KEY POINTS:
Everyone owning a portfolio of investments, or thinking about acquiring one, should try to have at least a basic understanding of the recent radical overhaul of tax on investments if they want to minimise their tax.
And they must consider the tax impact on all their income and
investments - even those shares they bought years ago and tucked away in the bottom drawer or the portfolio they inherited and have left untouched.
The introduction of KiwiSaver was, in part, the catalyst for the changes. Recognising the importance of systematic savings in quality diversified portfolios, the Government introduced KiwiSaver, which also prompted it to address investment tax anomalies. The changes mean the tax environment for most investors is now far more favourable. Overall, by reducing the amount of tax payable, the changes will increase the returns for most investors.
However, the tax on investments has potentially become more complex for DIY investors and some people may suddenly have to give their previously simple, low-maintenance investments a lot more attention.
Those investors whose money is in professionally managed funds will have the complexities of the tax position taken care of by the fund managers. Those investing directly or with a mixture of DIY and managed funds - and many people fit into this category - may not even have considered the implications. It is important to look at your investments as a whole. Why would you want to pay more tax than you need to?
The first tax changes for managed-fund investors came into effect in April, with more to follow in October, coinciding with the first wave of KiwiSaver contributions.
We will also have to become familiar with three new acronyms: Fair Dividend Rate (FDR), Portfolio Investment Entity (PIE) and Personal Investment Rate (PIR).
FDR refers to taxable income from international investments.
PIE refers to taxable income from local investments.
PIR refers to the rate at which investors will be taxed.
On the international front, the relative benefit of directly holding shares in certain overseas countries (the grey list countries of Australia, the United States, Britain, Japan, Norway, Canada and Germany) has been removed.
The Government has introduced a new method of calculating the taxable return on all international shares, which, over the longer term, should be significantly lower than the current taxable level. The introduction of the Fair Dividend Rate (FDR) regime began on in April.
International share investments are now taxed only on up to 5 per cent of their market value, regardless of the actual income or gains earned.
For example, if you had international shares worth $100,000 on April 1, and that increased in value to $110,000 by March 31, 2008, you would pay tax only on $5000, or 5 per cent of the initial $100,000.
In the next year, $110,000 would be your starting value, so you would pay tax on $5500. For direct investors, this FDR income is taxable at your marginal rate of tax.
For managed fund investors, FDR income is taxed at 33 per cent, but this changes to the variable PIR rate under the PIE regime.
For locally held investments, the tax breaks appear even more generous. The second phase of the changes to tax on investments is the Portfolio Investment Entity (PIE) regime, which comes into effect on October 1, removes the tax on capital gains from most New Zealand and Australian shares - regardless of how actively a fund trades in these shares.
This makes investments in most Australasian funds very attractive from a taxation perspective. But individual active investors who buy and sell shares directly may still incur capital gains tax.
The PIE regime allows managed fund investors to be taxed at their own marginal rate, as opposed to the current flat 33 per cent. An additional sweetener for PIEs is 19.5 per cent tax band has been significantly widened.
Furthermore ,the top rate has been capped at 33 per cent, even for those in the top income tax bracket of 39 per cent. From next year this capped tax rate is further reduced to 30 per cent. Investing in passive funds is now less attractive because the previous beneficial treatment for these funds has been removed.
It is important to understand how each of these affects the others. Holding the wrong mix may not make you worse off, but there can certainly be benefits to structuring your portfolio properly.
Those earning income from salary or wages and holding investments under the PIE regime will have their investment income taxed at their individual PIR.
The changes mean some of the existing investment vehicles become tax effective and make other conventional ways of investing, such as direct New Zealand fixed interest, far less so.
Altering investments to minimise tax is a good idea, but you should consider your entire portfolio, your goals and objectives, and your risk profile. Minimising tax is not a strategy, nor is simply putting money into KiwiSaver. If you have a financial adviser they should be talking to you regarding your overall tax position.
If you don't have a financial adviser, now would be a good time to consult one. You have nothing to lose and you may develop an overall strategy to ensure you achieve your goals and in a more tax-effective manner. Don't leave it until the end of this tax year to find out you have overpaid your tax - PIE is a final tax and that means no refunds.
* Joy Scandlyn is the author of Retire Right: A New Zealand guide to planning for financial security and prosperity in your retirement
