The recent meeting between Finance Minister Michael Cullen and Australian Treasurer Wayne Swann raised the subject of mutual recognition for imputation and franking credits, again.
For some perverse reason this topic has been raised several times by New Zealand ministers and officials based on the quaint and frankly naive belief that the Australians are going to give New Zealand investors and companies an even break.
Give me a break There is more chance of an Aboriginal becoming Australian Prime Minister than there is of the Australian Government agreeing to mutual recognition. The fact is that mutual recognition would cost the Australian Tax Office billions in lost tax revenue – money it would rather spend on things like schools and health that would win votes.
How this works is beyond the scope of this column, but the brutal facts are that mutual recognition has far more going for it for New Zealand than it does for Australia, and in turn that means the idea getting the Australians to agree to it is a pipe dream.
A few weeks back I noted a recent paper by Casey Plunket from Bell Gully discussing potential reform to the imputation credit regime in New Zealand. Things have moved pretty fast since early June. In the past few weeks the Institute of Finance Professionals New Zealand has held forums in Auckland and Wellington to discuss a proposal to allow streaming of imputation credits generated by Australian companies to be given to New Zealand investors.
Separately, NZX has also come out with a proposal to adjust the imputation credit regime to make it more attractive for Australian companies to dual-list in New Zealand, via a tax credit. There is also a third proposal doing the rounds.
All this activity is happening because of a coming review of the imputation credit regime being conducted by the Treasury. From a purely domestic standpoint there is nothing wrong with the imputation credit regime; it is very efficient and ensures that New Zealand shareholders do not suffer the problem of double taxation on dividends paid by New Zealand firms. This would be fine if New Zealand were a "walled garden" and there were no foreign investment or New Zealand companies investing overseas. But New Zealand isn't a walled garden and cannot afford the luxury of being one.
AUSSIE INCENTIVES
As a country we are absolutely dependent on foreign investment to run our economy. The problem New Zealand faces is that there is a big incentive for Australian companies to make full takeovers of New Zealand companies and cut local shareholders out of the picture.
The strategy is for any Australian acquirer to load up on debt to the maximum amount allowed under the thin capitalisation rules and drive down the taxable profit of its New Zealand subsidiary to the lowest level possible. This maximises the profit earned in Australia (and the amount of franking credits to be paid to Australian investors) and minimises the imputation credits earned/tax paid in New Zealand.
If you look at the example of the ANZ Bank, which has many New Zealand shareholders, the dividend paid to an Australian tax resident is much higher than that received by a New Zealand tax resident because of the impost of double taxation.
The idea of change is to allow New Zealand investors access to the imputation credits generated from tax paid by ANZ in New Zealand. The NZX proposal is a variation on this idea and proposes a tax credit regime to offset some of the double tax hit for New Zealand shareholders of Australian firms.
Either proposal aims to achieve the same goal – a reduction in the grab for New Zealand companies by Australian-listed companies because the tax outcomes are so favourable to them. The hope is that imputation credit streaming or a tax credit will encourage Aussie firms to set up proper New Zealand listings and provide some much-needed depth to our capital markets. This is one idea among many being touted as solutions to the lack of growth in the New Zealand market.
Despite all the work on improving regulation, and efforts of NZX and the strong economy, the sharemarket is now smaller in relative terms than it was five years ago. As we move closer to an election the "hollowing out" of the sharemarket is being set as an election issue.
Whether it becomes one is hard to say, but with the advent of KiwiSaver and the PIE regime there is more focus on investment issues than previously. Fact is that what has been driving a lot of investment decisions both locally and in Australia has been New Zealand tax policy.
This is the big elephant in the room no one is really talking about. New Zealand's tax policy in respect of investment and wealth creation is still very flawed. We have seen some signs of improvement with changes to the rules for controlled foreign companies and the introduction of the PIE regime, but these are only first steps in what has to be a major overhaul of tax policy in this area.
SNATCHING DEFEAT
Improving the operation of the imputation credit regime as far as Australian companies goes is a step in the right direction, but it still feels like snatching defeat from the jaws of victory. Why? Because solving the issue of double taxation for one country still leaves many others where it is a problem.
What of New Zealand companies that earn income in Europe or North America? Much bigger markets than Australia but the impost of double tax on these dividends and income is not being addressed. The usual complaint of impact on tax revenue is given as a reason for not making changes to taxes on investments – but that is taking a short-term view when longer-term strategic decisions should be made.
Allowing streaming of imputation credits or having a tax credit seem like only half answers to a bigger problem. If that is all we want then that is all we are going to get. And is that really enough?
* Bruce McKay is an Auckland investment banker.
