New Zealand imposes capital gains tax by stealth – on the unfortunate few

10 November 2020

It is often said that New Zealand does not have a capital gains tax. But while that's widely accepted as a feature of our tax system, it may surprise many to learn that New Zealand does effectively impose a tax on capital gains received by a targeted class of overseas investors.

With the recent election campaign again reviving discussion around a capital gains tax (though not the tax itself), we look at the issues raised by this particular anomaly and consider whether a law change would make sense.

A hidden capital gain​s tax

Unlike many other jurisdictions, New Zealand does not have a comprehensive tax on disposals of assets conventionally thought of as “capital" in nature. As a base proposition, New Zealand taxes amounts of “income", only diverging from this under a few, disparate, circumstances.1​​ A comprehensive capital gains tax has been proposed on several occasions, but rejected each time, most recently in 2019.

One set of circumstances where the system diverges involves a curious rule.

In the absence of a comprehensive capital gains tax, it is common for companies to generate tax-free capital gains from their operations, for instance through the sale of a business or a property to a third party.

As most distributions from a company to its shareholders are taxable as dividends, the legislation provides a pathway for capital gains to be distributed by a company in a way that does not give rise to a dividend. When a company is wound up, it is usually the case that capital gains can be distributed to shareholders free of tax. This treatment gives effect to the broader policy of not taxing capital gains, by ensuring no tax is applied to such gains either at the company level or the shareholder level, where the distribution occurs on winding up of the company.

However, buried in the definition of “dividend" in the Income Tax Act 2007 is language which effectively reverses this treatment for certain non-resident shareholders of a New Zealand company. The ability to distribute capital gains in a tax free manner on winding up a company is “turned-off" where the shareholder is a non-resident company, if that non-resident company is associated with the company making the distribution. That type of shareholder suffers non-resident withholding tax (NRWT) on relevant capital gains at rates of up to 30%.

The law leads to some fine distinctions:

  • All New Zealand resident shareholders have the ability to receive tax free capital gains, but not all non-residents are afforded that same opportunity. ​
  • Individual non-resident shareholders can receive a tax free distribution, regardless of their shareholding level in the company making the capital gain distribution.
  • Some non-resident companies can receive capital gains tax free in some cases. For instance, a non-resident company holding a less than 50% interest in the company making the distribution can usually benefit from the concession. However, a non-resident with a 50% or greater interest cannot benefit from the concession and is subject to NRWT on the capital gain distribution.
  • The 50% threshold leads to a “cliff" effect – a non-resident company that is invested in a 50/50 joint venture company cannot receive capital gains in a tax-free manner. However, if that same non-resident instead held a 49.9% interest in the same joint venture company, it can receive a tax free distribution of capital gains.
  • The rule leads to other biases in investment structure and in the way investors choose to exit investments.

Because the tax is imposed in the form of NRWT on a dividend, the best case situation for most shareholders would be a 15% or 5% NRWT, depending on the relevant tax treaty applicable to a shareholder. Certain listed companies in selected jurisdictions may benefit from a reduction of NRWT to zero. But where the shareholder is resident in a jurisdiction with which New Zealand does not have a tax treaty, the maximum NRWT rate of 30% will apply. These rate differentials exacerbate the variation in the treatment of capital gain distributions.


The rule described above has existed since 1992 when New Zealand's current system of dividend taxation was introduced. Like the overarching dividend taxation system, the rule had its genesis in a report from the Valabh Committee, The Taxation of Distributions from Companies.

In the report, the Committee concluded that, although it supported a general rule that capital gains received by a shareholding company on liquidation of the investee company should retain their character as capital, this didn't provide a basis to go one step further and exclude capital gains distributed to a related corporate non-resident shareholder on winding up of the investee company from the scope of NRWT.

The Committee seems to have found support for its approach in an exemption which existed at that time for dividends paid between resident companies. Although not explicitly stated in the report, it appears that the Committee saw the fact that the intra-corporate dividend exemption only applied between residents as constraining its ability to extend a rule exempting distributions of capital gains on liquidation beyond distributions between resident companies.

However, that analysis provides no clarity on why NRWT should be imposed only on a narrow class of non-resident shareholders and not all.

The exception also initially applied to non-resident shareholders that were “related" to the company being wound up, which at the time that meant shareholders with ownership interests of 20% (or more) in the company. That is no longer the case under current tax settings, where the rule applies to non-resident shareholders “associated" with the company being wound up, which generally applies a 50% or greater ownership interest test. The increase in the ownership threshold from 20% to 50% went someway to blunt the effect of this rule, but in a sense further highlighted the distortion in treatment between shareholders that are substantively in the same position.

What issues are we seei​ng?

The imposition of tax on capital gains in the manner described above raises a number of considerations:

  • The exception for associated non-resident corporate shareholders goes against the base policy that New Zealand does not tax capital gains, without any obvious or principled justification for doing so. It is by no means clear what is unique about a capital gain derived by a non-resident corporate shareholder associated with the company making the distribution that warrants a tax charge. The rule also draws an unprincipled distinction between the treatment of individuals and corporates. ​
  • The various distinctions and differential outcomes mean that the rule can be relatively easily circumvented with professional tax advice. It is possible for certain natural person shareholders to hold their shares in a New Zealand company directly, rather than through an overseas corporate and escape the rule. Equally, an unwitting investor wanting the benefits of limited liability might find themselves caught out by this rule.
  • In a joint venture company scenario, a non-resident would look to ensure their interest in the company amounted to something less than 50% to prevent this issue from impacting them.
  • Where the investment is wholly owned by a non-resident, then holding the underlying New Zealand assets through a non-resident company rather than a New Zealand company (that is, operating as a branch) will avoid the issue, as will holding the assets through a New Zealand limited partnership.
  • Where the rule is engaged, it creates a bias in favour of the non-resident corporate exiting their investment by selling their shares in the New Zealand company, rather than the New Zealand company selling its business (generating a capital gain) and winding up. A share sale provides a tax free capital gain for the investor whereas the business sale does not.
  • The rule therefore invokes unnecessary tax structuring and transactional bias when an overseas investor is considering making an investment into New Zealand and/or exiting their investment.
  • The rule is embedded and requires detailed tax knowledge to identify. On the surface, the rules dealing with how capital gains are treated when a company is liquidated appear to provide a favourable treatment, and is consistent with New Zealand not taxing capital gains. However, it is only on delving into the definition of “dividend" in the general definitions section in the Income Tax Act 2007 that a much less favourable outcome is revealed for affected non-residents. The rule therefore impacts the unsuspecting.

Inland Revenue has done a good job over the last few years dealing with legislative anomalies to shore up the integrity of the tax system. While Inland Revenue will no doubt have competing priorities, the targeted tax on non-resident shareholders described above is worth revisiting.

Given that the rule is largely “​managed" in practice, it may be the case that a law change in this area would be a victory for common sense that eliminates unnecessary dead weight structuring costs and investment biases – all at no real cost to the revenue base.

If you have any questions about the matters raised in this article please get in touch with the contacts listed or your usual Bell Gully advisor. ​

1​ A relatively recent example is the “bright-line" test for residential property, which brings to tax a d​isposal of certain residential properties within 5 years of acquisition, regardless of the circumstances in which the property was acquired or disposed of.​

This publication is necessarily brief and general in nature. You should seek professional advice before taking any action in relation to the matters dealt with in this publication.