Terry Baucher looks at the IRD's latest plan to draw tax from withdrawals made on foreign held super funds and finds some shocking news.

By Terry Baucher*

Last year I covered the IRD’s confused and apparently retrospective approach to the taxation of foreign superannuation schemes.   I expressed the hope that the IRD would give some firm guidance on the matter.  Well last week the IRD’s Policy Advice Division released an Issues Paper “Taxation of foreign superannuation” setting out its proposals for clarifying the law on this complex area.  

Brace yourself for bad news

Just how shocking can be judged by the Issues Paper’s two key proposals.  These will hit hard anyone who was not a “transitional resident” at the time they transferred/withdrew funds from their foreign superannuation scheme.  

Firstly, from 1st April 2011 all lump sum withdrawals or transfers from a foreign superannuation will be treated as taxable.  The taxable amount or “inclusion rate” is determined by the period of time since the individual migrated to New Zealand.  The relevant inclusion rates are as follows:

For example, if you migrated to New Zealand in April 1999 and you now wanted to withdraw $100,000 from your foreign superannuation scheme, your inclusion rate would be 60% as it is between 13 and 16 years since you migrated here.  $60,000 would therefore be treated as income and taxed at your relevant income tax rate.   

Consequently, under the IRD’s proposals many long term residents now face losing up to a third of their accumulated foreign superannuation savings in tax, probably at the time when they are seeking to draw down on those funds.

You’ll note there is no deduction for the contributions made to the foreign superannuation scheme.  According to the Issues Paper “This is because the basic framework for the proposal is to tax an amount which represents the accumulated New Zealand tax that would otherwise have been paid had it been invested in New Zealand”.  In short, the IRD is taxing you because you didn’t invest and pay tax in New Zealand.  How that principle squares with the need for New Zealand to improve its savings and its current account deficit is obviously not a concern for the IRD. 

The second proposal targets anyone who transferred and/or withdrew funds from a foreign superannuation scheme between 1 January 2000 and 31st March 2011.  The IRD now considers such transfers/withdrawals retrospectively liable for income tax.   This retrospective tax charge won’t apply if you paid tax at the time of withdrawal/transfer (remember nobody was sure what those rules were and the IRD didn’t tell anyone until 2011 what they considered the rules to be).   Alternatively, you can “elect” to pay tax based on an inclusion rate of 15% of the amount transferred/withdrawn. 

Damn if you do, damned if you don't

This is a classic Morton’s Fork/Catch-22: either pay tax based on rules which few understood and about which the IRD issued no guidance, or pay tax because no-one understood the rules.  The Issues Paper conveniently overlooks the IRD’s role in not clarifying its view on foreign superannuation schemes despite the Finance and Expenditure Select Committee specifically recommending in 2006 that it do so.  It’s noteworthy that the Issues Paper doesn’t contain much technical analysis of how the previous rules operated.  The impression I, and several other advisors have, is that the IRD are still not entirely sure themselves.  This is hardly a sound basis for good policy-making. 

The above proposals do not apply to withdrawals/transfers made by transitional residents.  A transitional resident is someone who has either, never previously been tax resident in New Zealand, or has not been a tax resident for at least 10 years.  Usually, the period of transitional residency lasts for 48 months from the date of qualification. 

I don’t expect to see eye-to-eye with everything the IRD proposes but I am disappointed by these proposals.   They don’t tie in with much of the general scheme and purpose of the Income Tax Act 2007.  (They’re also a good example of the distortions which arise without a capital gains tax).  Furthermore, the Issues paper rather blithely ignores the “time-bar limits” regarding when prior tax years can be reviewed/re-assessed.   The IRD will say the Issues Paper merely clarifies the law but imposing retrospective taxation on transactions going back 12 years is no mere clarification. 

Have your say

The IRD have invited people to make submissions on the proposals and you can do so by emailing: policy.webmaster@ird.govt.nz with “Taxation of foreign superannuation” in the subject line.   The proposals are just that, so it is quite possible that the IRD may revise its position after considering submissions. 

This is a situation where if you think these proposals will affect you then you need to see a professional advisor.   It would be very naïve to think that you can ignore them.  Under the Tax Acts, it is every taxpayer’s responsibility to determine and then return their tax liability.  Accordingly, if you are affected by the IRD proposals and you do not advise the IRD of a transfer then you may face severe interest and penalties at a later date. 

You should also be aware that the IRD can compel companies which arranged transfers from overseas super schemes to provide details of any such transfers.   In fact, I understand that the IRD currently have details of all transfers involving more than $50,000 so you might already be on the IRD’s radar right.    Finally be aware that relying on your accountant’s advice (a.k.a. “the John Banks defence”) won’t save you from penalties and interest.  

This is only a brief summary of some complicated issues.  I will keep you updated on further developments but in the meantime review your own position and seek professional advice if necessary.

*Terry Baucher writes regularly for interest.co.nz on tax related issues. He is the founder of Baucher Consulting Ltd. Click here to read previous columns from Terry.