New Overseas Tax Rules - Worked sample problem

[Snoopy]

quote:Originally posted by Grail

with the "quick sale" rule does that mean that whether you are considered a trader or not you only get taxed at 5% (of your portfolio) instead of your income tax rate (on your total profit)?

No. If you are a trader the rules are as they are now. Pay tax, at your marginal tax rate on all of your capital gains. But, to counteract that you can offset any profits you make by losses on losing trades.

For the investor, you have to be clear in your mind that there is a distinction between *your* marginal tax rate (which the overseas tax rules do not change) and what your 'deemed income' is (which is where the new rules make a difference). For quick sales the amount that is added to your 'deemed income' is the lower of 5% of your cost of purchase or the actual proceeds of your quick sale. Perhaps it is ripe to bring in a simple example here.

Your buy $100,000 worth of shares during the year and they shoot up to $140,000 in value at which point you sell in that same year. As a trader, assuming a 33% marginal tax rate, you pay:

($140,000-$100,000)x0.33= $13,200 in tax.

As an investor, who happens to sell out within a twelve month period you pay the lessor of what your trader friend pays for the same deal ($13,200) or the tax on what is 'deemed' your income, based on the opening value of what you bought. For the second option your would pay:

0.05 x $100,000 x 0.33= $1,650 in tax.

As you can see that is quite a bit less tax to pay for our 'investor' albeit $1,650 more than he/she would have paid the previous year before the new tax rules existed.

The 'sting' for our investor is that no tax deduction is available to be carried forward into subsequent years for any portfolio loss.

SNOOPY

[Snoopy]

quote:Originally posted by Tim

If I have a number of UK investment trusts, can the $50000 rule for overseas shares apply to these

Yes the new tax rules will almost certainly apply to your UK investment trusts. Even if those trusts are listed on the NZX it doesn't save them. In fact the new rules were primarily set up with the express intention of taxing UK domiciled investment trusts.

quote:
Also with the changes should one overweight ones portfolio to aussie and NZ.

That is a tough question. If you overweight your portfolio to Oz and NZ shares the you can expect your portfolio to be more volatile. However, I have seen no evidence that your ultimate returns will be lower.

You should also remember that overseas fixed interest investments (outside Oz and NZ) are not subject to these new rules.

SNOOPY

[Tim]

Thanks Snoopy

Alot to get ones head around.

[Grail]

thanks for that snoopy, cleared things up for me

[patsy]

Unless I'm reading the legislation wrong, it seems that foreign collective investment vehicles that invest in assets other than shares are not caught.

This includes vehicles like hedge funds (the OM products quite popular in NZ and Australia) and, for example, Australian REITs that invest directly into property. Hedge funds do not pay dividends so the implication is that they would not be taxed at all (i.e., no income tax, and no fair dividend rule). Direct property REITs pay Australian franked income so that's the equivalent of a bond EFT of Snoopy's previous message.

[Snoopy]

quote:Originally posted by patsy

Unless I'm reading the legislation wrong, it seems that foreign collective investment vehicles that invest in assets other than shares are not caught.

From page 27 of the IRD report.

"The principle underlying the Commissioner’s making of a determination precluding use of the fair dividend rate method is that the method should not apply to investments in foreign entities that provide investors with a return similar to a New Zealand dollar denominated debt instrument." <snip>

"For the purposes of making a determination described under category 4 the criteria that the Commissioner will consider will include:
• The proportion of the foreign entity’s assets that comprise debt or other fixed return instruments (such as fixed rate shares).
• The extent to which the entity’s investments comprising debt or other fixed rate instruments are denominated in New Zealand currency.
• In relation to investments of the entity that are not denominated in New Zealand currency, the extent to which the exchange rate risk has been removed by swaps, forward currency contracts or other derivatives."

"The Commissioner will take into account the whole arrangement, including any interposed entities or financial arrangements, in ascertaining whether the investment in a foreign entity provides investors with a return similar to a New Zealand dollar denominated debt instrument."

I interpret all that to mean that any foreign assets that are *not* a defacto debt instrument are caught.

"This determination process is intended to provide sufficient flexibility to deal with cases close to the boundary."

And that 'escape clause' means that IRD reserves the right to change their minds on specific funds on a case by case basis.

"Determinations apply on a prospective basis only, <snip> For investments in place before 18 December 2006 (date of enactment of the new offshore tax rules), the Commissioner will apply any determination from the start of the tax year beginning after the making of the determination. This will also be the general rule for other investments <snip>"

I think this means that unless your 'borderline investmen't has been *specifically* checked out from information available *before* the start of the financial year, then there is no guarantee that it will be exempt.

quote:
Hedge funds do not pay dividends so the implication is that they would not be taxed at all (i.e., no income tax, and no fair dividend rule).

Patsy, I think you are being too broad brush with your comments here.

A hedge fund could easily operate purely in sharemarkets. At various times that could mean defacto ownership of shares. Those shares would pay dividends that could indeed be paid on to the hedge fund unitholders. It is equally possible that a hedge fund may only trade currencies and bonds. In that instance the hedge fund would be exempt from the new overseas ownership rules. That means your general statement that 'hedge funds do not pay dividends' is not true, even though it may be true in specific circumstances.

quote:
This includes vehicles like hedge funds (the OM products quite popular in NZ and Australia)

You are referring to the OM hedge fund products as promoted by Canopus Investments?

