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Busy Christmas ahead for investors

11 December 2006

Busy Christmas ahead for investors

By Paul Dunne, tax partner KPMG -Murray Sarelius, tax partner KPMG

Investors and fund managers have a busy Christmas and New Year ahead of them. The Tax Bill reported back by Finance and Expenditure Committee (FEC) last Tuesday (5 December 2006) contains substantial, and much needed, changes to the original draft legislation. The new tax rules could have a significant impact on investments outside of New Zealand and Australia, as well as on the conduct of the funds industry in New Zealand.

This Tax Bill has generated an unprecedented level of interest, debate and controversy – not only in tax and financial circles, but for the public at large. The reason for this is simple – the developments have the potential to impact on anybody with offshore investments. Although the end result is (and was always going to be) a politically-acceptable compromise, it is positive that the industry now has a clearer way forward and can start progressing some of the many practical issues that arise from the proposals. But we must not lose sight of the fact that the Bill introduces a formidable level of change for investors and the investment industry.

Individual investors and unit trusts

Before the new offshore investment tax rules take effect on 1 April 2007, investors should consider whether these rules will apply to them and, if so, what impact they will have on the after-tax return from their investments and the risk of those investments. Paying tax on a flat deemed return of 5% of the amount invested (referred to as the fair dividend rate) is great in a year when returns are high; but not so good in a year with poor returns.

The current rules, which tax unrealised gains on shares outside of the grey list countries, have a dampening effect on the volatility of such an investment. Tax on gains reduces positive returns, tax deductions on losses reduces the impact of negative returns. The new rules will not have this effect, making investment in sectors like emerging markets more risky. Effectively, Government and the New Zealand tax base will no longer underwrite some of the risk on those investments.

These new rules will apply to all family trusts investing overseas, and individuals investing directly if they hold foreign shares, and foreign superannuation, with a cost of more than $50,000.

Managed funds

For fund managers and trustees, the months ahead will be even busier. Not only do they need to consider how the new rules will impact on offshore investments they hold, they also need to consider the portfolio investment entity (PIE) regime. Managers need to consider whether they will offer PIE products, and KiwiSaver products, on 1 October 2007, when these rules come into effect. Trustees will need to consider whether to elect into the PIE regime on that date.

A PIE will have certain tax advantages. It will not be taxed on gains derived from New Zealand and Australian shares, unlike most managed funds at present.

A PIE will also be subject to tax at its investors’ marginal tax rates, to a maximum of 33% with no further tax being payable by investors on distributions. This has obvious benefits for low income earners and retirees who are subject to a 19.5% marginal tax rate who may be taxed at over 33% currently. Investors earning over $60,000 who could otherwise be taxed at 39% on their investment earnings get the advantage of a 33% maximum tax rate.
Managed funds will also need to face major issues with unit pricing and their technology to make the rules work and help investors understand their impact. Different managers and different funds may approach these issues differently. They do have one thing in common - whatever approach is taken, there will be changes and these will need to be explained to investors.

Superannuation trustees

Similarly, trustees of superannuation schemes will need to consider whether to, and how to, apply these new rules. The first thing to determine is whether it is in the interests of members to elect into the PIE regime. No trustee or manager can simply continue with the status quo, without at least considering the possible benefits, and cost, to members of applying these new rules.

This will involve weighing the benefit to certain members, such as the advantage of being taxed at a 19.5% marginal rate rather than 33% or the reduction of tax on Australasian equities, against the cost to all members of implementing the changes necessary to enter the PIE regime.

The good news on this front is that Government has acknowledged the position of superannuation schemes and provided an optional approach that is similar to the current provisional tax regime. Unfortunately, this may still require significant changes for many schemes, such as employer-sponsored funds that may have virtually no tax compliance currently. Electing into the PIE regime may see these schemes needing to take responsibility for increased tax compliance.


The offshore investment rules take effect from 1 April 2007. These changes demand that investors reconsider their portfolios.
In parallel, the new tax rules for managed funds come into effect from 1 October 2007.

These rules introduce massive change, both in tax concepts and implementation. Fund managers have significant challenges and opportunities ahead of them. Time is of the essence, the significant systems, technology and communication issues must be planned approved and implemented in less than 10 months.


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