Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill — Second Reading In Committee 
Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill — Second Reading In Committee 
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Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill 
Second Reading 
Hon PETER DUNNE (Minister of Revenue) 
: 
 I move  
That the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill be now read a second time 
. The main feature of this bill is a comprehensive reform of the taxation of income from share investments whether those investments are made through intermediaries such as managed funds or made directly by individuals. It is a long overdue reform that will put the tax treatment of different types of share investment on a similar footing. That means not only greater fairness for investors but also reducing the distortions in investment decisions so that tax is not the deciding factor in people’s decisions about how to save or invest. 
It is generally acknowledged that our tax rules on share investment operate very unevenly and create a number of biases. They overtax lower-income people who invest through managed funds they favour direct investment over investment through intermediaries and they favour investment in some countries over investment in others. To remedy this longstanding problem the bill introduces a whole new set of tax rules for managed funds now to be known as portfolio investment entities and another for offshore portfolio investment in shares. 
The first set of new rules puts investment through managed funds on a similar tax footing to that of direct investment in New Zealand and Australian companies. It is particularly important to get the tax treatment of managed funds right because they are the first investment choice for many ordinary investors whose numbers will increase from July next year when KiwiSaver begins. The proposed portfolio investment entity rules achieve parity of tax treatment of managed funds in two ways: one by not taxing them on their Australasian share gains and two by taxing income earned at investors’ personal tax rates if lower than 33 percent. 
The Finance and Expenditure Committee reports that the main concerns expressed in submissions on the proposed portfolio investment entity rules were that they were too prescriptive particularly as regards the criteria for eligibility and too complex. Taking into account those concerns the committee has recommended several changes to the draft legislation. They include streamlining the eligibility criteria and allowing portfolio investment entities greater flexibility in the way they operate. The committee has also recommended deferring the application date of the new rules to 1 October 2007 to align it with the date that KiwiSaver providers start to receive contributions. That will give funds more time to prepare for what will be a major changeover for them. 
Comprehensive changes to the tax rules on offshore share portfolios are the second limb of the reform of the taxation of income from share investments. This is the area that has overshadowed all else in the bill and the area that has elicited the greatest number of submissions. The main problem of the current offshore tax rules is that they provide incentives for New Zealanders to invest directly in companies resident in eight “grey list” countries all of which are considered to have tax systems similar to New Zealand’s. The “grey list” countries are Australia Canada Germany Japan Norway Spain the United States and the United Kingdom. The tax problem arises because under our tax law income from share investments is generally taxable only on dividends and companies in “grey list” countries do not generally pay high dividends. Therefore investment in them attracts little or no New Zealand tax. Meanwhile New Zealand investors in companies resident in other countries—for example Singapore and India to name two growing investment destinations—have a much higher tax burden. They must pay tax in New Zealand on 100 percent of the increase in the value of their shares each year. That is a major inconsistency in our tax law and it creates a disincentive to investing in many of the world’s most dynamic economies. 
The fundamental principle of the reform proposed in this bill is that New Zealanders should pay tax on their investment income regardless of where it is earned. Geography should not come into it. As introduced the bill proposed removing the “grey list” distinction and taxing up to 5 percent of the value of offshore share investments each year. Gains in excess of the 5 percent cap were to be carried forward to be taxed in later years with losses being deductible in a similar way. The many submissions on this part of the reform were critical of that proposed method which was seen as too complex and as taxing unrealised capital gains. 
In response to those concerns as well as to suggestions in a number of submissions that a deemed rate of return method would be preferable the Minister of Finance and I suggested to the committee that it consider replacing the original proposal with a fair dividend rate method—a form of deemed rate of return. That method would tax investors on 5 percent of the opening market value of shares held at the start of a year. However individuals investing directly and through family trusts would be able to pay tax on their actual returns if they were lower than 5 percent with no tax payable when returns were negative. That would deal with the concerns of some people that their offshore investments would be taxed even if they made a loss in a particular year. 
We saw the fair-dividend rate as a sensible replacement both on grounds of simplicity and of fairness because it would tax something close to a reasonable dividend yield rather than target capital gains. In a second round of consultation the committee found general agreement that the fair-dividend method was preferable to that originally proposed. Nevertheless many of those who were consulted preferred a lower fixed rate of between 3 and 4 percent on the grounds that it was more representative of average offshore dividend yields. The counter argument was that a 5 percent dividend rate would be more suitable because it would approximate the dividend yield of Australasian equities. One should remember here that many other countries have tax rules that discourage dividend payments which creates many of the inconsistencies that have made this reform necessary in the first place. 
Having listened to all sides in what was an extraordinarily technical debate the committee has recommended adoption of the 5 percent fair-dividend rate method. Consistent with the idea put forward by Ministers it would not tax individuals in family trusts in years when they made a loss. Under this approach managed funds will pay tax on a flat 5 percent of the value of offshore investments even in years when the return is less. Although some may argue that this creates a disadvantage for managed funds relative to direct investors the reality is more complex. Under the new rules managed funds have a number of tax advantages that direct investors do not enjoy including a tax rate that is capped at 33 percent and Australasian capital gains exemption. It is also very important to remember the major tax disadvantages that the managed funds currently face. At the moment they pay tax on virtually all their capital gains from onshore and offshore shares and they face a flat 33 percent tax rate even though many of their investors are on a tax rate of 19.5 percent. These reforms sweep away virtually all those disadvantages. 
The significant net improvement in the tax position of the New Zealand managed funds sector under the reforms is supported by recent analysis by the savings industry. That analysis shows that under a fair-dividend rate method most investors in New Zealand managed funds will enjoy a reduction in the tax they pay on their offshore investments. 
I think the committee has done a magnificent job of forging a consensus where there was none midway through the process. Whether the fixed rate is 5 percent or 3.5 percent is actually almost a detail. The important thing is that the committee has come up with a big picture solution that most can accept. That is a considerable achievement and I congratulate the committee members on that. The committee has also recommended a number of changes to other matters in the bill which I fully support but which I do not have the time to go into in detail here. Those are set out in far more detail in the committee’s report which members will be familiar with. 
In addition a Supplementary Order Paper that I released today extends the tax exemption from employer contributions to KiwiSaver to other registered superannuation schemes. This is a further measure to help New Zealanders save for their future. The exemption will apply to schemes and sections within schemes where the benefits paid depend on contributions made and on their returns. 
I conclude by thanking the Finance and Expenditure Committee for its hard work on this very complex bill and I commend its report and the bill to the House. 
Dr the Hon LOCKWOOD SMITH (National—Rodney) 
: 
 This is very important tax legislation. It has the potential to impact severely on investment in this country. The Finance and Expenditure Committee was told for example that this legislation has the potential to divert even more investment into residential property in New Zealand—an area where New Zealand does not need more investment. So it is very important legislation. 
Quite contrary to what the Minister of Revenue has just said the process the Government has gone through I would argue is not how we develop sound legislation at all. One respected submitter to the select committee said that this was legislation through media statement. I want people listening to this debate to know that most people who are interested in taxation matters in New Zealand have had no opportunity to make submissions on this legislation that we are debating tonight. Sure they had the chance to make submissions on the legislation the Government introduced but that is totally different from what we are debating tonight. The Government introduced legislation that would shrink the number of “grey list” countries and introduce and impose a capital gains tax on 85 percent of the gain on foreign portfolio investments. When I say portfolio investments I mean where New Zealanders have investments and shares offshore and the ownership of the company is less than 10 percent. 
The legislation as introduced is what the public and those interested in taxation matters were able to make submissions on. Tonight we are debating something totally different. Tonight we are debating this 5 percent fair dividend tax that the Government has now come up with halfway through the process. What makes this a bad process is that most of the 2226 submitters on the original legislation—and of course 99 percent of them were against it—never had a chance to make submissions on the subject of our debate tonight. About 12 of those 2226 submitters on the original legislation were invited by the select committee to make submissions on this totally changed legislation. That is just unfair to the so many other people who made submissions on the new capital gains tax that the Government proposed to introduce. It is so unfair to them that they never had the opportunity at all to make submissions on this 5 percent fair dividend rate tax. Those who did make submissions pointed out that there is nothing fair about this 5 percent fair dividend rate and there is nothing about just taxing dividends in this 5 percent fair dividend rate. When we look at the international weighted dividend yield a 5 percent rate clearly taxes capital gains. 
This Labour - United Future - New Zealand First Government has to decide what it intends to do with this taxation of portfolio investments offshore. Does it intend to tax capital gains or not? This legislation that we are debating tonight does still tax capital gains. I will get into that detail. 
What makes it even worse is that today a Supplementary Order Paper was introduced. The Minister did not even refer to it in his speech. 
Hon Peter Dunne 
: Yes I did. 
Dr the Hon LOCKWOOD SMITH 
: I apologise if he did. Today a Supplementary Order Paper has been introduced that makes yet another last-minute change. This is the second time we have seen that. With the KiwiSaver legislation the Government made a last-minute change that no one in the public had the chance to make a submission on and again no one in the public has a chance to make a submission on this very significant last-minute change to this legislation—a change that will extend the exemption from specified superannuation contribution withholding tax from employer contributions to superannuation schemes other than KiwiSaver schemes. Although I accept that that move is something National would support it is still a matter of principle in New Zealand that the public should have the chance to make submissions on legislation to ensure that the quality of the legislation produced is acceptable. 
I want to look at some of the detail of the measures in this bill to impose this 5 percent fair dividend rate. The select committee’s commentary on the bill sets out the Government’s objective. It states: “The objective of these changes was to tax portfolio investments in offshore companies more consistently regardless of whether the investment was made through a managed fund or made directly and regardless of where the investment was located.” This legislation we are debating does not achieve that objective at all. 
 Managed funds and individuals’ portfolio investments in companies overseas are treated totally differently. For example if we invest through a managed fund we are taxed on a 5 percent return regardless. If we invest as individuals in portfolio investments offshore we will be taxed on the actual return from those investments in any one year on up to a 5 percent maximum return. It is totally different treatment. If the objective was to make managed funds and individuals’ taxation the same when investing offshore then it would have been quite simple to change that and to make the two policies consistent. 
The provisions to enable individuals to be taxed at a return below that 5 percent flat rate for managed funds are complex. I will mention this exchange although it is probably a bit unfair to one of our advisers. At the select committee we asked a very senior adviser who knows this legislation inside out whether he would bother to have his portfolio investments offshore taxed at an actual return rate. This very experienced adviser indicated to the select committee that he probably would not. He indicated that the provisions are so complex that it would not be worth the candle to do it and that he would probably just pay the tax on the 5 percent flat return. When a senior adviser who knows the legislation inside out suggests that it is too complex to bother trying to get the benefit of being taxed on less than that 5 percent return we clearly have very very complex legislation and I suggest totally unsatisfactory legislation. 
Another big difference is a $50000 de minimis for individual investors. In other words individual investors have a $50000 zone of investment offshore on which they are not taxed. If they invest through a fund they do not have that. Funds will be consistently taxed therefore more than the investments of private individuals. That $50000 de minimis means there will be no tax to pay on a $50000 investment. If $50001 is invested the full tax rate is paid on the lot. The effective marginal tax rate on those extra few dollars above $50000 is thousands of percent. The result is that wives children and pets will all be listed as having shares offshore because no one in his right mind would pay those kinds of marginal tax rates. 
