The New Zealand Inland Revenue Department Issues Paper published in July proposing a tax amnesty and reform of the system of taxation of foreign superannuation masks a proposed new but simpler tax. No doubt the New Zealand Government hopes that by simplifying the system more taxpayers will comply with it.
The paper admits the concerns voiced by practitioners and commentators that the New Zealand system of taxation of foreign “retirement savings” is overly complex, based as it is on the systems of accrual of deemed income earnt offshore with various exemptions rather than the taxation of receipts. Suggesting there is noncompliance in the area, the paper states “current rules …can result in inconsistent outcomes… can be highly complex” and “lacking in overall cohesion”.
Sidestepping the complex treatment of overseas companies and family trusts however, the paper proposes the reform of the taxation of defined contribution and defined benefit superannuation schemes; not pensions and lump sums received from foreign governments other than those arising following employment. The proposed reforms do not relate to other overseas investments intended to be used as retirement savings or state old age pensions.
While the present accruals based system catches most pensions, the carve-outs from that system can cause pensions, lump sums and transfers received to be subject to the general tax system on a receipts basis. The paper further admits that “at the time the exemptions from foreign investment find (FIF) rules were… introduced, little consideration was paid to the tax treatment of lump sum payments and transfers”.
QROPS boost?
The Transitional Residents regime, which deems a new migrant not to be tax resident for the first 48 months from arrival – for the purposes of non-NZ source passive income – exempts pensions transferred to New Zealand schemes in that period from both the FIF and the general tax system. Accordingly, the present system will usually not tax lump sums received from foreign pensions. The reforms propose that most overseas “pension” income will be taxable on a receipts basis. Benefits received by New Zealand residents from local schemes will continue to be exempt.
Both New Zealand and non-New Zealand residents are exempt from New Zealand tax on Income and lump sum benefits received from New Zealand superannuation schemes. All New Zealand QROPS therefore comply with clause 3 (6) of the UK Categories of Countries Regulations 2006/206. The current NZ tax treatment of pension income, lump sums and transfers received by New Zealand resident individuals from non-New Zealand schemes such as US 401k, UK registered pensions and non-NZ QROPS is not the point that clause 3 (6) is intended to address and the difference of tax treatment between pension benefits from local and non-local schemes does not offend it.
The proposed reforms will affirm that QROPS transfers to New Zealand schemes will be exempt from tax for non- New Zealand residents, Transitional Residents (for four years) and others for the first two years of New Zealand residence. This may provide a boost the local QROPS industry.
The complexity in the present system arises when the individual is not a transitional resident, the foreign scheme is not an FIF and lump sums and transfers are received. In this situation “the amount received will generally be a dividend” or a distribution from a foreign or non-complying trust “and… taxable at the individual’s marginal tax rate”. To the extent that the rules deem the amount to be capital it will not be taxable but the information required from the foreign scheme to enable the New Zealand resident to distinguish between corpus, gains and income exposes the entire sum to income treatment.
The paper highlights the exemption from the FIF rules of employment-based pensions which are “locked in”. Such schemes are arguably exempt from tax on an accruals basis because to do otherwise would cause “cash flow problems”. It appears that this exemption left an unintentional trap that the “amnesty” seeks to rectify.
The proposal establishes “inclusive rates” being percentages of the pension, transfer or lump sum that are subject to tax at the individual’s marginal tax rate. The percentages rise from 0% between naught and two years to 100% from 25 years depending on how long the individual has been resident in New Zealand; the idea being to tax pensions, lump sums and transfers as income, therefore catching the income that would otherwise have been taxable had the sum been invested in New Zealand when the individual first became resident there.
The amnesty applies to lump sums withdrawals from foreign superannuation between 1 January, 2000 and 31 March 2011 and individuals who did not comply with their tax obligations at the time who may elect an inclusive rate of 15% for their withdrawal or transfer.
To qualify for the amnesty, an individual must disclose the existence of the transfer to the IRD before 1 April, 2014. Alternatively, they can choose to return income under the rules which existed at the time.
The IRDs admission that the tax treatment of lump sum payments and transfers from schemes exempt from FIF tax treatment was given “little consideration” raises the question as to whether such payments were intended to be taxed at all and whether it would be fairer to exempt them from tax altogether.
A review of some of the commentary of the subject may be found by clicking here
Michael Reason is a lawyer and owner of Reason & Partners LLP
