Article written by InvestNow

If you struggle with the concept of income tax, take comfort in knowing that even the greatest mind of modern times turned to mush in the face of a tax return. Income tax, Einstein said, is “the hardest thing in the world to understand”. But in NZ at least, managed fund investors have it relatively easy, specifically those invested in PIE funds.

The introduction of the Portfolio Investment Entity (PIE) regime in 2006 removed much of the tax reporting complexity for managed fund investors. Under the PIE rules (designed primarily to make KiwiSaver function efficiently) investors are simply taxed at an appropriate rate through the fund with no end-of-year wash-up required.

Previously, most managed funds in NZ were taxed at a high flat rate with individuals responsible for reporting income through their tax returns.

PIE funds collect a ‘final tax’ for underlying investors based on the Prescribed Investor Rate (or PIR) for each individual. The PIE system includes a built-in incentive for those on high marginal rates (30%, 33% and 39%) with the top PIR set at 28%. In most cases, PIE fund investors can breeze through the March 31 end-of-tax-year date: no paperwork required.

PIE Problems – An imPIRfection

The system isn’t perfect, however, as the Inland Revenue Department (IRD) highlighted last year in its crackdown on PIR errors. After switching over to a new data-sharing system, the IRD found about 1.5 million investors had supplied faulty PIR numbers to PIE managers (which includes KiwiSaver schemes).

More than 450,000 PIE fund investors were handed bills for overdue tax following the IRD sweep. The IRD also found almost 1 million investors had set their PIR too high, resulting in collective overpaid tax of $42 million that, unfortunately, is irrecoverable. The government has since introduced measures making it easier for the IRD to inform both investors and PIE funds of PIR errors. At the same time, there are moves afoot to allow the IRD to refund any overpaid PIE tax due to PIR mistakes.

“This does not remove your responsibility to let your PIE know your correct PIR,” the IRD says. As the 2019/20 tax year draws to a close, PIE fund investors should check their PIR is up-to-date – the IRD shows how here.

Complicating factors – Listed funds… and Australia

The PIE rules have at least one exception that may require investors reaching for their calculators, accountants or theoretical physicist. Listed PIEs (that many InvestNow members have via holdings in Smartshares funds) feature a slightly different tax treatment. As explained in the recently-updated InvestNow Investor Tax Guide, listed PIEs are taxed at a flat 28%. Investors in these funds who are on lower PIRs (10.5 and 17.5%) may be able to claim back the overpaid portion through an end-of-year tax return. The InvestNow guide covers off some of the listed PIE issues, but individuals should seek expert advice if they’re unsure.

However, the listed PIE complexities pale in comparison to the tax situation for Australian Unit Trusts (AUTs), such as the popular Vanguard funds on InvestNow. AUTs, and other non-PIE funds, are caught by the Foreign Investment Fund (FIF) rules in NZ. The FIF regime introduces layers of head-spinning complexity that pure PIE players gratefully avoid.

Under FIF rules, individual AUT investors can choose between two main tax-reporting methods – comparative value (CV), which taxes returns based on actual gains and losses over the year; or, fair dividend rate (FDR), where investors are taxed on 5% of the value of their fund holdings. To confuse the issue further, there are technically three different FIF tax-reporting options. Investors whose total FIF holdings remain under $50,000 during the year can use the ‘de minimis’ exception, where tax is only levied on actual fund distributions received over the annual period.

Whether AUT investors choose the CV, FDR or ‘de minimis’ methods can result in material differences to their tax obligations.

Post-March 31, InvestNow sends members annual reporting statements showing FIF tax outcomes based on both CV and FDR methodology. The annual statements also detail PIE tax paid along with other related information such as: foreign tax credits, imputation credits and AUT withholding tax. Combined with the InvestNow Investor Tax Guide, the annual member statements can help solve many of the year-end tax mysteries for fund investors in ways that even Einstein might understand.