What is the Tax on Shares, PIE funds & Term Deposits?

In NZ Portfolio Investment Entitles (PIE) funds offer a tax-efficient way to invest.

With a regular term deposit, the interest you earn is subject to your marginal tax rate, which can be as high as 39%. With a PIE term deposit, your earnings are taxed at a maximum rate of 28%. This can make PIE term deposits a more attractive option for higher earners, allowing you to keep more.

How does tax work?
All PIE funds are registered with Inland Revenue as multi-rate Portfolio Investment Entities. In April each year, an amount of tax is due for the previous 12 months.

New Zealand investments
For funds holding New Zealand investments, you are taxed on the income received in the fund (i.e., the dividends and interest payments paid into the fund from the underlying investments), less any available tax imputation credits. Imputation credits are available when an NZ company has already paid company tax on some or all of the amount they paid out as a dividend and avoids a double taxation issue.

For international investments:
In contrast, funds holding international shares, have their tax calculated under the complex FIF (Foreign Investment Fund) rules. The easiest way to explain this, is that tax is calculated according to the average balance of your investments through the year as if every investment paid a 5% annual dividend, not the actual income received.

This tax calculation takes your average balance throughout the year, multiples it by 5% and then multiples that number by your PIR. For investors with the top PIR of 28%, this equates to a tax cost of 1.40% of your average balance in the fund during the year. From this amount, foreign tax credits received from dividends paid by the underlying companies are deducted and you will have a net amount of tax payable.

Why do I pay tax when my portfolio value has declined?
In short, because tax payable on a PIE investment is not a capital gains tax. You are being taxed in relation to your income earned in the case of the NZ funds, or your average investment balance in the case of the global funds.

This stings a little when markets are down; no one likes paying tax at the best of times, let alone when their portfolio is showing a loss.

However, to put it into another investment context – the property market also drops in value, a Landlord may find their property worth less than they bought it for. Do they still pay tax on the rental income received? Absolutely. In the tax world, those two factors are mutually exclusive.

What is my PIE tax statement?
PIE tax statements give the breakdown of income received, tax credits applied and tax amounts payable are available in late April. In the case your PIR was noted incorrectly, you can vary your deduction in your Income Tax Return. If however your PIR was correct, you do not need to complete any additional information in your personal return. Everyone’s tax situation is unique and if you are unsure you should seek advice from an accountant or suitably qualified professional.

A final note on PIEs
It’s important to note that your tax is calculated on your PIR – which is either 10.5%, 17% or 28%. This is a benefit of a PIE; as the top tax rate is 28% rather than the higher amounts applicable under the Resident Withholding Tax (RWT) payable on direct share holdings. I would encourage all investors to look at tax as a small part of the bigger picture and a cost of investing, in a similar way that tax is a cost to earning an income.

In conclusion PIEs are more beneficial as this means you pay the tax later and only to a maximum rate of 28%.