Inland Revenue Consultation on the Effect of FIF Rules on Immigration

Inland Revenue has released a consultation document outlining potential options to address the widely acknowledged challenges with the existing Foreign Investment Fund (FIF) rules on individuals immigrating to New Zealand.

The consultation document seeks feedback on two core proposed changes which are aimed at simplifying the tax obligations for new or returning residents and ensuring the rules are fair and equitable.

In our experience working with a wide range of individuals, a constant area of frustration is New Zealand’s outbound taxation settings, specifically the current FIF rules and their application to portfolio (i.e., less than 10%) shareholdings in foreign companies.

These tax settings can create a financial barrier to highly-skilled expatriate New Zealanders returning, and new migrants relocating to New Zealand. For those individuals already here and holding interests in foreign companies, it can lead to them leaving, or looking to leave New Zealand. Many will have acquired these FIF investments while working overseas or as New Zealand based employees or consultants for offshore companies and will have established a connection to the company through either employment or through other key relationships, e.g., as founders, funders or providing mentorship or management expertise.

While some shareholdings will be significant, in most cases, these are often portfolio investments, meaning the applicable FIF income calculation method will be on a deemed income basis.

The intent of the proposed changes is specifically acknowledged as encouraging investment in the IT and technology sectors, as well as to attract foreign direct investment more broadly.

On that basis, the consultation document proposes the introduction of an alternative method of taxation for a limited group of individuals rather than all taxpayers. The focus is on migrants or returning New Zealanders who become subject to the FIF rules after a specified date by reference to tax residency or aligned with the transitional residence qualification rules.

Further, it is proposed that the amendments would generally only apply to the treatment of unlisted shares that are acquired in advance of migration to New Zealand.

An additional concession to extend the alternative treatment to all foreign share investments (including listed shares and shares acquired after becoming NZ resident) is proposed for individuals who may be subject to continued double taxation at a de minimis level (of at least 15% in the foreign jurisdiction), for example due to citizenship-based taxation. This concession is primarily aimed at American migrants, given the United States’ approach to taxing US citizens and green card holders on their worldwide income regardless of where they are tax resident.

Rebecca Armour

Partner - Consulting

KPMG in New Zealand

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Rachel Piper

Partner - Tax

KPMG in New Zealand

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Introduction of an elective alternative to deemed taxation

The main calculation methods for the taxation of portfolio investments (that is, less than 10% shareholdings) in foreign companies under current law are broadly summarised below:

The Fair Dividend Rate (“FDR”) method, which calculates taxable income at 5 percent of the opening market value of the investment at the start of the income year (e.g., 1 April for standard balance date taxpayers).
The Comparative Value (“CV”) method, which calculates taxable income based on the net movement in the share value (both realised and unrealised) during the income year and distributions received, with losses arising under the CV method capped at nil.
The “Cost” method, which is a variant of the FDR method that applies in the absence of a readily available market value for the underlying security. As a result, the Cost method constructs a starting “opening value” which is increased by 5% in each subsequent year (with the ability to reset the opening value in the 5th year).

For consideration under the consultation document are three alternative methods:

1. Attributable FIF method

This an existing method available for taxpayers holding non-portfolio interests e.g. investments of 10% or more in a FIF which derives less than 5% of its total income from passive income sources such as interest and dividends. Under such a method, taxation would essentially mean that FIF income only arises when dividend income is received and/or upon disposal to the extent the investment is held on revenue rather than capital account. The proposal is to remove the existing 10% threshold for accessing the method. Because this method requires information about the underlying active/passive income derived by the foreign company, it is acknowledged that portfolio investors may be unlikely to have access to the requisite information to do the calculations so this option may be of limited practical use.

2. Revenue account method

This alternative is to move to treating the investment in foreign shares as being on revenue account. This would cause shares to be taxed at the time of any dividend receipt and upon any gain arising at disposal. This method would most closely align with international norms.

A migrant who elects to apply this method would be required to apply it to their entire portfolio of pre-migration non-listed shares. A loss on disposal would only be allowed to be used to offset other FIF income arising from the revenue account method.

Inland Revenue’s preference would be for income under this method to be taxed at ordinary marginal tax rates (up to 39%), however it is acknowledged that foreign jurisdictions tend to tax capital gains at lower rates and for many migrants, taxing capital gains on FIFs at up to 39% might continue to deter migration.

3. Deferral method

The third method proposed is to tax FIF income on a realization basis akin to the treatment of foreign superannuation. This would likely involve taxation rates determined by reference to a schedule which recognizes the value of deferring the payment of tax. It potentially also addresses some issues with the valuation of illiquid shares.

KPMG View

The consultation document represents a positive step towards making New Zealand’s tax system more accessible to those who currently grapple with the challenges of holding foreign shares. The limited scope and focus of the proposed changes will however exclude many individuals who are currently adversely impacted by cashflow issues in funding deemed tax obligations (including in cases where there is no economic gain), or for whom the existing calculations require market valuations where none are readily available.

It is hoped that the proposed changes to the FIF rules are adopted and are effective to reduce some of the known complexity and provide much-needed relief to migrants, fostering a more welcoming environment for skilled professionals. Ideally, we would also like to see these proposals applied more broadly to any taxpayer holding FIF interests regardless of whether or not they are a new migrant or returning New Zealander. Inland Revenue acknowledges that wider reform may come at a higher revenue cost which could make such changes hard to justify.

Stakeholders are encouraged to submit their feedback on the consultation document by 27 January 2025.