Foreign investors in a New Zealand fund with only foreign investments will now bear no New Zealand tax on their income, whether or not the fund distributes that income. The tax change, which came into force in September 2011, should make New Zealand managed funds an attractive alternative to funds resident in Luxembourg, Ireland or the Caymans.
Reform builds on current tax regime for New Zealand funds
Although New Zealand managed funds generally take the legal form of a unit trust, they are not subject to the usual trust tax regime. Instead, if a fund is eligible to register as a portfolio investment entity (or PIE), and elects to do so:
- the fund calculates the share of its taxable income attributable to each investor, usually on a daily basis
- for investors who are New Zealand individuals, the fund pays tax on that income at a rate notified to it by the investor (called a portfolio investor rate or PIR). This rate approximates the individual’s marginal tax rate, but is usually somewhat lower, and
- for companies or trusts, the fund pays no tax on that income. Instead, it notifies the investor of how much fund income is attributable to the investor, and the investor must pay the tax. These investors are referred to as “zero rated investors”.
The tax legislation requires that the cost of the tax paid by the fund is sheeted home to each investor to whom the tax is attributable. In other words, tax is treated as an investor cost, rather than a fund cost. This is only fair. Otherwise the zero rated investors would bear a share of the fund’s tax as well as paying all of the tax on their own share of fund income. Most funds achieve this by cancelling investors’ units to pay the tax. For zero rated investors there is no fund tax liability and therefore no cancellation of units.
This tax regime is not affected by whether the fund distributes or accumulates its income. Distributions by the fund are tax free.
Treatment of non-resident investors in New Zealand funds
In 2008 when the PIE tax regime was introduced, it did not treat non-resident investors well. They could not be zero rated. Instead they had a PIR equal to the top tax rate (currently 28%). This made them unattractive to foreign investors, especially for a fund with income from non-New Zealand sources.
Making New Zealand funds attractive to non-resident investors
The Government recognised that this tax treatment was not sensible from a policy perspective. New Zealand should not be imposing tax on foreign source income derived by foreign investors, simply because that income is derived by a New Zealand fund. Furthermore, a Government appointed task force, the International Financial Services Development Group, pointed out that if New Zealand can make itself attractive as a residence location for foreign funds, there is an opportunity to create additional jobs and income.
Accordingly, the tax change now allows a New Zealand fund to elect to pay tax at 0% on foreign income attributable to foreign investors. The fund will treat the foreign investor as if it were a New Zealand company or trust. However, unlike a New Zealand company or trust, the foreign investor will have no New Zealand tax liability on the income attributable to it, either when earned by the fund, or when distributed.
Currently, this treatment is limited to funds with minimal New Zealand investments. On 1 April 2012, a more complex version of the regime comes into force, which allows funds with any level of New Zealand investment to use the regime. New Zealand income attributable to foreign investors will be taxed at a similar rate to the rate that would apply if the investor earned the income directly (generally between 15% and 0%).
For a New Zealand fund which is taxed as a PIE, has minimal New Zealand investments and no New Zealand investors, this reform makes New Zealand tax compliance very straightforward. There will be no New Zealand income tax. The fund will not be registered for GST. Nor are there any stamp duty or other transaction taxes to worry about.
The new tax regime is only available to unlisted funds which are subject to the PIE tax regime. Generally, to be a PIE an entity must be widely held and have 20 or more investors, none of whom owns more than 20%.
But there are circumstances under which:
- the requirement for 20 or more investors need not be met, and
- an investor is allowed to exceed the 20% threshold.
These exceptions allow wholesale funds, or funds of funds, to be PIEs. The fund must still:
- hold no more than 20% of the interests in any other entity. This is intended to prevent the fund having an influential stake in an operating business, and
- derive income only in the form of dividends, interest, rents, royalties, or payments on derivatives.
There is no requirement for a fund to diversify its assets. For instance, many funds hold only a single bank deposit.
Evidence required of non-resident investor’s identity
In order for a fund to treat an investor as a non-resident, the investor must provide the fund with:
- their full name
- date of birth (if applicable)
- home address in the country where they are tax resident
- tax file number in the country where they reside, and in New Zealand (if they have one).
The tax change may be of particular interest to Australian investors, or those promoting managed investment schemes to Australian investors. In particular:
- Australia’s current FIF tax regime seems unlikely to impose tax on Australian investors in an NZ fund until they receive a distribution or sell their units
- the unit trust instrument is one with which Australian investors will be familiar, and
- New Zealand offering documents can be registered in New Zealand and used in Australia for retail offerings, using the mutual recognition regime between the two countries. Alternatively, Australian offering documentation could be prepared for the New Zealand fund.