We need to talk about that red carpet rollout

22:43, Aug 19 2014

Just because you're xenophobic doesn't mean foreigners aren't out to get you.

That's the catch. It's irrational to fear the inflow of overseas capital, but only a nutcase would ignore the risks. Maybe Winston Peters isn't crazy.

We want foreigners to buy our assets because they pay the best prices. Having foreigners pay more for our assets means New Zealanders can't afford them. New Zealanders don't have enough money so we need foreigners to buy our assets.

Such circularity turns discussion into a tail-chasing dog, particularly when sales of farmland to Chinese are involved.

However, Chalkie reckons one aspect is often overlooked.

Why would an overseas buyer pay more for an asset than a New Zealander? Is it because they can accept lower returns on capital? Perhaps. Is it because they can sweat the asset more? Again, perhaps. But Chalkie reckons one reason stands out - tax.


There are huge tax advantages available to overseas investors that simply cannot be accessed by locals. They crank up the returns available to foreign buyers and make New Zealand assets worth more to overseas owners than to New Zealand residents.

One of Chalkie's favourite examples is Wellington Electricity Distribution Network, owner of the power lines carrying electricity around the capital.

Wellington Network was acquired in April 2008 by Cheung Kong Infrastructure Holdings for $785 million, from listed network company Vector.

Other bidders named were Australia's Hastings Funds Management and China State Grid. Note the absence of New Zealand names.

As a regulated utility, Wellington Network's returns are controlled by the Commerce Commission, so there was little scope for the new owner to make more money from it than Vector could.

At the time, CKI's managing director Kam Hing Lam said: "Upon completion of the transaction, Wellington Electricity Distribution Network Ltd will bring in immediate profit contribution to CKI."

Oddly enough, since CKI took it over Wellington Network has made nothing but losses.

Of course, those losses are not real and CKI did not pay $785m for a duffer.

Wellington Network is in fact highly profitable, with an earnings margin consistently around 30 per cent before interest and tax. What drags it into "loss" is interest on its huge debts.

Under CKI's ownership, Wellington Network's debt has consistently been around 80 per cent of its total assets. This contrasts with typical corporate behaviour since the financial crisis of 2008, whereby gearing is kept below 50 per cent and often 40 per cent.

Of the network's debt, around $300m was due to related parties at a premium interest rate. In 2012, for example, the related-party debt cost 12.5 per cent, compared to the commercial rate of 6.97 per cent.

In cash terms that worked out at $54m paid in related-party interest and $31m in bank interest.

The interest payments greatly exceeded Wellington Network's earnings before interest and tax, producing a loss - and a corresponding tax benefit - every year until 2013. In the last six years, the only tax expense recorded by Wellington Network was $2.2m in the year to December. On a cash basis, it appears that the business paid no actual tax at all.

The structure works because related-party debt allows overseas-owned companies to benefit from much higher levels of gearing than a locally owned company could.

Wellington Network borrows the money from a CKI company registered in the British Virgin Islands (BVI), which has a branch in New Zealand, and in each of the last two years paid tax of just under $1m.

So CKI manages to pay virtually zero tax in New Zealand, but it presumably pays tax in its local jurisdiction, right?

Er, no. Wellington Network is owned by an entity in the Bahamas, where, like BVI, the tax system is a warm bath for companies to float in the dark and listen to the sound of money - no company tax, no withholding tax, no capital gains tax, nothing.

There are plenty more examples, but we must get on.

The pattern here is of assets being transferred among overseas owners who seem able to pay very little tax.

Some are subject to Overseas Investment Office approval because they involve sensitive land. As far as Chalkie can tell, the effect on New Zealand's tax receipts does not figure in the OIO's analysis.

Chalkie sympathises, because it would be difficult to judge a buyer's propensity to dodge tax in future. Policies designed to limit the scope to shift profits elsewhere don't always work.

One example is the thin capitalisation rule, which potentially reduces the ability of foreign-owned companies to claim excessive tax deductions on interest costs. The current rule asks no questions about deductions up to a gearing of 60 per cent. Debt levels above that are deductable only if they are not more than 110 per cent of the worldwide group's gearing.

Firstly, 60 per cent is a high safe harbour threshold. Secondly, the comparison with worldwide debt levels is futile for private equity owners, whose structures are typically debt heavy. Thirdly, the thin capitalisation rules apply only to companies controlled by a single overseas owner, which again allows complex private equity structures to remain exempt. Fourthly, there is scope for some corporates to inflate their asset values, which reduces their apparent gearing to within the 60 per cent safe harbour.

These issues have been highlighted by Inland Revenue and there are proposals to tighten the rules next year.

This is good. Chalkie reckons we should welcome foreign investment, but not so much that we meet it at the airport with the tax equivalent of a red carpet on the tarmac, a chauffeur-driven limousine, free accommodation at Kauri Cliffs and an invite to John Key's house for drinkies every Friday night.

Whatever the benefits of overseas ownership - and there will be some - Chalkie reckons we should also take account of the costs.

The issue is the same whether the assets are companies or farmland. The would-be buyer of Lochinver Station near Taupo has been named as Pure 100 Farm, described by the Overseas Investment Office as "a wholly owned subsidiary of Shanghai Pengxin Group".

It may be, but its immediate parent is Milk New Zealand Holding, owner of the former Crafar and Synlait farms in Waikato and Canterbury. Milk New Zealand Holding is wholly owned not by Shanghai Pengxin, but by Milk New Zealand Investment, a company registered in the British Virgin Islands. The ownership was disclosed to the Companies Office on August 13.

Chalkie reckons owning New Zealand farms through a Caribbean tax haven may have tax advantages - or is that xenophobic?

Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.