7.2 Tax policy (continued)
7.2.5 Thin capitalisation rules
Tax thin capitalisation rules apply to deny offshore-owned companies deductions for interest on borrowing to the extent that they exceed a certain level of gearing (set by reference to their world-wide group gearing ratio, or a “safe-harbour” ratio). Reducing the safe-harbour ratio will reduce the level of gearing into New Zealand by offshore owners (other than for those already using their world-wide group ratio as a benchmark). While this of itself will have no impact on national saving, it would shift the composition of national savings more towards equity than debt.
Given the direct and beneficial impact a gearing reduction would have on New Zealand's net foreign liability position (and the beneficial impact on tax revenues), the SWG supports the recently enacted reduction in the safe-harbour ratio from 75% debt-to-assets to 60% (applying from the 2011/12 income year), as recommended by the TWG. Furthermore, the SWG recommends that a further reduction in the safe-harbour ratio should be considered, if the reduction to 60% does not result in many companies having to adopt their world-wide group ratio as a benchmark (indicating that the new safe-harbour ratio is still too high).
7.2.6 Reducing the inherent over-taxation of savings in income tax
It is reasonable to expect that New Zealand will always have an income tax. Given the over-taxation of savings income inherent in a relatively broad-based income tax, the SWG considered a range of potential mitigants.
Continue to broaden the base and keep rates low, with a simple structure (i.e., further reduce the first two T's for most income and raise T for income that is currently tax-preferred):
The SWG supports continued reduction in the rates of income tax and base broadening to lessen the bias against and distortions between savings.
Reduce tax rates on income from all savings/investment (reducing the middle T):
The most comprehensive approach is a Nordic/Dual system (across-the-board scheduler approach, taxing all savings/investment income at a reduced rate). The SWG agrees in principle with the argument behind a reduced rate on income from savings (which in the New Zealand context could be a rate of around 12.5%–15%). But the SWG notes that in the absence of a capital gains tax combined with New Zealand statutory rates of tax on income from savings that are not as high as overseas, the effort and complexity of a full-blown Nordic/Dual approach does not justify its adoption. The SWG considers that modifying the existing mechanisms (see below) can move New Zealand in the direction of a Nordic approach but in a more straightforward way.
Reduce tax rates on income for only certain retirement savings (in KiwiSaver and qualifying vehicles akin to KiwiSaver):
This option, common in other countries, offers certain savers/investors what is in effect a reduced rate on certain investment income (usually income arising from long-term saving), and therefore goes some way towards a Nordic/Dual approach. The SWG notes that this would not necessarily increase the level of national saving (although it would undoubtedly increase the level of savings undertaken through these vehicles). However, as stated earlier, if there are other reasons for favouring such vehicles (enabling better quality investment, encouraging longer-term saving) such a mechanism would be worth considering further. Again, this option should be considered applying rates of tax no higher than 12.5%–15%.
Broadening and rationalising the PIE regime:
The SWG notes that the current PIE regime offers certain savers/investors what is in effect a reduced rate on their direct investment income, and therefore goes some way towards Nordic/Dual. This currently arises only in a portfolio investment (and de facto bank deposit) context, and the extent of the reduction in the tax rate, if any, is a function of each investor's particular circumstances. Some are able to be taxed at their correct marginal rate, many at 28% instead of 33%, many at 17.5% instead of 30%, and some at 10.5% instead of 17.5%. Most investors in PIEs are effectively able to access a tax rate that is either 5 or 12.5 percentage points lower than their prima facie marginal tax rate.
While the original justification for the PIE regime was to try to apply investors' expected personal tax rates on their direct investment income to income from investments held through collective vehicles, from a savings perspective it can be rationalised as a mechanism for reducing tax rates on income from a broad spectrum of saving. The SWG notes the TWG recommendation that the capped top PIE rate should have been aligned with the top personal marginal rate, but the SWG considers that from a savings context (and absent Nordic and similar rate reductions on savings) the top PIE rate should be maintained at a minimum of 5 percentage points below the top personal marginal rate (and preferably 10 percentage points below).
Noting the inconsistency of rate reduction amongst different investors in PIEs, the SWG considers that the PIE rate-election rules should be changed to target a rate reduction for all investors closer to the benchmark of 5 to 10 percentage points (noting that for some investors this could mean an increase in the tax they pay on PIE investments).
What's more, absent those other reforms, the SWG recommends the broadening of the reduction of rates not only to all PIE incomes, but also to interest and dividends earned by New Zealand residents.
To achieve this, the SWG recommends that:
- PIE rate-election rules be applied for resident withholding tax (RWT) purposes. As with PIE, the RWT would be a final tax unless the investor has declared the wrong rate.
- Imputation credits be refundable to the extent that an investor's RWT rate is below 28%.
- Interest deductions related to such income be reduced consistently with the lower tax rate on income. This would apply if someone borrows to invest.
