What are your Investment Rules?

[SBQ]

A company that is earning money has three options when declaring a profit.

Which strategy is used depends on what kind of market the company is in and whether that market is static shrinking or growing. A company should only retain capital if they can reinvest those retained earnings and be sure that any resulting incremental investment earns more than its cost of capital. If they can't do this, then the company should pay out to share holders all of their earnings as dividends, and let shareholders decide where to reinvest that money for themselves. In this situation, it is absolutely the right thing to do to pay out all the company's earnings as dividends. It would actually be foolish not to do so!

Getting a dividend from a New Zealand company is generally very tax effective. That is because if the company has paid tax on their earnings, you as a shareholder should not as a rule have to pay tax again on that same money.

It is true that capital gains for long term investors carry no tax liability. But it is also true that capital losses for long term investors carry no tax deductibility. So I would challenge the statement that capital gains are more tax effective than dividends for NZ investors in NZ companies.

One particular problem I have noticed with the NZ market is that good growth companies need about five years of operations under the belt to really prove themselves. But so often, five years is enough to gain near market saturation in New Zealand. This means it is very possible to buy an NZ company with a 'proven growth record' only to have the growth story fall apart in year six.

Buyer beware!

SNOOPY

Lead by example. ie The Warehouse group, which in the past countless years has had a horrible track record for fulfilling a dividend paying policy while at the SAME TIME borrowing more debt and issuing tons and tons and tons of shares. They particularly done so throughout the 2000 during their expansion period.

Your view on dividends as being tax efficient misses my point. I'm speaking from a book value per share vs market value per share. Drain the profits in the company and so shall you drain the market share price (there's no way around that). If you seek companies that pay consistent dividends, then seek those that are mature companies with NO market growth (ie utilities). But that's not the story we see in NZ because it's well advertised with brokerage firms like Macquarie where investing in NZ equities is "all about the dividends". No one ever questions the shareholder who does NOT want a dividend because that triggers a tax consequence. No one has thought to say if the capital gain of the share keeps growing, then why not sell a portion of the shares when ever they WANT to elect a return on the investment. But what am I to know? NZ financial advisers know nothing about taxation because from ALL of the ones i've spoke to on the phone in NZ, they tell me, "well you'll need to speak to a tax adviser" which is something very wrong. All qualified CFA CPA advisers in N. America must have a full understanding of tax minimsation for their clients because taxation is such an integral part of investing and retirement planning. No fool in NZ should have to be stuck paying 2 sets of fees for financial advice.

Also it's not about how quick NZ companies can mature in NZ because likewise, they can fade away as quick and why should investors take that kind of risk. You know a small market (that the NZX is), also means small liquidity = the greater risk for the multi-millionaire that can't move in or out quick enough to change their position. It's more like get all the small investors in, and let them watch 95% of the mix of small companies fail.

Best to stick with buying houses - at least there's a for sure way path of keeping all those gains tax free.

[Snoopy]

Lead by example. ie The Warehouse group, which in the past countless years has had a horrible track record for fulfilling a dividend paying policy while at the SAME TIME borrowing more debt and issuing tons and tons and tons of shares. They particularly done so throughout the 2000 during their expansion period.

'The Warehouse' had a long and very successful expansion period that really only came unstuck after they became number one in the discount department score sector in NZ, then tried to take that model to Australia. The 'attack of the yellow sheds' in Oz was a failure. Growth then was refocused on NZ as 'The Warehouse' tried to become a full scale third force in the grocery sector (largely a failure) within the 'Red Shed' brand. After that 'The Warehouse' bought into other retail channels like 'Noel Leeming' and 'Torpedo 7'. Noel Leeming I think has been a largely successful acquisition. But Torpedo 7 has suffered a large write down in goodwill in recent years.

