Tax certainty is a key priority for sustainable infrastructure development. We spoke with Tax Advisory Group member Sandy Lau, Partner at PwC about the key structural issues that New Zealand’s infrastructure projects face as well as recommendations to foster sustainable infrastructure development.

What are the key tax issues faced by the infrastructure sector?

Infrastructure projects have some unique features which drive specific tax considerations. A key feature is that these are often long-term projects where significant costs are incurred upfront, and potentially for a number of years, before profits are realised. Therefore, certainty of the tax profile of the project is crucial for investors so they know what the return on their investment will be.

Another key consideration is that the projects will generally have high capital expenditure therefore understanding if and when that expenditure will be deductible/depreciable will be important. Things like blackhole expenditure will also be relevant, especially during the pre-commencement phase and if the project doesn’t end up going ahead.

The need to balance the tax profile of the various parties also poses additional complexity, for example the investors may be non-resident, iwi, charitable, central or local government. This could influence the investment vehicle that is adopted to carry out the project.

Finally, infrastructure projects are typically very highly geared, therefore the deductibility of any interest costs will often be a key issue to consider.

If you were to propose solutions for these tax issues, what short-term and long-term measures would you recommend?

Rather than specific measures or changes, I would think having certainty and a stable tax environment is critical. As noted, infrastructure projects often have a very long life span whereby the costs and profitability is forecast over the life of the project right at the start. Therefore, any changes to the tax rules which impacts the tax profile of the project can have a big impact for the investors. The recommendation would be to reduce the situation where the tax rules change back and forward – depreciation for commercial building is a good example of this.

On a more long-term basis, it may be worthwhile to consider whether New Zealand needs to rethink its tax settings in relation to infrastructure generally. We have a tax system that favours minimal distortions currently, it will be worthwhile to test if there are merits to pull tax levers to at least remove some of the barriers to undertake infrastructure projects in New Zealand, given the infrastructure gap we have.

An example may be to consider whether it makes sense to extend the current concession in the thin capitalisation rules for public private partnership projects to a broader set of infrastructure projects, given the fact that these projects are often very highly geared.

Are there specific tax incentives or exemptions in New Zealand that encourage infrastructure investment, and if so, can you provide examples of their impact on projects?

Different countries have pulled different tax levers for infrastructure projects. However, it is worthwhile to note that New Zealand’s approach to tax is to have a system that has minimal distortions, therefore there are only a few tax incentives and exemptions compared to other countries.

With that in mind, many countries have gone down the tax credit/incentives route, in particular, in relation to renewable energy. There’s a question as to whether there is the same need for this in New Zealand, given the size of our economy and the fact that we have a focus on renewable energy in our market already.

Another common approach is to have preferential tax rates for specific infrastructure projects. Again, not something that we have seen in New Zealand but it was something that the Tax Working Group recommended consideration should be given to.

The key comment that often comes up for using tax incentives or exemptions to influence behaviour is that it is hard to measure the benefit that is generated by pulling those tax levers. It also makes it more difficult to assess whether New Zealand is getting value for money as we would need to include the foregone tax revenue as part of the assessment. The alternative is that the Government can just pay more for a project if the economics of the project is challenging and there is a strong desire for the project to go ahead – this would provide a much more transparent view of the actual costs of the project.

Infrastructure projects often involve complex financing structures. How do tax considerations influence the financing choices made by investors and constructors in New Zealand?

Infrastructure projects are often very highly geared given the early stages of the projects will have high capital expenditure demands, therefore the ability to get a deduction for any interest expense will be an important consideration for investors and constructors. It may be difficult for investors or constructors from a cashflow perspective to equity fund all of the expenditure demands in the initial phases of the project where the demand for cash is high.

Things like the impact of thin capitalisation may impact on the structure that is adopted by investors and constructors. For example, there may be a preference for the use of a tax transparent entity so that New Zealand resident investors would not be impacted by co-investing with a non-resident investor, that is the thin cap rules would not apply to the New Zealand resident investor in contrast to a company being the investment vehicle. However, entities such as limited partnerships (which are transparent for tax purposes) do bring additional tax complexity for the investors which could result in additional compliance costs.

In your opinion, what are the top priorities or strategies that New Zealand should focus on to foster sustainable infrastructure development while maintaining a favorable tax environment?

Tax certainty is a key priority, as investors will want certainty as to when and how much tax they have to pay. Continuous changes to tax legislation are detrimental to making New Zealand an attractive place for investment, especially given infrastructure projects are often longer term and the strong desire to have certainty over returns for investors.

The other one is to regularly check and consider New Zealand’s international competitiveness as an investment destination. While this will depend on a number of factors, tax will be an important factor too. It is important that New Zealand’s tax system remains competitive to ensure we get the foreign investment needed.