Michael Cullen: One law for all when it comes to taxing gains from outside NZ

Finance Minister Michael Cullen defends his tax changes on overseas investment, and says a Herald columnist has got it wrong.

Legislation before Parliament includes reform of tax rules on income from investment in shares.

The reform is necessary because the rules for share investment now operate very unevenly.

They overtax some investors, favour direct investment by individuals over investment through managed funds, and favour investment in some countries over investment in others.

The reforms are designed to put the tax treatment of all these types of share investment on the same footing.

In a column last week, under the headline "New tax spells doom for Silicon Valley South", Peter Griffin commented on the Government's overseas tax proposals for share portfolios and their supposed effect on the venture capital industry.

Griffin's column revealed a lack of awareness of how closely the Government is working with the venture capital industry.

This consultation will ensure that venture capital investors who seek funding from overseas capital markets are not adversely affected by the reforms.

Among the sweeping generalisations Griffin made were that "this tax will hit everyone who invests overseas, but the impact on the technology sector will be particularly great" and that the rules would "extinguish the hopes of New Zealand technology companies attempting to tap capital markets abroad" by imposing capital gains tax on any share gains brought back to New Zealand for reinvestment in the company.

Griffin is behind on the state of play. The new rules are not aimed at New Zealand venture capital companies that go overseas to get the money they need to grow.

In calling for an exemption from the rules for new technology companies, Griffin fails to realise that the bill before Parliament recognises the important differences between passive investment in a managed fund and direct investments in venture capital companies that have gone overseas to get foreign money to pay for their next stage of development. This means New Zealand venture capital investors in such companies will be taxed as they are now.

The Government is also well aware that some such venture capital cases fall outside the current exemption in the bill. For this reason, the Government has instructed officials to develop comprehensive proposals to deal with industry concerns.

These steps show the Government is willing to listen to and provide solutions to the venture capital industry's concerns.

With the proposals for research and development credits announced last week as part of the business tax review and the announcement of a limited partnership regime, they send a clear message to the venture capital industry about the Government's commitment to fostering it as a vital component of the Government's economic transformation strategy.

Peter Griffin replies:

Dr Cullen has misunderstood or chosen to ignore the thrust of my argument. He is referring to investments in New Zealand start-ups that are undertaken by venture capital companies.

The proposed tax rules have exemptions to cover these types of investors when the start-ups move overseas. These exemptions need further scrutiny.

But venture capital is only one source of investment for growing technology start-ups, which are often owned by a small handful of shareholders who finance growth in the early stages entirely from revenue and cut costs by taking salaries at below market rates in return for a stake in the company.

At some stage, the company may undertake a public float to fund further growth. It may be more attractive to do this overseas, where there is a greater appetite for technology investment.

A listing on the Nasdaq or FTSE exchanges can also give credibility to a company, and get it noticed by potential customers and partners.

Once listed, these companies will be considered "foreign companies" and under the proposed tax rules a capital gains tax will effectively be applied to the capital gains of its New Zealand investors if the collective shareholding of New Zealanders is below 10 per cent of the company.

Once a public float dilutes the shareholdings of New Zealanders, it is likely that the combined shareholding will be below 10 per cent of the total share allocation.

The company's founders and other New Zealanders who believed in the company and invested in the hope of their shares appreciating will therefore be subject to the capital gains tax if they do anything other than reinvest their gains in more shares.

The proposed tax rules make taking Kiwi companies global less attractive and threatens to alienate investors and employees in companies that have international ambitions.