Your argument about 'The Warehouse' retaining more earnings and paying out a smaller or no dividend presupposes that 'The Warehouse' would have been able to use that retained capital wisely. With the possible exception of 'Noel Leeming', the historical hindsight tale is that 'The Warehouse' have been poor users of their own capital. Far from proving your point, I would suggest that the Warehouse is a very good example of a company that should not retain their own earnings. Paying those big dividends out of their earnings looks like the right thing to have done.

SNOOPY

[Snoopy]

I'm speaking from a book value per share vs market value per share. Drain the profits in the company and so shall you drain the market share price (there's no way around that).

I agree that in the medium term what you say above is correct, in a general sense.

If you seek companies that pay consistent dividends, then seek those that are mature companies with NO market growth (ie utilities). But that's not the story we see in NZ because it's well advertised with brokerage firms like Macquarie where investing in NZ equities is "all about the dividends".

The NZX has plenty of utility companies that you can invest in that are 'all about dividends'. Not sure of the point you are trying to make with those two sentences.

No one ever questions the shareholder who does NOT want a dividend because that triggers a tax consequence. No one has thought to say if the capital gain of the share keeps growing, then why not sell a portion of the shares when ever they WANT to elect a return on the investment. But what am I to know?

Making a profit will generate a tax consequence for a company, whether or not that profit is paid out as a dividend. So what you are suggesting is that a company that is making a profit should buy a company that is making a loss to extinguish that profit and the consequent tax liability?

I get you idea of taking a capital profit in small annual chunks rather than receiving that same money via a regular annual dividend. But the imputation credit system we have in NZ means that such a choice is 'tax neutral' for NZ shareholders. In NZ, there is no tax advantage in behaving as you suggest. In the US, with US investors investing in US companies, I accept your strategy may have merit.

NZ financial advisers know nothing about taxation because from ALL of the ones i've spoke to on the phone in NZ, they tell me, "well you'll need to speak to a tax adviser" which is something very wrong. All qualified CFA CPA advisers in N. America must have a full understanding of tax minimsation for their clients because taxation is such an integral part of investing and retirement planning. No fool in NZ should have to be stuck paying 2 sets of fees for financial advice.

I don't class myself as a cheerleader for NZ's financial advisors. But I don't think your criticism here is fair or accurate. You must have asked a very convoluted question to elicit the phone responses you have received. I am sure that if you had gone in to see these advisors in person, then you would have found a much more informed response forthcoming. Having said this, while I would expect NZ Financial Advisors to have a good grasp of NZ tax laws and their consequences, I wouldn't expect them to be able to advise on specific overseas tax issues.

If you have questions on NZ tax laws, the IRD website technical section for tax practitioners has all the information there is to know. Sometimes you have to go to the also on line 'Tax Information Bulletins' for a specific ruling. There is no charge for accessing these resources.

Also it's not about how quick NZ companies can mature in NZ because likewise, they can fade away as quick and why should investors take that kind of risk. You know a small market (that the NZX is), also means small liquidity = the greater risk for the multi-millionaire that can't move in or out quick enough to change their position. It's more like get all the small investors in, and let them watch 95% of the mix of small companies fail.

Investing in small high growth start ups is a high risk return game all over the world. Often an 'angel investor' selling down to let in a lot more smaller investors in is the only way small investors can participate in these business ventures. These ventures still remain high risk return though. You can't blame the ownership structure and 'big boys in the know selling out' for every NZ start up company failure.

Best to stick with buying houses - at least there's a for sure way path of keeping all those gains tax free.

No it isn't. Contrary to popular belief, you can lose capital by investing in property.

SNOOPY

[SBQ]

I agree that in the medium term what you say above is correct, in a general sense.

The NZX has plenty of utility companies that you can invest in that are 'all about dividends'. Not sure of the point you are trying to make with those two sentences.

