New Overseas Tax Rules - Worked sample problem

[Snoopy]

Now that we know what the new tax rules are, I have gone back to the sample problem that I introduced on the 'Proposed tax rule on overseas investments’ thread. There is a sample problem produced in the official IRD policy documentation introducing the new legislation. But this problem is far too simplistic to get an idea of how these new tax rules will work in practice over many years. My own sample problem is also simplified. That’s because I am only considering one overseas company, not the basket of overseas companies that will need to be considered together by most investors hit by this new regime.

Nevertheless these calculations will only need to be performed once – on an individual investor’s summary collective position. So I don’t expect any real case to be significantly conceptually more difficult than the example presented here. Please note that any reference to ‘overseas shares’ means ‘ overseas shares excluding Australian’ in this context of this example..

My problem follows the fortune of ‘Ms Investor’. Let’s call her ‘I’

I'll rework my sample problem to see where 'I' ends up under the about to legislated tax rules.

SNOOPY

PS I've read the press releases put out by IRD. I am fairly sure the sample calculation I am going to present to you is correct, but being a dog I can make mistakes. If you spot one please feel free to highlight it to me!

[Snoopy]

Problem Part 1 for FY2001 (April 2005 amendment)

I have some historic figures for YUM, the US parent company for Restaurant Brands KFC and Pizza Hut brands. Let's assume that this new tax regime applied from FY2001 and see what would have happened.

Let's assume 'I' bought 100 shares (we'll keep everything in round numbers) in December 2000 for $US34.655 dollars per share at an exchange rate of $NZ1= US42.32c. Brokerage was $US51.99. The shares paid no dividend in the time ‘I’ held them up until 31st March 2001, at which time the share price had increased to $US38.19. And the exchange rate changed to $NZ1= US42.19c. How much tax does ‘I’ pay on these shares for FY2001?

(All the above information carries over directly to this updated problem. Updated that is by the now published tax regime, nothing else.)

Using (A+B)-(C+D):

Where:
A is the market value of the unit-holding at the end of the income year.
B is the aggregate of all gains (e.g. capital returns) derived from holding or disposing of the interest during the income year (excluding dividends)
C is the market value of the unit-holding at the end of the previous income year; and
D is the total expenditure incurred by the holder during the income year in acquiring or increasing the interest.

(3819/0.4219 + 0) - (0+ (51.99/0.4232 + 3465.5/0.4232))= $NZ740.26

'Deemed Assessable Income' is the maximum of the dividend received (nil) and 0.05xC which is also nil (since I didn't own the shares at the start of the financial year), so no tax is payable at the end of FY2001 (March 31st 2001).
However, the amount 'available to tax' is deemed to be 85% of the capital gain of $NZ740.26.

0.85x$NZ740.26= $629.22

This figure becomes a figure 'E' (deferred income taxable) for the next tax year.


(continued)

SNOOPY

[Snoopy]

Problem Part 2 (Apr2005 Amendment)

It is now the end of FY2002. ‘Yum Restaurants International’ paid no dividends during the entire year. ‘I’ didn't buy or sell any shares during the year and the share price improved to $US58.78 based on an exchange rate (at 31st March 2002) of $NZ1= US43.06c. How much tax does ‘I’ pay for FY2002?

Using our formula (A+B)-(C+D) to work out the change in share valuation over the year:

(5878/0.4306+ 0) - (3819/0.4219 + 0) = $NZ4598.81

From part 1 of the problem, the deferred income taxable is ‘E’ =$NZ 629.22

Again there is no dividend paid, so the deemed assessable income from FY2002 is by default

0.05xC = 0.05 x (3819/0.4219)= $NZ452.60

Assuming a 33% tax rate, that means the tax payable is 0.33x $NZ452.60= $NZ149.36.

We have now paid tax on $NZ452.60 of notional 'income', so the amount of 'deemed assessable income' for FY2002 is reduced to:

(0.85x$NZ4598.81)-$NZ452.60= $NZ3,456.39. We must add to this figure the untaxed notional income accumulated in previous years of $NZ629.22. Thus

$NZ3,456.39+ $NZ629.22= $NZ4,085.61

becomes the new 'E' for FY2003.


