McLEAN AND CO. Chartered Accountants

Accounting          Taxation         Business Advice and Development Assistance           Audits                             

 P.O. Box 10 , Clive         133 Main Rd, Clive           Tel. (06) 8700952          Fax. (06) 8700955 

Email murray@mcleanandco.co.nz                                  Website www.mcleanandco.co.nz

 
 
EMAIL NEWSLETTER  APRIL 2007
 
 

Welcome again to the McLean and Co. Newsletter in which we discuss current taxation and business matters. We trust you find it informative.  

 

NEW CLIENTS

We are happy to accept new clients.  We would be happy to assist colleagues and acquantances as new clients.

 

INDEX

  1. GST on Grants and Subsidies

  2. Foreign Investments Tax- The Rules

  3. Purchasing Rental Property in the Name of a Family Trust- Pros and Cons

 

 

GST ON GRANTS AND SUBSIDIES

Any grants or subsidies received from the government, a local authority or a private organisation include GST and must be included as income for GST purposes.  The only exceptions are grants intended for overseas use for international development.

This applies to wages subsidies received from WINZ.   Although there is no GST on wages you pay to employees, any subsidy you receive to help pay an employee's wages will be GST- inclusive.  You need to include it as income in the GST Return for the period you received the subsidy.

 

 

FOREIGN INVESTMENTS TAX- THE RULES

From 1 April 2007 individuals with investments in foreign lands face new and complex taxing rules.. There have been a number  of changes for New Zealand-resident investors in non-Australasian companies.  For people who have a standard income year (the large majority), the new rules apply from the start of their 2007/08 income year on 1 April 2007.

The rules apply to investments of less than 10% in most foreign companies, foreign unit trusts, foreign life insurance policies, foreign investment vehicles and foreign superannuation schemes.

 

THE $50,000.00 RULE

The $50,000 rule applies to individuals, and not family trusts or companies.

What the rule means is that if the total cost of an individual's foreign investments is less than $50,000.00 the new rules do not apply.

If an investment was inherited by an individual its cost is the market value on the date of inheritance for purposes of determining whether an individual is under the $50,000 threshold.

The exchange rate on the date of your purchase of any shares in foreign currency should be used.

The $50,000 threshold takes into account brokerage fees if these are part of the cost of acquiring any shares.

If an investment was acquired before 1 January 2000, as an alternative to cost, an individual can choose to value "cost" at one half of the market value on 1 April 2007.

If the individual is under the $50,000.00 threshold they pay tax on dividends received and only pay tax on capital gains if they are a share trader or acquired the investments with an intention of sale.

A couple can qualify for a total NZ$100,000 threshold. This can be achieved by half of the shares costing $100,000 being held in each persons name, the shares being wholly jointly owned, or a combination of individual and joint ownership (each person would have to add half the cost of their jointly owned shares to their individual shares to find out if they qualify for the threshold).

 

FAIR DIVIDEND RATE

The Government has decided that it is only "fair" that individuals pay tax on a deemed return of 5% per annum on foreign investments  rather than on the actual return.   This will be "fair" to the Government if the actual return is less than 5% and "fair" to individuals if the actual return is greater than 5%.

The 5% return is calculated on the value of foreign investments as at 1 April each year starting from 1 April 2007.

This means that individuals will pay tax on an investment even if they sell it during the year.  On the other hand, no tax is payable on an investment acquired during the year (unless it is sold during the year) until the following year.

As the 5% return is applied to the market value of the investment it is "fair" that tax is paid on the capital growth of investments and movements in the New Zealand dollar.  As the New Zealand dollar is high at the present time individuals will suffer a tax cost when it falls.

It does mean that tax will no longer be paid on dividends received.  A credit for any tax deducted in the country where any dividend comes from will however be available.

The following table illustrates the 5% calculation of taxable income:

  2007/2008 2008/2009
Opening Value 100,000 108,000
Dividend Received 4,000 6,500
FDR at 5% 5,000 (100,000 x 0.05%) 5,400 (108,000 x 0.05)
Taxable Income 5,000 5,400

 

Tax is then payable on the Taxable Income ($5000.00 and $5400.00 in the example above) at the marginal taxation rate that the taxpayer is liable for.  So say the taxpayer has $100,000 in the Opening Value as per the example below , and the investments are in his/hers personal name, and his/ her total Taxable Income including this Foreign Tax Income is $35,000. Marginal taxation rates for an individual with taxable income $38,000 or less are 19.5%, so the additional tax to pay will be $100,000 x 5% x 19.5% equals $975.00.   If the individual has a total Taxable Income including this Foreign Income of say $75,000, and therefore the marginal taxation rate is 39%, the additional tax to pay would be $100,000 x 5% x 39% equals $1950.00.

Thus , if you have a taxable income in excess of $60,000, when the 39 cents marginal taxation rate kicks in, it would be advisable to have any applicable investments in excess of the $50,000 (or $100,000) threshold in the name of a company or family trust, where the additional tax to pay would be at 33% instead of 39 cents as per this scenario.

