KiwiSaver Act 2006

In a landmark – and (in the end) surprisingly brisk – development, the KiwiSaver legislation received the Royal assent on 6 September 2006. We now have a KiwiSaver Act 2006.

In Part 1 of this two-part edition of SuperScoop, we comment on some of the more noteworthy aspects of the KiwiSaver Act. In Part 2, we summarise the Act’s key features.

Part 1 - Commentary on KiwiSaver

KiwiSaver schemes – withholding tax exemption on employer contributions

This facility (outlined in the Key features section in Part 2) presents a significant challenge to existing superannuation schemes as matters stand.

Government policy announcements on and after Budget Day 2005 stated that KiwiSaver would complement existing schemes. Cabinet later endorsed the principle of “competitive neutrality” as between registered superannuation schemes and KiwiSaver schemes. The current proposal to confine a limited withholding tax1 exemption to KiwiSaver schemes runs counter to that principle of competitive neutrality.

If existing schemes are permitted to allow members to elect a lock-in of some or all future contributions according to the KiwiSaver scheme rules, then to that extent sponsoring employers should be allowed a withholding tax exemption materially corresponding to KiwiSaver. That exemption would apply instead of the KiwiSaver withholding tax exemption facility, but would have the same effect.

Trustees could deliver lock-in without unduly complicating scheme administration simply by requiring a member to transfer the “locked-in” portion of his or her balance direct to a KiwiSaver scheme on leaving service.

Accommodating existing schemes in this manner appears to have near-consensus support from industry groups and advisers, at the level of principle. A common reaction from employer sponsors is strong disappointment with this last-minute change to KiwiSaver, and a view that it inappropriately tilts the playing field.

We are optimistic that withholding tax neutrality will be extended to schemes where members elect a KiwiSaver-equivalent lock-in facility that is offered by trustees. Amendments to the Income Tax Act 2004 and the Superannuation Schemes Act 1989 to effect that change will of course require careful attention to detail.

The employer exemption facility prescribed in the KiwiSaver Act 2006 will then retain some practical significance. If withholding tax neutrality is not made available to existing schemes, then we expect that the exemption facility will only rarely be invoked.

Exemptions from automatic enrolment

A significant last-minute change to the employer exemption criteria is the inclusion of a “permanent employees” definition. With limited exceptions, employees other than those employed under a contract of service of 28 or fewer days’ continuous duration are now deemed “permanent”.

This change was not in the reported-back version of the KiwiSaver Bill. It may mean that in order to invoke an exemption from automatic enrolment, an employer must now offer scheme membership to a slightly wider group of employees than might previously have been thought necessary under the exemption facility. We would be happy to assist with any queries on this issue.

On a more positive note, invoking the employer exemption facility prescribed in the Act now involves fewer complications (and technical impediments) than would have been the case under the reported-back version. Chapman Tripp was heavily involved in lobbying for these changes.

“Partial conversion” to KiwiSaver

The provisions in the Act allowing the addition to an existing scheme of a “KiwiSaver section” have been streamlined.

It is no longer necessary to write to all scheme members before any such “partial conversion” proposal. Trustees now need only advise members after the event (by no later than the date of the next annual report). That advice must include a notice to each member concerning his or her right to transfer to the “KiwiSaver section”.

Not many members will wish to transfer all or any of their existing balances to a KiwiSaver section post-conversion. Only future contributions to a KiwiSaver section will be tax-advantaged, and existing balances will not be locked in under the KiwiSaver rules.

We predict there will be a low incidence of “partial conversions” to KiwiSaver by existing schemes. A KiwiSaver section within an existing trust deed will be a separately registered KiwiSaver scheme to which the full range of KiwiSaver scheme rules and process requirements apply. Those will include the requirements to enter into a scheme provider agreement with IRD and to remit member contributions direct to IRD (an unnecessary complication for schemes with existing administration systems).

We think it likely that there will be little to be gained, in practice, from adding a “KiwiSaver section” to an existing scheme when compared to establishing a separate KiwiSaver product or using one provided by the market.

A curious feature of the full conversion facility in the Act (which we think is even less likely to be invoked) is that there is a facility for conversion to KiwiSaver to occur without members’ consents if the Government Actuary is satisfied that the terms of the trust deed for the converted scheme are “no less favourable” than the existing scheme. Given the lock-in requirements that will apply under KiwiSaver, that test would rarely if ever be met.

KiwiSaver scheme rules

A couple of recent changes to these rules are noteworthy.

The first is the addition of a facility for withdrawal in cases of serious illness (which is defined as outlined in the Key features section of this SuperScoop).

