How Tax Affects Investment Decisions

Only two things in life are inevitable, so the saying goes: death and taxes.  Since no-one wants to pay more tax than they have to, investment tax has been a big issue recently, and the changes to the taxation of investments seem unclear in post-election NZ.   It seems remarkable that none of the opposition parties have really picked up on what may well be a capital gains tax on non New Zealand investments. 

One well respected analyst has shown that the capital gains tax, may be up to a whopping 80% plus.  It makes a mockery of the government wanting us to save for our retirement and yet may well tax our offshore investments at a rate double the highest marginal tax rate.

When you are comparing the returns you could achieve from different investments, make absolutely certain that you are taking tax into account.  Unfortunately it is common practice for newspapers to publish investment returns in the same table, when some take into account tax, and others do not.  Inevitably the question often arises “Why would I invest in a managed fund that returned X% when you can get 7.5% from a deposit?”

Unfortunately this isn’t the whole story.  Typically deposit rates are quoted before tax, but we quote all NZ managed fund returns after tax, because tax is paid within the fund.  So, if you “tax” the 7.5% deposit at 33% (the rate a managed fund pays) the return becomes a little over 5%.  Of course, if you aren’t on the 33% tax bracket then the outcome will be different again. 

Are you making investment decisions purely because of tax? While you should take tax into account when making investments, you should not choose investments with a “tax advantage” without really considering the underlying assets.  The question you should always ask is “Would I invest in this if it was taxed like everything else?” That way, if the tax advantage is removed you won’t be left with an investment you do not want, and you will not be taking on risk for the sake of minimising tax. 

Do you need to take specialist advice about investment tax issues? The answer is that it will depend on what sort of investment it is that you either have, or are considering making.  Taxation issues affecting for example unit trusts, are completely different than those associated with property development. 

Tax is a very complicated area and it can really pay to get specialised advice, particularly when it comes to investment income whether from managed funds or assets you hold directly.  The last thing you want is to receive a hefty bill for taxes you didn’t realise you had to pay, or paying more in tax than you have to.

The most practical advice is the same advice for anything else – make sure you really understand what you are investing in.