(continued)

SNOOPY

[Snoopy]

Problem Part 3 (Apr2005 Amendment)

We have now rolled forwards to FY2003, and Mr. Market has thrown in a couple of curved balls. On 30th September 2002 there was a 1:1 share split. As at 31st March 2003 the YUM share price was $US24.33 and the exchange rate on that date was $NZ1= 55.12c. But instead of owning 100 shares 'I' now owns 200 (due to the share split). Once again no dividend was paid during the year.

The estimate of tax to pay based on deemed assessable income is based on a fixed multiple of the capital you have at the start of the year, *no matter what the actual performance of the share during the year*.

0.05x(5,878/0.4306)= $NZ682.53 x 0.33 (assuming 33% tax rate)= $NZ225.24

So $NZ225.24 is the minimum down payment of tax to pay for FY2003.

The 1:1 share split ends up being a bit of a red herring because the proposed tax system is based on the total market value of the shares held - not the share price.

Even though the number of shares ‘I’ owns has doubled, the share price has halved (at least theoretically) to take account of the fact that twice as many ordinary shares exist as did before the split.

So the value of ‘I’ shareholding at the end of FY2003 is:

200 x $US24.33 = $US4866.00

Using the (A+B)-(C+D) formula to calculate the annual change in share value, we get:

(4866/0.5512+ 0)-(5878/0.4306 + 0)= -$NZ4822.71

Whether this amount is positive or negative, it is still subject to the adjustment factor of 0.85

That means the incremental ‘available to tax’ amount is:

-$NZ4822.71x0.85=-$NZ4,099.30

The deferred tax increment is negative for this year – a loss. If we add that to the available to tax increment ‘E’ carried forward from previous years we get:

$NZ4,085.61-$NZ4,099.30=-$NZ13.69

The available to tax amount is -$NZ13.69 which *is* negative. So that means ‘I’ can declare a loss (which may be offset against other overseas income in a real case) for the year. Back to our example, assuming this is representative of the only overseas income ‘I’ have, then the government allows a loss up to the deemed percentage that would have been taxable (again, 5%) if a gain had been made instead.

That means the maximum loss that ‘I’ can claim *under any circumstances* is $NZ682.53.

However, in this instance the actual loss I have made is only $NZ13.69 (The loss during the year is much greater but we must take into account the untaxed gains ‘I’ have been storing from previous years). That means the full amount I can claim as a loss is $NZ13.69.

In this particular example we shall assume there is no other overseas income to offset against this $NZ13.69 loss. That means the figure of -$NZ13.69 (note the minus sign) is carried forward as our ‘E’ into the next financial year.


(continued)

SNOOPY

[Snoopy]

Problem Part 4 (Apr2005 Amendment)

It is now the end of FY2004. Again ‘I’ hasn’t bought or sold any shares and no dividends have been paid to her. The share price is now $US37.99 and the exchange rate is $NZ1= 65.75c. What is the tax liability for ‘I’ in FY2004?

As at 31st March 2003 (start of the FY2004 financial year) the ‘Yum Restaurants International’ share price was $US24.33 and the exchange rate on that date was $NZ1 = 55.12c. That means the 'deemed assessable income' is as follows:

0.05x(200x$US24.33/0.5512)= $NZ441.40
x 0.33 (assuming 33% tax rate)= $NZ145.66

Now using (A+B)-(C+D), we can see how this investment changed in value during the year.

(200x37.99)/0.6575 + 0)-(200x24.33)/0.5512 +0) = $NZ2,701.14

That means the deferred tax increment is: 0.85 x $NZ2701.14 = $NZ2,295.97

And the total deferred tax amount ‘E’ is -$NZ13.69 +$NZ2,295.97= $NZ2,282.28

The total deferred tax liability is greater than the 'deemed assessable income' of $NZ441.40. That means we only have to pay tax immediately on the amount $NZ441.40. The amount of tax ‘I’ has to pay for FY2004 is $NZ145.66 (as just calculated).

The revised ‘deferred income to tax’ figure 'E' for the next financial year is calculated as follows:

$NZ2,282.28 -$NZ441.40 = $NZ1,840.88


(continued)

SNOOPY

[Snoopy]

Problem Part 5 (Apr2005 Amendment)

The share price was $US37.99 and the exchange rate is $1US=65.75c at the end of FY2004. At the end of FY2005 the share price was $US51.81 and the exchange rate was $1US=70.70c

During FY2005 ‘Yum Restaurants International’ started paying dividends for the first time.
These dividends were at the rate of 10c per share, making a gross total of $20 per dividend payment. Withholding tax was deducted at a rate of 15%. That works out at $3 per dividend payment, leaving a net return of $17. Dividends were paid on three dates during FY2005. These dates accompanied by the $NZ/$US exchange rate on the day follow:

Div payment date 1: 6th August 2004; $NZ1=US64.47c
Div payment date 2: 5th November 2004; $NZ1=US69.05c
Div payment date 3: 4th February 2005; $NZ1=US71.02c

Once again ‘I’ makes no further share purchases or share sales during the year. What is ‘I’ tax liability for FY2005, due to owning these ‘Yum Restaurants International’ shares?

