NZX

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.

Sweetners to encourage half the workforce to sign up to the state's KiwiSaver retirement savings scheme will ensure its success, fund managers say.

Workers will receive up to $20 a week in tax credits if they contribute the minimum 4 per cent of their gross income.  In the other significant change, employers will be forced to match the employee contribution, phased in over the next four years, starting with 1 per cent next year.

PricewaterhouseCoopers chairman John Shewan said the changes effectively made KiwiSaver a compulsory scheme because "you would be a bit silly" not to opt in. "There seems to be an increasing appetite for compulsion and in practicable terms that is what we have got now."

The controversial compulsory employer contribution would take some of the shine off the corporate tax cut, despite being partly offset by a $20 a week subsidy from the Government, Mr Shewan said.

Investment Savings and Insurance Association chief executive Vance Arkinstall said the changes to KiwiSaver would ensure its success.

"There is now no doubt that the proposition offered by KiwiSaver is so attractive that virtually all New Zealanders must consider joining. Even employees not changing jobs should consider opting in."

Mercer, which is one of six Government-appointed default providers for the scheme, expected the added benefits would result in the number of people opting into KiwiSaver to at least double from its previous estimate of 20 per cent over the next seven years.

"If you can afford savings at all you are strongly encouraged now to do them," Mercer head of New Zealand Tim Jenkins said.

Mr Jenkins said employers should view compulsory matching contributions positively because they would have a year to adjust and receive a tax credit to soften the initial cost.

AMP's general manager of savings and investment, Roger Perry, expected the KiwiSaver take-up rate to hit 80 per cent in the next few years, similar to the United States, which also has automatic enrolment schemes.

Some existing workplace superannuation schemes that were previously available only to management would now have to be opened up to all employees.

Some schemes would expand rather than contract as a result of KiwiSaver, Mr Perry said.

Business NZ chief executive Phil O'Reilly said KiwiSaver would impose more costs on employers. "The proposals to make compulsory matching employer contributions for KiwiSaver, even with the tax credit for reimbursements, will load costs on employers that are not needed at this difficult time.

"Compulsory costs imposed on employers without their agreement or buy-in is not helpful given the significant negative elements in the current business environment."

But New Zealand Exchange chief executive Mark Weldon said the matching tax credits for employer contributions would give businesses an edge in attracting and retaining high-value staff.

COMMENT - DAVID HARGREAVES
Nothing gets up shareholders' noses faster. Executive share schemes have been a bone of contention for, well, it seems like forever.

New Zealand Exchange has unwittingly breathed fresh life into the issue through its now-aborted plan to assist chief executive Mark Weldon to buy shares on favourable terms, subject to certain performance targets being exceeded.

NZX can probably be justified in feeling a bit picked-on regarding the huge outcry its scheme generated.

The reality is that the NZX example only highlights what is happening within a number of companies. But it is useful that the broader issue is being debated again.

I've never liked options schemes, or assisted share buying packages – call them what you will.

The point, as I see it, is that they are not what they are supposed to be. Executive share schemes, the logic goes, act as an incentive for the bosses to achieve – since they get the shares only by meeting certain performance targets.

But there are problems. The targets are generally too easy to achieve. There is no real disincentive for non-performance.

If targets are not met, which normally means the share price has not hit a certain level by a certain time, then the executive simply doesn't take up the shares. No loss to them.

Then there is the matter of the amount of control over the company the executives may get – again through no real risk. This can lead to a conflict of interest for the executives if they then get approached by another party looking to take over the company.

And there are a number of other pitfalls. So, what is the answer?

The best way to offer incentives to executives in a way that benefits all shareholders is just cold hard cash.

Give the executives a solid basic salary and leave plenty of room for extra payments on a yearly basis according to clearly defined performance targets. This means that if the senior executives hit their straps and have a brilliant year they get plenty. If they don't, they don't. Shareholders should not object to executives picking up big bonuses – because it will mean they have increased the value of the company.

If the executives believe in the company and want to own shares to back that up – fine. Let them buy shares at prevailing market prices.

I have no doubt we will continue to see companies coming up with these schemes for their executives. Executives like them. It is up to the shareholders to be vigilant. To keep questioning the companies. And to strongly urge alternatives.

Unhappy New Zealand Exchange shareholders are to put strong pressure on the sharemarket operator to either scrap or change a plan for chief executive Mark Weldon to acquire shares worth about $10 million.

Some significant NZX investors are vehemently opposed to the proposal, believing it is overly generous and that the performance targets Mr Weldon has to meet to get the shares are nowhere near high enough. There is also concern about the level of control Mr Weldon will gain.

The shareholders opposed to the scheme want the NZX to drop it, or alternatively to either issue fewer shares or raise the performance targets. They are expected to put their case to the NZX board early this week.

NZX chairman Simon Allen could not be contacted for comment yesterday.

The issue is due to go to a vote at the annual meeting on March 30.

The biggest individual shareholder in NZX is Fisher Funds Management, with 9.9 per cent. Chief investment officer Warren Couillault said the company was considering its position. "We will be discussing the matter with the NZX board this week."

Investment company Guinness Peat Group holds 2.3 per cent of the NZX shares. Its New Zealand director Tony Gibbs said he was "not particularly thrilled at all" with the proposals and planned to talk to the NZX chairman. "I think the directors should reconsider."

The NZX has a cap that stops any individual shareholder owning more than 10 per cent of the company. If the planned scheme goes ahead Mr Weldon could in three years' time hold more than 9.9 per cent.

GPG is known to be opposed to shareholder caps and earlier was successful in a campaign to lift a similar cap that was in effect at insurer Tower.

Under the proposal for Mr Weldon to gain shares, NZX would lend him around $10 million to buy up to 1.1 million shares. These would then be held by an NZX nominee company.

Mr Weldon would be able to take full ownership of the shares in three tranches over the next two to three years if a set performance target were achieved. He would not be required to pay interest on the loans till this target was exceeded.

The performance target is that "total shareholder return" - meaning any rise in share price plus annual dividends - exceeds an annual compounding rate of 10.5 per cent.

In the notice of annual meeting, NZX's board says this rate is "a fair market return having regard to investor expectations and (the board's) view on future performance thresholds for the company".

But some of the shareholders dispute this, one describing it as "a very low threshold".

In its annual report NZX says that in the 312 years since it listed, the company has achieved a total return to shareholders of 246 per cent - or about 42 per cent compounded annually.

Mr Weldon already owns nearly $10 million worth of NZX shares, more than 5 per cent of the company, bought under a similar scheme that was approved before the creation of NZX as a limited liability company in 2002. The shares had a purchase price of about $2 million, according to NZX's 2006 annual report.

Mr Weldon's base salary is $450,000, with a maximum annual bonus of $450,000. The annual report shows that Mr Weldon received a total of $875,000 last year. For the year to December NZX reported after-tax profits of $6.4 million, up 31 per cent on the previous year.

In the notice of meeting, NZX directors say Mr Weldon has created significant shareholder value in his time as chief executive and "he is the right person to take NZX forward through its next phase".