Cullen's wealth tax puts damper on Kiwi investment overseas

By Rob Hosking

Friday 17th May 2002

Tax changes likely to be signalled in next week's Budget could make leveraged investments far less attractive to New Zealanders investing overseas.

The government is likely to adopt one of the recommendations in the McLeod Tax Review - the wealth tax "risk-free rate-of-return" method of taxing New Zealand investments overseas.

"An 'in-principle' decision is expected to be announced in this year's Budget," the annual KPMG survey of financial institutions noted this week.

But implementation is expected to be delayed until after the election.

The risk-free rate-of-return method is calculated on a taxpayer's net investment in an asset by multiplying a taxpayer's net investment in an asset by a nominal interest rate - most likely the current government bond rate.

The appeal of this method is that both the tax authorities and investors know at the start of each year what the tax liability will be - regardless of how well or how poorly that investment performs.

However, it will also mean investors will be unable - as at present - to fully deduct the interest costs.

"That will present some cashflow difficulties for people who borrow to invest in offshore equities," KPMG tax partner John Cantin said.

"And if they are investing in a stock which doesn't pay a dividend that year, they have to come up with both the costs of paying the interest and the tax."

If the government does adopt the method, it is likely to foreshadow major changes in the way investors structure their affairs.

Leveraged funds and other investments funded in part by borrowing will become far less attractive and investors are likely to structure their borrowings so they cannot be clearly linked to the investment.

But the government is likely to counter this by more rigorous tracing rules, the KPMG report says.

Other changes are that investors may reduce overall borrowing.

"Given the impact on the borrowing decision, it is important for financial institutions to have a view not only of the application of the risk-free rate of return method but also on its application to their customers," the KPMG report warns.

At present the method is being considered only for offshore investments - something Finance Minister Michael Cullen has been keen to emphasise in the few public comments he has made on the issue.

However, there is a widespread assumption in the tax- planning industry that, if successfully implemented for offshore investments, it is only a matter of time before future governments apply the method to all investments.

Meanwhile, the government has signalled other investment changes to be announced in next week's Budget - this time concerning inward investment.

Additional spending on promoting New Zealand as a foreign investment opportunity would be part of the Labour-led government's third Budget, Dr Cullen said this week.

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