The select committee was advised that managed funds in New Zealand will migrate to Australia because with the complexity of these rules it just will not be worth being involved in New Zealand. If we invest in private companies offshore then either those will have to be revalued every year or we will have to pay tax on an assumed 5 percent gain. We were told at the select committee that this legislation will make it hard to recruit highly skilled people internationally. It was pointed out to us that if the value of the New Zealand dollar drops people will be taxed just if the currency shifts. If people get a New Zealand return then they can be taxed just on a New Zealand dollar shift. The New Zealand dollar value of offshore investments may go up if the New Zealand dollar drops and people would be taxed just on that currency shift. If the value of people’s investments drop this year they will not be taxed. If next year the value returns to the same level it started at last year then people will be taxed on that gain yet their net position will be unchanged. They will be no better off but they will be taxed on that gain just by the value returning to where it started. 
But the most serious thing as so many experienced funds managers pointed out to the select committee is that this legislation will distort investment. It will provide a serious disincentive to invest offshore in a diversified portfolio. This legislation will provide an even greater incentive for New Zealanders to bring back their money from overseas and invest in residential property here in New Zealand. People get the capital gains free and the returns are far better so why would they not? This is bad legislation because of all those complexities and distortions. 
R DOUG WOOLERTON (NZ First) 
: 
 New Zealand First supports the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill and we do so because it is a genuine attempt to make investment fairer across the board. Members will know that we have not had complete agreement in our caucus. I think members can take from that that we in New Zealand First have had a very very robust debate on this issue have not come to our conclusions lightly and have not given the bill just a once-over-lightly. We have gone into it in depth. 
It has always been iniquitous that what I like to call managed funds in New Zealand have been taxed at a rate of 33 percent whereas other investments have been taxed at the taxation level of the investor. Under this bill there will be a flow-through effect for those people who are on a lower tax rate and who invest largely in managed funds because they either do not have the expertise to invest for themselves or do not want to be bothered with it. I have said in earlier speeches that when the current leader of the National Party John Key was on our Finance and Expenditure Committee he seemed to come from the angle—and I do not blame him for it because this is his area of expertise—that every person who invests is an expert every person who invests comes from a background of expertise but that is way beyond the actual case in New Zealand. This bill for the first time makes an attempt to look after the mum and dad investors. We have to do that because there is a flow-through effect for KiwiSaver. The bill recognises even then that there are some small differences and at the end of the day we have had to accept a few compromises in this bill which we knew we would have to do—that was always recognised. 
It is pretty rich for Dr Lockwood Smith—who has been a valuable member of the select committee I might say—to say that there was an unprecedented number of submitters on the original bill and that not much diligence was shown in producing the modified bill as set out by the Minister of Revenue at the beginning of this debate. I would suggest most strongly that that is the proper response of a proper democratic select committee. If there is a whole bunch of submitters—and on this bill there were close to 3000—and there is significant opposition to a bill surely the right thing to do is to change that bill and to change it substantially in line with what the submitters require. That is exactly and precisely what has been done in this case yet Dr Lockwood Smith criticises that. 
We know that National members are not absolutely staunch in their criticism of this bill because they too recognise that although it is in some ways a compromise it is a huge step forward. We know that because those members have said that if they were to come to power some years hence they would not change it they would not kick this bill out and that is politics-speak for saying that they actually agree with it. 
Rather than criticise the select committee and the Government for changing the bill I applaud the select committee of which I am a proud member. I applaud the chairman of that select committee the officials and the Minister for listening to submitters. It would be a very barren Parliament I suggest that did not listen to close to 3000 people on an issue such as this one. 
Something that I certainly can take away from the select committee process is an insight into the issues that surround financial investment. I was impressed by the level of investment that people in this country make and the level of care and foresight that they put into looking after themselves in their old age looking after their families and in fact looking after their grandchildren by way of investment. It was quite touching actually to see people come to talk to the select committee not only on their own behalf—although most did that I must say—but also on behalf of others. 
Sitting suspended from 6 p.m. to 7.30 p.m. 
R DOUG WOOLERTON 
: In the 4 minutes and 30 seconds I have remaining I would like to speak about the fair dividend rate which is something the select committee settled on to take care of the conundrum of taxing equally everybody in the investment market. Dr Lockwood Smith has criticised the fair dividend rate of 5 percent saying that it is not fair and is too high. I point out to him that in actual fact the deemed dividend rate which he and his party would have supported—and I know this because of conversations in the select committee—would have worked out at about 3.4 percent in normal circumstances. I am sure the Minister will nod at me if I am correct. So the fair dividend rate of 5 percent is not too far away from the 3 percent deemed dividend rate that National would favour. But the fair dividend rate does not tax an investor in the year of a loss whereas the National Party’s proposed 3 percent deemed dividend rate would tax the investment even in years of a loss. Dr Lockwood Smith fails to mention that National would support a regime that taxed people when they made a loss. We in New Zealand First—dare I say it we on this side of the House—would never agree to such a situation because tax not only has to be fair but also has to be seen to be fair for people to participate in a voluntary tax regime that we run in New Zealand. 
Just before I run out of time I want to endorse this time a statement made by Dr Lockwood Smith but I want to endorse it from a different perspective. We believe that most people instead of going through all of the calculations required to pay this tax on their investment will just forget about doing that. They will not bother with accountants they will not bother mucking around and they will not worry about the infinite detail; they will simply pay the 5 percent on a regular basis at the beginning of each year. What does that tell us and why do I mention it? If people really thought this fair dividend rate at 5 percent was unfair—as they are proposing tongue-in-cheek—they would not do such a thing. They would hire accountants and go to the end of the earth to do whatever calculations it took to avoid paying that amount. But they see it as fair and I suggest—and it is certainly the view of the Government members on the select committee and those of us who support the Government—that by and large it will be paid straight up by most people. They will pay the 5 percent rather than muck around working out the calculations. 
It is true to say that most submitters would have favoured no change at all. Most people who presented to the select committee were direct investors who get tax rates that are not available to what I call the ordinary Kiwi. That is what this bill sets out to redress and it is no wonder in that case that most people who submitted were opposed to the bill. Given that and given that the select committee made the changes that most people would have wished us to make it is fair to say that New Zealand First members are pretty confident in supporting this bill. 
Hon BILL ENGLISH (National—Clutha-Southland) 
: 
 I think the previous speaker Doug Woolerton just showed how bereft the Government’s general approach to tax policy is becoming when he set forth for the benefit of the House the rather radical idea that this legislation is good because it is too complicated for people to get fair taxation so they will go for the simple version which means they will pay more than they should. Well that is a bad principle of tax policy. It should be the case that any taxpayer is able to understand their liability—that being a fairly calculated liability. Instead New Zealand First have decided—maybe it was intentional—to make the alternative so complicated that all direct investors will end up paying the higher rate when they could have got a lower one. This is actually a bad principle and it raises the issue of just what tax principles the Government now adheres to. 
We know this is a difficult area. I can recall giving speeches on tax measures related to exactly this problem almost 10 years ago—1986 or 1987 I think; maybe it was 1998—when the whole thing fell over partly because of the complexity that is now built into this law. In that case the member Doug Woolerton may be interested to know it was his party that pulled the plug for exactly the reason that he said that he supports this bill. Last time it pulled the plug because it was too complicated for an individual taxpayer to be taxed at the right rate. Today he said that he supports the legislation because it is too complicated for an individual taxpayer to be taxed at the right rate. Well I guess that is just politics and the passage of time. So I acknowledge that this is a difficult area and National does to. 
Actually a significant number of taxpayers will be better off. The Government has given up what looks like about $150 million of revenue by taxing people in the managed funds at the right rate—that being their own rate—and it will stop taxing capital gains. Those are good things. But the Government’s tax principles are getting harder and harder to divine. Certainly this process has been a mess just like the KiwiSaver process was. The only saving grace is that this result is better than what would have happened if Government members had not changed their minds and completely bypassed the generic tax policy process to get a result. 
Just when I thought maybe it was worth the effort today the Government announced a major change directly relevant to this regime saying it will extend exemption from the specified superannuation contributions withholding tax to superannuation funds that meet the criteria. The generic tax policy process stood the test of time and it is a real pity the Government has abandoned it—a real shame—because in the long run it will undermine the confidence of tax practitioners and taxpayers in the policy-making process. It might suit the Government in the short term—and we are seeing this fading Government take more and more short-term measures—but in the long term it will lead to greater complexity less compliance and less certainty about our tax system. Any Government needs consistent reminding by taxpayers about the impact of tax measures on them and those taxpayers need real and active opportunities to help shape the policy because that is what buys them into it. I would like to hear from the Government tonight as to whether it intends all its tax measures to now bypass the process. 
We are seeing an accumulation of multiplying complexity in our tax system. From the day the Government decided to put the top tax rate up to 39c we have seen a whole industry redevelop—one that I thought we had got rid of. It used to be the bad old days when people spent as much time working out their tax liability as they did creating wealth. Well particularly when it comes to anything to do with international taxes and anything to do with savings and superannuation people are now back into that business. There is more and more complexity for no obvious or well-specified benefit. 
I cannot help thinking Dr Cullen has fallen into the trap of his own cleverness. He has now moved away from the basic sound tax principles of broad bases low rates and no holes. He has now decided that he is the tax magician. He is sitting there in his office pulling a credit here an exemption there a deduction there a concession over there—and New Zealanders are the rats in the laboratory who are all meant to follow around according to the particular incentives and signals that Dr Cullen is trying to send. 
The abandonment of the generic tax policy process is a symptom of the fact that the Government is losing its rationale for how it is operating the tax system. It has become totally focused on ad hoc decisions driven by political forces and on trying to square up revenue when it knows it could actually afford to give it away. So that is the problem with the Government’s principles. 
To return to the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill itself is it not fascinating to see how our perception of different policy measures can change. When the McLeod Tax Review first came up with the idea of taxing deemed returns it was regarded—by probably most people—as quite radical. It is quite a logical idea but at the time that report came out back in 2001 there was really no political interest in it. Yet here we are where the same kind of measure—not exactly the same but similar—has turned out to be the one way of rescuing one of the long-running tax problems that the Government has had to deal with. I give the Finance and Expenditure Committee some credit for coming up with a better solution because if they had not this of course would have been a disaster. 
It is also clear from the select committee process that the Government vastly underestimated how many Kiwis were behaving in a rational way and directly investing savings overseas. I do not think the Government actually believed anyone was doing it; or it believed that if they did it then they were rich fat cats and deserved to get slugged. But of course the select committee was overwhelmed with several thousand submissions. Is it not ironic that Dr Cullen lectured us endlessly about not investing in housing and about the need to diversify and to get into financial investments but remained completely unaware of the fact that thousands of Kiwis were already doing it? That is a serious question. How did the Government ever conceive that its original measures would be acceptable? It could only be because Government members were either ignorant or stupid: ignorant in that they did not know the scale of direct investment by New Zealanders or stupid in that they knew and thought people were going to wear the original proposals—and of course those people did not. 
