Combination of rising sharemarkets & falling NZ dollar help reduce NZ Super Fund's tax bill by almost 90%

By Gareth Vaughan

Finance Minister Bill English, struggling to return the Government’s books to surplus, may not be happy to hear the annual tax bill of one of the country’s biggest corporate taxpayers has dropped nearly 90%.

The New Zealand Superannuation Fund’s annual report, issued yesterday, shows its June 2015 year income tax expense was $122.652 million. Certainly not an insignificant sum, especially from an entity that hasn’t received any government contributions for six years and is tasked with helping meet the rising cost of superannuation payments to retirees, and thus reduce New Zealanders’ future tax burden.

The $122.652 million is, however, down about 89% from the $1.095 billion of income tax paid by the Super Fund in the year to June 2014. That means the Super Fund had an effective tax rate of just 3.18% this year versus 25.18% last year.

John Payne, head of tax at the Super Fund, told interest.co.nz the combination of rising sharemarkets and the falling New Zealand dollar was key in the big turn around.

“I think it’s quite unusual. Equity markets have gone up significantly and at the same time the Kiwi has depreciated significantly. And that has created the circumstance. I’d like to think it was clever tax planning but certainly that wasn’t the case. It was just how the markets moved,” Payne said.

The drop in effective tax rate to 3.18% from 25.18% in 2014 was primarily due to how investment income is taxed, Payne said.

The Super Fund made significant gains on its physically-held equity investments as a result of rising global equity markets and these gains aren’t subject to tax. Physical equity holdings are taxed via the Fair Dividend Regime, being a deemed dividend of 5% of the market value of these stocks. The effect from this was magnified by the Super Fund’s exposure to physically-held equities increasing and its use of derivatives, which are taxed on a mark-to-market basis, declining during the year. On top of this tax deductible losses from currency hedging due to the NZ dollar’s fall were also a significant contributor.

Payne pointed out that in 2012 the Super Fund’s effective tax rate was 80.97%  because the opposite scenario occurred. Global equity markets fell with no tax deduction available for these losses, but the Super Fund recorded taxable gains from currency hedging as the NZ dollar rose.

Since last year Payne said the Super Fund had reduced its equity exposure through derivatives because the costs of taking derivatives positions have risen due to extra regulations and other factors.

Despite the reduction in tax paid this year, the Super Fund has now paid about $4.6 billion of tax since it started investing in 2003. (See more on this in Terry Baucher’s article here). In this Double Shot interview in August Super Fund CEO Adrian Orr suggested the Government could both resume contributions to the Super Fund, which were halted in 2009, and stop taxing it. Orr said future generations would benefit from these actions. Orr’s unaware of another sovereign wealth fund that pays tax, and the Accident Compensation Corporation doesn’t pay tax.

Higher nominal interest rates reflect better underlying economic fundamentals’

In his CEO statement in the annual report Orr noted the slow move towards “normal” times in the world’s major developed economies.

“Part of this normalisation, however, will be the United States Federal Reserve returning its interest rate setting to something that better reflects reasonable growth and low inflation. This means the very low interest rates of recent years are unlikely to last in the United States, although they will linger for a while yet in Europe,” Orr wrote.

“I am pleased to see this return to normality if it reflects improved economic fundamentals and prosperity. If the market is, however, dominated by investors constantly relying on central bank ‘pump priming’ for ever, then beware. Higher nominal interest rates reflect better underlying economic fundamentals. But it is the path to getting there that can create the jitters. These short-term concerns are exactly why we focus on multiple years ahead when setting our strategy,” added Orr.

He also noted the other major driver of uncertainty in global markets is China. In particular China’s ability to, and the time it will take to, transition from a manufacturing and investment-based economy into one underpinned by domestic spending.

“This is a necessary step for China to make to avoid the ‘middle income trap’ into which most emerging economies fall. The world will watch, assist, and benefit over time without doubt.”

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