Tax News

The New Zealand Tax Podcast year-end special.

The New Zealand Tax Podcast year-end special.

9 Jan, 2025 | The Week in Tax

  • Proposed changes to FIF regime
  • A look back at the highlights in tax in 2024

There have been several constant themes throughout this year. A surprising one has been the question of how we tax capital and whether we should have a capital gains tax. Throughout the year there have been a steady stream of stories on the topic. Meanwhile the Labour Party is currently reviewing its tax policy, and whether it’s going to go with a wealth tax or a capital gains tax.

A place where talent does not want to live

Intriguingly, Inland Revenue has added to this mix right at the end of the year with the release of an issues paper on the effect of the Foreign Investment Fund (FIF) rules on immigration.

Earlier this year I discussed a New Zealand Institute of Economic Research report called The place where talent does not want to live, which looked at the impact of the FIF rules on migrants to New Zealand. The NZIER report concluded that the FIF rules were acting as a hindrance to investors, particularly those migrants coming here who have previously invested in offshore startup companies.

The report also discussed an issue I’ve encountered fairly regularly of the impact of the FIF rules for American citizens. Even though they may have been resident in New Zealand for many years, because they are American citizens they still have to file U.S. tax returns. As a result, a mismatch arises for them between the FIF rules, which basically act as a quasi-wealth tax, and the realisation basis of capital gains tax that applies in America.

Inland Revenue policy officials have been aware of this issue for some time. In fact, I spoke to several officials earlier this year about the issues and potential options. The topic was highlighted as an option for review and was included in the Government’s tax and social work policy programme released last month. This report has therefore come out quicker than I expected which is a pleasant surprise.

The problem with the FIF rules

The problem is set out very clearly in paragraph 1.5 of the issues paper.

“Migrants will generally have made their investments without awareness of the FIF rules and may not be organised so that they can fund the tax on deemed rather than actual income. This is particularly a problem for illiquid investments acquired pre migration…. Because the FIF tax is imposed in years before realisation and on deemed rather than actual income, FIF taxes paid may not be creditable against foreign taxes charged on the sale of the investment.“

This highlights a key point about the FIF rules – they’re highly unique by world standards. When I’m discussing them with overseas clients and advisers, to make them more understandable I tend to explain them from the viewpoint that they’re a quasi-wealth tax. As the quote above notes problems also emerge whether the tax paid under the FIF rules can be fully utilised in the United States, for example. 

Fixing the problem – taxing the capital gains?

The paper canvasses several options for reform, including one of simply increasing the current $50,000 threshold above which the FIF rules automatically apply. A key proposal is that maybe the investments subject to the FIF rules should be taxed on what is called revenue account. That is only dividends received and any gain in the value of those investments attributed to New Zealand on disposal would be taxed. In other words, an investor would be taxed on dividends and then when the investment was disposed of, a capital gains would be become payable.

Now to buttress this option the paper proposes that there should be an exit tax. In other words, if someone elects to use the revenue account method, but then decides no, actually New Zealand isn’t working out for us for whatever reasons, and they become a non-tax resident, this migration would trigger an exit charge. I’ve seen this in other jurisdictions and current FIF rules do have a provision covering it. This approach should be pretty understandable to investors coming here.

Maybe a deferral basis?

Another alternative is a so-called deferral basis, is where the FIF rules would apply on a realisation basis. This would be achieved in a way similar to how withdrawals on foreign superannuation schemes are currently taxed when the tax charge arises on withdrawal or transfer into a New Zealand based Qualifying Recognised Overseas Pension Scheme.

The taxable amount would be based on a deemed 5% per annum income from the date of their migration, with an interest charge for deferral. Again, this would be buttressed by an exit tax.

What happens overseas?

Picking up on what I was saying at the start about the question of taxation of capital, most other jurisdictions don’t encounter this issue to the same extent as we do because they usually have a capital gains tax regime that applies to comprehensive capital gains. Actually, in paragraphs 2.3 and 2.4 I find there’s some intriguing commentary from Inland Revenue on this issue.

