Overseas share tax 'replaces one unfair plan with another'

The latest proposal on how overseas share investments should be taxed will replace one set of unfair tax advantages with another, the Government has been told.

Parliament's finance and expenditure select committee has this week been hearing oral submissions on the new proposals it announced earlier this month after its original plan to tax capital gains on overseas investments ran into widespread opposition.

The new proposal, referred to as the "fair dividend rate" (FDR) method, would see individual investors taxed on 5 per cent of the value of their overseas share portfolio at the start of the year. But if they made a return - including any dividends paid - of less than 5 per cent they would pay tax on that lower amount instead.

If their returns were negative there would be no tax liability. But managed funds will be taxed on 5 per cent of the value of their overseas portfolio even if they suffer negative returns.

Yesterday, Mercer Human Resource Consulting told the committee its analysis of the proposal showed individuals would be clearly favoured over managed funds, "as they don't have to pay tax when they incur losses".

"Our forward-looking analysis suggests that the annual return on a diversified unhedged international equity portfolio will be negative around a third of the time. In those years individuals will pay no tax yet managed funds will pay tax on 5 per cent of their holdings," Mercer's Tim Jenkins said.

As such, the proposals would "appear to compromise one of the key objectives of the tax changes, which was to remove inconsistency in treatment between individuals and managed fund arrangements".

The proposals are part of a wider rejig of investment tax intended to remove "unfair tax advantages for direct investors over other savers", Finance Minister Michael Cullen and Revenue Minister Peter Dunne have said.

Meanwhile, AMP Capital Investors, which will present its submission today, said that the 5 per cent "fair dividend rate" was "not fair".

When they announced the FDR proposal, Cullen and Dunne said the approach would not target capital gains, "but rather something approximating a reasonable dividend yield".

The 5 per cent rate represented "a realistic rate" based on historical returns on equity investments which had averaged around 8 per cent over the latter half of the last century.

However, AMP's head of investment strategy, Leo Krippner said AMP's analysis suggested that historical average dividend returns from overseas share investments were more like 3.5 per cent.

A spokesman for Cullen yesterday said the 8 per cent figure was based on the performance of the MSCI global share index over the last 20 years. The MSCI includes capital gains as well as dividend returns.

Krippner said the fact that the ministers were justifying the 5 per cent FDR by referring to a rate of return that included capital gains was "a little bit disingenuous".