Schedule method
Clauses 8 and 106
Issue: 5% rate is too high
Submission
(Accountants and Tax Agents Institute of New Zealand, Baucher Consulting Limited, Ernst & Young, Financial Services Council, KPMG, New Zealand Institute of Chartered Accountants)
The underlying rate of return used for the purposes of the schedule method is too high and should be 3.5% or 4%.
Baucher Consulting Limited and the Accountants and Tax Agents Institute of New Zealand raised the issue in their written submission, and suggested an alternative underlying rate of return of 3.5% in their oral submission.
Comment
The proposals in the bill rely on an underlying rate of return of 5% to calculate the tax ultimately payable on a lump sum.
Submitters argued that the actual returns are likely to be less than the 5% rate of return used by the schedule method model for calculating tax, particularly following the global financial crisis. Managers’ fees also have the effect of reducing the value of a person’s interest, especially when the interest is low in value.
Officials note that while the schedule method assumes an underlying rate of return of 5%, we consider this assumption to be robust. Historically, average rates of return are more in line with the assumed 5%.
Submitters also argued that the fair dividend rate (FDR) method under the FIF rules should not be used as a precedent (FDR provides a rate of return of 5% of the opening value of the interest).
Under the FIF rules, the 5% FDR acts as a cap on taxable income from the foreign superannuation scheme. When the actual rate of return is greater than 5%, taxpayers are still able to use FDR. When the return is less than 5%, taxpayers who are individuals are taxed on that. When there is a loss, no tax is paid. Submitters argued that these factors mean that on average, the taxable rate of return for foreign superannuation under the FIF rules is about 3.5%.
Officials note that when the issues paper proposing changes to foreign superannuation was released in July 2012, some submitters suggested that the growth rate should be lowered.
Other submissions on the issues paper suggested that the growth rate should not begin until 4 years post-migration, rather than the first year of migration (as was in the original issues paper).
The proposals in the bill pick up the latter approach – that is, delaying the start of the growth rate until four years post-migration. Officials consider that this is a sensible approach as it prevents a cliff face after the four-year exemption. However, allowing both the four-year exemption and a lower growth rate would be too concessionary.
Officials also note that taxpayers would have the formula method available as an alternative to the schedule method. Using the formula method would prevent over-taxation when the average rate of return is lower.
Recommendation
That the submission be declined.
Issue: The schedule year fraction should not reach 100%
Submission
(Accountants and Tax Agents Institute of New Zealand, Baucher Consulting Limited, Ernst & Young)
The schedule year fraction should never reach 100% (Ernst & Young).
The schedule year fraction should be capped at 75% (Accountants and Tax Agents Institute of New Zealand, Baucher Consulting Limited).
Comment
Officials note that the formula used to calculate the schedule method takes into account the deferral benefit received by a taxpayer from not paying tax on accrual.
In theory this means that the schedule year fractions could exceed 100% after year 26, but a decision was made to cap the rate at 100%.
Capping the schedule year fractions at a rate lower than 100% would have the effect of understating the deferral benefit for the taxpayers who gain the most from deferring the payment of tax – those who have held their interest for several decades.
Recommendation
That the submission be declined.