Time for a tax advocate
Three stories from the week in tax
- Why small businesses need a tax advocate
- More on using cryptocurrencies to pay salaries
- Another unknown unknown the UK regulations implementing the 4th EU Anti-money laundering directive
The unknown unknowns in tax
What are the “Unknown unknowns” of tax? Our 3 stories from the week in tax
- The financial arrangements regime and Inheritance Tax
- Wage theft and missing PAYE and KiwiSaver contributions
- National’s tax policy – indexing thresholds, changes to the bright-line test and loss ring-fencing
Podcast transcript
In February 2002, in the run up to the invasion of Iraq, then U S Secretary of Defense, Donald Rumsfeld, commented;
“Reports that say that something has happened are always interesting to me because as we know there are known unknowns. There are things we know we know. We also know there are known unknowns. That is to say we know there are some things we do not know, but there are also unknown unknowns. The ones we don’t know, we don’t know and if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.“
This quote was a core theme in my presentation last week to the Financial Advice New Zealand annual conference. The unknown unknowns are also a very difficult category in tax. And what are these unknown unknowns? The ones that trip up people because they didn’t know they were there.
Well in New Zealand the biggest culprit in this would be our financial arrangement rules. These rules have been around since 1986 and yet despite their very broad application, are largely unknown. I have come across CFOs who were completely unaware how they could apply.
Financial arrangements rules apply to just about any financial instrument you can think of. Mortgages, bank term deposit accounts, swaps, bonds, gilts in the UK phrase, all those all caught within it. It’s so broad it could apply to season tickets for public transport. And in one case I dealt with we thought that electricity contracts would be caught. Actually, we were debating whether in fact they were in the stock rules or in financial arrangement rules. Welcome to the arcane world of international tax.
But the financial arrangement rules are very broadly, largely unknown to individuals and they have particular bite in the foreign exchange field. That is where exchange rate movements such as is going on right now with Brexit which is back in the news again, so the Pound will move around.
Two groups of people get caught here. Obviously, investors who have bonds or term deposits denominated in an overseas currency, the value of the New Zealand dollar falls [that is more dollars are required to buy the offshore currency], they make an exchange gain and if the value rises, they have an exchange loss.
Then there are those with, for example, a rental property in the United Kingdom, and they have a mortgage there, it works the opposite way. The Pound may become weaker against the dollar so that in dollar terms, their mortgage diminishes, then that is income. Now on an unrealised basis for most people, this largely doesn’t matter, but very abrupt movements which add up to $40,000 on an unrealised basis will pull people into the foreign financial arrangements regime and they then will have to pay tax on unrealised gains.
The classic example I encountered was a client who had substantial property interests and mortgages in the UK. In year one there was an unrealised $300,000 foreign exchange gain, on the movement on the Sterling and had to cough up $100,000 in tax. The following year, it moved back the other way and she had a $300,000 loss but she never got that tax back. Even though there’s a wash up calculation when an arrangement matures or a mortgage rolls over and so of all the unders and overs are taken into account. But if you paid tax too soon in the piece, say you paid tax two years ago and then you find out that you actually never made any gain once everything is all closed out, you’ll never get the tax back. It’s one of the harsher parts of the financial arrangements regime.
The other trap is that the arrangements regime will apply to people who have total financial arrangements of $1 million or more and that is a gross amount. What I sometimes see is people may have $500,000 of term deposits and $500,000 of mortgages overseas mortgages and they think that after netting the two off, I’m below the threshold for the regime. Economically, your net worth comes out as nil. But financial arrangements regime takes them in aggregate so therefore the two are added together so the person actually has a million dollars in financial arrangements and is therefore within the accrual part of the regime. That person will be taxed on an unrealised basis.
The financial arrangements regime just the most common trap New Zealand advisors and clients fall into in my experience.
Following on from that, the other area that I’m seeing a lot more of is UK inheritance tax. Inheritance Tax is an estate and gift tax that applies to anyone domiciled in the UK or with assets in the UK.
