Foreign superannuation rules overhauled
On 20 May 2013 the Minister of Revenue introduced the Taxation (Annual Rates, Foreign Superannuation and Remedial Matters) Bill (“the Bill”), which reforms the way in which New Zealand residents are taxed on their foreign superannuation.
In our August 2012 Tax Alert we outlined the proposed changes as signalled in an Inland Revenue Issues Paper released in July 2012 entitled ‘Taxation of Foreign Superannuation’. In summary, the proposals were that individuals with an interest in a foreign superannuation scheme would be taxed on a receipts basis. That is, going forward an individual with a foreign pension scheme will only be liable for New Zealand tax on receipt of a pension payment or lump sum payment from the scheme, or when the superannuation is transferred to another scheme. The FIF rules would no longer apply to tax individuals on an accrued or deemed income basis.
A key driver for the changes is that the current framework for taxing foreign superannuation is extremely unclear and has resulted in very low compliance by taxpayers.
The Bill largely follows the proposals set out in the Issues Paper, but includes a few tweaks following submissions made during the public consultation.
Under the new rules two methods are proposed to determine the taxable income that arises on the withdrawal / transfer of a lump sum from a foreign superannuation:
- The schedule method (referred to as the inclusion rate method in the Issues Paper): A lump sum withdrawal or a transfer to another scheme would be taxed depending on how long the taxpayer has been in New Zealand before the withdrawal or transfer. Under the proposed regime only a portion of the lump sum would be included as taxable income in an individual’s return and income tax would be calculated on the income at the individual’s marginal income tax rate. The remainder would not be taxable in New Zealand.
The portion of the lump sum that is included as income in a taxpayer’s return is directly linked to the period the individual has been a New Zealand tax resident prior to receiving the sum. The proportion of the lump sum to be included as taxable income would range from 4.76% (where the sum is received during the first year after the expiry of the exemption period) to 100% (where the transfer is made after 26 years or longer).
- The formula method: This method was not included in the original issues paper and provides for a series of formulae which attempt to determine taxable income based on actual investment gains. We discuss this method further below.
Under both methods compulsory after-tax contributions that have been made while a person is tax resident in New Zealand can be deducted from the lump sum.
In addition, under both methods a one off exemption period will apply for the first 48 months a person is tax resident of New Zealand. No New Zealand tax liability will arise on the withdrawal or transfer of funds during this time. This is consistent with the transitional resident exemption, which currently applies to the derivation of foreign sourced income more generally by new residents.
As a concessionary measure, taxpayers who have previously made a lump sum withdrawal and have not complied with their tax obligations can pay tax on 15% of the lump sum amount. This income should be returned in taxpayers’ 2014 or 2015 income tax returns.
We comment below on the changes from the Issues Paper included in the Bill.
The schedule method
Apart from a name change, there have been only minor changes to the schedule method. As originally proposed the schedule method applied to “brackets” of years as opposed to requiring taxpayers to apply a formula to work out how much income should be included in their tax return based on the specific period of their tax residency (e.g. calculated on a days or monthly basis), which had the potential to create distortions and tax planning opportunities for those financially aware. This distortion has been remedied in the Bill with the removal of brackets of years. The Bill proposes that the portion of a withdrawal / transfer that will be taxable will increase yearly.
The formula method
The Bill proposes an alternative method to the schedule method to calculate a person’s taxable income arising from a withdrawal of an amount from a foreign superannuation scheme. This is the biggest change from the initial proposals in the Issues Paper. The formula method is intended to tax the actual investment gains derived while a person is resident in New Zealand (following the completion of the exemption period). This method will only be available for withdrawals from a defined contribution scheme.
To be able to use this method , taxpayers will be required to obtain the market value of their superannuation interest at the time the exemption period ends, as well as the market value directly before a withdrawal is made and information regarding contributions made to the scheme.
The legislation provides a complex formula to calculate the taxable gain to the taxpayer flowing from the withdrawal. An interest factor is then applied to the taxable amount calculated to recognise the deferral benefit that a person obtains by not paying tax on accrual. The interest factor is calculated as the average growth rate of the person’s superannuation interest for their period of New Zealand residency (following the expiry of the exemption period).
Commentary to the Bill states that this method was introduced following submissions on the Issues Paper. While it is encouraging to see a method introduced which proposes to tax actual investment gains derived, we believe the formula method is overly complex as it requires several difficult calculations to reach the end number. When faced with calculating their taxable income arising from a withdrawal from a superannuation scheme, the average taxpayer will favour the simplistic schedule method and would be unlikely to even investigate whether the formula method will give rise to a more favourable outcome. In reality, the formula method may not provide a real alternative calculation method for most taxpayers.
