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Tax Changes in Australia – will 1% make a difference.

New Zealand’s company tax rate will be lower than Australia’s, after new Australian Prime Minister Julia Gillard today announced that the Australian corporate tax rate would not be cut below 29 percent.

Finance Minister Bill English said the news was good for New Zealand:

“Taken together with other measures in the Budget, the reduction in New Zealand’s company tax rate to 28 percent from the 2011/12 income year will help our competitive position and help provide businesses with the right incentives to invest and export,” Mr English said.

It sounds like NZ company tax policy is on the right track.  This tax advisor isn’t so sure.

Australia’s steadfast refusal to contemplate mutual recognition of franking and imputation credits, combined with the zero-rate of withholding on dividends under the NZ/ Aus treaty means that the tax competition playing field still tilts in a north-westerly direction.

Australia is the number one source of foreign investment in New Zealand.  There is  currently no incentive for Australian investors to pay any tax in New Zealand.  Every dollar of NZ tax paid is simply money wasted.  Tax paid in Australia by Australian companies gives rise to Australian franking credits which can then be passed on to Australian investors.   These same companies  have no NZ investor base worth pandering to and accordingly have little desire to accumulate NZ imputation credits.

Prior to the introduction of the new NZ / Australia tax treaty,  company tax paid in New Zealand could at least be credited against NZ withholding taxes on dividends.  Now, with the zero-rate of withholding under the treaty, this advantage has disappeared.

The implications for international investments decisions are somewhat  frightening.  An Australian firm would arguably have to generate an almost 40% greater pre-tax return to justify making an investment in New Zealand as opposed to keeping it in Australia.

Think about what this means for the Australian Banks.  Expect more commercial lending to New Zealand borrowers to be done out of Australia.

The sad reality is that New Zealand cannot compete with Australia on company taxes while tax rates stay in the top half of the OECD and the struggling capital market remains less 25% of GDP (while Australia’s is close to 100%).

Part of the answer is to urgently grow our capital markets (increased compulsory contributions to KiwiSaver) , the other is scrap imputation and cut the NZ company tax rate to a point where the advantage of franking credits is virtually eliminated (we are talking mid-teens here folks!).

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