"Active income from the offshore operations of New Zealand companies may be exempted from domestic income tax to help them compete internationally," the Ministers explained.

The possible change was outlined in a discussion document released yesterday that seeks feedback on options for a major revamp of New Zealand’s international tax rules.

The Ministers continued:

"We are looking at a radical shift in our approach to taxing offshore income from our companies operating overseas, one that distinguishes between active income, such as manufacturing and industrial activity, and passive income, such as royalties and interest."

"Under such a distinction, offshore active income would be exempt from New Zealand tax, rather than taxed as it is earned, as happens now.

"The current rules may encourage New Zealand companies to relocate their headquarters to some countries where their offshore income is treated more favourably. Reducing the tax burden will improve their competitiveness and help to ensure New Zealand retains more activity," they added.

The ministers cited an example whereby a New Zealand-based company with operations in China would be able to take the same advantage of China’s tax holidays as companies from other countries. Under New Zealand’s current international tax rules, however, the company would pay tax at a 33% rate on such income.

Cullen and Dunne continued:

"We want to ensure New Zealand companies operating offshore with subsidiaries can obtain the same advantages in another country as their competitors."

"The tax rules of nearly all other countries distinguish between active and passive income, and either delay taxing offshore active income until dividends are paid or exempt it altogether, as Australia does."

"The rules can also create high compliance costs because they require New Zealand-based firms overseas to calculate their income tax in accordance with New Zealand tax rules, even though there may be little or no additional tax to pay here once they have paid foreign tax."

"Our tax system plays an important role in fostering a competitive business environment. That is why it is a key focus of the government’s Economic Transformation agenda."

The ministers said that new measures in this domain would bring New Zealand into line with most other OECD countries, while also reinforcing government efforts to improve the country's competitiveness as part of the wider Business Tax Review.

Also under consideration by the government is a possible reduction in non-resident withholding tax rates in the tax treaties that are negotiated with other countries. This is levied when a non-resident derives interest, royalties or dividends from New Zealand.

"Lower rates would help encourage inward investment and would also benefit New Zealand firms investing offshore because reciprocal arrangements could apply as tax treaties were renegotiated," said the ministers.

However, they added that if the government proceeded with improvements to the offshore tax regime, then it would be necessary to also introduce "protection measures" to ensure that only offshore active income is exempted.

"For example, if active foreign income becomes exempt from New Zealand tax, we would need to ensure that excessive interest is not deducted from New Zealand earned income," they stated.

Submissions are due by 16 February 2007, and the government expects to be in a position to make decisions by the middle of next year, the ministers concluded.