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Tax rules on share funds unfair

A fund manager is calling for changes to tax rules he says are unfair on Kiwi investors and the local funds management industry.

Monday, November 4th 2013, 5:42AM 9 Comments

by Susan Edmunds

Anthony Edmonds, of Wellington-based Implemented Investment Solutions (IIS), says the system unfairly disadvantages people who put their money in New Zealand-manufactured global share funds.

He said the fair dividend rate (FDR) regime, which taxes locally-structured global share portfolio investment entities (PIEs) differently to offshore-based products and direct investments, has left many New Zealand investors out-of-pocket and damaged the country’s funds management industry.

Edmonds said: “The FDR tax regime is unfair, as individuals using PIE global share funds, including KiwiSaver schemes, generally pay more tax than those who invest directly in global shares, which includes offshore global share funds.”

He said the Government had created a situation where investors had a tax incentive to invest directly offshore, and in offshore-manufactured funds.

“Imagine the outcry if the Government subsidised Australian lamb for Kiwi consumers.” 

Edmonds said the distortion that had been created was evident in IIS’ own range of global share products, which include both PIE and offshore-based funds managed by Russell Investments.

“For every $1 we get from mum and dad investors in our global share PIEs, investors put $10 into the offshore-manufactured solutions we have,” he said.

He said while the decision to invest in global shares outside of PIEs might make tax sense at present, removing the inequity would be a wider boost.

“For one, most KiwiSaver investors, who represent the largest and fastest-growing retail investment sector, must invest offshore via PIEs and therefore cannot access the non-FDR tax incentives,” he said.

"Encouraging mum and dad investors into NZ-manufactured global share funds would also ensure they are covered by local regulations while providing a boost to the New Zealand investment industry. 

“The fairest solution would be to change the FDR tax rules to ensure individuals pay the same amount of tax regardless of how they invest in global shares.”

He said the issue needed political attention and he was trying to get traction on it with the IRD. “Is this what they intended? I think investors on the whole are clever at figuring out tax, and what makes a good investment. They’re more clever than people give them credit for.”

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Comments from our readers

On 4 November 2013 at 8:23 am Brent Sheather said:
There are two reasons why I don’t use XYZ suss local share PIE fund investing in overseas shares. The biggest one is fees. Why on earth would I inflict a high annual management fee and a patently unfair and, illegal overseas, performance fee on my clients when I can buy for them an overseas fund with a base fee 1/3 of what they are paying locally and no performance fee? Remember I am supposed to put my clients interests first not the interests of the local fund management industry!

And while the government is sorting out FDR they should also take away PIE funds capital gains tax free trading advantage by extending that to Mum and Dad as well.

The bottom line is we don’t make cars in NZ because we can’t make them competitively. Looking at the fee structure of the local managed fund industry you would might come to the same conclusion....

Regards
Brent
On 5 November 2013 at 9:55 am Anthony Edmonds said:
Hi Brent

One of the key points here is that we have a foot in each camp. We have both offshore manufactured global funds which are taxed as FIFs, and the same global investments available as PIEs. From a business point of view I don't care that most advisers and their retail clients use our FIF $NZ hedged and unhedged global share funds (over their exact same PIE counterparts). To me this makes perfect sense for many of the advisers' end clients.

The point I was making in the article was that it seems perverse that many individuals get a tax incentive to buy the offshore manufactured solutions (over exactly the same solutions manufactured in NZ). The playing field should be level (not tilted in the favour of offshore manufactured funds).

It is worth noting that some individuals get significant benefits from investing in PIEs, so advisers also need to have PIE funds available as well (one example of this is my wife who could have over $900,000 invested in a global share PIE and pay tax at 10.5%).

Extending this, it isn't all just one way traffic in favour of FIF funds for individuals. There are a range of other issues to look at including things like the tax deductibility of fees, withholding tax slippage (or the potential for it), through to areas like the compliance costs associated with having to provide tax returns for global shares that are taxed as FIFs. To me this stuff is complex, which I am picking is where the value of really good fund research and analysis comes into play.

Reflecting on this as I type, the beauty of all of this from an advice perspective is that people need help and access to experts to help determine what options work best for them individually. So looking at this from an adviser's business perspective - long may the complexity and differences in tax treatments reign!

Seeing your performance based fee comment, I trust that you will enjoy my article in the next edition of Asset.

Regards

Anthony


On 5 November 2013 at 11:50 am realist. said:
Brent - I can honestly say that I disagree with 90% of what you say and write but wholeheartedly agree with you on this one.
On 5 November 2013 at 12:14 pm Realist said:
We agree with Anthony that in theory, FIF funds are tax advantaged by comparison with their PIE fund equivalents. However it does not necessarily mean that they will be in practise when you include compliance costs in the overall equation. This is because the tax situation is calculated over a client’s portfolio as a whole.

