Mary Holm: Dreams free, but tax still due

Just as a rose by any other name would smell as sweet, so interest by any other name would still be taxable. Photo / Thinkstock

The Herald recently gave extensive coverage to a financial Ponzi scheme called "Looney Tunes". "Bogus interest" was applied to about $7 million of payouts from that scheme.

The term "Ponzi" has also been used in the past to describe the frantic state of cash flows of failing finance companies. Can the term "bogus" also be applied to interest payments received from these companies during such periods of decline, say two years?

If so, the thought of seeking a refund of the related withholding tax comes to mind. Should I dream on?

Nice try. I expect you could, indeed, call interest payments bogus - if the money was not really interest but funds coming in from new investors.

But just as a rose by any other name would smell as sweet, so interest by any other name would still be taxable.

Says Inland Revenue, "the receipts were in the nature of income that you were entitled to receive in accordance with the contract you entered into". As far as tax is concerned, it's not relevant where the payer got the money from.

Tough on one income

In regard to your column last week, I agree that a family should be able to live on one income, but in reality that is not the case.

If my wife was not working there would be a number of things that we as a family would have to go without. Things such as car running costs not including fuel, internet and phone all bite into the average wage. We as a family do not take holidays.

The costs of things are just outstripping income, but there is not a lot of point in begging the boss too much for a pay rise as I know the business is only just ticking along to keep its six to eight employees going.

I guess it is about what your priorities are in life, and being able to work within a budget.

If people really looked at themselves, yes, savings can be made. But it is whether the ol' Kiwi is prepared to sacrifice their materialistic world.

Indeed. Another reader referred to last week's Q&A like this: "want less and work less, aka aim low and you can get it ... like the dole ... or the ultimate in tall-poppy avoidance!"

That's almost the opposite to what I meant by wanting less and working less. The Q&A was about two-earner families in which one partner would like to put in fewer hours on the job, perhaps to spend more time with the children. Deciding to forgo some material goods for that reason is hardly aiming low - unless you have a warped perception of what is high.

As for tall poppies, I suspect many hold their heads above the crowd partly because they are not caught up with spending hours in shopping malls or desperately keeping up with the Joneses.

Getting back to your letter, the way to make ends meet may not be to cut already tight car, internet or phone budgets. You may need more creative thinking. Read on.

Sharing the burden

Last week's "It takes two to pay ..." prompted me to write.

A few years ago, in a move designed to counter rising costs, my neighbour and I decided to share a few of our infrastructure basics. Things like the lawnmower, the clothes dryer, vacuum cleaner, some food items. We reckon our co-operation is saving us each around $40 a week.

At the same time we've been improving our living spaces. Fresh paint, modern landscaping. This is making our living environment so attractive, it's less tempting to go out and dine with friends. We would rather stay at home to do our entertaining. We're noticing a significant saving.

Our purchases are prudent. For example, I bought a near-new outdoor table and chairs for $200 (new price $700).

We're enjoying the challenge of co-operating at this level. At the end of the month seeing the improved bank balance is a delightful reward.

What a great idea to share "infrastructure" - as long as you have a few rules in place.

There are probably lots of items around most people's houses that are used only every now and then. They might include gardening tools, woodworking tools, or spare furniture used when hosting a crowd. A wander around every house would probably lead to a list.

Of course, it's not much help if you already have the stuff - unless you can sell it. But when it comes time to replace it, you could perhaps club together with neighbours. However, there would have to be some clear understandings about how things are cleaned and maintained, and what happens if somebody breaks something.

Dining in instead of out is also a good idea. Maybe - possibly with the neighbours who share the infrastructure - we could revive the old idea of progressive dinners. You go to one house for nibbles, another for the main course. It's not too much work for each household, more fun than a restaurant meal, and considerably cheaper.

On buying second-hand goods, that's an area where I have to acknowledge the younger generation does much better than we did. That's mainly thanks to the internet, and it's terrific. It's also great the way people pick up free items that others discard in inorganic rubbish collections - in areas where they still let you do it. I hate the change of policy in my neighbourhood.