'Deemed assessable income' is the maximum of either (a) the dividend income or (b) the amount calculated using the capital appreciation formula

(a) Total gross dividend income, including all withholding tax is:
(20/0.6447 + 20/0.6905 + 20/0.7102)= $NZ88.15

(b) 0.05x(200x$US37.99/0.6575)= $NZ577.79

Clearly (b) is the larger, so this is our 'deemed assessable income'.

Now using (A+B)-(C+D), we can see how our investment changed in valuation during the year.

((200x51.81)/0.7070+0)-((200x37.99)/0.6575+ 0)= $NZ3,100.40

From this we can calculate the deferred untaxed income increment for FY2005, remembering to add in the summary dividend payment:

0.85x $NZ3,100.40+$NZ88.15 = $NZ2,723.49

And therefore the total accumulated deferred income going out of FY2005 is:

$NZ2,723.49 + $NZ1,840.88 = $NZ4,564.37


‘I’ has a deferred future untaxed income balance greater than the 'deemed assessable income' of $NZ577.79. That means ‘I’ only has to pay tax immediately on $NZ577.79. The amount of tax ‘I’ has to pay for FY2005, assuming a 33% tax rate, is:

$NZ577.79 x 0.33= $NZ190.67.

However, some US withholding tax - that is recognized in NZ as part of a dual taxation agreement has already been paid, specifically:

(3/0.6447 + 3/0.6905 + 3/0.7102)= $NZ13.22

That leaves the net amount of tax to pay as:

$190.67-$13.22=$177.45

The amount of future assessable income can now be reduced by the amount of income that has just been taxed.

$NZ4,564.37 - $NZ577.79 = $NZ3,986.50

This is the 'E' value that ‘I’ needs to carry forward for tax purposes in FY2006.

It can also be thought of as the residual income for a future tax liability hanging over your head as a taxpayer!

(end of sample method 1)

SNOOPY

[Deev8]

quote:Originally posted by Snoopy

... but being a dog I can make mistakes. If you spot one please feel free to highlight it to me!

I agree up to March 2003.

At that point I agree that tax will be payable on deemed income of NZ$682.53, so NZ$225.24 of tax will be paid assuming a rate of 33%.

I also agree that the change in capital value over the year has been minus NZ$4822.71. Multiply that by 0.85 and add to it the NZ$4,085.61 carried forward from the previous year, and I agree that the running total of taxable income is minus NZ$13.69.

Where I departed from your figures was in the calculation of deferred taxable income to be carried forward.

As tax has been paid on NZ$682.53, I carried forward minus NZ$13.69 less NZ$682.53 - a carry forward of minus NZ$642.22.

However I know that I am as likely to be wrong as any dog, probably more likely!

[Tim]

Thanks Snoopy for the work you have done, but isnt this you capital gains tax ridiculus. I will move to a very overweight position in my portfolio of Aussi stocks and choose ones that primarily invest in overseas companies like Rinker, Brambles,etc. If I have to pay tax on my other overseas portfolio I will hide it overseas or I will never sell and pay just 5% per year

[Snoopy]

quote:Originally posted by Deev8



I agree up to March 2003.

Deev8, before I give my response, I would like to say that I very much appreciate you reading the nitty gritty of my example.

Certainly I don't think the example(s) given in the most recent ird policy discussion document is adequate in explaining the 'real' calculations that will be faced by most people over the coming years. It is only through in depth responses such as yours that we will all get to the bottom of how these calculations are done.

To clear up any possible ambiguity, given the other figures you have quoted, we are talking about the third part of my reworked problem:

Problem Part 3 (Apr2005 Amendment)

quote:
At that point I agree that tax will be payable on deemed income of NZ$682.53, so NZ$225.24 of tax will be paid assuming a rate of 33%.

