Amendments to the PIE rules

2011 changes to the portfolio investment entity rules including to how prescribed investor rates for recent migrants are set to more accurately reflect their income.

Sections DB 23, CX 56, HL 10, HL 21, HM 5, HM 6, HM 12, HM 14, HM 21, HM 25, HM 36, HM 38, HM 45, HM 56, HM 57B, IC 3, LS 2, OK 6B and table O17 of the Income Tax Act 2007; sections HL 10, HL 20 and MK 4 of the Income Tax 2004; section 57B of the Tax Administration Act 1994

Several amendments have been made to the portfolio investment entity (PIE) rules to ensure they operate as originally intended. The most significant of these is a change to how prescribed investor rates for recent migrants are set to more accurately reflect their income.

Application dates

The amendments apply from various dates as set out below.

Detailed analysis

Prescribed investor rates for recent migrants

Sections CX 56, HM 57B and LS 2

Section HM 57B provides that a recent migrant, in calculating their prescribed investor rate (PIR), must take into account their non-resident foreign-source income. Previously, PIRs were generally based on the lower of a person's New Zealand taxable income in the past two income years. However, this drafting resulted in an inappropriate outcome. Recent migrants often have very little New Zealand taxable income prior to migration. Accordingly, recent migrants were generally able to select low PIRs in their initial years in New Zealand, regardless of their actual New Zealand income.

Under the new rule, it is a recent migrant's net, not gross, world-wide income that is counted when determining their PIR. That is, if the person incurred expenditure in deriving their non-resident foreign-sourced income, those expenses should be subtracted from that income before determining the appropriate PIR.

In addition to taking account of non-resident foreign source income, section HM 57B(4) provides that a transitional resident must include income that has been exempted under section CW 27 when determining their PIR. This is appropriate as PIEs are able to invest into New Zealand.

This new rule applies when a person first becomes resident in New Zealand; however, it has an enduring effect. In subsequent years, when the investor determines their PIR, they must continue to include their worldwide income from years when they were not resident and disregard income exempted under section CW 27.

Example 1

For the purposes of this example, assume that the top PIR in all years is 28% and applies if a person's New Zealand taxable income is over $70,000.

Mike will move to New Zealand on 1 April 2012 from France. His net taxable income from France and New Zealand in different income years will be:

Year France New Zealand
2010-11 NZ$100,000 NZ$0
2011-12 NZ$125,000 NZ$0
2012-13 NZ$125,000 NZ$0
2013-14 NZ$30,000 NZ$50,000
2014-15 NZ$30,000 NZ$50,000

The NZ$30,000 Mike earns from France in 2012-13 and later years (ie, after his migration) is investment income. As Mike qualifies as a transitional resident, this income is exempt income in New Zealand. Mike has no other income.

In all of the income years from 2012-13 to 2014-15, Mike will have a PIR of 28%.

For the 2012-13 year, Mike's worldwide taxable income in the previous two income years was $100,000 and $125,000.

For the 2013-14 year, Mike's worldwide taxable income in the previous two income years was $125,000.

In determining Mike's PIR for the 2014-15 year, the lower of Mike's income in the previous two income years was from the 2013-14 year. Considering that year, Mike's New Zealand taxable income was only $50,000 as his $30,000 French income was exempt under section CW 27. However, for the purposes of determining his PIR, this exemption is ignored, resulting in a 28% PIR.

Exception if income significantly different

Under section HM 57B(3), a person who has moved to New Zealand can choose for this section to not apply in one, or both, of the income years in which they are first resident if they expect their New Zealand taxable income for that year to be significantly lower than it was before they migrated. This may occur, for example, if the person has educational qualifications that are not recognised in New Zealand.

If a person elects for this rule not to apply, their PIR will be determined as usual; that is, based on their New Zealand taxable income. However, section CX 56 will not apply to any PIE attributed income they derive. This means the person will have to include any PIE income in their own tax return, although they will receive a credit for any tax paid by the PIE on their behalf.

This new rule applies to PIR calculations for the 2012-13 and later income years for both new and existing migrants to New Zealand.

Investment by charities into PIEs

Section HM 21

Section HM 21 has been amended to allow registered charities to hold more than 20 percent of a PIE and be a PIE's only investor, provided the charity earns only tax exempt income under section CW 41 or 42. This amendment allows a charity to control a PIE.

On its face this amendment seems inconsistent with the general principle that a PIE should be widely-held. The rationale for this general rule is that it prevents a person from controlling a PIE and using it as their personal investment vehicle, which could provide a tax advantage compared to investing directly. However, there is no mischief in allowing a charity to control a PIE as the charity's income would be exempt whether the income was derived directly or through a PIE.

This amendment applies from 29 August 2011.