I am particularly concerned about the Supplementary Order Paper that the Government has put down that extends the exemption to employers’ superannuation schemes. Dr Cullen is now put in a position where he looks like he never thought of it. He came up with this measure did not think about the implications of it then at the last minute realised that he was going to skew investment patterns if he did not have the same exemptions for employers’ superannuation schemes as he had for KiwiSaver. Now is that not sloppy policy? One would have thought that in any regime in which the Government was looking at changing the regime on taxes on savings the connections from one bit to another would have been thoroughly examined and understood and built into the original proposals. 
Some of this legislation does represent progress. But I would have to say that the environment in which it has been pushed forward gives me real concern—both because the Government has abandoned good principles of tax policy and also because it is clear from its very significant last-minute manoeuvre to extend the exemption to employers’ superannuation schemes that it had not thought through the policy. It just had not thought about the connections which are pretty obvious. There is a whole Inland Revenue Department full of officials over there and Treasury and apparently the smartest Minister of Finance the world has ever seen yet they had never thought of it until yesterday. 
JEANETTE FITZSIMONS (Green) 
: 
 There are certain principles that a good tax system ought to try to observe. They would include having a broad-based system with a wide range of tax sources so that none of them needed to be taxed at too high a rate. They would include having a system that was fair in two senses: first that people in the same situation were treated the same and second that people were taxed according to ability to pay. A good tax system should be easy for the taxpayer to understand and comply with and it should be easy for the Government to administer. 
The present tax system does not meet those tests and neither does the tax system set out by the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill. The bill does address some anomalies but in doing so it creates others. Overall it replaces a dog’s breakfast with a different kind of dog’s breakfast. The Greens would like to vote for the annual rates and for the pass-through rules for managed funds which we strongly support. But we would like to vote against the overseas investment rules which are overall no more fair or simple than the present system. We will therefore abstain at this reading and at the third reading. 
The current system of tax has some major faults. We currently tax all those activities we want most to encourage: work and enterprise. We currently leave untaxed those activities we most wish to discourage: waste pollution use of scarce resources and speculation. However this bill does not address those issues at all—they are not on the Government’s radar despite our efforts. So I will turn to those matters that are addressed by the bill. 
The current situation does not treat taxpayers who are in like situations in a like manner so the system already breaches that principle. Overseas investors are treated differently depending on whether they are in countries on the “grey list” or in some other overseas country. Investors on a low tax rate pay more if they invest in managed funds than if they invest directly. Investors who are on a 39c tax rate pay less tax if they invest through a managed fund than if they invest directly. Investment in property is treated quite differently from investments in the sharemarket and I believe strongly biases investment towards property which has a lot of other side effects. Some investments pay no tax at all because they pay no dividend and all of the gains are paid out as capital gains which are untaxed. So looking at that particular dog’s breakfast we can see that the bill solves a few of those problems. 
The look-through rule for the portfolio investment entities is a very good move and we support it but if people’s tax rate is 19c in the dollar then that is all they should be paying regardless of whether they invest directly or through a managed fund. However the bill does not address the fact that people on a 39c tax rate are still advantaged if they invest through a managed fund. 
The bill tries to deal with those UK entities that pay no or little dividend and that provide all the benefit through a capital gain but it does not deal with them very well. In the process of trying to solve those problems the bill creates more anomalies. As the bill was introduced it removed capital gains tax on New Zealand and Australian investments and put it on investments in countries on the “grey list”—those eight countries that have previously been exempt. That created far more howls of protest and outrage than the revenue effect actually justified. The bill provided an exemption after negotiation for one company that had particularly skilled lobbyists. It also provided exemptions for people with investments of less than $50000—but many KiwiSavers will find that as their savings accumulate they will shoot through that ceiling of $50000 and become liable for tax on those investments. 
There were a huge number of submissions. The Finance and Expenditure Committee sat for weeks and weeks to hear them and they were very similar. As a result of those submissions we suddenly got a Supplementary Order Paper. After all those weeks of getting our heads around the incredible complications of the capital gains tax regime we then found overnight that the capital gains tax regime had gone— 
Dr the Hon Lockwood Smith 
: Sort of gone. 
JEANETTE FITZSIMONS 
: Sort of gone. We still have an exemption for one company which still has its very skilled lobbyists and we still have the exemption for investments up to $50000. The system still treats Australia and New Zealand differently from the rest of the world and one of the anomalies we have now is that that creates real boundary problems. What is a New Zealand company or an Australian company? Can it be defined? Submitters suggested to us that it would be very difficult to determine whether a company was a New Zealand company or Australian—what about its parentage its subsidiaries and so on? The system still treats investment in property and investment in shares on quite a different basis. So the bill has made a good attempt to address some anomalies but it has created others in the process. 
After hearing submitter after submitter say that the bill was unfair because it did not treat like investors in the same way that it was hugely complex and people would need an accountant and a tax lawyer to comply with it that taxpayers would find it hard to follow and that finance companies and managed funds would find it hard to comply with I eventually started asking questions of those submitters. I asked quite a number of questions. I asked whether it would be fairer and simpler if instead of all this dog’s breakfast we had a straightforward capital gains tax on all income from capital gains across the board with no exemptions. All the submitters to whom I put that question said that that would undoubtedly be simpler but that politicians would never go there. I wrote down the answer that John Shewan gave me. He said we would not be sitting here today if we had a comprehensive capital gains tax across all types of investment. So I am disappointed that the Government has chosen yet again not to look at that possibility. It would not be very hard to sell it to the public if it was made clear that additional tax would not be taken and that a broad-based capital gains tax would enable tax rates of other sorts to be lowered particularly income tax rates. The Greens’ preference would be to use the tax to provide a tax-free band at the bottom of the income tax scale which would mean every taxpayer got the same rebate. However the Government has not gone there. 
The absence of a capital gains tax is distortionary in other ways. It certainly is a big contributor to the overheated property market and to inflation and that has been identified by the Governor of the Reserve Bank. The absence of a capital gains tax makes things very difficult because it distorts investment behaviour into property. People’s second homes and investment properties push prices up. Young families cannot get housing and cannot get their own homes. It would be entirely possible to exempt the primary family home for every family from capital gains tax but to charge it on all other kinds of property investments. That would stabilise property prices stabilise the housing market enable young families to get into housing help with the inflation rate and help with New Zealanders’ level of indebtedness whereby they are borrowing against these ridiculously inflated house prices in the assumption that prices will go on rising whereas we know that a day will come when they will not. 
SHANE JONES (Labour) 
: 
 Kia ora anotatou. Firstly I acknowledge the efforts of my committee members on this marathon task of dealing with the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill. However I must say that when we prepared to break into a subcommittee and hear from the four winds what the various submitters had to say no one was more vocal than John Key about insisting that we spend the time and give concentration and effort to the people from Auckland particularly the submitters because they are high-quality very influential and likely to offer very coherent views that might influence the Government’s policy. It came as a great disappointment but not as a surprise to Doug Woolerton and others that the very person who never showed up to any of the hearings was John Key. 
I give full marks to the deputy chairperson of the Finance and Expenditure Committee—my fellow Northlander—who when we became bored of talking about tax compared notes about bulls. Before I talk about anyone else in the committee I pay a vote of thanks to Robin Oliver and his team. We were served up an array of problems and the committee went through a series of permutations but I must say to Mr Oliver and his team that they attended to our every need answered all of the questions and followed us from Auckland Wellington and down to Christchurch. So I pay a vote of thanks to them. Irrespective of who the Minister might be or perish the thought who the party might be we are well served by Robin Oliver and his team. 
Let us move to the lame very vacuous assertions that have been made by Mr English and others that we abandoned process. Let us get a few facts on the table. Fact number one is that no one less than Sir Roger Douglas recently commented to me when I saw him at a social occasion that this problem has bedevilled many Governments. It caused him some consternation and it defeated Ruth Richardson. Indeed we have employed and seen a host of experts come through the process and offer us their views such as my good friend Rob McLeod and Mr Stobo and it fell to this committee to craft a suitable and reasonable solution to a longstanding problem. 
In crafting this solution I remind everyone that there have been about eight policy documents over the last year or slightly longer so anyone who is suggesting to the public—who no doubt are riveted listening to these speeches at the end of the year—that due process was destroyed is not dealing with the facts. At the end of our process we provided an opportunity for nigh on 15 to 20 of New Zealand’s experts to give us their view about the fair dividend rate model. Of course there are a host of other aspects to this bill but the fair dividend rate model worked most people into a lather and it was all based on misinformation. 
I cannot say with any authority that that misinformation was fed by the Opposition but there was gross misinformation that was no doubt aided by the accountants whose capacity to add value is inversely related to the costs they charge. However absolute opportunity was created for the experts throughout the commercial community. Prior to that we heard from all members of the submitter community who wanted an opportunity to put forward their submissions or to speak to their submissions. 
It became apparent to the long-serving highly productive and industrious committee members aided by Mr Woolerton and our friends from the minority parties that this bill in the context of MMP politics aided with great advice from the officials could be improved upon. That is the essence of parliamentary democracy. One is served up legislation on a select committee and nothing is incapable of being improved upon. We heard from the submitters that the model we dubbed the 85 percent model was certainly capable of being enhanced. We had the opportunity to hear from Mr John Shewan from PricewaterhouseCoopers. He promoted the model of a deemed rate. Initially that model gained some favour. However he himself lost his enthusiasm to advocate for it presumably because some of his own clients did not like the idea—they wanted to pay zero tax. 
From out of the atmosphere that comprises parliamentary democracy we received a letter from the Minister of Finance the Minister of Revenue who invited us to study the fair dividend rate model. This particular part of the bill generated most of the submissions and we concentrated on it—some might say disproportionately but we gave it a suitable amount of effort and time—and we have delivered what I think is a reasonable compromise at this point in time. 
There have been earlier references to the importance of simplicity. The 5 percent model for the funds industry is a paragon of simplicity. To take into consideration the anxieties of the direct investors we have maintained the de minimis. We have also given them the opportunity to pay on that which they actually earn. 
Throughout the entire process Mr Woolerton myself and—indeed—Mr Copeland asked individual submitters what they were actually earning when they put their dough into international equities and why were they content to continue leaving their investments marooned at a 1.5 percent to 2 percent return. Of course we never got a satisfactory answer. In many cases we were led to believe that the full return on that investment was actually wrapped up in a capital receipt rammed back home to escape the tax net. How if we let that happen are we going to meet the cost of hospitals roads and a whole variety of other public-good investments? 
There has been some loose and very ill-informed language about this being a capital gains tax. Nothing—nothing—in this legislation suggests to me that it is a capital gains tax. It is a tax on the dividend and on that portion of the dividend that sits in the growing equity and it takes an approximation of what a reasonable person is going to earn. Who on earth is putting millions of dollars overseas for anything less than 5 percent? As no one less august than Winston Peters has said people may as well leave their money in the Kiwibank. Those are words that obviously reflect many years of wisdom as a long-term parliamentarian. 
However I would like to say in wrapping up that the select committee worked together well. We had our differences and part of the bill is supported and part is not supported by our friends from National. But we were there as legislators and agreed to park the adversarialism in the House and endeavour to do the best that we could with the hordes of submitters writing to us and wanting to speak to us. In levels of interest—some I hope as a parliamentarian never to see again—Bruce Sheppard looms very large on that list. No doubt in what passes for my career we will see a lot more of him. But we have a great deal of support out there amongst the professional advisers and the investment industry especially those coming from the funds industry because they have certainty they have simplicity and I think in time they will come to love what they have been served up. 
