Tax issues outlook for 2004: a watershed year?
What’s in store for the managed funds industry from a tax perspective in 2004?
Wednesday, February 4th 2004, 10:45AM
What’s in store for the managed funds industry from a tax perspective in 2004?
It has all the signs of being a watershed year…with the potential for much angst and gnashing of teeth. Why? One need look no further than our pre-Christmas ‘gift’ from Santa’s little helpers in the IRD and Treasury, ie: the officials’ Issue Paper, “Taxation of Non-Controlled Offshore Investment in Equity”.
Prior to its release, the general expectation was that the Issues Paper would focus on dealing with government concerns over recent product developments (especially Australian unit trusts) which can give New Zealand investors the opportunity to derive returns completely free of New Zealand and offshore tax.
The Issues Paper does that and more: both responding to the suggestion by the Tax Review 2001 (McLeod Review) that the current basis for taxing offshore portfolio investment should be replaced by the risk-free return method (RFRM), and also proposing a further step towards the redundancy of the capital/revenue distinction for tax purposes by specifically targeting most New Zealand-based index tracking funds.
It is clear that the Government wants to act quickly, with the seven week time frame for submissions supporting an underlying objective of having a new regime operating by April 1, 2005. Such speed for such significant and fundamental change should be of concern.
It should come as no surprise that the Government must now want to move quickly to protect its tax revenue position from the risk posed by largely Australian and UK-based investment products which can enable many (and in practice most) investors to earn returns without paying tax anywhere. However this risk is not new and while new products pushed the boundaries last year, proposing hasty and fundamental regime change seems like overkill – particularly in circumstances where there seems to be no clear consensus between the industry and officials (or even within those respective groups).
It is not as if the Government has not got at its disposal relatively straightforward mechanisms under existing rules to deal with the risks posed by these latest product developments. If the objective was to do no more than stifle certain product types, surely removing their ‘grey-list’ status under the current FIF regime is one option worth considering – especially if such a step is only a short-term fix pending more fundamental reform. The Issues Paper gives short shift to the prospect of using such existing tools: dismissing them because they “would not…be easy to do”. Without the benefit of any further explanation, it is hard to believe that such measures, especially in the role of mere stopgaps, can be more difficult to implement than deciding on and then constructing any of the rather radical alternatives put forward in the Issues Paper. Can it be in anyone’s interests to compromise the evaluation and design of any major reforms in this area simply to expedite a change to deal with what is, in the scheme of things, a relatively minor problem?
Of course, the proposals put forward in the Issues Paper cannot simply be wished away. Even if one agrees with its existence, the FIF regime is not beyond criticism. Also, and often overlooked, are the problems caused by shortcomings in how well the legislation is enforced – in particular policing the capital/revenue boundary outside a commercial context. What is hard to deny is that there has been for some time, and remains, widespread frustration with the manner and inconsistency with which investments and investors are taxed (a useful summary is contained in Chapter Seven of the Retirement Income Report of the PGR 2003). Major change is needed.
All stakeholders (investors, the funds management industry, officials, and Government) need to face up to agreeing on a consistent framework within which to evaluate the alternatives. The Issues Paper does not progress this one bit but is an interesting illustration of how different frameworks will almost inevitably lead to quite different outcomes. The IRD, for example, is probably most concerned with investors’ ability to ‘roll up’ income in offshore investments thus deferring (at least) any tax liability. One might speculate that the IRD’s eye is turned by the RFRM-variant ‘standard return rule’ described in Chapter Six of the Issues Paper. Treasury, in contrast, might be attracted to ensuring New Zealand’s total tax take on the investments of its residents is the same irrespective of whether those investments are in New Zealand or offshore (the so called ‘residence’ principle). Treasury might then support an extension of the FIF regime to all offshore investments (ie: removal of the grey-list), but with only a portion (70%) taxable to recognise taxation on a mark-to-market rather than realisation basis (ie: the “offshore portfolio investment rules” in Chapter Seven of the Issues Paper). By way of further contrast, if Appendix One to the Issues Paper fairly represents the industry’s issues and concerns, fund managers may be attracted to a basis of taxation which ensures investor’s own tax liabilities are the same irrespective of where (onshore or offshore) and how (direct or indirect, via unit trust or other), they invest. At the same time, the finance minister seems to remain interested in exploring the Tax-Exempt-Tax model, at least for superannuation and life insurance.
Three very different potential perspectives: three very different desired outcomes. Is this an irreconcilable problem? I certainly don’t think so. Of course, one cannot preclude, for example, the industry (in whole or part) being attracted to either the standard return rule or the offshore portfolio investment rules. Each of those options offers an improvement over the current position in certain respects: the standard return rule may involve a lower effective rate of taxation than the conventional actual/realisation basis, and the offshore portfolio investment rules would reduce the tax liability on what currently would be non-grey-list investments.
However, what is of concern is that despite years of attention, including many committees and working groups, it seems that we are still searching for a consistent and broadly agreed framework for approaching the taxation of investors and investments. Without that, we can’t really hope to get much of a consensus on specific regime changes.
Whether 2004 ends up being a turning point in making progress on one agreed framework depends partly on the Government’s willingness to not rush into further significant changes, and the industry speaking with one voice on articulating a position.
Of course 2004 isn’t just going to be about the potential for major changes to the taxation of offshore investments. Hopefully managed funds are going to have to deal with the good ‘problem’ of how and when to increase unit prices for their past tax losses which will become of value again as offshore markets recover. Happy (post-tax) investing!!
Paul Mersi
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