The Superannuation Schemes Regulations 1983 allowed approved schemes’ trust deeds to permit early payment of retirement benefits in cases of ill health or permanent incapacity. We think that the KiwiSaver rules might have produced some unfortunate results had they required (for example) a terminally ill member to await death before receiving a benefit.

Another significant change is that the hardship test (which previously mirrored the “serious financial hardship” test prescribed in the Tax Administration Act 1994) is now worded so as to correspond, with some exceptions, to the “significant financial hardship” test prescribed in the Income Tax Act 2004.

Scheme trustees are a little more accustomed to that test, which has applied for more than six years in the context of the fund withdrawal tax legislation and has been the subject of Tax Information Bulletins and other public commentary.

On the subject of fund withdrawal tax, there is an exemption for a withdrawal from a KiwiSaver scheme in order to purchase a first home. However, it is not immediately apparent how (for example) withdrawals at age 65 will be exempt from FWT if members remain in employment.

Wholesale investments

A small, but critically important, amendment will enable the trustees of a KiwiSaver scheme to become investment only (i.e. wholesale) members of a registered superannuation scheme. This facility was not in the First Reading version of the KiwiSaver Bill, which caused some disquiet.

Successor fund transfers

Amendments to the Superannuation Schemes Act 1989, which mirror corresponding “portability” provisions in the KiwiSaver Act, will now enable the Government Actuary to approve transfers between superannuation schemes without member consents in some circumstances. Subject to certain procedural requirements also being met, the Government Actuary can approve “successor fund” transfers without consents if satisfied that:

• the terms and conditions of the proposed replacement scheme are “no less favourable” to members than those of the existing scheme; and
• the transfer is otherwise reasonable in all the circumstances (including with regard to transfer values).

We think this provision may prove problematic in some cases.

One potential problem area is that, unlike certain other aspects of the KiwiSaver Act (which are expressed to apply despite contrary provisions in trust deeds), this facility will be subject to provisions in a trust deed which expressly require consents to transfer.

The Government Actuary is permitted to publish guidance on the principles which he or she may use to decide whether or not to approve transfers under the “no less favourable” test.

Implementation dates

The Act is expressed to come into force on a date to be appointed by the Governor-General by Order in Council. One or more Orders in Council may be made, bringing different provisions into force on different dates.

A Commencement Order will likely be made during November, under which the Act will then come into force for all purposes except member admissions to KiwiSaver schemes.

Thus, before the end of 2006 providers, employers and trustees will be able to begin invoking the KiwiSaver Act for such purposes as registering KiwiSaver schemes and obtaining employer exemptions.

However, the policy is that no member subscriptions for KiwiSaver schemes (either automatic or elective) will be permissible until 1 July 2007.

Regulations

The KiwiSaver Act contains very prescriptive regulation-making powers. We understand that regulations governing the “no unreasonable fees” requirement for a KiwiSaver scheme, and also prescribing forms, are currently being prepared with a view to entry into force in November.

A good many more regulations will follow in due course, including regulations relating to the mortgage diversion facility and default KiwiSaver providers.

It’s catching on…

We have noted with interest recent UK and Australian proposals for “opt-out” savings schemes which, if adopted, would mirror KiwiSaver in some key respects.

Earlier this year the UK’s Department for Work and Pensions published a package of proposed reforms under which, from 2012, employees aged 22 or over will be automatically enrolled in a “suitable employer scheme” or a new government low-cost personal accounts scheme (with an ability to opt out). Employees will be required to contribute 4% of earnings and employers 3%, with the UK Government contributing a further 1% through tax subsidies. These proposals have been informally dubbed “BritSaver”.

More recently, the economics committee of the House of Representatives in Australia has proposed introducing for new employees a 3% “soft compulsory” scheme on top of Australia’s compulsory superannuation system – a move that would see employees contributing a total of 12% of salary towards retirement savings. Inevitably dubbed “OzSaver” by some, these proposals also feature automatic enrolment with an opt-out facility.

Portfolio investment entity (PIE) and foreign investment fund tax proposals – a brief update

On 24 August, the Minister of Finance announced that along with KiwiSaver, the implementation of the proposed tax reforms would be delayed. The PIE tax reforms will now take effect on 1 October 2007.

This is just in time for entities electing into the PIE regime to receive the first KiwiSaver contributions from IRD after the initial 3-month “hold-back” period (commencing 1 July 2007) elapses.

The 24 August announcement did not mention any change to the start date for changes to the taxation of foreign portfolio equity investments (1 April 2007).

