The taxation of interests in foreign superannuation schemes and other forms of retirement savings held by migrants to New Zealand has for years been both complex and arbitrary. The growing number of people with such savings and increased focus by Inland Revenue on non-compliance in the area has heightened awareness of the problems.
The recently released Taxation (Annual Rates, Foreign Superannuation, and Remedial Matters) Bill (the Bill) attempts to simplify matters by introducing a new withdrawals (essentially, cash-based regime) to tax interests in foreign superannuation schemes. The Bill also contains a partial “amnesty” for people who have, since 1 January 2000, withdrawn, or transferred into a New Zealand scheme, a lump sum from a foreign scheme and not returned it as income.
This brief counsel explains this new regime, which will be of interest not only to people who hold or recently have held, foreign superannuation scheme interests, but also to New Zealand based schemes hoping to attract transfers from foreign superannuation schemes.
Changing the rules
Currently, an interest in a foreign superannuation scheme may be taxed under a variety of regimes depending on the nature of the scheme. This complexity has unsurprisingly led to a high degree of non-compliance. The proposed withdrawal regime is intended to simplify the taxation of foreign superannuation scheme interests, taxing New Zealand resident holders of such interests on a withdrawals basis. However in most cases, only a percentage of a given withdrawal is taxable.
The new rules do not apply to social security payments, pensions or annuity payments which will continue to be entirely assessable as received, subject to potential tax treaty relief.
The proposed regime will apply to foreign superannuation interests held by New Zealand tax residents, with effect from the 2014/15 tax year. It will not apply to withdrawals from Australian superannuation schemes, which are specifically exempt under the New Zealand/Australia tax treaty.
Taxation of “withdrawals”
Under the new regime, a person will be taxed only when they receive a “withdrawal” from their scheme, defined as:
- an amount derived from a foreign superannuation scheme
- a transfer from a non-Australian foreign superannuation scheme to a New Zealand or Australian superannuation scheme, and
- a transfer from any foreign superannuation scheme to a scheme for the benefit of another person.
A transfer to a superannuation scheme based outside of New Zealand and Australia is not taxed.
How are withdrawals taxed?
New residents (including those returning to New Zealand) will generally receive a withdrawal free of New Zealand tax, if the withdrawal is made within the first 48 months of residency. This provides a New Zealand tax free opportunity to bring superannuation savings into the New Zealand (or Australian) tax system. Whether this is possible or advisable will of course also depend on the tax and non-tax rules applying in the relevant foreign jurisdiction. One relevant fact may be that New Zealand savings vehicles are generally fully taxable, their only tax benefits being the maximum 28% tax rate and the exemption from tax on gains on Australian listed and New Zealand equities.
After the 48-month exemption period, the person will be taxed on a withdrawal from a foreign superannuation scheme interest under the default “schedule method”, or the “formula method”. Both methods tax only withdrawals – there is no tax on an accrual basis, as there is with the FIF regime. The effective rate of tax calculated under each method is intended to produce, on a net present value basis, a tax liability approximately equivalent to the New Zealand tax that would arise if the taxpayer had transferred their investment in the foreign superannuation scheme to a New Zealand scheme as soon as they became a New Zealand resident.
- Outside the 48-month exemption period, a percentage of each withdrawal made is treated as taxable income.
- The percentage depends on how many income years the taxpayer has been resident in New Zealand, and increases from 4.76% to 100% (after 30 years).
- Taxpayers cannot switch from the schedule method to the formula method.
- Outside the 48-month exemption period, withdrawals will be taxed based on the actual growth in value of the superannuation investment occurring after the taxpayer has been a New Zealand resident for 48 months.
- To use the formula method, the taxpayer must obtain information such as the market value of his or her foreign superannuation interest at the end of the exemption period, and information about contributions made.
- Taxpayers may have to use the schedule method if they can no longer obtain the required information for the formula method.
FIF rules grandparented for taxpayers currently applying FIF regime
Taxpayers who have already filed tax returns recognising income from their foreign superannuation scheme interests under the FIF regime can, from 1 April 2014, choose:
- to continue applying the FIF regime to their foreign superannuation scheme interests, or
- to apply the new withdrawals based regime.
A taxpayer may want to keep applying the FIF rules if they have been resident in New Zealand for some time and will make withdrawals in the near future. It may often be more tax efficient to pay tax on a deemed accruals basis than pay tax on a substantial, or perhaps the entire, amount withdrawn.
Low cost option for withdrawals from 1 January 2000 to 31 March 2014
The Bill provides “amnesty” provisions for taxpayers who have made withdrawals (including transfers) between 1 January 2000 and 1 April 2014 and have not complied with the tax law in force at the time of withdrawal. The amnesty allows the person to pay tax on 15% of the amount they have withdrawn.
For withdrawals already made, taxpayers will need to consider what tax treatment would have applied in the year of the withdrawal. In many cases, the withdrawal may have been tax exempt, for example if the taxpayer was a transitional resident, or the withdrawal was made after 1 April 2010 from an Australian scheme. In other cases, the withdrawal may have been entirely taxable.
In order to take advantage of the “amnesty”, the taxpayers must return 15% of the withdrawal in their 2013-2014 or 2014-2015 tax returns. Fortunately, it appears that the amnesty does not have a closing date. Based on the Bill, it appears that even where the issue is only revealed on an audit, taxpayers can choose the 15% if it is preferable. However, if the 15% is not included as income by the 2014/15 tax return then interest and penalties may apply.
For a person who currently has a foreign superannuation scheme interest, it may be worth making a withdrawal before 1 April 2014, if 15% is a lower percentage than the percentage that would be taxable if the person withdraws in the 2014/15 tax year and is therefore subject to the new provisions.
Withdrawals to pay tax
The Bill proposes to allow a person to apply to make a withdrawal from their KiwiSaver schemes to pay their tax liability arising upon transfers made from foreign superannuation schemes to a KiwiSaver scheme that are made outside the 48-month exemption period (if applicable). Caution must be exercised when making such withdrawals, as they may be unauthorised under the terms of the foreign superannuation schemes, and therefore risk triggering a foreign tax liability.
We support the government’s attempts to simplify the taxation of foreign superannuation interests. The new regime is a positive step, but there are fishhooks that should be considered by those with foreign superannuation scheme interests, their advisors, and New Zealand schemes seeking to attract transfers from foreign superannuation schemes.