Investors who inadvertently pay too little tax on their portfolio earnings - including those in KiwiSaver - could be left facing "significant consequences", a leading investment specialist has warned.
Mike Heath, general manager of Wellington-based investment managers InvestNow says many investors risk under-paying IRD by unwittingly selecting the wrong rate under the PIE (portfolio investment entity) tax rules applying to income earned from managed funds.
He says paying tax on a rate (which is known as a PIR or prescribed investor rate) that is too low - or too high - can have significant consequences.
"The Inland Revenue Department (IRD) can recoup any underpaid PIE tax and charge penalties if investors have set their PIR too low," he says. "Investors, however, cannot reclaim any overpaid tax if their PIR was too high."
Heath says because a person's PIR can vary over time, it is easy for investors to forget to change.
"Many firms, including InvestNow, send out reminders to clients each year to check their PIRs, but it is up to individuals to notify providers of any change. Investors can still get burnt if they fail to read the fine print; putting an annual PIR check note in your calendar should be right up there with reminding people when it's your birthday."
He says this is particularly important at a time when housing unaffordability is driving more New Zealanders to look at alternative ways of investing.
Heath says the PIR is the rate PIE fund managers use to deduct any tax on investments returns, including those from KiwiSaver.
He says the PIE rules, introduced in 2007 as a way of helping to ensure the success of KiwiSaver, essentially enable funds to be taxed at the appropriate individual rate rather than making them all swallow the top rate (currently 33 per cent).
"The top PIR rate is 28 per cent which represents a healthy 18 per cent discount on the top marginal rate of 33 per cent," he says. "This explains the tax effectiveness of PIEs for higher income earners; these new rules for managed funds have gone down a treat with providers, investors and even the government."
Currently there are four PIR rates – zero per cent, 10.5 per cent, 17.5 per cent and 28 per cent. In general the PIR should match a person's marginal tax rate with the exception of the top level.
Heath says there is one increasingly popular PIE under which the normal PIR rules don't apply – those listed on the New Zealand Stock Exchange (NZX).
Varying PIR rates are not able to be offered for these listed funds. Instead listed PIEs – which are effectively limited to the NZX-owned Smartshares range of exchange-traded funds (ETFs) – tax all investors at the top rate of 28 per cent.
"For investors already on the 28 per cent, this quirk is irrelevant," Heath says. "But it's highly likely that many Smartshares investors are in lower tax brackets.
"In fact Smartshares products are being actively promoted in some quarters as being ideal for children and low-to-middle income earners but without any up-front warning about the potential crusty tax complications."
Heath says investors on lower PIR rates who invest in listed PIEs can use the excess tax to reduce tax payable on their other income by including the distributions in their tax return.
He says while filing a tax return is a fiddly administrative task for many investors, 'normal PIEs' don't have this additional level of complexity.
Heath's comments come as a 2018 Colmar Brunton survey reveals up to 35 per cent of Kiwis don't understand how investing works while Stats NZ figures show that almost a third of all investments in New Zealand are in houses.
Despite these complexities and issues, Heath says KiwiSaver has helped lift an understanding of investing and he believes more New Zealanders are now looking at other ways of investing.
"Pre KiwiSaver investing was an alien thing to many Kiwis, so it has definitely built confidence in the concept," he says. "And as affordability is putting houses out of reach of many, people are looking to establish other investments alongside KiwiSaver."