However, in an extraordinary subsequent development, the Ministers of Finance and Revenue unveiled on 15 September 2006 a compromise proposal for the treatment of tax earned on overseas shares. Under this proposal, the assessable income earned by an investor from an offshore equity investment would simply equal 5% of the investment’s market value at the start of the year (or less if the investor could show the investment declined in value). Any dividends or capital gains in excess of the 5% threshold would not be taxed. The $50,000 minimum aggregate offshore investment threshold for natural persons would still remain.

This is essentially a resurrection of the risk free rate of return method first proposed in the McLeod tax review of 2001 (with some modifications). It will be interesting to see if this method proves more popular now than it did when originally proposed.

Part 2 - Key features of KiwiSaver regime

Automatic enrolment

Automatic enrolment in a KiwiSaver scheme, on and from 1 July 2007, for all new “permanent” employees aged 18 or over but less than New Zealand Superannuation age (currently 65). Automatic enrolment will apply only to employees starting “new employment” with an employer that is not an exempt employer (see below).

“New employment” does not include:

temporary employment – this is narrowly defined, as employment under a contract of service that is for a period of 28 continuous days or less;

employment in respect of which an employee remains on the same payroll as for his or her previous employment (e.g. by reason of a promotion or change of role); and

employment with a successor to the business in which the employee was last employed (e.g. an asset purchaser).

A key point is that (with limited exceptions) all employees commencing employment with non-exempt employers under contracts with a duration of 29 or more continuous days will be subject to the automatic enrolment rules.

Opt-out

New employees will now have the ability to opt out of KiwiSaver during weeks 2 to 8 of their new employment (this was previously weeks 2 to 6).They will do so by completing a form and either sending it to the IRD or giving it to their employer.

Following an opt-out, deductions from an employee’s pay will cease and the employer or the IRD (as the case may be) will refund all contributions made by the employee in respect of the new employment.

Opt-in

All other persons under age 65 (including beneficiaries, current employees, the self-employed and persons aged under 18) will have the ability to opt in to the KiwiSaver regime and contribute at any rate they select.

Deduction and rate of contributions

KiwiSaver contributions will now be deducted from a new employee’s first pay after starting their new employment. The employer must remit these contributions to the IRD along with PAYE and their monthly schedule.

KiwiSaver contributions must be at the rate of either 4% (the default) or 8% of an employee’s gross salary or wages – and each rate is net of tax.

In a change from the version of the Bill that was introduced into Parliament, the required contribution rate can now be made up of both an employee’s and their employer’s contributions. However, any employer contribution counting towards the required level must be fully vested. To the extent that employer contributions need not count towards the 4% or 8% thresholds, they may be subject to a vesting scale.

Employer contributions are not compulsory. However, if an employer agrees to contribute to an employee’s KiwiSaver scheme then it may do so by remitting contributions to the IRD.

Withholding tax exemption for employer contributions

In a further very significant (and now well-publicised) last minute policy change, introduced without public consultation in a Supplementary Order Paper dated 29 August 2006, the Income Tax Act 2004 now prescribes a withholding tax exemption for employer contributions to KiwiSaver schemes. This applies with respect to employer contributions up to a maximum of the lesser of an employee’s contributions and 4% of the employee’s gross salary or wages.

The practical effect of the limited withholding tax exemption for KiwiSaver schemes is that the most tax-efficient way to contribute to a KiwiSaver scheme will now be for an employee to contribute 4% of his or her gross salary or wages, and for his or her employer to contribute a matching 4% for the employee’s benefit (which will then be fully exempt from withholding tax).

IRD will hold initial contributions

The IRD will hold the contributions made by and on behalf of KiwiSaver members in a holding account for three months. After this period, the contributions will be forwarded to the appropriate KiwiSaver scheme provider - see below - with interest.

Which KiwiSaver scheme?

The KiwiSaver scheme in which a person is enrolled in will depend on:

• whether the person makes an active choice of scheme; and
• if the person does not make an active choice and is an employee, whether his or her employer has nominated an “employer-chosen” KiwiSaver scheme.

If an employee does not make an active choice, then he or she will be automatically enrolled in the relevant employer-chosen KiwiSaver scheme.

If the employer has not nominated a scheme, or the person is not an employee, then he or she will be enrolled in a default KiwiSaver scheme chosen at random for them by IRD.

The default providers will be selected through a tender process that is currently under way.

A person can be a member of only one KiwiSaver scheme at any time.

