Why understanding tax is so taxing, but worth the effort when investing

New Zealand is currently at an interesting part of the economic cycle, with some commercial property seeing a softening of asset values, suggesting we are in a buyer's market. With New Zealand's election wrapping up last weekend, the conversation around tax and the impacts of potential new tax policies on commercial real estate is top of mind.

PMG Chief Financial Officer, Nigel Lowe, recently shared his insights into policy, politics and commercial property.

I often see people’s eyes glaze over at the mention of tax – for some, it’s something they’re more than happy to leave to the experts to sort out on their behalf. While that’s certainly a wise move, and we strongly recommend that you seek independent tax advice on your individual circumstances, here are some tax “basics” to think about.

How tax differs between investment types may not seem all that interesting on the surface, and you could easily assume it all works pretty much the same. But taking a closer look at the methods behind how different investments are taxed could be an important point of difference when deciding where to invest. Again, a specialist tax advisor will be best placed to talk through these issues, with your circumstances in mind.

At PMG, our commercial property funds are all multi-rate Portfolio Investment Entities for tax purposes – or PIE funds, which offer some advantages in terms of the tax investors pay on their investment income, so we’ve shared answers to a few common tax questions.

How does tax work in a PIE fund?

Investors in multi-rate PIEs are taxed on their share of the funds’ taxable income, rather than having a tax liability on distributions, like certain other investments.

The tax you pay on income derived from a PIE fund (your share of PIE tax) is calculated based on your Prescribed Investor Rate (or PIR), which is capped at a maximum of 28 per cent.

So long as investors have selected the correct PIR and have a PIR of more than 0 per cent, all tax obligations are managed by the PIE fund and no additional tax is payable by the investor. If you have elected the incorrect PIR and are a NZ resident individual, Inland Revenue performs an end-of-year square-up on your PIE income. This may result in either additional tax to pay or a refund.

The applicable PIE tax rates could make a significant difference to investors’ net returns after tax especially when you consider the top personal marginal tax rate is currently at 39 per cent.

The graphic below represents an example of how PIE tax distributions may compare to other (non PIE) income:

Why are there taxable and non-taxable components of my distributions?

Your distribution from the PMG PIE funds is not separately taxable as a dividend. Instead, we use gross cash distributions to fund your share of the PIE tax (calculated at your PIR). So you should not include distributions in your tax return. However, PMG will typically disclose both taxable and non-taxable components so you can see the makeup of the distribution.

The taxable component of the distribution represents an investor’s portion of taxable income in a PMG PIE fund. PIE tax is calculated on this component at your PIR (which as mentioned above is capped at 28 per cent). The PIE tax is deducted from the gross cash distribution.

The non-taxable component is the difference between the gross cash distribution and the taxable component. The non-taxable component of investment returns can be any number of things, including any non-taxable amounts such as capital gains or the benefit of tax depreciation on investments of the PMG PIE funds.

However, it should be noted that:

• While regular PMG PIE funds distributions may have taxable and non-taxable components disclosed, there is no requirement for all taxable income of a fund to be paid out to investors.
• In some cases, special distributions may also be made and in these cases, the reason for the special distribution will be clearly stated.
• Investors who have a PIR of 0 per cent may have an obligation to return their share of PIE taxable income in their tax returns. We provide separate reporting to these investors on what may need to be included in their tax returns.

What is the difference between net and Gross cash distributions?

Net cash distribution is what investors receive after any PIE tax is deducted from distributions, in other words, ‘what investors receive in their bank account’, while gross distributions are before any PIE tax is deducted or ‘what the fund pays out to investors’. But to reiterate, the distribution itself is not separately taxable.

How does tax on my PIE fund investment income work if they are held in a Family Trust?

PIE tax on investments made via a family trust works broadly the same as any other method of investing in PIEs, with the trust electing an applicable PIR. A NZ family trust can elect a PIR of 0, 17.5 or 28 per cent (and 10.5 per cent in limited cases).

The Trust Deed and income tax rules may also allow the trust to distribute the PIE income (and any PIE tax deducted) to beneficiaries. The beneficiaries may then be liable to return tax on the beneficiary income at their personal tax rate (with a credit for any PIE tax deducted). This may be beneficial if beneficiaries have a personal tax rate of less than 28 per cent.

There is draft legislation (not yet enacted) raising the trust tax rate from 33 per cent to 39 per cent from 1 April 2024. If that change proceeds, a trust that elects a PIR of 28 per cent will continue to pay PIE tax at 28 per cent and not the higher trust rate.

What changes are on the way for commercial property tax?

The biggest potential change for commercial property is the removal of tax depreciation on buildings. Both major political parties have announced policies to remove building tax depreciation if they are in Government. However, depreciation on commercial fit-out will still be available.

The removal of tax depreciation on buildings will increase taxable income for PIEs that invest in commercial property, such as the PMG PIE funds, and could therefore reduce the net cash distributions to investors.

It’s worth noting however that even with the removal of tax depreciation, having a PIR capped at 28 per cent, means commercial property investment via PIE funds may still have advantages compared to the way other investment holdings (including direct property investment) are taxed.

How do I file a tax return for my PIE fund investment?

For fund managers like PMG, we report PIE income and pay PIE tax on investors’ behalf directly with the IRD so they receive investment details directly from the manager. Investors generally don’t need to file a tax return to include PIE income provided they have selected the correct PIR rate (we say “generally” because there are special rules that apply to investors who can elect a 0 per cent PIR).

This is something those who I see frequently glaze over that ‘tax talk’ will be happy to hear, I’m sure.

Disclaimer: The information in this blog is of a general nature and was current on 17 October 2023. It is not intended to be regulated financial advice for the purpose of the Financial Markets Conduct Act 2013 and does not take your individual circumstances and financial situation into account. PMG does not provide financial advice. Please seek advice from a licenced financial advice provider before making any investment decisions.