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Budget 2005: What do the tax changes mean for investment markets

Russell Investment Group examines the impact on tax changes announced in the Budget and asks if they are good.

Friday, May 20th 2005, 1:10AM

The government has proposed a new taxation regime for investments. Two changes in law scheduled to take effect April 1 2007:

  • Eliminate the tax on capital gains from NZ shares held in a pooled fund.
  • Apply a voluntary ‘flow-through’ regime to all pooled funds in New Zealand so investors pay tax on income at their own tax rate.

In addition, the Government has floated some ideas regarding tax on offshore shares:

  • Scrap the Grey List tax exemption. The Grey List is a list of seven countries where New Zealand investors receive preferential tax treatment.
  • Tax the returns on offshore shares based on changes in their value.

What will be their likely effects?

Based on the detail provided so far:
The overall tax that most investors pay on the total returns from New Zealand shares will be quite low. After-tax returns on former grey list shares will be considerably smaller, and all overseas share investments will have some or all of their capital gains taxed.

The tax system will bias investors away from offshore shares toward New Zealand shares.

Tax-exempt institutions will enjoy a greater range of fund choice. Lower rate taxpayers who invest in pooled funds will be better off.

Are these effects good?
The expected shift of share investments toward New Zealand would reduce the spread of investments, increasing risk. It could also flood the domestic share market, leading to distortions in share prices.

With respect to the objectives of the Stobo review, these changes address some ‘problems’ but create some others. The abolition of the grey list removes any geographic biases in offshore share investing but New Zealanders investing in offshore shares will pay more tax.

The tax treatment of capital gains on New Zealand shares in actively managed pooled funds will be at odds with that of actively managed direct investments. Capital gains from New Zealand shares will be tax-free for most investors, but some or all of the capital gains from offshore shares will be taxed.

Former tax exemptions for pooled funds domiciled in grey list countries will be eliminated, even for those that do not invest in shares.

This comment is provided by Russell Investment Group boss Ed Schuck.

« Budget 2005: First step, but detail to comeTask force releases options paper »

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