Tax is a topic that can get complex and overwhelming quickly, especially when understanding how it can impact your investing. It’s important to understand the basics to make sure you’re on track with payments or refunds owed (and to keep the Inland Revenue Department off your back)!
When searching online for quality resources explaining the basics of tax we didn’t have much luck. So, we’ve created a simple, easy to digest beginners guide in the hopes we can answer a few of the many tax-related questions you have.
If you’d like to skip the basics and jump to the technical detail, especially about tax on overseas investments, we’ve written a comprehensive tax paper here.
Additionally, if you have a particularly unique situation or are looking for tailored advice, we recommend speaking to an account or tax specialist. Katrina Scorrar, who contributed to our foreign tax paper is excellent in this space.
Why only income tax matters
In New Zealand, we’re not taxed on capital gains (except residential property) or on our wealth generally. So, it’s mainly income tax that matters. That is, tax on any income you are receiving – from employment, interest earnt on savings, dividend from shares and any other sources. The amount you pay is determined by the amount of income you receive from these sources.
Similar to employers, banks, trading platforms and share registries (i.e. Link and Computershare) have a responsibility to deduct a proportion of your income as Resident Withholding Tax (RWT) before giving you back the difference. When you start saving, investing in shares or otherwise, you tell the bank and share registries what the correct RWT is for you.
If it’s wrong at the end of the year, you can tell Inland Revenue Department (IRD) or they will tell you! Get it considerably wrong and they might charge you penalties and/or interest at a cool 7% per annum. Ouch!
What is my Resident Withholding Tax (RWT) rate?
As mentioned, your RWT rate is chosen by you and based on your estimate of your total income in the current financial year (1 April to 31 March).
For this reason, it’s important to choose an RWT rate that is reflective of your total income – wages, dividends from shares, interest from a bank account etc. Noting that it’s only on the income you’ve received. There is no capital gains tax unless you are classified as a trader – more on this below.
What is the RWT scale?
|Estimated total annual income||Tax rate|
|Income up to $14,000||10.5%|
|Then up to $48,000||17.5%|
|Then up to $70,000||30%|
|Then up to $180,000||33%|
The first priority is your wages or salary. This is calculated by either you or your employer, based on a progressive rate from 10.5% to 39%. That means your “first” $14,000 are taxed at 10.5%, the next $34,000 (to a total of $48,000) are taxed at 17.5%, as shown in the table above effective 1 April 2021.
This is smoothed out over a year based on your pay period, which is why if you change jobs or have fluctuating income it’s a good idea to do a tax return. Inland Revenue will also tell you if you have underpaid or overpaid according to information and payments they have.
When investing with Kernel, we’ll collect your RWT in anticipation of future product developments. Watch this space!
Index funds vs Exchange Traded Funds (ETFs) vs individual shares
The tax obligation between index funds, ETFs and individual shares varies significantly. Choosing the wrong product can lead to you paying more than necessary. It’s complicated to explain because it depends on the combination and number of investments which is personal to you. Tax is also just one factor to consider when choosing investments.
When investing in index funds, like Kernel’s, you usually get a better tax treatment if the fund is New Zealand based and has registered itself with Inland Revenue as a Portfolio Investment Entity (PIE). All Kernel funds are registered as PIEs which means you pay the tax later and only to a maximum rate of 28%.
Here are a few insights to consider when comparing index funds vs ETFs vs individual shares (if you live in New Zealand):
- Both local and foreign ETFs are not the best structure for most New Zealand investors. They are however advantageous if you live in the USA and there are lots of online resources promoting that.
- Similarly, Australian based investments are normally designed for the Australian investor. New Zealanders cannot claim the tax credits (called franking credits) like they can from NZ investments.
- The maximum tax rate in an index PIE fund is 28%, compared with 33% and 39% if you hold shares directly.
- When invested in individual shares or ETFs you pay the tax as each dividend is received. With Kernel’s index funds, you only pay this in April each year. As a result, your money stays invested and growing in a fund throughout the year rather than being withdrawn immediately.
- Paying tax at year-end is beneficial, as you haven’t had money withheld throughout the year and it allows credits to take effect creating refunds. For the year to March 2021, 36% of our investors received a refund (and without doing any paperwork), whilst only 33% had more than $1.00 of tax to pay.
- Owning individual overseas shares (up to $50,000 invested) may work out to be more cost-efficient initially. However, other transaction costs for holding and claiming credits may work out to be larger than the difference. When you have more than $50,000 invested overseas then an NZ based fund pays less tax over 70% of past years.
I need to pay tax when investing in shares, where do I start?
For NZ residents, not tax residents somewhere else in the world, it is only the dividends paid by the New Zealand companies that are taxable. That means there is no tax on capital gains, the change in the share price or on the total amount invested. For a total investment under $50,000 bought directly in overseas shares, it is the same treatment but beware of the extra costs of accessing directly… Over $50,000 invested, see below.
How much tax do I pay investing in a Portfolio Investment Entity (PIE) fund?
The amount you pay depends on your Prescribed Investor Rate (PIR) and the share of tax credits you receive from companies in any given fund.
Tax on PIE funds is not directly related to the distributions (dividends) paid by a fund, or by the change in value of a fund. You might still owe PIE tax even if a fund loses value. It’s related to the amount of investment income received by the fund.
