By Terry Baucher* (email)
Last time I explained how, following a change in UK tax law in 2006, the Foreign Investment Fund (FIF) rules effectively imposed a form of capital gains tax through the “fair dividend rate” on holders of UK personal pension schemes.
Logically, you’d think that being outside the FIF rules might be a better option, but in the taxation world logic doesn’t always feature, as several people who decided to transfer their accrued superannuation entitlements from an overseas scheme to a New Zealand superannuation scheme are in the process of discovering.
In recent years a growing number of new migrants to New Zealand have taken the opportunity to transfer superannuation entitlements they built up when not New Zealand tax residents to New Zealand superannuation schemes. The changes in the UK tax law in 2006 which allowed transfers to qualifying registered overseas pension schemes (“QROPS”) were designed to make this process easier.
As part of the IRD’s Compliance Focus Programme for 2011-2012, it is targeting the treatment of foreign superannuation fund entitlements transferred to a QROPS or other New Zealand superannuation scheme. The IRD has sent out risk review letters to a number of taxpayers requesting information about overseas superannuation fund entitlements they have transferred to a New Zealand superannuation scheme.
Tax much?
For some taxpayers the results of the IRD review are potentially catastrophic.
The IRD position is that if the foreign superannuation scheme is not taxed under the FIF regime (because it does fit the criteria to be an “employment related foreign superannuation scheme” and therefore exempt from the FIF regime), then the tax treatment of the amount of funds transferred is determined under the ordinary principles of the Income Tax Act 2007.
For income tax purposes a foreign superannuation scheme is probably a unit trust. The transfer of the funds in the foreign superannuation scheme to either a QROPS or other New Zealand superannuation scheme is deemed to be a redemption of the investment in the unit trust. Special rules apply when units in a unit trust are redeemed, the effect of which is to treat as a dividend any excess over the amount subscribed or contributed. In other words, all capital gains and accrued income are taxable on transfer to a New Zealand superannuation scheme.
Tax by revision
For example, consider the case of someone who contributed £150,000 to a UK pension between January 1990 and December 2004 when they migrated to New Zealand. At the time of migration the UK pension scheme was valued at £240,000.
In June 2005 when the UK pension scheme was valued at £250,000, the migrant transferred the funds in their UK pension scheme to a New Zealand superannuation scheme. If the IRD’s analysis is correct the entire £100,000 excess over the £150,000 contributed will be taxable even though only £10,000 of the excess actually relates to a period when the person was a New Zealand tax resident. A broadly similar result arises if the UK pension scheme is instead classified as a foreign trust.
Regardless of how the foreign superannuation scheme is classified the suggested IRD treatment seems iniquitous as it taxes income and gains for periods prior to when the migrant became a New Zealand tax resident.
Fortunately, the position is a little easier for those pension schemes which are subject to the FIF regime (which, as we explained in our previous columns, includes most UK pension schemes).
Although the holders of such schemes will be taxed under the FIF regime usually, but not always, through the application of the 5% “fair dividend rate”, the actual disposal of those foreign superannuation schemes through transferring to a New Zealand superannuation or KiwiSaver fund is not taxable. Similarly, no tax charge should arise if someone who qualifies as a “transitional resident” makes a transfer within the first 48 months of their arrival in New Zealand.
Analysis paralysis
The number of taxpayers who could therefore be affected by the IRD’s new approach may not be very significant. Nevertheless, for those taxpayers who are affected, the implications are harsh. What is also concerning is that in 2006 the Finance and Expenditure Select Committee recommended the IRD Policy Advice Division review the treatment of foreign superannuation fund transfers.
For the matter to be unresolved five years later is frankly very disappointing. In the continuing absence of clear direction from the IRD all anyone can do is seek professional advice if they believe they may be affected by the IRD’s approach.
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*Terry Baucher is New Zealand tax specialist and consultant. You can find his columns in our new personal finance section.
7 Comments
Interesting. I have a freind who transferred their UK pension to a QROPS some years ago - most of the complexity (which she discussed with me) seemed to come from the UK 5 year rule (not from the NZ end). If I am reading this column and your previous one correctly any UK pension transfer to a QROPS done a few years ago is now outside the FIF rules? There seems to be a contradiction beweeen what you say above -
''fortunately, the position is a little easier for those pension schemes which are subject to the FIF regime (which, as we explained in our previous columns, includes most UK pension schemes).
and what you said in July:
''In March this year, the Inland Revenue stated that it considered that any UK pension fund which could allow a transfer to a QROPS was not eligible for the exemption from FIFs taxation.
The Inland Revenue’s interpretation applies to any person who has interests in a UK pension scheme which the person has either transferred into a QROPS or is eligible to do so.
The new interpretation therefore catches those taxpayers who could transfer funds into a QROPS but have either chosen not to do so, or were unaware that they could do so''.
