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New investment rules positive but tough

17 May 2006

New investment rules positive but tough on international equities

Government released draft tax legislation today that will change the way New Zealanders invest. From 1 April 2007, qualifying New Zealand funds will stop being taxed in their own right and start collecting tax on behalf of investors as a final tax.

A key advantage is that professionally managed funds will no longer pay tax on capital gains on New Zealand and Australian shares. This is a very positive move that will reduce the real cost of engaging professional fund managers to administer investments.

The trade-off is that funds and individuals holding shares in overseas companies will be subject to tax on unrealised capital gains. At present, individuals investing in companies resident in a “grey list” country are taxed on dividends received, capital gains are not taxed. The new rules will tax 85% of the increase in value of overseas shares, other than listed Australian shares.

There is a way to limit the impact of taxing unrealised gains, but it is complicated – taxable income can be capped at the greater of the amount of dividends received or 5% of the value of the investments at the start of the tax year or cost, until the shares are realised at which time there is a wash-up to make sure tax has been paid on the total taxable gain. This cap will also help to reduce the impact of unrealised exchange movements, which may be taxed currently.

Offshore investments subject to these rules are treated as a single pool, so the wash-up on realisation is deferred if the sale proceeds are reinvested in offshore shares. This means the 5% cap could apply for a number of years, even if some shares are sold if others are purchased.
The good news is that an individual holding overseas shares that cost less than $50,000 will not be subject to these rules.

The bad news, this exclusion does not apply to investments held by a family trust or through a managed fund.
Murray Sarelius, tax partner at KPMG, says

“This is another step along the path of imposing income tax on amounts that would normally be subject to a capital gains tax.

Government is not introducing a capital gains tax – instead capital gains are being relabelled as income and taxed under a regime that was originally introduced to combat the abuse of international tax havens in the late 1980’s. These rules protect the beach house and rental property from capital gains tax, but penalise investors that have chosen to hold a diversified portfolio including overseas equities.”

Not being a capital gains tax means we miss out on any reduction in the taxable gain to reflect the time that the shares are held. For example, Australia only taxes 50% of the gain if the asset is held for 12 months or more and most countries have some form of indexation (reducing the gain by the effect of inflation).

Murray Sarelius, tax partner at KPMG says “The rules governing the taxation of foreign share investments are poorly understood, applied and enforced at present. These changes increase the complexity of the rules and the number of people affected. In short, these changes will make international equities unattractive for many individual investors – only they may not realise that fact until too late.”


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