capital gains regime for all investors.

This seems overkill when it was happy to exempt New Zealand share investments.

All should be disclosed soon.

All interested parties, including investors, should ensure that they keep up to date with the proposals and take advantage of the opportunity to give their views through the submission process.

* Mike Shaw is a senior tax partner at Deloitte.