By Patrick McCalman & Hamish Tait
We have all heard it said enough times to know that New Zealand has an infrastructure deficit. Whether it’s broken pipes, a congested transport network, or energy shortages, New Zealand has struggled to achieve the right level of investment – both to maintain existing infrastructure and to build new assets to keep up with population growth. New Zealand also faces significant challenges such as climate change, urban sprawl, lack of scale, and rising construction costs. Unfortunately, New Zealand is not in a unique position of having an infrastructure deficit which means that there is global competition for capital and capability. However, New Zealand is unique in many challenging ways including being a long way from the rest of the world. This means that we need to make sure that we have the right policy settings to make sure a New Zealand infrastructure opportunity as investible as possible.
The Government is looking at what levers it can pull to enable this – appointing the rebadged National Infrastructure Funding and Financing Limited to be New Zealand’s infrastructure shopfront, reviving the Public Private Partnership Programme, and instructing the Infrastructure Commission to develop a 30- year national infrastructure plan.
Consistent with this focus, Inland Revenue has just released an Officials’ issues paper on New Zealand’s thin capitalisation settings and whether they might be discouraging foreign investors from investing in privately owned infrastructure projects in New Zealand. The issues paper proposes two options for attracting more foreign investment into New Zealand, by relaxing the thin capitalisation settings using one of two proposed options (more on the options proposed below).
This issues paper was released as part of a pre-Budget tax announcement from Minister of Finance Hon Nicola Willis that states that the Government is removing tax roadblocks to investment. In that announcement, the Minister of Finance notes: “Presently, New Zealand’s thin capitalisation rules limit the amount of tax-deductible debt that foreign investors can put into New Zealand investments. The purpose of these rules is to prevent income being shifted offshore and to protect New Zealand’s tax base. However, there is a risk that the rules may be deterring investment, particularly in capital-intensive infrastructure projects that are typically funded by large amounts of debt. We need to strike a balance.” The Minister of Finance has allocated $65 million for a change to the rules, pending the outcome of the consultation.
There is a very limited time to comment on the proposals in the issues paper (submissions are due 19 June 2025). We expect that this is to enable the final proposals to be finalised and included in the next Tax Bill, which is anticipated in August of this year. While there is a lot of detail to be worked through in the consultation as to how the rules will work, it is highly likely that one of these options will proceed given that it has already been allocated Budget funding.
The issues paper notes that the government is committed to ensuring that New Zealand remains an attractive place for non-residents to invest. The issues paper works briefly through the current thin capitalisation settings, background to this proposal, and a problem definition to ensure that the policy direction in introducing these changes is clear. The issues paper then sets out details on the two potential solutions being consulted on:
But are the proposed changes enough?
The Proposed Options
Option One
New Zealand’s thin capitalisation rules currently limit interest deductions for non-resident owned entities where debt exceeds 60% of net assets plus non-debt liabilities (unless the worldwide group is more highly geared). The intention of these rules is to both set the effective tax rate on non-resident investment and also prevent non-residents from artificially loading levels debt against the New Zealand tax base. The rules apply to both related party and third-party debt.
Under Option One, interest paid would be deductible provided the following key requirements are met:
These changes are positive, as they recognise the commercial reality that infrastructure projects are often highly geared. Infrastructure is capital intensive, and its long-term, predictable revenue streams align with long term debt repayment profiles. Debt funding is also typically cheaper and more accessible in this context than equity financing. Denying interest deductions on infrastructure assets only increases their cost, as assets need to generate greater profits to meet equity investors’ required rates of return. The changes will therefore help to remove this barrier to investment.
The changes also recognise that tax deductions should be claimable for what is a genuine economic cost (interest) if it arises on a commercial level of debt. This principle is reflected to some extent in existing law – in 2018 a specific concession for infrastructure project finance was introduced to allow interest deductions for third party debt provided on limited recourse terms. However, this concession is very specifically drafted to apply only to PPP structures. It is sometimes possible for other structures with only third party debt to also achieve a full interest deduction (e.g. in a corporate entity owned by a group of non-residents), however this is not always the case. This reduces certainty and equity for investors who cannot structure into the rules.
However, some concerns do arise with Option One.
Firstly, the option only applies to eligible infrastructure. This will result in inevitable line drawing exercise and so has the risk of creating projects, which are demanded by the market and able to be funded by third parties, but which fail to be able to avail themselves of the rule. The result will be projects where the tax cost increases because they fall on the wrong side of the pen.
