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By Mark Russell, Partner/FATCA Leader, PwC
Investing in a portfolio investment entity (PIE), such as a KiwiSaver scheme, has tax advantages. Getting to grips with the tax requirements related to these investments can be confusing. Once these requirements are understood, the benefits of investing in a PIE fund are clear.
If you’re investing in a managed fund in New Zealand, it will most likely be a PIE. An advantage of investing in this type of fund is that the applied tax rates can be lower than if you invest directly in a company or through a non-PIE fund.
But the rules for working out your PIE tax rate can be confusing and, in some cases, if you don’t understand you can end up worse off.
How do tax rates work for PIE funds?
When you join a PIE fund you need to choose a Prescribed Investor Rate (PIR). Tax is deducted from your PIE fund on 31 March each year (or earlier if you withdraw from the fund) using the PIR you’ve chosen.
You can update your PIR at any time if you selected the wrong rate or your circumstances change. Do this by contacting your fund provider with your new PIR, along with your IRD number.
What are the PIR rates?
Use the flow chart below (Figure 1) to determine your correct PIR. It’s important you apply the tests to each of the last two tax years.
PIR rates are designed to closely mirror personal marginal tax rates. The key difference between PIRs and personal marginal tax rates is that the highest PIR is 28 per cent. This means if your marginal tax rate is 33 per cent, you achieve a 5 per cent tax rate reduction by investing through a PIE fund.
If you’re on a lower marginal tax rate there are also benefits to investing in a PIE. For example, your PIR is 17.5 per cent, you earn NZ$48,000 from taxable income and NZ$22,000 from investments. If you invest directly, so not through a PIE, that NZ$22,000 will be taxed at 30 per cent (NZ$6,600).
If instead you invest in a PIE fund, the investment income is taxed at 17.5 per cent (NZ$3,850), resulting in NZ$2,750 less tax. It’s clear that you would be better off investing through a PIE fund rather than outside one.
What if my circumstances change?
It’s important to choose the correct PIR, since the lower PIE tax rates only apply if you choose the right PIR.
If your circumstances change and the PIR you previously advised no longer applies, you have to inform the fund manager of your new rate.
If your PIR has increased, and you do not inform the fund manager, the income from your fund must be included in your tax return. It’s then taxable at your ordinary marginal tax rate rather than the PIR rate.
If you have too much PIE tax deducted, you generally cannot get the excess refunded.
What if I invest through a trust or company?
If you invest through a trust, you must choose between a PIR of 28 per cent or zero per cent.
If you select 28 per cent, the fund will deduct the tax, and no further tax is payable by the trust or any trust beneficiaries that have income distributed to them. This works well if the trust retains the income or distributes it to high-tax-rate beneficiaries.
If the trust opts for the PIR of zero per cent, the fund will not deduct any tax. In this case, the trust will have to include the income in its own tax return and pay the tax. This is preferable if the income is distributed to low-tax-rate beneficiaries — like older children — or the trust has expenses or tax losses to offset against the income.
All companies are obliged to select the zero per cent rate, and include the income in their own tax return and pay the tax.
Can PIRs make me worse off?
PIRs are based on your past two years’ income. So your PIR may be higher than your marginal tax rate if you have a sudden income drop, such as on retirement or following the sale of a business. You might want to consider investing directly until your PIR falls.
Overall, PIE funds are a very tax-effective way of investing for the majority of investors.
MARGINAL TAX RATE: the percentage of tax paid on additional income. The IRD sets tax rates classified into different income brackets. As income increases, so too does the tax rate. The marginal rate is the tax rate applied to the highest portion of an individual’s earnings.
PORTFOLIO INVESTMENT ENTITY (PIE): a portfolio investment entity (PIE) is an entity (such as a managed fund) that invests the contributions from investors into different types of investments. A PIE will generally pay tax on investment income based on the prescribed investor rate (PIR) of their investors, rather than at the tax rate of the entity itself. Investors are required to provide their IRD number to the entity, to enable tax to be deducted.
PRESCRIBED INVESTOR RATE (PIR): the PIR is the rate used to calculate tax on your investment income.
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