If individuals or family trusts (but not companies) can show that the total return on all investments is less than 5% an alternative method of calculating the taxable income can be used and no tax payable in the year that there is a loss.  The FDR rate of return can never be lower than zero.   No losses are carried over under the new method each year is treated separately.

Examples:

(A) If you make a total return of more than 5 per cent:

John holds offshore shares that have a market value of $100,000 at the start of the year. These shares are worth $115,000 at the end of the year. John also receives a $10,000 dividend.

Under the fair dividend rate method, John pays tax on 5 per cent of $100,000 or a lower amount if his return for the year is less than 5 per cent. No tax is payable if his shares make a loss.

John's total return for the year is the $15,000 capital gain on his shares and the dividend of $10,000.

His total return is therefore $25,000. However, his taxable income for the year is limited to 5 per cent of the opening value of his shares. This would result in taxable income of $5,000.

(B) If you make a total return of less than 5 per cent:

Mary also holds offshore shares that have a market value of $100,000 at the start of the year.

These shares increase in value to $102,000 at the end of the year. Mary also receives a $1,000 dividend.

Mary would pay tax on 5 per cent of $100,000 (her opening value) unless she can show that she made a return of less than this.

Mary's total return for the year is $3,000 (comprising a capital gain of $2,000 and a dividend of $1,000), which is less than 5 per cent of her opening value of $100,000.

Therefore, Mary is only taxed on $3,000.

(C) If you make a loss:

Judy holds offshore shares that have a market value of $100,000 at the start of the year, which decrease in value to $75,000 at the end of the year. She also receives a $10,000 dividend.

Judy would be taxable on 5 per cent of the opening value of her shares unless she can show that her total return for the year is less than 5 per cent.

Judy's total return for the year comprises a capital loss of $25,000 and the dividend of $10,000.

Her net return is therefore a loss of $15,000. Because Judy has made a loss on her offshore shares, no tax is payable.

 

THE NEW ZEALAND RULE

The new rules do not apply to New Zealand investments so individuals will still pay tax on dividends received from New Zealand companies and capital gains will be exempt from tax unless an individual is a share trader or acquired the shares with an intention of sale.

Thus, for example if an individual invested in a New Zealand resident company unit trust this would not be caught by the new legislation 

 

THE AUSTRALIA RULE

There is an exclusion for investments in Australia, but not all such investments

The exclusion only applies to shares in companies included in the All Ordinaries Index of the Australia Stock Exchange ("ASX").   To qualify for the All Ordinaries Index a company must be an Australian tax resident (and some are not) and must retaining a franking credit account .   There are currently 477 companies in the All Ordinaries Index with around 32 that will not qualify under this criteria.  

Thus, for  example if an individual invested in a Australian resident company unit trust , as opposed to shares, this would  be caught by the new legislation.

 

THE GPG RULE

If an individual has shares in Guiness Peat Group PLC they will not be subject to the new rules for 5 years.

 

THE QUICK SALE RULE

Should an individual buy and sell investments in the same year tax is payable on the lesser of:

  • the gain on sale, or
  • 5% of the average cost of the investment

 

PROVISIONAL TAX

Individuals should be aware that these rules  apply from 1 April 2007. If the implementation of these new foreign investment rules means that they are liable for Provisional Tax (which would mean that the income tax to pay as a consequence is more than $2,500.00) then you should pay the expected tax to pay prior to 7/3/2008.

 

CONSULTATION WITH YOUR FINANCIAL ADVISOR

It may be appropriate, as a consequence of this new legislation:

  • to consult with your financial adviser to ascertain if you have the most tax effective investments
  • to revise your financial portfolio if appropriate

 

WHAT CLIENTS HAVE TO DO IN RELATION TO THEIR 1/4/2007- 31/3/2008 TAX PERIOD

If you are liable for this new foreign investment tax, as described above it is calculated on either:

  • 5% of the market value of foreign investments as 1/4/2007.
  • a lower figure if it can be shown that the rate of return is less than 5%

The first and immediate task you therefore have to do is establish the market value as at 1/4/2007 and keep this information for the end of the year 31/3/2008 tax return preparation.

 

 

PURCHASING RENTAL PROPERTY IN THE NAME OF A FAMILY TRUST- PROS AND CONS

 

While effective for some property investors, trusts certainly aren't for everyone.

 

A lot of investors buy property in the name of a trust. They commonly do so for "tax reasons" and "asset protection". But trusts aren't one-size-fits-all. The tax benefits don't work for everyone, and the asset protection mightn't be necessary - or effective - for everyone.

 

On the other hand, if a trust is going to suit your circumstances, it's better to set one up sooner rather than later.

