Tax Advisers - Deloitte

New Zealand
The new tax paradigm... beat
the rate
Teresa Farac
Deloitte
Auckland
Thomas Pippos
Deloitte
Wellington
New Zealand’s tax regime has been predicated on being fair
and free from distortions. To minimize those distortions
regarding the taxation of foreign portfolio investment (FPI),
a new tax regime, known as the Fair Dividend Rate (FDR),
is being introduced. Once it is finally approved by
Parliament, the FDR would be effective from April 1 2007.
Current rules result in material tax distortions for FPI as
between direct and indirect (via a fund) investment, and
between investment in and outside of certain jurisdictions,
known as the grey list. The grey list includes many of New
Zealand’s traditional trading partners that have a robust tax
base, including Australia, Canada, Germany, Japan, Norway,
the UK and the US. Within a grey list jurisdiction, FPI is
generally taxed only on dividends.
Outside the grey list jurisdictions, FPI is generally taxed on
an unrealised mark-to-market basis, which goes further than
clawing back any tax preferences that may be enjoyed, and is
difficult to reconcile with the general premise of no capital
gains tax. The distortion is compounded in a managed funds
context where, due to their scale and pattern of activity, funds
are generally viewed as holding all investments, including
FPI, on revenue account. The main exclusion is passive
tracking funds.
A simple solution would be to extend the grey list to more
countries with robust tax systems and to remove the
investment bias between direct investment and investment
through funds by taxing funds only on dividend income.
According to the government, however, this would not be fair in that not enough
income would flow back into the tax base.
The main features of the proposed regime include:
• no grey list for FPI;
• FPI, other than investment into Australian tax-resident listed companies, would be
subject to an FDR method;
• Australian FPI not subject to FDR and equity investments in New Zealand would
no longer be treated as being held on revenue account; and
• the initial FDR rate would be 5%. Individuals and family trusts can reduce its
impact in certain cases.
In short, the FDR methodology taxes investors at a flat level of gross income
calculated at 5% of the market value of investments held at the beginning of the tax
year. Nuances include:
• no ability to recognise and carry forward investment losses;
• individuals and family trusts could pay tax at a lower rate if they undertake complex
calculations to establish that their economic income is less than the 5% rate. The
expectation is that for them their effective FDR will be around 3.5%;
• managed funds would need to calculate the 5% gross income on a daily rather than
annual basis; and
• investments without a readily available market value would have notional income
calculated at 5% of the cost, with the cost compounding by 5% annually with
limited options to review to a true market value.
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