Secondly, this option would only apply to greenfield investments. In any case where an infrastructure investor incurs a genuine economic cost (third party interest at commercial levels), it is difficult to see why our tax settings should only allow a tax deduction in a greenfield context. More broadly, we need to carefully consider whether New Zealand’s tax settings should incentivise the creation of new infrastructure projects to the detriment of updating or developing existing infrastructure. This would distort investment decisions between different types of projects, and arguably ignores the value of brownfield development. According to the Infrastructure Commission, New Zealand is near the bottom 10% of OECD countries for the value we get from infrastructure spend. The Commission has also highlighted the importance of maximising the potential of existing infrastructure in improving efficiency. Excluding brownfield development from the new rules runs counter to this strategy.
Option Two
Option Two proposes interest would be fully deductible if:
Conceptually this rule overcomes the issues with Option One and allows the market to determine the projects which are best to be undertaken and funded. In that respect it reduces the risk of tax -based distortions to investment decisions. It is difficult to see why any new rule should be restricted to infrastructure as defined (as it is then necessary to get the definition right). If financial markets are willing to fund an investment, with limited recourse, third party debt, does it make sense for our tax rules to deny a tax deduction for the interest cost? Limiting exemptions to a specific structures or sectors can act as a barrier to investment and may create distortions by incentivising investment in New Zealand only via specific structures or into specific sectors. The design of this rule would, however, require greater rigour to ensure that interest costs taken against the New Zealand tax base are only be used to fund assets within the New Zealand tax base. That it itself is not insurmountable and properly designed would provide a rule where tax’s influence on investment choice would be minimised.
Other matters which could be considered
Withholding tax
The issues paper does not consider any changes in relation to withholding tax, which can be a significant cost for infrastructure investors. Due to upfront expenses such as interest and tax depreciation, infrastructure projects tend to have taxable losses in their early years (i.e. not yet be paying corporate tax to generate imputation credits) but may still be cashflow positive. In this context, investors will often prefer to extract cash where it is not needed within the project vehicle.
Under New Zealand’s current tax settings, any return to investors in early years may be subject to non-resident withholding tax (NRWT) at a rate of 15% to 30% if the dividends are unimputed (depending on the country). Some double tax agreements (DTAs), such as with Australia and the US, can reduce this withholding tax to 0%, however many older DTAs (e.g. with the United Kingdom and other European states) do not which imposes an additional tax cost of their investment. Even for those who can access a 0% rate, to obtain a 0% rate often requires a Competent Authority determination, which provides a level of risk or uncertainty to overseas investors trying to get to grips with how certain and reliable this is.
To attract the foreign direct investment we need, the Government should consider unilaterally reducing NRWT rates to 0% on shareholdings greater than 10%. This would equalise the tax treatment for returns paid to investors, regardless of which country they are from/which DTA is in place, helping to broaden New Zealand’s potential pool of infrastructure investors. It also avoids the undesirable distortion created by the current rules which encourages a limited partnership instead of company structure.
Tax loss carry forward
Due to the significant upfront costs involved in infrastructure, tax losses often arise in the early phases of projects. Previously, a shareholder continuity test limited the ability to carry forward tax losses where there was a greater than 51% change in ultimate shareholding, which presented an issue for infrastructure projects carrying forward losses.
Since 2021 the business continuity test has allowed companies that breach the shareholder continuity requirement to carry losses forward provided there are no major changes in their business activities. This has been a welcome change for taxpayers in a number of industries who may have early-stage tax losses that would otherwise be lost. However, greater clarity is needed on the technical application of these new rules to different types of infrastructure projects (including whether different project phases could be a ‘major change’).
It may be useful for Inland Revenue to consider publishing infrastructure-specific guidance on the rules – and potentially considering any remedial amendments if any issues are identified or the interpretation is unclear for investors.
Next steps
It is extremely positive to see consideration be given in this area. The question really comes down whether we want this rule to focus solely on (new) infrastructure or whether we prefer a rule which is more principle based and so allow investment to find its natural home.
Consultation on the proposed changes is now open, with a deadline for submissions set for 19 June.
If you would like to discuss the changes, or are considering making a submission, please contact your usual Deloitte advisor.