New Zealand’s Experience with Territorial Taxation

The Tax Foundation has published a series of case studies that focus on the international trend of countries transitioning to territorial taxation. The latest study covers New Zealand’s territorial tax system.

In 2009, New Zealand implemented a territorial tax system much like that found in other developed countries. This system first distinguishes between the active and passive income of controlled foreign corporations (CFCs), where passive income is basically investment income such as dividends, interests, royalties and rents, and active income is everything else. Second, it exempts active foreign income entirely from New Zealand tax while continuing to tax passive foreign income as it is earned. In 2012, New Zealand extended the exemption system to controlling investments in all foreign companies, not just CFCs.

What is interesting about this policy change is not just that New Zealand became one of the latest countries to move to a territorial tax system but also that it was essentially a return to the territorial system that existed in New Zealand from 1891 to 1988. Indeed, New Zealand was the first developed country to have a territorial tax system. In 1988, New Zealand moved to a worldwide tax system without deferral, meaning all foreign income of CFCs was subject to New Zealand tax as it was earned, regardless of whether it was repatriated or remained abroad.

New Zealand’s poor economic performance under worldwide taxation is testament to the economic importance of foreign investment. When firms increase foreign investment and wages, they also increase domestic investment and wages. New Zealand is one of only two developed countries that switched from a territorial tax system to a worldwide system and then returned to a territorial tax system for competitive reasons.

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