Back in July 2023, the due date for responses to one of the previous government’s lesser-publicised bills was coming up fast. It was Mataraki weekend – the new public holiday to recognise the Māori New Year. Clearly, it wasn’t a holiday that meant much to the Finance and Expenditure Select Committee, with consultation responses for the Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill due that evening.
In preparation, NZSA joined forces with a joint submission prepared by NZX Limited and the Securities Industry Association (SIA). The SIA is the ‘umbrella body’ for New Zealand’s wealth managers, representing the likes of Craigs Investment Partners, Forsyth Barr and many other investment market participants. While we prepared our own submission, each organisation endorsed the submissions of the others – the first time ever that these three organisations have supported each other in this way.
The sections of the Bill we were particularly focused on was a proposed increase in the trust tax rate to the highest income tax bracket – a flat rate of 39%. It’s a proposal that has, somewhat surprisingly, ‘flown under the radar’ since it was first read in May 2023. We say surprising, given the sheer number of New Zealanders that operate trusts. For many middle-income New Zealanders, a trust offers simplicity in estate planning. For most, setting up a trust is not part of some nefarious plan to avoid tax or to generate a large portion of income in its own right. So paying a 39% rate of tax (the same tax rate used by those earning over $180,000 per year) on a relatively lower income hardly seems appropriate under the principles of a progressive tax regime.
To some extent, this was recognised in the Regulatory Impact Statement (RIS) prepared by Inland Revenue:
“Integrity pressures that arise from misalignment between the company, trustee, PIE and top personal tax rates make it very difficult for the Government to raise significant additional revenue in a way that is progressive and economically efficient”IRD, Regulatory Impact Statement, Taxation of Trustee Income, May 2023
Of course, there are no doubt tax advantages for some New Zealanders in directing income through a trust – particularly those who earn non-PAYE income at a level that would otherwise attract a 39% tax rate. That points to the need for a broader review of the taxation system – something that is again referred to in the RIS. The general flavour of the RIS appears to be that increasing the trust tax rate is a good idea – given the short timeframes imposed by the then-Government.
Certainly, this was a key point raised by NZSA in its own submission in July 2023:
We consider that a more holistic review of taxation rates is required to address imbalances and biases between different investment approaches and create a level playing field for different investment structures.
This should include consideration of simplification of tax structures to encourage fairness and minimise scope for tax minimisation.NZSA Submission, July 14th 2023
The change to the trust tax rate may not feel like a ‘mainstream’ issue for many investors. However, it adds to a pattern of changes introduced by Government’s over decades – all of which have unconsciously resulted in a negative outcome on the interests of DIY individuals.
“Let’s encourage savings and investment” said the Government of 2007. And who are we to argue – after all, an encouragement to save and invest to provide for financial security in our retirement is indeed a laudable aim. The impact that KiwiSaver has had on the future financial well-being of New Zealanders is profound and (frankly) was long overdue by the time it came into being in July 2007. At the same time, however, we all learnt that our favourite lunchtime snack was to become an acronym for a new form of investment and savings. Whereas KiwiSaver investments are ‘locked up’ until age 65, the birth of the PIE (portfolio investment entity) offers a clear benefit for investors to invest via funds at any age and stage – thanks to the relative tax differential. Paying 39% on your income? Or even only 33%? No problem – come and have a slice of PIE and enjoy a maximum tax rate of only 28%.
So when it comes to PIE, this is not just a case of the Government encouraging us to invest – in this case, they are also telling us HOW to invest. There’s an additional unintended consequence to this level of tax differential also – since most funds don’t invest in much below the NZ50 index, there’s some argument that this has hurt a company’s ability to secure early-stage capital in a listed environment, leading to long-term reduced choice for investors in public markets – part of our verbal commentary to the Select Committee when it comes to increasing the trust tax rate.
There may also be an emerging impact on the underlying ‘investment literacy’ of most New Zealanders, as they invest via structures and lose touch with the underlying investment.
