When tax matters

Whilst tax shouldn't be the sole driver of an investment strategy, it can materially shape your clients' investment outcomes. In this blog, Tax Consultant Katrina Scorrar, Principal at JAS Accounting and Advisory explains the specific situations where tax can meaningfully influence investment decisions.

For clients on the top tax rate of 39%, a multi-rate or listed PIE will allow them to cap the tax cost at 28% of the taxable income received, providing a potential tax saving of 11% per year versus investing direct.

For clients with tax losses the type of investment income and the tax credits generated can become important considerations.

For example:

• If clients have tax losses they may not be able to use foreign tax credits. So the value of those credits may be lost, while at the same time foreign income still reduces the loss balance.

• Imputation credits received on dividends are not able to be refunded, they can only be carried forward as a tax credit to use in the future (and therefore lose value over time).

• PIE income for individuals has a minimum Prescribed Investor Rate (PIR) of 10.5%. Tax losses cannot be utilised against PIE income. This means clients could be paying tax on investment at 10.5% (or higher if they haven’t advised the optimal PIE rate) and unable to utilize the tax losses.

Transitional tax residents are typically people who have recently moved to New Zealand. For a set period after arrival, any investment income earned overseas is exempt from New Zealand tax. While this exemption is in place, investing in offshore assets or in foreign-investment zero-rate PIEs can provide considerable tax savings compared with most local investment options.

Although portfolio investment entity (PIE) funds are usually tax-efficient, they are taxed at a single flat rate. In some circumstances this flat rate can exceed the total tax that would apply if the same income were earned directly and taxed at marginal rates.

For instance, a client who receives $75,000 a year solely from PIE income faces a flat 28 % rate, resulting in $21,000 of tax. If that same $75,000 were generated through direct investments, progressive marginal rates would apply and the tax would fall to about $15,670

PIE funds can be especially tax-friendly when a client has a one-off jump in income, say, a taxable gain from selling property under the bright-line rule - because the Prescribed Investor Rate (PIR) is calculated using the lower of the client’s taxable income from the two previous tax years. That means the PIR does not automatically rise in the year the extra income is earned.

The opposite is also true: if a client’s income drops for a single year, the PIR stays unchanged until the start of the next tax year, at which point it can reset to the lower rate and remain there for up to two years.

When you look at tax from both the New Zealand and U.S. perspectives, the way each country treats investments—and especially how tax credits can or cannot be used—often pushes your overall tax bill higher. Income from PIE funds and New Zealand shares is a common trouble spot: the PIE credits and imputation credits that reduce your New Zealand tax usually cannot offset the U.S. tax on the same earnings, so you may end up paying tax twice.

PIE funds also raise added complexities under U.S. tax rules, which in turn drive up compliance costs. An investment that appears tax-efficient in New Zealand can therefore lose much of its appeal once U.S. tax and reporting obligations are taken into account. Because of these cross-border pitfalls, getting specialised advice is essential.

The home‑country tax treatment and the ability to utilise New Zealand tax credits can significantly impact the total tax cost. This depends on where the client is tax resident and highlights the importance of considering worldwide obligations, not just New Zealand.

Because most children have little or no other income, you can often lower their overall tax by making the most of their lower marginal tax rates and any credits attached to their investments.

That typically means favouring investments that are taxed at the correct rate, such as a PIE that uses the child’s PIR or those that provide refundable credits, like resident withholding tax on interest. These are generally more advantageous than relying on imputation credits attached to dividends.

The FIF rules effectively operate as a wealth tax, imposing a liability even when the investments generate no cash income. As a result, investors may have to sell assets to pay the tax and to cover the often-significant compliance costs of calculating FIF income.

For more on how FIF tax works, you can read this blog.

Understanding the impact of tax and any associated compliance costs is important , but as you know, it's just one factor.

Disclaimer: This is general guidance for financial advisers and is not tax advice. Individuals should obtain advice specific to their circumstances.