Unbeknownst to individuals or Trusts, they might find themselves in the middle of complex tax rules which result in paper foreign currency gains but also creates actual cash tax liabilities that need to be accounted for to the Tax Department.
To set the scene, you are a returning kiwi, or on an overseas migrant, and you’ve kept your family home in the overseas jurisdiction (which has a mortgage on it) as a rental property and you also have some foreign currency bank accounts. As a New Zealand tax resident, you return your net income from the rental property and that’s about it – pretty easy so far, right? Unfortunately two further important tax adjustments need to be considered:
- Do you have an unrealised gain or loss on the foreign mortgage / bank accounts?
- Do you need to withhold tax on interest payments?
Unrealised gains or losses
Foreign currency borrowings or bank accounts are classified as financial arrangements for taxation purposes. If you have financial arrangements, it is highly likely you will have unrealised gains or losses as well as realised gains and losses from foreign exchange movements that you need to consider for tax purposes.
As an example, if you held USD 150,000 over a range of USD bank accounts over the last financial year, the effect of the tax rule on this balance is as follows:
Cash on 1 April 2015 was NZD 173,180 (converted as NZD 1 = USD0.7481)
Cash on 31 March 2016 was NZD 217,580 (converted as NZD 1 = USD 0.6894)
Unless an exemption applies, this means that you may need to return the gain of $44,390 in your personal tax return and pay tax at you marginal tax rate. If your marginal tax rate is 33%, you’ll have a tax bill of $14,648.
Does withholding tax apply to the interest I pay?
The story may get worse – if you have paid interest to a non-resident bank, it is likely that you needed to withhold tax from this payment and pay it to the Tax Department in New Zealand. The rate can vary depending on the country involved but generally the rate will either be 10% or 15% (of interest paid). Any tax you need to pay will be a further cost to you as banks require you to pay interest free of withholding tax.
There are some exemptions to this rule but the most practical solution is to register your security with the Tax Department and pay Approved Issuer Levy at the rate of 2%. This 2% levy only applies once the security is registered with the Tax Department.
Are there any exemptions?
Like all tax rules there are exemptions, but due to the voliatity of the exchange rates even the main exemption is difficult to fall within.
The main exemption to this rule applies if you are a cash basis person. A cash basis person is defined as someone whose:
- Income and expenditure from all financial arrangements (which should be your foreign currency bank accounts and mortgages) are under $100,000; or
- The total aggregate value of all of your financial arrangements are under $1,000,000; and
- The difference between a cash basis holder calculation and an accrual basis holder is less than $40,000 (this calculation is over the life of the financial arrangements, not just over one year).
If you fall within these rules it means that you only account for the foreign currency movements when they are realised.
There are some other ways to reduce your exposure to these rules but they are fact specific.
Where to from here?
While no currency is immune to this issue, this is causing headaches for taxpayers with British pound mortgages in 2009 – 2013 and now taxpayers with US dollar cash deposits between 2013 – to present; in fact, if you had bank accounts or a mortgage overseas, you need to make an assessment of your risk.
As a starting point, a discussion with your tax advisor will determine whether you are likely to have an exposure. Even if you consider yourself to be safe for the time being, it may be worth exploring some forward planning around how you could mitigate this issue in the future. Experience to date suggests there are still a large number of taxpayers in this bucket and additional Tax Department compliance procedures will likely identify the exposed taxpayers.
If you would like to discuss the implications of your foreign currency borrowings or bank accounts, contact Graham Lawrence on 09 367 1617 or email, to find out what your obligations are.