McLEAN AND CO MAY 2007  NEWSLETTER  PAGE 2     

FOREIGN INVESTMENTS TAX- THE RULES

From 1 April 2007 individuals with investments in foreign lands face new and complex taxing rules.. There have been a number  of changes for New Zealand-resident investors in non-Australasian companies.  For people who have a standard income year (the large majority), the new rules apply from the start of their 2007/08 income year on 1 April 2007 .

Te rules apply to investments of less than 10% in most foreign companies, foreign unit trusts, foreign life insurance policies, foreign investment vehicles and foreign superannuation schemes. 

THE $50,000.00 RULE

The $50,000 rule applies to individuals, and not family trusts or companies.   What the rule means is that if the total cost of an individual's foreign investments is less than $50,000.00 the new rules do not apply.   If an investment was inherited by an individual its cost is the market value on the date of inheritance for purposes of determining whether an individual is under the $50,000 threshold.   The exchange rate on the date of your purchase of any shares in foreign currency should be used.   The $50,000 threshold takes into account brokerage fees if these are part of the cost of acquiring any shares.

If an investment was acquired before 1 January 2000, as an alternative to cost, an individual can choose to value "cost" at one half of the market value on 1 April 2007.

If the individual is under the $50,000.00 threshold they pay tax on dividends received and only pay tax on capital gains if they are a share trader or acquired the investments with an intention of sal e.

A couple can qualify for a total NZ$100,000 threshold. This can be achieved by half of the shares costing $100,000 being held in each persons name, the shares being wholly jointly owned, or a combination of individual and joint ownership (each person would have to add half the cost of their jointly owned shares to their individual shares to find out if they qualify for the threshold). 

FAIR DIVIDEND RATE

The Government has decided that it is only "fair" that individuals pay tax on a deemed return of 5% per annum on foreign investments  rather than on the actual return.   This will be "fair" to the Government if the actual return is less than 5% and "fair" to individuals if the actual return is greater than 5%.  The 5% return is calculated on the value of foreign investments as at 1 April each year starting from 1 April 2007 .

This means that individuals will pay tax on an investment even if they sell it during the year.  On the other hand, no tax is payable on an investment acquired during the year (unless it is sold during the year) until the following year.

As the 5% return is applied to the market value of the investment it is "fair" that tax is paid on the capital growth of investments and movements in the New Zealand dollar.  As the New Zealand dollar is high at the present time individuals will suffer a tax cost when it falls.

It does mean that tax will no longer be paid on dividends received.  A credit for any tax deducted in the country where any dividend comes from will however be available.

The following table illustrates the 5% calculation of taxable income:

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Tax is then payable on the Taxable Income ($5000.00 and $5400.00 in the example above) at the marginal taxation rate that the taxpayer is liable for.  So say the taxpayer has $100,000 in the Opening Value as per the example below , and the investments are in his/hers personal name, and his/ her total Taxable Income including this Foreign Tax Income is $35,000. Marginal taxation rates for an individual with taxable income $38,000 or less are 19.5%, so the additional tax to pay will be $100,000 x 5% x 19.5% equals $975.00.   If the individual has a total Taxable Income including this Foreign Income of say $75,000, and therefore the marginal taxation rate is 39%, the additional tax to pay would be $100,000 x 5% x 39% equals $1950.00.

Thus , if you have a taxable income in excess of $60,000, when the 39 cents marginal taxation rate kicks in, it would be advisable to have any applicable investments in excess of the $50,000 (or $100,000) threshold in the name of a company or family trust, where the additional tax to pay would be at 33% instead of 39 cents as per this scenario.

If individuals or family trusts (but not companies) can show that the total return on all investments is less than 5% an alternative method of calculating the taxable income can be used and no tax payable in the year that there is a loss.  The FDR rate of return can never be lower than zero.   No losses are carried over under the new method each year is treated separately.

Examples:

(A) If you make a total return of more than 5 per cent:

John holds offshore shares that have a market value of $100,000 at the start of the year. These shares are worth $115,000 at the end of the year. John also receives a $10,000 dividend.   Under the fair dividend rate method, John pays tax on 5 per cent of $100,000 or a lower amount if his return for the year is less than 5 per cent. No tax is payable if his shares make a loss.  John's total return for the year is the $15,000 capital gain on his shares and the dividend of $10,000.   His total return is therefore $25,000.  However, his taxable income for the year is limited to 5 per cent of the opening value of his shares. This would result in taxable income of $5,000.

(B) If you make a total return of less than 5 per cent:

Mary also holds offshore shares that have a market value of $100,000 at the start of the year.  These shares increase in value to $102,000 at the end of the year. Mary also receives a $1,000 dividend.   Mary would pay tax on 5 per cent of $100,000 (her opening value) unless she can show that she made a return of less than this.   Mary's total return for the year is $3,000 (comprising a capital gain of $2,000 and a dividend of $1,000), which is less than 5 per cent of her opening value of $100,000.   Therefore, Mary is only taxed on $3,000.