The Issues Paper originally proposed retrospective application of the new rules from 1 April 2011. This caused a great deal of uncertainty for taxpayers preparing their 2012 income tax returns as it was not yet clear whether the proposed rules would be enacted into legislation.
Sensibly, the Bill proposes a prospective application date of 1 April 2014, which should provide greater certainty for taxpayers and allow taxpayers to make informed investment decisions with regard to the tax consequences.
Grand-parenting of the FIF rules
As originally proposed in the Issues Paper, taxpayers who had historically complied with their tax obligations by applying the FIF rules to their foreign superannuation interests were to be required to continue to apply the FIF rules going forward. The rules introduced in the Bill will allow taxpayers to choose between continuing to apply the FIF rules and applying the new rules.
However, as proposed, the new rules do not provide a mechanism to recognise any tax paid previously under the FIF rules or alternatively the number of years a taxpayer has previously complied with the FIF rules. As such, the choice afforded to taxpayers may be no real choice at all. In our view this is an undesirable outcome. Taxpayers who have historically complied with their tax obligations are at a disadvantage to those taxpayers who have been unaware or wilfully non-compliant with their New Zealand tax obligations. While the proposed rules have been designed with simplicity in mind, we believe this can be achieved while still affording taxpayers credit for previous compliance. For example under the schedule method, the years in which a person has complied with the FIF rules could be treated as exempt, similar to the first 48 months in which a person is tax resident in New Zealand.
Transfers to another foreign scheme
An area of uncertainty in the Issues Paper was in what circumstances the transfer of funds from a foreign superannuation scheme to another scheme would give rise to a New Zealand tax liability. It was clear that a transfer from a foreign superannuation scheme to a New Zealand fund would be taxable under the schedule rate method. However the Issues Paper did not expand on whether transfers from one foreign scheme to another foreign scheme or transfers to purchase a foreign annuity would trigger a New Zealand tax liability. The Bill clarifies this uncertainty and provides that:
- Withdrawals and transfers from an Australian superannuation scheme will not be taxable by virtue of the Australia - New Zealand double tax agreement;
- Transfers from a foreign (non-Australian) superannuation scheme to an Australian superannuation scheme will be taxable. This is because a subsequent transfer / withdrawal from the Australian scheme would be exempt; and
- Transfers between two foreign (non-Australian) superannuation schemes will not be taxable. Instead a tax liability will arise on the eventual withdrawal based on the length of residence from when they initially acquired the interest in the first scheme.
The outcome reached in terms of transfers between two foreign (non-Australian) schemes is a sensible one as the New Zealand tax liability is deferred until the taxpayer has the cash flow available to meet the tax liability which arises. However, a cash flow issue will still arise for taxpayers transferring to an Australian scheme.
Transfers to a New Zealand Scheme
As noted above, the transfer of funds from a foreign superannuation scheme to a New Zealand scheme will trigger a New Zealand tax liability. This may give rise to cash flow difficulties as tax will be payable immediately, with the taxpayer not having access to the funds for what could be a number of years.
In an attempt to alleviate these difficulties the Bill proposes a mechanism to allow taxpayers to withdraw an amount up to the value of the tax due where the funds from a foreign superannuation scheme are converted into an interest in a New Zealand KiwiSaver scheme. However, unless the funds withdrawn are those contributed while the taxpayer was living in New Zealand this mechanism may provide very little benefit to taxpayers. This is because the withdrawal of transferred foreign funds may give rise to a tax liability in the foreign jurisdiction (for example funds transferred from a UK pension may be subject to UK tax at 55% if they are withdrawn from the New Zealand scheme).
It is clear that the proposals in the Bill are an improvement on the current taxation of foreign superannuation schemes. In particular the new rules will be much simpler to apply, perhaps with the exception of the formula method.
The changes included in the Bill have gone some way to remedy the concerns raised by taxpayers in submissions on the original Issues Paper. The key issue which remains is providing those taxpayers who have previously complied with the FIF rules a mechanism to recognise prior tax paid / prior years of compliance should they choose to apply the new rules are going forward.
The rules are not yet set in stone and there is still time for further taxpayer input. The Bill is still awaiting its first reading in Parliament. Following this, it will be referred to the Finance & Expenditure Select Committee at which time public submissions will be called. For more information, please contact your usual Deloitte tax advisor.
Tax Alert June 2013 contents:
- Tax Alert June 2013
- Further Reforms to the Tax Treatment of Land-Related Lease Payments: Shifting the Capital-Revenue Boundary?
- Do your facts stack up? Don’t Google it!
- New foreign super and mineral mining bill introduced
- Foreign superannuation rules overhauled
- Clarifying the acquisition date of land: Certainty please
- Confirmed legislative changes for the taxation of mining