Gains tax will hit paper profits

In the second part of our three-part series on investment tax, we look at the Government's role and the structure of the proposed tax as well as where any repatriated money will go.

The most controversial tax legislation in years - an overhaul of the treatment of overseas investment - will come before Parliament's finance and expenditure select committee this week. After a firestorm of criticism greeted the original proposal last year, the Government has made concessions and modifications designed to slash the number of people adversely affected by the changes.

But the contentious core remains: the new regime imposes a capital gains tax that, up to a point, is a tax on unrealised gains.

The main changes to the original proposal are:

* Carving out Australia.

* Taxing not 100 per cent of the capital gains but "only" 85 per cent.

* Lowering the cap which determines how much is taxed in any one year (before cashing up and repatriating the profits) from 6 per cent to 5 per cent.

* Special treatment for venture capital investors.

* A five-year holiday for shareholders in any company exactly like GPG.

As amended, the new rules treat investors holding shares directly in Australian-listed companies as though they were local companies. Only the dividends are taxable, as now.

(Investors will still be unable to take advantage of the franking or imputation credits accompanying those dividends, but that is another story, one of unfinished business between the two Governments.)

Investors whose stake in Australian companies is via collective investment vehicles, like the managed funds used by superannuation schemes, would be better off under the new rules, because they drop the capital gains tax that applies when those shares are sold for a profit.

Documents obtained by the Business Herald under the Official Information Act show that in March Treasury and Inland Revenue Department officials reckoned the cost to the revenue from exempting Australia - about $40 million a year - would be about the same as the extra revenue gained by taxing 85 per cent of share gains in other countries. The overall overseas tax changes would be revenue-neutral.

The same officials also repeatedly describe the 5 per cent cap system as "generous".

It works like this:

Provided the investor's total portfolio of non-Australasian shares cost more than $50,000 and is still worth at least that, he or she will have to pay tax on any dividends they generate and on 85 per cent of any gain in the market value of the shares. Tax losses are allowed if they fall in value.

But the amount that is liable to be taxed in any single year is limited by the 5 per cent cap.

Should the sum of any dividends plus 85 per cent of the share price appreciation over the year come to less than 5 per cent of the market value of the shares at the start of year, then that is all that is taxable that year.

If it is more than 5 per cent, then the excess taxable income above 5 per cent is carried forward to later years.

If the investor owns shares in several companies they are pooled for the purposes of calculating tax.

There is also "rollover relief". Selling an interest in one overseas company and reinvesting the proceeds in another will not trigger a tax liability on any deferred unrealised gain.

When - or if - the investors sell up and repatriate the proceeds, they will be liable for whatever tax remains unpaid.

Only leaving the capital overseas until they die lets them off the hook.

One objective of the new regime is to have a more level playing field between those who invest in overseas shares via managed funds and those who hold the shares directly.

That has become more pressing with the KiwiSaver workplace superannuation scheme, to start next April, which the Government hopes will boost saving through managed funds.

Most New Zealand investment in foreign shares is subject to capital gains tax already, officials argue, because 80 per cent of it is through collective investment vehicles which are generally taxed on realised profits.

"Essentially, there are only two ways to balance the treatment of individuals and funds," officials said in the documents obtained under OIA. "Either a reasonable level of tax can be imposed on individuals' direct offshore investments to bring their tax closer to the level of a fund investment, or New Zealand managed funds' offshore investments could be taxed the same way as individual.

Tomorrow: The lobbying campaign and the chances of altering the tax. What it means for tech companies.