(C) If you make a loss:

Judy holds offshore shares that have a market value of $100,000 at the start of the year, which decrease in value to $75,000 at the end of the year. She also receives a $10,000 dividend.    Judy would be taxable on 5 per cent of the opening value of her shares unless she can show that her total return for the year is less than 5 per cent.   Judy's total return for the year comprises a capital loss of $25,000 and the dividend of $10,000.   Her net return is therefore a loss of $15,000. Because Judy has made a loss on her offshore shares, no tax is payable.

 THE NEW ZEALAND RULE

The new rules do not apply to New Zealand investments so individuals will still pay tax on dividends received from New Zealand companies and capital gains will be exempt from tax unless an individual is a share trader or acquired the shares with an intention of sal e.   Thus, for example if an individual invested in a New Zealand resident company unit trust this would not be caught by the new legislation. 

THE AUSTRALIA RULE

There is an exclusion for investments in Australia , but not all such investments.   The exclusion only applies to shares in companies included in the All Ordinaries Index of the Australia Stock Exchange ("ASX").   To qualify for the All Ordinaries Index a company must be an Australian tax resident (and some are not) and must retaining a franking credit account .   There are currently 477 companies in the All Ordinaries Index with around 32 that will not qualify under this criteria.     Thus, for  example if an individual invested in a Australian resident company unit trust , as opposed to shares, this would  be caught by the new legislation.

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THE GPG RULE

If an individual has shares in Guiness Peat Group PLC they will not be subject to the new rules for 5 years. 

THE QUICK SALE RULE

Should an individual buy and sell investments in the same year tax is payable on the lesser of:

PROVISIONAL TAX

Individuals should be aware that these rules  apply from 1 April 2007 . If the implementation of these new foreign investment rules means that they are liable for Provisional Tax (which would mean that the income tax to pay as a consequence is more than $2,500.00) then you should pay the expected tax to pay prior to 7/3/2008. 

CONSULTATION WITH YOUR FINANCIAL ADVISOR

It may be appropriate, as a consequence of this new legislation:

WHAT CLIENTS HAVE TO DO IN RELATION TO THEIR 1/4/2007- 31/3/2008 TAX PERIOD

If you are liable for this new foreign investment tax, as described above it is calculated on either:

The first and immediate task you therefore have to do is establish the market value as at 1/4/2007 and keep this information for the end of the year 31/3/2008 tax return preparation.

CHANGES TO PROVISIONAL TAX AND GST

There are important changes happening to the way GST and provisional tax is paid from 1 April, 2007 , although the majority of the changes occur in the 2008 income year.

FROM 1 APRIL, 2007

·          You'll notice the dates change on GST forms.  Return periods should be changed to allign with balance dates 

2008 INCOME YEAR

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For a standard March balance date provisional tax will be due on 31 August, 15 January and 7 May.

The GST Ratio Method applies to taxpayers who are registered for GST and have Residual Income Tax under $150,000.   Taxpayers who elect under this method will pay provisional tax 6 times a year based on a ratio of prior years Residual Income Tax over taxable supplies and multiplied by the current period's total taxable supplies.  IRD will calculate and notify the taxpayer of the initial ratio and any subsequent changes to the ratio.

The benefit of the ratio method is that provisional tax is paid in line with seasonal sal es thereby assisting cashflow.   The ratio method is also a safe harbour in that Use of Money Interest won't be charged for taxpayers who qualify throughout the year.

A taxpayer will need to elect to use the ratio method in phone or by writing to IRD.

KIWISAVER

KiwiSaver is a voluntary, work-based savings initiative to help you with your long-term saving for retirement.  It's designed to  maintain a regular savings pattern.  It is administered by Inland Revenue Department.

Work-based Saving

For many people, KiwiSaver will be work-based. This means you will receive information about KiwiSaver from your employer, and your KiwiSaver contributions will come straight out of your pay.

What you Get When you Retire

NZ Super provides for a basic standard of living in retirement, but it may not be enough for the kind of retirement you want.     KiwiSaver is intended to complement NZ Super.

Government Initiative

The government has created the framework for the KiwiSaver initiative, to help New Zealanders financially prepare for retirement.   There is a range of membership benefits to encourage you to get saving, including a $1,000 tax-free kick-start and subsidised scheme fees. Some people may also be eligible for help with the deposit on their first home.

Membership

KiwiSaver membership is voluntary and open to all New Zealand residents and people entitled to be here indefinitely, aged up to 65 - the age of eligibility for NZ Super.

If you are 18 years or over and start a new job from 1 July 2007 , you will be automatically enrolled in KiwiSaver and contributions will start from your first pay. You then have eight weeks from starting to decide if it's right for you.

There are some exceptions to automatic enrolment. You won't be automatically enrolled if you:

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Opting Out

If you are automatically enrolled and decide to opt out you can do so from the end of your second week of employment. To opt out, fill in the opt out form in the information pack you will get from your employer.

If you opt out, any contributions already deducted from your pay will be refunded.

