NZ Herald 19 September 2009

AI suggest you ask your accountant if she or he will be happy to support you if you are audited — including paying any tax, interest and penalties that you may be found to owe.

The New Zealand law in this area is confusing. “The writer’s statement unfortunately indicates perfectly how misunderstood the rules are — including sadly by accountants, not taught at University of Auckland Business School I can assure you!”, says Craig Elliffe, professor of tax law and policy at — I’ll leave you to guess which business school.

The confusion is not helped by the lack of readily available information on Inland Revenue’s website, www.ird.govt.nz. Could that lack spring from the department’s hesitance to try to write clearly and simply about a topic that is not clear and simple? Don’t blame them. They didn’t pass the law.

Nevertheless, many people like you need to know whether to pay tax or not. So here’s a quick outline of the situation.

While there is no capital gains tax in New Zealand, some capital gains — on shares, property or other assets — are taxed as if they are income.

The gains are taxable — and losses deductible — if you are in the business of trading the assets, or if the profits are business profits. So far, so clear-cut.

But gains are also taxable if they “come from any undertaking entered into or devised for a profit making purpose”, or if you bought the assets “with the clear and dominant purpose” of “selling or otherwise disposing of them”.

I would argue that everyone who buys shares or property does so with an eye to selling at a profit. But some people say their main purpose in buying shares is to get the dividends. However, your first paragraph rather counts you out of that group. And the fact that you are a “casual player” won’t let you off the hook.

Nevertheless, it seems that many people who buy shares with plans to sell them don’t pay tax on their gains — and many do the same with property. As long as they are not audited, they get away with it. And even if they are audited, some seem to talk their way out of trouble. You’ll have to decide whether you want to run the risk.

Comments Elliffe, “I think the level of tax avoided in this casual way could be substantial, and that was part of the reason for thinking that a capital gains tax would be fairer and in some respects clearer.”

Indeed, talk of the government’s introducing a capital gains tax has increased lately. Whether or not it does, I hope the government at least clarifies the tax position for you and thousands of others. The difficulty in knowing where you stand is not good enough.

By the way, you didn’t ask whether I think frequent share trading is a good idea, but I can’t resist saying that it’s not. Costs eat into your gains, and chances are you won’t be good at picking the right shares anyway. Read on.

AOh dear. It sounds as if you have broken one of the two basic rules about investing in shares: diversify. It’s really risky to invest in any fewer than, say, ten different shares. It’s better still to go for 20 or 30. Some even say 50. Then, if a few collapse, it doesn’t much matter.

If you haven’t enough money to do that, invest in a low-fee share fund that itself holds a range of shares.

True, crashes happen every now and then, bringing down pretty much all shares with them. But if you follow the other basic rule — staying in for the long haul — you can be almost certain that most shares will do well.

If you invest in a share fund, you won’t be able to assess the chances of each company performing well, as you did with Feltex and Vector. But — as your results would suggest — an ordinary investor won’t usually gain by doing that anyway.

That’s because if a company’s prospects are good, investors in the big financial institutions will already know that and will have bought some of the shares. That demand will have pushed up the share price to the point where it’s not necessarily a good buy for you. You’ll always be too late. It’s better, and easier, to just buy a wide range of shares, either in or out of a fund.

What about property? I assume you’re talking about rental property, seeing you already have a mortgage-free home.

In some circumstances you’re right about the “bricks and mortar” aspect of investment property ownership. But that’s if — and only if — you hold the property with a relatively low or no mortgage.

What if you have a large mortgage, and are forced to sell, perhaps because redundancy means you can no longer pay the difference between the rental income and the mortgage and other expenses? If house prices have fallen, it’s possible your proceeds will be smaller than your mortgage. You lose the property and are left with a debt to the bank. That’s considerably less secure than worthless Feltex share certificates, and it is happening these days.

By the way, good on you for acknowledging that property costs eat into gains. When many people consider their profits on property ownership, they forget all the rates, insurance, and maintenance they’ve paid over the years.

AThat’s a bit strong. Over-simplified, perhaps.

To put others in the picture, I was advising non-employees to try to contribute $1043 a year to KiwiSaver to get the maximum tax credit. I said setting up regular contributions — $20 a week or $87 a month — is a good idea.

“It makes budgeting easier, and you’ll buy more units in your KiwiSaver fund when the price is down than when the price is up. That means your average price will be lower than the average market price. This is sometimes called dollar cost averaging.”

The difference between your take on the situation and mine is that you are comparing DCA with putting all the money in at the start of the KiwiSaver year, in early July. In that case, you’re right — if the two options are contributing the same amount regularly or contributing the lot upfront, in most years the latter will probably be better financially.

However, given budget constraints and human nature, I suspect most people are likely to do one of the following:

• Contribute when they think markets are down. This is silly. Trying to time markets is a fool’s game that even the experts often get wrong. You never know when the share, bond or property market will fall further or rise.
• Put all the money in at the end of the KiwiSaver year, in late June. This would work well if prices have fallen throughout the year. But, as you say, that happens in share markets only about a third of the time, and even less frequently in other markets.
• Set up regular contributions, and make the most of DCA. Financially, this is the best choice of the three — even though it isn’t as good as making the full contribution at the start.

However, DCA also has a psychological advantage over all the alternatives, including contributing the full $1043 upfront. If you contribute regularly and the market is rising, you’re happy because your KiwiSaver investment is growing. On the other hand, if the market falls through the year, you can take some comfort from the fact that your $20 or $87 is buying you more units as time goes by. You didn’t buy the lot at what now look like high prices.

This is what you I presume you mean by minimising regret.

Given that we’re not talking about huge amounts of money anyway, I see nothing wrong with doing something slightly less than optimal financially that makes you feel better. What’s life about, after all?