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Towards Consensus on the
Taxation of Investment Income
Craig Stobo
Outline of presentation
• Background• Downside from no consensus• Opportunity now• History and context• The financial system is vital for growth• Objectives of the project• Outside the scope• Project timeline and process• Policy Objectives – offshore and onshore• Policy Objective – taxation of investment
income onshore• Policy Objective – minimising effects of
boundaries in tax rules • Potential options for reform• Questions and Discussion• Feedback
Background
• Ministerial interest• Positive fiscal position• Consensus building
opportunity
Downside from no consensus
• No obvious subsequent process for going forward
• “Band-aid” legislation inevitably continues
• Migration to offshore vehicles continues
Opportunity now
• Interested in your view of the pros and cons of the options presented
History and context
• McCaw Tax Review (1982)– Criticised high rate, narrow base
– Base broadening leads to the TTE model (tax, tax, exempt)
• Valabh Committee (early 1990s)– Proposed capital gains tax (shelved)
• TOLIS (Taxation of life insurance and superannuation fund savings 1997) – Proposed alignment of
investor/vehicle rates
– Shelved for political / fiscal reasons
History and context ctd• McLeod Tax Review (2001)
– NZ tax system fundamentally sound– Rationalise entity specific rules– Consider taxing investment entities
under RFRM• Taxation of offshore portfolio investment
as test/first step
• Officials’ Issues Paper (2003)– Taxation of non-controlled offshore
investment in equity– Options to fix grey list:
• Standard Return • Comparative value @ 70%
– Onshore RFRM option mooted• Result: consider offshore and onshore
together
History and context ctd
• Australian Unit Trusts (2004) – addressed immediately due to delay in consideration of offshore
• Towards Consensus on the Taxation of Investment Income (2004)– Offshore and onshore issues
considered together
– Report on pros and cons of broad options and recommendations on ways forward (October 2004)
The financial system is vital for growth
• Productive use of capital • Technological innovation• Information/monitoring = firm
governance and performance• Distortions can
disproportionately hurt certain types of investment
• Bottlenecks in an otherwise liquid system hurt growth
• Tax is misallocating investment in managed funds
Objectives of the project
• Consistency between direct and indirect portfolio investment
• Consistency within indirect• Options should:
– Protect the integrity of the tax base
– Minimise compliance costs for investors and the industry.
– Not penalise lower income savers
• Revenue neutrality not an objective in itself
Outside the scope
• The basic structure of tax laws outside the area of investment
• Capital gains tax• Owner-occupied housing • Treatment of debt instruments
under the accrual rules • TTE (tax/tax/exempt) model • Savings-related concessions
Project timeline and process
• Chair appointed – July• Consultation – August / Sept
– Large number of key stakeholders to be consulted
– Feedback sought
• Options finalised – Sept / Oct• Report developed for
submission to Government – late Oct
Policy Objective –onshore and offshore
• Onshore – tax entity as a proxy for the ultimate investor
• Offshore rules – objective is different– Cannot tax offshore entities
– Necessary to tax investor as proxy for entity
Policy Objective - taxation of investment income
onshore• Integration between entity* tax
and owner/investor tax– E.g. imputation avoiding double-
taxation
• Poor integration creates distortions– Investments, vehicles or
strategies may be chosen for tax purposes
* Entity = managed fund vehicle and/or ultimate investment
Policy Objective – minimising effects of
boundaries in tax rules
• Taxation of vehicles different from marginal rates and from each other
