Trust in tax. Or would you prefer a pie?

After the well-publicised events of the last week, taxation is shaping up to be a major issue for New Zealanders heading into October’s election. Nonetheless, buried within the hype and commentary surrounding PM Hipkins’ ruling out of capital gains and wealth taxes, there was reference to a much-less publicised event – an upcoming increase in trust tax rate, from 33% to 39%.

I use the word ‘upcoming’ loosely. We live in a parliamentary democracy, so naturally NZSA (and others) have at their disposal a means of making their views felt. What is perhaps of interest is that submissions on the handily named Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill closed on Friday July 14th. Given that this date was a public holiday to celebrate Mātāriki, I’m unclear whether this should be regarded this as a cynical effort to minimise submissions by interested parties or a mark of disrespect for Māori.

Perhaps it’s both.

However, fear not. NZSA is not one to shirk from a submission, even if rare Wellington winter sunshine on a public holiday beckons. There are three key messages in our submission to the Finance and Expenditure Committee, relating to the proposed increase in the Trust tax rate:

1. The proposal is a further ‘nail in the coffin’ for representation of individual investors in tax structures and government policies.
   
2. The tax differential (between 28% for PIE/Company rates to 39% for Trusts and individual investors) will encourage investment decisions to be based on taxation rather than investment fundamentals.
   
3. A higher trust tax rate encourages a bias towards distribution and expenditure as compared with ongoing productive investment and long-term savings growth.

Pleasingly, the NZSA’s submission has been endorsed by both the Securities Industry Association and NZX Limited.

Representation for individual investors

A few weeks ago, I wrote about the Prime Minister’s comments surrounding potential long-term outcomes of the Michael Wood saga. Amongst other comments, the PM noted that there was some consideration being given to preventing MP’s from holding direct investments in shares. Our contention is that there is already a serious lack of representation of individual investors in Parliament – and PM Hipkins’ comments reflected an institutional and unconscious bias within the House, against the needs of individual investors.

Investors are now able to choose from a plethora of options when it comes to investment. For many top-tax rate individuals, PIE’s (portfolio investment entities) have become a de rigeur choice – not just for the versatility and flexibility they provide, but simply because the maximum tax rate is 28%. Parliament has unconsciously created a regime that is inherently biased towards the needs of funds and large institutions. An increase in the trust tax rate is yet another step on that unconscious journey.

It’s important to note that NZSA supports the variety of investment options for New Zealanders. There’s something to suit everyone, regardless of age or stage, personal passions and interests and individual capability. But when those options get slanted in a manner that actually begin to affect the underlying investments – well, that’s when we get interested.

So interested in fact, that we’ve offered to participate in a more collaborative approach with the Finance and Expenditure Committee to ensure effective representation for individual investors.

Tax should not influence investment decisions

We think the current tax structures have reached the point where a more holistic review of both tax rates and tax structures is required. A tax differential of 11% (between 28% – 39%) for doing basically the same thing for the same investor does not seem to underpin the ideals of a progressive tax system. Similar to our commentary calling for a review of the Companies Act last week, there is a limit to how much Parliament can tinker around the edges of existing structures.

The proposed trust tax rate accentuates a move towards taxation dependent on the type of activity – as opposed to taxation based on income. The more complicated the rules, the more scope there is for tax minimisation; a superb outcome for tax accountants and (potentially) lawyers, but quite the handbrake on the rest of us.

The proposed increase in the trust tax is part of the government’s effort to minimise tax minimisation practices amongst high-income individuals who choose to use trusts as a means of reducing their tax rate. Unfortunately, the move will hurt many more New Zealanders who utilise trusts as a form of estate planning and to provide for their own retirement. It has the unintended consequence of proportionally disadvantaging middle New Zealand to a far greater extent than the high-income individuals to which it is targeted. As noted in the Regulatory Impact Statement accompanying the proposal;

Our ability to determine whether the proposals will have a disproportionate impact on certain groups or types of trusts is limited.

Regulatory Impact Statement, Taxation of Trustee Income

Well well. In other words, the data is so bad that no-one really knows just who will be impacted.

So what might a holistic review consider? As always, NZSA would prefer to be led by the data and evidence to create an optimised outcome. It’s interesting, though, that PM Hipkins’ promise to rule out wealth or additional capital gains taxes has somewhat limited the scope for potential options. Right now it looks like the tax dicussion on the election campaign trail will be led more by the politics. While unsurprising, this has some risk of resulting in a potentially sub-optimal impact for any considered, independent and holistic review of our tax structure.

Spend or save?

There is inevitably a human and behavioural response when it comes to taxation. In addition to individuals wondering aloud what an 11% tax difference might make to their future, there is one more unintended consequence we should be concerned about. Any distribution or allocation of trust income to beneficiaries is taxed at the beneficiaries marginal tax rate. So, depending on the beneficiaries, a trust tax rate at 39% is more likely to result in more income being made available for beneficiaries with less focus on the development and growth of investment funds.

In other words – this change will encourage many New Zealanders to spend more and save less.

That sounds just like what we need. Not. Our savings and investment habit has improved in recent years, thanks to the likes of KiwiSaver and the afore-mentioned plethora of investment options now available. But that does not mean it’s great. A common complaint of issuers looking to raise capital in New Zealand is that there is simply more capital available in Australia – hence the inevitable increase in our companies looking across the Tasman for their next capital opportunity. This could be the subject of a whole other discussion – but for brevity’s sake, suffice to say that introducing a disincentive to save does not help us play a vital role in developing our own future as a nation. NZSA believes that we need to try harder when it comes to mechanisms (including taxation) that can improve and incentivise savings and investment behaviour by New Zealanders.

Like most, NZSA believes that our taxation system should uphold the progressive principles on which it is founded – it should encourage individuals to pay their fair share of tax relevant to their income. The proposed change in the trust tax rate has the potential to be significantly regressive – that is, impacting individuals with a higher tax bill than they would otherwise pay. Worryingly, though, no-one really knows. While the government expects to raise $350m as a result, it admits that “this is highly uncertain and largely dependent on the extent of the behavioural response of trustees.“

And as all investors know, uncertainty is no-one’s friend.

Except, in this case, for tax accountants.

Oliver Mander

Oliver is the Chief Executive of NZSA. NZSA is very clearly a-political, and will remain so, but will always advocate for fairness when it comes to investors and investment markets.