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Terry Baucher explains the latest twist on the taxation of foreign pension funds and finds a 'distasteful double standard' in the new rules

Posted in Personal Finance

By Terry Baucher*

Over the past two years I’ve written regularly on the tax treatment of foreign superannuation schemes, charting the issues and the Inland Revenue’s response.

The principal issues which were unclear were whether foreign superannuation schemes were subject to the Foreign Investment Fund (FIF) regime, and what was the tax treatment on transfer?  

“Probably”, and “Not sure” in case you’ve forgotten.  

On Monday, the Minister of Revenue introduced the Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill into Parliament which should prove the final chapter in this saga.  

The legislation largely follows the proposals set out in an Inland Revenue issues paper released in July last year (explained here in an earlier column)  but also incorporates some of the submissions made in respect of the issues paper.

The new rules will take effect from 1 April 2014.

Under the proposed legislation, interests in non-Australian foreign superannuation schemes will no longer be taxed on an accrual basis under the FIF regime or as if a transfer represents a distribution from a company or trust.

Instead under a new set of rules a tax charge will arise when either a cash withdrawal is made or an amount is transferred into New Zealand or Australian superannuation schemes.

Withdrawals in the first four years after a person becomes resident will not be taxable.

Note that these rules will not apply to interests in Australian superannuation schemes which are generally exempt under the New Zealand-Australian double tax agreement. 

The Schedule Method

After the four-year exemption period, a person’s tax liability on a withdrawal will generally be calculated by reference to a particular fraction based on how long the person has been a New Zealand resident before making the withdrawal. This is the “schedule method”, the new name for the “inclusion rate” described in last year’s issues paper. This fraction will be applied to the withdrawal to determine the person’s taxable income. The relevant fraction starts at 4.76% and rises each year until it reaches 100% for transfers made in the 26th and subsequent income year after the end of the initial four year exemption.

For example, Lucy became a tax resident on 14 July 2016 so her four year exemption expired at the end of July 2020.  She withdraws a lump sum of $50,000 on 27 January 2024.  There are three income years beginning in Lucy’s assessable period, so Lucy is required to use the schedule year fraction for year three.  The corresponding schedule fraction is 14.06%, so her assessable income will be $7,030 (being $50,000 x 14.06%).  Assuming Lucy’s tax rate is 33%, she will be liable to pay $2,319.90 of tax on her $50,000 lump-sum.   (Note it appears under this example that as Lucy's exemption period expired after the start of the 2020-21 income year, then transfers in the rest of that income year are not caught.  It will be interesting to see if this treatment is amended before enactment). 

The Formula Method

An alternative method ("the formula method") will allow holders of defined contribution schemes to calculate the actual gains.

This rather involved method will incorporate an interest factor to compensate for the implied benefit from deferring taxation of the gains and income until transfer.  

Both methods assume a growth/interest rate of 5% which is intended to reflect that the payment of tax has been deferred until receipt.  The 5% supposedly also acts as an effective cap should the actual gains prove greater (we should be so lucky, eh?).

Those persons who complied with the FIF rules prior to the introduction of this legislation on 20th May 2013 will have the option to either continue to return income under the FIF rules, or to apply the new rules instead.  If they continue to apply the FIF rules, any withdrawals or transfers in relation to that foreign superannuation interest will not be taxed under the proposed new rules.

These proposals have the great merit of simplicity and should eliminate the uncertainty of treatment which has been a problem since it was first identified in 2006.

Troubling details

So far, so good, but the legislation also contains a couple of troubling proposals.  

The first is that it will apply to all transfers even those made into a locked-in scheme such as a KiwiSaver fund.

In this case it’s proposed to allow the taxpayer to withdraw an amount up to the value of the tax due from their KiwiSaver scheme.

This sounds all well and good but ignores the fact that where the transfer is made from a UK pension fund, withdrawing funds would possibly either invalidate the transfer or trigger a 55% tax charge in the UK.

I also struggle with the concept that a person who makes a transfer but cannot access the transferred funds until a later date has somehow derived income.   

The other issue relates to the treatment of transfers made prior to the commencement of the new rules.  

According to the Regulatory Impact Statement released with the legislation, the rules relating to the taxation of lump-sum transfers were so complex they “resulted in significant levels of non-compliance, which has been estimated to be approximately 70%”.  

Now you might think this level of non-compliance would be a good reason for an amnesty particularly given the admitted complexity of the legislation. You would be wrong.  

Instead the legislation proposes that for transfers made between 1 January 2000 (the choice of this date is not explained), and 31 March 2014, persons will have the option to either apply the rules that applied at the time of transfer (you know the ones Inland Revenue never explained) or opt to pay tax on only 15% of the lump-sum amount transferred.  If the 15% option is chosen no penalties and interest will apply from the tax year in which the original transfer was made.

A 'distasteful double standard'

According to the Regulatory Impact Statement, an “amnesty is not recommended as it would create an unfair advantage for non-compliant people over people who have complied with the law and fulfilled any resulting tax obligations”.  

