1. Towards Consensus on the Taxation of Investment Income Craig Stobo

2. Outline of presentation Background Downside from no consensus Opportunity now History and context The financial system is vital for growth Objectives of the project Outside the scope Project timeline and process Policy Objectives – offshore and onshore Policy Objective – taxation of investment income onshore Policy Objective – minimising effects of boundaries in tax rules Potential options for reform Questions and Discussion Feedback

3. Background Ministerial interest Positive fiscal position Consensus building opportunity

4. Downside from no consensus No obvious subsequent process for going forward “Band-aid” legislation inevitably continues Migration to offshore vehicles continues

5. Opportunity now Interested in your view of the pros and cons of the options presented

6. History and context McCaw Tax Review (1982) –Criticised high rate, narrow base –Base broadening leads to the TTE model (tax, tax, exempt) Valabh Committee (early 1990s) –Proposed capital gains tax (shelved) TOLIS (Taxation of life insurance and superannuation fund savings 1997) –Proposed alignment of investor/vehicle rates –Shelved for political / fiscal reasons

7. History and context ctd McLeod Tax Review (2001) –NZ tax system fundamentally sound –Rationalise entity specific rules –Consider taxing investment entities under RFRM Taxation of offshore portfolio investment as test/first step Officials’ Issues Paper (2003) –Taxation of non-controlled offshore investment in equity –Options to fix grey list: Standard Return Comparative value @ 70% –Onshore RFRM option mooted Result: consider offshore and onshore together

8. History and context ctd Australian Unit Trusts (2004) – addressed immediately due to delay in consideration of offshore Towards Consensus on the Taxation of Investment Income (2004) –Offshore and onshore issues considered together –Report on pros and cons of broad options and recommendations on ways forward (October 2004)

9. The financial system is vital for growth Productive use of capital Technological innovation Information/monitoring = firm governance and performance Distortions can disproportionately hurt certain types of investment Bottlenecks in an otherwise liquid system hurt growth Tax is misallocating investment in managed funds

10. Objectives of the project Consistency between direct and indirect portfolio investment Consistency within indirect Options should: –Protect the integrity of the tax base –Minimise compliance costs for investors and the industry. –Not penalise lower income savers Revenue neutrality not an objective in itself

11. Outside the scope The basic structure of tax laws outside the area of investment Capital gains tax Owner-occupied housing Treatment of debt instruments under the accrual rules TTE (tax/tax/exempt) model Savings-related concessions

12. Project timeline and process Chair appointed – July Consultation – August / Sept –Large number of key stakeholders to be consulted –Feedback sought Options finalised – Sept / Oct Report developed for submission to Government – late Oct

13. Policy Objective – onshore and offshore Onshore – tax entity as a proxy for the ultimate investor Offshore rules – objective is different –Cannot tax offshore entities –Necessary to tax investor as proxy for entity

14. Policy Objective - taxation of investment income onshore Integration between entity* tax and owner/investor tax –E.g. imputation avoiding double- taxation Poor integration creates distortions –Investments, vehicles or strategies may be chosen for tax purposes * Entity = managed fund vehicle and/or ultimate investment

15. Policy Objective – minimising effects of boundaries in tax rules Taxation of vehicles different from marginal rates and from each other Distortions arise from differences on Tax rates on earnings, or Tax rates on distributions, or Tax treatment generating timing advantages Example: SSCWT at 33% instead of 39%

16. Boundary examples $100K $10K TCG$6.7K NZ Investor 39% C/A NZ Super Fund R/ANZ Co INVESTMENT VIA SUPER FUND No claw-back on distribution = $6.7k in pocket IC – Imputation credits C/A – capital A/C R/A – revenue A/C TCG – taxable capital gain NTCG – non-taxable capital gain $100K $10K TCG$6.7K+3.3K ICs NZ Investor 39% C/A NZ Unit Trust R/ANZ Co INVESTMENT VIA UNIT TRUST Dividend of $10K - 6% claw back = $6.1K in pocket

17. Policy Objective – minimising effects of boundaries in tax rules ctd Implicit capital gains tax on managed funds –“Business” and “purpose” tests –Intermediated investment can result in additional tax –Active trading = tax & fees Indirect inactive = no tax, fees Direct inactive = no tax, no fees –Tax creates a wedge against using knowledge of professionals

18. Boundary examples NZ Investor 39 % C/A $100K $10K TCG$6.7K+$3.3K ICs NZ Unit Trust R/ANZ Co INVESTMENT VIA UNIT TRUST Dividend of $10K = $6.1K in pocket $100K NZ Co $10K NTCG NZ Investor 39% C/A COMPLIANT DIRECT INVESTMENT ON C/A = $10K in pocket

19. Policy Objective – minimising effects of boundaries in tax rules ctd Preferences for investments in offshore vehicles –Stems from grey list –NZ based funds are disadvantaged

20. Boundary examples NZ Investor 39% C/A NZ Managed Fund R/AJapan Co $100K $10K TCG$6.7K NTCG INVESTMENT VIA NZ VEHICLE = $6.7K in pocket UK Managed FundJapan Co NZ Investor 39% C/A $100K $10K NTCG INVESTMENT VIA GREY LIST VEHICLE = $10K in pocket

21. Policy Objective – minimising effects of boundaries in tax rules ctd Direct investment into grey list –Usually held on capital account –Result: only dividends taxable –Total tax and timing advantage Non-grey list investment –Taxable on accrued capital gains

22. Boundary examples NZ Investor 39% C/AUK Co $100K $10K NTCG COMPLIANT DIRECT INVESTMENT IN GREY LIST COUNTRY ON C/A = $10K in pocket NZ Investor 39% C/AFrench Co $100K $10K TCG COMPLIANT DIRECT INVESTMENT IN NON GREY LIST COUNTRY ON C/A = $6.1K in pocket

23. Potential options for reform Income calculation Onshore1. Managed fund vehicle tax rules (a)Tax on managed fund vehicle with credit for tax paid (b)Final tax at variable rates RFRM Shift capital-revenue boundary 2. Flow through (a)Withholding tax with wash up (b)Withholding at variable rates RFRM Shift capital-revenue boundary OffshoreRFRM or Standard Return Comparative Value

24. Questions and Discussion Do you agree with the objectives of the project? Do you agree with our identification of the boundaries with current tax rules? Do you agree that these boundaries distort investment behaviour? What do you think of the options presented – e.g. do they address the boundary issues identified / are they technically feasible? Do you have preferred options for tax reform? What do you consider are the pros / cons of your options for tax reform?

25. Questions and Discussion ctd Under an RFRM how would you set the rate onshore and offshore? What is the size of your funds / assets under management? Where is the boundary between portfolio and direct investment for managed fund vehicles? Do you provide for tax at 33% on realised and unrealised capital gains? How regularly do you turn over your portfolio (% per annum)?

26. Questions and Discussion ctd Does your business take advantage of tax effective vehicles, such as passive funds, AUTs, OIECs and wraps? Is the tax environment driving NZ fund managers offshore? Do you believe that FITB issues can be solved by tax reforms? What do you expect the impact of the reforms to be on product differentiation? Do you consider the impact on EMTRs for lower income savers in product design?

27. Feedback By 10 September Feedback to: –Darshana Elwela darshana.elwela@ird.govt.nz –David Carrigan david.carrigan@ird.govt.nz