Tax News

The business transformation project at the Inland Revenue Department

16 Nov, 2020 | The Week in Tax

This week Andrea Black (ex Inland Revenue and Treasury and former independent advisor to the Tax Working Group) and I take a closer look at the impact for Inland Revenue of its Business Transformation programme and find some puzzling discrepancies

Transcript

By Terry Baucher

I’ve previously discussed on a number of occasions the impact of Inland Revenue’s Business Transformation on taxpayers and tax agents. This week we’re going to take a closer look at how Business Transformation has affected Inland Revenue itself. And to discuss this with me, my guest this week is Andrea Black, who when we spoke last year, was then the independent advisor to the Tax Working Group.

Prior to her role with the Tax Working Group, Andrea was at Inland Revenue between 2000 and 2012. During that time, she was involved in the Inland Revenue investigation of the Australian owned banks’ structured finance tax avoidance schemes. This ultimately resulted in the banks paying over one billion dollars in tax and interest.

In 2012 Andrea was seconded to Treasury, a move which then became permanent and she stayed at Treasury until 2015. She then returned to Inland Revenue for a final year.  Andrea is currently the policy director and economist at the New Zealand Council of Trade Unions. This is a role in which she has been working with the Public Service Association who have been supporting Inland Revenue staff during recent restructures

Morena. Andrea, welcome to the show. So, when you were at Treasury and Inland Revenue what was the expectation about Inland Revenue’s Business Transformation?

Andrea Black

The kind of vibe at the time was that it was going to become a knowledge-based agency, smaller, smarter. We could see that our colleagues in processing were likely to lose their jobs, but it looked like they were going to be good processes to support them through that and generally restructure the department.

TB

Was the expectation at that time (2016) that Inland Revenue would lose one third of its staff?

Andrea

To be fair, there was an expectation that there was going to be quite a lot of job losses. But if you thought about it logically, if you were going to have a much flasher computer, you were possibly going to need fewer people. And the old computer system FIRST was honestly held together by bits of wire and there were lots of people doing lots of things to try and hold it all together. So, you could totally see that when things were finished you might not need as many people.

TB

Listeners may find this a bit surprising, but it’s actually quite unusual to sit in an Inland Revenue office and see the terminals they’re using. The only time I’ve done this was way back in 2012 when we were trying to resolve a matter involving transfers of imputation credits. I was shocked at what I saw, because the computer screen I was looking at was something from the 1980s.

The upgrade was well overdue. And what I was hearing was that there was something like 800 people whose role was to reinput data received from tax agents and taxpayers, so it could be serviceable and used elsewhere.

Andrea

You know, that’s right, and then they did these dumps into something called Data Warehouse, which was how the analysis was done. So the High Wealth Individuals work that I led was all done from Data Warehouse. So in my new world there would be a greater use of capital, the labour would become more productive. It was not a surprise, you know, it was an expectation.

TB

But you have been surprised by what’s been happening with staffing, not so much the numbers of staff, but the type of staff who are leaving.  This caught our eye as well, by the way.

Andrea

Yes. We expected that our processing colleagues and some of our colleagues that were holding things together with bits of wire would find themselves without work. And we assumed that there would be processes for dealing with that. We also heard that they were going to have fewer layers and fewer managers. So, the expectation was there would be the types of changes that would be very orthodox and very ordinary. But then there were the changes in May 2017 after I left Inland Revenue.

I started hearing from so many unhappy colleagues. Processing staff seemed to be largely unchanged. But the cuts were falling on the senior technical staff, you know, the senior investigators and the principal advisors, the group I had worked with on the bank tax avoidance cases, and had then gone on to the Frucor case. These senior investigators had their pay being cut and the principal advisers were going to get mixed up with everyone else as technical specialists.

Now, one thing I just want to address is that I’ve heard it said that most people haven’t had a pay cut, and that’s possibly true. But it was the people at the top who were the most impacted. There’s a few things that’s happened. There are very able people who were managers and team leaders who come back as technical specialists. So that’s kind of a plus in the senior investigator and technical space or the principal adviser cohort. On the other hand, I would say possibly half of the senior top talent has left. That’s a lot of talent to lose.

I mean, and I’m sure you’re aware, there was 18 months where my LinkedIn feed was just going ping, ping, ping, with all  my long term friends and colleagues from Inland Revenue, posting that they were now working for themselves or were ow with another agency or now with a big four now or overseas. You would normally have expected a degree of turnover, but it was almost like every day or every well, let’s say every week, I don’t want to exaggerate. And yet  there was another one of these people moving on.

TB

There’s something else that I think is an important point to be made here – that Inland Revenue salaries at that level you’re talking about are actually quite competitive because the Big Four accountancy firms are after people like yourselves and other policy advisors, who are highly experienced people and technically very good. So Inland Revenue has to be competitive.

