Changes for trusts, tax rates and Portfolio Investment Entities – Mark Lister

OPINION

If you hold some of your investments in a trust, your tax rate is going up next week.

You might need to rethink the types of assets you own and the investment vehicles you
choose to ensure you’re not paying more tax than you need to.

But beware – the impost might not be the showstopper some are suggesting it will be, and it doesn’t always make sense to build an investment strategy around tax minimisation.

Fine-tuning could be the order of the day, rather than a dramatic recalibration of your approach.

From April 1, the tax rate for trustees will increase from 33 per cent to 39 per cent for all trusts with income over $10,000.

This will bring the trust tax rate into line with the highest personal tax rate.

It is expected to encourage some investors who own assets in a trust to move into Portfolio Investment Entities (PIEs), which attract a maximum tax rate of 28 per cent.

Almost all the unlisted managed funds in New Zealand are PIEs, as are some listed vehicles such as real estate entities like Goodman Property Trust and Precinct Properties.

Moving some of your directly owned trust assets (such as your fixed income or shares) into a similarly-exposed PIE vehicle will indeed save you some money on your tax bill.

New Zealand doesn’t have a capital gains tax, and only income attracts the ire of the taxman.

Cash, term deposits and fixed income (assuming it’s held to maturity, rather than traded) only generate returns via income, which means these assets will feel the brunt of higher taxes most.

Using the five-year government bond yield (which has averaged 4.8 per cent over the past 30 years) as a guide, the after-tax return improves from 2.9 per cent to 3.5 per cent if one can reduce their tax rate from 39 per cent to 28 per cent.

While that’s only marginally above half a per cent, it’s a reasonable proportion of the overall return.

When it comes to shares, things get murkier.

New Zealand shares have delivered an annual total return of 8.6 per cent over the past 30 years, which increases to just above 10 per cent if we account for imputation tax credits.

About 40 per cent of the return has come from share price gains, which are untaxed, the majority of which has been from cash dividends.

After taxing those dividends at 39 per cent, the annual tax drag is 2.6 per cent, which means the total return falls to 7.4 per cent.

At the lower PIE tax rate of 28 per cent, the tax drag is 1.9 per cent, which means the total return only falls to 8.2 per cent, a saving of three-quarters of a per cent.

However, portfolios don’t manage themselves, and managed funds are at the more expensive end of the spectrum when it comes to fees.

According to the sorted website, the average growth fund charges total fees of 1.5 per cent per annum, which could wipe out all your tax savings (and more) unless your fund manager can beat the market.

International shares are taxed differently, and for most investors (including PIE funds), the “fair dividend rate” method is used.

It assumes a “deemed dividend” return of 5 per cent, and investors pay tax on that at their marginal rate, even if the market goes up 25 per cent like it did in 2023.

The tax drag on a fixed 5 per cent return is 2.0 per cent at the 39 per cent rate, and 1.4 per cent at the lower 28 per cent PIE rate.

The difference there is 0.55 per cent, which isn’t as significant relative to the average return of 10.1 per cent from US shares over the past three decades.

Using a PIE structure can be an excellent complement to directly held investments, especially for those looking to minimise tax for the parts of the investment landscape where it makes sense.

A good investment adviser will have a range of options and tools at their disposal to satisfy those who want to use PIEs across the board, direct investments only, or a combination of both.

It’s extremely important to be tax aware, and to minimise costs where you can.

However, ensure you are taking a holistic approach.

Fees are an obvious consideration, as is the flexibility one might lose if exclusively using PIEs, and the inability to have a say about how your investments and sustainability goals are managed.

Whether you’ve got a trust or not, it’s an opportune time to take a closer look at how your affairs are structured. Just don’t let tax considerations alone drive your investment decisions.

Mark Lister is an investment director at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision, Craigs Investment Partners recommends you contact an investment adviser.