“Because New Zealand does not tax capital gains without the FIF rules, no New Zealand tax would ever be paid on an investment in a foreign company that paid no dividends and was sold for a capital gain.”

This is an interesting insight to the issues caused by non-taxation. In effect without the FIF rules the Government is forsaking potential revenue. I always thought the expansion of the FIF rules in 2006 was really a sidestep around the difficult issue of taxing capital. And of course, despite having kicked the capital gains tax can down the road back in 2006, it’s still there.

Tax driven behaviour, or just a rational investment choice?

The issues paper goes on, quite controversially in my view, to argue that without the FIF rules in New Zealand, residents have a tax driven incentive to invest in foreign companies that enjoy low effective tax rates and do not pay significant dividends. Speaking with 40 years of tax experience, yes taxes do drive investment behaviour.

But this argument sidesteps a huge criticism, which is still valid, of the current FIF rules. When they were introduced in 2006, many of the submissions against them argued that the New Zealand stock market is so small in global terms that investors would be unwise to be fully invested here, and therefore should be spreading their risk by diversification and investing in offshore markets.

That is as valid a criticism of the FIF rules now as it was back in 2006. And of course, memories of the 1987 stock market crash, which was actually quite catastrophic by world standards, still run deep in many areas. We now have this scenario here where the FIF rules were designed because the Government wanted some revenue.  It saw tax driven behaviour happening offshore, but it ignored a key fact, the importance of diversification. And if you don’t tax the capital but you want the revenue, where do you go from there?

Backdating the introduction of the changes?

Anyway, the whole paper is a very worthwhile read. It has one further highly interesting suggestion that changes could be back dated to take effect from 1st April 2025 and the start of the next tax year. Such a swift law change doesn’t happen with issues papers. Normally there’s usually another year or so before legislation is introduced and then comes into effect.

This option is actually very encouraging for migrants. I have had a number of inquiries on this issue, and I know of clients who have backed away from New Zealand because of the FIF rules. So, they will be looking at the proposals with great interest.

The paper also canvasses whether it should apply to new migrants or to existing New Zealand tax residents. That’s a good question it should certainly apply to migrants who can reorganise their affairs in anticipation, but I believe it should also apply to U.S. citizens who still have to file U.S. tax returns and are very disadvantaged by the current FIF rules.

Worth noting that although this is largely a tax measure it’s important to the Government because the existing FIF rules are seen (as the NZIER report noted) as a hindrance to attracting high quality migrants. Changing the law is seen as a priority as part of the Government’s general economic programme,

Submissions are open now and continue until 27th of January. I urge everyone interested in this topic to submit. We will be submitting a paper on this ourselves. We will also be contacting clients on this matter as it’s quite a welcome Christmas present.

The year in review

Moving on, its been a very busy year in tax. And I guess the biggest story in many ways was the Budget on 30th May, with the promised increase in tax thresholds finally being enacted with effect from 31st July.  That was certainly the most eagerly anticipated one, and according to my data reads, it was the most read transcript over the year.

The tax cuts which weren’t

These tax cuts as they were called (which they’re not because they’re only inflation adjustments) also highlighted a big and continuing problem with our tax system, which the politicians apparently don’t want to address. The threshold adjustments only factored in inflation from 2018. They therefore effectively locked in the inflationary effect of the non-adjustment between 1st October 2010 (the last time the thresholds were adjusted) and the 2018 baseline.

On the other hand, in order to help pay for these adjustments which will reduce government revenue, the threshold on Working for Families which has been at $42,700 since 1st July 2018, was not increased. This means that families with income above that threshold have their Working for Families credits abated at 27.5%. Consequently, they face some of the highest effective marginal tax rates in the country.

And as I have repeatedly said in past podcasts, our politicians are very much less than transparent about the impact of what’s called fiscal drag. That is, as wages increase with inflation, they pull taxpayers up into higher tax brackets. We have a particularly big problem around the now $53,500 threshold where the tax rate jumps from 17.5% to 30%, the biggest single jump in the whole tax scale.

