What Cullen said about Australian unit trusts
Finance minister Micheal Cullen, in an address to chartered accountants, outlines his problems with tax-efficient Australian unit trusts.
Wednesday, August 6th 2003, 9:17PM
I shall now turn briefly to an issue that has been attracting media attention. It concerns investment products aimed at New Zealand investors that claim virtually to remove any tax being paid on the resulting income.As I understand it, the arrangement works something like this. A New Zealand resident purchases units in an Australian unit trust, and the unit trust uses those funds to buy – for example – New Zealand Government bonds.
Interest from the bonds is paid to the Australian unit trust, with only a 2% levy deducted. Because Australia, unlike New Zealand, taxes the entity as a trust, rather than as a company, the interest is not taxed in Australia under Australian tax rules because it is not sourced in Australia and does not relate to an Australian beneficiary.
The unit trust distributes its income by way of non-taxable bonus issues so that the New Zealand investor ends up with more units. Given the way New Zealand and Australian tax law inter-relates, no New Zealand or Australian tax is payable at this stage.
Gains that New Zealand residents derive from the eventual sale of their units may, however, be taxable, depending on whether the investment was held on capital or revenue account.
The answer to this question will vary depending on the specific facts and, in particular, on the purpose for which the investor acquired the original investment.
I am not a tax expert but it seems to me to be a mighty effort to argue that shares or units with no realistic dividend yield were purchased otherwise than for the purpose of sale. That would make all the gains taxable. I note that a few tax experts have also raised this warning.
Regardless of the intricacies of the capital versus revenue law, the main point is that New Zealanders may be able to derive interest from New Zealand Government bonds virtually tax-free if they invest through one of these Australian unit trust structures. An identical investment through a New Zealand vehicle would be clearly subject to New Zealand tax.
From the Government’s perspective this is unacceptable and, if necessary, we will change the law to ensure that this option is not available.
As a first step, October will see the release for consultation of an issues paper that will raise options to deal with this problem and other issues that arise under the foreign investment fund rules.
One of the options canvassed will be a version of the McLeod Review’s risk-free rate of return method.
The lesson of the last 40-years is that loopholes are not in anybody’s interest. They distort the flow of funds and to the extent that they are effective in eroding the tax base they simply increase the pressure on the tax rate in other parts of the system.
This is an extract from a speech Finance Minister Michael Cullen (actually delivered by Associate Revenue minister David Cunliffe) made to the Institute of Chartered Accountants in Auckland.
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