Income from life insurance

Sections HL 10, HM 12 and HL 10 of the Income Tax Act 2004

Section HM 12 has been amended to ensure that PIEs are able to derive income from life insurance policies. PIEs are restricted to earning only passive types of income, such as income from financial arrangements and dividends. Income from life insurance policies is another type of passive income; however, such income was inadvertently not included in the list of types of income that a PIE can derive.

This amendment applies from the beginning of the PIE regime, 1 October 2007. Accordingly, similar amendments have been made to section HL 10 of the Income Tax Act 2004 and 2007.

Intra-group financing of land investment companies

Section IC 3

Section IC 3 has been amended to provide that a PIE is able to group with wholly owned subsidiaries, provided the subsidiaries are:

  • multi-rate PIEs;
  • land investment companies;
  • a company that meets the requirements of section HM 7(a) and (d) (ie, a company that could be a PIE if it elected to be one); or
  • foreign PIE equivalents.

This amendment is intended to accommodate intra-group financing between land investment companies and PIEs in the same tax group. For example, a subsidiary company of a PIE could be set up to borrow money and on-lend it to another subsidiary company, with that second company using the money to purchase land. Under the amended rules both companies would generally be able to group with the PIE. Such grouping was generally not previously possible.

This amendment applies from 29 August 2011.

Double counting of income

Sections HL 21, HM 56 and HL 20 of the Income Tax Act 2004

Under the previous PIE rules it was possible for some of an individual's taxable income to be counted twice when calculating their PIR. This occurred if a person informed a PIE of a rate that was too low, resulting in the PIE income becoming taxable income. The amount was counted twice because PIRs are determined with reference to both a person's taxable income and their attributed PIE income. Accordingly, the person's attributed PIE income would have been counted as both attributed PIE income and taxable income, possibly resulting in an excessively high PIR for subsequent years.

Accordingly, section HM 56 has been amended to ensure that this double counting does not occur.

This amendment applies from the beginning of the PIE regime, 1 October 2007. Similar amendments have therefore been made to section HL 21 of the Income Tax Act 2007 and section HL 20 of the Income Tax Act 2004.

Conditional entitlements

Section HM 38

Section HM 38 sets out the appropriate tax treatment of conditional employer contributions to superannuation funds. These are contributions made on behalf of employees, but where the employee only becomes entitled to them after a vesting period, which is normally a minimum period of employment. Previously, the interest earned on a conditional employer contribution is taxed at the employee's rate if the vesting period is no longer than five years. If it is longer, the interest is taxed at the PIE's tax rate until the vesting period is over.

Section HM 38 has been amended so that, if a vesting period is within the five-year period, the interest earned on conditional employer contributions is taxed at the employee's tax rate. This removes any tax disadvantage of having a vesting period longer than five years.

This amendment applies from the beginning of the 2012-13 income year.

Other amendments

The other amendments to the PIE rules are as follows:

  • Section DB 23 has been amended to ensure that revenue account investors in a PIE cannot inappropriately claim deductions for the cost of an investment if they are not taxed on the proceeds of that investment. This amendment applies from 29 August 2011.
  • Section HM 14 has been amended to remove the requirement that a multi-rate PIE that is listed have only one investor class. This amendment applies from the beginning of the 2010-11 income year.
  • Section HM 45 has been amended to clarify that a PIE is able to make a voluntary payment of tax at any time, even if an investor has not reduced the amount invested in the PIE. This amendment applies from 29 August 2011.
  • Section HM 25 has been amended to shift the date that a PIE loses its PIE status by 1 day, to make the current PIE rules consistent with the rules that applied prior to 1 April 2010. This amendment applies from the beginning of the 2010-11 income year.
  • Sections HM 5 and 6 have been amended to correct minor drafting errors, with effect from the beginning of the 2010-11 income year.
  • Section HM 36 has been amended to clarify the types of expense a PIE is able to deduct from the net income of its investments on behalf of its investors. This amendment applies from the beginning of the 2010-11 income year.
  • Section LS 2 is amended to ensure that investors in a PIE receive tax credits for tax paid on their behalf if their attributed PIE income is not excluded under section CX 56. This amendment applies from the beginning of the 2010-11 income year.
  • New section OK 6B is inserted and table O17 is modified to ensure that a Māori Authority receives a credit to its Māori Authority credit account when it is attributed imputation credits by a PIE. A similar amendment has been made to section MK 4 of the Income Tax Act 2004. These amendments apply from 1 October 2007.
  • Section 57B of the Tax Administration Act 1994 has been modified to provide that a PIE which performs its tax calculations quarterly does not need to provide an investment summary for an exiting investor until the next 30 June if the PIE has made a payment of tax on behalf of that investor. This amendment applies from 29 August 2011.