New Overseas Tax Rules - Worked sample problem

[Snoopy]

Problem Part 3 (WILDCAT September 2006 proposal)

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 own 200 (due to the share split). Once again no dividend was paid during the year.

Using our formula: 0.05x(V-V1)

0.05 x (200x$US24.33/0.5512) = $NZ441.40

If we look at the change in capital position including dividends (there are no dividends in this instance) we find:

(200x$US24.33/0.5512) -(100x$US38.19/0.4219)= -$NZ223.90

That is a loss for the year, so no tax is payable.

Note that if this company were to go broke (god forbid) the tax already paid on the notional dividend received during years 1 and 2 (even though no dividend was received at all as a matter of fact) is not recoverable, or even offsetable, against gains made in future years.
In bankruptcy, not only would you lose all your investment but also you would have paid a tax levy to the government on the way through for the privilege of doing so. That would be a bitter pill to take.

(continued)

SNOOPY

[Snoopy]

Problem Part 4 (WILDCAT September 2006 proposal)


It is now the end of FY2004. Again ‘I’ hasn’t bought or sold any shares and no dividends have been paid. The share price is now $US37.99 and the exchange rate is $1US= 65.75c. What is the tax liability for ‘I’ in FY2004?

As at 31st March 2003 (start of the financial year) the ‘Yum Restaurants International’ share price was $US24.33 and the exchange rate on that date was $NZ1=US55.12c.

Using our formula: 0.05x(V-V1)

0.05x(200x24.33)/0.5512 = $NZ441.40

The profit and loss position for the year is

(200x$US37.99)/0.6575 -(200x$US24.33)/0.5512 = $NZ2727.88,

or more than our notional ‘Fair Dividend rate’. That means this year we get a ‘free lunch’, as we only have to pay tax on the fair dividend rate.

Assuming a tax rate of 33% the tax to be paid is:

0.33x $NZ441.40= $NZ145.66.

(continued)

SNOOPY

[Snoopy]

Problem Part 5 (WILDCAT September 2006 proposal)

The share price was $US37.99 and the exchange rate is $1US=65.75c at the start of FY2005. 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?

The ‘Fair Dividend rate’: 0.05x(V-V1) is

0.05x(200x37.99)/0.6575 = $NZ577.79

The total actual dividend income, including all withholding tax is :

(20/0.6447 + 20/0.6905 + 20/0.7102)= $NZ88.15

Clearly this is below the ‘Fair Dividend rate’, yet some US withholding tax -that is recognized in NZ as part of a dual taxation agreement, has already been paid, specifically:

($US3/0.6447 + $US3/0.6905 + $US3/0.7102)= $NZ13.22

We can use that tax already paid to offset tax that is deemed due under the ‘Fair Dividend rate’ method.

(200x$US51.50)/0.7070 - (200x$US37.99)/0.6575 = $NZ3012.71

Clearly this gain is larger than our fair dividend rate

Based on a tax rate of 33%, ‘I’s tax liability is:

0.33 x $NZ577.79= $NZ190.67

But some of that tax has already been paid in the USA. That leaves the net amount of tax to pay as:

$NZ190.67-$NZ13.22=$NZ177.45

(end of workings showing WILDCAT method in action)

SNOOPY

[Snoopy]

Time to look at the cashflow from the newly proposed 'WILDCAT' tax compared to the legislative proposal



By comparing the size of the 'total' tax take mountain, you can see that Cullen/Dunne have made a significant concession in terms of total tax due. From a cashflow perspective however (blue columns), the WILDCAT proposal actually means 'more money sooner' for the government, a fact that won't make them unhappy.

WILDCAT shares with the Cullen/Dunne legislative proposal a tax holiday in FY2003 during the poor year when the investment value slumped. I should add here that *only* WILDCAT (of the proposals so far) guarantees that no tax is payable in down years. The downside of WILDCAT is that no overseas tax losses can be carried forward under these circumstances either. A further downside of 'WILDCAT' is that under conditions of investment volatility over several years, it is likely that the same capital gain portion of capital value will be taxed more than once.

WILDCAT has quite a large cashflow issue. At no time - even during the final dividend year - does cashflow from the company get anywhere near the amount that needs to be paid to the NZ IRD for tax. The problem is that unless you only tax actual capital gains banked, *all* of these proxy tax methods will have cashflow issues.

What is needed to make things always cashflow manageable here is something like Halebops deferred payment plan system. Without this there are going to be cashflow problems almost by design. If we accept this design limitation, I think Cullen and Dunne have come up with the goods here. If I have to choose a new overseas investment tax regime based not on realised capital gain then this is the best one so far (IMO).

SNOOPY

[Dazza]

appreciate it snoopy
keep up the good work

[Snoopy]

quote:Originally posted by aspex

Questions for Snoopy
What is the assessed income in each case?

OK aspex, I shall answer (with the qualification that the information I am basing this answer on is based on government press releases and is incomplete in detail). The government has come up with a new platitudinal acronym to describe this new tax but I shall continue to use the acronym 'WILDCAT' for consistency. The answers I give apply to private individuals, not operators of managed funds.

quote:
1. Start of year at capital $100k. Dividend income $3k. Cap gain $10k

'Deemed income' is $5,000 (based on 5% of opening capital), so based on a tax rate of 33% the actual tax payable will be 0.33 x $5,000= $1,650.

quote:
2. Cap. $100k Dividend income $7k. Capital loss -$10k

The capital loss more than wipes out any dividend income, so no tax is payable.

quote:
3. Cap. $100k Nil dividends. Capital loss -$10k

Again the capital loss more than wipes out any dividend income (which happens to be nil in this example) so no tax is payable.

SNOOPY

[Snoopy]

quote:Originally posted by aspex

Thanks, Snoopy.
I presume that if the dividend income were $7k and there was also a gain of $10k, tax would be payable on the $7k rather than on the $5k notional income. Sorry, I should have included that one in the list.

If you start with $100,000 worth of shares Aspex, as an 'opening balance' my reading of the examples given are that you would only pay tax on 5% of the opening value of your overseas portfolio, or $5,000 worth.

The amount of tax you would pay, based on a 33% tax rate would therefore be:

0.33 x $5,000= $1,650, *regardless of the fact that your actual income was higher ($7,000) and the fact that you made a capital gain on top of that!*

SNOOPY

[Mr_Market]

What if you had zero investment balance on 'opening balance day'? Say that coincidentally you happened to sell down your investments the day before balance day, then also happened to buy them back the day after balance day.

[Mr_Market]

quote:Originally posted by aspex

Yeah right.
It could save heaps but then you may become a trader, even if you are out and into the same stocks.

Two trades in a year does not make you a 'trader'.

[Snoopy]

quote:Originally posted by Mr_Market


Two trades in a year does not make you a 'trader'.

Two trades a year based on a 1.5% commission will result in the loss of 3% of your capital every year.

Cullen's 'Wildcat' tax at a 33% tax rate on 5% of your opening balance will result in the loss of 1.65% of your capital every year.

Thus the tax saving strategy proposed by Mr Market, if it is allowed, will save you the tax. But you will lose *far more money* than your potential tax obligations simply by being forced to pay double brokerage fees every year.

I guess some people would see Mr Market's idea of 'dodging the tax' as a good strategy, even though it would cost one far more than any potential 'Wildcat' tax obligation if carried out!

SNOOPY