New higher tax rate for top earners

Will you pay NZ’s new top income tax rate?

From 1 April 2021 a new tax rate will be applied to NZ’s top earners.

This increases the top tax rate for individuals to 39% for the 2021-22 tax year for annual income above $180,000. This is expected to impact about two percent of all NZ earners, approximately 75,000 people.

Updated income tax rates

NZ’s income tax system is often misunderstood. NZ has progressive tax rates, sometimes called gradual tax rates. These rates increase as your income increases. The new income tax rates for individuals are:

$0 - $14,000 = 10.5%

$14,001 - $48,000 = 17.5%

$48,001 - $70,000 = 30%

$70,001 - $180,000 = 33%

$180,001 upwards = 39%

So, if you earn $50,000 each year, you pay:

• First $14,000: taxed at 10.5 percent.
• $14,0001 to $48,000: taxed at 17.5 percent.
• $48,001 to $50,000: taxed at 30 percent ('marginal tax rate').

In this case, you will pay $8,020 in tax per year, leaving a take-home pay of $41,980.

The rates are based on an individual’s total income for the tax year, which could include from sources such as: salary or wages, welfare – such as working for families, schedular payments, interest from a bank account or some investments (see the next section for more on this), earnings from self-employment, money from renting out property, and overseas income.

NZ has a 'pay as you earn' tax system. For most people earning a salary or wage, this means income is taxed before they get paid. This is also the case with income such as welfare and interest.

Other income is not taxed before you get paid. This includes income from self-employment or renting out a property, and some overseas income. You pay tax on this income at the end of the tax year. The amount of tax you pay depends on your total income for the tax year.

Behavioural responses to higher taxes

While the tax increase for big-earners hardly signals a radical change in the tax system, NZ’s Inland Revenue Department (IRD, who collect the taxes) has suggested that there will be some “behavioural response” by top earners.

This might include some of the basic approaches below, noting that the wealthiest Kiwis have a few more options available to them too!

Trusts

One of IRD’s concerns is that people will shift assets into other entities that pay less tax – perhaps in trusts, as the gap between the trust tax rate of 33 percent and the new maximum individual tax rate of 39 percent is enough to make such a move worth considering for many of NZ’s wealthiest people.

The last time such a gap between tax rates opened up, the number of trusts nearly doubled – between 2000 and 2008. This time around, trust tax rates are not being increased, but they are threatening to do so if there is a big move to putting income into family trusts to avoid the 39% tax rate.

Most companies are also taxed at a maximum of 28 percent.

PIE funds

Even for top earners and trusts, Portfolio Investment Entities (PIE) structured funds have a maximum tax rate of 28 percent on any income earned within them.

What is a PIE fund? – you’re probably already invested in one, all KiwiSaver Schemes are structured as PIE funds.

Invest for long-term capital gains in growth assets that pay little or no income

This includes buying shares in growing companies that pay little or no dividends.

Of course, this can also be investing in the ‘Kiwi favourite’ of residential property, where the main objective is capital gain rather than income.

Borrow to invest

This isn’t common for investments like shares but is very common for property investment and for business owners.

As a general guideline, any interest on a loan taken out to invest is tax deductible. Such a tax deduction reduces income.

Income changes

Many people can adjust their income in response to such changes. This might include employees who cut back on hours to earn less in wages. This is a well-known phenomenon, for example, Infometrics chief forecaster Gareth Kiernan has been recently quoted as saying there had been a “distinct spike” in the number of people earning exactly $60,000 a year between 1999 and 2001, when a higher tax rate was introduced for income above that level.

Anything else?

The updated tax law was passed in early December and takes effect from 1 April 2021. Other tweaks included were:

• Increased information gathering powers for IRD. Noting the area that some may call a “loophole” regarding trusts, the law significantly expands obligations to provide IRD with information on the use of and financial position of trusts, particularly around distributions and settlements made by trustees to beneficiaries.
• An increase to the working for families family tax credit – amounting to about $25 per week from March 2021.
• Looking ahead to the 2022 tax year, trusts will have plenty of additional reporting to IRD too. Annually, this includes a statement of profit or loss and a statement of financial position, information on any distributions made, information about any settlements made, additional information, and probably information on related party loans.

While seeing a good accountant is the best way to learn more about anything mentioned above, if you would like to arrange a complimentary initial consultation with one of our financial advisers – who in this case are more focused on investing than taxation – then just reach out to us to book in.

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