The Overseas Investment Amendment Bill (No 2) ("Bill") was introduced on 20 March 2020 and sets out the proposed Phase II amendments to the Overseas Investment Act ("Act"). This is the third in a series of articles discussing the changes introduced by the Bill, the
first article having covered the new national interest test and call in powers, and the
second article having covered exclusion of lower risk investment from the scope of the regime.
As set out in our first article, the Bill will need to be prioritised by the Government if it is to pass before the next election, with it yet to have its first reading and referral to a Select Committee. Saying that, the Government is increasingly likely to want to see the national interest test measures passed without delay, where (given the impacts of COVID-19) New Zealand owners in critical sectors could be suffering economic stress, attracting interest from well-capitalised offshore acquirers. It may be concerned about the extent to which consent requirements under the Act constrain stressed businesses' ability to quickly obtain finance.
More recently, David Parker indicated at a COVID-19 Select Committee meeting that further urgent changes to the Overseas Amendment Act were being considered in response to COVID-19. We note that Australia has recently announced temporary changes to its overseas investment regime which enable oversight of all foreign investment during this time. It is unclear whether any COVID-19 related changes proposed by this Government will be incorporated in the current Bill (which then would need to be fast-tracked through the legislative process) or will be introduced in a separate Bill. We will provide a further update once changes, if any, are announced.
This article covers changes intended to simplify the existing Investor Test that applies to all applications and the Benefit Test that applies to most applications that include sensitive land. The changes largely reflect the preferred options identified in a Treasury paper released in November last year (a table analysing that paper can be found
here).
This article will be followed by:
Article 4: Application processing times, penalties, new enforcement tools, and new tax information requirements.
We are holding a CPD seminar on Tuesday 5 May 2020 to discuss changes to the Act - to register your interest in attending, please email [email protected].
This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.
Overview
Reduction in scope of the Act - Overview
One of the Bill's most welcome amendments to the Act is a complete overhaul of the current Investor Test, which applies to both business assets and sensitive land applications. The main changes to the Investor Test are:
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replacing the current "good character" test with more certain "character" investment test factors, which cover only serious convictions, contraventions or proceedings;
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replacing the current "business experience and acumen" and "financial commitment" requirements with new certain "capability" investor test factors, which focus on disqualification of controlling individuals from certain roles and, for the first time, investor tax compliance considerations;
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the new character and capability investor test factors will act as "disqualifying" requirements, where the Investor Test is satisfied as long as these factors are not engaged (with an overriding discretion for the Minister to decide the Investor Test is met in any event).
Importantly, New Zealanders will no longer be required to meet the Investor Test, repeat investors will be able to rely on a previous Investor Test assessment in certain circumstances, and there is a new Investor Test pre-clearance process that can be used whether or not a transaction is imminent.
Overall, the proposed changes to the Investor Test should materially improve the operation of the Act by introducing a more targeted and certain test, and by reducing unnecessary compliance costs and delays. This, in turn, should better encourage high quality beneficial investment in New Zealand - one of the objectives of the Bill.
For sensitive land applications, the Bill replaces the counterfactual test (introduced by High Court decision
1, and which has been criticised for its uncertain and counterintuitive outcomes), simplifies the existing Benefits Test and removes the "substantial and identifiable" benefit requirement that applies to a large amount of sensitive land
2. The Bill also entrenches the existing more stringent test for farm land that is set out in the current Ministerial Directive Letter.
While these measures go some way to addressing issues with the Benefits Test that currently deter beneficial overseas investment, there remains a risk that some core underlying issues with the test will be carried over into the new regime. We set out below why further amendment or guidance might be required.
Investor Test
Key issues under the status quo
Currently, the Investor Test requires investors to satisfy four components being: (i) the individual(s) that will control the investment ("IWC") are of good character; (ii) the IWC possess business experience and acumen relevant to the investment; (iii) the investor has demonstrated financial commitment; and (iv) none of the IWC are ineligible individuals under the Immigration Act 2009 (being those ineligible for visas or entry permission, for example because of deportation).
In relation to the good character requirements, the Minister is currently required to consider offences and contraventions of the law (concepts that are undefined) and "any other matter that reflects adversely on the person’s fitness to have the particular overseas investment". In order to meet this test, applicants must provide all material that could possibly fall within the broad scope of these requirements, even if it clearly has no bearing on character. The matters that potentially need to be addressed in an application have increasingly expanded, to the point where any allegations, regardless of the credibility of the alleging source, need to be addressed.
