KEY POINTS:
One year on and the Government's fair dividend rate (FDR) rules are about to hit investors right where it hurts: in the wallet.
The rules affect two groups of people: first, investors with direct holdings of overseas shares, excluding certain Australian ones; second, people who invest in managed funds that are domiciled in New Zealand and invest in overseas equities.
The first group - direct investors in equities - only pay tax according to the value of their holdings. If the capital value of their investments has grown 5 per cent or more, they have to pay tax on that 5 per cent figure. Below that, they pay tax according to the actual return. So if their return in the tax year just passed was zero or negative, they have no taxable income.
The story is different for fund investors: they pay 5 per cent on the value of their funds over the year, calculated daily, says Leo Krippner, head of investment strategy at AMP Capital.
That means they lose out big time when returns are negative.
In most cases, that includes KiwiSaver funds, meaning that as well as being hit with a capital loss in their first year, investors are going to have to pay tax nonetheless. A few will escape due to their balance dates being later in the financial year, says Krippner. But that won't be the case next year.
Most direct investors won't be paying tax on their investments this year, but they don't get off scot free: many will need to pay an accountant to find out that they have no tax to pay.
And, if the markets rebound next year to the highs of early 2007, investors will be deemed to have made a taxable capital gain, even though their investments were just regaining lost ground.
Ironically, a third group - those whose overseas investments cost less than $50,000 - are worse off than the wealthier group that this tax was aimed at. Because their investments fall below the $50,000 threshold and are exempt from FDR, they are taxed on any dividends, as they were in the past. Had the investors' holdings exceeded the threshold, they would not have had to pay any tax on their investments this year because of the capital loss they have almost certainly experienced. "Surely another mistake of the rules," says Mike Newton, director of SELECT Asset Management.
Some investors will be able to complete their own tax return, but those with Australian shares may be forced to pay for expert advice because, in many cases, it is not clear whether shares from that country will fall under FDR or be taxed on dividends, as local shares are.
To get an exemption, the equities must be Australian resident, maintain franking accounts and be included within an approved index of the Australian Stock Exchange.
The rules are so complex, some investors and industry people are calling it a bureaucratic muddle. Some Australian equities are exempt but the IRD doesn't publish a list of exempt companies.
Stockbroker ABN Amro Craigs, which has produced a list for its clients detailing more than 400 companies, says it was a painstaking effort that took hours of work and will need to be updated regularly.
Just to muddy the waters further, there are other exclusions to the FDR rules: investment in Guinness Peat Group and New Zealand Investment Trust for the next few years; venture capital investments in a "grey list" company, previously New Zealand-resident or with significant New Zealand business (maximum 10-year exemption); and investments in Australian share/units covered by the Australian exemptions acquired through an employee share purchase scheme.
Some overseas private superannuation schemes, such as "registered" Australian schemes, are exempt. Others are not.
"These rules are just a joke, they are so convoluted and complex," says Newton. "It was all about the Government being unhappy that they weren't participating in retained earnings of overseas companies.
"Non-compliance is going to be widespread," he adds, because investors don't understand the rules and some object to paying what they see as a capital gains tax that isn't charged on other investments.
The fair dividend rate tax rules, along with a new portfolio investment entity (PIE) tax treatment of investment funds, were supposed to make funds more attractive to investors.
But this year, those who chose to invest by this route are being hit harder than they would have been had they invested directly. In a "normal year" where overseas equities rose in value, says Paul Dunne, tax partner at KPMG, funds would have been more attractive than direct holdings.
The rules are so confusing that even the IRD had them wrong until The Business Herald pointed out the mistake. Its IR6G form, published last month, was last week still referring to the old rules where investors were exempt in respect of seven "grey list" countries.
There is some help. NSA Tax is selling a product to accountants to help them do the calculations.
The IRD's website (see Links below) has a step-by-step questionnaire to determine if investors are liable for FDR and a calculator which works out the income in New Zealand dollars from an equity or portfolio, taking into account any acquisitions or disposals over the year.
Meanwhile, the IRD is on the verge of publishing new rules for investors with overseas equities, which are expected to mean a greater level of disclosure.
Diana Clement is an Auckland-based personal finance and investment writer ent writer