Domicile, without getting in to too much detail, is a complicated concept, but basically, it’s where your permanent attachments are. I spoke in a previous podcast earlier about the unfortunate New Zealand woman whose Scottish partner died and because they weren’t married, she finished up paying £50,000 pounds inheritance tax on the transfer of his interest in the New Zealand property to her. So that’s not the first trap to watch for.
And I’m seeing more and more people caught by this, we have 300,000 Britons in the country. People like me, who’ve come from Britain, many more still have assets over in the UK. Maybe their children are going backwards and forwards to the UK and working there. And they’re all potentially all caught up in the inheritance tax regime.
A common thing that often gets overlooked is the implication of having assets in the UK or burial plots. Famously after Richard Burton died in 1984 the then HM Inspector of Taxes nailed his estate for inheritance tax on the basis that he had retained a burial plot in the village in Wales from which he came. So that was a very expensive burial plot as it turned out. I believe he actually is buried in Switzerland, but that’s how arcane the rules around inheritance tax are. It is the great unknown unknown. And as Donald Rumsfeld said, “These unknown unknowns tend to be the difficult ones.”
Earlier this week, Andrea Black who runs the excellent blog “Let’s Talk About Tax” went drinking with some young people. Actually, she was there to advise a group of hospitality workers who had been caught out as a result of Wagamama going into receivership. And the issue they were talking about is what’s called wage theft in the hospitality industry.
This is where the company, an employer, goes bust owing employees thousands of dollars in unpaid wages and salaries. There is often also a lot of unpaid pay as you earn floating around. There are several issues here. First and foremost, the employees have been left out of pocket and so they want to know what’s going on and when they can recover that. Then the tax man is very much often out of pocket. It often emerges that pay as you earn has been unpaid for several months an issue which I’ve seen this, and which Andrea talks about it as well.
You do wonder how quickly Inland Revenue reacts to this. Now I do hope that one of the things that will come out of Inland Revenue’s business transformation is much swifter responses to issues where pay as you earn falls into arears. My experience is Inland Revenue has let this go on for far too long. I’ve come across instances where there had been unpaid pay as you earn for going on for four years, which is just an absurd position. Someone there is either deliberately playing the system, in which case they should be hit with the full force of the law or is so hopelessly incompetent they should have been put out of their misery long ago.
Now the other thing that also comes into play for the employees is the unpaid employer KiwiSaver contribution and this adds up to quite a bit. Back in 2016 I spoke to Radio New Zealand about this matter.
At that time there was over $29 million dollars in outstanding KiwiSaver payments. In June 2015 1,663 employers had failed to pass on 15.3 million dollars in KiwiSaver payments deducted from employee’s salaries. Employees are missing out on this and on the employer contributions and it’s a real issue within the industry. Andrea asks whether the Small Business Council looked at this issue. We’ve delivered our report to the Minister and what I can say this matter did come into discussion during our deliberations.
One other thing on this. There is a tax bill just going through Parliament at the moment, the Taxation (KiwiSaver Student Loans and Remedial Matters) Bill.
It covers a number of matters. One is the question that we talked about previously about people with the incorrect prescribed investor rate. There’s also provisions making it easy for Inland Revenue to collect unpaid employer contributions in relation to KiwiSaver and ensuring employers pass on the employee contribution to Inland Revenue.
Hopefully employees will get the investment returns they’re missing out on because they haven’t been paid or the deductions and employer contributions haven’t yet hit their KiwiSaver account. By the way, submissions on that bill close on Monday so you’ve still got a chance to make a submission in support of that or raising other issues.
Finally, National have released their tax policy for next year. A number of things they are promising include tax cuts. Particularly they’re proposing something which I think is long overdue, and that is indexing tax thresholds. I think this is one of those quite sneaky tax increases that causes bracket creep and pushes people up into higher tax brackets gradually and it’s something which is effectively a tax increase by stealth. I think in the interest of transparency it’s a good move.