The good character issue, in itself, is resulting in additional and disproportionate delays, costs and angst for applicants, with associated reputational damage to New Zealand as an investment destination. Applicants are too frequently required to address immaterial or otherwise irrelevant matters that have no bearing on the character of the IWCs or relate to entirely different people, and often necessitate formal responses from senior personnel on these matters.
While the business acumen and financial capability factors are not as problematic as the current good character factor, Treasury has recognised that they add little to the investor assessment process and are, therefore, wasteful of both the OIO's and applicant's time in addressing them.
What the Bill does
The Bill, at new section 18A, replaces the existing Investor Test with a significantly narrowed and more certain version, which:
- clarifies that the purpose of the test is to determine whether investors are unsuitable to own or control any sensitive New Zealand assets, by assessing whether they are likely to pose risks to New Zealand, based on factors relating to their character and capability.
- critically, replaces the broadly drafted requirements for good character with a clear and finite list of investor test factors that go to the character of an individual and which should operate as a certain bright line test (the Ministers are no longer empowered to take into account factors that are not expressly listed in the Act). The matters in the list are limited to convictions for offences (resulting in imprisonment for an individual or a fine for a corporate entity), civil pecuniary penalties for contraventions under an enactment, penalties for a contravention of the Act or Regulations, current formal proceedings in relation to any of the above and any enforceable undertakings entered into with a regulator. Sensibly, in relation to all but the most serious of these factors the relevant event or offending is required to have occurred within the last 10 years;
- introduces new "capability" investor test factors, namely:
- prohibitions from being a director, promotor or involved in management or management banning orders;3 and
- factors relating to tax evasion, abusive tax positions, and outstanding unpaid tax of $5 million or more (discussed further below);
- removes the business experience and acumen factor and the requirement to demonstrate a financial commitment to the investment - these were, rightly in our view, considered to be of limited value in screening investors;
- provides that the Investor Test can be met in one of two ways - either the decision-maker is satisfied that none of the investor test character and capability factors are established, or, if they are established, the decision-maker is satisfied that the factors do not make the investor unsuitable to own or control sensitive New Zealand assets. Importantly, this second limb ensures that none of the factors are automatically disqualifying of the investor, allowing the decision-maker some discretion to grant consent where appropriate, despite the presence of one or more of the factors; and
- overall, re-frames the Investor Test – investors are no longer required to positively establish their business acumen and good character, but merely that none of the defined list of investor test factors apply. This will remove the need for positive submissions on these matters.
The only existing component carried over unchanged from the current Investor Test is the aspect relating to ineligibility under the Immigration Act 2009 (which now will be included in the list of good character requirements), but these factors are no longer automatically disqualifying under the new framing of the test.
Further reducing the scope of the Investor Test, the Bill excludes New Zealanders from its scope, so New Zealanders that are individuals with control in relation to an application/investment will not need to satisfy the test. This makes sense, as New Zealand individuals do not require consent under the Act to own or control sensitive New Zealand assets in their own right. This is a positive amendment, and we expect it will reduce the number of IWCs on a number of transactions (conceivably to zero, on some).
We make the following comments on two areas where the Investor Test has been expanded compared to the status quo, to address Government concerns that the current good character test does not specifically consider corporate good character or tax compliance:
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The good character test now expressly applies to both the relevant overseas person (which captures incorporated investors) and each IWC. Our initial concerns about extending the test to corporates that are by their nature controlled by natural persons (who are already subject to the test) have been largely alleviated by the bright line test proposed in the Bill. In our view, there is some residual risk, for example, that the test could capture an offence committed by a company under one group of controllers that is subsequently replaced. However, we assume this risk can be mitigated by the OIO taking into account any submissions in applications to this effect (although, we note the additional costs that will fall to investors who may need to make such submissions).
