OVERSEAS SHARES: SHOULD YOU BE A DE MINIMIS INVESTOR?

Overseas shares: Should you be a de minimis investor? It’s a good question. Learn why staying under the “de minimis” threshold might not actually get you the most tax-efficient outcome.

To introduce this, firstly let’s point out the obvious: Investing globally offers New Zealand investors the opportunity to diversify their portfolios and tap into international growth. However, navigating the tax landscape associated with overseas investments can be complex. This article delves into the tax considerations for New Zealand residents investing abroad, highlighting potential pitfalls and offering guidance to optimize tax efficiency.

New Zealand’s Tax Obligations on Global Income

As a New Zealand tax resident, you’re required to pay tax on your worldwide income, encompassing earnings from both domestic and international sources. This includes interest, dividends, and other returns from overseas investments. It’s essential to understand that different investment types are subject to varying tax rules and rates.

Double Tax Agreements (DTAs) and Their Role

Investing internationally may expose you to taxation in both New Zealand and the country where your investment resides. To mitigate the risk of double taxation, New Zealand has established Double Tax Agreements (DTAs) with numerous countries. DTAs determine which country has taxing rights over specific income types and often provide tax credits to offset taxes paid overseas. For instance, if you pay tax on investment income in a foreign country, you might be eligible for a corresponding tax credit in New Zealand, ensuring you’re not taxed twice on the same income.

Tax Treatment of Different Overseas Investments

Foreign Investment Funds (FIFs)

Investments in overseas shares, mutual funds, or certain foreign superannuation schemes typically fall under the Foreign Investment Fund (FIF) regime. The FIF rules are designed to tax New Zealand residents on attributed income from their offshore investments, even if that income hasn’t been repatriated. There are several methods to calculate FIF income, with the Fair Dividend Rate (FDR) and Comparative Value (CV) methods being the most common. The FDR method taxes a deemed return of 5% on the market value of your overseas investments, while the CV method taxes the actual change in value plus any distributions received. Choosing the appropriate method depends on your specific investment portfolio and market conditions.

Australian Unit Trusts (AUTs)

Many New Zealand investors are drawn to Australian Unit Trusts (AUTs) due to their accessibility and familiarity. However, it’s crucial to recognize that AUTs are subject to Australia’s tax laws, which mandate the distribution of all income, including realized capital gains. For New Zealand investors, this means that even if you haven’t sold your units, you might still be taxed on the trust’s realized gains. This scenario can lead to unexpected tax liabilities, especially if the AUT has significant turnover in its investment portfolio.

De Minimis Exemption

So we come to our original question re overseas shares: should you be a de minimis investor? New Zealand’s tax system provides a de minimis exemption for individuals with total FIF investments costing less than NZD 50,000. Under this exemption, investors are taxed only on dividends received, rather than on attributed income under the FIF rules. While this might seem advantageous, especially for investments with low dividend yields, it’s essential to consider the long-term implications. For instance, if your investment’s value appreciates significantly, surpassing the NZD 50,000 threshold, you’ll transition out of the de minimis exemption and become subject to the standard FIF rules, potentially leading to higher tax liabilities. But, read on…

Tax Sparing Credits

In certain situations, New Zealand’s DTAs with specific countries allow for tax sparing credits. These credits enable New Zealand residents to claim a tax credit even if tax hasn’t been paid in the other country, often to encourage investment in developing nations. Currently, New Zealand has such agreements with countries including China, Fiji, India, Korea, Malaysia, Singapore, and Vietnam. To claim these credits, investors must complete a disclosure return.

Common Tax Pitfalls for Global Investors

Overlooking Foreign Tax Obligations

It’s not uncommon for investors to focus solely on New Zealand’s tax requirements, inadvertently neglecting tax obligations in the investment’s country of origin. This oversight can lead to penalties, interest charges, or even legal complications abroad. Before investing internationally, it’s imperative to research and understand the tax laws of the foreign jurisdiction and ensure compliance with all applicable regulations.

Misapplying the FIF Calculation Method

Selecting the incorrect method for calculating FIF income can result in either overpaying or underpaying taxes. For example, in a year where your investments yield a return significantly higher than 5%, using the FDR method might be more tax-efficient. Conversely, in a downturn, the CV method could be advantageous. Regularly reviewing your investment performance and consulting with a tax professional can help determine the most appropriate calculation method for your situation.

Ignoring Currency Exchange Impacts

Investing in foreign assets introduces currency exchange risk. Fluctuations in exchange rates can affect the value of your investment and, consequently, your tax obligations. For instance, a favorable exchange rate movement might increase your investment’s value, leading to higher taxable income under the FIF rules. Conversely, adverse movements could result in losses that might not be fully deductible. It’s essential to factor in currency considerations when assessing the potential returns and risks of overseas investments.

Strategies to Optimize Tax Efficiency

Utilizing PIE Funds for International Exposure

Portfolio Investment Entities (PIEs) offer a tax-efficient vehicle for gaining international investment exposure. PIEs apply the investor’s Prescribed Investor Rate (PIR), capped at 28%, to income, which can be particularly beneficial for individuals in higher tax brackets. Moreover, income earned within a PIE is generally excluded from the investor’s personal tax return, simplifying tax reporting and reducing administrative burdens.

Leveraging Double Tax Agreements

Before investing in a foreign country, it’s prudent to review New Zealand’s DTA with that nation. DTAs can provide clarity on taxing rights, potential tax reductions

Get Advice

So, re overseas shares: should you be a de minimis investor? It depends. Check out this excellent article at InvestNow. Talk to your financial advisor; contact us! It might be more worthwhile (in your situation) to look at other options such as rental property, managed funds or direct investments.