Andrea

It might not necessarily be the end of the world, because there were really capable technical people who had become team leaders and managers, who came back as technical specialists, so with the remaining people I wouldn’t necessarily be worried or concerned. But there has also been a massive contraction in morale, which I think you’ve alluded to, Terry, in the past with the engagement scores.

TB

Yes, I have been tracking Inland Revenue staff engagement scores. In Inland Revenue’s report to June 2019, it was at 29%, which unbelievably was actually up from the previous year.

Andrea

I did a contract with an agency last year they were at 60% and wanted it to be higher. At my time at Treasury, I think 60% would have been really low.

TB

So Inland Revenue has a problem. Now you’re supporting the Public Service Association.

Andrea

Yes, when I started working with the PSA one thing came to mind, I think it was last year following the Commissioner’s presentation to the Finance and Expenditure Committee. She was being queried about the number of audit hours. She said yes there had been a fall in audit hours, but Inland Revenue was still meeting its return targets. And I remember thinking at the time  “Wow, that’s really impressive.”

But later I got thinking and said to the PSA whether it would be worth finding out about the hours, but also the composition of Inland Revenue’s return.

There’s a lot of talk about how Inland Revenue get seven dollars return for every dollar it receives in audit. And that’s right to a point. But that amount is an identified “discrepancy.” And this discrepancy is a change in tax position.

And if we look at the definition of “tax position” in section 3 of the Tax Administration Act 1994, pretty much anything, any interaction between Inland Revenue and taxpayers, is a tax position.

So a tax position includes, say, the tax avoidance cases with the banks, or a case where someone says they earned nothing but Inland Revenue finds they did earn a million dollars. The tax on a million dollars would be a discrepancy or change in the tax position.  Both of those involve a liability for an amount of tax and these are matters people would consider a discrepancy.

But a discrepancy is also a change in a memorandum account, or a change in the amount of tax losses. So if Inland Revenue finds that someone had overstated the losses, that counts as a change in tax position. And all these things are what I would call good work. All of these things are important activities in the investigation function.

But if you think about it, there’s different degrees of effort and different degrees of pushback that you get from a taxpayer. There’s a spectrum. So on one hand, you would have changing someone’s tax return which means they have to pay more tax and they really don’t want that.

But on the other hand, you could have an adjustment of losses for a company that’s perennially a loss maker or, and this is my favourite example, adjusting the imputation accounts of New Zealand subsidiaries of Australian companies. After the double tax agreement with Australia changed, you no longer had to attach imputation credits in order to be exempt from non-resident withholding tax.

In those circumstances, changes to losses or imputation credit accounts aren’t met with much pushback because they don’t really affect the material position. It’s still useful work but it’s a sort of lower quality discrepancy versus the higher ones where you would be changing someone’s taxable income in a way that they had to pay tax.

Now, from an investigation perspective, the top end, like in the bank tax avoidance cases, you know, taxpayers throw everything they’ve got at it in resisting amendments and it’s a lot of work. And so, a discrepancy coming from that is really hard won.

All the time that I was in the field, I saw all the effort really going into what I call the high value discrepancy. I mean, there would have been some other stuff that went on. You know, like if you’re doing an audit, you find things. But I found that the audit programme was really targeting only what I call the high quality discrepancies.

TB

And speaking from the other side, those were the fights that we’d be having with Inland Revenue: what was deductible, what was taxable. We’d sort out arguments about incorrect imputation credit accounts and losses brought forward relatively quickly and resolve those issues. And we don’t tend to dig into the trenches for them. But the other point of these highly more technical matters, yep, that’s where the fights happen.

Andrea

That’s right. And so while strictly speaking, everything is a discrepancy, everything I always saw when I was in the field at Inland Revenue was the audit programme was targeted to the high quality ones, but low quality ones might just tick in.

So knowing that, when I was hearing that even though the audit hours had gone down, Inland Revenue was still meeting its targets, I was like “Okay. There’s a couple of ways that could happen. The new computer could be really, really flash and be doing an awesome job. Or maybe there’s another option.”

So, after discussing it with the PSA I filed an Official Information Act request asking for audit hours by year and broken down by area. I also asked for discrepancies split by type. And I gave the examples of loss adjustments and imputation adjustments. Because I know in the past investigators always coded those things up.

So if we saw, like, lots of going after people’s income tax. I’d have been really comfortable; the Department would have been just awesome to be able to deliver that with really few audit hours.

TB

Yes. The Official Information Act (OIA) request that you got back is really very interesting reading.

Andrea

So in terms of audit hours, we’ve got a breakdown for each of the years ending 30th June 2016 which would have been the last year I was at Inland Revenue, through to 30th June 2020. And this is a version of what came from the Andrew Bayly Parliamentary questions from last year.

