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Beware a sudden surge of income from currency fluctuations 09 Nov 2015

The sudden drop in the New Zealand dollar will increase the value of money held in overseas bank accounts or overseas fixed interest investments. Most investors are what is termed a “cash basis person”. This is someone (including a company or trust) who, roughly speaking, doesn't have more than a million dollars of money owing to them and by them, in total. You add the two together. There are other conditions but we are leaving   them out to make this article readable. A cash basis person pays tax on their income received. It takes in currency gains only when the investment matures or is repaid. Larger investors have to also include income earned but not received by balance date (31 March for most of us) and currency gains made each year regardless of whether the investment has been repaid.

For example, you are not a cash basis person. You lent a bank $A100,000 on 1 June 2015 at 5% for one year. You have earned income at 31 March 2016 of 10/12 of 5% of $A100,000 = $A4167, but you won’t get it until 1 June 2016. This is income earned but not received. Also if you purchased the $A100,000 for $NZ103,000 and it is worth $NZ108,000 at balance date, you would include the extra $NZ5,000 as income.

A currency surge affects income and if it is big, like $US, the impact on income can also be big. This can have a significant effect on the amount of provisional tax you should be paying. If your personal year-end tax bill, which is calculated on all your income, and called Residual Income Tax (RIT), climbs over $50,000, you’ll be socked for backdated interest at 9.21%.  RIT is what’s left after deducting tax taken off at source.  It’s worse for companies and trusts. The interest kicks in if the RIT goes over $2,500. Therefore, if you think you may exceed either of these RIT thresholds, you should pay some more provisional tax, now.

There’s another rule to catch you. Look at the sum of money owing to you and by you, again, in total. Calculate income calculated as a non cash basis person and deduct income calculated as a cash basis person. Call this total A. Now take expenditure (like interest expense and bank fees relating to a mortgage) calculated as a cash basis person and deduct expenditure calculated as a non cash basis person. Call this total B. Add A and B together and if the figure exceeds $40,000 you are now a non cash basis person. You have to include in your tax return your income earned but not received and the value of currency gains on your investments.   You don’t get taxed twice, but you could be paying tax on some of your income a year earlier than expected. If the amount is big enough you could exceed those RIT figures mentioned above and get caught for interest. What about shares in foreign countries? This has nothing to do with being a cash basis person or otherwise.    A different formula is used to calculate income from foreign shareholdings (except most Australian shares) and this may not be affected by currency fluctuations to the same extent as fixed interest investments. The dividends from most Australian shares, when converted to $NZ may be higher than last year to the extent our exchange rate has fallen relative to the $A.

Monitor your investments right through to the end of the year in case the $NZ slips further.

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