How Investment Tax Changes May Influence Portfolios?

Over the past few weeks, the government has announced changes as to how investments will be taxed.  As this has still not been finalized by parliament, there could well be changes before the April Fool’s Day 2007 commencement date.  Many commentators and investment advisers believe that these changes are being made too quickly, and that the government does not really have a good understanding of investing particularly for retirement purposes.  With the investment assets declaration that cabinet ministers have to make, it is obvious that the majority of cabinet ministers do not have any significant investments, so they lack any real personal investment management experience.

Essentially, the proposed changes are good news for those people who are interested in investing primarily in Australasia, especially in shares.  They will only be taxed on the dividends received.  This change favours New Zealand managed funds, which currently pay tax on realised and unrealised capital gains.  However, once one diversifies away from Australasia, a capital gains tax comes into play once a threshold level is reached.

The proposed taxation changes discriminate against individuals and family trusts, and favours joint investment ownership.  For illustrative purposes, let us assume an investment portfolio which has 40% offshore (excluding Australia) assets (shares, fixed interest, property, hedge funds etc).  Only 85% of the offshore asset values are used for the calculations, and an assumed rate of return of 5% is used.  Individuals have a $50,000 exemption threshold.  If we use these assumptions a $250,000 individually owned portfolio would have a $2125 offshore taxable income liability, a family trust would have $4250 offshore taxable income liability, whereas a jointly owned portfolio would have none.  Increase the portfolio size to $500,000 and the figures become $6375 for an individual portfolio, $8500 for a trust portfolio and $4250 for a joint portfolio.

Quite clearly, there will be tax advantages to be obtained by holding portfolios in joint ownership, especially when in retirement where income needs will primarily be met from GRI and an investment portfolio.  However, when one partner dies the amount of deemed taxable income will increase.  Also, when you draw down on your portfolio to meet living expenses, you may well incur a tax liability.

Dr Cullen appears to have made another turnaround when it comes to this capital gains tax.  He has been on record as saying the reason for no capital gains tax on property was because property, especially if it were a holiday home, may not have an income stream or produce insufficient income to pay any capital gains tax.  If we use that type of argument, then why is it that international shares will be taxed at close to an assumed income of 5%, when the reality is that the income stream from them will be closer to 1.5%.

We believe that the proposed tax changes will bring significant compliance costs for investors.  If this is the case, then investors will most likely be no better off than they are now.  Currently, paying capital gains tax on unrealised capital gains is largely voluntary.  It can easily be minimised by a skilled investment adviser.  Similarly, we believe it will be a relatively straight forward process to minimise the effects of the proposed tax changes.

Unfortunately, it seems that the taxation changes are essentially political.  They have been designed primarily for those that may take up the KiwiSaver scheme.  These people are likely to be small investors, who are unlikely to be affected adversely by the complexities or cost of the capital gains tax.