The New Zealand Tax Podcast. Getting ready for the new tax year; the 'Scheme Pays' option for foreign superannuation scheme transfers; could bank taxation changes be in this year’s Budget?

We're racing towards the end of the current tax year. And naturally, at this time of year, tax advisors will be planning ahead and considering what elections we might need to make before 31st March, whether to bring forward taxable income into this year or, if we can, defer taxable income into a later tax year because we are aware that in that new year a lower tax rate will apply.

Right now, I'm discussing these timing options with a number of clients who are thinking about transferring or withdrawing funds from their UK pension schemes. Such transfers/withdrawals are taxable under the foreign superannuation scheme transfer provisions in Section CF3 of the Income Tax Act 2007.

Long-term followers will know that I am not a fan of this regime, but it's now been in place since 2013. One of my major criticisms with the regime is that it triggers a tax liability for the transferor, even though that person may not be able to access the funds in the scheme to pay the tax. This wasn't really grasped by most of the industry until after the reforms were put in place.

The Scheme Pays solution

Subsequently, there's been a long period of consultation between industry specialists and Inland Revenue, and then between Inland Revenue and HM Revenue and Customs (HMRC) to find an answer to this issue. Fortunately, and finally, that answer has now been found and will become effective from 1st April. It's known as the ‘Scheme Pays’ option, under which the transferring scheme, the receiving scheme (which for UK purposes is known as a qualifying recognised overseas pension scheme or QROPS) will pay the tax on behalf of the transferor, the transfer scheme withdrawal tax.

The benefit of the Scheme Pays option is twofold. Firstly, the tax may be paid from the funds that are transferred. The problem that had existed previously was that HMRC could have treated a withdrawal to pay the tax as an ‘unauthorised withdrawal’ for UK tax purposes, which could come with a 55% tax charge on it. Working through a solution which was mutually acceptable to HMRC and Inland Revenue took some time.

Secondly because a QROPS is a portfolio investment entity the tax rate payable is capped at 28%. The option that now becomes available for people considering a transfer into a QROPS is If they do so, they will pay tax at 28%, which if they're a higher rate taxpayer - 39% - is a very attractive option.

When to transfer?

The issue now under consideration is whether a person transfers a scheme before 1st April, be taxed at the usual personal tax rates and is therefore responsible for meeting the tax personally. Alternatively, defer the transfer until on or after 1st April and into a QROPS. The deferral will increase the amount of taxable income, but the trade-off is a flat 28% tax charge. There are some clients where that's an extremely attractive option, and we're talking about saving tens of thousands of dollars as a result.

There is an argument, in my view, that the tax rate for all transfers like this should have been 28% or linked to the top prescribed investor rate all along, because basically part of the rationale for this regime is countering people getting a benefit from investing offshore.

The transfer scheme withdrawal tax

The individual making the transfer is still liable for determining the taxable amount of the transfer. For example, if it's $100,000, the receiving QROPS will withhold 28% or $28,000 from the amount transferred and pay it to Inland Revenue. The transferring taxpayer has got 10 working days from the point at which the funds reach the scheme to ask the scheme to pay the tax (‘Transfer Scheme Withdrawal Tax’) on your behalf.

The taxpayer can calculate the taxable amount using either the ‘Schedule Method’, or the ‘Formula method’ if it is available. For many people who are transferring defined benefit schemes, such as UK teachers' pensions or UK police pensions, they must use the Schedule Method.

It may have taken a long time to resolve but the Scheme Pays option is a good alternative. As I said, it has the potential to save thousands of dollars for some taxpayers. So if you're considering transferring your UK pension you should get in touch with your local tax advisor.

Changes to banking taxation ahead?

Moving on, in my last podcast I mentioned in passing that the Minister of Finance had made comments about a potential banking review. Subsequently there's been a couple of stories in the New Zealand Herald and Business Desk on this matter, in particular, Inland Revenue are preparing a consultation document entitled Changes to Tax Rules for Foreign-Owned New Zealand Banking Groups.

