Ask not what the country can do for investors...
An IRD discussion paper suggests investment tax should produce the best return for the country - not what's best for investment.
Michael Coote in the NBR, 8 July 2005
Submissions are invited by a post-election deadline of September 30 for Inland Revenue's 71-page weightily entitled discussion paper, "Taxation of investment income: the treatment of collective investment vehicles and offshore portfolio investment in shares".
The odd bits the government actually wants our opinion on are highlighted in the text - in case anyone gets carried away over non-negotiables.
The authors have had to steer a tortuous dialectical route betwixt the Scylla of the Stobo Report, which preceded the paper as a scoping exercise, and the Charybdis of the present hotch-potch of arbitrary rules.
The funds-management industry has long complained that New Zealand collective investment vehicles (CIVs) suffer tax disadvantages when compared with direct investment and tax-minimising foreign-managed funds, not to mention rental property.
The compromise regime offered in the discussion document gives the appearance of one curate's egg being substituted for another, except that the second is meant to be better in parts.
In chapter 4 we learn that tax neutrality is an objective but only in a highly conditional way. What is meant is neutrality between investing in New Zealand shares directly or through a qualifying CIV.
Otherwise, there is a noticeable lack of neutrality. In particular, the paper is not written to address tax neutrality for DIY landlords versus collectivised shareholders.
Moreover, as widely noted, neutrality would break down between a New Zealand sharemarket fund and a fund investing abroad. A comparative value taxation method is proposed, whereby all overseas-invested CIVs would be subject to an omnivorously extended foreign investment fund (FIF) taxation regime. Tax-driven investing would then prefer New Zealand equities over "fiffed" CIFs.
In addition, relative to local equity, funds invested in debt instruments that were repackaged as equity for tax purposes, or which used derivatives to diminish equity risk, would be disadvantaged.
Internationally, certain FIFs will be advantaged over others provided they invest in "companies that are listed on a recognised exchange in a country with which New Zealand has a double taxation agreement".
The philosophical guts of the paper are to be found in chapter 5 from the section "Economic and policy issues" onward. On the face of it, this is a demonstration of how anything can be proved with numbers.
The games begin with table I (p51), in which it is deduced that a domestic investment with a pre-tax 10% return and 33% New Zealand tax will yield 6.7% for the investor and 10% all-up return to New Zealand, whereas a foreign return of 12% and 33% foreign tax, but exempt tax in New Zealand, will produce 8% return to both the investor and our country.
This jiggery-pokery is supposed to prove that "the investor would choose the foreign investment because it yields the higher return to the individual (8%). However, New Zealand as a whole would be better off if the investment were made domestically."
The gaffe is blown on the whole thrust of the paper in the implication that what produces the best return to New Zealand - and not to the investor - is what should dominate investment taxation policy.
The gist of 71 pages is thus summed up in two sentences. Tax paid abroad is dismissed as "simply another expense of the foreign company ... such as wages or rent", whereas tax paid here is a lofty social duty.
Unfortunately, if table I's two initial pre-tax returns are set at the same number - either 10% or 12% - the example gives equal returns to the investor and therefore a matter of indifference in respect of choice unless tax treatment is skewed to favour domestic investment.
Perhaps the authors assume readers are too stupid to recognise crude manipulation. Things go downhill from there in terms of the paper's already dubious argument.
In the convoluted section that follows, the paper is concerned to distinguish "national welfare maximisation" from "world welfare maximisation" in order to justify giving the "national interest" (defined as the post-foreign tax and pre-domestic tax return) priority over the "world interest" (pre-tax return).
These angels share the head of a pin with the "investor's interest" (the post-tax return), which is an entity to be aligned with the national interest but not the world interest.
It probably helps to have a PhD in mediaeval scholastic philosophy to make sense of this sophistry but most intelligent taxpayers should be alerted to submit away with a vengeance, unless they are betting that when wearing their voters' hats they will cut a long story short more effectually.
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