Please note, this isn’t an argument against PIE’s (or funds, ETF’s or any other form of investment structure). All we want is a level playing field.
By all means, tax the income – but don’t tax the structure.
An 11% differential between PIE investments (taxed at 28%) and Trusts (proposed at 39%) is a further nail in the coffin for the representation of individual investors in tax structures and government policies, and will only trap those trust beneficiaries who cannot afford to pay their lawyer or accountant to minimise their tax burden.
There’s other aspects that have unconsciously shaped previous Government’s attitudes towards individual investors – through either inaction or action
Delving further back into history takes us to 1989. A time when mobile phones were the size of bricks, the BNZ was about to become a household name for all the wrong reasons, and when I still had hair. The Government of the day (rightly) introduced the Imputation Credit scheme, to ensure that individual investors would not be double-taxed on the same underlying income. This feature of our tax system has indeed stood the test of time, and followed the introduction of a similar regime (franking credits) in Australia in 1987.
As time has passed, there has been a push for commonality of standards on everything trans-tasman, from food safety standards to business law. Corporates have also continued to consolidate and integrate their trans-tasman businesses – one could argue, mostly to the detriment of New Zealanders.
But lo, the humble separation of imputation and franking credits remain.
The incentive is clear: New Zealanders are not motivated to invest in income-producing Australian companies, and the Australians who still remember that New Zealand has a stock exchange are not motivated to invest in New Zealand. Gosh, what could possibly be wrong with that?
More recently, we saw the previous Government tie itself into knots over the Michael Wood affair. Readers may remember this – he was the Minister who had forgotten he owned shares in Auckland Airport. 12 times. At the time, NZSA commented not just on Mr. Wood’s inaction, but also the reaction of then-Prime Minister Chris Hipkins. Hipkins stated that a potential outcome would be that no MP’s should be able to own individual shares.
Unconsciously, Hipkins reflected what many individual investors already believe – that there is little representation and advocacy for them in Parliament. After all, no-one has ever opined that MP’s should be banned from owning property; imagine the hue and cry that would result.
The change to the trust tax rate adds to the ‘death by a thousand cuts’ mentality that pervades the investment landscape for individual investors.
Our joint approach
In addition to issues created by tax differentials, NZSA, SIA and NZX also commented on the limited amount of data available to support whether the proposed increase to the trust tax rate would actually result in an increase to government revenue. This was also acknowledged by Inland Revenue in the May 2023 RIS:
This approach is expected to raise $350 million per annum. However, this is highly uncertain and largely dependent on the extent of the behavioural response of trustees.IRD, Regulatory Impact Statement, Taxation of Trustee Income, May 2023
The lack of data was highlighted by IRD as a significant limitation on the quality of their analysis. Interestingly from our perspective, another verbal submitter was prepared to estimate that 89% of trusts would be over-taxed as a result of the proposal.
As commented above, we also highlighted the longer-term impact on the health of New Zealand’s capital markets and the degree of ‘fairness’ as it applied to a progressive tax regime.
How have we, as a nation, got to the point where ‘investment’ has become a dirty word? Or more particularly, where the capability and passion to self-manage investments has become looked down on by those who set the rules.
We have advocated for further research into mechanisms (including taxation) that can improve and incentivise savings and investment behaviour by New Zealanders. We want to see encouragement for New Zealanders to invest – while still maintaining their ability to choose how they invest.
The time for tinkering around the edges has passed. The time for implementing changes that can be implemented in the short-term (regardless of longer-term impact) has passed. New Zealand investors need a holistic review of taxation that reduces complexity, minimises scope for avoidance (loopholes) and encourages long-term investment decision-making.
We not only need a Government that has the guts to take it on – but one that is prepared to engage with investment markets and participants to help them.
Oliver appeared in front of the Finance & Expenditure Select Committee on January 31st, together with Kristin Brandon (NZX), Bridget MacDonald (SIA) and Julian Braithewaite (SIA). For those political tragics who wish to listen to our verbal submission, this can be viewed at this link from 2:05:15.