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Inland Revenue

Tax Policy

Chapter 3 – Taxation of non-residents

Taxes on debt supplied by non-residents
Taxation of equity supplied by non-residents

This chapter explains the implications for the taxation of non-residents flowing from the above decisions.

The two most important sources of income earned by non-residents are debt (money that foreigners lend to New Zealand firms) and equity (direct investment in New Zealand firms).

Taxes on non-residents raise significant amounts of revenue. NRWT on debt and equity brought in about $265 million in the year to 31 March 1991.

Company tax cannot be precisely separated into payments attributable to resident and non-resident shareholders. However, non-residents own, on average, about 40% of all New Zealand companies. This suggests that non-residents pay about $800 million in company tax.

Taxes on debt supplied by non-residents

New Zealand taxes income earned from debt supplied by foreigners by applying NRWT to interest paid to non-residents.

Most foreign countries provide tax credits for NRWT. However, credits are effectively limited for many financial intermediaries because NRWT is applied to gross interest and credits are restricted to net income. Tax-exempt bodies, like foreign pension funds, also cannot take advantage of credits because they have no domestic tax liability against which to credit NRWT.

Intermediaries and pension funds are very important players in debt markets.

There are a number of well-known techniques for avoiding NRWT. As a result, until recently the practical effect of New Zealand’s NRWT on interest tended to be:

  • NRWT was paid by those taxpayers who could receive credits.
  • Taxpayers who could not receive credits avoided or evaded NRWT.

This produced a desirable result from New Zealand’s point of view, as the Government raised revenue with a very limited effect on interest rates.

Interest NRWT appears to have increased bond yields by about 2% of the yield during 1990. This was equivalent to about 30 basis points (0.3 of a percentage point) on average during 1990. This implies that additional interest paid to foreigners on overseas debt because of interest NRWT was about $100 million.

In contrast, NRWT on interest raised approximately $180 million in the year to 31 March 1991. This suggests that a large proportion of NRWT was borne by foreigners.

Thus New Zealand already has low effective taxes on interest paid to non-residents. However, this is achieved by wide-scale avoidance and evasion - practices this Government cannot and will not condone.


As a first step to implementing its policy of maintaining low taxes on interest paid to non-residents, the Government has decided that resident borrowers will be able to apply for ‘Approved Issuer’ status under the Income Tax Act. Approved Issuers will be able to pay NRWT-free interest to the non-residents from whom they borrow.

Approved Issuers will be required to pay a levy for the right to pay NRWT-exempt interest. The amount of the levy will be equivalent to 2% of the exempt interest paid.

Full details of this scheme are contained in the Budget supplement on taxation measures.

The practical effect is that residents who have been avoiding or evading their obligations to deduct NRWT will be able to become Approved Issuers and so pay interest that is exempt from NRWT.

Taxation of equity supplied by non-residents

New Zealand applies the company tax to the earnings of companies owned in whole or in part by non-residents and NRWT to dividends paid to non-resident shareholders out of those earnings.

New Zealand’s imputation credit system allows residents to claim credits for New Zealand company tax paid by New Zealand resident companies against personal income taxes on dividends. The combination of company tax, personal income tax, and the imputation system ensures that resident shareholders are taxed on both the retained and distributed income that they earn through New Zealand resident companies.

New Zealand’s imputation credit system does not extend to non-residents and New Zealand charges NRWT on dividends. As a result, non-residents earning income in New Zealand are taxed twice by New Zealand on that income: once as the income is earned and again when dividends are paid.

At first sight, it appears that this system for taxing foreign equity will raise the cost of capital in New Zealand and also encourage debt financing.

The true situation, however, is less clear-cut. The Government has commissioned further work on this issue.

First, it may be that there is a bias towards debt financing inherent in world capital markets caused by other countries’ tax systems. If this is the case, then it would not be practical nor desirable for New Zealand to attempt to correct that bias through its tax system.

The tax system should allow taxpayers to finance their operation in the least costly manner before New Zealand taxes, given the costs of various types of capital New Zealanders face in world markets.

Second, foreign credits for the tax New Zealand imposes on equity may reduce or eliminate the effect of New Zealand taxes on the return to equity.

An important reason why this is so for the taxation of equity and not the taxation of debt is that financial intermediaries are less active in the equity market. Because NRWT is levied on gross income flows but home taxes are levied on net income, NRWT can exceed intermediaries’ net profits. However, if intermediaries are not large players in the equity market, this is not such a problem.

On the other hand, tax-exempt investors, like foreign pension funds, are often active in both the debt and equity markets. Foreign tax credits are not available to such investors. In this case, it is likely that the imposition of New Zealand taxes would tend to increase the cost of capital in New Zealand.

In many cases, New Zealand taxes on income from foreign-source equity may only alter which country gets the revenue from taxation rather than reduce taxation itself.

This would be the case, for example, for a small non-resident individual investor who pays dividend NRWT to New Zealand and pays income tax with a credit for dividend NRWT to his or her residence country. Any reduction in New Zealand NRWT would be matched by an increase in home country taxes. The rate of return earned by the investor after all taxes would not have changed. The foreign government would, however, have collected more revenue at New Zealand’s expense.

In order to actually lower the effective rate of taxation, reduction in taxes by either the source or the residence country and recognition of those reductions by the other country without counteracting adjustments is necessary.

This suggests that bilateral or multilateral action is an important part of any move to effectively reduce the taxes New Zealand imposes on equity supplied by non-residents.

One option is bilateral recognition of imputation credits.

Australia and the United Kingdom are the two countries with imputation systems that provide the bulk of investment into New Zealand at present. Australia is by far the major destination for New Zealand outward investment and is one of the chief sources of investment into New Zealand.

New Zealand will be exploring the possibility of mutual recognition of imputation credits in forthcoming bilateral discussions.