The Incoming Trust Tax Wave: How PIEs Can Be Lifesavers for NZ Trusts

In a matter of days, many of New Zealand's trusts will face a change that's set to increase their annual tax rate by a whopping 18%. This shift, impacting nearly 50,000 trusts, is tabled to hit with the new financial year starting April 1, 2024.

A leap in the trustee tax rate from a flat 33% to a flat 39% targeting NZ trusts with trustee income over $10,000 —those that significantly contribute to the sector's tax pool.

The eye-watering figures don't stop there; according to the Finance and Expenditure Committee, the top 5%, or roughly 9,000 of 177,000 trusts, accounted for nearly 80% of this tax income, paying $13.3b of a new estimated total trust tax of $17.1b.

This adjustment is designed to align the trustee tax rate with the top individual marginal rate, a move initiated by the former Labour government without the progressive income tax thresholds afforded to individuals. The introduction of the 39% tax rate in 2021 led to a ballooning of taxable ‘trustee income’ from $11.4 billion in 2020 to $17.1 billion in 2021, as per Inland Revenue (IR) data.

This shifting from allocated beneficiary income back to trust income maintained a maximum tax rate of 33%. The benefit of that retained income is now gone.

As a result, many investors, accountants, lawyers, and wealth advisers have been reviewing their and their client asset base to advise the best course of action.

The result is a flock towards Portfolio Investment Entities (PIE) in particular, managed funds, that benefit from a capped maximum tax rate of 28%.

Assets that can be comparably shifted into the PIE regime can save investors up to 40% on their tax bill, equating to 0.55% of the asset value per annum in a majority of years.

The initial tax proposal presented a flat trust tax change to 39%, up from the 33% on trustee income. Many trusts, tax advisers, and industry bodies highlight that most trusts don’t have high income (often due to beneficiary income distributions), with calls to create exemptions to limit the over-taxation and financial burden this would create on many.

This week, Finance Minister, Nicola Willis welcomed the proposed changes, which emerged from the Parliament’s Finance and Expenditure Committee's review of the Taxation (Annual Rates for 2023–24, Multinational Tax, and Remedial Matters) Bill.

The revisions aim to balance the tax rates for high-income individuals and trusts, ensuring fairness across the board.

“We broadly agree with the proposal in these submissions that trusts with income below a de minimis threshold be taxed at the lower rate… (sic) These amendments would mean that, for the 2024–25 and later income years...(sic):

• Trusts with trustee income up to and including $10,000 (after deductible expenses) would continue to be taxed at 33%

• Trusts with trustee income of more than $10,000 (after deductible expenses) would be taxed at 39%.”

The 39% tax change is expected to impact approximately 49,000 of New Zealand's 400,000 trusts, with the rest remaining unaffected.

Additionally, the committee has recommended measures to simplify tax compliance for estates and trusts, especially those set up for disabled individuals, and exclude certain trusts from the heightened tax rate.

The upcoming shift in tax regulations could have a profound impact on the tax obligations of New Zealand trusts, particularly those that generate a significant portion of the income. With $470 billion in assets distributed among 150,000 entities, trustees are now critically evaluating their asset allocation, distribution strategies, and the fundamental purpose of their trusts.

Of note, investments in shares have seen a substantial increase, more than doubling over the past decade to 2022. The Inland Revenue's Trust Disclosure report from November 2023, covering the 2022 tax year, highlighted an impressive $91 billion invested in shares.

But here's the silver lining—trusts can potentially mitigate some of this impending financial impact. How?

By strategically shifting some investment assets into funds with a PIE structure. These benefit from a top tax rate of 28%, a game-changer that's already enticing both investors and advisers.

This pivot not only shields trusts from the full force of the tax hike but reduces their tax obligation and also underscores the agility and foresight needed in today's investment landscape.

Although the $91 billion also includes ownership of private businesses, which are ineligible for the PIE regime, there exists a considerable pool of publicly traded assets including those listed on the NZX, but more commonly abroad via major markets. These assets are often held directly or through foreign funds and Exchange-Traded Funds (ETFs).

