Taxation issues
Investing
“When we had decided to transfer our UK pensions to New Zealand it was difficult to find out the costs involved in transferring them and what the implications were to us relating to the changing regulations in the UK.
We chose Lyfords to help us with transferring our pensions because they provided clear advice that enabled us to make an informed decision on the value to us of transferring our UK pensions.
Lyfords stood out from the other pension providers because their experience was obvious which was reflected in their clear and valuable advice.
We now know exactly where our wealth is located and feel we have far better control over it for our future benefit.
What we like most about Lyfords is the clear communication on the process involved and progress along the way. We found Lyfords to be very easy to deal with and they made the entire transfer process worry free.”
What are the FDR and CV taxation methods?
In constructing a diversified portfolio around 60% of your investment may be held overseas. Investments held outside of New Zealand and direct Australian share investments fall under the FIF (Foreign Investment Fund) regime.
There are advantages and disadvantages based on how your portfolio is constructed.
PIE Funds
Foreign investments in Portfolio Investment Entities (PIE) funds are taxed under FDR (Fair Dividend Rate) method. Examples of PIE investments are Kiwisaver funds, superannuation schemes.
The investor declares their taxation rate 0% (only applicable to Family Trusts), 10.5%, 17.5%, 28%. This is the PIR (Portfolio Entity Rate). The rate is based on your highest income in the previous two years. For income earners that fall in the 30% or higher marginal tax range there is an advantage to investing via a PIE fund. However, this is not straight forward, see the discussion around FDR and CV below.
Since the 2021 taxation year the IRD is now refunding any overpaid PIE tax. Previously this was not refunded. They will also request a payment if the rate is under declared.
The major advantages for PIE funds is when your marginal tax rate is 30% or higher and taxation is managed by the fund manager.
FDR Method
Effectively the part of your portfolio that falls under the FIF regime can be taxed under FDR or CV. For PIE funds its compulsory that investments are taxed under the FDR method.
Effectively (simplifying) with the Fair Dividend Rate (FDR) method the taxable income for funds that fall under FIF rules is calculated as 5% of the opening balance on the 1st April.
For example, lets assume your portfolio balance on the 1st April was $100,000 and at the end of the tax year 31 March the balance was $110,000 (a 10% growth). The tax is effectively calculated based on 5% of the opening value, $100,000 which is $5,000. This is treated as taxable income and you pay tax at your marginal tax rate on this amount.
If the funds that fall under FIF grow by more than 5% you are winning, if less than 5% you are disadvantaged.
CV Method
With the CV (Comparative Valuation) method your taxable income for the part of the portfolio that falls under FIF rules is calculated as the closing value on 31 March minus the opening value on 1 April the previous year.
For example. If the opening value was $100,000 on 1 April and the closing value on 31 March the following year was $110,000 (a 10% gain). The taxable income would be $10,000. Your tax liability is based on this as being your taxable income for investments that fall under the FIF regime.
If your balance on 1 April was $100,000 and on 31 March it was $90,000 (a 10% fall) then your taxable income would be negative $10,000. Unlike investment properties the IRD deem this as $0 and losses cannot be carried forward.
In the 10% gain scenario the investor would be better off calculating their tax on FIF investments under FDR. In the 10% loss scenario the investor is better off under CV calculations.
The advantage of non PIE investments
With investments that are not held in PIE funds and that fall under FIF rules you can change each year between the FDR and CV calculations based on which one gives you the lower taxable income.
MyFidicuary in their taxation paper May 2023, showed the ability to switch FIF calculation methods can reduce the expected annual tax rate paid over a period of years by an average of approximately 0.60% (compared with choosing or having to stick with the Fair Dividend Rate method every year as occurs with PIE funds).
The Lyfords advantage
For clients with portfolios held in non-PIE investments and held on a custodial wrap platform each year in May we email a paint-by-numbers guide to completing your tax return.
By using the myIRD system many of the input numbers are automatically included and for the FIF calculations we provide a simple fill in the numbers guide with examples.
Where you have a more complex tax structure like owning rental properties or a business then we do recommend using an accountant.