My words were "estimate of tax to pay",

not a definitive

"(the amount on which) tax will be payable."

quote:
I also agree that the change in capital value over the year has been minus NZ$4822.71. Multiply that by 0.85 and add to it the NZ$4,085.61 carried forward from the previous year, and I agree that the running total of taxable income is minus NZ$13.69.

OK

quote:
Where I departed from your figures was in the calculation of deferred taxable income to be carried forward.

As tax has been paid on NZ$682.53, I carried forward minus NZ$13.69 less NZ$682.53 - a carry forward of minus NZ$642.22.

Deev8, something has happened to your arithmetic here.

By my calculator

-$NZ13.69 - $NZ682.53 = -$NZ696.22

Or am I misinterpreting what you are trying to do?

Nevertheless your comments have a conceptual 'ring of truth' about them.

Let's look at a slightly different problem (different in term of the timing of the investment only, all other numbers remain the same).

Let's say the inital investment was made on the first day of FY2003 (1st April 2002) and your task is to find the tax payable as at the last day of FY2003 (31st March 2003)

I have previously said:

"So the value of ‘I’ shareholding at the end of FY2003 is:

200 x $US24.33 = $US4866.00

Using the (A+B)-(C+D) formula to calculate the annual change in share value, we get:

(4866/0.5512+ 0)-(5878/0.4306 + 0)= -$NZ4822.71"

In this 'start the investment in FY2003' sub-case, our investor has clearly lost 'big-time'. 85% of this 'big-time' loss is:

0.85 x -$NZ4822.71= -$NZ4,099.30

However, the amount of the loss claimed cannot exceed 5% of the opening balance or:

0.05x(5,878/0.4306)= -$NZ682.53

That means I *can* declare a loss of $NZ682.53 on my overseas investment portfolio, AND I can carry forward an amount of my loss into the next tax year of:

-$NZ4,099.30 - -$NZ682.53= -$NZ3,416.77

Am I making sense so far?

HOWEVER, let us return to the example in which you found the alleged error. I agree that if tax has been paid on $NZ682.53, then you have a point.

But *does* tax have to be paid on $NZ682.53? I am arguing that because of the timing of the original purchases, in financial year 2001 - and the consequent downstream effect that a cumulative loss of -$NZ13.69 has accrued - it does not. Do you agree or disagree?

SNOOPY

[Snoopy]

quote:Originally posted by Snoopy



Certainly I don't think the example(s) given in the most recent ird policy discussion document is adequate in explaining the 'real' calculations that will be faced by most people over the coming years.

<snip>

I agree that if tax has been paid on $NZ682.53, then you have a point.

But *does* tax have to be paid on $NZ682.53? I am arguing that because of the timing of the original purchases, in financial year 2001 - and the consequent downstream effect that a cumulative loss of -$NZ13.69 has accrued - it does not. Do you agree or disagree?

And just to give you the reference where I got my ideas from, I refer you back to the investment income discussion document issued in the middle of 2005.

http://www.taxpolicy.ird.govt.nz/pub...nvincomedd.pdf

Under paragraph 5.60,

"Treatment of losses

5.60 Losses would be allowed under the proposed approach. A loss would arise if the “available to tax” amount were negative. The government proposes to allow a loss up to the deemed percentage that would have been taxable (again, 6% (edit-now 5%)) if a gain had been made instead. Also, when the proposed approach applies in the context of a pool of offshore assets, and a portion of the assets is realised, any negative “available to tax“ amount would be available as a loss in proportion to the ratio of the realisation to the market value of the pool at the time. The full loss would be allowed when the pool is realised."

I'll give the disclaimer that this is/was a discussion document and as such it has no legal standing. The views expressed in this 'invincomedd.pdf' document may not even co-incide with the views that the IRD have now. Neverthless it is the most complete information on the IRD thinking of how to deal with losses that I know of.

The specific words that caught my attention were:

"any negative “available to tax“ amount would be available as a loss in proportion to the ratio of the realisation to the market value of the pool at the time."

That's why I only carried forward the -$NZ13.69 as the loss to be carried forward beyond FY2003. -$NZ13.69 is the equivalent of the 'available to tax' (although I don't like that term) amount in the investment income discussion document. No mention is made in the reference paragraph of the equivalent NZ$682.53 'downpayment' proxy taxable income amount.

This is my own interpretation of the literature out there. I still could be wrong.

SNOOPY