TE URUROA FLAVELL (Maori Party—Waiariki) 
: 
Tenatatou katoa. Amidst all of the fanfare that came with the 2006 census figures last week there were a couple of facts that are relevant to the debate today. Fact No. 1 is that for Maori aged 15 years and over the median income is $20900. For all New Zealanders the median income is $24400. That is a tangible difference between Maori and everyone else of $3500. Fact No. 2 is that 10.2 percent of Maori have an annual income of more than $50000 compared with 18 percent of all New Zealanders. 
Some members may be familiar with a gentleman by the name of Henry Ward Beecher a Presbyterian minister who like his sister Harriet advocated for the abolition of slavery and for the right to social justice. One of his sayings was: “In this world it is not what we take up but what we give up that makes us rich.” Looking at the situation described in those census statistics and being mindful of the ever-increasing gaps between rich and poor in this land the Maori Party comes to the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill wondering what this Government will give up in order to make all New Zealanders rich. 
The Maori Party taxation policy is driven by two key forces: manaakitanga and rangatiratanga. The application of manaakitanga would be evident in acknowledging the mana of others as having importance that is equal to or greater than one’s own through the expression of aroha hospitality generosity and mutual respect. In practising rangatiratanga there is an emphasis on following through on commitments made and integrity and honesty are demonstrated. So it is that manaakitanga and rangatiratanga lead us to address the 1.9 million taxpayers in this nation who are on an income of less than $25000. Those people are paying a massive $3.5 billion in tax while at the same time the Government accumulates surpluses that in the last financial year have totalled an amount of $11 billion. So we look to those people in any initiative that is seemingly designed to enhance the economic position of New Zealanders. 
The central feature of this bill is meant to be a reform of the taxation of income from share investments—New Zealand - based managed funds or direct investment—with the clear purpose of removing inconsistencies. The Maori Party is certainly supportive of any initiative that can act in a way to enhance fairness and consistency in savings policies. We know that the current taxation rules on share investment have needed an overhaul for quite some time. The treatment of individuals and companies has been at best uneven. Direct investment by individuals appears to have been favoured over investment through managed funds. Some investors are overtaxed. So this bill was intended to place the taxation treatment of different types of share investment on an equal footing. The bill is branded as introducing greater fairness into the rules and reducing the distortions that are evident in current taxation policy. Well that is all well and good. But does it do that? 
In order to understand the reform we need to take the widest possible view. To look at only part of the picture will inevitably short-change those New Zealanders who are looking for greater fairness in the way their investment income is taxed. Despite the stated purpose of reducing the taxation distortions on investments the bill introduces an ad hoc capital gains tax regime rather than one that has consistency. The bill also attempts harmonisation between Australia and Aotearoa allowing equity between investors operating in both countries. In effect that means New Zealanders can invest in Australia instead of New Zealand without a taxation penalty. We need to ask what benefit it will be to the nation if people invest elsewhere. The bill suggests that from next year people who invest in New Zealand - based managed funds will see greater fairness in the way their investment income is taxed. The new rules will remove several taxation disadvantages for people who invest through managed funds many of whom are described as ordinary middle-income savers. 
Into that mix let us throw the humble New Zealand pie. We are not talking about the mince and cheese variety. The pie introduced in this bill is a portfolio investment entity which comprises any savings vehicle that elects to go into the regime. The bill removes the current major taxation disadvantages from New Zealand managed funds: the full tax on capital gains and overtaxation of low-rate investors. By treating those funds in a similar way to direct investment by individuals the disadvantages are removed. Investors in actively managed funds who invest offshore would be significantly better off under the fair dividend rate than under the current rules. Alongside that the Finance and Expenditure Committee reported that investors in actively managed funds who invest offshore would be significantly better off under the fair dividend rate that it has recommended than under the current tax rules. We note too that for individual investors and family trusts if the return on investment is less than 5 percent of the opening market value individual investors and family trusts will not be taxed at the fair dividend rate—5 percent—but at a lower rate or they will pay no tax. So we are in the same situation again of some people paying tax and others not. 
We are also concerned about the tax increase on superannuation contributions that faces lower-income earners who are being made to offset the risk of “salary sacrifice” by higher-income earners. It is those people who form the “not” category that we speak of today. Although we support the removal of the different taxation rates from those who invest directly and those who invest through managed funds our primary concern is about those New Zealanders who struggle to put kai on their tables let alone to contribute to a savings culture. Every dollar of a poor person is taxed including the dollars of those persons on benefits. However this bill determines that those on high incomes have the means to benefit from asset value increases which are non-taxable. We have to ask whether that is fair. 
Our other key concern around the whole concept of a savings culture is associated with our concerns around the concept of the genuine progress index. That is the argument that says we need to broaden the tax base so that taxation is also used as a valid means of demonstrating the real costs of pollution and environmental damage. In the context of the capital gains tax for example we know that investors are receiving taxation concessions even though it is not known whether any actual income is being made. If income were calculated on the full cost basis the actual capital gain might be negative but investors have no idea of how much depletion of or damage to the environment is occurring. There is a good chance that capital gains are overstated and a good possibility that there is no capital gain. Thus although a company may be able to claim a positive and growing wealth it is a false claim a false measure of wealth because it has failed to take account of all the costs involved. The notion of gain and wealth masks potential because that is not really accounted for. The market response to that argument is that the market knows and that it takes all of that into account. The genuine reply to that is to ask how the market knows because it is not being measured. 
Finally it is appropriate to refer to the recent study released last week by the World Institute for Development Economics Research. The Helsinki-based institute has estimated that the richest 2 percent of adults own more than half of global wealth while the bottom half of the population own a mere 1 percent. If 2 percent of adults have more than half of the world’s wealth including property and financial assets in their hands I ask whether that is fair. Is it just that in Aotearoa the proportion of all children who are in severe or significant hardship has increased from 18 percent to 26 percent since 2000? Is it socially desirable that the people who suffer the greatest poverty in New Zealand are our children with 38 percent of them in the hardship categories? I remind the House of the statement I made earlier: in this world it is not what we take up but what we give up that makes us rich. What are we prepared to give up in order to enhance wealth creation for all citizens of Aotearoa? 
I advise the Minister that the Maori Party is a little ambivalent with regard to this bill. Our concerns regarding poverty and the big picture lead us to vote against it at this point in time but we are prepared to consider other views further on. Kia ora tatou.  
GORDON COPELAND (United Future) 
: 
 In my maiden speech to Parliament on 29 August 2002 I stated that one of my goals in coming into Parliament was to overhaul a discriminatory tax system that skews New Zealand investment in the direction of housing while starving business of much-needed capital growth. That was something identified for us by Sir Ivor Richardson one of New Zealand’s tax experts in the 1988 Royal Commission on Social Policy. The United States for example has 34 percent of total household assets in housing and 66 percent in other investment assets such as stocks and bonds. New Zealand is diametrically the opposite with 61 percent in housing and just 39 percent in growth-orientated assets. So immediately I came into Parliament I began working on this issue. 
Prior to coming into Parliament it was obvious to me that saving through interest-yielding bonds stocks and shares etc. through superannuation funds and other managed funds were greatly disadvantaged in New Zealand when compared with the alternative of investing in the rental housing market. I was well aware of those realities because during the 1980s when hundreds of New Zealand corporates were busy winding up their staff superannuation schemes I was busy setting one up for the Catholic Archdiocese of Wellington. I well remember the disappointment of staff members over the next few years that the returns achieved through the fund which was managed by a large financial service organisation were below their expectations. 
Disadvantage of course is a relative thing but I am here referring to the high degree of overtaxation on investment through superannuation and other portfolio investment funds when compared with the alternative of investment in the residential rental housing market. I will briefly outline the three major disadvantages because when this taxation bill becomes law this week they will all have been overcome. 
The first was in relation to the taxation rate on employers’ contributions on behalf of their staff superannuation funds. Those contributions when I came into Parliament were taxed at a flat rate of 33c in the dollar which of course greatly disadvantaged the many staff saving through those funds whose marginal tax rate was just 19.5 percent. Still to this day 75 percent of all New Zealand taxpayers pay tax at 19.5 percent or less. However the top tax rates on such contributions had remained capped at 33c. Early on in the last Parliament I took that point up with Dr Michael Cullen and the tax on such contributions was adjusted to the marginal tax rate of the saver in the 2003 Budget. The first disadvantage had been removed. 
The second problem was that savers’ earnings in portfolio investment funds were also taxed at a flat rate of 33c in the dollar. Others have mentioned that Roger Douglas grappled with that problem. Various Ministers of Finance during the 1990s grappled with that problem but when I came into Parliament such funds were still taxed at a flat rate of 33c in the dollar. That of course also greatly disadvantages the vast majority of New Zealanders who have a marginal tax rate of 19.5 percent. On this issue early in 2003 I worked very constructively with both Dr Michael Cullen and Vance Arkinstall of the Investment Savings and Insurance Association. We looked at how we could practically ensure that those savers were taxed at their correct marginal tax rate—again leaving in place the 33c cap. The issue is fairly technical and previous attempts to resolve it during the 1980s and the 1990s had not managed to crack this difficult nut. 
United Future therefore advanced the matter with the Government in its Budget bids for both 2004 and 2005 and I am therefore truly delighted that the problem is resolved through the portfolio investment entity and see-through provisions contained in this bill. Henceforth savers will be taxed at their correct marginal rates. Disadvantage No. 2 has been successfully overcome after a span of 20 or so years. 
Disadvantage No. 3 was the fact that investors through superannuation funds and other portfolio investment funds were subject to capital gains tax on share investments. That reality is completely skewed and was the principal tax distortion I mentioned in my maiden speech. It has now for some two decades been tilting New Zealand investment away from company equities and towards residential rental properties. We like to think that New Zealand does not have a capital gains tax but that has not—at least for the last two decades—been true of share investments through managed funds. We have had a capital gains tax on such investments for that period of time. Craig Stobo was one of those who early on after my coming to Parliament was a passionate advocate of seeing that distortion removed. I strongly picked up on the theme and again it was included in United Future’s Budget bid for both 2004 and 2005. That anomaly is also removed in this tax bill so problem No. 3 is resolved. 
The net result of those three disadvantages being overcome is that for the first time in a couple of decades we can now say that we will have something of a level playing field between investment in stocks and shares on the one hand and investment in the residential rental housing market on the other. This is a great step forward for New Zealand and for New Zealand savers. In addition this bill pretty much irons out any differences between individual investors—that is people who invest their own funds using their own skill and expertise—and the much larger number of New Zealanders who save through portfolio investment entities. 
These measures combined with the KiwiSaver initiative which will kick in from 1 July 2007 should see New Zealand at long last begin to build a far more balanced savings portfolio. That in turn will give new momentum and strength to both the New Zealand economy and to the financial security of New Zealanders and their families. It will give financial security to people in their retirement years and to families during a person’s working life as he or she prepares for retirement as these two things come together. 
Therefore the second reading of this bill tonight is actually a moment to savour. It successfully and at last delivers on what various Governments of all shades—starting with Labour in the 1980s moving on to National in the 1990s and reverting back to Labour again in 1999—have failed to solve. At long last we have some real solutions to take New Zealand forward. 
