Reason, Michael: New Zealand’s Foreign Superannuation Tax Amnesty and Reform (August 2012)

Tax amnesties tend to be a sign of tax systems in trouble but, properly executed, they boost government revenues.1 The New Zealand Inland Revenue Department Issues Paper published in July2 proposing a tax amnesty and reform of the system of taxation of foreign masks a proposed new but simpler tax. No doubt the New Zealand Government hopes that by simplifying the system more tax payers will comply with it.

The paper admits the concerns voiced by practitioners and commentators3 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 that the taxation of receipts. Suggesting that the there is noncompliance in the area the paper states that “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 actually received to be subject to the general tax system on a receipts basis. The paper further admits that “at the time the exemptions from FIF rules were… introduced, little consideration was paid to the tax treatment of lump sum payments and transfers”.

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.

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 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 0 and 2 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 catching the income that would otherwise have been taxable had the sum been invested in New Zealand when the individual first became New Zealand resident.

The amnesty applies to lump sums withdrawals from foreign superannuation between 1 January, 2000 and 31 March, 2011 and individuals and 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 at: http://www.trustee.net.nz/id-170/What-is-a-Superannuation-Scheme.html

John Rhodes English solicitor in a speech given to the International Tax Planning Association in 2006 echoing earlier research
Taxation of foreign Superannuation July, 2012 prepared by the Policy Advice Division of Inland Revenue and the New Zealand Treasury http://taxpolicy.ird.govt.nz/news/2012-07-24-foreign-pensions-issues-paper-released
Casey Plunket a New Zealand barrister and solicitor and Andrea Black of the IRD in a 2009 NZLS tax conference paper – Taxing New Migrants Foreign Retirement Savings, Peter Loerscher – Frozen pension funds in the UK – Chartered Accountants Journal February, 2011, Martin Riley – UK pensions – why IR should rethink – Chartered Accountants Journal May, 2011