There’s a number of interesting other matters they want to deal with. That said, I’m not entirely sure if you are not a homeowner or rental investor and you’re trying to get into the investment property or to rent a property you’d appreciate what they’re proposing. They want to dial back the bright line test for residential property from five years to two years and remove loss ring fencing, which is a big break for tax investors.
That brought a fairly forthright denunciation from Jenée Tibshraeny. She also was less than impressed by the idea of removing the inflation component of interest. It’s an arcane point which has been talked about for some time which although it sounds arcane it is actually quite important.
Anyway, that will be the first shots fired in next year’s election about tax policy. All eyes will be on what the coalition will do in next year’s Budget. Given that tax thresholds haven’t been raised for more than 10 years by that time it’s hard to imagine that they wouldn’t try and do something, particularly when they’re running a surplus. I mean, cynical tax cutting budgets are not just the preserve of right wing governments. But we shall wait and see.
Time for a wealth tax to address inequality?
A free-ranging discussion with journalist, academic and author Max Rashbrooke about taxing wealth, especially on those who have it and who are ‘not in the system’, and who ‘pay very little tax now’.
Podcast Transcript
Paying tax on crypto
This week in tax:
- Inland Revenue’s three new rulings on taxing crypto-assets paid as salary and wages/bonuses
- New draft determination on using smartphone for business
- Is Inland Revenue audit activity on the decline?
Podcast Transcript
This week, Inland Revenue with a world first. How much of that telecommunications tool expenditure is deductible and how much audit activity is Inland Revenue currently undertaking?
Paying employees with cryptos
This week Inland Revenue achieved what is thought to be a world first when it released three rulings regarding the treatment of crypto-assets provided to employees. Crypto assets more commonly have referred to as cryptocurrency have been around for about 12 years or so now, and have generated a lot of heat and excitement, particularly with the dramatic rise in the value of Bitcoin. And they’ve been around long enough that they’ve started to enter into mainstream business activities and questions have therefore arisen quite frequently about what’s the tax treatment of crypto currencies.
So Inland Revenue released a frequently asked questions on the treatment of crypto-assets a few months ago and now it’s gone one further with the release of three public rulings. These apply from 1st of September, setting out its views of the tax law that applies in three specific circumstances set out in these rulings.
This has created a great deal of excitement in the crypto-asset world because as far as can be told Inland Revenue is the first tax authority to go down that route. And it gives a lot of clarity to the treatment which is necessary as questions have arisen as businesses have been involved and the blockchain technology, crypto-assets have been expanding. They’re becoming used in different ways and tax issues are popping up all the time. And there’s still a lot of work to be done in this tax space.
But these are interesting steps forward. As I said it excited the crypto-asset community and I fielded inquiries from four journalists including one from the U S on what was the implications of this.
What Inland Revenue has done is issued three public rulings. Under the rulings process Inland Revenue comes across certain transactions and says, hey these transactions are happening, this our view of the tax treatment. These rulings are designed to give clarity of understanding to everyone involved in that.
And as the crypto-asset community and businesses that are in this field are expanding, for them, this is a big step forward because it acknowledges what the tax treatment is of payment of salaries to employees in crypto-assets which also will free up cashflow for them and help expand the business.
For those businesses in the crypto-asset sphere, this is very important, which one of the reasons that caused so much excitement. My Twitter feed has been full of commentary on the matter.
So what has Revenue actually done? There are three public rulings, 19/01, 19/02 and 19/03. 19/01 is the big one because it considers the income tax treatment of crypto-assets received by employees as part of their regular, that’s a key word, remuneration. The ruling commentary discusses when crypto-assets will be treated as part of an employee’s salary and wages and therefore be subject to PAYE, pay-as-you-earn. That’s of course for Inland Revenue is a very important part, because if these people are being paid in crypto, it wants to make sure it gets, its cut as soon as possible and then it talks about the implications of crypto-assets being subject to PAYE.
So for example, and this is not such good news for some if in fact you get paid in crypto does that affect your student loan repayments? What about Kiwisaver, working for families’ entitlements. It also explains that crypto-assets not subject to pay-as-you-earn would be treated as fringe benefits and subject to FBT.
