Risk free rate proposal may progress

A discussion document on the “risk free rate of return” is expected from the Inland Revenue Department within the next couple of months.

Thursday, October 9th 2003, 10:13AM

by Rob Hosking

A discussion document on the “risk free rate of return” is expected from the Inland Revenue Department within the next couple of months.

The proposal, put up as a way of taxing investments offshore, was included in the McLeod Tax Review in 2001. Finance Minister Michael Cullen’s office yesterday indicated he is still “somewhat agnostic” on the RFRM method but believes it is worth looking at.

Preliminary work by the Treasury suggests that if the method was adopted the government would rake in more money than under the current regime - about $20 million more, according to this year’s Budget tables.

The method would replace the current FIF regime and cut through the issue of “grey list” and “non-grey list” countries.

Investors’ tax liability is calculated by taking the value of the investment at the beginning of the year and multiplying it by the “risk free rate” - set at the current government bond rate - and adjusting for inflation.

The issue for investors is likely to be that if their investment makes a loss they will still have to cough up the same amount in tax as they would if it made a high return.

Some analysts have also warned there could be distortionary effects of the tax - investors would opt for firms which have a high dividend policy.

There has also been a fear that the policy would eventually be applied to all investments, not just offshore ones, although Dr Cullen has repeatedly denied that the government has this in mind.

Cullen is to make a major speech on tax issues tomorrow. It is not known whether there will be any further signalling of intentions with regard to the RFRM method: however it appears likely there will be new announcements on tax relief in other areas. Earlier this year he indicated that if the high government surpluses continued there were four priorities for tax relief. These included both the tax treatment of savings and of venture capital.

Rob Hosking is a Wellington-based freelance writer specialising in political, economic and IT related issues.

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