Hunter: KiwiSaver funds in global shares liable for tax slippage

For many investors, having a stake in the global market is one of the key ways to achieve a diversified portfolio. But a recent report by Hunter Investment Management has shown that investing in global markets through offshore unit trusts could result in some unhealthy tax slippage for your funds.

The report showed that if a New Zealand taxpayer, including KiwiSaver funds, invests in global shares via an offshore fund like an Australian unit trust, then there are three potential sources of tax slippage.

Where an investor holds shares located in different countries, there is typically 15% non-resident withholding tax deducted against the dividends that they pay.

Where the mechanics of the Fair Dividend Rate (FDR) tax calculation methodology means that New Zealand taxpayers are unable to get a tax deduction for 95% of the fees within an offshore share fund. In contrast, where the fees are charged directly to the NZ taxpayer, including being charged within a PIE fund, they are able to get a tax deduction for 100% of these.

Which can provide a significant source of potential tax leakage for New Zealand investors if they are unable to get an offset for this. The magnitude of this will be a function of the return the fund gets on the currency hedging arrangements. The greater the return from currency hedging, the greater the quantum of tax slippage will be.

Managing director of Hunter Asset management Tony Hildyard told Good Returns that tax slippage “is a hidden issue but it is significant”.

“When you have both the regulator and investors saying ‘you have to get fees as low as possible’, tax slippage is a hidden fee. It is significant, it has a major compounding effect. You can’t just sit there and claim that you have low fees if you have tax leakage in there.”

Hildyard said that it is crucial for investors “to be aware of the cost. Tax is a cost. Investors think that the headline return might be index minus their fees, but in reality it may be index minus fees minus ten to twenty basis points for tax leakages they weren’t aware of.”

“This problem comes when investors go into a foreign pool and don’t directly hold the assets. So it all depends on the structures that you use. It’s the passive funds in particular that need to be careful, they try to take advantage of the big offshore funds which is precisely where you get this problem.”

Comments from our readers

On 19 October 2020 at 9:49 am Pragmatic said:

The most significant contributor to performance is mediocrity. Tax must always be a secondary consideration, as the industry grapples with paying a premium for beta.

On 20 October 2020 at 10:55 am Anthony Edmonds said:

Hi Pragmatic. I agree that accessing good investment managers is important, but it is also critically important to understand issues like tax leakage. This reflects that this leakage is a given/known each year, whereas things like alpha aren't a given.

Also, the numbers start to add up really quickly. For an Australian unit trust owning global shares the tax leakage (for a Kiwi) associated with the under lying non-resident withholding tax is the dividend yield (let's call this 2% currently) multiplied by the standard non-resident withholding tax rate globally which is 15%, Accordingly this might be 0.30% today assuming a 2% dividend yield. Interestingly this is not the same as an extra 0.30% of fees in a well structured PIE, as fees are tax deductible. Accordingly for someone on a 28% PIE, having 0.30% per annum of tax leakage is akin to paying an extra 0.41% per annum in fees (this is a point that Tony missed in the article).

That brings us to the next issue, being the non-tax deductibility of fees when they are embedded in an Australian unit trust. This is a function of the FDR tax calculation. For a management fee of 1% in an Australian unit trust, this costs investors on a 28% PIR another 0.27% per annum. To be fair I always confuse myself as to whether in fact I should use 33% in this calculation, which would result in a bigger number.

The same sort of leakage happen where Kiwi's invest in an Australian unit trust that owns Australian shares, because if we assume that an underlying portfolio has a yield of 3.5%, then a person on a 28% PIR is paying around 0.42% per annum more in tax if they go through an AUT, plus they also have the additional non-deductibility of fees issue outlined above.

Obviously there are other factors that come into play as well, like an individual's ability to switch tax treatments for their FIF funds in negative return years, but I think that often people don't rationally weigh this up against the tax slippage that they are incurring annually in these vehicles.

Key here is that anyone building portfolios needs to take tax into account, including tax leakage. Also, if you think about alpha as some sort of reward for risk, it is irrational to give a whole lot of this premium away due to tax leakage.

As I stated at the outset, I agree with your point about accessing great managers etc. In my mind there is plenty of opportunity for specialist active global equity, global property, global infrastructure, and Australian equity managers to enter the NZ market with well structured tax effective PIE funds. They will end up with a big jump on their competitors selling offshore based funds to Kiwi investors that have tax leakage in them.

On 20 October 2020 at 3:57 pm deluxe_cabbage said:

But if your value proposition that you shout from the hilltops is index investments for low fees, and you achieve this throught AUT's, the reality is that you aren't all that competitive, where others are using index mandates or actively managing direct holdings.

On 21 October 2020 at 7:42 am MPT Heretic said:

This is a good discussion and worthwhile to understand all the nuances.
Perhaps someone can outline the tax implications of the PIE which buys into an offshore fund rather than direct global shares. Better, worse or the same as an AUT?
What about the NZ investor who holds direct Australian shares rather than via a PIE. Any difference in the NRWT issue?
Also a thought about the non tax deductibility of fees embedded in the AUT. These reduce the return and if the fund earns say 5% in a year gross, less fees of 1%, tax will be paid on 4% for a non PIE. So wont any tax leakage be limited to the marginal average return above 6% p.a?

Hunter: KiwiSaver funds in global shares liable for tax slippage

Hunter Investment Management have warned that investors, including some KiwiSaver funds could be losing out to tax slippage due to buying global shares through offshore unit trusts.

Monday, October 19th 2020, 6:00AM 4 Comments

Comments from our readers

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