The classic property mantra is “Location, Location, Location”. Did you know it is so classic it first appeared in print in 1926? So what about shares? Do they have a similar catch-phrase? We don’t think so. But in the case of Kiwis, think it should be…“tax, tax, tax”.
Before we lose you to that repeated, terrifyingly dull three letter word, this blog is not going to get technical. Rather it will point out some of the flaws in ignoring the impact of tax when choosing your investments. And the bonus you didn’t know you needed: a handy tax comparison calculator.
Location 1 – Home or Away
The first tax difference or “location” to note is that NZ investors in NZ companies get a huge performance head start; normally over 1% a year*.
This means that a foreign investment must earn over 1% extra each year just to cover the extra tax. This is because (simplistically) if the NZ company paid tax to the IRD, a shareholder can use that payment as a credit against their own tax responsibility to the IRD. These are called imputation credits.
In comparison, if you’re investing in Australian shares, you miss out on the equivalent of these credits. For the rest of the world, it gets far more complicated.
The lure of the international
Overseas investments can be attractive compared to New Zealand based products for several reasons. There is a great deal more to choose from, investors can pick from some of the world’s best investment managers and headline fees are sometimes much lower.
At an individual company level, the choice is massive. By most estimates, approximately 630,000 companies are now traded publicly throughout the world. This compares to a choice of only 120 in NZ! Plus the global brand names and company stories can be much more enticing…
However, in many cases, you will pay much more tax than if you invested in a New Zealand fund or company. The extra tax may more than offset any saving in manager fees (active or index), leaving you with a lower overall return.
For example, consider a typical kiwi investor who invests in a US-listed Exchange Traded Fund (ETF) via an NZ investing platform. Tax will reduce their long-term return by between 1.5%-2% per annum, due to the foreign withholding taxes and New Zealand’s Foreign Investment Funds (FIF) tax rules. 1.5-2% p.a. compounded over the long term – that can be huge.
If, instead, they invested in the same global equities, but through an unlisted NZ PIE fund, the ‘tax cost’ would be only around 1.4% per annum. This is compared again to the ‘tax cost’ of 0.2% in a NZ equity fund.
Location 2 – Structure
We are not, however, suggesting you only invest in New Zealand – diversification is after all, very important. But the second “location” is what structure is used.
Tax structure matters a lot because choosing the wrong structure, can really cost you in the end. A number of investments available to Kiwis are just repackaging an overseas fund (a wrapper) and are not designed for our fiscal environment.
For example, we famously have no capital gains tax on investment gains if you are not “day trading”. However, overseas investments, including many Australian products, might intentionally be taxing those gains for the benefit of their local investors.
There might also be tax leakage. This is where the withholding taxes on a dividend payment to a foreigner cannot be fully claimed by you as a Foreign Tax Credit. These FTCs are where you, in effect (based on a large number of double tax treaties), tell the IRD you have partially paid the necessary tax to another government, so you don’t need to pay that amount to them.
Location 3 – Effort & Costs
Finally, the third “location”, is the degree of effort required by you. Kernel’s international funds are designed to take care of all the tax obligations, for a consistent 1.40% p.a. in total tax cost.
Your alternative is to utilise the complexity of tax law. You can file a tax return to calculate it yourself, or more likely need an accountant, to choose the best method. The ability to switch FIF calculation methods can reduce the expected annual tax rate paid over a period of years by an estimated 0.20%. But, this comes at a cost. Not only of that paperwork, but also the platform membership fees, brokerage and FX fees and spreads. These more than likely exceed that long term benefit.
While tax is but one consideration of choosing an investment, we suggest it is the key factor to start with. The use of an unlisted NZ PIE fund for investing internationally, provides the greatest certainty and least amount of cost.
There are always scenarios that can be constructed where another method might have advantages. However, the disadvantages and effort required especially over longer time periods should be carefully considered.
If you want to read the full 10-page paper, with more technical explanation, click here. We warn you; there is some jargon and detail.
But what you’ve really been waiting for…The Calculator!
Tax is obviously a complex topic especially when investing internationally. It’s an industry unto itself with the permutations plus different and offsetting impacts that may affect any individual. Naturally, per the standard disclaimer, this is not tax advice. Dual or transitioning tax residencies or holding US person status are immediate exceptions to generally applicable tax rules discussed. In particular, persons who are transitional tax residents or are US citizens should seek specialist advice in relation to their personal circumstances. Care has been taken to ensure the information contained in this guide is accurate at the time of publication however, we give no warranty it is error free. The information is intended as guidance only and the authors accept no liability for claims arising directly or indirectly out of reliance placed on the information contained.
*We assume in this article, you are earning over $70k a year, but the calculator can show there is a still an impact at lower or retired levels of income. A consistent rate of 2.5% dividend is used through the article, but you can also vary this in the calculator.