Taxation of Investment Income- A New Regime

During April 2006, the Government introduced tax reforms, which would apply to Collective Investment Vehicles (CIVs), from 1 April 2007.

The thrust of the effort is to remove distortions that currently favour direct investment over CIVs. These new entities will be known as Qualifying Collective Investment Vehicles or QCIVs).

There are a number of key areas of change and already much comment has been made however the main areas of interest may be;

Direct investment in shares, excluding Australasia, will be subject to the new regime for all investors. Investors must treat 85% of the annual change in value of such shares (plus all dividends) as taxable income, and losses will now be available for offset.

The change in value is described as the difference between the closing and opening market value of the shares. To ease cash-flow an individual can elect to pay tax on 5% of the closing market value of the offshore portfolio and income received during the tax year.  The balance of the taxable income is carried forward and is payable when the shares are sold. Taxation on repatriated income can be deferred by re-investing in other foreign shares.

An individual whose cost of offshore shares is less than NZ$50,000 will only pay tax on dividends. These must be held in countries with which New Zealand has a double tax agreement (DTA).  For investments held before 1 January 2000 one can use 50% of the market value at 1 April 2007. Dividends will still be taxed as above.

For New Zealand Managed Funds income through QCIVs will be taxed at 19.5% tax deducted by the QCIV on behalf of investors who earned $48,000 or less. All other investors will have tax withheld at 33%.

Tax credits can be used to make payment and investors will generally not need to file a tax return because of this income. Tax paid will not affect entitlement to means-tested family assistance payments, student loan repayments or child support payment obligations.

NZ and Australian resident listed shares via a QCIV, with the emphasis on ‘qualifying’, will be exempt tax on capital gains made on the sale of shares. This capital gains advantage or relief will not be available to active direct investors.

New Zealand unit trusts that remain a CIV (those that do not elect in) are as per the current regime, gains on NZ shares and Australian listed resident companies will be fully taxed. However, other offshore shares will be taxed on 85% rule, plus dividends.

Superannuation Funds are treated much the same as a unit trust, the capping of tax at 33% and tax at 19.5% those earning under $48,000.  Super funds will lose the current benefit of capital gains tax-free MSCI (Grey list only) global share, passive index funds whether they become QCIVs or not.

Australian Unit Trusts (AUTs) are not included in the tax exempt category for QCIVs (active or passive) or individuals (passive) unless listed on the ASX and are not included in the $50,000 per person deminimis threshold for individuals who directly invest outside Australian shares. An individual’s taxable income will be the same as ‘direct investments in offshore shares (ex-Australia)’. For other investors income will be taxed on the 85% rule.

UK investment trusts are generally listed in London, they will qualify for the $50,000 exemption. Once the threshold is exceeded they will be taxed on the greater of 85% rule plus distributions, subject to the 5% cap basis.

Non NZ resident listed companies on NZX (excluding GPG), and some UK investment trusts will not offer the capital gains exemption of QCIVs. Direct investors may include them in their $50,000 exemption or the 85% rule plus distributions and 5% cap will apply.

Keeping funds in a foreign currency account will be regarded as repatriation however death will not trigger an obligation to pay it seems. Estate beneficiaries may need to account, but much detail is yet to be disclosed, and could change before April 2007.

While the focus of much commentary has been on shares or equities, be aware that the legislation will equally affect fixed interest and bonds, direct or via a fund, in much the same way. Also, be aware that with the GPG exemption already confirmed, further change maybe made before April 2007.  Note; The commentary provided is general in nature and should not be relied upon, alone, for specific situations. Please seek specialist advice before acting.

Original Article published May 2006