Now you’ve noticed I referred to crypto-assets, now the rulings throughout, use the term crypto-assets to “cover digital assets that use cryptography and blockchain technology to regulate their generation and verify transfers”. Because as the rulings go into, there is more to crypto-assets than Bitcoin and Ether, although they’re the best known and people thinking of them as terms of a store of value. The ruling makes the point that there are the, these crypto-assets, the field crypto-assets covers Bitcoin yes, but other crypto-assets with different functions.
So very simply, the first binding ruling, the big one you could argue, 19/01 says that if you pay someone as part of the regular remuneration, then payments of crypto-assets would be subject to pay-as-you-earn. So as I mentioned a minute ago, Inland Revenue then is getting to clip its ticket on the matter of making sure the pay-as-you-earn is collected. Inland Revenue is always concerned about this, is that employees receive payments and may not either declare that “accidentally on purpose” or simply because they think it’s tax paid and Inland Revenue misses out on the tax. By treating the regular of regular payments with crypto-assets as remuneration and bringing it into PAYE pay-as-you-earn, Inland Revenue resolves a problem for it of compliance.
It is also, something that is extremely useful for employers because as they’re expanding and in this space they obviously burning a lot of cash. If they have the ability to play some or all of an employee’s remuneration in crypto-assets that actually frees up their cashflow and help business investment. I would expect that those businesses working in this space will look to make more use of this provision. It probably also to be fair, regularizes, something that may already be happening.
There is just one caveat I have about this position and that is the implications of the Wages Protection Act, something not covered in the Inland Revenue rulings. The Wages Protection Act 1983 says that wages are payable in money and then defines money “as in relation to any wages means any New Zealand coin or New Zealand bank notes or combination of both. The tender of which in respect of the payment of those wages is legal tender”. Now that dates back to 1983 and the world has moved on since then, quite considerably. So the question arises from a technical perspective, is crypto currency money for the purposes of wages? Is there an issue there? I imagined that crypto companies are looking at that.
But even if Inland Revenue possibly may have got ahead of the game there, it is, as I mentioned, dealing with something that it’s probably in practical terms seeing already. So, the basic position is that you pay someone crypto-assets, you’re up for PAYE on that, assuming it’s a regular payment. “Regular” is the key word, as mentioned earlier.
One of the rulings, binding ruling 19/02 deals with the question of bonuses being paid in crypto-assets and that makes it clear that it’s a PAYE income payment and subject to the pay-as-you-earn rules. Pretty straight forward, no controversy there.
The third ruling deals with question of irregular payments which are maybe not part of salary wages and not part of bonuses. Instead the employer passes crypto-assets to an employee for example, an Initial Coin Offering, Initial Exchange Offering, Security Token Offering or Token Generating Event, all of which are happening right now. This is an amazingly complicated field. Fascinating to work with at the time and moving very, very quickly.
It really should not be understated that Inland Revenue have done well here to get ahead of the game.
These rulings last for three years and over time they may evolve. Certainly, I’d expect in three years’ time that it will have another closer look at them again. But the point is they’re bringing certainty to an industry which wants some certainty around what it can do in this space. And as I said, in doing so it’s actually freed up investment into that.
Now you may have a view as to whether you think blockchain technology and Bitcoin, are just speculative froth, but the point is it’s real. They’re here and so the tax authorities have to deal with what’s happening in the real here and now. So, praise to Inland Revenue for doing so.
To quickly summarise, the crypto-assets that aren’t provided as part of salary and wages or as bonus, they broadly speaking would generally be treated as a fringe benefit and the value of the fringe benefit will be the value at the time that crypto-assets are provided to the employee. Market value is determined by the employer itself when it’s selling them or on the open market value. So that’s a really interesting point.
Watch this space as I said it got the crypto-asset community extremely excited. It is putting Inland Revenue in a world first and will be interesting to see how this develops.
