Overseas investments such as foreign shares and managed funds held by New Zealand tax residents are generally taxed under the New Zealand foreign investment fund (FIF) rules.
The FIF rules are specific to tax and the treatment adopted will not appear in the financial statements. When a taxpayer has investments which are subject to the FIF regime, any dividend income received on those investments will not be included in the income tax return. If the dividends have had foreign or New Zealand tax withheld on them, the amount withheld may be able to be claimed as a tax credit in the income tax return subject to certain criteria.
The two main methods used for calculating FIF income are:
- If the investments made a loss during the year or if the gain is less than 5% then the comparative value (CV) method would produce a lower amount of FIF income and would be the better option.
- If the gain made on the investments exceeds 5% of the opening market value then the fair dividend rate (FDR) method would produce the lower amount of FIF income as it essentially limits the amount of FIF income to 5% of the opening market value.
Both trusts and individuals are able to calculate their FIF income using both methods and can then select the method which produces the lowest amount of FIF income.
When the FIF rules don’t apply
The FIF rules do not apply to individuals who have investments in the following circumstances:
- In overseas companies and managed funds costing less than NZ$50,000
- Persons who have ownership in an overseas company of greater than 10%
- Most shares in listed Australian companies
Investments in overseas companies and managed funds costing less than NZ$50,000 and Australian shares not included in the FIF regime will usually be treated under the normal income tax rules, when on the basis the shares were not acquired with an intention of disposal, shareholders only pay tax on dividend income they receive. If the investors have over 10% ownership different tax rules apply.
Fair dividend rate method
One of the methods used to calculate the amount of FIF income on overseas investments is the FDR method. This method is the only method available for investments held by companies unless the shares are “non-ordinary” such as preference shares and fixed-rate shares. This is one of the main reasons why companies are generally not the best entity to use for investing in listed shares overseas. With this method the FIF income is 5% of the total opening market value of the investments which is then taxed at the applicable rate.
If investments are purchased and subsequently sold during the same tax year, they will still be included under the FDR method. The taxpayer can select to have the investments purchased and sold during the year calculated by using either the quick sale gains method which includes the actual amount of any gain made, or by the peak holding method which includes 5% of the cost of the investments as FIF income.
The FDR method is more likely to be used when investments have made a large capital gain during the tax year.
Comparative value method
The other method available to calculate the amount of FIF income is the CV method which essentially taxes any capital gain made. This method calculates FIF income by using the following equation (Closing value + Gains – Opening value + Purchases).
The items in the formula are broken down as follows:
- Closing value: The total market value of the overseas investments as at the last day of the tax year.
- Gains: Any dividends received from the overseas investments and any amount derived from disposing of some of the overseas investments during the year.
- Opening value: The total market value of the overseas investments as at the first day of the tax year.
- Purchases: The amount of money paid for overseas investments purchased during the year.
Note: Any loss incurred using the CV method will not be able to be claimed unless it arises on a forced CV investment (e.g. guaranteed rate of return).
Only one of the above methods can be used each year. For example, in the same tax year you cannot calculate some investments using the CV method and other investments using the FDR method. However, if the FDR method is chosen but certain investments are required to be calculated using the CV method then it will be acceptable to use both in this instance.
If you have any questions about investing in overseas companies or managed funds, please contact your local Findex tax adviser.