To bang a drum already beat repeatedly, this hinders a discussion around what is happening with our tax system? How much revenue have we really raised because politicians have been happy to use fiscal drag to quietly increase the tax take.

But the main effect is that the burden of tax falls on low to middle income earners who face significantly higher marginal tax rates because of the effect of abatements on people receiving social support, such as Working for Families.

So overall, those tax threshold adjustments were welcome. They were overdue, but they were one step forward and two steps sideways and half a step back because there’s no comprehensive commitment to ensuring that we have regular threshold adjustments.

If America can do it, why not here?

Just as an aside, in America all thresholds are automatically index-linked. Countries vary on their treatment of inflation and thresholds. And in low inflation periods, you can get away with not needing to do it every year, but you can’t leave such adjustments for 14 years without finally having to do something.

A year of anniversaries

2024 was quite a big year for me personally. I started working in tax 40 years ago in Britain and it so happened that the British budget on 30th October had several announcements which have huge significance not just for UK migrants who have moved here but also for many Kiwis. So, I find myself, somewhat ironically, still doing a lot of work on the impact of British taxation.

It’s also been 20 years since I started Baucher Consulting and as I said in the podcast much has changed, and yet in some ways little has changed. One constant which hasn’t really changed is the behavioural impact of tax- this week’s discussion of the FIF regime is the latest example. I’d like to thank everyone who’s supported me over the these past 20 years.

Our fantastic guests

Looking at some other highlights of the year in terms of the podcast, we had a lot of great guests this year and my thanks again to all of them. My particular favourite episode was the Titans of Tax with Sir Rob McLeod, Robin Oliver and Geof Nightingale. Many thanks to Sir Rob, Robin and Geof for giving up their time. It was a fantastic discussion and very, very enjoyable. It was extremely well received all around. It was fascinating to just sit back and listen and to three experts who’ve been very heavily involved in the last three major tax working groups.

My thanks also to all my other guests this year, including the four finalists for this year’s Tax Policy Charitable Trusts Scholarship. Again, thank you so much for your input. Very interesting to talk to you, and the future of tax policy is in good hands.

Inland Revenue goes full throttle on compliance work

One of the big themes for the year, and less of a surprise, was Inland Revenue’s ramping up its enforcement approach. One of our guests very early in the year (and thanks again) was Tracy Lloyd, service leader of Compliance Strategy and Innovation at Inland Revenue. Tracy’s podcast was a really interesting one looking at what tools Inland Revenue is using and  how it’s ramping up its investigative activities.

We’ve seen Inland Revenue’s more aggressive approach constantly through throughout the year. It has made announcements about cracking down on the construction sector, looking at liquor stores. Pretty much every week there’s a media release that another tax fraudster has been jailed or received substantial fines or home detention. In addition Inland Revenue is making use of information received through the Common Reporting Standards on the Automatic Exchange of Information.

These things will continue to come through. Inland Revenue got $116 million over four years to beef up its investigation activities and to improve its tax collection. As part of this we’re seeing a crackdown on student loan debt, which is a much more problematical issue mainly because the biggest portion of debt is held by persons overseas. It’s therefore not so easy to collect. 

Inland Revenue’s activities will continue to ramp up but I think it may start to find there’s increasing push back as it clamps down. I think it’s previously been slow in responding, and during the COVID pandemic that was understandable. But right now, the faster it responds to debt issues developing, the better for all of us. Zombie businesses which linger on are no good to anyone.

The surprising continuing debate over capital gains

But the other big thing this year has been a surprising one.  It’s the question of the shape of the tax system and persistent media stories about whether we should have a wealth tax or capital gains tax. This is a topic I don’t see going away. I see the pressure mounting on it because as, the Government’s main agency, Treasury, is pointing out we have ongoing demographic pressures in relation to superannuation and funding health.

And as I keep pointing out, we also have the question of climate change. We have insurers withdrawing cover and I think that means the Government will be expected to step in. And that means sharing the burden, which means ultimately some form of tax increases.  All this means the composition of the tax base will continue to be a matter of debate.

