Tax and infrastructure: Options for change

2/12/2024

Tax and infrastructure: Options for change

The Government’s Tax and Social Policy Work Programme includes a review of the thin capitalisation settings for infrastructure. While this is a positive step, our tax policy wish list for 2025 and beyond suggests there is room for more ambitious thinking. In this thought piece, we explore the potential for broader tax reforms that could better support New Zealand’s infrastructure needs and attract private investment.

Thin capitalisation settings for infrastructure

NZ’s inbound thin capitalisation rules generally reverse (ie disallow) interest deductions by an entity that is, or is controlled by, a non-resident, to the extent the entity has a debt to asset ratio of more than 60%.

Since July 2018, and subject to some limitations, these thin capitalisation limits have not applied to interest on third-party debt incurred by participants in Government-approved public-private partnership (PPP) projects. The concession was provided because of concerns that international participants were at a disadvantage to domestic participants, who are not subject to thin capitalisation constraints on their funding of local assets. The concession removed a potential impediment to international investment in PPPs.

The impending review of the thin capitalisation settings for infrastructure was not mentioned in the Minister’s media release about the Work Programme or in the Government’s recent update to its guidance on the PPP framework. See our article here.

However, we expect the review will be focused on whether the current concession is too narrow. The concession currently applies only to participants in core Crown PPP projects, but not infrastructure projects with private involvement undertaken under different models by local government or private projects. It also only applies to interest on third-party debt (with limited exceptions) where the lender’s recourse is limited to the assets associated with the PPP project and the income arising from those assets.

This concession was a step forward, but there is certainly scope for broadening the concession to other infrastructure projects and funding models. However, considering New Zealand’s large infrastructure deficit, we believe the Government should also consider bolder tax concessions to unlock greater investment potential.

A bolder approach to tax and infrastructure?

Perhaps surprisingly given New Zealand’s infrastructure needs, the thin capitalisation concession is the only measure concerning infrastructure generally or PPP projects specifically in tax law. Yet both Inland Revenue and Treasury have cited it as justification for rebutting a bolder tax-related approach to attracting private investment in infrastructure.

The New Zealand Superannuation Fund (NZSF) suggested a bolder approach in a 2018 submission to the Tax Working Group (TWG). The NZSF proposed a nationally significant infrastructure regime to facilitate direct capital investments by non-resident sovereign wealth and pension funds in large infrastructure projects. The NZSF proposal included suggestions that:

qualifying projects should receive a tax rate substantially less than the prevailing corporate tax rate;
no tax should be imposed on profit distribution to NZ and foreign investors (including the NZSF); and
all interest on third-party non-recourse funding should be fully deductible (as in the thin capitalisation concession, which was being introduced around the same time).

The TWG supported the NZSF submission despite Inland Revenue and Treasury contending that targeted tax incentives normally draw resources away from other projects. In context, that seems somewhat irrelevant, since sovereign wealth and pension funds are unlikely to be interested in whatever those “other projects” may be.

Inland Revenue and Treasury also opposed the NZSF submission on the basis that capital productivity is likely to be enhanced by taxing investments as neutrally as possible. That opposition seemed ideological more than a statement of fact.

As part of the then Government’s consideration of a nationally significant infrastructure regime, the 2019-20 Tax Policy Work Programme stated that there would be a review of whether the tax system should have a role in driving infrastructure investment. This followed the Tax Working Group’s support for the NZSF submission. Unfortunately, this was not progressed.

Accelerated depreciation is another option

Another possible approach would be to allow accelerated tax depreciation on project assets. This was briefly floated in Inland Revenue’s 2022 long-term insights briefing “Tax, foreign investment and productivity” (LTIB). The LTIB is currently under review and a renewed version will be issued in 2025.

Accelerated depreciation can take the form of increasing the depreciation rate of a qualifying asset or allowing some immediate expensing of the asset with the remaining cost depreciated at normal rates. The 2022 LTIB noted that New Zealand allowed accelerated depreciation of machinery and equipment before 2010, and that accelerated depreciation could be restricted to new assets. The United States and Australia were cited as examples of jurisdictions which had previously introduced partial expensing schemes (what the United States calls “bonus depreciation”) for qualifying assets.

Our tax policy wish list for 2025 and beyond includes further consideration being given to accelerated depreciation, at least in respect of new infrastructure and other capital-intensive projects for which private (and most likely international) capital is required.

From a political standpoint, any moves in this area would need to be reconciled with the Government’s recent removal of tax depreciation on almost all commercial buildings. This was done to offset the fiscal cost of reintroducing full interest deductibility on residential rental investments. This was very poor and short-sighted tax policy from a ‘NZ Inc’ standpoint.

Time for a change

Given the continuing and growing need for significant investment in public infrastructure, perhaps it is time to revisit the ambitious NZSF proposal, or look at other broader reform options, rather than merely reviewing the current thin capitalisation concession. Tax is not the only factor which international infrastructure investors take into account, but it is obviously an important consideration as Inland Revenue has recognised.