I want to talk a little bit about residential housing investment and emphasise that a lot of myths have circulated in New Zealand over probably the last 20 years in relation to this issue. I am talking here about books that have been written encouraging Kiwis to dump their funds into residential housing investment some of which perpetuate myths about the tax system that are factually incorrect. For example there is a myth abroad that there is no capital gains tax on investment in residential housing. Well that is not true. It is true that when people invest in that area they can deduct the interest on the money they borrow for the house then deduct depreciation on it and therefore gain a timing tax advantage as compared with some other forms of investment. 
However I emphasise that in recent times action by the Inland Revenue Department with strong support from United Future and from Dr Alan Bollard of the Reserve Bank has ensured that gains made through capital growth and assessment of depreciation recovered when a house is sold are taxed when a rental property is sold in circumstances where the owner in the first instance purchased the property with the intent of resale in mind. That has actually been the law of New Zealand for many many years. Some of the myths that have been perpetrated in that regard have been singularly unhelpful in terms of the design of New Zealand’s overall macro savings situation. Undoubtedly the great driver of the great majority of rental property owners is that they do buy those houses with the intent of reselling them at an appropriate time and making what they think will be a tax-free capital gain. 
I want to encourage the Inland Revenue Department to remain vigilant in ensuring that the law is upheld in that way. Over the last 3 years the department has assessed literally millions of dollars extra in tax by looking into those arrangements in a little more depth. It is very very important that it keeps that up so New Zealand can at last approach the situation I would like to see—that is about 50 percent of assets are in housing and 50 percent are in other forms of investment shares bonds commercial property and fixed interest investments. 
RODNEY HIDE (Leader—ACT) 
: 
 First let me acknowledge Mr Robin Oliver from the Inland Revenue Department. I do not think anyone in the civil service has a tougher job than the man whose responsibility it is to keep his head right across our tax system and to keep up with those who would try to manoeuvre their way through the loopholes that inevitably exist. Mr Oliver and his team do an extraordinary job. 
I think too that we politicians should recognise the point that we are not experts obviously in the technical detail of tax policy and legislation or its impact and that the expectation of us in the process is really to set the broad principles and the philosophy within which Mr Oliver and his team can work. I feel that that is where we have been letting the tax system down. As I look back over the past few years at the changes that have been made I feel that in the main they have been of a retrograde nature. Our tax system has become more complicated and has moved away from good principles of taxation. 
I have to say that I always enjoy listening to Mr Copeland’s contributions because he is a politician who does understand the tax system. Although I was unable to make a full contribution to the Finance and Expenditure Committee this time around I can tell that Mr Shane Jones has grown in the role of handling legislation such as this and the changes it makes. 
But let me cover some of the principles. The first one—and we heard this from Jeanette Fitzsimons—is that the tax be broad-based. By that we mean it should cover the entire range of what it is we are taxing because to the extent that it does not we create an automatic loophole and to the extent that we have a loophole we create a distortion. It will also mean we have a higher tax rate to raise the same amount of revenue we would otherwise have. 
Broadly we have in New Zealand two tax systems. One is a tax on consumption that is called the goods and services tax which in a sense is a good tax—if there is such a thing—because it does not double tax investments. It taxes only consumption. On top of that we have an additional tax system that is a tax on income which automatically is a double tax on investment because when we earn a dollar we get taxed then we get taxed again if we invest it. That is why tax economists favour a consumption tax over an income tax. Then we have a variety of sin taxes for people who smoke gamble drink and do other things that we deem society not to want. 
Gordon Copeland 
: Back the horses. 
RODNEY HIDE 
: And back the horses. So we like the tax system to be broad-based. 
We also—and Jeanette Fitzsimons made this point—like the system to be fair. There is always a debate about what is fair. One person’s fairness is another person’s injustice. When I think about fairness I think that each person in the same circumstance should be taxed the same obviously and that those who earn more should pay more tax. I think that is not a bad principle. But I do not think it is fair that as one earns more money one goes into a higher and higher tax bracket. I do not see why a person who earns twice as much as his or her neighbour should pay four or five times the amount of tax. It seems to me that if we are to be fair a person who earns twice as much should pay twice as much tax. Of course if we are to do that then we are striving towards a flat tax. 
I listened carefully to Mr Flavell who said he was concerned about income distribution. That is true but I make two points. The first is that it may well be that some percentage of the world of a country or of Auckland owns a large percentage of the wealth or receives a large amount of income. But how is that achieved? 
Hon Member 
: Hard work. 
RODNEY HIDE 
: Maybe but it is not something that just fell out of the sky necessarily. When we are thinking about redistributing wealth we should understand that it is not smart to do it through the tax system actually. Tax is a very very blunt instrument with which to distribute wealth. Why? The reason is that when we tax hard the people who are on a high income or who have a lot wealth then those people tend—and I will not use a profanity—to leave the country or they tend not to invest here. Therefore the economy is flatter than it would otherwise be. So it is not smart to be taxing people hard; it is actually better to have a tax system that raises the money needed then provide for those we want to help with direct payments rather than by trying to corkscrew the tax system. By the way if we try to corkscrew the system we will not actually get very far because people do not like being punished through the tax system. When Britain had a tax rate of 98c in the dollar no rich person paid it. That was the reality. Actually the income gaps in the UK widened with high taxes. 
So I make the point that although we have a concern about helping those on a low income giving that help through the tax system is not the smartest way. Really if we want to be fair we want one tax rate so that people who earn twice as much as other people pay twice as much tax. By the way GST is a flat tax. It is a flat tax on consumption. If we spend twice as much as other people we pay twice as much GST. That again seems to me to be fair. If we have a flat tax for GST why not have a flat tax for income? 
We also want a system that is easy for the Inland Revenue Department to administer. I say to Mr Copeland that that is what I am worried about. Imagine having a tax system that relates to the “intent” of a taxpayer. That is actually pretty tough and I think we are giving a big job to Inland Revenue Department officials and to the courts because people who truly want to rip off the system will know how to get around the intent clause—by being very careful about it. How can it be that a person’s tax is determined by what he or she intended at the time and how on earth is an official to know when looking at a tax return what the intent of the taxpayer was when he or she made a purchase? People can make up a great cock-and-bull story about why they bought a house and are now selling it and why they have done it 10 times over a year. At some point one has to accept the story; at some point one does not. It actually becomes an arbitrary system whereby Inland Revenue Department officials and the courts judge what is in a taxpayer’s mind at the time. I do not believe that it is necessarily a good system. 
By the way we also want a tax system that is easy to comply with—but the system has become a whole lot harder. Why? Because we have tried to hit the rich by putting the tax rate up to 39c. We have tried to screw the playing field around to encourage this and discourage that. The tax system has become so much harder in the last few years. If the Government wanted to make it easy it would make it flat. That would make it easy and fair. 
We also want a tax system to be efficient. By that I mean that the Government has a target of how much money it needs. In the case of the Labour Government I think its target is way too high given the surplus. When a Government is designing a tax system it should be doing it so that it raises the amount of money with the least cost possible. The real costs are not in filling out the paper in having an Inland Revenue Department to run and in the court system; those are actually a small part of it. The big cost is the impact on the economy on jobs on investment and on trade. That is the cost of tax. We want a system that raises the targeted amount of revenue for the least cost. As politicians we do not think about that enough. 
I again ask Mr Flavell to think about this. If we have a costly tax system—a system that is making it hard to invest in New Zealand is discouraging investment or is discouraging business—then over time we will have an economy that is smaller than we otherwise would have. What gives us a costly tax system is for example our trying to register our wealth through it. If we try to do that trick we are not helping the poor at all. What we are doing is making the whole country poor. That is why I say that the efficiency of the tax system is a key point. We want a low flat tax rate and a strong economy. To get that the Government should set the tax rate for the amount of money it wants. It can set it at 10c 20c 40c or 50c. It will have an efficient system for the amount of money it wants to raise therefore it will have more money and therefore it will be able to help more poor people and have more Government-run hospitals. If that is what it wants it can do it. As politicians we have to ask ourselves about the principles and efficiency of the tax system. In terms of the technical side of things I suggest that in Mr Oliver we are in good capable hands. Thank you. 
TIM GROSER (National) 
: 
 First of all like Mr Hide I would also like to thank Robin Oliver for his great contribution and advice over the years. My past career has not much run into his although I have talked to him from time to time. But I have certainly been aware of his considerable influence and of the respect in which his advice is held in a number of important quarters in this country. I am not sure that I want to follow Mr Hide in congratulating Mr Jones on his chairmanship of the Finance and Expenditure Committee. That is not because I have any particular reason to doubt the judgment; I attended my first meeting of his committee only 2 working days ago. It is just that Mr Jones may have a significant role to play in the Labour Party’s political future and whether receiving high praise from the leader of the ACT party is of great benefit to him is something on which I would pass no particular judgment. 
I have been watching the political progress of this bill with a mixture of bemusement amusement and sometimes I would have to say amazement. The first question was—and I am really addressing here the question of the differing treatment of overseas investment income—whether there was a problem. Oh yes we have known for a long time there were a number of problems—a number of distortions. But the first-order question that would arise because it really is an implied quantitative question is about the extent of the problem and whether the problem was of such a dimension that attempting to fix it would not raise larger costs than those resulting from the problem in the first place. The second order in any logical sequence of thought would have been to ask about the optimal ways through to address that problem. 
The deluge of submitters against the bill has really meant that this bill—a bill of extraordinary complexity—has undergone the equivalent of genetic modification: political manipulation. It reminds one very much of that clichéd joke about the camel having been composed or designed by a committee. In some parts the bill looks as though it bears only a casual resemblance to its original life form its original structure and its original ideas. It has been pushed and pulled to assuage this or that submitter this or that party in support of the bill this or that opinion and this or that new fact that emerged in the process of examining the bill. 
That reminds me of something that is often said about ideas that run into trouble. They are said to go through five stages. The first stage is the first-mover stage. Somebody in Mr Cullen’s office—maybe Dr Cullen himself; I do not know whether it was him or an adviser in his private office—or someone from Treasury or the Inland Revenue Department would have drawn attention to this distortion and made the argument that something needed to be done about this problem. Stage two is of course growing interest in the proposal. Stage three is that the proposal is the new consensus; everyone around Dr Cullen’s office agrees that now is the time to move to reduce or remove the distortion. Everyone is on board. Technicians perhaps in the Inland Revenue Department who are aware of the vast technical complexity actually involved in implementing such a policy recommendation are very wise to stay quiet. 
I think we are now at stage four of the idea with one further stage to come. Stage four is the stage when an idea goes a little sour. Growing doubts appear about the wisdom of having embarked on the course of action in the first place. So now that the submitters have come in we see water is pouring into the ship and instructions have gone out to put out the political lifeboats and get ready to jettison some of the ballast that is not required. We have the extraordinary vision of Sir Ron Brierley who has now through the political process that I am describing gone beyond the status of being a living legend amongst New Zealand investors to become effectively at least for some years to come a de facto head of State in terms of taxation treatment. 
