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  • Help for those who get a bit of help

    Hi Guys

    Interesting comment from Brian Gaynor in this morning's NZ Herald.

    Brian Gaynor: Help for those who get a bit of help

    20.11.2004 - COMMENT
    Two events this week, the release of the Stobo Report and a hard-hitting speech by Reserve Bank Deputy Governor Adrian Orr, had similar themes.

    They highlighted our love affair with residential property and the low growth of managed funds.

    Full implementation of Stobo's recommendations should encourage individuals to reduce their exposure to residential property and stimulate investment in the sharemarket through managed funds.

    There are also strong indications of further policy initiatives, including tax changes that will encourage short-selling - the sale of shares, which are not owned, with the object of buying them back at a lower price.

    This development would be a boost to Mark Weldon and the NZX.

    Individuals have two choices as far as investment is concerned. They can either look after their own money (DIY) or give it to specialists to manage for them (indirect investment).

    Residential property is a DIY investment in which individuals make all the buying and selling decisions.

    Residential property does not attract a capital gains tax and can also have other tax advantages, as some costs can be deducted against income earned from other sources.

    Most other traditional investments, particularly shares and fixed-interest securities, are managed on a DIY basis or through pooled funds offered by investment institutions.

    It is difficult to estimate how many shares are managed through DIY or managed funds, but Australian surveys give us some guidance in this area.

    According to last year's ASX Australian share ownership study, 7.4 million or 51 per cent of adult Australians own shares.

    A breakdown shows that 39 per cent own shares directly and 12 per cent have indirect shares through a managed fund or self-managed superannuation fund.

    A survey by Statistics New Zealand three years ago showed that 21 per cent of the adult population here owned shares.

    The total value of these shares was $14 billion, compared with $182 billion invested by individuals in residential housing, holiday homes and rental property.

    The low level of share ownership has several reasons, including the dismal performance of listed companies in the 1980s and 1990s, and an ill-conceived privatisation strategy under which state-owned enterprises were sold through trade sales to foreign buyers instead of through share offers to the public.

    But tax has also played a major role. In theory, New Zealand has no capital gains tax, but individuals who invest in the sharemarket for a profit can be assessed as traders by the IRD and required to pay tax.

    This reduces the attractiveness of equities because active investors are afraid that they will be identified as traders, particularly if they "stag IPOs" - sell new issues as soon as they list for a quick profit.

    Even though there is no legislated capital gains tax, most fund managers provide for tax at 33 per cent on realised and unrealised profits. Tax is paid only when the profits are realised.

    This is because court decisions have determined that pooled investment funds should be subject to tax on realised profits.

    This has had a big effect on fund management, as it is extremely difficult to compete against other forms of investment, particularly residential housing and DIY share ownership, which are not subject to capital gains tax.

    It also disadvantages unsophisticated investors who don't have the time or skill to look after their own investments, individuals on a 19.5 per cent marginal tax rate - they pay 33 per cent through managed funds - and women.

    Overseas studies show men adopt a DIY approach to share investing and women have a stronger bias towards the indirect approach.

    So it is not surprising that managed funds in New Zealand have grown extremely slowly in recent years, particularly compared with Australia.

    Since 1996, Australian funds under management have risen from A$425 billion to A$760 billion and are now 94 per cent of gross domestic product, whereas in New Zealand, managed funds have grown from $34 billion to $51 billion and represent just 36 per cent of GDP.

    Meanwhile, we have gone on a borrowing binge. Reserve Bank figures show that individuals have trading bank borrowings of $98 billion, nearly twice the amount invested in managed funds.

    The Reserve Bank has issued numerous warnings on over-reliance on debt-fuelled property investment.

    Deputy Governor Adrian Orr told a Napier audience this week that our banks were borrowing heavily overseas and a high percentage of this was being lent to individuals.

    Ideally, households would have used the recent run of strong economic growth to build up a buffer against a major economic shock.

    Instead, they have tended to borrow more and invest heavily in a few domestic asset classes, especially housing.

    The result is that a major shock could result in more defaults and heavier losses for banks and other lenders.

    But the Reserve Bank's warnings haven't fallen on deaf ears.

    In July, the Government appointed Craig Stobo to consider options for making the tax law more consistent between direct and indirect investment, and to develop options for change that would minimise the extent to which the tax system distorts the way New Zealanders invest.

    After widespread consultation, Stobo came to the obvious conclusion that the 33 per cent capital gains tax on indirect investment should be abolished.

    This will benefit individuals who want to reduce their dependence on residential property but don't have the expertise or time to adopt a DIY approach to the sharemarket.

    It will also benefit individuals on a low marginal tax rate and women, because of their preference for the indirect approach.

    The immediate response to the Stobo report was positive.

    Finance Minister Michael Cullen endorsed the view that the capital gains tax on managed funds should be abolished and this is likely to become effective from April 1, 2007.

    The other expected tax change relates to short-selling.

    Short-sellers need to borrow shares from long-term holders before they can sell. They return these shares to the lender when they have bought them back on the market.

    But under present tax legislation, institutions that lend these shares are deemed to have sold them and are subject to a capital gains tax.

    This is a huge deterrent to short-selling, because the fee income earned from lending the shares would be far less than the capital gains tax payments.

    Although the implementation of the Stobo report will ultimately abolish all capital gains tax on managed funds, there is widespread speculation that the capital gains tax impost on the lending of shares will be abolished earlier, probably by the middle of next year.

    This will stimulate trading volume on the NZX and give more opportunities to investors.

    * Disclosure of interest; Brian Gaynor is an executive director of Milford Asset Management.
    Regards
    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx
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