Multimillion dollar suite of pro-business tax cuts
19 May 2005
Hon Dr Michael Cullen - Minister of Finance
Multi-million dollar suite of pro-business tax cuts
Budget 2005 reinforces the government’s commitment to economic growth, delivering a multi-million dollar suite of pro-business tax changes, Finance Minister Michael Cullen says.
He said the package more than delivered on the government’s promise to recycle back to business any revenue received from the carbon charge.
"Estimates are that the carbon tax will generate around $720 million over the forecast period ending 30 June 2009. The business tax proposals the government is putting in place are expected to cost almost twice that amount at $1.42 billion.
"This is equivalent to a cut of around 2 per cent in the corporate tax rate. It will deliver a better growth dividend, because the government measures are designed to raise productivity and support the transition to a knowledge-based economy," Dr Cullen said.
Specific themes of the budget business tax pack are to encourage savings, ensure a more productive use of capital, improve New Zealand’s access to worldwide capital, skills and labour, and reduce compliance costs.
To encourage savings and support work-based savings:
- Ensuring portfolio investment by financial intermediaries, such as collective funds, is not overtaxed relative to direct investments.
- Ensuring that income from these funds is taxed at the individual’s correct tax rate, thereby preventing the over-taxation of members earning less than $38,000 a year.
To ensure a more productive use of capital:
- Changing the depreciation rules so that rates better reflect how assets decline in value and to reduce the compliance costs to business.
- Removing barriers to R&D investment [announced last week.]
To improve New Zealand’s access to worldwide capital, skills and labour:
- Assisting the recruitment of top talent by providing a temporary tax exemption on the foreign income of new migrants and of New Zealanders who have been non-resident for tax purposes for at least ten years and who come here to work.
- Making New Zealand more attractive to international investment by aligning our tax rules on securities lending more closely with those of other countries.
To reduce compliance costs: [Announced last month.]
- Changes to Fringe Benefit Tax to reduce the fringe benefit valuation rate applying to motor vehicles, raise the minimum value thresholds for unclassified fringe benefits and exempt the private use by employees of work tools where the tool in question costs less than $5000 each.
- Aligning GST and provisional tax payments to reduce the number of tax payment dates and allowing businesses to base their provisional tax payments on a percentage of their GST turnover.
2005-06 2006-07 2007-08 2008-09 Total
Carbon tax [79.9] [321.9] [319.2] [721.0]
Financial intermediaries 120.0 100.0 220.0
Depreciation 219.0 276.0 260.0 222.0 977.0
FBT 7.0 28.0 28.0 28.0 91.0
Tax simplification 46.0 53.0 99.0
International recruitment 11.5 11.5 11.5 34.5
Implementation 3.1 3.5 1.4 1.1 9.1
Net cost to government 229.1 239.1 145.0 96.4 709.6
- Statement and fact sheet on changes to the rules governing collective funds.
- Depreciation fact sheet.
- International recruitment fact sheet.
- Securities lending fact sheet.
Tax changes for low income and small investors
Tax changes to create a fairer savings regime for low income and small investors are outlined in Budget 2005.
Finance Minister Michael Cullen said the proposals, which developed out of the Craig Stobo report Toward Consensus on the Taxation of Investment Income, would remove current inconsistencies in the treatment of different taxpayers and investments and would create a more transparent and coherent tax environment.
- eliminate a tax disadvantage applying to collective funds and;
- ensure that income from these funds is taxed at the recipient’s correct tax rate.
"The new rules, to come into effect on 1 April 2007, will apply to registered superannuation schemes, group investment funds, widely held unit trusts and other entities which have savings as their primary function.
"Currently gains from the sales of New Zealand shares tend to be taxed if the shares were bought through a collective fund but not if they were bought directly. This anomaly disadvantages collective funds and will be removed.
"The second rule change will allow the income from investments through managed funds to 'flow through' to the saver’s normal income tax rate, whether that be 19.5 per cent, 33 per cent or 39 per cent. Now many are taxed at a flat 33 per cent, which delivers a modest incentive to people on the 39 per cent rate but penalises lower income earners on 19.5 per cent.
"The two changes are inter-linked and voluntary. Not all funds are equipped to make the transition immediately. Those that are will have to decide what offers the best deal to their members," Dr Cullen said.
He said the issue of offshore investment was proving more difficult. The government had considered using a version of the risk free rate of return method but had rejected this as administratively complex and also because of "perception problems" surrounding the requirement that tax be applied even when the investor had incurred losses.
"Officials are now focussing instead on an income calculation system based on actual shifts in value," Dr Cullen said.
Details will be outlined in a forthcoming discussion document.
Fairer rules on taxing investment income
New rules will make the taxation of income from investment through managed funds more consistent and fairer to investors. They will apply to widely held unit trusts, registered superannuation schemes, group investment funds and other pooled investment vehicles - to be known as "collective investment vehicles".