We have not quite got to stage five. Stage five is of course the stage where the pernicious unintended effects of legislation like this come fully home to roost. Those who were not involved are rewarded and those who were involved and were responsible for the idea are punished. Well fortunately we have a thing called the democratic process and the people responsible for that are the New Zealand electorate. I took particular note of the point that Bill English made earlier in this discussion about the Government almost certainly being unaware of the huge numbers of New Zealanders—not just a few rich folk out there—who are affected by this bill and I am sure Mr English was absolutely right. The Government had quite a shock when it found out the dimension of the problem that it had raised by stirring the swamp up on this particular issue. 
The bigger picture here frankly is the need for serious tax reform rather than fiddling with something that could well have been left alone. We now see that we are in a position in this country where we have the fatal combination of bracket creep in terms of taxation jargon and unadjusted taxation rates. This bill of course does not want to go anywhere near that issue. We understand that because we know there is a subsequent stage to come in the process of so-called taxation reform. It will come sometime before the next election when an adjustment to the brackets is made in order to take account of the fact that in the last 6 years there has been a 50 percent growth in the number of taxpayers who fall into the $38000 to $60000 a year income bracket where they move because of the discontinuity in the tax break from paying 19.5 percent of their income to paying 33 percent. So the argument will be made later on the adjustment will be made and then the New Zealand public in a rather larger political debate than even this debate will have to make up its mind as to whether in the course of a 3-term Government that amounts to a credible and continuing commitment to taxation reform. 
The second bigger picture here is the need to do something about this country’s savings position. Like others I am sure in this House I am aware of quite a complicated debate in economic circles—well at some levels people say there is not necessarily a problem and others define it in terms of the way that one measures savings flows. That often comes down to a question about whether a dollar invested in housing equity is equal to a dollar invested in a Government surplus is equal to a dollar invested in managed funds and about the complicated economic effects that arise from those different forms of savings. Although I accept that there are differences of view amongst commentators on that I do not think there is any serious question that a couple of things in that overall picture are of great importance to New Zealand. 
First of all if we look at the narrower definition of savings in financial assets we see we do not look very flash. As time goes by particularly in comparison with Australia the situation looks increasingly less attractive from our point of view. That is factor No. 1. Factor No. 2 which I do not think there is a great deal of disagreement on is the dismal picture on investment flows which are—at the present moment with our current account deficit being around 9.7 percent of GDP—the second-highest in the developed world behind Iceland’s. That is a very serious problem for this country. Part of the problem of course is the huge imbalance in investment income. That is not an argument to put controls on inward investment. No no we should be very thankful that foreigners are prepared to fund a high level of consumption with their own savings. 
But of course there is a problem here. In 2005 some $13 billion went out of the country in terms of investment outflows. That represents a return from investment in New Zealand assets. So it is a matter of some importance that we actually implement policy structures that are designed to encourage an outward flow of investment from New Zealand taxpayers which will actually start to ensure that we have some reverse flows to balance off that rather dismal picture overall. 
Does this bill address that issue? Does it provide the greater certainty required for New Zealanders to invest increasingly more of their assets in overseas investments? I think not; I think decidedly not. 
A party vote was called for on the question  
That the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill be now read a second time. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Bill read a second time. 
In Committee 
Part 1 Annual rates of income tax for 2006-07 tax year 
Dr the Hon LOCKWOOD SMITH (National—Rodney) 
: 
 Part 1 of this Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill has actually been largely ignored because of the very controversial issues contained in Part 2 in particular. But Part 1 is a very important part of this bill because it confirms the current income tax rates for the 2006-07 year. There are a number of questions that I think should be rightly posed about this to the Minister in the chair the Hon Peter Dunne because when the current tax rates—including the 39 percent tax rate—were introduced by this Labour Government back in 2002 I clearly remember Dr Cullen speaking in this Parliament and telling New Zealanders that this higher tax rate of 39c in the dollar would be imposed on only 5 percent of New Zealand income earners. It would be only the highest income earners who would be paying this high tax rate. So the question I now have for the Minister in the chair is what percentage of New Zealand income earners when we confirm these same tax rates—including the 39 percent tax rate above $60000 income—will be paying that 39 percent marginal tax rate. 
I think it is a relevant issue. Dr Cullen promised that only 5 percent of New Zealanders would pay this rate. It is relevant to the Minister in the chair because we all know he is of the view and has pushed the policy quite strongly that the tax thresholds should be indexed. Now I have two questions on that matter to the Minister. The first question is when will the tax thresholds be indexed. The second question in relation to that is at what point they will be indexed. 
Let me explain what I mean. Will they be indexed at a point where only 5 percent of New Zealand income earners pay that top tax rate? In other words will the threshold be raised until only 5 percent of New Zealand income earners pay the top rate as Dr Cullen promised or will they be indexed at the status quo where—what is the figure—10 percent or 15 percent of New Zealand income earners now pay that top tax rate? So I think there are two issues there that I would be particularly interested in. The first issue is what is the percentage of New Zealand income earners paying that top tax rate. The second issue is when indexation will start and what proportion of New Zealand income earners will lock into that top tax rate. 
There is no question that by confirming these tax rates this Parliament is locking in a very high level of revenue collection—a very high level. Revenue collection by this Labour Government has gone up since it came into office in 1999 I think something like 60-odd percent—a massive increase in tax collection by this Labour Government. Clearly this Labour Government is currently carrying very large fiscal surpluses. So I think the Minister in the chair should tell us exactly when the indexation of the thresholds will start and whether it will lock in the status quo where a very much higher number of New Zealanders will be paying that top tax rate. 
 I think New Zealanders deserve to know whether this Government will seriously address the possibility of a reduction in personal income tax rates for New Zealanders. We are becoming a very highly taxed country. The proportion of our GDP being taken as tax is climbing now. It has declined for many years and it is now climbing again. We all know that that is a negative for our economy. For the percentage of our GDP taken in tax to be climbing again is a negative for economic growth. Given the overall tax policy he is pursuing as Minister of Revenue I would like to hear as well from the Minister what the prospects are not only for indexing thresholds but of us seeing these actual tax rates that Part 1 confirms are the current arrangements—15 percent up to $9500 21 percent up to $38000 33 percent from $38000 to $60000 and 39 percent from $60000 and above—being reduced. These are very specific questions to the Minister. 
Hon PETER DUNNE (Minister of Revenue) 
:  
Let me respond to the points the member has raised. The first point he asked was what is the percentage of taxpayers now in the 39 percent bracket bearing in mind the claim in 2000 that only 5 percent of taxpayers would be affected. If he cares to look at Treasury’s estimates that were produced at the time of this year’s Budget he will see that that figure has now risen to 12 percent. He will note also from the comments made to my right that that has to be taken into account alongside income growth in the period since the year 2000. [ 
Interruption 
] 
The second question that the member raised—and by way of interjection now he makes a reference to bracket creep—was to ask when indexation might occur. Let me say this in response to him. The Budget last year made provision for the start of an indexation programme along the lines that my own party had advocated for. The agreement that we have between the two parties at this stage relates to a business tax review. That work is ongoing and will be completed in time for decisions next year. We have indicated that the consequence of any shift in corporate tax rates or corporate tax arrangements will have implications for the personal tax system and they will be considered at that time. 
So in response to his question I would expect decisions on all of these matters to be made in the first half of next year—announcements around the time of next year’s Budget—and legislation to be in the House shortly thereafter to give effect to changes in time for 1 April 2008. All of that information has been available since the business tax review document was released in July. 
A party vote was called for on the question  
That Part 1 be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Part 1 agreed to. 
Part 2 Amendments to Income Tax Act 2004 
Dr the Hon LOCKWOOD SMITH (National—Rodney) 
:  
Part 2 is obviously the really significant major part of this bill. I would like to take two or three calls on it at various stages this evening because I would like to deal with two or three issues. Let me first though just revert back to an earlier comment. Do I see Mr Shane Jones anywhere in the Chamber? He talked a moment ago about how sensible this bill and the new regime in Part 2 on taxing foreign portfolio investments are. I want to contrast that with what Mr Jones said publicly when he thought his comments would not be recorded in Napier only 2 or 3 weeks ago. That was after the Finance and Expenditure Committee had done most of its work on this bill. 
What did Shane Jones the Labour chair of the Finance and Expenditure Committee have to say about this taxation regime? He said: “Why bother investing in shares when you know you’re going to get taxed potentially on gains”—so there was Shane Jones acknowledging there would be a tax on capital gains—“you’ve not even received now called the fair dividend rate …”. So he acknowledged the fair dividend rate would be a tax on capital gains that someone had not even received. He went on to say: “… when you have all the incentives possible to go out and buy another house as a rental?”. That is what Shane Jones the Labour chair of the Finance and Expenditure Committee really thought about this legislation when he thought that his audience would not report back to this Parliament what he had said. I think it is very informative that the chair of the select committee actually said that kind of thing in a public gathering in Napier and did not expect it to get back to this Parliament. 
The first issue that I want to focus on in Part 2 is the establishment of the portfolio investment entities. In principle we have no problem with that proposal. We support the concept of establishing for managed funds the principle that they should not be taxed on their capital gains here in New Zealand on investments in New Zealand. I think it was Gordon Copeland who emphasised that point; having their taxation arrangements the same as those on individuals’ investments in New Zealand makes perfectly fine sense. 
But the issue becomes more complex when we introduce the look-through procedures as Part 2 does to try to tax individuals’ investments in managed funds at their personal marginal rate. What makes it more complex is that the returns to investors are not being taxed in the investors’ hands at their marginal rate. That would be a much more simple process. The problem for Labour members was that if they approached it in that simple way that would affect the Government’s family tax credit arrangements particularly its big icon policy of Working for Families. Obviously if it were to be done in that sensible way—the investment return is received in the hands of the investor to be taxed at his or her marginal rate—of course it could make a significant difference to the amount of income that a family received through Working for Families. So what the Government decided it had to do and what this Part 2 does is to force the new portfolio investment entity established in Part 2 to calculate the tax and pay it on behalf of the individual investor so that it does not count against the individual investor’s entitlements to family tax credits and Working for Families tax credits. 
But that introduces massive complexities. I want the Minister in the chair Peter Dunne to answer quite an important question on this. The select committee heard from a group of very significant researchers at Auckland University. I thought Michael Littlewood and Susan St John made an important submission to the select committee on this issue. They made the point that it is simple to say we should tax the returns at an individual’s own rate in a managed fund investment but giving effect to that is anything other than simple. They say that if we take a modern superannuation scheme with an investment choice—one where investors have some choice—in order for a big scheme with 100000 members to become portfolio investment entity - compliant it would involve up to 15 billion extra data points. I will repeat that figure. The evidence to the select committee was that for a major fund to become portfolio investment entity - compliant calculating out the tax on the basis of an individual investor’s individual tax rate would involve up to 15 billion extra data points of information that would have to be kept by that superannuation scheme. That is a massive increase in extra data handling by a managed fund. 
That was not put to us by some person off on a wild daydream; the people who made that submission to the select committee were Michael Littlewood and Susan St John who are two very respected researchers in this area. They put it to the committee that this measure would impose a huge compliance cost and that many employer superannuation schemes simply would not be able to become portfolio investment entity - compliant because they would not be able to pass on those costs. 
