Taxation Summary - part 4
Summary of key points in relation to the Select Committee’s final report on the new investment tax regime
This is part 4 of a series commenting on the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill.
Parliament's Finance and Expenditure Select Committee released its final report on the proposed new investment tax regime last week. The Committee's final recommendation is largely the same as the interim recommendation it made in its earlier report, published in late October. The report supports the Bill’s intention that investors in offshore equities will be taxed according to the "fair dividend rate" of 5%.
For individuals with more than $50,000 invested overseas, all dividends and capital gains of up to a cap of 5% of the opening value of their portfolio will be taxed, but no tax will be paid on an overall loss.
xperts who made submissions were unanimous that 5% was well above the actual dividend yield on international shares and a consensus emerged that a level around 3% would be more appropriate. Critics say the weighted average dividend yield in world markets is about 2.2% and that the tax will be viewed as a capital gains tax or wealth tax given the disconnect between actual income derived from foreign portfolio investment.
Enforcing compliance with the new rules may be problematic, placing pressure on Inland Revenue. Investors are likely to resent being taxed as if they've earned a 5 per cent dividend return when they have received less than that.
It is also viewed negatively that although individuals will not pay tax on their overseas investments in years when they sustain losses, they cannot carry those losses forward. Therefore investors will pay tax on gains as their investment recovers to its pre-loss levels.
The industry has questioned the Committee's decision not to align the treatment of direct offshore investment with that of offshore investment via a New Zealand managed fund.
However, the legislation has been received more favourably than the previous proposals and is intended to remove long-standing distortions in the tax treatment of investors in relation to share and unit trust investments.
Tax experts have expressed surprise that this level of structural change to tax legislation was largely determined in the select committee outside of the generic tax policy process.
Exemption for Australian unit trusts (AUTs)
Investments in some AUTs will be exempt from the new offshore portfolio investment rules. The exemption will apply if an AUT:
- collects resident withholding tax from investors on any income paid out by the trust. This is known as the RWT proxy regime which only applies to individuals and family trusts; and
- realises at least one third of its gains each year (based on minimum turnover threshold rules). As an example, if the cost of investments held by an AUT is $100 and the market value of those assets at year end is $118, the net proceeds of asset disposals during the income year must be equal to $6 (i.e. a third of the $18 rolled-up value in the trust) for the exemption to apply.
The exemption may be of limited application since only income paying AUTs with RWT deducted will qualify and generally AUTs roll-up capital gains where possible (as gains are taxed when realised). In order to pay income, AUTs need to realise capital gains and pay capital gains tax in Australia as a result.
Next steps
The Bill containing the Committee’s recommendations will now go back to Parliament and is expected to be enacted. Tax experts say the revised version is too harsh and has "rough edges", some already visible and some yet to develop, which will require further work.
