Among the chief issues of taxpayers subject to the FIF rules has been income arising when cash might not be available to pay the ensuing tax bill, and the difficulties faced in calculating income where the relevant investments are not in a listed company, so market values are not easily located. Another common gripe is the double taxation faced by mobile workers – someone moving here for several years can see tax arising under the FIF rules and then find those interests subject to capital gains tax in an overseas jurisdiction without access to tax credits.

The government has recognised these rules have quite a nasty impact on skilled workers moving to New Zealand and so an officials’ issues paper has been released on the topic, available here. In due course, it will influence legislative amendments to the FIF rules. The paper only considers the impact on new migrants, and the possible changes would only apply to migrants who come to New Zealand after a specific date, although some other small changes may be made (e.g. increasing the $50,000 de minimis threshold).

Note that most migrants can use the transitional residents’ exemption for the first four years, so they are initially not taxed on FIFs, but are taxed after four years. The new proposal would not affect the transitional residents exemption.

Somewhat frustratingly, the officials’ issues paper has been released in December with submissions due on 27 January. Given the Christmas/New Year period, this does not leave much time to review the document.

It discusses three proposals for amending the FIF rules:

Revenue account method

Under this method, non-listed shares would be treated as being on revenue account. This would mean only dividends would be taxed in New Zealand until the shares are sold or the individual ceases to be a New Zealand tax resident. Capital gains would be taxed when realised or if the person leaves New Zealand, but only as the gain relates to the period the person has been a New Zealand tax resident.

A concern raised by officials is that the applicable rate of tax (up to 39%) might still be a significant deterrence as the marginal rate tends to be lower where overseas jurisdictions tax capital gains, examples being 15% or 20% in the United States, 8% to 22.5% in Australia and 18% or 24% in the United Kingdom.

An additional concern posed is around the cost base of the shares acquired, as they would have been acquired before the individual became a New Zealand tax resident. Officials suggest the cost base should either be the value of the shares on the date the person becomes a New Zealand resident (or the date the FIF rules begin to apply to the person), or to apportion the taxable gain or loss arising into a pre-New Zealand residence portion and the remainder, with only the remainder being taxable.

The revenue account method would apply to a taxpayer’s entire portfolio – this way, they cannot cherry-pick their investments. This method would be optional, but with the inability to reverse once an election has been made. It could only be chosen in the first year a person is eligible to make the election.

A disclosure would be required, with the election to apply the revenue account method, the number of shares owned, the cost of further shares acquired throughout the year, the cost of shares disposed of throughout the year, the amount shares are disposed for throughout the year and the gain from the disposal of shares throughout the year.

Deferral method

An alternative proposal would be to apply the fair dividend rate method retrospectively upon disposal. This would involve taking the sale price of the shares and calculating the gain based on a deemed 5% per annum return over the period the taxpayer has been in New Zealand. This approach is similar to the schedule method used to calculate the tax on foreign superannuation lump sum receipts.

It would solve the cash flow issue, the valuation issue and the double taxation issue. Unfortunately, officials identify concerns around tax arising on losses given the deemed 5% per annum return. Additionally, due to the calculation method, there is a question of whether a tax credit would still be available against overseas taxes such as US capital gains tax.

Officials have considered whether both solutions adopted for foreign superannuation lump sum receipts could be utilised as part of the deferral method. The second of these solutions is the formula method, which is complex because it includes an interest charge, but would provide a way for taxpayers to be taxed on their actual gain.

Dividends would be taxable on receipt under this approach, albeit discounted in accordance with the inclusion schedule applying to a complete sale.

This method would be optional, but with the inability to reverse once an election has been made. It could only be chosen in the first year the interest is subject to the FIF rules. A disclosure would be required, with the election to apply the deferral method, the date from which the assessable period starts and whether this is the date that the individual’s transitional resident status ended or the date the shares were acquired.

Adjusting the attributable FIF income method

The attributable FIF income method is currently available for taxpayers with an income interest of 10% or more in FIF. The FIF itself needs to be active (that is, engaging in a business as opposed to earning passive income such as interest or dividends), and sufficient information needs to be available to provide to Inland Revenue to enable them to check the applicable calculations.

The benefit of the attributable FIF income method is that only dividends are taxed, unless the interest is held on revenue account, at which point any capital gains would also be taxable on sale.

The proposal would see the 10% threshold removed and thus enable any individual to access this method. Concerns are raised given that the attributable FIF income method is designed to be utilised by more active shareholders, and there would need to be some other approach to differentiate between active and passive shareholders. Possibilities being floated include restricting the 10% threshold removal to illiquid investments.

One of the issues identified with this approach is the relevant calculations are quite complex and require access to detailed financial statements which might not always be available, and accordingly, officials are not in favour of this approach, but are open to comments.

Comment

It is generally acknowledged the FIF regime exists due to the absence of a broad-based capital gains tax in New Zealand and helps ensure foreign investments are taxed in New Zealand, given foreign companies pay little in the way of dividends.

It is good to see the New Zealand government is acting to tweak these rules. While the FIF rules have been in existence since 1988, the removal of the old grey list in 2007, with the introduction of the fair dividend rate (and associated methods) regime broadened the impact of these rules significantly. In the nearly two decades since then, it has become more of an issue thanks to people moving to New Zealand and New Zealanders obtaining access to greater foreign investment opportunities.

Unfortunately, these proposals only look at share investments. We have found in practice the harsher tax consequences to skilled workers moving to New Zealand can be found in the financial arrangements rules (i.e. tax on cash and term deposits), which, among other things, see unrealised foreign exchange movements on bonds and foreign denominated mortgages being subject to tax.

Given the impact the FIF rules have on many of our clients, Baker Tilly Staples Rodway will be submitting on these proposals. If you have any comments about the proposals, please contact your Baker Tilly Staples Rodway advisor, who will be glad to discuss this further with you and forward your comments to our tax team putting together the submission. Our specialists can also help with any of your other tax requirements.