The changes will reduce inconsistency in the taxation of investment income and remove the main tax disincentives to investing through managed funds.
The government will also consult on proposals to reduce the extent to which offshore investment in shares is taxed differently, depending on where and how the investment is made.
All the proposals will be detailed in a government discussion document to be released next month.
How will it work?
- In most cases income in managed funds will "flow through" to investors and will be taxed at their correct tax rate (not a flat 33 per cent rate).
- The complex differences between superannuation schemes, unit trusts, group investment funds and other entities performing a similar savings function will be removed.
- Funds will be able to make tax-free capital gains on domestic shares in the same way as individual investors do now.
- There will be no distinction between tax-favoured passive funds and tax-penalised active funds.
- Tax on offshore investment in shares will not be dependent on which country the investment is made in.
Flow-through and domestic investment
- The new rules for managed funds will apply from 1 April 2007 and will be optional.
- Instead of funds themselves paying tax on the income, they will withhold tax on behalf of each investor, at the investor’s correct tax rate. This is known as “flow-through” treatment. Funds will then pay the tax to Inland Revenue in the same way as banks pay withholding tax on the interest paid to depositors. This approach has real advantages for investors on a 21 per cent tax rate, whose investment income will be taxed correctly at 21 per cent and without their having to provide any cash to fund the tax.
- The tax withheld at the fund level will be treated as final withholding tax. This will ensure that the earning of fund income will not:
o automatically trigger the need for the investor to file a tax return;
o affect social policy programmes delivered through the tax system (such as family assistance).
- An approach for dealing with tax losses in a "flow-through" environment will be presented in the discussion document, and the government will explicitly seek feedback on the proposed approach.
- If the fund income cannot be allocated to specific investors in the fund, the income will continue to be taxed at the managed fund level at a flat 33 per cent tax rate.
- Profits from sales of domestic shares that investors earn through a qualifying fund will not generally be taxed. This will make the tax treatment consistent with the treatment of share profits from direct investment.
- Certain gains from the sale of New Zealand shares that would be taxed if they had been earned by an individual direct investor will continue to be taxed if they are earned via a collective investment vehicle: for example, schemes that have been entered into to exploit the boundary between debt and equity. A proposed approach to achieving this will be presented in the discussion document, and the government will explicitly seek feedback on the proposal.
At the beginning of the tax year Mike invests $1,000 into a defined contribution superannuation fund that invests in domestic shares. At the same time he provides his tax rate of 21% to the managed fund. The fund earns $100,000 for its 100 investors for the tax year - made up of $50,000 ($40,000 + $10,000 imputation credits) in dividends and $50,000 from profits on the sale of shares. The $50,000 sale profits are not taxed. The $50,000 of dividends is taxable to the fund’s investors.
Mike’s share of the taxable dividends is $500 ($400 + $100 imputation credits). The tax payable by the fund on his behalf is $500 X 21% = $105. The fund can use Mike’s share of the imputation credits of $100 to offset his tax, leaving $5 of tax to pay. The fund pays the $5 to Inland Revenue and adjusts Mike’s investment in the fund to reflect the tax payment. (Under current law, the superannuation fund would probably pay tax on the entire $100,000 that it earns for its investors at 33%.)
Portfolio investment into foreign shares
- The current distinction between investments in grey list countries (Australia, the United States, the United Kingdom, Japan, Germany, Canada and Norway) and investments in other countries that are more heavily taxed under the FIF rules will be removed. This will remove a disincentive for New Zealanders to invest in high growth economies - such as those in Asia.
- This will not result in the current foreign investment fund rules applying to all offshore investments. Instead the government will outline proposed new rules in the discussion document.
- These proposed new rules will reduce the extent to which offshore investments in shares are taxed differently. The proposals will balance revenue, economic and compliance concerns.
Where to from here?
The proposed changes will be detailed in a forthcoming discussion document that will invite further consultation on the operation of the new rules. Once enacted, the changes are planned to come into force from 1 April 2007.
Depreciation changes for better investment decisions
Changes to the tax depreciation rules will see new depreciation rates that better reflect how assets decline in value and reduce compliance costs for businesses. Current tax depreciation rates are likely to be too fast for buildings and too slow for short-lived plant and equipment, which can create tax biases that distort the structure of capital investment away from the best investment opportunities. To deal with any biases, depreciation rates for short-lived plant and equipment will increase and depreciation rates on buildings will reduce.
More neutral tax depreciation rules will mean that businesses have incentives to invest in assets that provide the best commercial returns. The changes will help businesses make better decisions about capital investments.
How will it work?
Improved tax depreciation rates to better reflect how assets decline in value
- Tax depreciation rates for short-lived plant and equipment will be made more consistent with those applying to long-lived plant and equipment. Rates for short-lived equipment will increase.