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The introduction of new investment test factors will specifically provide for taking into account penalties imposed for an abusive tax position, or tax evasion or similar acts (in each case, including equivalents in other jurisdictions), and tax defaults where the investor has outstanding unpaid tax of NZ$5 million or more. Tax compliance history can be considered under the good character test but in practice matters to be considered are generally confined to prosecutions for non-compliance and tax compliance of a natural person (as an aspect of the good character test). While consideration of any prior New Zealand tax-related penalties or defaults should be a straightforward matter, this change will also require that a potential investor takes into account equivalent penalties and defaults in other jurisdictions, and could therefore be highly burdensome for some investors. In some jurisdictions, for example, the tax authority itself (without needing to secure a conviction or judgment of a court) can impose material civil penalties (such as penalties for tax evasion).
Significantly, the Bill also introduces a more streamlined process for repeat overseas investors, who may now rely on having met the new Investor Test in relation to a previous consent when making subsequent applications. Although the exact detail of how this will work in practice has not yet been finalised, we expect that any subsequent applications under the same ownership and control structure will merely need to disclose the details of the new transaction and sensitive assets, together with either details of any investor test factors that have changed since the most recent application or a declaration that there have been no such changes.
A further welcome addition is a new process that allows an overseas investor to apply for pre-clearance of an ownership and control structure and IWCs against the Investor Test, regardless of whether it is involved in a current transaction - this will operate as a standing clearance of the investment structure and controlling individuals for future transactions under the same structure. We expect the new pre-clearance regime to be particularly useful for overseas private equity fund managers, allowing the fund manager to obtain pre-clearance of the structure, key entities and individuals associated with a new fund prior to transacting, which could prove an advantage in competitive processes against other offshore bidders who may not invest in New Zealand assets regularly enough to warrant seeking and holding such pre-clearance.
Benefits Test
Key issues under the status quo
As well as satisfying the Investor Test, overseas persons wishing to acquire an interest in sensitive land must usually satisfy the benefit to New Zealand test ("Benefit Test"). Under the Act, the Minister considers benefits claimed by an applicant against 21 different factors set out in the Act and Regulations (of varying economic, cultural and environmental values). For land greater than 5 hectares, these benefits must be "substantial and identifiable". A counterfactual test then requires that the benefits which the applicant considers will arise from the transaction, be compared against what is likely to happen if the investment does not occur (in order to determine whether "net" benefits will, in fact, be derived from the transaction).
The application of the Benefit Test has, over time, become increasingly problematic for investors, resulting too often in disproportionate and, counterintuitively, worse outcomes for New Zealand. As acknowledged by Treasury in the Regulatory Impact Statement accompanying the Bill, the current Benefit Test is "unclear and unnecessarily complex, creating uncertainty, imposing unnecessary costs and resulting in time consuming processes, all of which deter overseas investment". Key criticisms of the existing Benefit Test include:
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Under the counterfactual test, the benefits of a transaction are measured against a hypothetical scenario of (normally) an adequately funded New Zealand purchaser ("AFNZP"). In reality, this is often the least likely scenario.
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The substantial and identifiable benefit requirement often results in expectations of benefits that are simply not possible and/or not proportionate to the asset's sensitivity or the interest being acquired by the investor.
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The 21 different benefit factors have led to a tendency towards a tick box assessment of the individual benefit factors (and many applicants adopting a "scattergun" approach) rather than a holistic view on net benefits in the round. While case law has stated that a holistic view is the correct approach, this has not happened in practice.
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Some factors, such as giving effect to or advancing a significant Government policy, are rarely treated as met by the OIO, reflecting a reluctance to take account of factors unless they can be evidenced by an economic number or dollar value (which is not always possible or practicable).
Perhaps due to these issues, the OIO and Ministers appear to struggle to take a proportionate approach to the level of sensitivity in the benefit assessment, for example by taking account of the nature of the interest (leasehold or freehold), the industry, or the transaction (for example, a well-managed asset that is changing hands between competent overseas investors).
We commonly see these issues crop up in the following scenarios (noting that there are many other examples):
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Where there are likely no interested New Zealand buyers, the assumed AFNZP scenario can effectively leave a vendor with a stranded asset. This creates risk for prospective purchasers as to their eventual exit and liquidity options, with a corresponding chilling effect on investment in New Zealand.
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Where an overseas owner manages its business to a high standard (and provides benefits promised under (and over and above the level required by) a previous OIO consent), the asset becomes increasingly difficult to sell. That is, each overseas buyer has less scope to demonstrate additional incremental benefits in order to receive consent or is held to an increasingly higher standard.
What the Bill does
The amendments to the Benefit Test in the Bill are set out below, together with our comments on the effectiveness (or otherwise) of the changes in dealing with the issues under the status quo.
