Moves to simplify tax rules on foreign super

OPINION: It hardly comes as a surprise to learn that there are parts of the tax rules that are more complicated than they should be.

One of those areas deals with how foreign superannuation schemes are taxed. Included in the usual flurry of post-Budget activity this year is proposed legislation to simplify those rules.

We live in a modern, mobile world where labour easily crosses borders. Kiwis are especially known for their love of travel, including working holidays during which they contribute a portion of their earnings into compulsory retirement savings. Also affected are migrants, looking to make a new life in New Zealand.

The result is that there is a large number of New Zealanders who have savings in superannuation schemes that are based offshore. For a long time, the tax rules for these have been far from clear – especially regarding lump sum receipts.

People who aren’t New Zealand tax residents and transitional residents (generally, the first four years of tax residency for new Kiwis and returning ex-pats who have been away for more than 10 years) don’t have to worry about any of their foreign superannuation holdings, as they don’t have to pay tax on any non- New Zealand sourced income. But what about New Zealand tax residents?

To date, they’ve had to wade through a mire of different tax regimes to work out the right treatment. The first port of call is the foreign investment fund (FIF) regime. This body of rules deals mainly with investments in foreign companies but also applies to holdings in foreign superannuation schemes. Under the FIF rules, tax is paid on notional income calculated under a variety of possible methods.

These include the “fair dividend rate”, which generally calculates income as equal to 5 per cent of the opening market value of an investment; and “comparative value”, which taxes the movement in value of an investment – even if not realised. The practical difficulty in applying these rules to foreign superannuation schemes is that it can be difficult to obtain the information needed to carry out the calculations.

Because (as is the case with tax rules) there are a lot of exceptions and exclusions, it’s quite possible that the FIF regime may not apply to a particular foreign superannuation scheme. If that’s the case, other tax rules need to be considered. The tax treatment may depend on the legal structure of the fund.

New Zealand’s company tax rules will apply if it is a foreign company or unit trust. Cash distributions are taxed as dividends unless an exception to the dividend rules applies, such as certain returns of original capital. Alternatively, if the foreign superannuation scheme is structured as a trust, then distributions received may be taxed as beneficiary income.

The rules for foreign trusts are complex. As with the FIF rules, it can be difficult – to the point of impossible – to obtain the information needed to work out if a distribution can be treated as tax free. Foreign superannuation schemes do not maintain their records with New Zealand tax rules in mind.

So the Government has decided to simplify matters. Regular pension receipts will continue to be taxed. It is proposed that lump sum withdrawals be taxed on a progressive basis. The longer a person has been a tax resident, the greater the percentage of the lump sum that will be subject to tax.

For example, after two years of residency, it is proposed that only 9.45 per cent of a lump sum be taxed; after 10 years the percentage increases to 44.39 per cent; 100 per cent is taxed after 25 years. The FIF and other rules will be specifically kept out of play. There are transitional rules, including a “15 per cent” method for taxpayers who haven’t complied with past obligations – provided they disclose their failure to comply.

Different rules applying to the trans-Tasman transfer of super savings will come into effect next month.

The proposed legislation will provide clarity to the taxation of foreign superannuation. It will also encourage the repatriation of superannuation savings to New Zealand sooner rather than later. The costs of early exit and any tax costs in the country of the scheme still need to be considered.

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