Opting In

If you are in a job already you can join directly through a scheme provider or your employer. This also applies to government employees working overseas. Those who are, for example, self-employed, under 18 or on a benefit can join by contacting a KiwiSaver scheme provider directly.

KiwiSaver Schemes

With KiwiSaver you can choose a savings scheme to suit you. There will be a range of scheme providers and several investment types, from conservative risk to growth funds. You can change KiwiSaver schemes but can only belong to one scheme at any time.  If you don't want to choose your own scheme IRD will allocate you a default scheme, or to your employer's preferred scheme, if they have one. You can change this later if you wish.  The Government has named the six default providers they intend to appoint for people who join KiwiSaver without nominating a preferred savings scheme.  They are- ASB, AMP, ING, Mercer, AXA and Tower.

Use KiwiSaver to Help Pay your Mortgage

Some scheme providers could offer a mortgage diversion option. After you've been with a scheme for 12 months you can choose to have up to half of your regular contribution go towards the mortgage on your home. The rest would go to your KiwiSaver account. Mortgage diversion may be available for new and existing mortgages, but can only be used towards the mortgage on your main home (not an investment property or holiday home).Once your mortgage is paid off, all contributions would go to your KiwiSaver account. Employer contributions cannot be diverted to your mortgage.

To find out more about mortgage diversion, talk to your scheme provider.

First Home Deposit Subsidy

KiwiSaver offers a first home deposit subsidy of $1,000 each year of membership in a scheme, up to a maximum of $5,000. To be eligible you must have been saving through a KiwiSaver scheme for at least three years and meet criteria. Income and house price caps will apply.

The first home deposit subsidy is administered by Housing New Zealand and will be available from 2010. To find out more visit the Housing New Zealand website.

Accessing Savings

Generally, you cannot access your savings until you're 65 or have been with KiwiSaver for five years - whichever is later. But there are special circumstances when you may be able to make a withdrawal (excluding the government contribution of $1,000). Special circumstances include:

If you move permanently overseas, you can also withdraw your funds 12 months after you leave. This includes the government kick-start contribution of $1,000.

When your savings mature you can withdraw them in a lump sum. Alternatively, some KiwiSaver schemes may offer other options. If you die before you are 65 your savings will be paid to your estate. You cannot borrow against your savings.

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 Role of Employers

Employers' main KiwiSaver responsibilities include:

Employers can also contribute to their employees' KiwiSaver accounts. These contributions can count towards your minimum contribution of 4%, and are also exempt from specified superannuation contribution withholding tax (SSCWT) up to a cap of whichever is less: your contribution or 4% of your before-tax pay.  Employers already offering registered superannuation schemes can apply to the Government Actuary for an exemption from enrolling new staff.

Employees

Your KiwiSaver Account with your scheme provider is kick-started with a $1,000 tax free contribution from the government. Each pay day your contribution is deducted from your pay for investment through your KiwiSaver account. You can choose to save 4%, or 8% to speed things up. The amount you contribute each pay is based on your before-tax pay. After a year in KiwiSaver you can take a break from saving, called a contributions holiday. Employers can help their employees to save, with tax-free contributions to their KiwiSaver accounts (limits apply-refer above). The amount you save each pay is calculated on your before-tax pay.

If you are automatically enrolled your savings will be deducted from your first pay. If you're already in a job and opt in to KiwiSaver, your savings will start as soon as your employer starts making deductions. Once your contributions have started, Inland Revenue Department will hold them for three months while you decide on your KiwiSaver scheme and investment profile. Your contributions are then paid, with interest, to your KiwiSaver scheme provider for crediting to your KiwiSaver account - along with the $1,000 tax-free government contribution. Inland Revenue Department then regularly passes your contributions to your scheme provider.

Your Regular Savings Amount

If you are self employed, talk to your scheme provider about your contribution rate. If you are an employee, your savings will be 4% of your before-tax sal ary or wages (that means your total sal ary, including bonuses, commission, extra sal ary and overtime). Or, you can contribute 8%. You can also switch between contribution rates.  

Lump Sum Payments

You can make lump sum payments whenever you like. Once you've made a lump sum payment you can't withdraw it until your savings mature. You can pay lump sums directly to your scheme provider, or to Inland Revenue Department by:

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 Temporary Breaks from Saving

After you've been saving with KiwiSaver for 12 months you can apply for a savings break, called a contributions holiday, of between three months and five years. There is no limit to the number of times you can take a contributions holiday. If you suffer financial hardship within the first 12 months of saving, talk to Inland Revenue Department. You may be eligible for an early contributions holiday.

Going on holiday

If you take a trip overseas or in New Zealand , but are still paid by a New Zealand employer, your KiwiSaver contributions will continue unless you request a contributions holiday. If you take a break from saving while you're away you can still make lump sum payments.

EMPLOYERS- TIMELINE FOR KIWISAVER

MAY 2007  

JUNE 2007  

JULY 2007  

OCTOBER 2007