Forum Archive Index - February 2002

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Larry asked for comments on Cullen's speech today.  I
think the headline for this post more or less sums it up.

>
>-Cullen
>
>The Review's preferred solution is that investment in
>listed shares and securities be taxed at a standard
>risk-free rate of return, no matter the country of
>investment. 
>
>I am interested in this idea because it has the
>potential to make the relevant tax rules simpler, fairer
>and more effective. I hope to be in a position to set
>out in some detail the likely direction the government
>will take on these issues in the upcoming budget. 
>
>

Now if you go to the treasury website you get a more
detailed run down on this

http://www.treasury.govt.nz/taxreview2001/finalreport/ove
rview3.html

And a break down of the Risk Free Return Method (RFRM)
formula


Net asset value at the start of the year
                  x
Statutory risk-free real rate of return
                  x
        The investor's tax rate


I can't see any other way of interpreting what Cullen is
saying except to say he is introducing a wealth tax.  It
is possible that this sort of tax will not make much
difference to funds management companies.  They have a
broad spread of funds which means that returns will
converge towards the 'notional rate'.  They also have
sufficient size to be able to liquidate their positions
for tax purposes with relative ease.

For the small investor however, this RFRM will be a
disaster for any overseas investments they hold, and here 
is why.  

Many overseas companies have very low, sometimes zero
dividend yields.  Under the above scheme they will have
to pay tax at a 'notional rate' highly likely to be above
any cash income they receive.  So in order to pay their
tax, small investors will have to sell down part of their 
investment each year.  For most investors this will be 
impossible as the minimum marketable parcel requirements 
overseas are much larger than New Zealand.

A second problem is that shares do not always go up in
value, often they go down.   Under this scheme, share
investors will be required to pay money on their past
wealth, based on a notional return they might have
earned, even if their shares have subsequently crashed in
value.  In other words it is possible for shareholders to
left with a large tax bill with no assets to sell with
which to pay it.   Those 80% of 'day traders' who end up
not making money please take note! 

A third problem for this method is that it would become
impossible to calculate one's tax, as the tax rate
becomes an implicit, not an explicit variable.  For those
that are a bit rusty on the maths this means:

Old Situation: 

1/ Calculate Income
2/ Determine Tax Rate

New Situation  

1/ Calculate Wealth
2/ use Wealth to work out notional income
3/ Determine Tax Rate on notional income
4/ Check reduction in Wealth 
5/ Use Wealth to work out notional income 
6/ Determine Tax Rate on notional income 
7/ etc. etc. 

In other words it will be impossible to calculate your
wealth or your tax rate in any simple way, as an increase
in one means an increase in the other and vica versa.  
Did someone say 'simpler'?

A fourth problem is that overseas wealth is highly
subject to exchange rate fluctuation, which is
particularly relevant to a small country currency such as
ours.   This means, for instance that you could
prepurchase a holiday overseas and find yourself with a
massive tax bill because the NZ currency suddenly
depreciates.  Of course the costs in the country you were
planning to visit have not gone down, so any increase in
'wealth' which you are being taxed on, is illusory.

To summarize, this coming tax law change assumes that any
notional increase in wealth, (which bears no connection
to any actual increase in wealth remember) will be
accompanied by an accompanying ability to pay it.  This
is so obviously false, that I find it astonishing that
any principle so basically flawed could ever make it past
the discussion stage let alone rearing its ugly head in
the upcoming budget.  Can anything be done to stop this? 

SNOOPY










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