- Tax depreciation rates for buildings will reduce for buildings acquired from today. The new rates will not apply to existing building investments.
Asset Old diminishing value rate (%) Old diminishing value rate plus loading (%) New diminishing value rate (%) New diminishing value rate plus loading (%)
Laptop computer 40 48 50 60
Appliances (domestic) 26 31.2 30 36
Metal detectors 22 26.4 25 30
Printing machines (rotary) 9.5 11.4 10 12
Buildings 4 (no loading for buildings) 3 (no loading for buildings)
Dams (concrete) 2 2.4 2 2.4
Reducing compliance costs for businesses
„Ï To reduce some of the compliance costs to business from having to maintain fixed asset registers, the low value asset threshold will rise from $200 to $500. This will reduce the number of assets that businesses must annually account for on their fixed asset registers and the number of tax adjustments required when disposing of assets.
A company buys a facsimile machine for $450 for use in its office. Under the current rules, the machine would be placed on the company’s fixed asset register and tracked and depreciated over its five-year estimated useful life. Under the new rules, the company will be able to claim an immediate tax deduction for the entire purchase price of the machine. This will mean it will not have to track the asset on its tax fixed asset register.
Where to from here?
The changes are included in the Taxation (Depreciation, Payment Dates Alignment, FBT, and Miscellaneous Provisions) Bill introduced today. Changes to the depreciation rate for buildings will apply to buildings acquired from today, while changes to the other depreciation rates will apply to assets acquired from 1 April 2005. The increase in the low value asset threshold will apply to assets acquired after today.
Reducing tax costs for international recruitment
A temporary tax exemption on foreign income will be made available to people who come to work here, whether they are foreigners or New Zealanders who have been non-resident for tax purposes for ten years.
Tax on offshore income is an important issue for highly skilled people who are in demand internationally and for the businesses that recruit them from overseas, which often end up bearing the "tax costs" themselves in the form of higher pay. The new exemption will thus remove a tax barrier to New Zealand gaining the skilled people it needs.
How will it work?
- New and returning residents can apply for a certificate of exemption if they have not been tax-resident for at least ten tax years.
- New employees will be exempted from tax for five years on all foreign income except dividends, interest, employment income and business income relating to services.
- Those who come, or return, to New Zealand who are not in employment will receive the same exemption for three years.
- The exemption will be available to people only once.
A New Zealander who has worked in France for fifteen years owns $70,000 worth of shares in French companies and pays tax in France on the dividends she receives. Under current New Zealand law, if she returns to work in New Zealand her shareholding will be treated as foreign investment funds. She will have to pay New Zealand tax on the value of the shares as it accrues, regardless of how much has been distributed. The new exemption will mean that only distributions from the shares will be taxed in New Zealand during the period of exemption.
Where to from here?
The new exemption is included in the Taxation (Depreciation, Payment Dates Alignment, FBT, and Miscellaneous Provisions) Bill introduced today. Once enacted, the exemption will apply to people arriving in New Zealand from 1 April 2006.
Updated tax rules for securities lending
The tax rules on securities lending transactions will be updated to bring them into line with the rules relating to other commercial transactions and with those of countries such as Australia. The reform will remove tax barriers to securities lending transactions and make New Zealand more attractive to international investment. It will also introduce new rules to prevent the use of securities lending for tax avoidance.
Securities lending involves the lending of shares to another party for a fee. It allows brokers to transact in shares in which they have a shortfall and provides a relatively risk-free way for larger holders of shares to increase their overall returns. Internationally, securities lending plays an important role in facilitating market liquidity.
How will it work?
- "Qualifying transactions" involving the lending of equities will be taxed on their economic substance rather than legal form, meaning the lender will be treated as the owner of the shares over the period of the transaction.
- New anti-avoidance rules will apply to arrangements where a party, unable to use imputation credits, “lends” the relevant securities to a resident party who can use the credits.
Example of taxing transactions on their economic substance
A broker, anticipating a drop in the share price of NZ Limited, enters into a contract to sell NZ Limited shares to a third party for $6.00 a share. The broker does not hold any NZ Limited shares so enters into a securities lending agreement to "borrow" the shares required from an institutional investor.
Legally, the borrowed shares are sold by the institutional investor to the broker, who then goes into the market at the end of the month to buy replacement shares (at $5 per share) to return to the institutional investor. Instead of being taxed on any realised gain on sale of the shares, the institutional investor is treated as holding the shares for the entire period and receives a taxable lending fee as additional income. The broker is able to enter into an additional sale and makes a profit of $1 per share less the lending fee. The market benefits from additional transactions and increased liquidity.
Where to from here?
The new rules are included in the taxation bill introduced today. Once enacted, they will apply for income years and transactions beginning on or after enactment. The associated anti-avoidance measures will apply from the date of enactment.