Taxing Investments

There has been quite a lot of background noise over taxation in recent months.  We all know that the government is struggling to find ways to increase its revenues without committing the mortal political sin of increasing tax rates.  We have also seen the massive sums of money which a number of companies, especially the major trading banks, have attempted to reduce their tax liabilities by.  The recent successes by Inland Revenue will effectively provide the government with another two billion dollars which they would otherwise have had to borrow, further adding to the mountain of debt that the country faces.

It is well known that when it comes to taxation on investments, there is no such thing as a level playing ground.  Investment property has been taxation advantaged for years, so it is no wonder that property has often been the favoured form of investment.  But as the Prime Minister has been quick to point out, property prices have risen dramatically in countries where there is a capital gains tax on property.  With property prices in some of those countries having plunged over the past couple of years it could be some time before “the gains” become taxable again.  There does not seem to be a tax credit in those countries where there is a capital gains tax on property, when there are capital losses.  Governments have a need for reliable and predictable tax takes, which is a real limitation of capital gains taxes on property.

For most investors in diversified investment portfolios, there have now been two tax returns completed under the new investment taxation regime.  There is no definitive generic answer if investors are better off under the PIE regime or the FDR regime.  It varies on a number of factors.

Small investors who have taxable income of over $14,000 will generally be well served using PIE investments.  Those on lower income levels can pay more tax under the PIE regime and are unable to claim the tax credits when their marginal tax rate is less than their prescribed investor tax rate (PIR).  Under a falling market situation, foreign shares held in a PIE arrangement will pay more tax than comparable investments that are foreign investment funds that can use either the FDR or CV taxation methods.  They will also probably be paying higher fund management fees using a PIE fund, rather than for example investing in an Australian Unit trust, and will also have a very restricted choice of funds that they can invest in.  PIE versions of some Australian Unit Trusts are now available; however the management fees are higher.

Smaller investors can also be disadvantaged.  For example a couple who had invested $95,000 in the disastrous ING DYF could not claim tax losses (assuming the total foreign investment fund holding was less than $100,000) whereas a couple who had invested $105,000 in the same fund would have total tax losses of almost $82,000 which could be used to reduce any other assessable income.

Structuring individual portfolios for taxation efficiency is not straight forward, and should be done on a case by case basis.  From client comments, it is obvious that a number of tax agents do not understand investment taxation, and find that it is easier to tell the clients that they should only invest using PIE’s.  This makes the tax agent’s job more straightforward, but may not be in the best interests of the client.  Certainly if the client cannot provide a well prepared tax report to the tax agent, there may be a significant cost for the tax agent to prepare the necessary information. 

Investors who have a contractual relationship with a financial planner would expect to be provided with a tax report at no additional cost by their financial adviser.  Our experience is that it should only take a matter of a few minutes to use this information to complete an investor’s tax return.  Masterfund investors have little flexibility in how their investments will be taxed, other than by selecting their PIR rate.  These people will invariably have paid a lot more tax over the past couple of years, than those who had a well structured portfolio tailored for the clients’ needs.