A fairer approach to taxing foreign-currency financial arrangements

By Stephen Walker

While recent reforms to New Zealand’s tax rules for migrants have focused on the Foreign Investment Fund rules relating to overseas shares, the Financial Arrangements rules can create even greater tax exposures and disincentives for people considering a permanent move to New Zealand.

Recent and prospective migrants, and other taxpayers, should therefore welcome the significant changes proposed in the Taxation (Annual Rates for 2026–27, FBT Simplification, Foreign Investment Funds, and Remedial Measures) Bill (the Bill).

Why change?

New Zealand’s Financial Arrangements rules apply to a wide range of arrangements, including bank accounts, bonds, term deposits and loans. Income and expenditure in relation to these arrangements are generally calculated in New Zealand dollars, even where an arrangement is denominated in another currency.

For example, a New Zealand tax resident holding USD in a US bank account may have taxable income solely because the USD strengthened against the NZD during the income year, even if the account earned no interest and there were no transactions.

This often surprises migrants when their four-year transitional residence exemption expires. Many have no intention of converting their funds into NZD, yet they face unpredictable tax liabilities from exchange-rate movements that are outside their control and may never be economically realised. For some, this has been a factor in deciding to leave New Zealand or not to relocate here.

What is changing?

The Bill proposes several measures intended to reduce compliance costs and uncertainty for taxpayers with foreign-currency financial arrangements:

1. A functional foreign currency election
2. Quarantined foreign financial arrangements, particularly to improve alignment with US tax treatment
3. Removal of the revaluation requirement for arrangements acquired to satisfy visa eligibility requirements
4. Expansion of the list of arrangements that are exempt from the Financial Arrangements rules.

Functional foreign currency election

Under these proposals, individuals, family-run companies and family trusts would be able to calculate income from foreign-currency financial arrangements in a currency other than NZD.

An eligible taxpayer could elect either:

• A single nominated functional currency for all non-NZD financial arrangements, or
• The currency in which each individual arrangement is denominated.

For example, an individual holding mainly USD cash accounts could elect to apply USD to all non-NZD arrangements. Alternatively, they could calculate each arrangement in its own denomination.

For most individuals with foreign-currency bank accounts or loans, the broad economic effect would be that movements between the elected currency and NZD are ignored. Instead, foreign-currency interest income and expenditure would be calculated in the relevant currency and converted into NZD using an appropriate exchange rate.

The same broad approach would apply to foreign-currency bonds. The coupon and any face value changes required to be spread over the bond’s term would be calculated in the relevant foreign currency and converted into NZD each year. Foreign-exchange fluctuations over the term of the bond would generally be ignored.

Several integrity measures are proposed:

• A taxpayer could not apply a single functional currency to some arrangements while applying arrangement-by-arrangement currencies to others.
• A taxpayer who elects out of the new rules and returns to the existing rules could not elect back in for five years.
• The election would not apply to higher-risk arrangements that may be used to derive exchange gains, including forward contracts, swaps, options and contracts for difference. Holding such an arrangement would not prevent the taxpayer from applying the election to other eligible arrangements.
• A person carrying on a business of trading in foreign currency or holding financial arrangements principally to derive exchange-rate gains would not be eligible.

A taxpayer could change their functional currency in a later income year if there were sound commercial reasons and the Commissioner was notified.

Transitional adjustments

A modified base price adjustment, or true-up calculation, would be required when a taxpayer:

• First elects into the functional currency rules
• Changes the functional currency applying to an arrangement
• Ceases using the rules, or
• Becomes ineligible to use them.

The true-up calculation compares income and expenditure under the elected currency with the amount calculated under the previous currency. Unlike an ordinary base price adjustment, any resulting income or loss would generally be deferred until the arrangement matures or another event triggers the requirement for a final true-up (base price adjustment).

This is intended to limit the immediate cash-flow impact of entering the regime while ensuring that relevant exchange movements arising before a change in treatment are ultimately recognised.

Quarantined foreign financial arrangements

US citizens remain subject to US tax on worldwide income regardless of residence. Although foreign tax credits can mitigate double taxation, problems arise where New Zealand and the US recognise the same income at different times or characterise it differently.

New Zealand’s Financial Arrangements rules may spread income over the term of an arrangement and calculate it by reference to NZD values. The US may instead recognise the equivalent income on maturity and calculate it in USD. Because the tax arises in different years, foreign tax credits may not be available when needed, resulting in double taxation.

