Say I have a personal income derived solely from New Zealand share dividends in the $40,000-$70,000 range (gross dividend total). Thirty-three per cent will already have been garnered in the form of imputation credits, so I will have been over-taxed.
Come year-end, IRD will recognise that I have been over-taxed, but because the tax was in the form of imputation credits, I will earn tax credits for the following year - not a tax refund for the amount of tax overpaid. This tax credit isn't much use to me if I have no other source of income.
I can get around this by investing some of the money in term deposits instead, and any of the tax taken on the interest can be refunded to me at year-end if I have been over-taxed. My term deposit is effectively ``tax-free', in the sense that any tax taken will be returned if I have earned matching imputation credits.
If I invested in a PIE instead of a term deposit, wouldn't I be worse off?
Mary Holm: You've outlined the tax position on imputation credits and term deposits correctly. So what happens when we introduce PIEs - or portfolio investment entities - into the mix? It all depends.
Firstly, the key features of PIEs are:
Now to your question. I assume you are talking about direct investment in shares, and are considering investing some of the money in a cash PIE - which is similar in many ways to a term deposit. Would it be better than a term deposit in the situation outlined?
No. Pie income does not go onto your tax return, so you wouldn't be able to use any excess imputation credits you have from your direct investments.
What's more, if you invest in a term deposit and work out that you will be entitled to a refund of the tax withheld from your interest (the resident withholding tax) of more than $500 a year, you could apply for a certificate of exemption. This would reduce the tax withheld through the year, so you would get the benefit of the money sooner.
However, if you are a bit flexible, there's a way you can achieve your goal using PIEs, and pay less tax in total.
To do this you would need to do your New Zealand share investing via a PIE that holds New Zealand shares, rather than investing directly. PIEs have their advantages, apart from tax. Generally, you can get much wider diversification, which reduces risk. And the fund managers keep track of dividends and other paperwork.
Then there's the tax. Most share PIEs can themselves use imputation credits, which will reduce the tax you pay on your PIE income.
Let's look at an example from Inland Revenue. The PIE allocates to you, as an investor, $100 of dividend income, $10 of deductions and $33 of imputation credits.
The taxable income would be $90 ($100 minus $10) and the tax on that would be $17.55 (at the 19.5 per cent rate) or $27 (at the 30 per cent rate). The PIE would then subtract the $33 of imputation credits, giving you a refund of $15.45 or $6.
You would be credited with that refund, which would go into your PIE account, buying you more shares.
You wouldn't need to file a tax return to do this. The PIE would take care of it all for you. And because you could take advantage of the generally lower tax rates in PIEs, your total tax would be lower.
Another advantage of this is that you could keep all your money in shares, if that is your wish - without having to put some in term deposits solely for tax reasons.
Mary Holm is the author of bestselling books on KiwiSaver and personal finance. She is also a highly praised seminar presenter. Her written advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following that advice.
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