Tax changes must deliver a level playing field

Media Statement 27 September 2006

Tax changes must deliver a level playing field

The Property Council of New Zealand supports the Government’s initiative to encourage savings and investment in New Zealand with the proposed changes to investment income taxation. The changes are designed to standardise taxation treatment across the industry to create a level playing field between individuals and collective investment vehicles.

While the Property Council welcomes the inclusion of property investment vehicles in the proposed Portfolio Investment Entity (PIE) regime, changes to the Taxation (Annual Rates, Savings Investment and Miscellaneous) Provisions Bill are required in order to create an even-handed taxation regime. These changes are necessary if potential investors are to make choices on the relative merits of investment rather than taxation advantages and disadvantages.

Anthony Beverley, Chairperson of the Investments Policy Committee of the Property Council said if the bill was passed without amendment, it would knock-out the majority of property trusts from being able to elect into the proposed PIE regime.

“The Property Council is encouraged by the proposed introduction of the new PIE regime, which would enable investors to benefit from the new tax pass-through environment. However the bill contains current provisions that would in fact prevent the overwhelming majority of property trusts from electing into the PIE regime. Unless this situation is addressed, investors in property vehicles – including over 200,000 ‘mum and dad’ investors – stand to miss out on the benefits of the tax reforms available to other collective investment vehicles

“The barriers that prevent property trusts from electing into the PIE regime are not insurmountable. We have been working with Ministers, Members of Parliament and departmental officials to identify solutions to the barriers to entry. If minor changes are made to the bill, the barriers to entry will be removed and property trust investors will be able to enjoy the benefits of tax reform along with everyone else,” Mr Beverley said.

Key changes to the bill that are required to allow property trusts to elect into the PIE regime include –

1. the removal of the notional wind-up (deemed disposal) treatment of property funds. This change would remove the crystalisation of capital gains or depreciation claw-back tax that would otherwise arise under a notional windup treatment;

2. the removal of the requirement for property trusts to assess the number of days that each investor has been in the fund for each quarter. The requirement to calculate portfolio investment tax on a daily basis is impractical and should occur on a quarterly basis;

3. allowance for investment in property to be held via a special purpose subsidiary company, which is a widely held structure in the property industry;

4. raising the maximum investment threshold from 10 per cent to 20 per cent, with a grandfathering provision for those Trusts that currently have cornerstone shareholdings above this level. This amendment will discourage anti-competitive behaviour where a non-portfolio investor could effectively negate the tax status of a PIE entity simply by acquiring a greater than 10 per cent stake; and

5. allowance for managers of both listed and unlisted property trusts to hold investments in the trust, a feature that is common throughout the investment industry where investors push for managers to invest their own funds.

Daniel Newman, Policy Director of the Property Council said promoting a national culture of saving and improving income in retirement is an ongoing challenge confronting all New Zealanders.

“By amending the bill to enable property investment vehicles to elect into the proposed PIE regime, Parliament would significantly improve the ability of small investors in particular to improve their savings profile,” said Mr Newman.

As the present PIE proposal is that, as the PIE pays the tax, a foreign investor will not get credit for the underlying tax. The Property Council considers that the proposals need to be modified so that a non-resident investor has the ability to claim a tax credit in their home jurisdiction for tax paid in New Zealand on their share of the PIE income.

“Changes to the bill are necessary to ensure that foreign investment is not treated differently.

Foreign investment is necessary to ensure that property and infrastructure can be developed to meet the needs of current and future users. It is therefore necessary to remove provisions that would otherwise discriminate against that investment source,” Mr Newman said.

The property entities that have had direct input into the Property Council’s submission on the Taxation (Annual Rates, Savings Investment and Miscellaneous Provisions) Bill include: AMP Capital Investors; Dominion Funds; ING Property Trust; Kiwi Income Property Trust; and Macquarie Goodman.

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Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill

Questions and Answers – how to improve the investment return for small kiwi investors

What role do property funds play in generating personal wealth for small kiwi investors?

Over 200,000 New Zealanders (the majority of whom are small ‘mum and dad’ investors) invest in property investment vehicles. These vehicles take the form of unit trusts, investment syndicates and listed property vehicles.