Ability to stop contributing

Employees who do not opt out of the KiwiSaver regime within the prescribed period (or within any extended period which the IRD may allow at its discretion), and employees who have opted into the KiwiSaver regime, must then continue contributing to KiwiSaver unless they have successfully applied for a contributions holiday.

An application to the IRD for a contributions holiday may be made at any time after 12 months’ contributory membership of KiwiSaver, or earlier if an employee experiences significant financial hardship (in which case he or she may apply to the IRD for a contributions holiday of a maximum 3 month period).

A contributions holiday must otherwise be for a minimum period of 3 months, and for a maximum period of 5 years. After 5 years, an employee can apply for another contributions holiday (there is no limit on the number of successive contributions holidays).

Access to balances

Contributions are “locked in” until the later of five years from joining a KiwiSaver scheme and New Zealand Superannuation age (currently 65) except in cases of significant financial hardship, permanent emigration, serious illness or to purchase a first home.

Savings will be payable as lump sums when KiwiSaver members become entitled to receive them.

The ability to withdraw contributions in cases of serious illness was added to the legislation following a recommendation from the Select Committee considering the Bill. “Serious illness” is narrowly defined as an injury, illness, or disability that either:

• results in the member being unable to engage in work for which he or she is suited by reason of experience, education or training, or any combination of those things; or
• that poses a serious and imminent risk of death.

Both employee and employer contributions (if any) can be withdrawn to purchase a first home. This feature is in addition to the first home deposit subsidy described below. However, a KiwiSaver member will not be able to access the $1,000 upfront contribution (see below) for this purpose.

Another significant addition to the Act is the introduction of a mortgage diversion facility. KiwiSaver providers will not have to offer KiwiSaver members this facility. If offered, it will allow members to divert up to half of their KiwiSaver contributions (excluding any employer contributions) into repaying a mortgage. This facility will only be available for members who have had 12 months’ contributory membership of one or more KiwiSaver schemes. The details of the facility have yet to be announced.

Additional incentives

The Government will provide an up-front contribution of $1,000 to each new KiwiSaver member, which will not be taxable. This money will be invested with other KiwiSaver contributions and will be locked away until New Zealand Superannuation age, except in cases of permanent emigration.

Administration fees for KiwiSaver schemes will be subsidised by the Government, by way of a uniform annual credit to each KiwiSaver member’s account.

A one-off first home deposit subsidy will be available after three years’ contributory membership of KiwiSaver or of an exempt employer’s superannuation scheme (see below). This will entitle members who qualify (based on a household income limit and regional purchase price caps) to a Government contribution of $1,000 for each year of post-1 July 2007 contributory membership, up to a maximum of $5,000 per member. The subsidy must be applied towards the purchase of a first ever home and paid direct to the vendor’s solicitor. The home must be the member’s primary place of residence for a reasonable period of time.

Exempt employers

An employer offering employees an existing scheme (or two or more schemes, which may be treated as one for this purpose) will be eligible able to apply to the Government Actuary for an exemption from the KiwiSaver automatic enrolment rules, provided the scheme meets certain criteria. An exemption will be granted if the Government Actuary is satisfied that:

• the scheme is open to all new “permanent employees” aged 18 or over but under 65 who start employment on and from 1 July 2007;
• the scheme’s trust deed permits transfers to and from other schemes (to the extent that such transfers are available);
• the scheme is a registered superannuation scheme; and
• the scheme’s trust deed provides for an amount of at least 4% of gross base salary to be contributed to, or otherwise credited within, the scheme in respect of each person who becomes a permanent employee and a member on or after 1 July 2007. This contribution requirement does not apply during any period when an employee is permitted to take a contributions holiday under the trust deed.

The 4% threshold can be made up of member and employer contributions, and employer contributions for this purpose are calculated before deducting withholding tax. However, employer contributions do not count unless:

• the employee is able to require them to be contributed on his or her behalf; and
• the effect of any prescribed vesting scale is such that, to the extent required in order to count towards the 4% threshold, employer contributions vest before a member’s sixth year of scheme membership.

The employer exemption criteria do not require a five-year vesting scale – only that after five years the employer’s contributions have vested to the necessary extent (if any).

If the scheme is defined benefit in nature, the employer can satisfy the 4% threshold test if the actuary to the scheme certifies to the Government Actuary that the value of each employee’s accrued benefits are, as a matter of fact, increasing during each membership period by at least 4%.

The criteria for exempt employer schemes have evolved significantly since the Bill’s first reading. These changes have improved the clarity of the criteria and appear to have made it practicable for many employers to seek an exemption.

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