Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill

I would like to take a call on the 5 percent fair dividend rate, which is contained in Part 2 of this bill. I think I have earned the right to speak on this, because I listened to many, many hours’ worth of submissions on the fair dividend rate, and I must say that some of them were a mixture of ignorance, wisdom, and everything in between. I think that it is very important to at last put a few facts on the table with regard to the process that has led to the 5 percent rate and, if you like, its “embeddedness” into the reality of what it means to invest in the stock exchange. When we buy shares in a company, we become a part-proprietor of that company. We may be only one-millionth proprietor, because there might be almost a million other shareholders, but we, nevertheless, are proprietors of that company. After that company has earned an income and has paid its due tax on that income—in whatever jurisdiction in whatever country in the world it belongs to—the after-tax income belongs to the shareholders of that company. Therefore, as investors, we have a share of that income.

What this bill attempts to do is to say that the Government will tax us a fair amount and a fair rate, based on the fact that we have just gained an income. After all, this is an income tax bill. The evidence placed before the Finance and Expenditure Committee, which is very well known, was that over time if we invest on the international stock exchange around the world—and we could look at various periods, but if we take the period from about the 1980s through to today, which is about 26 years—on average, the income yield, or the return yield, to an investor is 9 percent. This bill says that the Government will tax investors on 5 percent out of that 9 percent. Why not the whole 9 percent? The reason is that some part of that 9 percent, in addition to the income that investors receive from the company, is the market’s evaluation of the future income stream of the company, which we call capital gains. It is an estimate of what the ongoing earnings might be, capitalised today. The whole theoretical basis underlying that is called the internal rate of return, or the net present value, of future income streams, which comes into today’s valuation on the stock exchange of those particular shares.

This bill does not, in any shape or form, tax genuine capital gains from the stock exchange. It is a tax on, if you like, a fair dividend yield—and I will put this fairly and squarely on the record: if a company earns an income after tax, regardless of whether it distributes that income by way of dividends or retains it, the investors, as shareholders, have still gained an income from that company. That is the essential point of the fair dividend rate method. We are saying that if people are shareholders, they have earned some income and, because we have an income tax system on every other form of income in New Zealand—whether the income is gained here or from overseas—those people need to pay their fair whack of tax on that income.

I have mentioned that the average return is 9 percent and that we are taxing at a rate of 5 percent. Is there anything magic about that? The answer is no, but the rate is about right. It is as right as any other rate that anybody who came before the select committee could otherwise argue for. Some people who came before the select committee—many people, actually—said that investors should pay tax only on the actual dividend they receive. That is pure nonsense, and anybody who has ever had any dealings at all or who has ever invested in the stock exchange knows that that is nonsense. I, for one, was very disappointed to sit there and hear members of my own profession come along and make that ridiculous argument. As I said before, it does not matter whether one receives a dividend; one receives an income. And if a shareholder does not receive an income, everybody knows that the value of that person’s shares on the stock exchange goes up. Immediately, when a company declares its profit, the value normally goes up. It comes down, of course, if the company declares a loss.

Dr the Hon Lockwood Smith: That’s a capital gain.

That is not a capital gains tax; that is a share of income earned. I have just explained the difference between the two things. I will take another call if the member does not understand the difference, and I will explain it again. One gains a share of an income when one buys a share in a company. One becomes a proprietor of that company. We are attempting to put an income tax on a fair share of that income. I would say that the 5 percent is actually rather conservative when we take that reality into account.

I will take just a brief call on Part 2. I will focus on a couple of aspects of interest to us in the National Party.

First of all, the key point, I think, is the one made by my colleague Dr the Hon Lockwood Smith. The changes to portfolio investment entity compliance are something that, in principle, we welcome, but Dr Smith has asked a number of, admittedly, highly technical questions that are extremely important in terms of whether we can realise, through the policy implementation, the reasons for our moving in this direction in the first place. We look forward to the Minister of Revenue responding to Dr Smith’s invitation for him to take the call.

