Investment Tax Return Time

The taxation regime for investment taxation changed three years ago. This saw the introduction of the PIE (portfolio investment entity) regime, and also the foreign investment fund taxation regime. Interestingly the first two returns for the scheme were from what would be considered one of the worst on record for a number of years, and the past year, one of the best.

Now let’s look at the differences taking a simplistic approach. This is not intended to be taxation advice. You should seek taxation advice from a qualified experienced taxation professional.

Assume that you have $300,000 of foreign investment funds to start with. What is the tax situation? Firstly, let’s assume that the foreign investment funds increase in value by 25%.

Opening value = $300,000    Closing value = $375,000

Using the FDR (Fair Deemed Rate of Return) method, $300,000 * 5% = $15,000

Using the CV (comparative value) method = $75,000

Quite clearly, given the option, the FDR method would be the one to use for this period, with the taxable income being $15,000. It would be the same for a PIE investment.

Secondly, let’s assume that the foreign investment funds decrease in value by 25%.

Opening value = $300,000    Closing value = $225,000

Using the FDR method, $300,000 * 5% = $15,000.

Using the CV method = -$75,000.  As this is less than $0, tax is based on $0.

Quite clearly, given the option, the CV method would be the one to use for this period as there would be no tax to pay. However if invested in a PIE version, the PIE would have to pay tax based on $15,000.

As a rule of thumb, if investment returns from foreign investment funds are greater than 5%, the FDR method is the method to use. When the returns are less than 5%, the CV method is the method to use. PIE versions are disadvantaged taxation wise when the returns are less than 5%, and they invariably have a higher management fee by about 0.15%. Despite the PIE regime having been in place for three years, there is a distinct lack of good quality single sector investment funds available.

So why would an adviser recommend that their client invest only in PIE funds rather than utilise the beneficial investment aspects of foreign investment funds? Four possible reasons may apply. (1) The investor may be on the current top marginal tax rate of 38%. The top tax rate under the PIE regime is 30%. (2) For a client who needs to limit their taxable income for child maintenance or alimony purposes. (3) To keep taxable income low for income tested welfare benefits or Working for Families. (4) The adviser only has access to PIE funds and therefore only recommends PIE investments.

With the tax reports provided for users of WRAP administration providers, completing a tax return should not be difficult. It is not necessary to categorise every investment. These details are automatically provided to the client to assist in tax return preparation.

If an investor is below the de minimis thresholds, the foreign investment taxation regime does not apply. For any foreign investment fund holding, the taxable income is dependent on the amount of any distributions. As the distributions can be high and vary significantly from year to year, these investors may be better off investing in PIE compliant funds. For those investors in Masterfunds, they have little choice. Most Masterfund offerings available in this country are now PIE’s.

In conclusion there is no categorically definitive answer as to whether it is better to invest in PIE funds. It comes down to an investor’s individual circumstances. Skilled investment advisers should be able to advise on what is best under your own particular circumstances.