Inland Revenue is proposing new rules to attempt to prevent international private equity groups from using internal loans to jack up debt levels and avoid paying tax here.
In an issues paper on "thin capitalisation rules" officials at IRD said while New Zealand already had rules to take into account the overall indebtedness of foreign owners of assets, they only apply when a single non-resident controls the New Zealand investment.
The cost of repaying debt on loans is generally tax deductable. While this is an incentive to invest, it can also encourage international companies to load as much debt as possible into jurisdictions of relatively high taxation.
The IRD paper states that while the rules to calculate the global indebtedness of a company appeared to work for publicly listed multi-nationals, they "seem deficient in the case of private equity investment", where a group of investors work in concert.
The rules were "ineffective" when the debt funding for a global group was derived from its ultimate shareholders, as is often the case with private equity investments rather than banks.
The paper proposes extending the rules on foreign investments to entities not controlled by a single non-resident, as well as excluding related party loans from the debt-to-asset ratio.
"Excluding related-party debt from the worldwide ratio would ensure the world wide debt ratio could be used to justify high debt levels in New Zealand only to the extent it reflected genuinely third-party borrowing by the worldwide group."
The paper concedes that the changes would impact the level of tax deduction available to some investors, and some may opt pull out as a result, the overall impact would not be significant and "there are likely to be overall net benefits for New Zealand because of the increased tax collection".
Revenue Minister Peter Dunne said the issue of tax on foreign investment were a balancing act.
"We want to ensure that a fair amount of tax is paid, but do not want to discourage investment," Dunne said.
"On the other hand, the proposals in this paper represent one step more towards ensuring that non-resident investors pay their fair share of tax," he said.