The key point from our perspective is that these positive changes to portfolio investment entities could have been introduced with the Government staying away from the whole issue of the “grey list”. The Government lurched away from its initial proposal, a crude but unrealised capital gains tax, as submitters poured into the Finance and Expenditure Committee with their problems with this issue. Thank goodness the Government moved away from its initial proposal—we should be thankful for small mercies—but although the fix of the fair dividend rate that we have before us is certainly superior to the original proposal, we can see all manner of unintended consequences that will have to be addressed in due course.

We know what some of these consequences will be, as the submitters have already drawn attention to some of the major policy issues that we will have to confront as this bill is implemented. There are issues to do with the huge portions of our workforce that are employed by multinationals, and the fact they are locked into employee stock ownership options, often for a number of years. These employees will not be in a position, unless they want to leave the company, to get out of the company and pay the tax bill. This is one of many problems that submitters have identified.

Then there is the question about currency shift. This is, at one level, just a question of equity, but, at another level, there will be some long-term effects from the way that the Government has approached this. If we are taxed on foreign investment earned, obviously, by definition, we need to convert our earnings into New Zealand dollars to arrive at the assessable income required. This will involve an exchange rate, and if the currency has fallen, the assessable income will rise. Is that fair? And what are the economic implications?

This raises—in my mind, at least—some quite interesting questions about how we actually address tax policies and residency policies in the era of globalisation. This is something that we have had to look at in almost all aspects of policy making, whether we are talking about trade or employment, because we are operating in this country, for all intents and purposes, with global competition for skilled and semi-skilled labour. It is also necessary to look at the implications of this in terms of the legislation before the House tonight.

So many of our policy models, including tax models, are based on the dominant model. That model is that, let us say, Mr John Smith and Ms Mary Smith live their lives in New Zealand, earn their incomes in New Zealand, travel to Fiji for their holidays—when it is not having a coup—and are New Zealanders in every sense. That is still by far the dominant policy model to which our policy structures have to accommodate. But it is being eaten away at the edges by a number of other issues that people have to have uppermost in their minds if New Zealand is going to survive and really place itself well in the forefront of small, developed countries.

Let me convert the John Smith analogy to Mr and Mrs Chen Wang. I am sure that the Minister, being an aficionado of Taiwan, knows that that is a common family name in Taiwan. Or I could use a Korean example, Dr Che, who is living amongst the, I think, 30,000 Korean families that we talked to the Korean President about on Sunday during Mr Key’s courtesy call on him. How would those people sitting in Auckland react? Perhaps a large number of them still have very substantial assets deriving from their opportunities in Pusan or Seoul. Those assets will be converted into New Zealand dollar terms when the currency falls. Do members think that when the implications of this come home to roost, those people will lift their glasses of soju and thank the Labour-led Government? I doubt it very much.

If anybody except the dedicated financial investor is still listening, I will be surprised, but if they are, I suggest to them that they are now understanding the complexity of the issues that this bill addresses, and they are starting to see the issues that we had to deal with and the sorts of things that happen in the investment world.

Following on from Mr Copeland, I think that if people in other countries, for whatever reason, will pay out dividends, incorporate that into capital, and pay out on what they call the capital account, then it is totally acceptable for us to work towards some sort of regime that will, in part, capture a fair amount of that. That is what is called the fair dividend rate, that is what is encompassed in Part 2, and that is what we are doing. All over the world there are different tax regimes. People talk about our wonderful neighbour Australia, which taxes the heck out of people who invest in overseas countries—to a far, far greater degree than we do here in New Zealand—yet I hear it lauded as a wonderful bastion of free enterprise, go-go business, and all of the rest of it. It is absolutely acceptable that something like this is done, because of the situation this bill faces as far as the investment areas are concerned.

