New Zealand Investment Taxation To Remain Irrational?

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

05 November 2001

The voter-conscious New Zealand government may have turned tail and run on publication of the McLeod report on taxation last week, promptly denying any complicity in its conclusions, but in fact it can't escape some of the report's more basic implications, especially those dealing with the taxation of investment, which is crying out for reform.

The Government can't pretend it wasn't warned: the McLeod committee was given the task of thoroughly appraising the country's tax system, spent about a year and almost $1 million gathering submissions, published a paper outlining the main issues, gathered even more submissions, and only then produced a final report, which should not have been a surprise to ministers, unless they've spent the last year on a fishing trip.

The report recommends more consistency in the way investments are taxed. For instance, at present capital gains on shares are tax-free, yet unit trust investments in the same shares would be taxed at 33% on their income and gains. But this rule applies only to managed funds: the same investment in an index-tracking fund is untaxed.

As the McLeod committee's final report says: "A particular concern is the extent to which savings decisions seem to be dominated by tax considerations ... "

The committee's response is to suggest a new way of taxing some investments, based on the notion of a 'risk-free return' which would tax investments according the current return on Government stocks. Thus, if Government stock is returning 6%, and inflation for the year ahead is expected to be 2%, an investment would be assumed to earn 4%. An investor with $10,000 invested and on the 39% tax bracket, would pay $10,000 times 4% times 39%, which equals $156.

This basis would be rewarding for investors earning more than 4% return, but would be negative for those earning less - probably exactly the poor people the Government would wish to encourage to save more. Because of this problem, the McLeod committee said special rules might be needed to provide relief for cash-strapped taxpayers.

The McLeod system would also punish holders of capital-growth investments. International share trusts, for example, often produce next to no income even if they make good capital gains, so investors would have to pay their annual tax bill out of other income, or by selling a few of their units every year.

The McLeod committee recommended that the risk-free-return method should apply to "savings and investment entities", which would include things such as unit trusts, group investment funds and some life insurance and superannuation schemes. It also suggests applying the tax to investments in overseas investment funds listed on sharemarkets, as well as overseas unit trusts. In its interim report, the committee also recommended applying it to direct shareholdings and housing. But mixed reactions during the consultation phase persuaded the committee to back off the sacred cow of housing.

One can see that the political implications of the changes recommended would cause any Government to be a bit queasy, let alone one that's under fire. So perhaps after all it's no surprise that New Zealand's government has booted the issue into touch by referring it to the Treasury and Inland Revenue departments for more work, where it can be quietly buried.

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