One of the major concerns for US citizens living in New Zealand, is how to invest without creating complex US tax issues.

For those who have had to make this consideration, it is well publicised that US citizens can be caught in between competing foreign investment tax systems, being FIF in New Zealand, or PFIC in the US.

As a reminder, US citizens residing anywhere in the world, remain tax residents of the USA. This means that the worldwide income of a US citizen (including investments) must be reported annually to the IRS.

We’ll begin today by discussing what a PFIC actually is, and two common platforms that we see PFICs become an issue, Sharesies and KiwiSaver.

What is a PFIC?

A PFIC is a Passive Foreign Investment Company, a coin termed by the IRS in the late 1980’s, and forms part of a tax regime designed to encourage US citizens to invest in US companies, as opposed to foreign companies.

Specifically, a PFIC is any non-US company which generates its income passively (broadly speaking).

Using the NZ stock exchange for example, Air New Zealand or Spark, these are not PFICs as they actively earn their income. However, PFICs tend to have names such as the NZX Top 10 Fund, or the Asian Healthcare Fund. These latter investments likely have no business activity, and thus exist solely to generate income through passive investments.

Why this is an issue for US citizens, is PFIC reporting.

When a US citizen invests in a PFIC, each fund must be reported annually on Form 8621.

This form was designed to be complex, with even the IRS estimating total completion time as around 32 hours per fund. Most US tax accountants shouldn’t take anywhere near this long however.

In addition, the unrealised gains in a PFIC can be taxable on an annual basis. As an example, if an individual owned shares in a PFIC valued at $1000 at the start of the year, and this value escalated to $1500 by year-end, a tax liability could arise for the $500 growth, even if no actual withdrawal took place.

It is important to note at this point, PFICs have varying different types of taxation, and US tax advice should be sought here.

PFICs have a reporting threshold of $25,000 USD across all investments. For example, if a US person had a Kiwisaver worth $50K, and 5 small PFIC investments worth $200 each (such as ETFs through Sharesies), then all 6 funds would need to be reported on their own Forms 8621. This can be a very expensive endeavour.

Is KiwiSaver a PFIC?

KiwiSaver accounts themselves are not necessarily a PFIC. Instead, they are all set up as New Zealand trusts.

This usually means that when a US person invests in KiwiSaver, they have an ownership share of a foreign trust.

However, it is what this trust invests in that we must consider. Most KiwiSavers invest the clients money into PFIC funds. This can be, for example, funds such as the ASB Balanced Fund, or the Milford Growth Fund.

The specific fund that the KiwiSaver invests in, is usually where PFIC reporting is needed.

Again, there are options around this, and we would strongly recommend obtaining US tax advice if you need clarification above.

Is Sharesies a PFIC?

Again, as above, Sharesies itself is not necessarily a PFIC, however this one is debatable given their investment model.

For those of you unfamiliar with Sharesies, here’s a brief description of the platform. Sharesies is a New Zealand based investment platform, whereby individuals are able to invest small (or large amounts) into fractional shares. This means you can purchase just ¼ of a share should you choose, as opposed to buying a full share. This is beneficial for some investors, as some US tech stocks can be hundreds of dollars for a single share.

Sharesies offers worldwide stocks and fund investments, and no minimum investment amount. As a result, the service has grown hugely popular in the short few years its existed.

But, where Sharesies is problematic, is that a very large amount of the investments they offer are indeed PFICs.

Understandably, as an NZ based platform, Sharesies does not provide any obvious identification of which of the stocks it offers, are indeed PFIC investments. The vast majority of their clients are likely not US persons, and as a result it would seem they have no interest in labelling specific funds as PFICs.

Why are PFICs through Sharesies an issue?

As discussed above, once the $25,000 USD threshold has been met across all of a US person’s PFIC investments combined, then each individual PFIC investment must be reported completely exclusive of the others.

In the case where a US person has a KiwiSaver worth $40,000 NZD (about $29k USD), then at this point they have met the $25k USD threshold. This means, each new PFIC investment they make will require its own set of (expensive PFIC reporting).

We frequently see clients come to us, who have unwittingly invested $5 or $10 across 10 different PFIC investments offered by Sharesies, and as a result, must now file PFIC reporting for each separate fund. As you can imagine, the costs of this reporting can be well in excess of the investment value.

Is there any other concerns with PFICs other than the filing costs?

Yes, as mentioned above, PFIC taxation is particularly punitive. The most common form of PFIC taxation, section 1291, can result in the maximum US tax rate being applied to the gains made by a KiwiSaver or an investment fund.

Summary

Investing in both KiwiSaver or other platforms such as Sharesies, Hatch or managed funds, can come with complex US tax requirements.

It is essential to obtain advice prior to beginning a KiwiSaver or an investment journey, to ensure that the US tax minefield is navigated without creating a complicated and costly tax filing requirement.

Book an appointment with us today, info@usatax.nz