To have a fair dividend rate of 5 percent is absolutely fair. All of these things are a compromise, and I think it is as good as we will get into the foreseeable future. Likewise, with the portfolio investment entities, it is no secret that some of us would have liked to have seen some newer, more innovative players come into the market in this area. I know that the Minister Peter Dunne’s Supplementary Order Paper is trying to address some of that.

But it is no surprise, because of the things that Dr Lockwood Smith has mentioned, that those who have become default providers in the first instance in this area are, in the main, some of New Zealand’s biggest investment companies. They are the ones with the computer horsepower, and all of the sorts of things that enable them to look after the individual mum and dad investors who—what shall I say without being mean to them—do not have the expertise to look after their own taxation, or the time, I might add, to go through all of the calculations that that entails. The portfolio investment entity will do it for them. It is right that that happens. There is no hidden agenda here. Most New Zealanders will be thankful that those companies actually have the computer horsepower, and those sorts of things, to do all of these calculations.

People are talking about the hidden misdeeds of this Government, and saying that it is heading in directions that may be secretive, and that it has other agendas. The Government is simply understanding and accepting that people who invest through a managed fund will not, by and large, run off to the accountant to do all of these things themselves. These people are not, with due respect, sophisticated investors.

Part 2 takes care of a lot of these things. I think the fair dividend rate is the proper way to go. Although it is a compromise, it is something that will do the job admirably. In respect of the portfolio investment entities, although we would like to have seen some more innovative companies involved, it is no surprise that they have ended up being the bigger companies in New Zealand.

Having raised a few issues, just a moment ago, over the establishment of the portfolio investment entities, I will now raise some issues around the shrinking of the “grey list” and the establishment of the 5 percent fair-dividend rate. I cannot help but note that Gordon Copeland from United Future, in speaking a moment ago, said it is foolish to argue that this 5 percent fair-dividend rate new tax is in any way a tax on capital gains. Of course the Ministers, in writing to the Finance and Expenditure Committee when the Government did the big U-turn on the original 85 percent capital gains tax, said to the select committee that this fair-dividend rate was a method “which would also not target capital gains, but rather something approximating a reasonable dividend yield.” The Ministers even said they did not want it to be a capital gains tax.

I put this example to Gordon Copeland. One has $100,000 in a portfolio investment offshore—less than 10 percent shareholding in any company. If in New Zealand one has a zero dividend payout for the year, and, let us say, the investments are mainly in America, the UK, Canada, or whatever—they have to be in “grey list” countries—and the exchange rate between New Zealand and those countries was to decline by 10 percent, then those investments in New Zealand dollar terms have gone up for the year. One has had no income from them, yet, under this 5 percent fair-dividend new taxation that the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill would bring in, one would be taxed on those—even though one has had no income. All that has happened is that the capital value in New Zealand dollars of those investments has gone up, because the New Zealand currency has declined against those foreign currencies.

So the capital value of that investment in New Zealand dollar terms has gone up. One has had no dividend, and the value of one’s investments in the currencies of investment has not gone up. But the New Zealand dollar value has gone up. That can be nothing other than an apparent capital gains tax, because in New Zealand dollars one has had an apparent increase in the New Zealand dollar value of the capital of one’s investment, and one is going to be taxed on it.

I say to Gordon Copeland that this tax does tax capital gains. I would appreciate hearing the Minister’s comment on that—whether the Government has really thought through that issue and it is happy that New Zealanders will face taxation when the currency goes down. When the currency goes up, of course, they are not necessarily in a better position, because, although they may not owe tax, or may owe less tax when the currency goes up, they do not recover the tax they have paid when the currency goes down.

