KEY POINTS:
Smart investors who embrace the new tax changes for managed funds could be a whole lot better off.
Financial professionals have found ways in which higher-rate taxpayers in particular can benefit from the portfolio investment entity (PIE) rules - which provide tax breaks on managed fund investment.
By earning their investment income from PIEs, taxpayers may be able to lower their income on paper and qualify for Working for Families and other means-tested benefits.
The new rules scrap the tax on realised and unrealised capital gains for managed funds that become PIES and reduce the top rate of tax paid by investors on fund income to 33 per cent (30 per cent next financial year) - or 19.5 per cent for investors on that marginal rate.
All existing managed fund investors will benefit if their fund gets PIE status, says Jeff Matthews, senior financial adviser at Spicers Wealth Management, because they'll no longer have tax on realised and unrealised capital gains taken off at source.
To put the change into perspective, investors in Fisher Funds' NZ Growth Fund have received an annualised return of 18 per cent after tax and fees since the fund launched in August 1998. Under the PIE system, that would have been 25 per cent a year, said general manager Glenn Ashwell.
The change in tax rules for managed funds also helps Kiwisaver investors, who should see their investments grow more quickly than they would have under the old rules.
There are some traps to be avoided and, to take advantages of the tax breaks, many investors will need to rearrange their investment portfolios to maximise their tax position. Everyone who owns PIE investments will need to work out their own individual "prescribed investor rate" (PIR), which is the rate at which their PIE investments will be taxed. If they register for tax at 33 per cent but later find out that they're only subject to 19.5 per cent tax, they cannot reclaim the overpayment, says Matthews.
But, at any time during the year, they can complete a new PIR form and return it for the next tax period. On the flip side of that coin, says Geordie Hooft, partner at accountants and advisers Grant Thornton in Christchurch, PIE income is not included in an investor's tax return and, as a result, is not included in the calculation for means-tested benefits such as Working For Families.
If, however, the investor gives the fund management company a lower PIR rate than they are entitled to, then the PIE income is included in the investor's personal tax return.
Some people may choose to sell their foreign-domiciled managed funds and buy New Zealand ones instead, says John Commins, general manager of Equity Investment Advisers & Sharebrokers. "But, by doing so, investors are narrowing their universe of choice enormously."
The people who need to make the greatest changes to their portfolios may be those whose income exceeds the limits for the 19.5 per cent tax rate by only a few thousand dollars. By juggling their investments, they may be able to creep back under the limits.
Under the new rules, an investor can have non-PIE income (such as salary, dividends and rents) of up to $38,000 and a total income of no more than $60,000 to qualify for a PIR of 19.5 per cent on their PIE income. In theory, that could mean that a couple earning $120,000 could pay just 19.5 per cent tax on their entire income - providing their investments are correctly structured.
However, says AMP Financial Services' general manager of savings and investments Roger Perry, if an individual's total income exceeds the $60,000 threshold they will pay 33 per cent (30 per cent next year) tax on all of their PIE income. Perry said there were certain other tips and tricks that investors needed to be aware of:
* Investors who have offshore investments such as shares will face complex tax calculations. Investing in a PIE will mean these calculations will be done for them.
* Those with joint accounts will be taxed at the rate of the higher income earner - and may want to open accounts in the name of the lower income earner to attract the lower PIE rate.
* PIEs mean the incentive for investors to seek higher returns from risky investments such as some finance company debentures will be reduced.
Several commentators The Business spoke to said they expected many of the Australian-based managed funds that were popular with Kiwi investors would set up a system that met the PIE rules, allowing New Zealand investors to get the tax breaks while still investing in their favourite Australian funds.
Many in the financial services industry say banks and finance companies will be looking at cash and fixed-interest PIEs - allowing their investors to benefit from the tax breaks.
There may also be a number of special-purpose PIEs such as a PIE that invested in Telecom shares only, which could appeal to higher rate taxpayers, who would pay tax at a higher rate if they invested directly.
According to researcher Fundsource, around half of local retail managed funds are converting to PIE status.
Many of the managed funds that aren't converting are being wound up or new PIE versions are being launched instead.
* Diana Clement is an Auckland-based personal finance and investment writer
Tastier tax
* New Portfolio Investment Entity (PIE) rules applied from the start of this week, October 1.
* Investors in PIE funds will have their share of any returns taxed at their own "prescribed investor rate". Most managed funds were taxed at 33 per cent, regardless of what rate individual investors were on.
* The prescribed investor rate will be 19.5 per cent or 33 per cent - less than the maximum rate of 39 per cent on other income, such as salary.
* That advantage will grow from next April, when the top prescribed investor rate falls to 30 per cent.
* Investors in PIE funds will no longer be taxed on capital gains on New Zealand shares or on many Australian shares and unit trusts.