Fractional reserves

You should know better than to perpetuate the lie told to the general public, which you stated in your fourth answer last week. "Banks cover their costs and make their profits on the difference between what they pay on term deposits and the interest they earn when they lend the money out as mortgages and other loans."

You should be aware of Fractional Reserve Banking, which allows banks to create credit of perhaps 20 times the amount of deposits which they hold. When they lend that credit out, they secure it against property, so that if the borrower defaults, they get the property instead.

As they get interest on such loans, they are getting more than 20 times the rate of interest paid to the original depositor. No wonder they have marble halls and always get richer. They have been conning the public for centuries.

That is, of course, before they start trading in currencies, commodities, futures and derivatives, which are additional ways of creating wealth.

I can't believe that you don't know these things when you hold the regulatory positions you do. Why can you not tell the truth?

If I agreed with what you are saying, I'd be too busy setting up a bank to bother about things like telling the truth in columns. Banking sounds like the ultimate Get Rich Quick scheme. Indeed, I have to wonder why you're not in it yourself - or at least heavily invested in every bank share in sight. Perhaps because you haven't got it quite right.

Under fractional reserve banking, which is used by all New Zealand banks, the bank keeps only a fraction of the money deposited with it, as a reserve. It lends out the rest, or makes other use of it. This wouldn't work if everyone wanted to withdraw their bank deposits at once, but because that doesn't happen - unless there's a run on the bank - banks can use our deposited money elsewhere.

But that doesn't mean they multiply their lending by 20 times their deposits - or any other number.

David Tripe, director of the Centre of Banking Studies at Massey University, puts it simply. "Banks have to get funds in to cover their lending."

Tripe suggests you look at any bank's balance sheet. The loans, plus other assets, have to equal the deposits, plus other liabilities. There's an ANZ National Bank balance sheet on the "fractional reserve banking" entry in Wikipedia that shows this.

I should add that I was a bit narrow in that sentence you quote, because we were discussing term deposits. I should have said "what they pay on deposits from all sources".

Margin lending

Your last reader's comment in last week's column was that there wasn't a mainstream New Zealand bank that would lend money to buy shares at a favourable interest rate.

I have a margin loan with ASB Securities, charging 6.2 per cent, and a limit of $250,000, so there is one bank out there.

Strictly speaking, ASB Securities is not a bank. It describes itself as "a member of the ASB Group", which "is able to work closely with another member, ASB Bank Limited, whose ultimate shareholder is the Commonwealth Bank of Australia. This allows ASB Securities clients to seamlessly combine the exceptional banking services of ASB with the share broking services of ASB Securities."

Free ad about exceptional services aside, the bank and share broker are connected. And Lisa Winkle, managing principal of ASB Securities, confirms what you said: "The ASB Margin Lending product provides investors with the opportunity to leverage their investment portfolios by borrowing against a wide range of approved NZX and ASX listed securities. The current floating interest rate is 6.2 per cent per annum."

A couple of translations: Leveraging means borrowing to invest. And borrowing against listed securities means using the shares you buy as security for the loan - in the same way as a house is security for a mortgage. If you don't repay the loan, the lender claims the asset.

Winkle adds, "Margin Lending is not suitable for all types of investors, so we suggest customers talk to us about the best investment options for them."

I say "amen" to that. If you borrow to buy any investment - shares, property or tulip bulbs - and the price rises, you do particularly well. But if the price is down when you have to sell, you do particularly badly. And share prices fall frequently. This is not for the faint-hearted, or the financially stretched.

A couple of other readers wrote in about ways to borrow for share investing, but I've decided not to go into it here, as it's too risky for the vast majority of readers. If you want to take part, and you're not financially sophisticated enough to find out how to do it elsewhere, I suggest you have second thoughts.

Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her website is www.maryholm.com. Her advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.