The Great Unexpected: tax issues facing those with foreign assets and liabilities (Part 1)
“Ask no questions, and you'll be told no lies.” This Charles Dicken’s quote and the synonymous quintessential “Ignorance is bliss” are commonly cited by accountants, especially when it comes to the various tax issues for New Zealand tax residents that have foreign assets and liabilities.
Unfortunately, the time for burying heads in the sand is well and truly over. Increasing amounts of information are being shared between governments. This means the likelihood of the IRD investigating foreign holdings is higher than ever, and the chances of reducing penalties by pleading ignorance becoming more difficult.
The underlying concept any current or soon to be New Zealand tax resident must understand is that tax residents pay tax on their worldwide income. Even if that income has not arrived in New Zealand or, as you will see, even when no income is received at all.
Whether you have recently (or not so recently) become a New Zealand tax resident, or, you are an optimistic Kiwi looking to invest overseas then these are some, not all, the tax issues you might face.
Note that due to its complexity, this content is general in nature and should not be taken as specific advice. It is extremely important to discuss any foreign holdings you have with a tax professional to assess potential tax issues.
Foreign Currency Denominated Bank Accounts
Any bank account that is denominated in a foreign currency, even those held with a New Zealand bank, has potential tax exposure.
In this case the Income Tax Act defines these types of asset as Financial Arrangements. Unlike other countries the exception for Financial Arrangements in New Zealand is very low. Whereby any foreign denominated bank account with an equivalent of more than NZ$50,000 will require Financial Arrangement income calculations.
In short, both realised and unreaslised gains from movements in foreign currency exchange rates could result in a hefty tax bill.
Foreign Currency Denominated Loans, Term Deposits and Bonds
Similar to the above, loans, term deposits and bonds are also considered Financial Arrangements. However, the NZ$50,000 threshold is not available as an exception. Therefore, almost all will require Financial Arrangement income calculations.
By way of a simplified example:
| 01/04/20 UK Loan @ 0.4804 | £1,000,000 | NZ$2,081,598 |
| 31/01/21 UK Loan @ 0.5240 | £1,000,000 | NZ$1,908,396 |
| Taxable Foreign Exchange Gain | NZ$173,202 | |
| Tax Payable at 33%* | NZ$57,157 |
*Note that tax is payable on the standard income tax rate appropriate. The current top individual tax and trust rate of 33% has been used as an illustration only.
I think most would agree that a potential tax bill of $57,157 for receiving no realized benefit is a tough pill to swallow.
Interest paid to non-resident lenders
The tax issues associated to those paying interest to foreign lenders is by far one of the hardest to justify.
Commonly when a bank pays interest to its customers it will deduct Resident Withholding Tax (RWT). This same concept applies to when New Zealand tax residents pay interest to non-residents, i.e. foreign banks. However, in this situation the tax is called Non-Resident Withholding Tax (NRWT).
The premise therefore is logical, a non-resident is deriving income from a New Zealand source. That income is interest, which based on both the New Zealand Income Tax Act and Tax Treaties with other countries means that New Zealand gets its share of tax on that income.
New Zealand tax residents are therefore required to pay NRWT to the IRD, generally monthly, on behalf of non-residents receiving interest. Rates for NRWT are dependent on Tax Treaties with various countries, with rates commonly being either 10% or 15%.
Unfortunately, this is where the logic stops. As illustrated below the likelihood of a foreign bank accepting a lower interest payment due to the withholding of NRWT is very unlikely which leaves the NRWT burden on the interest payer.
| Expected Situation | Actual Situation | |
| Monthly Interest on Loan | $1,000 | $1,000 |
| NRWT @15% paid to IRD | $150 | $176 |
| Interest Paid to Foreign Bank | $850 | $1,000 |
| Total Cost to NZ Interest Payer | $1,000 | $1,176 |
As dire as this sounds there is some light at the end of the tunnel. Firstly many banks that are registered in New Zealand i.e. ANZ Australia, HSBC etc. are considered New Zealand tax residents and therefore exempt from NRWT.
Secondly, the IRD do understand this situation and have an alternative to NRWT. Interest payments made to a foreign bank can qualify for an Approved Issuer Levy (AIL) instead of NRWT. The AIL rate is 2% of the interest payment, however retrospective registration of AIL is prohibited, which means you are stuck paying NRWT until AIL registration is approved.
Do you need to panic now?
If you have recently become a New Zealand tax resident, then start planning rather than panicking. Individuals that have become a tax resident for the first time, or haven’t been a tax resident for the past 10 years are exempt from almost all of the above tax issues for 4 years from the date of becoming a tax resident. This exemption is called transitional tax residency, however it can only be used once.
If you have been a New Zealand tax resident for more than 4 years then get your head out of the sand. Should IRD come knocking then ignorance is definitely not bliss.
Due to its complexity, this content is general in nature and should not be taken as specific advice. It is extremely important to discuss any foreign holdings you have with a tax professional to assess potential tax issues.
Call Withers Tsang on 09 376 8860 to understand your tax obligations, plan your cashflow and get great property, business and tax advice.
