18 September 2006
Jo Doolan
Tax Director, Ernst & Young Ltd
Replacing capital gains tax with wealth tax unlikely to appease investors
A ray of hope has been offered to offshore portfolio investors amidst a week of gutter politics. Yet Ernst & Young Tax Director Jo Doolan is concerned the new proposal is “rather murky”with lots of uncertainty as to how it will
actually apply.
The proposal is to impose tax based on a deemed rather than actual return of 5%. So regardless of what you earn you pay
tax based on 5% of the market value of your investment at the beginning of the year. Individuals do not pay tax if they
can prove they have lost money in a particular year.
The Ministers of Finance and Revenue were at pains to stress that the capital gains element is removed under these
proposals. Based on the example given if individuals want to prove they made a return of less of than 5 percent then the
capital gain is taken into account.
To quote from the example in the Ministers’press release: “Where an individual makes a total return of less than 5 per
cent is illustrated by Mary who also holds offshore shares that have a market value of $100,000 at the start of the
year. These shares increase in value to $102,000 at the end of the year. Mary also receives a $1,000 dividend. Mary
would pay tax on 5 per cent of $100,000 (her opening value) unless she can show that she made a return of less than
this. Mary's total return for the year is $3,000 (comprised of a capital gain of $2,000 and a dividend of $1,000), which
is less than 5 per cent of her opening value of $100,000. Therefore, Mary would only be taxable on $3,000.”
Jo Doolan says this still represents a form of capital gain tax. “The latest proposals create an illusionary basis of
taxation, usually called a wealth tax, that only seems okay if you view them through 3D glasses,” she says.
“Uncertainty exists for trusts and other entities and where for example bonus and cash issues are made during the year.
It is not clear whether foreign tax credits will be allowed and whether the rules change if someone is a share trader.
Jo Doolan explains why the changes are needed: “The current system of taxing offshore portfolio gains was devised long
ago as part of taxing all offshore investments. Part of these changes included an initiative to reduce compliance costs
by exempting from tax share investments in countries that found their way onto a “good” list, called the grey list. To
be on the grey list countries needed to have a similar tax system to New Zealand and similar tax rates. If you invested
in these countries then you did not pay tax in New Zealand because if was a fair assumption the tax had been paid in the
offshore country,” Jo explains. “Like many forms of taxation, the system was exploited and change was clearly required.”
“We have since been treated to endless proposals and discussions on ways to change the system. Beneficial changes to the
domestic rules were coupled with proposed changes to the foreign rules in the hope negative changes would slip through,”
says Jo.
The proposed changes were complex and included taxing unrealised offshore changes, says Jo.
“Investors flooded the Finance and Expenditure committee with an unprecedented number of submissions who, under the
chairmanship of Shane Jones, have the invidious task of trying to calm the furor. Most were happy to articulate their
opposition to the proposals but solutions were thin on the ground.”
In the latest development the Ministers of Revenue and Finance said in their joint statement: taxing a deemed return
rather than a real return is to ensure greater fairness, and helps fund hospitals, schools, roads and other government
services.
“If this amended version of a risk-free return is adopted does this mean investment advisors will be changing their
advice to only invest in NZ blue chips and go for the high risk high return investments off shore?” Jo asks. “We may
have the final solution, but adopting an illusionary system of taxing made up gains rather than actual gains is more
akin to a wealth tax rather than fair and equitable.”
“My preference is let the status quo remain in place and hit those that rort the system under the anti avoidance
rules,”says Jo Doolan.
ENDS