25 May 2006

Minister of Revenue: Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill First Reading

I move that the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill be now read a first time.

I shall be recommending later that the bill be referred to the Finance and Expenditure Committee for consideration.

The central feature of the bill is a wide-ranging reform of the taxation of income from share investments ? whether through New Zealand ? based managed funds or direct investment.

To understand the reform, it is necessary to look at the wider picture of how that investment income is taxed now, and what is wrong with the way it is being taxed now. To look at only part of the picture, at a small corner of the picture, is to miss the rationale, the shape and the sense of the reform.

The current tax rules on share investment operate very unevenly. They overtax some investors, they favour direct investment by individuals over investment through funds, and they favour investment in some countries over investment in others.

What the bill does is place the tax treatment of different types of share investment on an equal footing, to introduce greater fairness into the rules and reduce distortions that they create.

>From next year, people who invest in New Zealand-based managed funds will see greater fairness in the way their investment income is taxed. The new rules will remove several tax disadvantages for people who invest through managed funds, many of whom are ordinary, middle-income savers.

And with the expected introduction of KiwiSaver from next year, many more will join their ranks.

One of the key improvements in the taxation of income from New Zealand based managed funds is that lower income investors, whose investment income is currently over-taxed at 33%, will be taxed at their correct rate. Those whose tax rate is 39% will continue to have their savings through funds taxed at 33%.

The other key improvement is that capital gains on New Zealand and Australian shares held via a New Zealand based managed fund will no longer be taxed. This will increase the gains for people who invest in this way, and put them on an equal tax footing with direct investors into New Zealand and Australian shares.

The current tax rules on offshore investment in shares are riddled with inconsistencies, with the result that some investors pay less tax than others who have similar investments.

Under the current rules, individuals who invest in shares in companies based in one of eight so-called "grey list" countries ? such as the US and the UK ? pay little or no tax in New Zealand on their investment income. The simple reason is that companies in those countries usually pay low or no dividends on which investors can be taxed.

On the other hand, the same investment made through a New Zealand managed fund will typically be taxed on 100 percent of realised capital gains. The proposed rules will generally align the tax treatment of "grey list" investment done directly and through managed funds.

Another huge inconsistency in the way offshore share investments are currently taxed is that direct investors in shares in companies in the remaining countries ? countries such as Singapore, India and Korea ? have a much higher tax burden. They must pay tax, in New Zealand, on 100 percent of the increase in the value of their shares each year.

That group of direct investors will be better off under the new rules because, unless their dividends are higher, they ? together with all other direct investors in offshore shares ? will pay tax on 5% of the opening value of their shares in most years, limited to 85% of any gain they make.

Most individuals who hold overseas shares outside Australia will not be affected by these changes because those whose shares cost less than $50,000 will be exempted. That threshold of $50,000 for each individual obviously means that a couple could easily hold between them shares costing up to $100,000 without being affected.

However, direct investors with share portfolios above the threshold levels in countries that are favoured by the current tax rules will be affected.

The proposed changes to the taxation of investment in offshore shares have a clear policy basis: if you live in New Zealand you are expected to contribute to New Zealand by paying tax here on your income, wherever it comes from.

That principle should apply to all, regardless of the country they invest into.

Investments in Australian-resident listed companies will continue to be taxed as at present, which is mainly on dividends because they pay out a high proportion of their earnings as dividends, that being encouraged by both the Australian and New Zealand tax systems. There is also the factor of the closer economic relationship between Australia and New Zealand, as well as the move towards a single market for the purposes of investment.

Recent weeks have seen a lot of misinformation about the proposed changes being directed at people who hold overseas shares, resulting in a lot of ill-founded concern on the part of people who, in many cases, will not be adversely affected by the changes in the bill.

To allay that concern, I announced last week that I would bring an amendment to this bill that would grant a five-year holiday from the new rules for overseas portfolio investments in shares in certain types of widely held foreign companies that have a substantial New Zealand shareholder base.

That holiday is intended to give those companies time to consider shifting their headquarters to New Zealand, which would bring considerable benefits to New Zealand, and for the government to complete its review of the controlled foreign company rules. The amendment will be effected by way of Supplementary Order Paper to this bill.

The reform of the tax rules is very complex. It is complex because it deals with a very wide and complex area of investment activity covered by complex tax rules. For this reason I ask members to consider the proposed reform in its entirety, keeping in mind that it is aimed at achieving a coherent and balanced tax treatment of New Zealanders' investment income.

These new rules have been developed after a lengthy consultation process, from the release of the discussion document nearly a year ago, and the over 800 submissions it attracted, through to more consultation earlier this year before decisions were made.

Now the select committee will have the opportunity to hear evidence on the proposals and to recommend any changes it considers appropriate, and I will await its deliberations with interest.

The bill also makes important amendments to the tax rules in several other areas.

It introduces changes to ensure that employer superannuation contributions are taxed at about the right marginal tax rate for individual employees. The changes are designed to minimise the potential for taxpayers to use excessive "salary sacrifice" as a means of paying less tax. That practice involves reducing salary heavily in exchange for corresponding increases in employer superannuation contributions, to take advantage of lower tax rates.

While the government obviously wants to encourage people to save for retirement, excessive salary sacrifice, merely to reduce income tax, is unfair and against the policy intent of the law, which is to ensure fair taxation.

The bill introduces changes to the foreign investment fund rules that will resolve tax compliance problems for people in New Zealand who have interests in Australian superannuation schemes. The changes will also remove disincentives for skilled people who have an interest in an Australian super scheme to come to work in New Zealand on a long-term basis.

The bill makes changes to the tax treatment of expenditure on geothermal wells to remove uncertainty about the deductibility of capital losses arising from failed wells drilled in New Zealand. It allows vendors of patent rights to spread income from sales evenly over three years, thus alleviating potential cash-flow problems that could constitute a barrier to investment in research and technology.

A further change will assist Inland Revenue in its investigation of tax evasion and avoidance schemes by allowing the department to remove documents for inspection.

Finally, the bill sets the income tax rates that will apply for the 2006-07 tax year.

These are some of the many changes introduced in this omnibus taxation bill. They and other proposed changes are described in detail in the separate commentary on the bill, which has been distributed to members of this House.

I commend the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill to the House.

ENDS

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