Contrast this declaration with the lack of official action following the release on Tuesday and Wednesday of reports by the Inspector-General of Intelligence and Security and Independent Police Conduct Authority.   In my view a distasteful double-standard applies here.  

On the one hand no official action will be taken against Government officials and officers who either “arguably” breached the law or acted "unlawfully, unjustifiably and unreasonably".

By contrast taxpayers are expected to pay tax on transactions involving law which is in the Inland Revenue’s own words “complex” and “difficult to understand” and about which the Inland Revenue offered no guidance.

Is that not “unfair”? 

If the Inland Revenue is concerned about equity it could either allow those taxpayers who previously paid tax in relation to a transfer to reassess their position using the proposed 15% option or refund the tax paid.  That it won’t do so demonstrates its desire to raise revenue has trumped equity.  

As an interim proposal I suggest the start date for transactions to be subject to this concessionary relief is brought forward to 1 January 2011 which was the year when the Inland Revenue first made some public utterances on the issue.  

Very obviously, I recommend anyone who may be affected by these proposals to contact their professional advisor to determine their position.

I also recommend you make submissions to Parliament’s Finance and Expenditure Select Committee when it considers the Bill.

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*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here » 

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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5 Comments

Just typically of I.R.D and

Just typically of I.R.D and even more so of National.....i.e. lets screw the little guy, or paper boy-girl...........but boy DON'T EVER remotely consider taxing 'our financial backers'.
This as you say, is blatantly unfair and opportunist of this Government. But then again what more can we expect from John Key and National.
 
 
 

Shame on the IRD, by their

Shame on the IRD, by their incompetence and delay people will suffer financially, many made major decisions based on what is now accepted as being incorrect advice given directly from the IRD.
  
 

As far as i can see, i am

As far as i can see, i am about to suffer a NZ capital gains tax on my UK pension fund which will trigger a UK penalty tax because of the early withdrawal clause in QROPS. This situation is so messed up. I am assuming some IRD beauracrats cant afford to back down, but why cant some politican with some balls stand up and say the rules should be the same for all overseas pension transfers to kiwisaver?
e.g. Aussi pension transfer, no problem. UK pension transfer... should be the same. Simple, understandable, plan-able in advance, the way NZ tax rules used to be.
Even IRD admit their own rules were too complicated to follow, their advice was wrong (I rang them up for advice several times since i returned from my OE) I made decisions based on their advice. I am now up for a 15% tax on my hard saved savings that i am still 15yrs too young to access.
NZ was known for simple to follow tax rules. I could understand it. Now even the accountant i spoke to a year ago who said 'IRD no longer does retrospective tax changes' because they are too disruptive to the industry was wrong.
If i 1) got advice by phone from IRD that my UK pension was not liable for FIF, and 2) from an accountant and 3) from IR 257 (2003-2010 version) why am i now liable for a new capital tax on it and a QROPS penalty for paying a tax?
I get the feeling that the only thing the IRD would like more than a UK pension is a stone made from blood. My suggestion: think again.

Here here mate, I'm in a very

Here here mate, I'm in a very similar situation.
How can this go ahead and no one in the main stream media is showing IRD up for what they are, absolute idiots gone power mad. Come on Cambell Live, you're doing a great job with ChCh fiasco. Admitedly that's WAY more important than this, but at some point you need to report other 'c*&k up's' by Government departments.
Everyone makes errors, but ONLY IRD make them, and then have the cheek to charge the suffer for the pleasure.
Come on MP's, do something about this !!!!!!!!!

Unfortunately the MP's will

Unfortunately the MP's will do absolutely nothing, are not are foreigners "rich bas....ds?"
NZ from being a somewhat finacially backward but essentially fair country has morphed into little more than an incompetent banana republic. Interested in grabbing as much as they can from wherever they can. 
The point is that official advice was given, and the advice was wrong. The reason for the so generous offer of no penalties nor use of money interest is simply that the IRD Commisioners advice was incorrect and thus an official error and mistake, The Standard rules covering such events must be applied and these prohibit penalties or use of money interest in such cases so not really that generous.. But we also have the 15% Inclusion rate, where or how this figure was "magiced out of the air" is a mystery, I suppose it came from the same place as the notion that investments earn 5% per annum, show me pleeeease.
 
Now the law change will commence from 1 April 2014 (2014/2015) tax year and further  that any amendments by the IRD for lump sums taken or transfers made in earlier years will apply to that year. Given the length of time this has been going on it is a convient way to get around the time limits provisions for assessment amendments by the IRD and effectly starts the clock running from 2014/2015, how cleverly sneaky.
I also note that one can put the "extra liability " in the 2013/2014 return, thes liability arising is paid in Feb 2015, rather than Feb 2016 when using the 2014/2015 return, give me a discount and I will think about it otherwise "on your bike".
As I said previously this is a shameful inditement of the IRD, it has nothing to do with fairness and everything to do with money grabbing. The moral of the story, think long and hard about moving to NZ can you really afford to be hit on what will be the largest investment you have? Also don't trust the IRD even when you have things in writing for when it suits them they will change the rules of the game...........now that is a point perhaps NZ really won every Rugby World Cup ever held, using the same logic they surely did.!