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Reduce tax bill by giving PIEs a miss

Many New Zealand investors and advisers are stuck in the habit of assuming PIE structures are the best option – but that ignores the fact that investments sometimes go through rough patches, it has been argued.

Thursday, August 18th 2016, 6:01AM 5 Comments

by Susan Edmunds

Ben Brinkerhoff and Damon O’Brien, of investment solutions firm Consilium, have written a paper looking at the options for investment in foreign funds.

They said investing in FIF assets through a PIE structure would offer investors more convenience, with no tax returns required.

But using an Australian unit trust (AUT) would result in lower taxes over the long term.

With a PIE, an investor nominates a prescribed investor rate up to 28%.  Investors pay tax at that rate on 5% of the opening value of their FIF assets, whether markets go up or down - the FDR method.

With an AUT, they can choose the FDR method of a PIE fund, with a marginal tax rate of up to 33%,  or can opt to take into account the actual gains and losses of their portfolio.

“The advantage here is that if your aggregate FIF investments lose money - and all will from time to time - you won’t have to pay tax on those assets that year. However, if you invest through AUTs, you will need to file a tax return with the IRD.”

Brinkerhoff and O’Brien said an investor whose international portfolio lost 10% over the year, with a marginal tax rate of 33% and a PIR of 28% in a PIE, would end up 11.4% down after tax..  Someone in an AUT would only lose the 10% with the market, and pay no tax.

If the market gained 10%, the PIE investor would still pay 1.4% in tax but the AUT investor would pay 1.65%.

O’Brien said there was a general impression that PIEs were the most effective structure. “It’s become easy to talk about PIEs in a blanket way, that they are all tax efficient, and people stop inquiring.”

But he said when people were investing for the long term, they needed to consider that markets could drop as well as rise. “The fact is PIEs can’t opt out of paying tax but a unit trust can. That’s the part of the calculation that people need to be reminded off. In a normal good year the PIE may be better but the average over time may not necessarily be.”

O’Brien said AFAs’ code of conduct suggested that clients should expect tax considerations were being taken into account.

He said Consilium’s own filters considered tax as a consideration, along with a range of others.  “It goes to the underlying expected after-tax return. We don’t start with tax being the main priority.”

Tags: tax

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Comments from our readers

On 18 August 2016 at 5:24 pm Anthony Edmonds said:
I was really impressed to see information from one of my articles getting used!

Note that my article that Consilium referenced also had some other important considerations that need to be factored in by anyone doing meaning analysis of this (that have been overlooked in the discussion paper). In my world advisers (working with individuals) need to be able to access AUTs and PIEs, which is why we have both available. The reason for this is covered below.

In my article (that Consilium have referenced) I also highlighted that investors in an AUT can't get a tax deduction for the management fees under FDR. Also, NZ investors can't get any benefit from the withholding tax deducted on the dividends on the underlying global shares.

Both of these factors create meaningful levels of tax slippage - which I am surprised aren't looked at in Consilium's comparison paper. This is especially surprising when the article gets down to talking about the AUT benefit for global shares being 0.21%. The tax slippage I am pointing to (which is missing) is going to be significant in comparison to this.

Without this additional information - the "comparison" isn't a true comparison. Note that my article wasn't written to be a true comparison, but rather to shock the NZ investment management industry into realising that the NZ Government provide tax incentives to offshore managers through what I believe are poorly designed tax laws. That said, I still provided detail on this tax slippage - I just wrote the article carefully to make sure it didn't get in the way of a good read (and the political point I wanted to make)!

Also, no consideration is given to some of the other tax benefits that are provided by PIE. For example, given my wife has no normal income, if she invested $960,000 in a global equity PIE, she would only be taxed at 10.5% (being the PIR rate for people whose normal income is less $14,000, and when combined with their PIE income is less than $48,000). This creates a massive benefit for her from using a PIE. Extending this, if you have a decent look at the PIE tax benefits for retired couples - then the same type of benefits are also available to to people with pretty large portfolios (you can have a pretty substantial portfolio between a retired couple and get on to a 17.5% PIR rate. I am happy to dig out the math if anyone was interested in this). This concept was pretty well explained in my article in the Asset March 2010 issue!

My point here is that while I agree with the general thrust of the article - there are other factors that need to be covered to make the"discussion paper" complete. Further I find it quite challenging that advisers could address the needs of all of their clients (who are individuals) without having any global share PIE funds "approved". This reflects that even if the PIEs were to fail on the criteria expressed in the paper, this is more than likely to be offset by the massive tax benefits that PIEs can offer to some individuals (like my wife, or the "retired couple" example shown above).
On 19 August 2016 at 10:07 am Brent Sheather said:
Hi Anthony

I agree that’s a very disappointing effort from Consilium. I for one would be interested in the calculations for someone with a $1m portfolio showing the relative advantages and disadvantages of a PIE fund with low fees. The allocation to the global PIE would be a maximum of $75,000 to be consistent with best practice. Of the rest of the portfolio most of it would be non-PIE except for $200,000 and the average yield of the rest of the portfolio would be around 3%. The analysis, to determine the relative attractiveness of global PIEs versus other alternative global equity products, would need to have regard to total expenses and these would average about 30 basis points. My clients are almost always retired so would have national super as income as well.

If you are happy to do this Anthony and you need more info you can email me at brent@cpam.co.nz

Regards
Brent
On 22 August 2016 at 12:55 pm Anthony Edmonds said:
Hi Brent.

Happy to help. I will email you and get some key assumptions off you.

Regards

Anthony Edmonds
On 22 August 2016 at 1:15 pm morphs said:
Hi Anthony
Is the article you mention in Asset March 2010 available online anywhere?
Regards,
Geoff
On 23 August 2016 at 4:18 pm Anthony Edmonds said:
Hi Geoff.

It is on our website in the articles: http://iisolutions.co.nz/articles/

It is the article titled "PIE and paying tax at 12.5%" - which highlights it is a bit dated, as the correct PIR rate is now lower again.

If anything is unclear, yell.

Regards

Anthony

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