Of course, we have options like capital gains tax, wealth taxes, or as Dr. Andrew Coleman suggested (another one of the fascinating podcasts this year) maybe we should rethink our issue of Social Security taxes, where again we’re a unique jurisdiction in that we don’t have them. We used to have such taxes way back from the early 1930s through until late 60s, before they were finally abolished,

So overall lots to discuss this year. I’d like to thank all my guests again, and all the listeners, readers and all those who chip in and comment away. Your comments are read and always welcome. And on that note, everyone have a very happy festive season. We’ll be back with what’s new in the tax world in January 2025.

IRD’s new property tax decision tool.

IRD’s new property tax decision tool.

29 Jul, 2024 | The Week in Tax

  • shared housing
  • time to overhaul the FIF regime?

Last week, as part of its continuing drive to increase compliance, Inland Revenue released an updated property tax decision tool.

What this does is help people work out when a property might be taxable under any of the land taxing rules, including the bright-line test. It’s been updated to take account of the bright-line test changes which took effect on 1st July this year.

The growing issue of helping families into housing – what are the tax implications?

Generally speaking, since 1st July, the bright-line test only applies where the end date for sale as determined under the rules is within two years of when the property was deemed to have been acquired. The aim of the tool is to work through all the various scenarios that might apply. So that’s something worthwhile, and I think we’re going to see more of people wanting to make more use of this because of a developing trend around shared home ownership where people who are not necessarily couples are coming together to purchase properties. There are also families wanting to help elderly parents.

We’re seeing some very interesting scenarios develop as a result. One of those scenarios was the subject of last week’s Mary Holm’s column for the New Zealand Herald.

“We’ve bought my wife’s parents’ house. They had a small mortgage on it, with no income, just super, coming in. They didn’t have enough money to keep paying the mortgage, hence they were going to start a reverse mortgage to keep things afloat.

If they sold the house they would’ve struggled to get into a retirement village and stay near family etc.  So we bought the house so they don’t ever have to leave – so let’s say they will be there for at least another 10 years.

They pay us $750 rent per week. We took out a 30-year $800,000 mortgage, with just the interest on it at $1977 a fortnight, so we are topping up mortgage payments as the rent does not cover it. We also pay the rates, insurance and any maintenance costs.

How do we treat this in terms of any possible tax or claims as such?”

Mary asked Inland Revenue and me for comment. Notwithstanding that a net loss was foreseeable, my advice was you never always know what the full story is as there may be a detail which for whatever reason, the correspondent has overlooked. The basic approach I took was you should report it. Inland Revenue were much of the same view but noted that any excess deductions would be ring fenced.

As I mentioned to Mary, I think we’re going to see a lot more of this. Because they’re coming from both ends of the generational spectrum. In this case we’ve got the elderly parents wanting to stay near family and then at the other end, young people trying to get on the housing ladder.

Is shared home ownership an answer to housing affordability?

Over the last 20 years or so I’ve seen the practice develop quite rapidly of parents, grandparents and other relatives helping their children or grandchildren get their foot on the property ladder.  This was the subject of an interesting report on shared home ownership released by Westpac called Next Step Forward. The report notes that the housing market is increasingly difficult, and “the home ownership dream is increasingly out of reach for some New Zealanders”. The report’s analysis is that shared home ownership will become increasingly common and how might that develop.

The report describes the housing market as “distorted”. To give you some idea of the scale of the problem, the report notes “As of February 2024, the median house price was 6.8 times the median income compared to 5.4 times in 2004 and roughly 2.3 times in 1984.” So over 40 years, the median house price relative to median income has practically trebled.

The report also notes that home ownership rates in New Zealand have been declining steadily since peaking in 1991 at 73.8%. They’re  down to 58.7%, so a 15 percentage point drop over 30 years is pretty substantial. But the report projects that within 25 years, the proportion of homeowners will have dropped to 47.9%. (The report notes the outlook is even worse for Māori and Pacific peoples, where the home ownership rate is lower, at 47% and 35%, respectively, as of 2023).