By investing in property investment vehicles, New Zealanders have a stake in commercial property: a tangible investment in buildings and places that enable countless types of mercantile activity (retail, commerce, tertiary education, manufacturing, warehousing etc).

An investment in property funds can deliver a competitive financial return for investors. Commercial property has emerged as a lucrative form of investment in recent years.

What benefits can the proposed Portfolio Investment Entity (PIE) regime offer small kiwi investors?

The proposed PIE regime is effectively a tax pass-through regime. It would allow investors to be taxed at a marginal tax rate. If this outcome in achieved it potentially delivers investors an improved financial dividend in line with the Government’s objective of encouraging savings. However to achieve this outcome the investment vehicle first has to elect into the PIE regime.

What’s wrong with the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill in its current form?

Very simply, the Bill contains measures that prevent property investment vehicles from electing into the PIE regime. This is a major problem because it means more than 200,000 New Zealanders who have confidence in property funds would miss out on the benefits of the a tax pass-through regime.

The Property Council considers that the exclusion of property investment vehicles from the PIE regime is a result of drafting errors. We understand that the government intends that widely held (commercial) property investment vehicles are to be included in the proposed PIE regime.

The Property Council is seeking amendments to the Bill to enable property investment vehicles to elect into the PIE regime. In so doing we are seeking to achieve a level playing field. We are simply seeking the opportunity to have an equal chance to elect in. If we get that chance, it will be the small kiwi investors who will reap the benefit.

The Property Council will detail specific proposed changes in its submission on the Bill. We will present oral evidence to supplement the submission

What specific changes are needed to enable property investment vehicles to elect into the PIE regime?

There are at least five major issues that need to be addressed –

- Deemed disposal on election into the PIE regime

The Bill deems entities that have elected into the PIE regime have disposed (‘notional windup’) of their investments at market value.

On face value, a notional windup will have a major impact on most property investment vehicles in terms of tax crystallization. In most cases the cost of tax crystallisation would cost millions of dollars, which would prevent most funds from electing into the PIE regime.

The solution to this issue would be an amendment to remove the notional wind-up treatment of property funds.

- Calculating Portfolio Investment Tax

The Bill requires a listed property trust to assess the number of days that each investor has been in the fund for each quarter. Trusts listed in New Zealand have many thousands of investors and their shares are traded daily on the NZX. It is administratively impossible to assess the daily attribution of each individual unit holder.

The solution is to simply assess the tax liability based on the investor’s marginal tax rates, on a quarterly basis. The Property Council believes this solution would be revenue neutral for Crown.

- Portfolio Investment Entity Criteria – Investment-Out Requirements

The Bill prohibits the investment in property to be held via a special purpose subsidiary company, which is a widely held structure in the property industry.

The solution is a “look through” structure that takes account of the underlying assets. A “look through” structure still achieves the initial outcomes promoted in the Bill.

- Portfolio Investment Entity Criteria – Investment-In Requirements

The Bill requires that a portfolio (a PIE) needs a minimum of 20 investors, with no single investor holding greater than a 10 per cent equity share. However an investor holding greater than 10 per cent is a common feature in the listed property sector.

Investors rightly expect a portfolio manager to put his or her equity on the line (the principle being: “one alignment of interest”). This practice is encouraged by investors both in New Zealand and internationally.

If the investment maximum investment threshold remains at 10 per cent, this could encourage anti-competitive behaviour where a nonportfolio investor could effectively negate the tax status of a PIE entity simply by acquiring a greater than 10 per cent stake.

The solution is to raise the threshold to 20 per cent, ensuring consistency with the regulations currently in place through the NZX in relation to the takeovers code and NZX listing rules. This framework ensures the necessary protection of investor’s rights In addition a ‘grandfather’ provision should apply to current cornerstone shareholdings that exceed 20 per cent..

- Independent Management Requirement

The Bill means that that an entity cannot elect into the PIE regime if an investor has the power to influence the entity in the making or disposal of an investment. Common practice is for the manager of both listed and unlisted property trusts to hold investments in the trust. The key principle here is one of alignment of interest between manager and investor and is common across the investment industry.

The solution is to waive the independent management requirement for property trusts.

ENDS

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