The proposed quarantined foreign financial arrangement rules would allow income and expenditure from qualifying arrangements to be calculated on a cash-flow basis, better aligning the timing of New Zealand and overseas taxation.

The election would apply arrangement by arrangement. To qualify, the arrangement must:

• Be held by a New Zealand tax resident individual
• Not have a New Zealand source
• Be subject to overseas tax in a country with which New Zealand has a double tax agreement, because of the individual’s citizenship or working rights
• Not give rise to an overseas foreign tax credit for income recognised under New Zealand’s spreading rules.

A US bond illustrates the issue. Assume a five-year bond has a face value of US$30,000 and a 5% coupon. Under the current New Zealand rules, the taxpayer may be required to return both the coupon interest and unrealised gains or losses on the bond’s face value. In the US, only the coupon may be taxable annually.

Consequently, a US credit may be available for New Zealand tax on the coupon but not for New Zealand tax on unrealised value changes. When the bond is disposed of, the US may tax the realised movement in value, while little or no corresponding New Zealand tax arises because that income was recognised earlier. This can produce double taxation.

Under the proposed rules, only the coupon interest would generally be taxable annually in New Zealand. Any increase in the bond’s face value would be recognised through the base price adjustment at maturity. Aligning the timing of New Zealand and US taxation should allow foreign tax credits to operate more effectively.

Transitional rules would apply. A taxpayer could also apply the functional currency election to a quarantined foreign financial arrangement, subject to the relevant transitional calculations.

Visa-related financial arrangements

Active Investor Plus Visa applicants must make qualifying investments in New Zealand. These may include New Zealand-sourced financial arrangements that do not qualify for the transitional residence exemption.

As the investment may need to be made before the applicant arrives, it can be acquired before New Zealand tax residence begins. The current rules require the arrangement to be revalued when the individual becomes tax resident, potentially creating an unexpected tax liability from changes in value between acquisition and the start of residence.

Under the proposal, effective from 1 April 2025, no revaluation would be required for an arrangement acquired specifically to obtain an Active Investor Plus Visa. Its opening value would instead be its acquisition-date value. The treatment would be mandatory, preventing taxpayers from choosing whether to apply it based on the resulting tax outcome.

Expansion of exempt financial arrangements

The Bill also proposes three modifications to the list of arrangements that are excluded from the Financial Arrangements rules (the “Excepted Financial Arrangements”):

• The existing exemption for private-purpose foreign-currency loans, such as an overseas mortgage funding a personal-use property, would be extended to individuals who are not cash-basis persons.
• The exemption would extend beyond loan accounts to foreign-currency transaction accounts held for private or domestic purposes, such as personal bank accounts.
• For the existing NZ$100,000 threshold applying to variable principal debt instruments, exchange-rate movements after acquiring them would generally be disregarded. The threshold would be tested using the exchange rate when the arrangement was entered into and thereafter only when subsequent changes were made to the principal.

What does this mean?

Existing taxpayers with foreign-currency bank accounts, loans or investments should reconsider how the Financial Arrangements rules will apply to them from 1 April 2027.

For individuals with modest overseas arrangements, the expanded exemptions may be the most valuable change. Personal transaction accounts, private foreign-currency loans and certain lower-value debt arrangements could fall outside the rules entirely, removing calculations where compliance costs are disproportionate to the amounts involved.

The largest financial impact may be for higher-net-worth migrants, particularly those arriving from the US. The functional currency and quarantined arrangement rules should reduce tax on unrealised exchange movements and double taxation caused by timing differences between New Zealand and US rules. The relief for investments made to satisfy Active Investor Plus Visa requirements should also make New Zealand’s tax treatment more predictable.

However, the proposals do not abolish the Financial Arrangements rules or eliminate every cross-border mismatch. Eligibility requirements, elections and transitional adjustments will still require careful consideration.

If enacted as proposed, the changes represent a meaningful shift towards taxing the underlying economic return from foreign financial arrangements rather than exchange-rate movements an individual may never realise. Existing taxpayers and prospective migrants should review their arrangements before the new rules take effect, as the most favourable treatment may not apply automatically.

If you have any questions about financial arrangements or the proposed changes, please contact your usual Deloitte advisor.