What are we going to do about this? Well, as the report suggests shared home ownership is going to become more common. This in turn is going to trigger all sorts of tax issues. Which is why something like Inland Revenue’s property tax tool is handy. The report, incidentally, doesn’t really discuss tax other than mentioning tax free capital gains do play a part in people’s investment decisions and may have an impact on the housing market

There’s no real short answer to this issue. Raising incomes would be one thing, freezing or slowing the rate of house prices would be another, and building more homes would be a vital third factor.  Pulling all this together is a huge problem and each solution comes with secondary effects.

International tax deal in trouble?

Moving on, an equally complicated scenario and one we’ve been covering for several years, is the question of the taxation of multinationals. Back in 2021, the OCED/G20 declared a breakthrough international tax deal over the taxation of the largest multinationals in the world. The deal proposed a Two-Pillar solution over the question of taxing rights. Ultimately this is where the idea of a minimum corporate tax rate of 15% emerged.

Agreeing in principle was one thing, but the negotiations have been going on since then and increasingly it seems to be that they’re running into difficulty. A key 30th June deadline has now passed, and it appears that some governments are starting to lose patience with the whole process. 

One of the ideas behind the agreement was to head off the implementation of digital services taxes (DSTs). As part of the process these DSTs were put on hold by several jurisdictions, including the UK, Austria, India and others. In the meantime, as negotiations have dragged on, other countries such as Canada have said “Well, we’ve had enough of this, we’re going to go ahead and impose a digital services tax.”

Meantime, the United States whose companies such as Alphabet and Meta are at the heart of the issue have threatened retaliatory tariffs on countries imposing DSTs. Nobody wants a trade war, but someone has to blink in terms of getting a deal past this impasse. So, they’re continuing to negotiate, even though the deadline theoretically has expired.

Time to go back to first principles?

On the other hand, as Will Morris, PWC’s Global Tax Leader points out in this short video. Maybe we should just go back to first principles instead of trying to hammer out a deal through the existing Pillar 1 process which some consider is not really fit for purpose.  

It’s not a bad idea but it would delay further progress in the matter, and I think that’s where governments who’ve got elections to win may not be prepared to wait much longer. I think generally the public is a bit antsy about the question of corporate taxation. As I noted last week, when we looked at the OECD’s latest corporate tax statistics, statutory corporation tax rates have  pretty much stabilised after 20 years of falling.

However, there are still substantial gaps in public finances as a result of first the Global Financial Crisis, then the pandemic and increasingly we’re having to deal with the impact of climate change as well. When the insurers are leaving the market, who picks up the tab? In my view, that’s going to be we the taxpayers.

There will be pressure to get some sort of deal across the line, but I also think although we may see corporate tax rates elsewhere in the world rise, I think with our 28% rate, we haven’t really got much room for manoeuvre for an increase at this point.

A place where talent does not want to live?

Finally, the New Zealand Institute of Economic Research released a fascinating report on Thursday. Provocatively titled The place where talent does not want to live, it looks at the question of New Zealand’s immigration policy and how that sits alongside our international tax regime.

The report was prepared for the American Chamber of Commerce in New Zealand, the Auckland Business Chamber, the Edmund Hillary Fellowship and the NZUS Council. It’s a fascinating document because it pulls together points, we don’t always hear discussed when we’re looking at immigration policy, how does our tax system interact with that policy?

The report notes that conceptually, we have developed tax rules which make sense in a tax context. However, they lead to wider issues once they start operating in a broader context. In particular the report really focuses on the Foreign Investment Fund (FIF) regime which it considers disadvantages many investors who come here hoping to use their skills and their capital to help build the economy and the tech sector in particular. 

I’ve seen comments on this topic previously from entrepreneurs, and it’s easy perhaps to be cynical and say, “Well, they’re speaking out of self-interest” but 40 years of tax experience also tells me that behavioural responses to tax are very observable and policymakers should pay attention to such responses.

