Always Blow on the PIE
You may have heard of the iconic episode of NZ TV series, Police Ten 7, when Auckland Policeman Guy Baldwin apprehended a suspected car thief. It was 3:00am in the morning and so the conversation was understandably strained. The suspect, stalling for time, conveyed an intention to wander down the road to buy a pie. The officer’s reply was out of the blue and very food safety focused: “Always blow on the pie - safer communities together”. The segment went viral.
Today there’s a different hot topic PIE story out there – and many investors are now wondering if a PIE (Portfolio Investment Entity) investment option might help them avoid a “tax burn”, given the maximum and final tax on a PIE investment is 28%, irrespective of your other income.
Since 1 April 2021, for those earning more than $180,000 a year, the marginal tax on every dollar above that threshold is 39%. From 1 April this year, the trustee tax rate also rises to 39%, though there is an exception that allows Trusts earning less than $10,000 a year, to continue to pay trustee tax at 33%. Potentially, 49,000 of the 400,000 Trusts in NZ are about to be taxed at 39%.
For income generated by investments, perhaps a PIE structured investment may offer some relief, as the maximum Prescribed Investor Rate (PIR) tax is currently limited to 28%. Let’s explore this some more.
Consider a simple term deposit - if the interest income generated was 4.8%pa, and from 1 April 2024 trustee tax is levied at 39%, the after-tax return is 2.9%. Whereas if invested via a PIE (with a maximum PIR of 28%), 4.8%pa gross delivers a net return of 3.5%. In terms of this comparison, where we can get the exact same product via a PIE solution, a PIE seems a no brainer, except as we move beyond simple term deposits, tax and risk all start to get a whole lot more complicated.
Many domestic managed investment funds are PIEs, and these have fees. So, we may need to balance a tax saving with the dilemma of extra costs. And, if we’re talking about investing beyond NZ (which we surely would), then assuming more than $50,000 was invested offshore, the Foreign Investment Fund tax regime (FIF) likely applies and in this, a PIE may not always be the best option.
Without going into all the detail, on assets outside of NZ, a PIE must deem a dividend of 5% to have occurred every year and it then pays tax on that assumed dividend, irrespective of what the return was. This is referred to as the Fair Dividend Rate (FDR). So, in those years when results are less than 5% (yes, even in negative years), the PIE must still pay tax on 5%; while individuals and family trusts investing in directly held assets can elect to pay tax based on a Comparative Value (CV) test (meaning tax is only paid on what is made and, if that is 5% or more, the tax payer can switch to the FDR method instead of the CV to limit tax. But their tax “rate” may not be limited to just 28%, as would be the case with a PIE).
PIE investments may not always be an advantage. It is important to properly understand all the risks when constructing any investment strategy. Ultimately, a good portfolio is diversified, it will seek the best returns, net of tax and fees and it will strive to smooth results. There is plenty of research that implies good financial advice adds 2-4% to returns over time*, as much as the avoidance of greater loss, as to the generation of higher gains. (*Source: Measuring the Value of Advice, Vanguard & The Value of Advice, Russell Investments)
Tomorrow is precisely unknown, and we should always be wary of past returns except, mostly markets do what they have always done and for as long as our society is by in large as it has always been, then we should be confident in the systems and processes we’ve used successfully in the past to deliver good outcomes. Meantime, always remember to blow on the pie...
Please note – tax is complex, and this by no means solicitates specific advice. We do recommend you check with your tax professional before taking any action.
The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.
