Scope of changes
Issue: Receipts-based approach should be available only where the rights in the scheme were first acquired while non-resident
(Matter raised by officials)
The receipts-based approach contained in the bill should be available only where the rights in the foreign superannuation scheme were first acquired when the person was a non-resident. Where the person first acquired the rights in the foreign superannuation scheme while they were New Zealand resident, the FIF rules would generally apply.
Under current law, foreign superannuation schemes are taxed either under the FIF rules, or taxed upon receipt (or transfer) under the company, trust, or other tax rules. Broadly speaking, rights acquired while a person was resident in New Zealand are subject to the FIF rules.
The bill as introduced does not restrict the receipts-based approach to situations where the person was non-resident when they acquired the rights in the scheme, although persons who were New Zealand resident at the time of acquisition would not be eligible for the four-year exemption period (this means that they would instead apply the schedule or formula method based on the date that they acquired the rights in the scheme).
However, officials consider that the receipts-based approach is not appropriate for taxpayers who first acquire rights in a foreign superannuation scheme while they are already New Zealand resident. Under existing law, this is reflected in the fact that the FIF rules generally apply where the rights in the foreign superannuation scheme were acquired while resident in New Zealand.
The policy intention of the changes contained in the bill – in particular, moving to a receipts-based approach – is to make it easier for people who have migrated or returned from overseas with foreign superannuation to comply with their New Zealand tax obligations. While the receipts-based approach in the bill broadly approximates the FIF treatment in terms of the amount of tax actually payable, an important difference is that under the receipts-based approach, if a person leaves New Zealand before receiving the lump sum they will not be subject to any tax.
We consider that allowing taxpayers who acquire rights in a foreign superannuation scheme while they are New Zealand resident to use the receipts-based approach could undermine the existing rules that generally apply for portfolio investments.
For example, a New Zealand resident intends to retire overseas and wants to save for their retirement through a managed fund.
If they choose to save through a New Zealand-based managed fund, they will be subject to New Zealand tax on their investment gains as they are earned (paid by the managed fund). If they choose to save through a foreign managed fund, they will be subject to New Zealand tax under the FIF rules on the gains as they are earned.
If the receipts-based approach is available to them, it is possible that a taxpayer who intends to retire overseas may be able to invest into a foreign fund that is set up to provide retirement benefits, and choose to withdraw that lump sum when they move overseas. This would mean that they would not pay any tax on the gains they earned in that fund while they were New Zealand resident.
Officials consider that this is not consistent with the underlying policy intention of the rules.
Complexity can arise where rights in an employment-related scheme are acquired partly while non-resident and partly while resident. This could occur, for example, if the employer or employee continues to contribute to the scheme or where rights are vested while the person is a New Zealand resident.
Under the existing rules which determine whether the FIF rules or other receipts-based rules apply, in many cases, such as where rights in an employment-related scheme were acquired partly while non-resident and partly while resident, the rules must be apportioned. That is, the FIF rules apply to those rights that were acquired while New Zealand resident and other tax rules would apply to the remainder of the rights.
Officials do not favour such an apportionment approach, as it is highly complex and compliance-heavy.
Rather, officials consider that the receipts-based approach should be available only where the person first acquired the rights while they were non-resident. A non-resident means someone who was not New Zealand resident under YD 1 of the Income Tax Act 2007.
Where the person first acquired the rights in the foreign superannuation scheme while they were New Zealand resident, the FIF rules would generally apply.
As noted above, in general, this recommendation would mean that there is no change from the position under existing law for those taxpayers with a foreign superannuation scheme that they have acquired while New Zealand resident, because the FIF rules generally apply where the rights in the foreign superannuation scheme were acquired while the person was resident.
That the submission be accepted.
Issue: Lump sums should not be taxed
Clauses 8 and 18
(Accountants and Tax Agents Institute of New Zealand, Baucher Consulting Limited, Ernst & Young)
One submitter argued that unless the pre-New Zealand capital base was merely nominal at the time the person became resident in New Zealand, the entire value of a lump sum withdrawal should not be taxed (Ernst & Young).