My point is the over emphasis of dividend payments without consideration of appreciation in share price across pretty much all listed NZX companies. I'm not talking exceptions here but a company like The Warehouse should not have a dividend policy during their expansion stage (once they've built enough red sheds all over NZ, then ok i can see the argument). It's prevalent talk in NZ where when people discuss investments in equities (in any share holding), they put dividend payment as the priority. It's riddled in NZ talk so much that NZ brokerage firms use the same emphasis to their clients.

Making a profit will generate a tax consequence for a company, whether or not that profit is paid out as a dividend. So what you are suggesting is that a company that is making a profit should buy a company that is making a loss to extinguish that profit and the consequent tax liability?

???? Let me clarify to the elementary learner. If a company looks to do expansion, they require capital ($$) to deploy. What are the ways a company can raise $ ? Actually I can't believe i'm questioning this as every finance major (and thus every Financial Adviser) should know the main ways for raising capital. i) Borrowing direct from the bank or from external entities ii) Issuing Junk Bonds iii) Issuing more shares ; common or preferred, and iv) Retained Earnings or Shareholder's Equity. Which one poses the least impact on the state of the company's finances? Ding Ding! it would be the latter, using after tax profits it's retained in equity. But The Warehouse group didn't do that. No no, for decades they dished out a stupid 5 or 6% dividend policy while doing the worse, issuing more common shares. No where did I imply profits to be maintained in a company to buy out a losing company - where did that idea come from?

I get you idea of taking a capital profit in small annual chunks rather than receiving that same money via a regular annual dividend. But the imputation credit system we have in NZ means that such a choice is 'tax neutral' for NZ shareholders. In NZ, there is no tax advantage in behaving as you suggest. In the US, with US investors investing in US companies, I accept your strategy may have merit.

'Dividend Tax Credit' is standard treatment everywhere ; because it's not fair to apply corporate tax rates on the profits of a company, then issues dividends where the shareholders again get taxed at the full marginal tax bracket. I know this... What it seems is, somehow, they've forgot that a capital gain is tax free. Warren Buffet has been very critical about this and will never ever pay a dividend from Berkshire.

I don't class myself as a cheerleader for NZ's financial advisors. But I don't think your criticism here is fair or accurate. You must have asked a very convoluted question to elicit the phone responses you have received. I am sure that if you had gone in to see these advisors in person, then you would have found a much more informed response forthcoming. Having said this, while I would expect NZ Financial Advisors to have a good grasp of NZ tax laws and their consequences, I wouldn't expect them to be able to advise on specific overseas tax issues.

No they don't. The questions I asked regarded around FIF / FDR rules and more specifically, if a wealthy person living in NZ was to inherit $10M from a family member living in N. America, for which the $ is wholly invested in US equities, what would the NZ resident best do with that $ ? It's not even questions like this. Most simply tell me straight out that from a tax point of view, you're better to invest in NZ real estate; after all, the key reason why the NZ gov't has been trying to attack rising house prices with CGT is to address the gross differences between investing in managed style funds or in real estate. BWT, none of the financial advisers informed about using IRD's website but instead, say they know a great 'tax consultant' I can be referred to.

Investing in small high growth start ups is a high risk return game all over the world. Often an 'angel investor' selling down to let in a lot more smaller investors in is the only way small investors can participate in these business ventures. These ventures still remain high risk return though. You can't blame the ownership structure and 'big boys in the know selling out' for every NZ start up company failure.

No it isn't. Contrary to popular belief, you can lose capital by investing in property.

NZ shouldn't even be in this game of speculating small start ups in NZ. Take a look at the investment make up in Scandinavian countries; they're smart enough to figure out that they have no barriers for their citizens to speculate. Notably, investors there (and gov't pensions there) invest directly in US equities - even in small risky startups in the US. Instead in NZ, we have a TAXED coerced decision by Michael Cullen (who brought in FIF) to address this discrepancy by making NZ residents to favor NZ assets.

Let me put it this way. If we were go shopping in a massive supermarket complex and all the shelves are full of choices you can choose to invest in. What % does NZ sit in all those shelves? Maybe 1% at best? So why should people in NZ be limited to choosing their retirement in that 1% of the global market share of assets to choose to invest in?