As mentioned above, Kernel funds are PIE funds and because of this they receive tax credits on some of their investment income – mainly “imputation credits”.
Imputation credits represent a credit to you for the tax paid on New Zealand profits from companies that the fund is invested in. These credits are designed to prevent double taxation, where a company has paid company tax, so you don’t do so too.
You might get lucky and receive a credit for some of the tax the company has paid, particularly if you have a PIR lower than 28% (the company tax rate). When these credits leave you in a surplus at the end of the year, you’ll receive a refund.
If you are due a PIE tax refund for your Kernel funds specifically, we expect that we will receive payment from the IRD in May, which we’ll automatically allocate to your Kernel wallet.
Here’s an example to illustrate the above:
|Gross Dividend paid||Imputation credits||Tax at 28%|
|Company A||$10||$2.80 (full 28%)||$2.80|
|Company B||$10||$2.50 (not all dividend related to NZ profits)||$2.80|
|Company C||$10||0 (no NZ profits)||$2.80|
In this example, only $3.10 of tax is owed by the investor (effectively 10.3% tax on the total income of $41.67).
What is my Prescribed Investor Rate (PIR)?
Your Prescribed Investor Rate (PIR) is the tax rate which is applied to any income earned from investment in a Portfolio Investment Entity (PIE) fund. Learn more here.
So, when will I pay tax?
All income tax is due at the end of the financial year (31 March).
If investing in a PIE fund, tax is calculated at two points – when you sell a large portion of units in a fund and at the end of the financial year.
For Kernel funds, we keep a record of how much tax needs to be paid (or returned) at all times. At the beginning of April each year, we’ll email investors their PIE tax balance and provide a period of time in which investors can deposit money to pay anything outstanding.
To make things even easier, Kernel investors can choose not to deposit money and use any available money in their wallet to pay what is owed. There is also the option for us to sell just enough units from an investor’s largest fund holding in order to cover the tax liability. Once those have been processed, we pay the funds to the IRD before the end of April.
When will I start to be taxed as a day trader?
If you are regularly buying and selling shares, then you might be classified as a share “trader” by the IRD. Once you fit into that category, you’ll be liable for tax on any capital gains and income received from the shares (dividends).
The challenge is that there is no clear descriptions or number of trades per year that classify you as a trader. It’s the intention rather than the activity that is important. Under NZ law, the IRD can review up to 7 years or trading history, so bear that in mind when buying and selling shares.
Our broad understanding is that changing your portfolio monthly or more, will be considered trading regardless of profit or value. We’re hoping for a bright line rule like residential property now has, as proven property flippers were always required to pay tax on their profits. In essence, anything approaching day trading by changing positions quickly is likely to classify.
Taxation on local vs global investments
If you buy more than $50,000 of overseas shares directly or are invested in a fund holding overseas shares, the tax is subject to a more complex choice of calculation called the FIF “Foreign Investment Fund” regime.
Tax on overseas investments and the FIF regime is relatively complicated so it’s best to read more here if this applies to you.
At Kernel, we take care of all the calculations, payments and claiming of tax credits for you when investing both locally and internationally.
Do I get taxed on my dividends?
Yes. Under the Income Tax Act, dividends from companies whether listed on a stock exchange or not, large or small, are categorised as income and subject to income tax. Dividends from companies listed on any stock exchange are paid via the share registry (Link and Computershare are the two in New Zealand). They deduct the tax first before giving you the rest.
Dual citizenship – how does this work with taxes?
This is less about where you have citizenship and more about where you are considered a tax resident. For most countries that is predominantly based on how many days a year you are in the country and your ties to that country (I.e. do you have a home there).
However, for the United States, all citizens and green card holders are required to calculate and pay U.S. tax every year, regardless of whether they step foot inside the US. This is unique (globally, only Eritrea does the same) and means that if you hold a U.S. passport, you should be clear on your obligations by using a tax adviser or accountant.
Tax on rental income vs the sale of shares
Rental income is taxed on the difference between rent received and expenses that can be deducted. In March 2021, the Government controversially removed interest deductibility, so increasingly landlords will find themselves with larger tax bills to pay.
For shares and diversified funds like Kernel’s, the use of tax credits means these are an increasingly attractive option for income. The bonus being there are much fewer ownership obligations and lower price entry point. It is also important to consider total return (income plus capital gain) in any assessment between shares versus property.
When should I seek an account to take care of my taxes?
When it gets too complicated or time-consuming for you! If you have a variety of assets spread around the world or assets (beyond your home) in joint names, a company or trust, an accountant can simplify and ensure you are paying the correct amount.
The Foreign Investment Fund regime, if you have over $50,000 invested overseas, is an area where it can be complex to work out which method leads to the least tax. If investing solely with Kernel, there is very little need for an accountant as we do all the work for you, including the payment to the IRD (if any) at the correct time.
Where can I find my Kernel tax calculation and payments?
At the end of each financial year (during April) we produce an annual tax summary called a PIE Tax Certificate. You’ll find this in the “My Documents” section when you log in to your Kernel account. This downloadable document shows the detail of the amount of income, any credits, tax paid and your PIR. It’s never been so simple!
PHEW. You made it! Not as complicated as you thought, right?
Now that you understand the basics, you might like to check out our comprehensive tax paper focused on foreign investments. Or if you would like to chat with our friendly Auckland-based team, get in touch below.