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April 07 newsletter

2007 is a busy year for new legislation and changes to investment tax rules, with particular impact on managed fund investors.

I don’t agree with commentators who suggest that all gains made on residential property investment should be taxed. Because similar rules apply to direct share investors and a level playing field broadly exists.

But the playing field is tilted against investors who use managed funds for investments. Managed fund companies do pay tax on the capital gains made on their investments. So, compared to the direct investor, a managed fund investor will be 33% behind when the starting gun is fired, a big number that must be made up by the investment management team. And there are many well known commentators who believe that to be impossible.

As you may recall from our November 2006 newsletter, KiwiSaver kicks off on 1 July 2007. The KiwiSaver funds will be managed funds. Imagine the consternation in Dr Cullen’s office in a few years time, when the voting public says, “Hey, that 33% tax has turned my fund (yes, the fund the Government made me contribute to) into an investment dog.”

The managed fund industry has been lobbying the Government for years to get that tilted playing field onto an even keel. And now that Dr Cullen has realised that the public may be baying for his political blood, his Terrace Treasury team have come up with the bright idea of changing the tax rules so that managed funds investors are taxed on the same basis as direct investors. Genius – that’s why they get paid the big bucks.

Portfolio Investment Entity (PIE)

Dr Cullen’s dream team has decided that, from 1 October 2007, under the new PIE regime, managed funds, including KiwiSaver funds, will not pay capital gains tax on their New Zealand and (some) Australian share investments. Investors will pay tax at their marginal tax rate on dividend income. The maximum tax rate will however be 33%.

A PIE will be subject to the FDR rules (see below) on their international share investments. The tax will be at the investor’s marginal tax rate. Please note that the 5% FDR will apply regardless of the actual investment return.

Fair Dividend Rate (FDR)

Of course, there is a sting in the tail. The dream team had a spare hour between lattes and decided to change the tax on overseas investments. From 1 April 2007, investors will pay a maximum amount of tax (FDR) on 5% of the value of their investments in overseas shares or overseas unit trusts.

If your overseas investments cost less than $50,000 (or $100,000 if jointly owned), then you will fall under the de-minimis rule and you will only be required to pay tax on dividend income.

The tax rate will be the marginal tax rate (19.5%, 33% or 39%). So, an investor on a marginal tax rate of 33% with a $100,000 investment will attract a maximum tax of $1,650 (33% of $5,000). However, based on the comparative method, if the total return is less than 5%, a lesser amount of tax will be paid by individual and family trust investors.

Random page of the month

Why not invest overseas so you too can pay tax?