Proposed amendment
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Comment
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The relevant counterfactual will be the current state of the sensitive land and the activity on it.
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This significant improvement removes the requirement for speculative assessment of future scenarios. However, we note that there may be some circumstances where the new test is less helpful, for example, where a business will likely do better in the future with the overseas investor than with the current owner (eg. the "failing firm" scenario).
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Relevant benefit factors will be reduced in number and broadened to encompass a range of benefits.
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This may help drive a more holistic approach to assessment of factors and it is helpful that the range of benefits claimed remains wide. However, the drafting ultimately summarises existing benefits and there is a risk that the current approach (assessing each factor individually rather than as a whole/focusing on economic benefits) will remain unchanged.
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Investors in sensitive land will not need to demonstrate that the benefits are "substantial and identifiable".
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This is a significant improvement, which should allow for a more flexible, sensible and targeted approach (noting that there is a new similar test which will apply to farm land that exceeds 5 hectares – see below).
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The OIO will be required to apply a proportionate approach, taking account of the sensitivity of the land, the size and nature of the land, and the nature of the overseas investment.
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This is a welcome improvement as the OIO are now clearly directed to apply a proportionate approach to all applications. The drafting of the provision includes examples of what, say, sensitivity of the land, would mean. We note that Treasury has specifically stated that this amendment will signal an openness to investment by reducing the risk of asset stranding by allowing for greater consideration of the benefit that a transaction may have on market liquidity. However, the extent to which this section drives improvements to the approach of assessment remains to be seen.
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Only positive impacts can be considered (except for extraction of water for bottling).
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This change clarifies what was generally understood to be the correct position (but this was tested in the first OceanaGold decision, where Hon Eugenie Sage took into account negative impacts – an approach that was overturned when different Ministers considered a fresh application). Note that negative impacts can be considered under the national interest test. This likely reflects a compromise between Labour and the Green Party.
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Farm land (which includes land primarily used for agriculture, horticulture etc) that exceeds 5 hectares will be subject to a more stringent benefit test. The Minister must place higher relative importance on factors involving economic benefits and the involvement of New Zealanders in the investment, and be satisfied that the benefits demonstrate "a substantial point of difference".
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This amendment embeds the test currently set out in a Ministerial Directive Letter for rural land (not including forestry land), although slightly narrows the application to farm land. The first such Directive was given under the previous National Government reflecting a longstanding political concern about overseas ownership of farm land (although the scope and application of the directive was expanded under the current Labour Government in 2017 from farm land to rural land while removing forestry land). This factor is discussed further below.
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Broadens the benefit test to allow recognition of an investor's plans to protect wāhi tapu area listed under the Heritage New Zealand Pouhere Taonga Act 2014 or Māori reservations.
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While some submitters raised concerns that this might further complicate the Benefit Test, Treasury's recommendations reflect concerns raised in consultation that there was little awareness of, and protection for, sensitive sites, and Māori relationships with them. We note that the relevant wāhi tapu and Māori reservations can be easily identified under legislation.
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Of all the changes, we consider the stricter farm land benefit test will likely be the most problematic. A key risk with this proposed test is that it covers such a wide range of land uses, including sectors which rely on overseas investment, and/or where it is difficult to ever demonstrate substantial points of difference, particularly in relation to well-managed assets.
Given the experience with the "substantive and identifiable" benefit test, it is also likely that the OIO/Ministers will struggle to apply a proportionate approach in the context of the stricter test. Arguably, the test should be narrowed in terms of which farm land it applies to, so it is more targeted to the issue intended to be addressed (for example to remove sectors where it can be shown foreign capital is critical to sustain the industry and/or the nature of the sector means substantial points of difference are unlikely where the asset is well managed).
It is of note that Treasury recommended against legislating this requirement, noting the status quo allowed decision-makers greater discretion not to apply an elevated threshold where this would not address the threshold's policy intent.
Overall, the changes to the Benefit Test are an improvement on the status quo, particularly when considered together with other amendments to the Bill (as discussed in
Article no 2). However, there remains a risk that current problematic approaches to the benefit factors will be carried over, particularly if the proportionality test is only narrowly applied and if the current proposal with respect to farm land is adopted. Clear guidance from the Treasury to the OIO in this respect will be required.