From the "www.canopus.co.nz" web page these funds

"...may feature a preset bonus return above a certain benchmark index compiled from price movements in the underlying baske

[patsy]

I've checked with accountants at one of the "big four" firms. These are their comments:

1) Non-exempt taxpayers investing in any non-NZ-domiciled fund, regardless of the underlying investment (except for bonds, debt instruments, fixed interests) will be taxed using FDR (unless, of course, the total performance is less than 5%) - this includes REITs simply because the actual fund is not considered an "Australian company"

2) This includes hedge funds (incidentally, the one I was referring to was OM-IP www.maninvestments.com.au)

3) The above excludes funds that promise guaranteed returns (like a few within the OM-IP family) - those are taxed using the actual performance, not the FDR method

4) Most of NZ funds will apply for PIE status but IRD reserves the right of approving or declining such application - final ruling is expected by 1 October 2007

5) The only NZ fund for which there is still debate within the IRD is the Lion Tamer family - anything can happen to them (including ending up as an FDR fund, which will erode its performance)

5) Listed indices in both NZX and ASX are caught by the FDR rules

As an aside, I've just found this page:

http://www.moneyonline.co.nz/ Follow the "New Investment Taxes" link. There is a nice little summary there.

[OldRider]

My undertanding of the OM family of funds is that they are not viewed as share owning funds,
but similarly to cash or fixed interest.

What happens with them is a certain percentage of their funds is given to the guaranteeing bank,this amount together with the interest acrued is sufficient to return the guaranteed amount. The balance is invested in derivatives and the like to get the growth.

As such any capital gain is taxable when the fund closes,thus they would not be a part of this regime any more than is a foreign bond.

My understanding only, do others have a different view?

[Snoopy]

quote:Originally posted by patsy

I've checked with accountants at one of the "big four" firms.

Good work Patsy. I think when you ask for advice like this, you have to consider the angle the respondent is coming from. Anyone in the "big four" will be in "big trouble" if they issue wrong advice. That means where there is doubt, the advice will of necessity be conservative.

quote:
These are their comments:

1) Non-exempt taxpayers investing in any non-NZ-domiciled fund, regardless of the underlying investment (except for bonds, debt instruments, fixed interests) will be taxed using FDR (unless, of course, the total performance is less than 5%) - this includes REITs simply because the actual fund is not considered an "Australian company"

Are there ozzie REITs in the ASX200 or ASX all? If so they must be considered companies by the ASX. The NZ IRD document you quoted has an external link to the approved ASX company list with no rider that certain listings are excluded....

Do I have to count NZ managed overseas funds (who pay the new tax at the operational level, so the unit holder doesn't have to) in with my $NZ50,000 overseas investment allowance? If not, this may be the way to go to balance my overseas exposure in the future.

Do the Australian REIT pay less tax than an equivalent ASX company? If not, why would they be singled out as a 'tax dodge' vehicle by the NZ IRD?

I'm not expecting you to answer these questions Patsy. Just pointing out where the grey areas might be. Maybe your "big four" person knows the answers, or maybe he/she was just guessing.

quote:
2) This includes hedge funds (incidentally, the one I was referring to was OM-IP www.maninvestments.com.au)

Not surprising the "big four" say it is covered by the FDR, considering OM-IP use an 'opportunities portfolios' which I presume is financial planner speak for shares. The term is used to make people believe the hedge funds they are investing in is a new asset category, when in reality they are not.

quote:
3) The above excludes funds that promise guaranteed returns (like a few within the OM-IP family) - those are taxed using the actual performance, not the FDR method

All of the OM-IP hedge funds I have read about have this feature. The question is what is the tax treatment of the bonus lock up interest that is dependent on hedge manager performance. If the managers lose money then you only get the guaranteed return and the holding is exempt. If they make money then you get a top up payment and the whole thing comes under the claws of the new FDR regime.

That interpretation doesn't seem reasonable - a grey area?

quote:
4) Most of NZ funds will apply for PIE status but IRD reserves the right of approving or declining such application - final ruling is expected by 1 October 2007

So you won't actually know if your NZ fund is subject to FDR until 1st October, yet you need to decide whether to hold the fund or not by 1st April? That reeks of uncertainty.

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[Snoopy]

quote:Originally posted by OldRider

My undertanding of the OM family of funds is that they are not viewed as share owning funds,
but similarly to cash or fixed interest.

What happens with them is a certain percentage of their funds is given to the guaranteeing bank,this amount together with the interest acrued is sufficient to return the guaranteed amount. The balance is invested in derivatives and the like to get the growth.

As such any capital gain is taxable when the fund closes,thus they would not be a part of this regime any more than is a foreign bond.

My understanding only, do others have a different view?

What you say makes perfect sense Old Rider. But I wonder if the IRD will have the same sense of 'sense' if you see what I mean?

There is nothing in that IRD document Patsy referenced that says what percentage of 'non bond' content a primarily bond fund can have before it is regarded as 'not a bond fund'. The comments that *are* there imply there is 'wriggle room' to sort out the marginal calls. But they don't pin down where the hurdle is.

You may find OM are 'caught out' by not turning over 25% of the total fund (which probably equates to 100% of the hedged bit) every year.

SNOOPY