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Building for tomorrow - does tax have a role?

August 28, 2019


Partners Barney Cumberland
Senior Associates Paul Windeatt

Tax reform (Tax Working Group) Infrastructure (inc funding)

In its final report, the Tax Working Group (TWG) recommended that “the Government should consider the development of a carefully designed regime to encourage investment into large, nationally significant projects that both serve the national interest and require unique international expertise to succeed”. The Government responded positively in April, stating that high priority should be considered to including infrastructure in its next tax policy work programme.

The Government has now finalised that policy programme for the next eighteen months, setting the agenda for possible tax reforms in the medium term. The programme, which has a substantial list of workstreams, can be accessed here.

In that programme, IRD and Treasury are tasked with considering whether the tax system should have a role in driving public infrastructure investment. The Government is also considering other policy levers to promote investment in infrastructure, detailed in a number of articles here.

NZSF submission to the TWG

The background to infrastructure’s inclusion in the tax policy programme is intriguing. The TWG’s recommendation was primarily influenced by the New Zealand Superannuation Fund’s (NZSF) submission made in June 2018, which was founded on NZSF’s interest in co-funding infrastructure projects as part of its investment portfolio.

NZSF argued that new infrastructure was needed to cope with New Zealand’s growing population and the wider socio-economic benefits that infrastructure would bring about. It stated that to deliver this infrastructure, New Zealand would need to attract international investors for “new sources of capital and funding, construction skills and other operational resources”.

The NZSF urged the TWG to recommend a concessionary Nationally Significant Infrastructure regime to attract international institutional long-term investors, with the criteria including:

  • project size and value;

  • a “public utility test” and specific agreement with the government;

  • the contractor’s demonstrated capability to deliver world class infrastructure;

  • a commitment to contribute project expertise; and

  • alignment with the Treasury’s living standards framework.

The types of infrastructure projects that the NZSF had in mind include public transit systems, large scale housing development, communication, energy, and water reticulation assets. A clear implication of the NZSF’s submission is that the investors would have a long-term management (as well as implementation) role. These types of projects would seem similar to those generally known as Design Build Operate (DBO) projects.

Noting that Australia has a tax regime to incentivise the development of nationally significant infrastructure assets, the NZSF suggested the introduction of a concessionary regime in New Zealand that, in part, would:

  • attract a tax rate substantially less than the 28% corporate tax rate on income derived from the asset for a “meaningful part of the life” of the asset;

  • exclude any further tax impost on distribution of the profit to both domestic and foreign investors;

  • grant full deductibility of third party non-recourse funding; and

  • grandparent the tax concessions for the project term, to provide certainty in case of a law change after commencement of the project.

By comparison, the Australian regime, tightened in 2018 from a concern about misuse through stapled structures, provides a 15% withholding tax rate (down from the usual 30%) on income distributions from such infrastructure for the first 15 years that the asset is used.

Opposing view of the TWG Secretariat

The TWG agreed with the NZSF submissions, despite receiving contrary advice from the TWG Secretariat (comprising Treasury and Inland Revenue officials) that was advising the TWG. The Secretariat considered there were significant drawbacks to NZSF’s idea, including that:

  • targeted tax incentives lower the cost of capital for investors in those activities but often draw resources away from other higher return investments;

  • New Zealand does not have to offer comparable tax incentives to other countries for investment to take place;

  • most infrastructure projects are financed directly by the Crown, with private financing sometimes used, but evaluating costs across different projects will be more difficult if incentives are provided;

  • a concessionary regime would favour a limited number of larger projects, while many smaller projects in aggregate may create higher living standards;

  • the narrowing of the Australian regime appeared to reflect a general tightening of preferences for infrastructure projects; and

  • the Treasury Private Public Partnership team had not noted any difficulties in drawing investors to infrastructure projects.

What next?

Inland Revenue and Treasury would now appear to have an unpalatable task – either they backtrack on their earlier Secretariat view or they have to withstand political pressure and hold firm to that view. They will also need to be mindful of the pending establishment of the independent New Zealand Infrastructure Commission (NZIC) in late 2019, which adds another unknown factor into the mix.

Looking to overseas models, the most significant way of boosting available infrastructure capital that the NZIC may consider (and that Inland Revenue and Treasury might support), other than the tax incentive proposed by the NZSF, could be by value capture finance.

Infrastructure investment does not currently benefit from any substantive tax concessions. The only existing concession, introduced in 2018, is a “public project debt” exemption from the thin capitalisation rules. This concession applies to a foreign-controlled New Zealand entity contracted to provide, build or upgrade a particular public infrastructure asset and to maintain or operate the asset (ie a DBO asset).

The concession can allow that entity unrestricted interest deductibility on third-party debt, where the lender’s recourse is limited to the relevant infrastructure asset and income from it. This was a response to similar infrastructure thin capitalisation concessions introduced by Australia and the UK. The purpose of this concession was to improve the competitiveness in the bidding process for Public Private Partnership procurement contracts, so that foreign investors subject to the thin capitalisation rules were not disadvantaged.

Sector based tax incentives have not been favoured in New Zealand for a long time due to their perceived distortionary impact (being one concern of the TWG Secretariat). Wider economic factors such as interest rates and private factors like investment portfolio spread play a big role in driving interest by pension funds and sovereign wealth funds in infrastructure investment internationally.

Given such factors change over time, there seems merit in at least ensuring that New Zealand’s tax settings provide a level playing field for overseas infrastructure investors (such as the 2018 change to the thin capitalisation rules), even if it is decided that New Zealand does not need to go so far as to offer incentives in this area (in contrast to what has been done by past governments to entice overseas film production to our shores). However, such fine-tuning, by itself, will not, in the words of the Revenue Minister, “reverse the current infrastructure deficit”.

Many countries are grappling with how to address past under-investment in infrastructure. There is no silver bullet to this complex, politically fraught problem, but whether tax will have a significant role to play in addressing the issue might, in part, depend on the impact that the Australian measures are having. Although their rules have been tightened, it seems that the Australian government still believes there is a role for a concessionary tax regime to encourage investment in critical, big ticket infrastructure.

The difference, if any, that the Australian regime is making to international investment in infrastructure over there, is one issue that presumably will be looked at before any recommendations are made here. If Inland Revenue and Treasury remain unconvinced, then it would seem unlikely that the NZSF will be granted its wish.