Tax reform for non-residents investing in certain PIEs
Positive changes are being legislated for in relation to taxation of non-residents investing via portfolio investment entities (PIEs). A PIE is generally a widely held collective investment vehicle that meets certain eligibility requirements. The rules, contained in a Supplementary Order Paper to the Taxation (Tax Administration and Remedial Matters) Bill 2010, are intended to remove a barrier to non-residents investing into New Zealand managed funds by ending the current over-taxation of non-resident investors in PIEs.
New Zealand generally operates a source and residence based taxation system, whereby residents are taxed on their worldwide income and non-residents are taxed on their New Zealand-sourced income. However, a non-resident investing through a PIE is currently taxed on both their New Zealand-sourced and foreign-sourced income at the top PIE tax rate of 28 percent. This treatment is inconsistent with how a non-resident investor would be taxed if they invested directly into foreign and New Zealand assets. This proposal is intended to ensure that non-resident investors in PIEs are subject to roughly the same tax treatment on the income they earn as would apply if they invested directly.
How the new rules work
In summary, the proposals provide for two categories of foreign investment PIEs:
PIEs applying this option can have both non-resident and resident investors but must derive principally foreign-sourced income. A de-minimis threshold for NZ income is allowed in order to ensure that PIEs can hold sufficient cash reserves to meet applications, redemptions and day-to-day expenses. A PIE is allowed to derive:
- Income from NZ financial arrangements with the term of 90 days or less for which the total value does not exceed 5% of the total value of the PIE investments. If a PIE invests in another PIE, the PIE attributed income that comprises income from NZ financial arrangements is taken into account is calculating this threshold.
- Dividends paid by a company resident in NZ for which the total value of all shares held by the PIE in all NZ companies does not exceed 1% of the PIE investments.
The thresholds should generally be monitored on a quarterly basis similar to other PIE eligibility requirements.
Provided these conditions are met, the PIE can elect to become a foreign investment PIE and can apply a 0% rate to income allocated to “notified foreign investors”. The concessionary tax rates that apply to foreign investors also apply to transitional residents who are, generally, first time residents in their first 4 years of NZ residency.
Notified foreign investors must not be resident in NZ, a controlled foreign company or a non-resident trustee of a trust that is not a foreign trust. They must notify the PIE that they wish to be treated as a notified foreign investor and provide certain information, including their name, date of birth, home address, their tax file number in the home country or a declaration if they are unable to provide it, and their NZ tax file number if they have it.
Expenditure incurred by the PIE in deriving foreign sourced income allocated to foreign investors is not deductible.
PIEs that have both non-resident and resident investors and both foreign and New Zealand-sourced income can elect into Category 2. These PIEs cannot hold direct investments in NZ land including income from the lease of land or interests in land holding companies.
This option provides greater benefits to investors, for example, by allowing PIEs to be used as vehicles for non-residents to hold New Zealand debt. However, it is more complex for PIEs to implement and comply with, as it may involve significant systems changes. It adds 3 more tax rates to the already existing PIE rates. PIEs will need to also track different types of income and apply different rates.
The income of notified foreign investors will be taxed at varied rates as follows:
- 0% on foreign-source income;
- 0% on dividends derived from New Zealand companies that are fully imputed;
- 15% on dividends derived from New Zealand companies to the extent to which they are not fully imputed where the investor is from a country that has concluded a tax treaty with New Zealand;
- 30% on dividends derived from New Zealand companies to the extent to which they are not fully imputed where the investor is from a country that has not concluded a tax treaty with New Zealand;
- 1.44% on New Zealand financial arrangement income (being the deductible approved issuer levy rate); and
- 28% on other New Zealand-sourced income.
During the consultation process it was strongly submitted for that the rate on NZ financial arrangements be reduced to zero percent in line with the pending changes in relation to widely-held bonds, however the proposal did not receive sufficient support from Officials.
PIEs in this category will also have an option to elect to apply NZ non-resident withholding tax instead of the PIE tax to dividends which are not fully imputed. This should allow non-resident investors to claim tax paid in NZ as a foreign tax credit in their home country. If this option is selected, the PIE will be required to pass up the dividend within 2 days of its receipt. We note that in practice difficulties may arise in meeting this tight timeframe and the ongoing consultation process with the industry may see an extension to this timeframe.
Category 1 is simpler than Category 2 as it does not require tracking of different types of income.
The bill implementing the changes is expected to be enacted in 2011, with the application date depending on the PIE category. Category 1 will apply from the date the bill receives royal assent, while Category 2 will apply from 1 April 2012.
Not all PIEs are covered
It should be noted that the new rules in the Bill are intended to apply to multi-rate PIEs and not listed PIEs. Multi-rate PIEs are widely held collective investment vehicles which are not listed on the NZ stock exchange. They pay tax at variable rates elected by the investor depending on the investor tax profile. Tax is returned on taxable income allocated to investors and distributions do not attract a tax liability. It was considered that further analysis was required with respect to extending the current proposal to encompass listed PIEs. Accordingly, foreign investors holding foreign investments via listed PIEs will continue to be taxed at the standard corporate tax rate.
Added complexity to foreign investment fund rules
An avoidance provision is included in the Bill which affects investments by New Zealand residents in Australian companies. Certain Australian listed companies benefit from an exemption from the Foreign Investment Fund (FIF) rules. The avoidance rule removes this exemption if the Australian company invests in a foreign investment PIE, the aim being to prevent NZ residents investing back into NZ via foreign vehicles. While targeting a specific scenario, in practice this provision will add unnecessary complexity to an already difficult set of FIF rules.
The context of the new rules
The proposal to remove tax on foreign-sourced PIE income earned by non-residents was first raised during the Jobs Summit in January 2009. It was considered that the imposition of tax in this situation potentially acted as a barrier to the development of New Zealand’s fund management industry as it discourages non-residents from investing in New Zealand Funds.
Subsequently the Capital Market Development Taskforce (“CMDTF”) recommended pursuing opportunities to develop New Zealand as an exporter of high-value middle and back-office services for fund management companies in its final report to Government in December 2009. One of the areas the CMDTF identified where New Zealand could export financial market services is in the Asia-Pacific region.
Following the final report of the CMDTF the New Zealand Government established an advisory group, the International Fund Services Development Group, to report back on how New Zealand could successfully position and market itself as an international funds domicile. The Government was particularly interested in how this positioning might create opportunities for strengthening New Zealand’s funds management industry and capital markets and raise New Zealand’s profile as a successful niche player in financial services. A recent report of this group suggests that New Zealand should join forces with Australia in building a financial services hub in the Asia-Pacific to take advantage of fast-growing nations in the region. Given that Australia is positioning itself as a centre for asset management services, it looks at New Zealand as potentially a complementary partner in servicing the Asia-Pacific region.
It was acknowledged that creating the hub will require major tax and regulatory reform. The pending legislation to cut PIE tax on foreign-sourced income to zero is the first step in that direction. The report recommended putting in place the regulatory framework by the end of next year, followed by a coordinated bid to attract business for domicile in New Zealand.
In conclusion we note that the reform is a positive step towards growing NZ funds management industry. However the costs of electing into the regime may well outstrip any benefits that may arise at least in the short term. In addition while the tax changes are one step, the overall success of the reform will be largely dependent on the creation and implementation of an adequate regulatory framework for foreign investments via NZ.