Also, I point out to Gordon Copeland, the weighted international average dividend yield at the moment is 2.2 percent—the committee heard that repeatedly from experienced international fund managers. Those fund managers said the weighted average dividend yield internationally is currently 2.2 percent. That means if one is assuming a 5 percent return for managed funds here in New Zealand, one is taxing way beyond the dividend yield. I do not care what fancy way Mr Copeland wants to define “income”. Income is only what one receives. Income is always defined by what one receives. That is why we refer to things as capital gains; they are gains because they are not income. They are only income when the capital is realised. If one is in a trading position, then one is taxed on that realised capital here in New Zealand—as Mr Copeland pointed out.

I come back to the point that with this 5 percent fair-dividend rate—which is supposedly fair, and which National is seriously opposed to—because of a number of these issues, such as currency shifts, one faces a tax bill. If one’s investment goes down in value this year, returns to the same value next year, and no dividend is paid, then one is taxed on the return to the same value as one started at. I would appreciate the Minister telling me whether I am wrong there, but I believe I am right. Over a 2-year period, if the value of one’s investment offshore goes down this year one is not taxed—I accept that. But if it returns to the start value next year, one is, in terms of wealth, no better off, because one is only back to where one started, yet one faces a tax bill and has had no income. The investor is only back to what the investment was valued at last year—and Mr Copeland is saying that that is income. He is saying that this new tax is taxing only income. I put it to you, Mr Chairman, that it is not credible to make that argument. I would appreciate the Minister’s comment on that.

So National is very opposed to this new 5 percent fair-dividend rate tax. It is a new tax that does have an element of capital gains in it, and it is unfair.

I will not get an opportunity to speak on the third reading of the Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill, so I will take another brief call to reinforce that the Minister the Hon Peter Dunne has actually got it right when the Government has chosen to tax income on international share investments at a rate of 5 percent. Just following on from the remarks I made earlier, let us take a real-life illustration of the principle at work here. It is well known that for many, many years Microsoft paid no dividends—no dividends whatever. It would be patently absurd to argue, however, that the shareholders in Microsoft were not getting an income, because each and every year Microsoft declared massive earnings after tax. The whole reason that its price zoomed up many, many percentages every year on the stock exchange was the income the company was producing.

And that illustrates the point. Where one has zero dividend in spite of the fact that one has a huge income, then quite obviously the amount of dividend distributed has actually no meaning whatever, in terms of what is the right amount of income to tax. That is why the average dividend yield internationally is 2.2 percent. Some companies do not actually pay dividends. Unilever in Britain is another example of a company that does not pay dividends. The tax systems there do not encourage companies to pay dividends, so they simply capitalise that income and move on.

The other point Dr the Hon Lockwood Smith raised was in relation to foreign exchange movements. Well, that is a different transaction. A profit on a foreign exchange movement is also a profit and is taxable in New Zealand dollar terms. If one has a loss on foreign exchange because of that, then obviously that loss also offsets one’s tax here in New Zealand, because, simply speaking, one pays tax in New Zealand on New Zealand dollars. But there are two elements happening. One is the income one gets from the company, which will be taxed at 5 percent. The other thing is the loss or gain one makes on the currency movements that have occurred between New Zealand and whatever country one has invested in during that period of time. They are two quite separate things, and we should not confuse them.

I thank firstly my colleague Gordon Copeland, and, also, Doug Woolerton, for their comments on Part 2 and the contributions they have made. I also say to Dr Smith that I am going to attempt to respond to a number of the points he raised. I go back to the first point he raised concerning the portfolio investment entity rules as they affect superannuation funds. He will be aware that the Finance and Expenditure Committee has made a number of changes in that area. For example, there is now a simplified method of allocation available for entities such as superannuation funds to allow them the benefits of being a portfolio investment entity with few compliance costs. That method will require the fund to continue to pay provisional tax. The fund will be required to calculate the portfolio investment entity tax accurately on behalf of its members at the end of each year, rather than on a quarterly basis, and would make an annual investor interest adjustment within 3 months of the end of the tax year in order to ensure that 19.5 percent taxpayers receive an additional entitlement to reflect their lower tax rate. The fund will also be liable for the tax on the share of the current year’s income that is paid out to investors that exit the fund during the year. The select committee has recommended some other changes as well.