@Aaron: As long as it is longer term any residential property that is not your own home sold within 5 years of buying it for a profit will be taxable. Bright Line Test.

The Bright Line Test was a joke to begin with when they changed it to 2 years. No one is going to think 5 years is would make any difference. It won't. IRD already has rules in place where if you flip a house, the gains are taxed at income rates. Do it many times over 1 year after another.. expect to be taxed on the capital gain. Planning for retirement doesn't come in 2 or 5 years... the time frame should be over decades, for which this 5 year holding period on a house is of moot interest.

[Aaron]

The Bright Line Test was a joke to begin with when they changed it to 2 years. No one is going to think 5 years is would make any difference. It won't. IRD already has rules in place where if you flip a house, the gains are taxed at income rates. Do it many times over 1 year after another.. expect to be taxed on the capital gain. Planning for retirement doesn't come in 2 or 5 years... the time frame should be over decades, for which this 5 year holding period on a house is of moot interest. [/FONT][/COLOR]

It was never changed to 2 years it came in at 2 years and has changed to 5 years. The reason it came into being was probably vote grabbing as people became jealous of house flippers making heaps of untaxed dollars because existing rules were pretty weak.

[SBQ]

It was never changed to 2 years it came in at 2 years and has changed to 5 years. The reason it came into being was probably vote grabbing as people became jealous of house flippers making heaps of untaxed dollars because existing rules were pretty weak.

Ok, it was INTRODUCED at 2 years and CHANGED to 5 years. Being too critical are we? All the people I know that bought real estate in Auckland 10-20 years ago have made bank. Not a single i've known bought with the intention to sell within 2 or 5 years. Instead they kept buying more houses and if you ask me, owning NZ real estate has turned out a very good strategy for retirement planning. As i've pointed out, there's a huge difference in tax treatment between those that choose to invest with ie Kiwi Saver vs those that bought Auckland properties.

[Aaron]

Ok, it was INTRODUCED at 2 years and CHANGED to 5 years. Being too critical are we? All the people I know that bought real estate in Auckland 10-20 years ago have made bank. Not a single i've known bought with the intention to sell within 2 or 5 years. Instead they kept buying more houses and if you ask me, owning NZ real estate has turned out a very good strategy for retirement planning. As i've pointed out, there's a huge difference in tax treatment between those that choose to invest with ie Kiwi Saver vs those that bought Auckland properties.

Just thought I would help you get your facts straight. Too critical?? I don't think so, I just thought I would help you with your facts. Don't disagree regarding housing having been a better bet than Kiwisaver though.

To be fair I am not adding to the debate.

[Snoopy]

'Dividend Tax Credit' is standard treatment everywhere; because it's not fair to apply corporate tax rates on the profits of a company, then issues dividends where the shareholders again get taxed at the full marginal tax bracket. I know this... What it seems is, somehow, they've forgot that a capital gain is tax free. Warren Buffet has been very critical about this and will never ever pay a dividend from Berkshire.

There is a substantial difference in the treatment of dividends paid to NZ citizens from NZ companies, and US citizens receiving dividends from US companies.

I believe that US companies pay tax on their profits. Then shareholders pay tax again on any dividends received from those tax paid profits. Contrast this to the NZ case where NZ companies pay tax and build up 'imputation credits' with the IRD. Dividends can then be paid out to the company's shareholders with no further tax liability, as long as the company's imputation credit balance is positive.

Your assertion that NZ shareholders of NZ companies are paying tax twice on the same profits when they receive dividends is not correct.

SNOOPY

[Snoopy]

Most simply tell me straight out that from a tax point of view, you're better to invest in NZ real estate; after all, the key reason why the NZ gov't has been trying to attack rising house prices with CGT is to address the gross differences between investing in managed style funds or in real estate. BWT, none of the financial advisers informed about using IRD's website but instead, say they know a great 'tax consultant' I can be referred to.

