For many investors, having a stake in the global market is one of the key ways to achieve a diversified portfolio. But a recent report by Hunter Investment Management has shown that investing in global markets through offshore unit trusts could result in some unhealthy tax slippage for your funds.

The report showed that if a New Zealand taxpayer, including KiwiSaver funds, invests in global shares via an offshore fund like an Australian unit trust, then there are three potential sources of tax slippage.

1.  Non-resident withholding tax on the dividends paid by the underlying companies.

Where an investor holds shares located in different countries, there is typically 15% non-resident withholding tax deducted against the dividends that they pay.

        2. Tax deductibility of the fees within an offshore fund.

Where the mechanics of the Fair Dividend Rate (FDR) tax calculation methodology means that New Zealand taxpayers are unable to get a tax deduction for 95% of the fees within an offshore share fund. In contrast, where the fees are charged directly to the NZ taxpayer, including being charged within a PIE fund, they are able to get a tax deduction for 100% of these.

        3. Australian sourced income creating tax slippage for New Zealand taxpayers.

Which can provide a significant source of potential tax leakage for New Zealand investors if they are unable to get an offset for this. The magnitude of this will be a function of the return the fund gets on the currency hedging arrangements. The greater the return from currency hedging, the greater the quantum of tax slippage will be.

Managing director of Hunter Asset management Tony Hildyard told Good Returns that tax slippage “is a hidden issue but it is significant”.

“When you have both the regulator and investors saying ‘you have to get fees as low as possible’, tax slippage is a hidden fee. It is significant, it has a major compounding effect. You can’t just sit there and claim that you have low fees if you have tax leakage in there.”

Hildyard said that it is crucial for investors “to be aware of the cost. Tax is a cost. Investors think that the headline return might be index minus their fees, but in reality it may be index minus fees minus ten to twenty basis points for tax leakages they weren’t aware of.”

“This problem comes when investors go into a foreign pool and don’t directly hold the assets. So it all depends on the structures that you use. It’s the passive funds in particular that need to be careful, they try to take advantage of the big offshore funds which is precisely where you get this problem.”