Proposed tax changes will make people poorer in retirement

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Diversified Investment Strategies' Norman Stacey has written a paper evaluating the proposed tax changes to managed funds. The paper is so good we are reproducing it here. Also the paper clearly outlines how the changes will work against investors.

Friday, July 8th 2005, 6:55AM

The government’s intention to change the taxation of investor’s returns was announced by Minister of Revenue Michael Culen in his budget speech this year. The follow-up media release on June 28 is mild, but the simultaneous, lengthy ‘discussion document’ released by the IRD's, Policy Advice Division reveals advanced planning for a serious new distortion and tax-grab from investors.

If successful, the plan will result in significantly dimmer prospects for private portfolios beyond the April Fool’s Day, 2007 start date. Important changes proposed are:

1. Government’s plan is to introduce a comprehensive new capital gains tax on the offshore components of an investor’s portfolio.
2. New Zealand’s onerous Foreign Investment Fund (FIF) regime will extend to traditionally friendlier and more familiar jurisdictions, including Australia. A portfolio’s offshore holdings – cash deposits, property, shares or funds – will be fully assessable on any increase in price, converted to NZ$, and irrespective of actual trades if any or the investor’s purpose.
3. The new tax will be on accrued gains, measured yearly and at the investor’s full marginal rate (usually 39%). No deduction will be allowed for taxes already paid by offshore companies or on offshore investments at source.
4. The previously favoured, ‘grey list’ of seven investment jurisdictions (Australia, Canada, Germany, Japan, Norway, United Kingdom, and the USA) – previously deemed to have rules, regulation and tax-levels roughly similar to New Zealand - will be extinguished. Imposition of double taxation will have the effect of making jurisdictions that are more respectable less competitive than investments in less regulated and lower-taxed regimes, or in dodgy tax havens.
5. For private portfolios, investing into New Zealand assets will remain as current – provided the holder is not a trader. Local fund managers will have won a major concession. They alone will be able to trade locally without incurring tax, provided they set up new vehicles (called ‘QCIV’s).
6. QCIV’s will have the flexibility to withhold tax at investors’ marginal tax rates.

Effects will include:

a) New Zealand will switch overnight from having a competitive and efficient regime for private client portfolio investors to operate from, to an unattractive place in which to hold offshore investments, with probably the most punitive tax regime anywhere.

b) Portfolio gains from the offshore components of portfolios will be up to 39% less, while additional accounting, transacting to realize cash for taxes, banking and tax filing will incur costs.

c) New Zealand assets, including property and shares in New Zealand-domiciled companies may be re-priced by dint of their tax advantage, but only alluring for investors while capital gains are sustained. Income yields may eventually be lower.

d) Those fund managers deciding to set up new “Qualifying Collective Investment Vehicles” will be able to exploit tax-free trading gains in the New Zealand markets. QCIV’s may be able to stag new issues of NZ shares, or ‘wash trade’ taxable dividends into tax-free capital gains.

e) Increased value of offshore holdings caused by depreciation of our heady New Zealand dollar will become taxable. Either portfolio diversification costs will be considerably higher, or country risk management will be compromised.

f) Private clients will need to respond to new, optimal asset allocations. Trustee will need to reassess what earlier constituted a prudent approach to investing. To suffer double taxation on offshore holdings, versus venturing into less savoury domiciles will need to be weighed.

g) Avoidance and emigration industries will receive a boost.

Diversified’s View:
Diversified’s considered view is that the proposed changes will significantly reduce efficiency of private provisioning for retirement via New Zealand investment portfolio.

Wealth owned will be lesser in the long term, due to the additional taxes levied on investors, and by discouragement of potential savers by low net returns legally achievable and by the additional requirements of filing and remitting taxes.

Creating a tax-driven incentive to favour investing in New Zealand assets, and a disincentive for normal international diversification, constitutes a new and major distortion of optimal investment allocation.

Investors successfully coerced into favouring New Zealand assets at the expense of international diversification, are likely to have lesser net worth at retirement than may otherwise have been achieved, due to the restricted range of opportunities available locally, and New Zealand’s lower sustainable growth rate, than elsewhere.

The supposition that investors will be encouraged to use local fund managers because of a slight tax advantage, may not reach the levels expected. Additional tiers of fees and costs, poor performance, poor transparency and limited variety of local offerings, especially to access international investment opportunities, will persist as impediments.

Further, prior tax advantages have demonstrated the fund managers themselves capture a portion of the tax savings, in the form of higher fees.

The Minister of Revenue’s Media Statement of June 28 is disingenuous. The rules are not ‘fairer’. The IRD’s 75-page ‘discussion document’, reveals the full agenda.

Make no mistake; this is a new tax grab, relegating individual well-being behind government’s ‘national welfare maximization’, and ‘world welfare maximization’ considerations [Italicised phrases from the discussion document].

The IRD Policy Advice Division’s, ideology-driven tome matches its’ peculiar view of commerce and wealth creation, with an endearing naivety of the tax loopholes it is inadvertently creating.

What you can do?

1. Do not be misled by the media statement’s spin. These are far-reaching changes. Refer to the tedious and ideological government discussion document from IRD, available on: http://www.taxpolicy.ird.govt.nz/publications/files/html/invincome/index.html - all 75 pages of it.
2. Make submission to:
1. By Mail to: Taxation of Investment Income C/o The Deputy Commissioner - Policy Advice Division Inland Revenue Department PO Box 2198, Wellington Or
2. By email to: policy.webmaster@ird.govt.nz Putting “Taxation of Investment Income” in the subject line of electronic submissions;
3. Send a copy to: John Key john.key@national.org.nz
3. Keep your passport current to visit our future graduates.

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