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39% trustee rate – will this mean more PIEs?

July 2024 - Tax Alert

By Troy Andrews & Vinay Mahant

Any proposal to increase tax rates is sure to promote discussion. The legislative journey that has ultimately resulted in an increase to the trustee tax rate from 33% to 39% from 1 April 2024 has been no different. Although the change means there is now alignment with the top personal tax rate, a misalignment remains as companies and portfolio investment entities (PIEs) continue to be taxed at a maximum rate of 28%. While company tax is arguably just an interim tax until profits are distributed to shareholders, investors in PIEs have a permanent tax benefit.

While a 5% tax rate differential already existed between the trustee and top prescribed investor rate (PIR) for PIE investors, this has more than doubled to a headline 11%. With trusts commonly used for holding investment portfolios and their prevalent use in New Zealand for asset protection purposes, the immediate reaction may be to shift to investing via PIEs. It is important to understand that there are pros and cons with the tax settings of different investment decisions rather than the tax rate differential being the only driver. With this in mind, we have set out below some points that should be considered as part of the investment decision-making process in the context of the trust rate change and PIEs from a tax perspective.

What do I need to consider?

A key benefit of the PIE rules is that tax is capped at 28%. This is in line with the fact that the regime is intended to be concessional to promote and encourage savings (note that most, if not all, KiwiSaver schemes have elected to be PIEs). PIEs are taxed in a similar way to direct investments in New Zealand fixed income and New Zealand equities and are generally viewed as being more efficient from a tax perspective for investors with a tax rate above 28% for these investment classes. However, this is not always the case in the context of Foreign Investment Fund (FIF) investments.

Many trusts and individuals have the advantage of flexibility as they can choose to calculate FIF income under either the “Fair Dividend Rate” (FDR) or “Comparative Value” (CV) method, whichever is the most beneficial. For example, the FDR method could be chosen in years where the returns from international equities are greater than 5% and the CV method could be chosen when returns are less than 5% or where the value of equities declines. This option is not available to a PIE, which must use FDR regardless of how the overall market is performing.

It is also worth noting a benefit to the FDR method for many investors can be an outcome of no FIF income arising in the year an investment is acquired/made. There is essentially a “holiday” for tax purposes if an investment is made after the start of the year (i.e., there is an opening market value of nil) and is not also sold in the same year (if it was sold, a quick sale adjustment occurs). This can be a strategic difference between direct investment where investors are likely to be allowed a “holiday”, whereas many PIE funds generally don’t get this benefit as they undertake a different form of the FDR calculation (often called the periodic or daily method) where the 5% deemed return is calculated on the average balance for that period (normally a day).

The above highlights how the increased tax rate differential resulting from the trustee rate change should not immediately signal a structural change to investments. As the tax settings at play could lessen or even outweigh the 11% headline rate differential, it is important that these are considered before decisions are made. It is also important to understand that while it can be material, tax is just one of many factors that should be considered when reviewing the overall effectiveness of an investment and an investment structure (e.g. factors such as management fees charged/asset performance should also be considered).

For completeness, PIE and company/shareholder misalignment issues are known to Inland Revenue who have stated that they will monitor the effect of the trustee rate change including monitoring structural changes that are made by taxpayers.

Please contact your usual Deloitte advisor if you have any questions or would like to discuss the broader impact the trustee rate change may have on your trust.

Defined terms:

FDR method – The fair dividend rate (FDR) method deems 5% of the opening market value of FIF investments to be taxable with adjustments for “quick sales” which is a technical term for shares that are both bought and sold during the same year.

CV method - The comparative value (CV) method taxes the actual annual economic return from FIF investments including unrealised gains, realised gains and dividends.

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