If you move to New Zealand with shares, managed funds or other investments overseas, one of the more unusual parts of our tax system you may encounter is the foreign investment fund – or FIF – regime.

The rules can be surprising, particularly if you have moved from a country where investments are principally taxed on dividends and capital gains when they are sold.

New Zealand does not have a comprehensive capital gains tax. Instead, many foreign investments can be subject to the FIF regime, which calculates taxable income each year by reference to the value invested or performance of the investment – even if you haven’t sold anything or received that amount in cash.

The rules are also changing with further changes now before Parliament.

Why does New Zealand have FIF rules?

The history helps explain what can otherwise look like a rather odd tax.

In countries with a capital gains tax, an investor may pay tax on dividends while holding an investment and on the gain when it is eventually sold.

New Zealand generally doesn’t tax investment gains in that way.

Without additional rules, someone could therefore invest in an overseas company that retains most of its profits, receive very little taxable dividend income in New Zealand, and ultimately realise a substantial gain that may not be taxable due to being considered a “capital gain”.

This was one of the issues behind the development of the modern FIF regime.

The Fair Dividend Rate (FDR) method, one of the main allowable methods, introduced from 2007, was designed to provide a different way of taxing returns from many offshore investments, rather than introducing a conventional capital gains tax.

How does FIF work?

Broadly, New Zealand tax residents need to consider the FIF rules when they hold shares, managed funds and certain other investments overseas.

There are numerous exemptions. One of the best known is the $50,000 de minimis exemption for individuals, based broadly on the cost of relevant investments rather than their current market value.

Above that threshold, one commonly used method is FDR. In simple terms, this generally calculates taxable income at 5% of the opening market value of the relevant investments, with adjustments in some cases. Note that the 5% is the amount of income to include in your tax return, not the amount of tax, which is calculated as the taxable income multiplied by your marginal tax rate.

Individuals may sometimes obtain a better result using the Comparative Value method where investments have performed poorly.

The important point is that your New Zealand taxable income may bear little resemblance to the dividends you actually received, which are not separately taxable if you are calculating your income using the FIF rules.

New migrants may have four years before FIF applies

For people moving to New Zealand, there is an important concession.

Many new migrants – and New Zealanders returning after a sufficiently long period overseas – qualify as transitional residents.

This generally provides an exemption from New Zealand tax on most types of foreign income for approximately four years. During that period, foreign dividends and FIF income are generally exempt. Applying for Working for Families tax credits, including Best Start, can end the transitional residence exemption for both you and your spouse or partner. This decision is irrevocable.

The exemption period provides a valuable opportunity to work out how an existing investment portfolio will be treated once the exemption ends. It is worth doing this early. We sometimes see people discover the FIF rules only after their transitional residence exemption has expired.

The rules are changing

The Government has recently proposed a number of changes to the FIF rules, partly in response to concerns about their impact on migrants and returning New Zealanders.

These include increasing the individual FIF de minimis threshold from $50,000 to $100,000 and expanding access to a new Revenue Account Method (RAM). RAM is principally relevant to people with unlisted (private) foreign company investments and can allow income to be taxed when dividends are received or investments are sold, rather than annually under FDR.

At the time of writing, some of these changes are still before Parliament.

Forewarned is forearmed

While the policy reasons for the FIF rules may be interesting, most of our clients are more concerned about what the rules mean for their own investments.

Some don’t like the idea of paying tax calculated by reference to an investment portfolio when they haven’t received the corresponding income in cash. Others are comfortable with the outcome, particularly given that New Zealand doesn’t have a comprehensive capital gains tax, but find the annual calculations and information requirements onerous.

If you are moving to New Zealand with overseas investments, it is worth understanding the position before your transitional residence exemption expires.

Planning ahead may give you an opportunity to simplify or restructure your investments, consider whether the new RAM rules could apply, and make sure you have the information needed to comply with the FIF rules once they become relevant.