 

If, in the future, you decide to hold your properties in the name of a trust, you'll need to transfer them from your name into the trust's name. This will incur legal fees, and if you had a rental property in another name and you were claiming depreciation you will have to declare the depreciation back as income (assuming the property went up in value which is normal). You will then embark on a gifting programme to gift the value of the transfer

 

The longer you wait to do the transfer, the higher the growth you'll have had in the value of your properties, and the longer the gifting programme you will have to embark on.

 

 

TAX REASONS  

Possible Disadvantages:

 

1. The negative gearing dilemma

 

You don't get negative gearing tax benefits in your personal tax return when you own properties in a discretionary family trust.   Any tax benefits you'll get by setting up a trust will need to outweigh the loss of these benefits. So what does that mean?

 

If you're negatively geared, the interest payments on your loans, plus all other property-related expenses  outweigh the rental income you're earning from your properties. Basically you're making a loss on your property portfolio each year. This is desirable for some investors, because the loss can be offset against personal income - allowing them to pay less tax.

 

However, this only applies if you own properties in your name or in a LAQC which you are a shareholder in, and not in the name of a trust. Basically the negative gearing losses get stuck in the trust. They can't be offset against your income because you don't own the properties - the trust does.    If you make a loss that loss stays in the trust and is available to be offset against future profits of the trust.

 

At some point in the future, your rents will increase and your interest payments might decrease (assuming you're paying off the principal). For these reasons, your property portfolio could become positively geared. If you own those properties in a trust, you'll then be able to claim the losses incurred in past years (when the properties were negatively geared).   However, until that point, you might be substantially worse off from a cash flow perspective. And with less cash flow, your ability to acquire more investments might be restricted.

 

So it's vital to consider your long-term strategy.    Are you likely to be negatively geared for a long time (for example, because you plan to use any excess income from your properties to service loans on more properties)?     In this case, a trust mightn't be the best solution for you.

 

You might think, "I'll just transfer my properties to a trust once my portfolio becomes positively geared."

 

 

2. Ongoing costs  

The potential tax benefits of a trust will also need to outweigh the ongoing operation costs.  These would include:

  • setting up the trust

  • ongoing gifting costs

  • other ongoing professional fees

 

   

 

Possible Advantages:

 

1. Income distribution

 

Current income tax rates for trusts are 33% from the first dollar. Current personal income tax rates are 19.5% up to $38000, 33% $38000-$60000, and 39% over $60000.

 

If you own properties in your name, you're taxed on the properties' income on top of your earnings. So if your salary is $60,000, and you earn $40,000 from your properties, you're taxed on a personal income of $100,000. The tax rate if the properties were in an individual's name would then be higher than if they were held in a trust. 

 

The main way a trust can reduce your tax bill is by allowing you to distribute this income (the extra $40,000) in a more tax-efficient way. In other words, that $40,000 can be taxed in someone else's hands - typically a family member in a lower income tax bracket.

 

The trust's income could be distributed to a spouse who isn't working, for example. That spouse would be taxed at a lower rate than his/her partner - by taking advantage of the tax-free threshold and lower income tax brackets. This is useful for couples if one partner is on the highest tax rate, while the other partner has little or no income. However, if both partners earn a similar amount, there mightn't be a benefit.

 

 

2.   Asset Protection 

 

If you buy properties through a trust, in theory they'd be protected if you were sued.  For some individuals this is an important consideration.  This can be subject to claw back as described below

 

 

3.  Rest Home Subsidies

This is a major reason while individuals put property into a trust (whether it is investment property which is rented out or property they live in), as it it not regarded as personal property if an individual has to go into a rest home in relation to government provided rest home subsidies.  There is a claw back period from the setting up of the trust and the finishing of the gifting programme, and this is a good reason why, if you wish to set up a trust, that you set it up sooner rather than late.

 

SOME INFLUENCING FACTORS AS TO WHETHER YOU SHOULD USE A TRUST OR NOT FOR INVESTMENT PROPERTY

 

1. How high is your income (and therefore your tax rate)?

 

2. How many family members (potential beneficiaries) do you have?

 

3. How many of those family members are on low (or no) income?

 

4. How soon is your property portfolio likely to become positively geared (i.e. income exceeds expenses)?

 

5. Will the tax benefits outweigh the ongoing costs of maintaining the trust?

 

6. Are you at high risk of being sued because of your occupation?

 

7. How important are the asset protection features of trusts to me?

 

FOR McLEAN AND CO KNOWLEDGE CENTRE AND ARTICLES ABOUT TAXATION AND BUSINESS IN GENERAL PRESS HERE FOR BUSINESS STARTUP KNOWLEDGE CENTRE PRESS HERE
FOR INFORMATION ABOUT COMPANY INCORPORATION PRESS HERE FOR PREVIOUS MONTH EMAIL NEWSLETTERS PRESS HERE

FOR PROPERTY INVESTMENT AND TAX INFORMATION PRESS HERE

FOR FRANCHISE INVESTMENT AND TAX INFORMATION PRESS HERE

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