Dunne Peter: Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill — Second Reading In Committee 
Dunne Peter: Taxation (Annual Rates Savings Investment and Miscellaneous Provisions) Bill — Second Reading In Committee 
[Volume:636;Page:7092] 
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.