So overall, I can invest in a rental for 0 per cent tax or shares/bank deposits for 30 per cent tax. A huge difference.
A: You're ignoring several key points. We need to compare apples with apples. That means, firstly, setting aside buying your own home. That's different from any other type of investment in that you get tax-free accommodation. For that and several other reasons - not all of them financial - "investing" in your own home is a good deal.
Rental property, however, is comparable with investments in bank deposits or shares.
I'm sure I've never said that bank deposits get equal tax treatment to rental property. As you say, nominal - not inflation-adjusted - interest is fully taxed. There are some good arguments for taxing only interest earned above inflation, but that's another story. As things stand, bank deposits are taxed more heavily than property.
But what about shares? That's the investment I do sometimes say is taxed in much the same way as property, as follows:
• On shares, the company usually pays tax on its profits. Then, because of dividend imputation, shareholders don't pay any further tax on dividends they receive. And - unless a shareholder is a regular trader - they don't usually pay tax on capital gains if they sell the shares at a profit.
• On a rental property, the owner pays tax on rental income. And again - unless the investor is a regular trader - they don't usually pay tax on capital gains if they sell at a profit.
But, you might say, landlords often don't end up paying any tax, or much tax, on their rental income - and many even get a tax deduction against their other income. That's because they can deduct all sorts of expenses - rates, insurance, maintenance, perhaps property management expenses, and interest if they have a mortgage.
True. But they get those deductions only because they have to spend way more money than their deductions will cut their tax. A $100 deduction cuts tax by $33 or less. The whole investment makes sense only if the landlord later sells the property, not only for more than they bought it for, but quite a lot more.
The extra gain needs to make up for the expenses over the years, plus compensation for the fact that the landlord spent the money in earlier years and got it back later on. They lost the use of that money in the meantime - money they could have earned interest on.
What this all means is that a landlord who doesn't sell at a hefty gain would have been better off if they hadn't ever bought the rental property. It's all quite risky, given we don't know what will happen to property prices.
I know, I know, just this past week the ASB Housing Confidence Survey showed expectations of house price rises are the highest in the history of the survey. But the crowd has been dead wrong before. I'm no forecaster, but I would be worried if I were counting on house prices to keep rising.
We've strayed a bit from the comparison between rental property and shares. In a share investment - whether via direct holdings or through a share fund - expenses are usually much lower than dividends. So it doesn't matter so much if the shareholder makes little or no gain on selling the shares. They've already received some return on their investment.
In some cases - although it's much less common for shares than property - a share investor borrows to invest. In that case, the interest they pay is deductible in the same way as mortgage interest.
One further point: If you invest in shares via a portfolio investment entity, or PIE fund - which is what I recommend for most people - the top tax rate is 28 per cent, compared with 33 per cent on rental income. So arguably shares in a PIE are tax-favoured.
The main point, though, is that on both rental property and shares, income minus expenses is taxable - with the tax on dividends usually paid at company level. And on both investments capital gains on selling usually are not taxable. Neither has a clear tax advantage.
KiwiSaver tax credits
Q: I am now 65 and able to withdraw my KiwiSaver funds. One question in the withdrawal application form raised my interest and that was whether I have been a New Zealand permanent resident during the period of my membership. I have.
However, I know of a young woman who joined KiwiSaver in 2007 but has now been living overseas for several years, during most of which time she has continued contributions to her KiwiSaver account and has received tax credits.
I have now managed to ascertain that, if a KiwiSaver member contributed and received a tax credit while not a New Zealand resident, then on withdrawal IRD would claw back that portion of the accumulated tax credits which related to the period of permanent non-residency. That is not my issue.
My interest was whether the IRD would also claw back any revenue (or losses) which the accumulated tax credits had derived over the years. I have asked several providers. Some could not answer and others gave conflicting answers.
I also asked whether, if revenue or losses on accumulated tax credits were clawed back, would IRD make an adjustment in respect of income tax that had been paid on revenues over the years. No one could provide me with an answer.
What is your understanding of the situation?
A: I didn't know, so I asked Inland Revenue.
The spokeswoman said KiwiSaver members are required to tell their scheme provider when they no longer live in New Zealand. "It is the responsibility of scheme providers to determine member tax credit eligibility and to submit member tax credit claims to Inland Revenue on behalf of their members."
She goes on to confirm what you say, as follows. "On withdrawal, a member is required to complete a statutory declaration, which has a question on residency. If it is determined the member was not resident and present in New Zealand for some, or all of the period of the membership, then any member tax credits that were paid during the time the member was out of the country are required to be returned to Inland Revenue."
However, the clawback doesn't include returns earned on those tax credits. And therefore, predictably, there are no adjustments made for tax.
"Hmmm," I said to the spokeswoman, "It seems to be in people's interest to continue to get tax credits while overseas. While they lose the tax credits themselves later, they will still benefit from returns earned on that money in the meantime. Any comment on that?"
After repeating that people are supposed to tell their providers on leaving to live overseas, the spokeswoman added, "Legislatively, a member tax credit claim should not be made if a member is not eligible to receive a member tax credit."
Where does this leave us? If the young woman wants to maximise her wealth - and ignore ethical considerations - she can probably continue to keep her overseas residency a secret from her provider. But she is ripping off New Zealand taxpayers.
Also, nobody knows how the rules might be changed before she withdraws her money in retirement. Maybe by then Inland Revenue will claw back not only the tax credits, but also returns earned on them, plus a penalty.
Student allowance
Q: A friend was asking me if they should take out a trust as their children will soon start at university and their income is too high for the student allowance. But I recently heard the rules may have changed and those families with a trust are now excluded from student allowances. Is this correct?"
A: It depends. But first, some background for other readers.
For students under 24, the Government looks at their parents' income before giving them a student allowance - which, unlike a student loan, doesn't have to be repaid. It's like a gift to help support the student.
If the student is living with his or her parents, and the parents' income is more than $83,662 a year, the student can't get an allowance. If the student isn't living with parents, the cutoff is $90,771. The idea is that parents on higher incomes "could reasonably be expected" to support the student. If they don't, the student can always get a loan.
So what about your friend's thinking? "Families with trusts are not automatically excluded from student allowances," says a spokesperson for the Ministry of Social Development. "It will depend on whether there are income-earning assets in the trust and the amount of income."
He adds that any income a student receives from a family trust "has always been included in assessing entitlement to a student allowance.
"We can also assess whether parents have taken steps to deprive themselves of income (for example, by diverting income through a trust or a company). In these cases, the income can be added back into the parental income assessment to work out if a student is entitled to a student allowance."
It sounds as if that's what your friend had in mind. And in case they are planning some fancy moves, read on.
"In 2011, the definition of income was broadened to include 'attributable trustee income' from family trusts as part of the income test for parents," says the spokesperson.
"This means that all trust income for the year that hasn't been distributed as beneficiary income will be regarded as 'attributable trustee income'. As attributable trustee income is considered parental income for student allowance purposes, parents will have to declare this. This may put the parental income over the limits and mean the student is not eligible for a student allowance."
The basic idea is that "people must first look to their own resources before seeking assistance from the State", says the spokesperson. Fair enough too.
• 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 opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's 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.
