Taxation Summary - part 3
This is part 3 of a series. Further summaries will be prepared as the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill progresses.
Parliament’s Finance and Expenditure Committee has now expressly rejected the 3% deemed rate of return method proposed by PwC and is still favouring the fair dividend rate (FDR) method in place of the now abandoned comparative value method.
The Committee released an interim report on 27 October in relation to the proposed FDR method. We can provide you with a copy of that report upon request.
Summary of the rules
In a nutshell, the FDR method taxes 5% of the
opening "market value" of offshore
share investments of less than 10% each year.
The de minimis exemption will continue to apply
to individuals who hold qualifying investments
costing less than NZ$50,000. Individual and family
trust investors are taxed on a lesser amount
if they can show that their actual return is
less than the 5% deemed return. An investor’s "actual
return" includes the annual gain in value,
dividends and net sale proceeds. If the actual
return exceeds the 5% deemed return (including
dividends), the investor is only taxed on the
5%.
The Commissioner of Inland Revenue will have
the power to identify specific debt-type investments
to which a comparative value method must be applied
in lieu of the proposed fair dividend rate. A
comparative value method must also be applied
to specific equity instruments with debt characteristics
(for example, fixed rate shares and redeemable
preference shares).
Recovery of investment amount
The FDR method taxes the opening market value
of a portfolio at the beginning of the year.
The original cost of the investment is not relevant
in determining whether or not tax is payable
in an income year. So, if an investment falls
in value in one year and increases in value the
next year, an investor could be taxed on the
gain in value in the second year. To this extent,
the method could, in effect, tax the recovery
of the investment amount. This is justified by
the Government on the basis that the method is
not a capital gains tax but seeks to tax a fair
deemed dividend return. A loss could be offset
against gains elsewhere in the portfolio since
a pooled approach rather than investment–by-investment
is being adopted as described below.
Deductibility of losses
Qualifying investments (those to which the FDR
method would apply*) are pooled for the purposes
of applying the FDR method. To this extent, gains
and losses in a portfolio are offset - only net
movements in value are relevant in applying the
method. However, negative movements in value
(i.e. losses) are not deductible for tax purposes.
Negative movements in value merely result in
no tax being payable. Again, this is justified
on the basis that the FDR method is not a capital
gains tax.
Dividends and RWT proxy regime
Dividends are not taxed separately. The total
amount payable is 5% of the market value at the
beginning of the income year irrespective of
the actual dividend return. Neither the interim
report nor the draft legislation attached to
it describes the relationship between the FDR
method and the RWT proxy rules. Deduction under
the RWT proxy rules could result in over taxation
of investors. If the relationship between the
regimes is not clarified before the introduction
of the rules, Australian fund managers may need
to cancel their RWT proxy facilities to avoid
over taxation.
Market value / cost method
Special rules apply in circumstances where investments
do not have a verifiable market value. Where
the market value cannot be determined, the investor
may apply the "cost method". Under
the cost method an investment is taxed at 5%
of cost. The cost base is increased by 5% each
income year for the purposes of applying the
method.
Submissions and kick-off
The Finance and Expenditure Committee intend to invite certain individuals and organisations to make submissions. The closing date for submissions is 9 November. We are in the process of finalising a further submission.
The 1 April 2007 application date for individuals
and family trusts remains unchanged. Managed
fund investors will not be required to apply
the new rules until 1 October 2007.
*Offshore portfolio investments which do not qualify for the FDR method would broadly be defined as those which have an effectively non-contingent obligation, directly or through an arrangement, to return an amount to the investor that exceeds the issue price of the investment.