According to the report in the Herald (paywalled)

 the document outlines a series of technical proposals aimed at improving the integrity of the tax system. Apparently, the changes would affect offshore banks that have branches in New Zealand (about 6% of the banking sector by assets according to 2024 figures) rather than locally incorporated banks with which the vast bulk of Kiwi households and businesses engage. While the proposed changes could see banks pay a bit more tax, they aren't aimed at generating material amounts of additional tax revenue for the Crown.

Although it's interesting to see this issue under consultation, it represents one of the group of technical issues that Inland Revenue is always mulling over particularly because being the banking sector, there's possibly quite some large sums involved.

A banking levy surprise in the Budget?

Dileepa Fonseka in Business Desk wondered, whether in fact, there might be some form of banking levy introduced as part of the budget on 28th May. He considered whether such a levy could possibly be tied to the recently established Depositor Compensation Scheme (DCS).

Dileepa notes that in Europe, 17 countries and the United Kingdom have introduced bank levies or financial stability contributions in the years following the Global Financial Crisis. Many were levied on the liabilities banks carry rather than profits and are designed ensure financial stability and to cover the cost of insuring bank deposits. 

It’s possible anything which taxes banks more might be a bit of a vote winner, even if, as experts note, there's a chance that such levies might ultimately be passed through to customers. Dileepa also makes an interesting comparison with a similar levy which was a surprise sprung by Scott Morrison in 2017 when he was the Australian Treasurer (Finance Minister).

It’s interesting to see the stories circulating in this space. We'll get more details on the Inland Revenue consultation when it is publicly released, and we'll discuss it then. Meantime, as I said in the first podcast of the year, we could expect to see a bit of electioneering around a potential bank levy.

Foreign Investment Funds and transitional residents

Finally, this week, there's an interesting Inland Revenue Technical Decision Summary, TDS 26/01, regarding the opening value of foreign investment funds. It relates to a transitional resident, a person who has either not previously been resident in New Zealand or has been non-resident for at least ten years. Transitional residents generally are eligible for a 48-month exemption from New Zealand income tax on their overseas investment income. But what happens when that exemption period expires?

The taxpayer in the TDS also requested a 31st December balance date, which had been approved by Commissioner. In other words, without saying so specifically, this client is probably an American who must file US tax returns to 31st December. And as the TDS notes, a 31st March balance date means there are high compliance costs because the person has to calculate income for US tax purposes to 31st December and then for our purposes to 31st March.

The taxpayer’s last day of his transitional residence exemption period was actually 31st December 2024.  He requested a change of balance date for his tax year from 31st March to 31st December to align with his US filing period.  Inland Revenue agreed to the request which means that balance date could be used for calculating hi FIF income. Which is good because that is very handy for many American clients, because of the dual reporting they have to do.

But the other point is that the TDS agreed the opening value for each FIF interest for the purposes of the income year ending 31st December 2025 would be nil, not the value as of 31st December 2024. That means that when applying the fair dividend rate, which is 5% of the opening value and any quick sales adjustments, the opening value would be NIL. Therefore, for the year to 31st December 2025, only the quick sales adjustment calculation will apply in relation to the FIF interests acquired and disposed of during that tax year.

This is an interesting little summary. It confirms a point that some of us had thought was the case, that clients required to file American tax returns could switch to a 31st December year end to help ease compliance. The taxpayer still has to request a change but this TDS indicates Inland Revenue should accept the request.

Still on foreign investment funds, we should hear this week about the final form of the proposed change, allowing taxpayers required to file US tax returns to adopt a quasi-capital gains tax or “revenue account” approach to their foreign investment fund interests, i.e. being taxed on a realisation basis. The Finance and Expenditure Committee is due to report back on 10th March on the Bill and we'll bring you that news next week.

And on that note, that’s all for this week, I’m Terry Baucher and thank you for listening. Please send me your feedback and requests for topics or guests. Until next time, kia pai to rā. Have a great day.