For some years now it has been the situation that IRD was having their cake and eating it too when it came to the use of incorrect prescribed investor rates (PIR) for Kiwisaver and other portfolio investment entity (PIE) investments.

PIEs were created in October 2007, following the introduction of Kiwisaver. Before then, tax laws meant that if you invested in New Zealand managed funds, you could find yourself paying much more tax compared to the situation  if you had invested directly in shares. This was a significant disincentive to investing in managed funds and would have discouraged a lot of New Zealanders  from joining Kiwisaver.

I’m sure most of us are familiar with the classic steak and cheese pie, but when it comes to investment PIEs, the most common type is known as a multi-rate PIE (MRP).  If you have invested in this type of PIE, i.e., of which most KiwiSaver funds are, you will notify the provider of the PIR which most closely matches your marginal tax rate based on (the lower of) one of the previous two tax years. A person’s marginal tax rate is the tax rate that applies to the last dollar they earn. If a person earns more than $70,000 their marginal tax rate would be 33% or 39% if more than $180,000 from 1 April 2021. However, while marginal income tax rates can be up to 39% now, PIE rates are capped at 28%. The PIE provider pays tax on your behalf based on the PIR you have advised. The MRP adjusts your investment account by that amount of tax and, importantly you do not need to front up any cash for any tax due.

So, what about the cake? Under previous laws, when the correct PIR had been used or where a too high rate had been used, the income from the PIE investment was deemed excluded income, which meant it was a final tax and the PIE income did not flow through to your individual income tax return and assessment.  Therefore, if you had elected a rate that was too high, or you had defaulted to the highest PIR, but you could have elected a lower PIR, the overpaid tax on your PIE income couldn’t be refunded.

However, where tax on your PIE income had been underpaid because you had notified a rate that was too low, the PIE income ceased to be excluded income and was, technically, required to be included in your tax return, and taxed at your marginal tax rate with a tax credit for the PIE tax that had already been paid. The difference between the treatment of overpaid and underpaid PIE tax raised equity concerns, particularly the non-refundability of overpaid tax on PIE income; and this is where the IRD having their cake and eating it too became an issue.  The reality was few people were aware of this quirk and, until Inland Revenue introduced their new computer system last year, Inland Revenue only rarely pursued any underpaid tax.  When the new system came in it was found that thousands of taxpayers had been using a PIR rate that was too low and therefore had underpaid tax.  Fortunately, the government decided to be generous and did not pursue the tax short-fall.   But Inland Revenue did then start advising Kiwisaver schemes what the correct PIR should be going forward if investors were using the wrong tax rate.

From the 2021 tax year, the law has been changed and if you have been using a PIR that is too high for your situation, you will now be entitled to a refund of the resulting overpaid tax.  The other positive change is  where you have selected a PIR that is lower than what it should be for the year, the maximum tax rate of 28% will still apply to the PIE income, whereas previously you could have ended up paying tax at 33% or 39% on this income if your total income exceeded $70,000 for the year.

It is important to note though that if your PIR is too low for the year, and there is additional tax to be paid, that this will be included as part of your end of year tax liability that will be due to be paid to IRD with your terminal tax, and you will therefore need to find the cash to pay for this. This is something to be aware of for those of you with large amounts invested in PIE funds either through Kiwisaver, Managed funds or directly through PIE investment platforms such as Sharesies and InvestNow. 

Sources:

https://www.treasury.govt.nz/sites/default/files/2020-01/ria-ird-pies-jan20.pdf

https://investnow.co.nz/pies-pie-tax-questions-answered/

https://www.ird.govt.nz/roles/portfolio-investment-entities