Maybe the Government today with its latest Supplementary Order Paper enabling superannuation schemes to be exempt from specified superannuation contribution withholding tax without becoming portfolio investment entity - compliant will solve this compliance problem for many superannuation schemes. Maybe that last-minute move could help with this issue. But I would like the Minister in the chair Peter Dunne to respond to the very serious submission made by those researchers. I ask whether the Government has looked seriously at the issue of the massive increase in the number of data points of information required by a significantly sized superannuation scheme in order to become portfolio investment entity - compliant. Where that fund is an employer superannuation scheme obviously it cannot pass on those costs. 
So I think that there are significant issues around the design of this proposal to tax individuals’ investment in managed funds at their own marginal tax rates. It is complex because the returns from the investment are not being taxed in the individuals’ hands; the tax is being calculated by the fund—by the portfolio investment entity—which adds significant complexity. For example given that the portfolio investment entity pays the tax on behalf of the investor what happens when the investor pulls out? There are a number of overs and unders here. If the investor pulls out of the portfolio investment entity presumably that entity has to pay the tax. 
I would appreciate the Minister in the chair telling members how often the portfolio investment entity recalculates investor ownership of investment in the fund to make sure that the averaging throughout the year delivers an average tax rate because we must not forget that the tax rate that the portfolio investment entity pays is the average of the individual tax rates of all the investors in that fund. In order to get that exactly right the portfolio investment entity would have to attribute income on a daily basis. Does the Government intend that portfolio investment entities should attribute income on a daily basis a quarterly basis or a 6-monthly basis? I think that the Minister should explain that to the Committee because I am sure that many members would not have much of a grip on that issue. It does affect the fairness of the tax rate paid because depending on the balance of investors on a daily basis in a particular portfolio investment entity fund it influences the average tax rate owed on the income received by the fund on any given day. 
So I really would appreciate the Minister responding to a number of significant issues in relation to the establishment of portfolio investment entities. Later on I will come to a number of other issues relating to the investment of income in offshore portfolio investments. However with regard to the portfolio investment entity issue we support the concept of taxing people’s investments in managed funds at their own marginal rate. But because the Government does not want to affect their Working for Families income it means that portfolio investment entities have to do all the tax calculations and pay the tax on behalf of investors and that causes huge complexity. 
I would appreciate it if the Minister could respond to those specific concerns. 
GORDON COPELAND (United Future) 
: 
 I would like to take a call on the 5 percent fair dividend rate which is contained in Part 2 of this bill. I think I have earned the right to speak on this because I listened to many many hours’ worth of submissions on the fair dividend rate and I must say that some of them were a mixture of ignorance wisdom and everything in between. I think that it is very important to at last put a few facts on the table with regard to the process that has led to the 5 percent rate and if you like its “embeddedness” into the reality of what it means to invest in the stock exchange. When we buy shares in a company we become a part-proprietor of that company. We may be only one-millionth proprietor because there might be almost a million other shareholders but we nevertheless are proprietors of that company. After that company has earned an income and has paid its due tax on that income—in whatever jurisdiction in whatever country in the world it belongs to—the after-tax income belongs to the shareholders of that company. Therefore as investors we have a share of that income. 
What this bill attempts to do is to say that the Government will tax us a fair amount and a fair rate based on the fact that we have just gained an income. After all this is an income tax bill. The evidence placed before the Finance and Expenditure Committee which is very well known was that over time if we invest on the international stock exchange around the world—and we could look at various periods but if we take the period from about the 1980s through to today which is about 26 years—on average the income yield or the return yield to an investor is 9 percent. This bill says that the Government will tax investors on 5 percent out of that 9 percent. Why not the whole 9 percent? The reason is that some part of that 9 percent in addition to the income that investors receive from the company is the market’s evaluation of the future income stream of the company which we call capital gains. It is an estimate of what the ongoing earnings might be capitalised today. The whole theoretical basis underlying that is called the internal rate of return or the net present value of future income streams which comes into today’s valuation on the stock exchange of those particular shares. 
This bill does not in any shape or form tax genuine capital gains from the stock exchange. It is a tax on if you like a fair dividend yield—and I will put this fairly and squarely on the record: if a company earns an income after tax regardless of whether it distributes that income by way of dividends or retains it the investors as shareholders have still gained an income from that company. That is the essential point of the fair dividend rate method. We are saying that if people are shareholders they have earned some income and because we have an income tax system on every other form of income in New Zealand—whether the income is gained here or from overseas—those people need to pay their fair whack of tax on that income. 
I have mentioned that the average return is 9 percent and that we are taxing at a rate of 5 percent. Is there anything magic about that? The answer is no but the rate is about right. It is as right as any other rate that anybody who came before the select committee could otherwise argue for. Some people who came before the select committee—many people actually—said that investors should pay tax only on the actual dividend they receive. That is pure nonsense and anybody who has ever had any dealings at all or who has ever invested in the stock exchange knows that that is nonsense. I for one was very disappointed to sit there and hear members of my own profession come along and make that ridiculous argument. As I said before it does not matter whether one receives a dividend; one receives an income. And if a shareholder does not receive an income everybody knows that the value of that person’s shares on the stock exchange goes up. Immediately when a company declares its profit the value normally goes up. It comes down of course if the company declares a loss. 
Dr the Hon Lockwood Smith 
: That’s a capital gain. 
GORDON COPELAND 
: That is not a capital gains tax; that is a share of income earned. I have just explained the difference between the two things. I will take another call if the member does not understand the difference and I will explain it again. One gains a share of an income when one buys a share in a company. One becomes a proprietor of that company. We are attempting to put an income tax on a fair share of that income. I would say that the 5 percent is actually rather conservative when we take that reality into account. 
TIM GROSER (National) 
: 
 I will take just a brief call on Part 2. I will focus on a couple of aspects of interest to us in the National Party. 
First of all the key point I think is the one made by my colleague Dr the Hon Lockwood Smith. The changes to portfolio investment entity compliance are something that in principle we welcome but Dr Smith has asked a number of admittedly highly technical questions that are extremely important in terms of whether we can realise through the policy implementation the reasons for our moving in this direction in the first place. We look forward to the Minister of Revenue responding to Dr Smith’s invitation for him to take the call. 
The key point from our perspective is that these positive changes to portfolio investment entities could have been introduced with the Government staying away from the whole issue of the “grey list”. The Government lurched away from its initial proposal a crude but unrealised capital gains tax as submitters poured into the Finance and Expenditure Committee with their problems with this issue. Thank goodness the Government moved away from its initial proposal—we should be thankful for small mercies—but although the fix of the fair dividend rate that we have before us is certainly superior to the original proposal we can see all manner of unintended consequences that will have to be addressed in due course. 
We know what some of these consequences will be as the submitters have already drawn attention to some of the major policy issues that we will have to confront as this bill is implemented. There are issues to do with the huge portions of our workforce that are employed by multinationals and the fact they are locked into employee stock ownership options often for a number of years. These employees will not be in a position unless they want to leave the company to get out of the company and pay the tax bill. This is one of many problems that submitters have identified. 
Then there is the question about currency shift. This is at one level just a question of equity but at another level there will be some long-term effects from the way that the Government has approached this. If we are taxed on foreign investment earned obviously by definition we need to convert our earnings into New Zealand dollars to arrive at the assessable income required. This will involve an exchange rate and if the currency has fallen the assessable income will rise. Is that fair? And what are the economic implications? 
This raises—in my mind at least—some quite interesting questions about how we actually address tax policies and residency policies in the era of globalisation. This is something that we have had to look at in almost all aspects of policy making whether we are talking about trade or employment because we are operating in this country for all intents and purposes with global competition for skilled and semi-skilled labour. It is also necessary to look at the implications of this in terms of the legislation before the House tonight. 
So many of our policy models including tax models are based on the dominant model. That model is that let us say Mr John Smith and Ms Mary Smith live their lives in New Zealand earn their incomes in New Zealand travel to Fiji for their holidays—when it is not having a coup—and are New Zealanders in every sense. That is still by far the dominant policy model to which our policy structures have to accommodate. But it is being eaten away at the edges by a number of other issues that people have to have uppermost in their minds if New Zealand is going to survive and really place itself well in the forefront of small developed countries. 
Let me convert the John Smith analogy to Mr and Mrs Chen Wang. I am sure that the Minister being an aficionado of Taiwan knows that that is a common family name in Taiwan. Or I could use a Korean example Dr Che who is living amongst the I think 30000 Korean families that we talked to the Korean President about on Sunday during Mr Key’s courtesy call on him. How would those people sitting in Auckland react? Perhaps a large number of them still have very substantial assets deriving from their opportunities in Pusan or Seoul. Those assets will be converted into New Zealand dollar terms when the currency falls. Do members think that when the implications of this come home to roost those people will lift their glasses of soju and thank the Labour-led Government? I doubt it very much. 
R DOUG WOOLERTON (NZ First) 
: 
 If anybody except the dedicated financial investor is still listening I will be surprised but if they are I suggest to them that they are now understanding the complexity of the issues that this bill addresses and they are starting to see the issues that we had to deal with and the sorts of things that happen in the investment world. 
Following on from Mr Copeland I think that if people in other countries for whatever reason will pay out dividends incorporate that into capital and pay out on what they call the capital account then it is totally acceptable for us to work towards some sort of regime that will in part capture a fair amount of that. That is what is called the fair dividend rate that is what is encompassed in Part 2 and that is what we are doing. All over the world there are different tax regimes. People talk about our wonderful neighbour Australia which taxes the heck out of people who invest in overseas countries—to a far far greater degree than we do here in New Zealand—yet I hear it lauded as a wonderful bastion of free enterprise go-go business and all of the rest of it. It is absolutely acceptable that something like this is done because of the situation this bill faces as far as the investment areas are concerned. 
To have a fair dividend rate of 5 percent is absolutely fair. All of these things are a compromise and I think it is as good as we will get into the foreseeable future. Likewise with the portfolio investment entities it is no secret that some of us would have liked to have seen some newer more innovative players come into the market in this area. I know that the Minister Peter Dunne’s Supplementary Order Paper is trying to address some of that. 
But it is no surprise because of the things that Dr Lockwood Smith has mentioned that those who have become default providers in the first instance in this area are in the main some of New Zealand’s biggest investment companies. They are the ones with the computer horsepower and all of the sorts of things that enable them to look after the individual mum and dad investors who—what shall I say without being mean to them—do not have the expertise to look after their own taxation or the time I might add to go through all of the calculations that that entails. The portfolio investment entity will do it for them. It is right that that happens. There is no hidden agenda here. Most New Zealanders will be thankful that those companies actually have the computer horsepower and those sorts of things to do all of these calculations. 
People are talking about the hidden misdeeds of this Government and saying that it is heading in directions that may be secretive and that it has other agendas. The Government is simply understanding and accepting that people who invest through a managed fund will not by and large run off to the accountant to do all of these things themselves. These people are not with due respect sophisticated investors. 
Part 2 takes care of a lot of these things. I think the fair dividend rate is the proper way to go. Although it is a compromise it is something that will do the job admirably. In respect of the portfolio investment entities although we would like to have seen some more innovative companies involved it is no surprise that they have ended up being the bigger companies in New Zealand. 
