Australian and NZ shares face shake-up under Cullen plan

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The top portfolio investment entity (PIE) tax rate could rise for non-KiwiSaver funds under proposals tabled to government last week by the mastermind of the $A38 billion New Zealand Superannuation Fund, Sir Michal Cullen.

Papers supporting the Cullen-led Tax Working Group (TWG) interim report suggest increasing the top PIE rate from the current 28 per cent to 33 per cent. The change would align all PIE tax levels with marginal rates outside of KiwiSaver.

Cullen, now in his 70s, is considered the architect of the modern NZ savings system. The TWG interim report recommends cutting the PIE tax rate by 5 per cent for KiwiSaver members below the top tier in a move that extends the discount – currently accruing only to high-income earners – across the membership base. If adopted, KiwiSaver PIE tax rates – known as the prescribed investor rate (PIR) – would be 5.5 per cent, 12.5 per cent and 28 per cent.

But – while not mentioned in the TWG report – the background advice paper says the non-KiwiSaver PIE system would be fairer and more “coherent” if the “capital income earned through a PIE is taxed at the investor’s personal tax rate”.

“Without doing this, the capped PIE rate will become more anomalous in an environment where we tax capital gains and make it more difficult to achieve other ways of avoiding the top-up tax, such as with dividend stripping transactions,” the paper says. “It raises the question of why we tax active businesses that take risks and employ people at 33% (after dividends and if capital gains are taxed), but allow passive investments to be taxed at lower rates.”

Removing the 28 per cent tax cap for non-KiwiSaver PIEs would raise an estimated $16 million in annual revenue, the paper says, and $43 million if applied across all PIEs.

If adopted the PIE rate adjustments would amount to an explicit tax incentive for KiwiSaver tilted towards low- to middle-income earners. Similarly, the TWG report favours dropping the employer superannuation contribution tax (ESCT) on KiwiSaver for those earning up to $48,000. The ESCT relief – capped at employer contributions of 3 per cent – would cost the government about $150 million each year, background papers show.

At inception in 2007, KiwiSaver employer contributions were tax-free until the previous National government imposed ESCT in 2009.

Elsewhere, the TWG report offers a range of options to impose a mooted capital gains tax (CGT) on Australasian shares held in PIEs. Australasian shares are currently CGT-free when held in PIEs but should, in theory, be taxed under the broader ‘capital income tax’ proposed in the TWG report.

However, the TWG report acknowledges that “imposing a realised capital gains tax on such assets held by MRPIEs [multi-rate PIEs], while retaining the benefits of the MRPIE tax regime, would require significant systems changes, amongst other practical issues”.

The report lays out several – all problematic – options to corral Australasian shares under a CGT regime including:

  • taxing individual PIE members on either realised gains or accrued gains;
  • treating CGT as a fund expense – a move the TWG “does not see… as a promising option”;
  • bringing Australasian shares under a fair dividend rate (FDR) regime as used now for global equities; or,
  • keeping the status quo.

“[Status quo] is the simplest option but would obviously mean that MRPIEs would have a significant tax advantage (no tax on share gains) over direct shareholding or investing via other entities, which would be taxed under the new rules,” the TWG report says.

“The Group intends to engage in further consultation with the industry on the above options.”

Property and listed PIEs would also require special treatment in a CGT world, the report says.

But the TWG recommends the FDR rules, which tax overseas shares on a deemed annual return of 5 per cent, remain in place – although under potentially lower settings.

“The Group notes that the fall in risk-free rates of return since FDR was introduced in 2007 indicates that the 5% FDR rate could now be too high, even in the context of a system which ordinarily taxes both gain on sale and dividends,” the report says.

Furthermore, all taxpayers could be forced to use the FDR approach rather than the optional ‘comparative value’ (CV) method available to individuals and family trusts. (Funds must use FDR for global share holdings.)

“… at the same time [we] are considering removal of the CV option for individuals and family trusts,” the TWG report says.

In a side-bar issue for the industry, the report also finds against charging GST on financial services despite “a strong in-principle” argument in favour of the levy.

According to a background paper on the issue, applying GST to financial services would “likely advantage saving through banks and other providers that charge through margins over managed funds and other financial institutions that charge through explicit fees”.

The industry is awaiting a much-delayed ruling from the government on whether retail fund fees (or at least in part as per existing ad hoc arrangements) should include GST, allowing providers to claim back the impost on input costs.

Nonetheless, the current GST exemption for financial services does create “in-source bias”, the TWG background paper says.

“This distortion arises because financial service providers are charged unrecoverable GST on services provided by third parties. The provider will not bear this GST cost if it carries out those services itself, so there is an incentive for financial institutions to insource production,” the paper says.

“The in-source bias creates an incentive for financial institutions to vertically integrate, and become larger than they would otherwise be without the exemption.”

The TWG final report is due next February with no further public consultation scheduled. Instead, Cullen said the TWG plans to seek advice from government and experts to draft the final details of the biggest tax reforms NZ has seen in decades.

– David Chaplin, Investment News NZ.

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