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C & D

Do Pie Fund Investors pay too much tax?

“PIE Fund’s (Portfolio Investment Entity Funds) pay too much tax relative to Foreign Investment Funds (FIF Funds)”. That is a statement that has been raised several times since the introduction of the current investment taxation framework that was introduced at the same time as KiwiSaver around ten years ago.

Investors have the choice of using either FIF Funds, or PIE Funds for their international share investments. Investors who invest in FIF Funds, provided they are over the de minimis thresholds, are deemed to have investment income based on using either the FDR (fair deemed rate of return method currently at 5% of peak holdings) or the CV method (comparative value method). The CV method is typically used in years where the returns are low. CV can result in a negative figure, meaning that no income is deemed to have come from the FIF investments taken on a whole portfolio basis.

PIE Funds when they are investing in Foreign Investment Funds must use the FDR method regardless. In a poor investment year, investors who use FIF investments have a taxation advantage compared to PIE investors. How often would it be expected that the CV method would be used 1 year in 3. So, in theory then, over a three-year period, the taxable income could range from 0-5% of peak holdings. Let’s call it on average 3.5% per year, and assume peak holdings of $100,000. So, the average assessable investment income per year is $3,500 compared to the PIE investor where it would have been $5,000 per year. For a typical retired investor whose marginal tax rate is 17.5%, the tax difference per year is $262.50.

PIE investors have their tax taken at source. Other than for trusts, where they have the choice of allocating taxable income to beneficiaries, PIE tax is a final tax, so does not need to be included in a tax return. However, to claim investment expenses such as adviser and platform costs, PIE investors need to file a taxation return. On the other hand, FIF investors need to prepare tax returns and make a tax payment. So there can be a significant taxation compliance cost.

A smart solution is to invest only in PIE funds and have the platform fee and the adviser fee automatically offset by the PIP (Portfolio Investor Proxy, typically the investment platform provider). If this method is used, we would aim to have around 95% of the investments in PIE Funds with the balance being in the investors on call cash account. For an investor with $300,000 of investments this would leave $216.38 (based on our fee schedules) of expenses non-deductible within the PIE investments. At a 17.5% marginal tax rate, the effective cost to the investor of not filing a return is $37.87 for the expenses not already claimed.

Depending on how the adviser structured the portfolio for the same investor using either FIF investments for International share exposure or PIE investments, we can have the investor pay more tax (in the example it would be $262.50 + $37.87 = $300.37) or face paying compliance costs of say $600, to file an investment tax return.

In practice, what we have found is that in the ten tax years since the investment tax regime was changed, it has only been twice that it may been preferable to use the CV method compared to the FDR method. It is not uncommon for PIE funds to have tax deductible losses.

In conclusion, we do not believe that PIE Fund investors have been taxation disadvantaged. They may however be taxation disadvantaged if there are periods of negative investment returns, but this itself is mitigated across the whole of the investor’s portfolio, not just for example, the international shares component. They also benefit from lower taxation compliance costs.

Disclaimer

Steven Barton (FSP 32663) and Susan Pascoe Barton (FSP 32382) are Certified Financial Planners and Authorised Financial Advisers.  Their initial disclosure statements are available free of charge by contacting them on (07) 3060080 or they can be downloaded from www.pascoebarton.co.nz. This column is general in nature and should not be regarded as personalised investment advice.