Tax rule change to reap $200m a year

The Government estimates changes to the thin capitalisation rules will bring in an extra $200 million a year in tax and over the next four years cover half the cost of cutting the company and portfolio investment entity tax rates from 30 to 28 per cent.

The thin cap rules apply only to foreign-controlled companies, and not all of them. Private equity firms generally escape them, and banks have their own regime.

They limit the extent to which they can debt-finance their New Zealand subsidiaries.

The more debt they have, the more interest they can deduct from their income, reducing the New Zealand tax they pay.

The key rule is that interest deductions may be disallowed if the debt percentage of the New Zealand company is more than 110 per cent of what it is for the worldwide group.

But if the New Zealand ratio does not exceed 75 per cent, then the worldwide comparison is not needed and all the interest may be deducted.

The Government plans to reduce that "safe harbour" to 60 per cent.

It is one of the changes recommended by the Tax Working Group chaired by Professor Bob Buckle.

Officials' advice to the group said international comparisons were tricky, but Australia has a 75 per cent safe harbour (and the Henry review makes no recommendation to reduce it), while the United States and Germany have 60 per cent.

A key judgment in considering any change would be how sensitive foreign investment is to tax imposed in New Zealand, officials said.

"Lowering the safe harbour will increase national income if the increased tax revenue from encouraging a switch from debt to equity finance exceeds the national income foregone by discouraging some marginal investment from taking place."

KPMG tax partner John Cantin said the changes were in line with the general approach of broadening the tax base while lowering rates.

Taking both changes together, some would be on the right side of that balancing line and some would not, Cantin said.

Deloitte tax partner Thomas Pippos described the cut in the threshold from 75 to 60 per cent as precipitous.

"It will leave certain taxpayers reeling."

Thin capitalisation:

* A company with thin capitalisation is one with high debt, which allows it to deduct interest from income and reduce tax. Budget rule changes apply to foreign-controlled companies.


Tomorrow: Decoding new property rules