The new PIE tax rules, which came into effect yesterday, have much to recommend them. Geordie Hooft, a taxation partner at Grant Thornton, looks at some of the issues.
New tax rules could give investors a larger slice of the pie. The Portfolio Investment Entity, or PIE, aims to apply a kinder rate to investments – 30 per cent instead of 39 per cent for top earners. The PIE compares with the traditional Collective Investment Vehicles (CIVs) which have been used for investment for a long time.
By pooling funds, investors are able to spread their risk through diversification and they are also able to participate in opportunities that might not have been possible at an individual level. However, CIVs suffer from a couple of disadvantages. Firstly, they are taxed on "capital" gains because they are generally in the business of trading shares, making such gains taxable. In contrast, a person holding shares directly is usually taxed only on dividend income. Secondly, the rate of tax paid by a CIV is generally based on the company tax rate, currently 33 per cent. For lower-income investors, this makes investing through a CIV rather unattractive.
The aim of the PIE is to better protect the interests of those investing in CIVs so that they are no worse off than had they invested directly. In many cases, investing through a PIE could be better than investing directly. The introduction of the PIE rules is tied in with KiwiSaver, which started on July 1. All KiwiSaver funds will be PIEs. How will it work?
PIEs will pay tax, based on the applicable rates of tax advised by the investors in the fund. The top rate of tax that can be applied is based on the company tax rate of 33 per cent (which is being reduced to 30 per cent from April 1 next year).
Investors need to advise their fund manager of their Portfolio Investor Rate. This is based on the following criteria:
# Nought per cent for charities, PIEs, companies and superannuation funds. This rate also applies to trusts, unless they elect to use a rate of 30 per cent.
# 19.5 per cent for individuals, as long as they had in either of the two years immediately before the current year:
(i) taxable income of $38,000 or less; and
(ii) a total of $60,000 or less in taxable income and PIE income.
# Thirty per cent (the new rate) for all other taxpayers. Effectively, this will be individuals who do not meet the criteria for the 19.5 per cent and trusts choosing to use this rate. Investors on 0 per cent will still need to include the income they receive from a PIE in their own tax returns, along with any tax credits attached to that income.
For other investors, the tax is paid by the PIE and does not need to be included in their personal tax returns.
This has the following advantages:
# Investors earning $38,000 or more (from April 1), will benefit from the lower tax rate applied to their PIE income.
# The investment income earned through the PIE will not be factored into calculating entitlements to Working for Families, or child support or student loan obligations.
Any other social benefits that depend on declaring taxable income will be similarly unaffected by PIE income. PIEs will also be able to take advantage of the same tax rules introduced in April this year relating to the taxation of investments in foreign companies. (This calculates the taxable income derived from investment in companies other than New Zealand and certain Australian companies as 5 per cent of the opening value of the investment.
Direct investors have the option of using the actual gains as the amount of taxable income if that amount is less; PIEs will not have that option).
Here are a couple of examples.
Deborah is a solicitor earning $100,000 a year. An investment in her own name earns income of $20,000 a year. Based on her effective marginal tax rate of 39 per cent, she would have to pay tax of $7800 on the investment income. If her investment was held via a PIE, it would be taxed at 30 per cent, with $6000 payable. The $20,000 would not be included in calculating her student loan repayments.
Murray, an apprentice welder earns $35,000. He has invested an inheritance in a managed fund and the income from that of $15,000 is taxed at the fund's rate of 30 per cent, resulting in tax payable of $4500. If Murray's fund qualifies as a PIE, and he advises the fund that his investor rate is 19.5 per cent, his investment income will be taxed at that rate, resulting in tax payable of only $2925. Further, he will not have to include the $15,000 in his Working for Families application.
Trustees that have investments in a PIE have to decide which investor tax rate to use: 0 per cent or 30 per cent.
Choosing 0 per cent means the PIE income will be taxable to the trust at the trustee rate of 33 per cent, unless it is distributed by the trust to beneficiaries to be taxed at their marginal tax rates. There would be an advantage in doing this if there are low-income beneficiaries on a 19.5 per cent tax rate.
Choosing 30 per cent means that the trust will not have to include the PIE income in its tax return.
A beneficiary of a trust receiving PIE income also does not have to return that income in their tax return. This is an advantage if income is to be retained in the trust or distributed to beneficiaries on higher incomes.
There is a warning, however, that choosing the 0 per cent rate could result in you becoming a provisional taxpayer.
Not any fund can be set up as a PIE. Special rules apply. For instance, the PIE must be a company, superannuation fund or group investment fund. It must be resident in New Zealand. The PIE must have at least 20 unassociated investors for each class of investment. Additionally, there are rules about what a PIE is allowed to invest in – 90 per cent of its investments must be "passive", such as land or financial arrangements (for example, deposits and share investments).
Given the many investors that a PIE will have, each with their own particular investor rates, the tax calculations for a PIE are extremely complex.
The default position is that PIEs need to carry out tax calculations, based on an allocation of income and expenses, on a daily basis. PIEs will also need to deal with reallocating investment units to maintain fairness between investors.
# Geordie Hooft is a partner, specialising in taxation, at accountants and business advisers, Grant Thornton. ghooftgtch.co.nz