• Distortions arise from differences on
• Tax rates on earnings, or• Tax rates on distributions, or• Tax treatment generating timing
advantages• Example: SSCWT at 33% instead of 39%
Boundary examples
$100K $100K
$10K TCG$6.7K
NZ Investor 39% C/A NZ Super Fund R/A NZ Co
INVESTMENT VIA SUPER FUND
No claw-backon distribution
= $6.7k in pocket
IC – Imputation credits
C/A – capital A/C
R/A – revenue A/C
TCG – taxable capital gain
NTCG – non-taxable capital gain
$100K $100K
$10K TCG$6.7K+3.3K ICs
NZ Investor 39% C/A NZ Unit Trust R/A NZ Co
INVESTMENT VIA UNIT TRUST
Dividend of $10K - 6% claw back = $6.1K in pocket
Policy Objective – minimising effects of
boundaries in tax rules ctd• Implicit capital gains tax on
managed funds– “Business” and “purpose” tests
– Intermediated investment can result in additional tax
– Active trading = tax & fees
Indirect inactive = no tax, fees
Direct inactive = no tax, no fees
– Tax creates a wedge against using knowledge of professionals
Boundary examples
NZ Investor 39 % C/A
$100K $100K
$10K TCG$6.7K+$3.3K ICs
NZ Unit Trust R/A NZ Co
INVESTMENT VIA UNIT TRUST
Dividend of $10K = $6.1K in pocket
$100K
NZ Co
$10K NTCG
NZ Investor 39% C/A
COMPLIANT DIRECT INVESTMENT ON C/A
= $10K in pocket
Policy Objective – minimising effects of
boundaries in tax rules ctd
• Preferences for investments in offshore vehicles – Stems from grey list
– NZ based funds are disadvantaged
Boundary examples
NZ Investor 39% C/A
NZ Managed Fund R/A Japan Co
$100K $100K
$10K TCG$6.7K NTCG
INVESTMENT VIA NZ VEHICLE
= $6.7K in pocket
UK Managed Fund Japan CoNZ Investor 39% C/A
$100K $100K
$10K NTCG$10K NTCG
INVESTMENT VIA GREY LIST VEHICLE
= $10K in pocket
Policy Objective – minimising effects of
boundaries in tax rules ctd
• Direct investment into grey list– Usually held on capital account
– Result: only dividends taxable
– Total tax and timing advantage
• Non-grey list investment – Taxable on accrued capital gains
Boundary examples
NZ Investor 39% C/A UK Co
$100K
$10K NTCG
COMPLIANT DIRECT INVESTMENT IN GREY LIST COUNTRY ON C/A
= $10K in pocket
NZ Investor 39% C/A French Co
$100K
$10K TCG
COMPLIANT DIRECT INVESTMENT IN NON GREY LIST COUNTRY ON C/A
= $6.1K in pocket
Potential options for reform
Income calculation
Onshore 1. Managed fund vehicle
tax rules
(a) Tax on managed fund vehicle with credit for tax paid
(b) Final tax at variable rates
RFRM
Shift
capital-revenue
boundary
2. Flow through
(a) Withholding tax with wash up
(b) Withholding at variable rates
RFRM
Shift
capital-revenue
boundary
Offshore RFRM or Standard
Return
Comparative
Value
Questions and Discussion
• Do you agree with the objectives of the project?
• Do you agree with our identification of the boundaries with current tax rules?
• Do you agree that these boundaries distort investment behaviour?
• What do you think of the options presented – e.g. do they address the boundary issues identified / are they technically feasible?
• Do you have preferred options for tax reform?
• What do you consider are the pros / cons of your options for tax reform?
Questions and Discussion ctd
• Under an RFRM how would you set the rate onshore and offshore?
• What is the size of your funds / assets under management?
• Where is the boundary between portfolio and direct investment for managed fund vehicles?
• Do you provide for tax at 33% on realised and unrealised capital gains?
• How regularly do you turn over your portfolio (% per annum)?
Questions and Discussion ctd
• Does your business take advantage of tax effective vehicles, such as passive funds, AUTs, OIECs and wraps?
• Is the tax environment driving NZ fund managers offshore?
• Do you believe that FITB issues can be solved by tax reforms?
• What do you expect the impact of the reforms to be on product differentiation?
• Do you consider the impact on EMTRs for lower income savers in product design?
Feedback
• By 10 September
• Feedback to:– Darshana Elwela
– David Carrigan
