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Capital gains tax to be outlined next week

Friday, June 24th 2005, 1:36AM 8 Comments

by Philip Macalister

Expect to see a huge brouhaha next week over tax - this time though it won't be about income tax cuts, but a discussion document proposing a capital gains tax on offshore managed funds.

The trigger for this will be a discussion document proposing that offshore-based funds are taxed under a comparative value method. The paper is being produced as the government has rejected the risk-free rate of return idea put forward last year by Craig Stobo.

Here's what's likely to be in the discussion document:

  • Tax all offshore-based funds on a comparative value basis
  • The tax rate will be on 100% on the change in comparative value of the funds
  • Abolition of the grey list
  • Have a threshold for individual investors. Investors below this level will be taxed only on dividends.

The big debate leading up to this discussion document has been about what level should the tax kick in at?

Since no one I have spoken to has come up with any compelling or consistent arguments to support a level of less than 100%. Don't be surprised if the paper suggests all the change in comparative value should be taxed.

Investors in domestic funds will be subject to a different approach. They will be treated on a flow-through basis and be taxed at their own marginal tax rate.

Such a move will create a huge home bias for investors - which apparently officials are comfortable with.

That's a really odd position to take when you think about the NZ Superannuation Fund. This fund is mandated to maximise returns without undue risk to the fund.

Its conclusion was that to achieve this objective it needed to invest the bulk of its money offshore into shares.

While the industry will be big in their opposition to this discussion paper, I understand that National Party leader, Don Brash, and finance spokesman John Key, are gearing up to go big on this too.

I wouldn't be surprised to see the changes to New Zealand based funds made by the due date, but changes to international funds pushed back.

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Comments from our readers

On 24 June 2005 at 7:58 am Jens Meder said:

While not commenting on the taxing proposals, at least until seeing more about them discussed, I would like to draw attention to this:

That the initial mandate for the NZSF to go for better profits abroad (which is different from investing abroad for a wider spread of diversification) - rather than for possibly lower earning rates at home - was not the best for the country's development and economic growth, which is arguably more important for future retirement welfare sustainability, than usually only marginally different earning rates, which are normally always only a fraction of the capital invested.

A million invested at home for say, needed infrastructure construction at 5% interest, creates far more wealth and earning power than a 20% return of the same capital from abroad.

If the new taxation proposals lead to more profitable investment at home, I cannot see how any New Zealander apart from the "get rich quicker myself" breed, can justify opposition? Jens.

On 24 June 2005 at 8:30 am Philip said:

Hi Jens

Thanks for the comments. I reckon what will be fascinating will be how the politicians handle this issue. I suspect the Nats will push the line that this is a government which wants to implement a capital gains tax. This will be a fairly emotive argument and potentially quite strong. After all no government in its right mind would go into an election proposing a capital gains tax.

On the other hand, Cullen will argue that this is not government policy, rather a paper from officials.

He will also note that closing date for submissions is October - after the election.

The government's most powerful argument will be this.

The changes, if implemented, will allow New Zealanders to help fund growth, infrastructure etc in their country. It's quite a strong, patriotic argument. One also which may resonate strongly with Kiwis.

In a funny way it's similar to what the Greens Rod Donald argues - invest locally not internationally.

On 25 June 2005 at 4:19 am Jens Meder said:

Hi Philip.

Indeed, I believe we've got a nation-building consensus in the making.

May I suggest it will be so much more exciting if incorporating the basics and goals of the "Ownership Society"? Jens.

On 29 June 2005 at 10:43 pm Wallis Keiller said:

Is the financial planning community aware yet that the proposed changes will see massive outflow of international equity funds and inflows to NZ residential housing? This is hardly the behaviour that should be encouraged for a small primary producing nation. We desperately need more investment offshore to hedge the risks in our own small economy. As for Jens Meders comments that a 5% return at home is better than a 20% offshore - absolute nonsense!

On 30 June 2005 at 10:39 am John Blackham said:

If what I have seen of the proposed legislation is correct it will deal a major blow to hitech (ICT & Bio) companies growing offshore.

For NZ hitech companies to grow they must go into offshore markets, for which they need the funding and market connections that US or UK VCs provide.

With this proposal, if a hitech company makes its US/UK entity its holding company and the value of the company goes from $10m to $20m in a year, the Kiwi shareholders would have to pay tax on $10m. Not only won't they have this (all their money will have been sunk into the company to grow it), but also with no liquid market for the company's shares (not being publicly traded on NASDAQ) they cannot even sell off any shares to pay the tax.

Not being able to become a US or UK entity will prevent a hitech company from;

a) getting investment from a US or UK VC - since they will not invest in companies in NZ.

b) selling to the US government - since we must be a US entity to do so.

Those who have set up in USA recently will be put in a terrible position unless there is a way to bypass the tax liability using a mechanism such as a trust, LLP or some other devious structure.

Assuming this goes ahead it means that the only option for NZ hitech exporting companies will be the Navman model of grow as large as you can in NZ then sell. Not a good recipe if we want to grow wealthy from large scale productive activity rather than investing in property.

On 30 June 2005 at 8:47 pm alan milton said:

Surely the proposed rules, if implemented, create a dilemma for financial planners and trustees who are charged with investing funds prudently, and diversification is recognised as part of this prudent process.

On 30 June 2005 at 9:47 pm Philip said:

I think you raise an interesting point Alan which hasn't been touched on too much in the discussion yet.

If the proposals go ahead New Zealand financial planners will be spending a lot more of their time on tax management issues, as opposed to investment issues.

I have argued for years that New Zealand has a better financial planning regime than Australia because our tax rules are relatively simple.

In Australia advisers get caught up in capital gains tax issues, rollovers and all sorts of other things which makes their job different to their cobbers on this side of the Tasman.

The one plus of this that it creates a reason for people to come and see a financial planner.

On 1 July 2005 at 1:21 am Jens Meder said:

Hi Wallis Keiller et al.

It is good to see this lively debate on taxation.

"Keep it simple", and avoiding tax management issues becoming more important than investment issues are sound principles not to be ignored.

For the security of diversification, a certain proportion of off-shore investment is sound and desirable.

And Wallis is right in that for an individual investor, a 20% return from abroad is indisputably better than a 5% return at home.

(But - this would seem to apply mostly to investors with expendable capital to spare, or for specific projects. Matter of fact, if a small island country is saturated with investment, any investment profitably abroad would be better than unprofitably at home, but we are not there yet. Here - starting from scratch - do not most of us prefer a substantial possibly mediocre investment in home ownership to a more risky and impersonal investment return from abroad, even if potentially more profitable? But let us say the answer to this is a matter of taste not necessarily on the basis of cash returns, and not argue about it.)

Howevwer - since the basic wealth creator is the PROFITABLY INVESTED RATE OF SAVINGS, with the return rate normally always only a fraction of the investment rate, THE NATIONAL ECONOMY BENEFITS QUICKER AND MORE FROM A HIGHER INVESTMENT RATE AT HOME, THAN FROM MARGINALLY HIGHER RETURN RATES OF THE SAME CAPITAL INVESTED ABROAD, creating most of the wealth there.

A million invested at home at 5%, with a labour content of say, half a million generates more taxable income than a 20% return from the same million from abroad. (0.5 million + 50 000, and whatever the investment created, versus just 200 000?) Right and relevant, or wrong and irrelevant, Wallis?

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