With the expansion of PIE-structured funds, many of these publicly traded assets can now be aligned with a similar strategy in a PIE.

This approach places assets into a well-diversified fund that benefits from a capped tax rate of 28%, offering a tax reduction of up to 40% in average and above-average years compared to the 39% tax rate on directly held shares.

This presents an efficient and effective way to minimise the overall tax burden, while still achieving the same underlying investment objective.

Important to note, is that investors, wealth advisers, and accountants, need also to pay attention to the Foreign Investment Funds (FIF) tax obligations.

FIF tax targets New Zealand tax residents with investments in offshore entities not registered on the NZX or ASX, levying tax on the year-over-year appreciation of these assets, not merely the dividends or income they generate.

Among the various methods for calculating this tax, PIE structured funds are mandated to use the Fair Dividend Rate (FDR) method, which assumes a 5% “deemed dividend” based on the portfolio's value.

• For a 28% PIR investor, this creates a 1.4% annual tax obligation, less the correct capturing of foreign tax credits for dividend withholding taxes.

Ahead of the 1st of April 2024, numerous investors are strategically transitioning their international investments (such as direct stocks in companies like Apple, holdings in Australian Unit Trusts, or shares in foreign-listed ETFs) to PIE-structured funds.

Trustees and investors are cognisant of the benefit of holding assets via the PIE regime, however, if they retain their foreign assets and then decide to sell part way through the year and then move into the PIE structured funds there is the potential to end up with a higher tax bill – paying tax under the foreign investment fund rules using the FDR or CV method up until the point in time they are sold, then again for the remainder of the year under the periodic FDR method once moved into the PIE.

As a result, a timely assessment and consideration of foreign assets is also needed as part of any investor's strategic move into PIEs. It is not a 31 March deadline, but something decision-makers and advisers, may not want to leave too long.

Outside of international assets, the trust tax changes also act as a timely reminder for investors to consider how they are managing their local cash assets. With a growing range of cash and enhanced cash fund options, there are now attractive ways to generate higher yield while also benefiting from the PIE-capped tax rate of 28%, a material saving vs having cash taxed at 39%.

Examples of tax impact on cash can be found here.

Kernel is at the forefront of investment innovation in New Zealand, championing this transition with a robust offering of 23 PIE funds that have also minimised international tax leakage for investors, by focusing on the fullest capture of foreign tax credits.

Tailored for the diverse needs of today’s trusts and investors, Kernel offers a broad mix of funds across core asset classes, including cash, bonds, and shares.

Whether it’s navigating the tax changes or optimising investment strategies, our suite of PIE funds stands ready to support your financial needs without compromising on quality or diversification.

As the trustee tax rate surge looms, the strategic importance of PIEs has never been clearer. Kernel’s commitment to providing forward-thinking investment solutions ensures that New Zealand trusts can confidently navigate this tax transition, potentially turning a fiscal challenge into a strategic advantage.

Kernel can support trusts to open accounts directly, or you can leverage our range of low-fee funds via a wealth adviser. Contact us today for more information.

The information and opinions in this blog are based on publicly available sources that Kernel believes are reliable, accurate and up to date. Kernel makes no representations or warranties of any kind as to the accuracy or completeness of the information contained in this publication and disclaim liability for any loss, damage, cost or expense that may arise from any reliance on the information or any opinions, conclusions or recommendations contained in it, whether that loss or damage is caused by any fault or negligence on the part of Kernel, or otherwise, except for any statutory liability which cannot be excluded.

All opinions reflect Kernel’s judgment on the date of this publication and are subject to change without notice. This disclaimer extends to any entity that may distribute this publication. The information in this publication is not intended to be financial advice for the purposes of the Financial Markets Conduct Act 2013, as amended by the Financial Services Legislation Amendment Act 2019. In particular, in preparing this document, Kernel did not take into account the investment objectives, financial situation and particular needs of any particular person. Professional investment and taxation advice from an appropriately qualified adviser should be taken before making any decision.