Two submitters stated that the schedule and formula methods imply that capital gains of superannuation funds should be taxed. This appears to eliminate the capital/revenue distinction within the Act and runs counter to the intention of the changes introduced in the Portfolio Investment Entity regime in 2007. The schedule method unfairly penalises foreign superannuation schemes relative to other investments, such as residential property held on capital account (Accountants and Tax Agents Institute of New Zealand, Baucher Consulting Limited).
The rationale behind the changes is to apply accrual taxation to lump sums, but instead of this being payable annually under the FIF rules it would be accumulated and payable only on receipt. An interest factor would be incorporated into the calculations to account for the use-of-money benefit that a person receives by not paying tax annually.
The eventual tax liability would, therefore, be a function of the length of time that the person holds the interest (as a New Zealand resident) before the income is received. A longer duration implies a greater deferral benefit.
Officials consider that this will ensure that the quantum of tax paid is relatively similar as for other assets (such as interests in foreign investment funds or foreign bank accounts).
That the submission be declined.
Issue: New rules should apply to pensions
Clauses 8 and 18
The proposed treatment for lump sums should also apply to pensions.
The submitter is concerned that, by taxing pensions in full, there is no acknowledgement that pensions comprise both income and capital. The submitter argues that the methodology underlying the schedule method could be applied to pensions as it should be possible to derive a taxable percentage based on the total value of the pension pot.
Officials disagree with this submission.
A key reason for changing the current rules is the complexity of the current rules in respect of lump sums. Officials are of the view that the complexity of the rules has been a factor in non-compliance.
The same non-compliance that exists in relation to lump sums does not exist with periodic pensions. This is partly due to the fact that the taxpayer is simply required to include the value of the pension in their income tax return. This is consistent with the expectation of taxpayers.
Requiring individuals to apply the schedule method or something similar to their pension would significantly increase complexity. In addition, it would require a boundary to be drawn between social security pensions (which would continue to be taxed in full) and other types of pensions, which would introduce further complexity.
Officials are of the view that an increase in complexity could adversely affect compliance.
That the submission be declined.
Issue: Eligible foreign superannuation funds
It should be clarified which schemes are included in the definition of a “foreign superannuation scheme”.
The submitter notes that the proposed legislation does not make it clear what superannuation funds would be taxed under the proposed new rules. The submitter suggests that it should include a number of common United States superannuation products and retirement savings schemes.
Officials note that the definition of foreign superannuation scheme is an existing definition in the current law. It is reasonably broad, and would likely include the schemes the submitter has mentioned.
However, more specific clarification would be more appropriate in a guidance document rather than in the legislation.
That the submission be accepted, subject to officials’ comments.
Issue: Clarifying the definition of foreign “superannuation scheme”
(Matter raised by officials)
The definition of a foreign “superannuation scheme” in the current law should be clarified to ensure that it does not include overseas social security schemes. This will preserve the existing tax treatment of payments from such schemes. This should be made retrospective to 2004.
It has been generally accepted that overseas social security schemes that make payments similar to New Zealand Superannuation are not subject to the FIF rules. Rather, when pensions or lump sums are paid from such overseas social security schemes, they will be subject to tax under the ordinary tax rules.
In general, this means that pensions from overseas social security schemes are subject to full tax. The taxation of lump sums depends on the character of the lump sum, but they are generally not taxed.
We consider that continuing this current tax treatment is appropriate in the context of the proposed changes.
The proposed new rules will apply to interests in a foreign “superannuation scheme”. They are not intended to apply to overseas social security schemes that make payments similar to New Zealand Superannuation.
The definition of a “superannuation scheme”, when originally enacted in 1989, excluded the historical equivalent of New Zealand Superannuation. Inland Revenue’s view is that the definition of a “superannuation scheme” also excluded overseas social security schemes that make payments similar to New Zealand Superannuation.
In 2004, as part of the rewrite of the Income Tax Act, the definition of “superannuation scheme” was restructured. It appears that, as a result of these drafting changes, it is not clear that the definition excludes overseas social security schemes that are similar to New Zealand Superannuation. This is not the intended policy outcome.
Officials consider that the definition of a “foreign superannuation scheme” should be clarified to ensure that it does not cover overseas social security schemes, consistent with the original intention under the 1976 and 1994 Income Tax Acts. This will preserve the existing tax treatment of payments from such schemes. This should be made retrospective to the enactment of the rewritten Income Tax Act in 2004.
That the submission be accepted.