Terry Baucher looks at Inland Revenue's retroactive tax grab on foreign investment funds transported to New Zealand. Your view?

By Terry Baucher* (email)

Last time I explained how, following a change in UK tax law in 2006, the Foreign Investment Fund (FIF) rules effectively imposed a form of capital gains tax through the “fair dividend rate” on holders of UK personal pension schemes.

Logically, you’d think that being outside the FIF rules might be a better option, but in the taxation world logic doesn’t always feature, as several people who decided to transfer their accrued superannuation entitlements from an overseas scheme to a New Zealand superannuation scheme are in the process of discovering. 

In recent years a growing number of new migrants to New Zealand have taken the opportunity to transfer superannuation entitlements they built up when not New Zealand tax residents to New Zealand superannuation schemes.   The changes in the UK tax law in 2006 which allowed transfers to qualifying registered overseas pension schemes (“QROPS”) were designed to make this process easier.  

As part of the IRD’s Compliance Focus Programme for 2011-2012, it is targeting the treatment of foreign superannuation fund entitlements transferred to a QROPS or other New Zealand superannuation scheme.   The IRD has sent out risk review letters to a number of taxpayers requesting information about overseas superannuation fund entitlements they have transferred to a New Zealand superannuation scheme. 

Tax much?

For some taxpayers the results of the IRD review are potentially catastrophic. 

The IRD position is that if the foreign superannuation scheme is not taxed under the FIF regime (because it does fit the criteria to be an “employment related foreign superannuation scheme” and therefore exempt from the FIF regime), then the tax treatment of the amount of funds transferred is determined under the ordinary principles of the Income Tax Act 2007. 

For income tax purposes a foreign superannuation scheme is probably a unit trust.  The transfer of the funds in the foreign superannuation scheme to either a QROPS or other New Zealand superannuation scheme is deemed to be a redemption of the investment in the unit trust.  Special rules apply when units in a unit trust are redeemed, the effect of which is to treat as a dividend any excess over the amount subscribed or contributed.   In other words, all capital gains and accrued income are taxable on transfer to a New Zealand superannuation scheme.

Tax by revision

For example, consider the case of someone who contributed £150,000 to a UK pension between January 1990 and December 2004 when they migrated to New Zealand.  At the time of migration the UK pension scheme was valued at £240,000. 

In June 2005 when the UK pension scheme was valued at £250,000, the migrant transferred the funds in their UK pension scheme to a New Zealand superannuation scheme.  If the IRD’s analysis is correct the entire £100,000 excess over the £150,000 contributed will be taxable even though only £10,000 of the excess actually relates to a period when the person was a New Zealand tax resident.  A broadly similar result arises if the UK pension scheme is instead classified as a foreign trust. 

Regardless of how the foreign superannuation scheme is classified the suggested IRD treatment seems iniquitous as it taxes income and gains for periods prior to when the migrant became a New Zealand tax resident.   

Fortunately, the position is a little easier for those pension schemes which are subject to the FIF regime (which, as we explained in our previous columns, includes most UK pension schemes). 

Although the holders of such schemes will be taxed under the FIF regime usually, but not always, through the application of the 5% “fair dividend rate”, the actual disposal of those foreign superannuation schemes through transferring to a New Zealand superannuation or KiwiSaver fund is not taxable.  Similarly, no tax charge should arise if someone who qualifies as a “transitional resident” makes a transfer within the first 48 months of their arrival in New Zealand.  

Analysis paralysis

The number of taxpayers who could therefore be affected by the IRD’s new approach may not be very significant. Nevertheless, for those taxpayers who are affected, the implications are harsh.  What is also concerning is that in 2006 the Finance and Expenditure Select Committee recommended the IRD Policy Advice Division review the treatment of foreign superannuation fund transfers.

 For the matter to be unresolved five years later is frankly very disappointing.   In the continuing absence of clear direction from the IRD all anyone can do is seek professional advice if they believe they may be affected by the IRD’s approach. 

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 *Terry Baucher is New Zealand tax specialist and consultant. You can find his columns in our new personal finance section.