An in-depth examination of the Foreign Investment Fund regime

What makes this report particularly interesting are the authors, Julie Fry and Peter Wilson. Julie is a dual New Zealand and U.S. citizen who in her bio notes that “her location and financial decisions have been impacted by the tax rules covered in the report.”  Peter was Manager of International Tax at the New Zealand Treasury from 1990 to 1997 and then Director of Tax Policy from 1998 to 2002. As such “He was responsible for advising the government on many of the tax issues contained in this report.” Consequently, outside of anything prepared for a tax working group, this report is one of the most in-depth examinations we’ve seen of our international tax regime and FIF regime.

The report notes that although we have a fairly open flow of migrants, “New Zealand has never been a particularly popular destination for talented people”. (Interestingly, we have no data on how long people on the various investor and entrepreneur visas stay).   

As the report notes there’s a competition for global talent and New Zealand is not attracting as many as we would like. We should therefore be thinking hard about the implications of this.

The report hones in on the FIF regime as being a particular problem for many investors because of the way that it taxes unrealised gains. This creates a problem of a funding gap where an investor is expected to pay tax on an investment which very often isn’t producing cash because as a growth company cash is being reinvested. (By the way, this is often a common argument against wealth taxes).

As the report notes, “New Zealand’s tax rules were not designed with the idea of welcoming globally mobile talent in mind.” For example, as Inland Revenue’s interpretation statement on residency makes clear it’s deliberate policy to make it’s easy to be deemed tax residency in New Zealand, and hard to lose. This has long term flow implications because as the report points out, people who would perhaps want to commit to New Zealand are reluctant to do so because of the tax consequences of doing so.

Chapter Three is the very, very interesting section of the report as it explains the development of our current international tax regime and the rationale for the various FIF regimes and their design. The overall objective was to protect the tax base, but they didn’t really think about what was happening with migrants. As Ruth Richardson and Wyatt Creech then the respective Minister of Finance and Minister of Revenue explained in 1991:

“The objective of the FIF regime, where it applies, is to levy the same tax on the income earned by the FIF on behalf of the resident as would be levied if the fund were a New Zealand company. Because the FIF is resident offshore with no effective connection with New Zealand, the only way of levying the tax is on the New Zealand holder.”

This is conceptually correct from a tax perspective but as the report keeps pointing out, it doesn’t really take into account what happens with migrants who made investment decisions long before they arrived in New Zealand only to find their accumulated savings are being taxed here under the FIF regime. I have a similar problem with the taxation of foreign superannuation schemes. Although the tax treatment conceptually ties in with our system, it seems to me we are effectively taxing the importation of capital and this paper is basically saying the same thing in relation to FIF.

How much tax does the FIF regime raise?

Section 3.5.1 on page 26 of the report has an interesting analysis of how much revenue the FIF regime raises. Because our tax reporting statistics aren’t very detailed, the answer is we don’t really know. The report concludes

“The high-level finding is that the level of overseas investment is small compared to total financial assets at the national level. Portfolio foreign investment is, in some years, one-thousandth of domestic investments. This suggests that the current FIF tax base is likely only to make a minor contribution to direct revenue.”

A suggested reform

The report concludes that in an international context where we were trying to attract the right talent, maybe we should be looking at the FIF regime. What it suggests is to separate the tax treatment of people who have always been tax resident from those of new and returning tax residents. The existing FIF rules would continue to be applied to those have always been New Zealand tax resident. Meantime a new regime should be designed for new and returning tax residents.

The report does touch on the question of a general capital gains tax regime (which could be an answer) but considers the development of a comprehensive CGT is a long term political consensus building project.

In discussions I’ve had with other colleagues on this matter we’ve noted how our American clients in particular are very affected by the current FIF regime. As American citizens they are required to continue to file American tax returns and are therefore subject to capital gains tax. This creates a mismatch between when they pay New Zealand income tax and the final US tax liability on realisation. Although the FIF regime creates foreign tax credits for US tax purposes, clients are frequently not able to utilise the foreign tax credits.

As people told the report authors this is extremely frustrating and there is no doubt that people are upping sticks and moving because of it. (I’ve also seen other clients switch into property investment instead).

Overall, this is a very interesting and highly recommended report considering the intersection of tax driven behaviour with wider economic issues.

And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts.  Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.