Cullen Moves To Close Circularity Tax Loophole

by Mary Swire, Tax-News.com, Hong Kong

08 August 2003

The government of New Zealand has surprised many this week with its haste to close a tax loophole known as circular investment, according to reports in the national media.

This was confirmed in an address to the Institute of Chartered Accountants given on Wednesday by Associate Revenue Minister David Cunliffe, on behalf of Finance Minister Michael Cullen. In the speech, he pledged to shut down Australian unit trusts which invest in New Zealand government stock and sell other investments claiming that they are free from New Zealand income tax.

These funds work by paying money into an Australian-based fund which pays no tax in New Zealand save a 2% 'approved user levy'. By taking New Zealand investors' money, funnelling it through an offshore trust and then reinvesting back in New Zealand, circularity is achieved. Returns can then be paid to local investors via annual issues of bonus units, which do not attract taxation when sold. However, the volume of transactions undertaken by a taxpayer must be infrequent enough not to attract the attention of the Inland Revenue Department.

"An identical investment through a New Zealand vehicle would be clearly subject to New Zealand tax," Dr Cullen observed, stating that such a situation is "unacceptable", and adding that: "if necessary, we will change the law to close the loophole." Dr Cullen announced that an issues paper will be released in October, for consultation on proposals pertaining to this and other associated foreign investment fund rules.

"The lesson of the last 40 years is that loopholes are not in anybody's interest. They distort the flow of funds and, to the extent that they are effective in eroding the tax base, they simply increase the pressure on the tax rate in other parts of the system," the Finance Minister announced.

Reacting to a possible change in the law, the National Business review wrote last week that: "The RFRM regime Cullen reportedly favours will certainly be a lot simpler but it looks likely to be just as distortionary. And the potential for regulatory creep into the rest of the tax system is positively terrifying."

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