New Zealand's taxation system employs a set of rules known as the Foreign Investment Fund (FIF) rules, designed to tax New Zealand tax residents on certain overseas investments. It is crucial for individuals or entities with investments outside New Zealand to understand these rules as they can significantly impact tax liabilities. This is a topic we spend significant time with clients on and find the FIF rules are a key deterrent for many to move to New Zealand, or settle here. Understanding, and mitigation is key. In this article, we delve into the application of FIF rules in New Zealand, exploring their scope, key principles, and implications for taxpayers.
The FIF rules were introduced to prevent New Zealand taxpayers from avoiding tax by investing in offshore entities that are not subject to New Zealand tax. These rules apply to investments in certain foreign entities, including shares in non-New Zealand companies, certain interests in foreign superannuation schemes, and some types of foreign unit trusts.
The FIF rules operate on an attribution basis, meaning that taxpayers are required to include a proportion of the FIF's income in their taxable income each year, regardless of whether any actual income is distributed to them. A lot of migrants and returning kiwis have share portfolios, or shares from previous employment, and these are generally subject to tax under the FIF rules.
There are five methods for calculation and the legislation prescribes which methods can be used by certain taxpayers. The default method is the Fair Dividend Rate method (FDR Method). FDR Method applies a deemed rate of return of 5% of the opening market value of the FIF investment. This means no losses can be realised, and tax is generally always payable, regardless of any cash receipt.
Some classes of taxpayers can choose to use the Comparative Value method (CV Method). CV Method compares the opening and closing market values of the FIF investment to determine any taxable income. This method is not available to all taxpayers, but if allowable, the taxpayer can pick the most beneficial method for them, but must apply that method to all their FIF interests which could be calculated using CV Method.
Certain exemptions and thresholds exist under the FIF rules, such as the $50,000 de-minimus threshold. Investments below this threshold are generally exempt from the FIF rules, although there are exceptions.
While the FIF regime was introduced to tax New Zealand residents on their offshore investments, it presents challenges, in particular for citizens accustomed to paying tax on realised gains. The most common pitfalls are as follows:
Taxation of Unrealised Gains: Unlike traditional taxation systems that tax gains upon realisation, the FIF rules tax unrealised gains. This means that taxpayers may be liable for tax on income they have not yet received, which can affect their cash flow and liquidity.
Increased Compliance Burden: The FIF rules can significantly increase the compliance burden for taxpayers with overseas investments. Calculating FIF income requires accurate valuation and reporting of foreign investments each year, adding complexity to tax filings.
Complexity and Penalties for Non-Compliance: The rules are complex, and not something that most accountants can recognise, or calculate easily. Failure to comply with the FIF rules can result in penalties and interest charges.
We are most commonly asked “how do I avoid the FIF rules” but unfortunately, the only way to avoid the FIF regime is to not have attributing FIF interests, or not be New Zealand tax resident. If you are New Zealand tax resident and you want to build a share portfolio including overseas shares, you are likely to have to account for tax using the FIF rules. It is important to note that FIF tax is a final tax in most cases, and this means that there is no tax on any dividends received.
We work together with our clients and their financial advisors to come up with a strategy that results in the net best outcome for our clients. That will generally include paying tax on FIFs, so it is important to have a full understanding of the rules, and how they will apply to you.
The FIF rules present challenges for taxpayers, particularly those accustomed to paying tax on realised gains. It is the key reason we see clients leaving New Zealand, or not moving here in the first place, and in our opinion, these rules need an overhaul. In the meantime, understanding these pitfalls is essential for taxpayers to navigate the complexities of the FIF rules effectively and ensure compliance with New Zealand tax laws. We partner with our clients and their other advisors to assist them to mitigate the challenges posed by the FIF regime and manage their tax liabilities more efficiently.
This article is intended for informational purposes only and should not replace specific tax advice. For personalised advice on all tax issues please contact us.
This article was accurate at the time of publishing.