I should just say to Dr Smith that the complexity issue has been substantially modified, and the proposals that the bill now contains are largely supported by the industry as being a vast improvement on what was in the bill in the first instance. The claim that was made based on the St John and Littlewood evidence has been substantially addressed in the amendments recommended by the committee.

I turn to the question that Mr Groser raised regarding share ownership schemes, which has been acknowledged as a problem. Again, the Finance and Expenditure Committee has made some amendments that seek to address that issue; for instance, no tax will now be payable for the period when an employee is unable to sell out of the ownership scheme. So some improvements have been made there.

I will talk on a point that both Dr Smith and Mr Groser also made about unrealised gains, currency shifts, and all of the impacts that they might have on the value of an individual investment. The key point to make here is what the key difference is between the respective arguments in this whole bill. The bill says that the fair dividend rate is deemed to be 5 percent or the actual value of the dividend paid in years where a profit accrues—in other words, where a gain takes place. Where a loss occurs, no tax is payable. The position taken by the National Party has been a 3 percent flat rate, payable in years when there is a gain but also payable in years when there is a loss. So the difference is essentially between 5 percent, which will actually average out at around 3.4 percent over a period of time, versus a situation that says it is 3 percent regardless of whether the value of one’s investment has increased or decreased. That is the essential difference between the two broad positions on this bill.

The members say it is complicated. Frankly, I think there is an issue of fairness here. Taxpayers will feel that it is reasonable to pay a tax in years when they have something positive to show for it. They will resent the idea of being taxed in years when there is a loss, and that is the nature of the debate that has taken place.

The one other issue is the debate that has been ongoing about whether this is a capital gains tax. The whole notion of the changes that the Minister of Finance and I recommended to the select committee was around dividend yield, and to get away from the notion that was implied in the original proposal—the 5 percent of the 85 percent, and all of that—of that being a capital gains tax. We wanted to make it absolutely clear that that was not our intention; we were seeking to get a reasonable tax payable on an investment. That is why we called it as such—the notion of a fair dividend rate became available. I note that again the difference between the parties is not great: a deemed rate of return on the one hand versus a fair dividend rate on the other, 3 percent flat on the one hand versus 5 percent—or zero in loss years—on the other. It is a very small point of difference.

Having heard a lot of the arguments—and I am sure the member will appreciate my saying this—having received several thousand letters and countless delegations, and having talked to lots of meetings up and down the country, we believe that the mechanisms contained in this part of the bill are a step forward. These things will always be difficult to some degree or other, but we sought to try to address the major issues, and come up with a regime that is fair and equitable and that recognises a couple of key points.

The member touched earlier on the question of the “grey list”. I thought I referred in my second reading speech to one of the anomalies, which is that the emerging economies of Singapore, China, and India are not on the “grey list”, so we immediately have a disadvantage for investment that goes into those economies as opposed to those on the “grey list”. We have been trying to create a regime where it is attractive for New Zealanders to invest offshore. We recognise that most people invest through their own efforts, and most of that investment goes into Australasia. Around 70 percent of investment from New Zealand goes into Australasia, around 15 percent into the “grey list”, and around 15 percent into non - “grey list” countries. Part of the emphasis on Australasia was simply a recognition of what is the status quo.

We have attempted, therefore, with the remaining 30 percent, to draw rules that are clear and unambiguous and that are essentially fair and do not discourage people. That is the real point in essence here, but I come back to the point that I began on. The essential difference between the two sides in this arguments is 5 percent for the funds and a floating rate, if you like, for individual investment, versus a flat 3 percent, win or lose. I think it is a very small point of difference.

The question was put that the amendments set out on Supplementary Order Paper 84 in the name of the Hon Peter Dunne to Part 2 be agreed to.

Amendments agreed to.