Dr the Hon LOCKWOOD SMITH (National—Rodney) 
: 
 Having raised a few issues just a moment ago over the establishment of the portfolio investment entities I will now raise some issues around the shrinking of the “grey list” and the establishment of the 5 percent fair-dividend rate. I cannot help but note that Gordon Copeland from United Future in speaking a moment ago said it is foolish to argue that this 5 percent fair-dividend rate new tax is in any way a tax on capital gains. Of course the Ministers in writing to the Finance and Expenditure Committee when the Government did the big U-turn on the original 85 percent capital gains tax said to the select committee that this fair-dividend rate was a method “which would also not target capital gains but rather something approximating a reasonable dividend yield.” The Ministers even said they did not want it to be a capital gains tax. 
I put this example to Gordon Copeland. One has $100000 in a portfolio investment offshore—less than 10 percent shareholding in any company. If in New Zealand one has a zero dividend payout for the year and let us say the investments are mainly in America the UK Canada or whatever—they have to be in “grey list” countries—and the exchange rate between New Zealand and those countries was to decline by 10 percent then those investments in New Zealand dollar terms have gone up for the year. One has had no income from them yet under this 5 percent fair-dividend new taxation that the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill would bring in one would be taxed on those—even though one has had no income. All that has happened is that the capital value in New Zealand dollars of those investments has gone up because the New Zealand currency has declined against those foreign currencies. 
So the capital value of that investment in New Zealand dollar terms has gone up. One has had no dividend and the value of one’s investments in the currencies of investment has not gone up. But the New Zealand dollar value has gone up. That can be nothing other than an apparent capital gains tax because in New Zealand dollars one has had an apparent increase in the New Zealand dollar value of the capital of one’s investment and one is going to be taxed on it. 
I say to Gordon Copeland that this tax does tax capital gains. I would appreciate hearing the Minister’s comment on that—whether the Government has really thought through that issue and it is happy that New Zealanders will face taxation when the currency goes down. When the currency goes up of course they are not necessarily in a better position because although they may not owe tax or may owe less tax when the currency goes up they do not recover the tax they have paid when the currency goes down. 
Also I point out to Gordon Copeland the weighted international average dividend yield at the moment is 2.2 percent—the committee heard that repeatedly from experienced international fund managers. Those fund managers said the weighted average dividend yield internationally is currently 2.2 percent. That means if one is assuming a 5 percent return for managed funds here in New Zealand one is taxing way beyond the dividend yield. I do not care what fancy way Mr Copeland wants to define “income”. Income is only what one receives. Income is always defined by what one receives. That is why we refer to things as capital gains; they are gains because they are not income. They are only income when the capital is realised. If one is in a trading position then one is taxed on that realised capital here in New Zealand—as Mr Copeland pointed out. 
I come back to the point that with this 5 percent fair-dividend rate—which is supposedly fair and which National is seriously opposed to—because of a number of these issues such as currency shifts one faces a tax bill. If one’s investment goes down in value this year returns to the same value next year and no dividend is paid then one is taxed on the return to the same value as one started at. I would appreciate the Minister telling me whether I am wrong there but I believe I am right. Over a 2-year period if the value of one’s investment offshore goes down this year one is not taxed—I accept that. But if it returns to the start value next year one is in terms of wealth no better off because one is only back to where one started yet one faces a tax bill and has had no income. The investor is only back to what the investment was valued at last year—and Mr Copeland is saying that that is income. He is saying that this new tax is taxing only income. I put it to you Mr Chairman that it is not credible to make that argument. I would appreciate the Minister’s comment on that. 
So National is very opposed to this new 5 percent fair-dividend rate tax. It is a new tax that does have an element of capital gains in it and it is unfair. 
GORDON COPELAND (United Future) 
: 
 I will not get an opportunity to speak on the third reading of the Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill so I will take another brief call to reinforce that the Minister the Hon Peter Dunne has actually got it right when the Government has chosen to tax income on international share investments at a rate of 5 percent. Just following on from the remarks I made earlier let us take a real-life illustration of the principle at work here. It is well known that for many many years Microsoft paid no dividends—no dividends whatever. It would be patently absurd to argue however that the shareholders in Microsoft were not getting an income because each and every year Microsoft declared massive earnings after tax. The whole reason that its price zoomed up many many percentages every year on the stock exchange was the income the company was producing. 
And that illustrates the point. Where one has zero dividend in spite of the fact that one has a huge income then quite obviously the amount of dividend distributed has actually no meaning whatever in terms of what is the right amount of income to tax. That is why the average dividend yield internationally is 2.2 percent. Some companies do not actually pay dividends. Unilever in Britain is another example of a company that does not pay dividends. The tax systems there do not encourage companies to pay dividends so they simply capitalise that income and move on. 
The other point Dr the Hon Lockwood Smith raised was in relation to foreign exchange movements. Well that is a different transaction. A profit on a foreign exchange movement is also a profit and is taxable in New Zealand dollar terms. If one has a loss on foreign exchange because of that then obviously that loss also offsets one’s tax here in New Zealand because simply speaking one pays tax in New Zealand on New Zealand dollars. But there are two elements happening. One is the income one gets from the company which will be taxed at 5 percent. The other thing is the loss or gain one makes on the currency movements that have occurred between New Zealand and whatever country one has invested in during that period of time. They are two quite separate things and we should not confuse them. 
Hon PETER DUNNE (Minister of Revenue) 
: 
 I thank firstly my colleague Gordon Copeland and also Doug Woolerton for their comments on Part 2 and the contributions they have made. I also say to Dr Smith that I am going to attempt to respond to a number of the points he raised. I go back to the first point he raised concerning the portfolio investment entity rules as they affect superannuation funds. He will be aware that the Finance and Expenditure Committee has made a number of changes in that area. For example there is now a simplified method of allocation available for entities such as superannuation funds to allow them the benefits of being a portfolio investment entity with few compliance costs. That method will require the fund to continue to pay provisional tax. The fund will be required to calculate the portfolio investment entity tax accurately on behalf of its members at the end of each year rather than on a quarterly basis and would make an annual investor interest adjustment within 3 months of the end of the tax year in order to ensure that 19.5 percent taxpayers receive an additional entitlement to reflect their lower tax rate. The fund will also be liable for the tax on the share of the current year’s income that is paid out to investors that exit the fund during the year. The select committee has recommended some other changes as well. 
I should just say to Dr Smith that the complexity issue has been substantially modified and the proposals that the bill now contains are largely supported by the industry as being a vast improvement on what was in the bill in the first instance. The claim that was made based on the St John and Littlewood evidence has been substantially addressed in the amendments recommended by the committee. 
I turn to the question that Mr Groser raised regarding share ownership schemes which has been acknowledged as a problem. Again the Finance and Expenditure Committee has made some amendments that seek to address that issue; for instance no tax will now be payable for the period when an employee is unable to sell out of the ownership scheme. So some improvements have been made there. 
I will talk on a point that both Dr Smith and Mr Groser also made about unrealised gains currency shifts and all of the impacts that they might have on the value of an individual investment. The key point to make here is what the key difference is between the respective arguments in this whole bill. The bill says that the fair dividend rate is deemed to be 5 percent or the actual value of the dividend paid in years where a profit accrues—in other words where a gain takes place. Where a loss occurs no tax is payable. The position taken by the National Party has been a 3 percent flat rate payable in years when there is a gain but also payable in years when there is a loss. So the difference is essentially between 5 percent which will actually average out at around 3.4 percent over a period of time versus a situation that says it is 3 percent regardless of whether the value of one’s investment has increased or decreased. That is the essential difference between the two broad positions on this bill. 
The members say it is complicated. Frankly I think there is an issue of fairness here. Taxpayers will feel that it is reasonable to pay a tax in years when they have something positive to show for it. They will resent the idea of being taxed in years when there is a loss and that is the nature of the debate that has taken place. 
The one other issue is the debate that has been ongoing about whether this is a capital gains tax. The whole notion of the changes that the Minister of Finance and I recommended to the select committee was around dividend yield and to get away from the notion that was implied in the original proposal—the 5 percent of the 85 percent and all of that—of that being a capital gains tax. We wanted to make it absolutely clear that that was not our intention; we were seeking to get a reasonable tax payable on an investment. That is why we called it as such—the notion of a fair dividend rate became available. I note that again the difference between the parties is not great: a deemed rate of return on the one hand versus a fair dividend rate on the other 3 percent flat on the one hand versus 5 percent—or zero in loss years—on the other. It is a very small point of difference. 
Having heard a lot of the arguments—and I am sure the member will appreciate my saying this—having received several thousand letters and countless delegations and having talked to lots of meetings up and down the country we believe that the mechanisms contained in this part of the bill are a step forward. These things will always be difficult to some degree or other but we sought to try to address the major issues and come up with a regime that is fair and equitable and that recognises a couple of key points. 
The member touched earlier on the question of the “grey list”. I thought I referred in my second reading speech to one of the anomalies which is that the emerging economies of Singapore China and India are not on the “grey list” so we immediately have a disadvantage for investment that goes into those economies as opposed to those on the “grey list”. We have been trying to create a regime where it is attractive for New Zealanders to invest offshore. We recognise that most people invest through their own efforts and most of that investment goes into Australasia. Around 70 percent of investment from New Zealand goes into Australasia around 15 percent into the “grey list” and around 15 percent into non - “grey list” countries. Part of the emphasis on Australasia was simply a recognition of what is the status quo. 
We have attempted therefore with the remaining 30 percent to draw rules that are clear and unambiguous and that are essentially fair and do not discourage people. That is the real point in essence here but I come back to the point that I began on. The essential difference between the two sides in this arguments is 5 percent for the funds and a floating rate if you like for individual investment versus a flat 3 percent win or lose. I think it is a very small point of difference. 
The question was put that the amendments set out on Supplementary Order Paper 84 in the name of the Hon Peter Dunne to Part 2 be agreed to. 
Amendments agreed to. 
A party vote was called for on the question  
That Part 2 as amended be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Part 2 as amended agreed to. 
Part 3 Amendments to Tax Administration Act 1994 
A party vote was called for on the question  
That Part 3 be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Part 3 agreed to. 
Part 4 Amendments to other Acts and regulations 
The question was put that the amendments set out on Supplementary Order Paper 84 in the name of the Hon Peter Dunne to Part 4 be agreed to. 
Amendments agreed to. 
Part 4 as amended agreed to. 
Schedule 
A party vote was called for on the question  
That the schedule be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Schedule agreed to. 
Clauses 1 and 2 
A party vote was called for on the question  
That clause 1 be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Clause 1 agreed to. 
The question was put that the amendments set out on Supplementary Order Paper 84 in the name of the Hon Peter Dunne to clause 2 be agreed to. 
A party vote was called for on the question  
That the amendments be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Amendments agreed to. 
A party vote was called for on the question  
That clause 2 as amended be agreed to. 
Ayes 61 
New Zealand Labour 50; New Zealand First 7; United Future 3; Progressive 1. 
Noes 53 
New Zealand National 48; Maori Party 3; ACT New Zealand 2. 
Abstentions 6 
Green Party 6. 
Clause 2 as amended agreed to. 
The Committee divided the bill into the Taxation (Savings Investment and Miscellaneous Provisions) Bill and the Taxation (Annual Rates of Income Tax 2006-07) Bill  
divided into Taxation (Savings Investment and Miscellaneous Provisions) Bill and the Taxation (Annual Rates of Income Tax 2006-07) Bill  
pursuant to Supplementary Order Paper85.