From what I understand QROPS have been very popular, and from what you said in July ANY UK pension fund which allows a QROPS transfer is now outside the FIF regime.
Ergo there must be lots of people effected by this, not a few!! Or am I misreading this?
Also - when folk have transferred their pension to a NZ QROPS - tehy will have been paying tax directly from the money invested anyway (taken directly by the scheme) so why would there be extra liability?
Actually ignore the above - its all explained (rather better than in the original article, I have to say), here:
http://www.broadbaseinternational.com/investments/nz-tax-on-investments…
From what I understand QROPS have been very popular, and from what you said in July ANY UK pension fund which allows a QROPS transfer is now outside the FIF regime.
AndyH I might not have made it cystal clear but the IRD position is that any UK pension fund which allows a QROPS transfer is now INSIDE the FIF regime. That means transfers from UK pension funds should generally speaking not be caught with the problem I've outlined in this column.
Also - when folk have transferred their pension to a NZ QROPS - tehy will have been paying tax directly from the money invested anyway (taken directly by the scheme) so why would there be extra liability?
Not sure who you're referring to here - any NZ tax liability will happen at the point of transfer BEFORE it reaches the QROPS; the QROPS is then taxable like any other NZ superannuation/KiwiSaver fund. It is worth bearing in mind that under UK tax law contributions to a UK pension scheme are tax deductible, subject to certain limits, and the income and capital gains of the scheme are also usually tax free. For some reason the IRD seem to see this as a bit iniquitous, I see it as highlighting a major problem of not having a capital gains tax.
Thanks everyone for all your comments: keep them coming!
Great piece Terry.
And there's so many areas of tax law now that are messy, and need to be sorted out. Chief amongst these is with the (retrospective) removal of the QC regime by Bill English in May 2010 (effective from March 2010), there are now some irresolveable issues around tainted capital gains. I know of a mom and pop dairy farming company that can't even sell the dairy herd to their son and daughter-in-law due to it tainting the herd livestock revaluation reserve (if they sold the herd to a complete stranger, then no problem).
Nothing will be done about it, I can't even get a politician (certainly not English or Dunne who've made a complete hash of the legislation) to read on the problem, but it is a huge problem for family centred companies (I might say the mainstay of the economy).
And don't even start me on the abortion that are LTCs. A lot of innocent taxpayers are going to get burned inside the mind-numbing complexities of those.
.. and yet the creator of this site would see all sorts of additional taxes foisted on us from the fortress of legislation, despite the incompetence of politcians planning anything, certainly an economy. Isn't that right Bernard.
When people transferred their UK pensions into a QROPS, they did so on the basis of the various tax rules in place at the time. If, in retrospect, some QROPS transfers should have had some tax payable, then that's an oversight by the tax policy people. No transferrer actively avoided a tax that wasn't in place. That doesn't make sense. So is it right that they be pinged retrospectively?
It also may put off people that might consider transferring their Aussie super to KiwiSaver. I appreciate there's an exemption, but what if the position changes on that one too?
I think if they want to impose a tax now, that's fine. But retrospectively? What next - a retrospective clawback of the lower income tax rates that came in a couple of years ago?
Two points : Firstly , huzzah to the IRD for assisting the Dept. of Immigration in discouraging comparatively wealthy immigrants from coming to NZ . We want more impoverished boat people , refugees , Ahmed Zaouis ...... anyone not requiring immediate and massive doses of state aid can jolly well feck off to Australia or to Canada .
And thirdly , " retrospectivity " ( as we now know it ) was a favourite device of the last Labour government . It allowed them to change the rules such that Harry Dumhoven wasn't booted out of parliament ( due to his Dutch citizenship ) , and it allowed Labour to wriggle out of a possible police probe into their illegal electioneering spending .
..... they needn't have worried , Police Commissioner Howard Broad was a complete patsy to the Labour government , and shat his police issue knickers every time that Herr Helen hove into his view . ...... Speeding ma'am ? ... heh heh , t'was only 148 kph ... and it was your driver's fault , how're you to know how fast your limo was going . No problems , Ms Clark .
Thanks for casting some much needed light on this subject Terry.
One question I have relates to defined benefits schemes of the type where the member accrues fractional benefits linked to final salary. For example, the member accrues benefits equivalent to 1/60th of final salary for each year of service. I know this type of scheme is no longer widely available in the UK, but there will be a significant number of NZers with accrued benefits built up before they were phased out.
First, does a defined benefits scheme qualify as an FIF (my guess is "no");
Second, are accrued benefits in schemes of this type eligible for transfer to a QROPS? If not, is the only option to leave such benefits in the UK?
I appreciate you might not have the time to answer these questions directly - however it may be a good subject for a future column.
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