Apportioning rules for private use of mobile phones
Moving on, Inland Revenue also released a determination on the employee use of telecommunication tools and personal use appointment. This is actually a draft ruling, it’s just setting out some rules around this, one of these things that happens in the background.
What this particular determination is talking about is where employees may use their own telecommunications tools, smartphones generally in employment, but they also have a private use proportion to them. This determination sets out a suggested apportionment.
It breaks it down into of three classes, class A, class B and the de minimis class. Class A, which covers quite a range of things, employers can treat 75% of the amount paid as a means of a reimbursement and therefore exempt income of the employee and then the other 25% is taxable. If the employer, for example just says pay 75% of the bill as an allowance for reimbursement, then the whole bill is paid is exempt. The allowance paid may also involve an amount to cover depreciation.
Then class B, where the employee, with a slightly different set of circumstances, provides their own phone and they pay for their own plan, but they are required to use it for work. Again, 25% of the amount repaid, by reimbursement is exempt income for the employee, but the balance is 75% is taxable.
Finally, in the de minimis class is if there’s a payment of no more than $5 a week, no more than $265 a year as a reimbursement for business use, then that is exempt income.
So that’s a draft determination that they’ve issued for commentary. When that feedback on that has been reviewed it will probably be finalised later this year, but in the meantime feedback is open until 20th September.
IRD audit watch
Now what is Inland Revenue up to in the investigation space? This is always something of interest to, to us as practitioners to just know how busy is Inland Revenue in this space? What can we expect? It’s a useful tool for tax agents because it reminds clients that they can’t just simply push the envelope thinking that nothing’s going on. They’ve got to be aware that part of the buttressing the whole integrity of the tax system is the risk of investigations.
So, what’s going on? There’s been some debate amongst the tax community and mutterings amongst each other that investigation activity seems to have dropped off a bit and we wonder how much of that is the effect of Business Transformation.
Those whispers appear to have reached the ear of Andrew Bayly, the MP for Hunua, who has fired off a whole series of questions to the Minister of Revenue.
Some of those responses were released this week and they make very interesting reading. Just one, there’s a whole heap of them here, but this one in particular caught my eye.
“How many hours in total, if any, have IRD assigned staff spent on investigations on a monthly basis since September 2017?”
For the period from 1 September 2017 to 30 June 2019 Inland Revenue advised that its staff spent a total of 1,096,000 hours on investigations related activities. That’s fine. It’s a big number.
What really catches your eye is the monthly breakdown on that.
In September 2017 the number of hours spent in investigations was 67,445. In June,2019 it was 19,421 a quarter of the effort of what was going on 18 months previously. And that is a bit of a concern to be honest because if they’re perception emerges that Inland Revenue isn’t paying attention on this, then people will take more chances and Gresham’s law starts to apply. In effect the bad will drive out the good. So Inland Revenue and the Minister ought to be concerned that this activity has dropped off.
The explanation offered is “I’m advised Inland Revenue plan carefully for its Business Transformation by devoting as many staff as possible to handling customer queries, including some staff who normally undertake investigations activity from the period of April 29 when the new income tax system went live through to June 2019.”
I’m not sure that during Business Transformation, it was wise to have actually relied on its introduction to take key frontline staff off investigation work and put them on the phones. They have the skills for that, but you would’ve thought that Inland Revenue should have those skills across all the lines. Either that or maybe the Business Transformation should have been phased in. Anyway, there’s a lot more in this space from Andrew Bayly’s questions. I’ll probably come back to them later and I understand the redoubtable Andrea Black might well have something to say about this.
And finally over the past few weeks has been an interesting debate going on over on the Stuff website about the progressivity or otherwise of the tax system.
Obviously, I’ve been watching this with interest. So next week I’m going to be joined by journalist and author Max Rushbrooke to talk about this and his suggestion for a wealth tax to address inequality. So, tune in next week for what should be a very interesting session.
Brexit and tax
This week in tax
- The impact of Brexit and the financial arrangements regime
- The Government’s tax policy work programme for the next 18 months
- 15 years ago…