SBQ, I am not a property investor, unless you count owning your own house as an investment (I see it as somewhere to live). So if any property investor is reading this and I have got what I am about to say wrong please feel free to correct me. But I think that the tax treatment of NZ property investment verses NZ based managed funds has been largely evened out.

1/ Claiming depreciation on building structures is largely not allowed. It used to be the case that a rental property owner could claim depreciation on a house that was clearly appreciating in value. While any such depreciation claimed would have to be paid back to the IRD if a rental house was eventually sold at a capital profit, the net effect for the landlord was to get an interest free loan consisting of the cumulative depreciation claimed. That rort is no longer available.

2/ Landlords can still claim depreciation on certain fittings such as carpets and curtains. This leads to a lower tax bill, because net rental income is reduced. Some might argue that this is still a cashflow advantage to the landlord. But these fittings do wear out and will require real cash to replace. So I do not see this as a rort.

3/ I think there are certain 'ring fence' rules as well where you can't offset losses on one rental property against gains on another. I am a bit vague on this so I would appreciate if any property investors can further explain. This restriction does not apply to share and managed fund investment where everything is managed on a portfolio basis.

4/ Certain equity managed fund investments have a tax structure known as a PIE. That means shareholders are taxed at a maximum rate of 28%, a concession rate not available to own your own property investors.

5/ All banks will loan more money against a property than a share investment portfolio. But this is only an advantage if the underlying investment does increase in value. I would argue that at current market prices, the outlook for equities is better than the outlook for property.

6/ The loop hole where non-residents of NZ can buy property in NZ for tax free capital gain to be raked off overseas has been mostly closed (Australians and Singaporeans can still do it). This should see house prices in the future only increasing in value to the extent that NZ buyers increase their own underlying earning/borrowing ability. And that means headwinds for the property market in the medium term.

SNOOPY

[SBQ]

SBQ, I am not a property investor, unless you count owning your own house as an investment (I see it as somewhere to live). So if any property investor is reading this and I have got what I am about to say wrong please feel free to correct me. But I think that the tax treatment of NZ property investment verses NZ based managed funds has been largely evened out.

.. points 1 -> 6

SNOOPY

Far from being an even playing field between share investment vs owning houses. I did not mention depreciation either so that should not be part of the mix. You didn't have to and the NZ gov't should of stopped this practice long long time ago. Just look at the 2 asset classes alone

a) Share investment ie Kiwi Saver / PIE funds you name it. Paying 28% in tax vs

b) A house in Auckland, which pays a very small portion of taxation of maybe 5%? [Rates + Insurance and any miscellaneous outgoings].

You don't even have to work out the difference, just open your eyes and see why so many people in NZ have invested in real estate hand over fist than plunking down a million dollars in some Kiwi Saver fund. No one is going to put in $1M into a managed fund that is stung 28% tax on the gain every year. You know why? Because the banks themselves don't do it, but they would gladly lend on the real estate asset.

Let's recap. Since when houses in NZ have lost value over a multi-decade time frame? After all when you choose a retirement strategy, it happens on a "long term" approach. So we're talking 20 or 30 years. The banks know better that houses don't lose value over a 20 or 30 year time frame.

Not trying to say share investments is a bad thing. If I was living in the US or in Canada, then the table would be flipped around as they have extensive capital gains tax laws that makes real estate less attractive than owning equities.

Don't take my word for it. I've spoken to many financial advisers in NZ. Years ago I asked about a managed fund in NZ that invested with the same view of Warren Buffet's Berkshire Hathaway. They thought hard and told me there was none, even in Australia that they knew off the top of their head. They went on to explain that it's not the focus of what NZ investors seeks ; again going back to, the preference is they seek dividend payment as the measure of the company's performance. FYI, BRKA share price in 1964 was $19 - go look at it what it's worth today.