KEY POINTS:
Tax changes to make it easier for New Zealand-based companies to expand overseas without having to leave the country were signalled by the Government yesterday.
But they are not likely to come into effect until 2009.
The plan is to introduce a distinction between active and passive investments
into the controlled foreign company (CFC) regime, and to tax only the latter on an accrual basis.
That would allow a company with a manufacturing operation in China, for example, to benefit from tax concessions there without having the effective tax rate on its Chinese profits topped up to 33 per cent back in New Zealand.
Passive income is the likes of interest and royalties.
"From the perspective of some businesses this is more important than changes to the corporate tax rate," Finance Minister Michael Cullen said.
The change would bring New Zealand into line with most developed countries, including Australia.
Revenue Minister Peter Dunne said: "A lot of New Zealand businesses have told us they can't afford to stay here. This should calm their concerns."
Cullen said the present regime had a certain theoretical purity but the rest of the world had not followed suit.
"It's Star Trek in reverse. We have boldly gone where no man has followed."
The present rules are intended to neutralise any tax incentive for a New Zealand company to invest overseas rather than at home, but instead it creates an incentive to move the company's residence and head office overseas in order to be able to benefit from lower tax rates on offer.
There is an exemption for eight grey-list countries, but Japan is the only Asian one among them; in effect the proposed changes extend the rules for them to the rest of the world.
"Even if New Zealand wanted to prevent outflows of capital it is unclear that an internationally stringent tax treatment of outbound CFC income is in its best interest, given the real world flexibility for companies and workers to migrate to other countries," the discussion document said.
"Firms can always escape New Zealand tax by moving overseas, or perhaps never coming."
Competitive realities also underlie another change signalled yesterday - a willingness to lower non-resident withholding taxes (NRWT) on dividends, and perhaps on interest and royalties.
These rates are enshrined in bilateral tax agreements with other countries. Lower rates would benefit not only foreign companies earning income here but also New Zealand firms investing abroad because of the reciprocity of the tax treaties.
"We are keen to renegotiate the whole double tax agreement with Australia," Cullen said, "but the Australians have made it clear that unless we were willing to move on non-resident withholding tax rates there would be only very minor changes."
PricewaterhouseCoopers tax partner Peter Boyce said the concession might be enough to induce the Australians to talk turkey about the mutual recognition of imputation/franking credits on dividends, long a sore point in transtasman tax relations.
Cullen estimated the revenue cost of introducing the active/passive distinction and the NRWT changes to be $100 million.
Boyce and KPMG tax partner John Cantin thought that estimate on the high side. But they welcomed the introduction of an active/passive distinction, which the tax community had been advocating since the present regime was mooted in the late 1980s.
Submissions on the discussion document are due by February 16.
What it means
The position now Fictitious New Zealand company NZ Co. has a manufacturing subsidiary in China which makes a profit of $100. Chinese tax law exempts foreign investors from tax in their first and second profitable years and imposes a 15 per cent tax rate in the third, fourth and fifth years.
But NZ Co. has to pay tax at 33 per cent of its global profits, so the IRD would take $33 in the first two years and $18 in the next three.
Under planned changes The Chinese subsidiary's income is not taxable in New Zealand.
NZ Co. gets to keep all $100 in the first two years, and $85 in the following three.
This puts it on the same footing as other foreign investors in China, and removes a reason for it to quit New Zealand.