Since the FDR methodology was introduced, we have found that in our client portfolios, the Australian Share Unit Trusts have been slightly out of phase performance wise compared to International Share funds and that there has always been tax to pay. That is, the alternative CV method, still gave rise to tax being needed to be paid, albeit at a rate quantum than the FDR 5% basis.
We always provide our clients who are over the de minimis, tax reports that show both the FDR and CV tax situation. Obviously the client should use the approach that provides the lower taxable income.

If one takes a broader approach to tax, that is adding in the compliance costs associated with a portfolio above the de minimis levels, compared to a PIE based portfolio, clients with portfolios of less than $500,000 may be better off financially by being invested in a PIE based portfolio rather than in FIF funds.

Some advisers seem to be so preoccupied with their obsession on fee’s that they completely fail to explore the investment universe and see what investment solutions are available. That is hardly putting the interests of their clients first. Those same advisers are often dead against hedging investments to the New Zealand dollar. If only their clients knew how much their adviser was really costing them in lost performance?
On 5 November 2013 at 12:55 pm Ian - Rotorua said:
FDR was the barmiest idea ever to come from the combined brains of Dunne and Cullen. It distorts portfolio investment be giving a tax incentive to owning NZ and Australian shares only. That leads to riskier portfolios for investors. Something for Todd McLay to look at now that Dunne is out of the IRD job.
On 5 November 2013 at 5:27 pm Realist said:
We agree with Anthony that in theory, FIF funds are tax advantaged by comparison with their PIE fund equivalents. However it does not necessarily mean that they will be in practise when you include compliance costs in the overall equation. This is because the tax situation is calculated over a client’s portfolio as a whole.

Since the FDR methodology was introduced, we have found that in our client portfolios, the Australian Share Unit Trusts have been slightly out of phase performance wise compared to International Share funds and that there has always been tax to pay. That is, the alternative CV method, still gave rise to tax being needed to be paid, albeit at a rate quantum than the FDR 5% basis.

We always provide our clients who are over the de minimis, tax reports that show both the FDR and CV tax situation. Obviously the client should use the approach that provides the lower taxable income.

If one takes a broader approach to tax, that is adding in the compliance costs associated with a portfolio above the de minimis levels, compared to a PIE based portfolio, clients with portfolios of less than $500,000 may be better off financially by being invested in PIE’s rather than in FIF funds.

Some advisers seem to be so preoccupied with their obsession on fee’s that they completely fail to explore the investment universe and see what investment solutions are available. That is hardly putting the interests of their clients first. Those same advisers are often dead against hedging investments to the New Zealand dollar. If only their clients knew how much their adviser was really costing them in lost performance?
On 5 November 2013 at 6:46 pm Brent sheather said:
Hi Anthony ...all good points..guess I'm of the view that tax regimes are volatile whereas low fees are forever ..but for small clients low cost pies are likely very competitive.
On 7 November 2013 at 2:04 pm Ran Derson said:
This tax issue is way out of proportion.

The only tax advantage to holding funds directly is for mum and dad investors with <$50k in overseas (FIF) funds. Anything more than $50k and then the investor would be subject to FDR. In that situation, the investor would be better off in a PIE, which would cap the tax at 28% capped tax rate.
On 7 November 2013 at 7:03 pm Anthony Edmonds said:
Hi Ran

I think you have missed a few of the details regarding the FIF rules as they apply to individuals in global share funds.

Firstly, they can elect to change the tax treatment for their FIF global shares between FDR and CV based on their returns. In contrast a global share fund always pays tax in accordance with the FDR methodology. This means that when returns from global shares are negative, individuals can elect to switch from FDR and CV - meaning they have no tax to pay on their global shares (whereas if they were in a PIE and on a 28% PIR they would pay an additional 1.4% in tax, despite markets falling). In negative return years, this creates a significant tax savings from using FIF funds.

In addition, individuals only pay tax on the value of their FIF global shares based on their value at 1 April (being the start of the financial year). Accordingly contributions and gains made during the remainder of the year aren't taxed. This means that in positive return years FIF investors can also potentially win out over their PIE global share counterparts.

The combination of these two factors, being the combination to potentially do significantly better that PIEs in both negative and positive years, means that in many cases FIF global shares provide far better after tax outcomes for individuals (as in essence they are lightly taxed).

Note (as I keep discussing/debating with Brent), this isn't always the case, as sometimes investors get far better outcomes from PIEs (which is a function of their specific circumstances - which is why investors should seek advice). Also, fund structures can have all sorts of hidden tax inefficiencies in them, which in turn points to the need to do really good fund research. And finally, as "Realist" highlights above, there can be some pretty significant compliance costs associated with completing things like tax returns for FIF funds.

There is article about this in a recent Asset mag, which I will happily forward you (I am pretty easy to track down). Standard disclaimers apply, being that you should seek your own advice. All the above is general etc.

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