And I think the PSA is looking to make the OIA public. But in the meantime, the PSA is happy for me to send it out to anyone who wants it.

TB

So total audit hours have fallen by two thirds roughly and hours on complex technical issues are down 90%.

Andrea

That’s right. That’s right. So I would have expected the discrepancies would have similarly fallen, but maybe that’s old thinking. The total has gone from $1.2 billion to $958 million, which is less but not a lot less.

So complex technical I found fascinating in terms of the discrepancy. It’s gone in the 2015/16 year, which was when I was there, from $296 million in discrepancies. It peaks in 2016/17 at $462 million and then it goes to $295 for the latest year.

So on the face of it, yes absolutely, the Commissioner is right. While the audit hours have gone down the return or the discrepancy is unchanged, which is why I was really interested in what the discrepancies represent because, one can think thoughts, but it’s important to see what the facts are. And like I say, I knew that the investigators always coded this up. But it seems like the new system doesn’t tell you how it’s broken down.

TB

A little bit aside here this is a point I’ve had an interest/concern about for some time is that Inland Revenue has access to more data relating to the state of the New Zealand economy than practically any other organisation, but we don’t see a lot of it.

I’m always disappointed how little data Inland Revenue releases. Because my view, and you may well share this, the more you tell people about what you know, the better enforcement is, because people aren’t going to try fancy stuff.

Inland Revenue will know for example how much is being spent by the average bakery, and what proportion is cash, what proportion is EFTPOS. They know that all those details.  So people shouldn’t try and hide cash sales because it’s not going to work. That sort of detailed information Inland Revenue could be doing more with, but isn’t doing so at the moment.

So to find out that the system doesn’t appear to carry that level of detail, I have major concerns. Not just as a tax agent, but also as a taxpayer who’s had to pay a substantial amount of money – $1.2 billion I think – on Business Transformation, one of the biggest I.T. upgrades in the country.

And you’re telling me Inland Revenue actually aren’t able to draw more data? Because I know there’s a lot of very discontented software providers in New Zealand who didn’t get a chance to deal with this project.

Andrea

Here’s what Inland Revenue said in the OIA.

“You have requested the total discrepancies be further broken down by time. I’m only able to provide loss reduction adjustments in part where these have been captured manually for the reporting by staff in our new system (START).

“The balance of any loss reduction adjustments and all imputation adjustments are either recorded in one of our heritage systems (eCase) which has been decommissioned, or as other information in START. To provide these figures, would require a manual review of individual case records.  Accordingly. I must refuse this part of your request…because the information sought cannot be made available without substantial collation or research.

It astounds me because what they are saying even is that even the managers don’t know how these are broken down. I’m speechless, I don’t know where to start with it.

TB

Wow, just talking generally about Business Transformation, obviously, I’ve talked in the past about how we as tax agents feel it’s gone.  To say underwhelmed would probably be unfair, but we have not been happy with some of the side effects of it.

So are you telling us Inland Revenue have got a system that doesn’t work well with agents who are the principle people who work with it and also doesn’t record information regarding audits?

Another thing is we know is that if they want to make any proprietary adjustments to the system, they have to get sign off from all the other tax authorities that use the same system. There are six or seven others, I think, including Finland. So there’s quite a lot of questions around how has been sold to us and how it’s actually operating.

And then come back to the point you started with – there’s been a fallout with low morale in Inland Revenue. That is not good for the tax system, let alone for Inland Revenue itself, but for us as taxpayers. I don’t think it’s a good system when the person on the other end of the phone is less than happy to be there. What is the PSA finding on this stage? It’s not particularly encouraging from what you have said.

Andrea

The PSA is in the middle of some processes so I don’t feel I can speak for them. They are looking at supporting staff through this, is probably the short answer to that question.

TB

A very diplomatic answer.  So what you’re telling me is a little disconcerting, because it sounds like these numbers may not mean everything you’d expect them to mean.  And talking about audit activity, we’re not seeing as much audit activity as previously. I think Covid-19 might have caused some interruption, but there definitely seems to be lower audit activity going on.

And I have to say, I do struggle with the numbers here which suggest Inland Revenue is identifying roughly the same amount of discrepancies but with one third of the hours. If the new system is as efficient as that, then they should be exporting it. The productivity gains are enormous. The New Zealand economy would go gangbusters if we could get those productivity gains across the board.

We’ve got an overall decline in discrepancies as well. The amount of revenue taken on this has declined from one point three billion in the year to June 2017, to now 958. And it’s a downward trend.

And they’re not seeing much gain in the hidden economy either. That number is constant roughly as well, which again surprised me because we know there’s a lot more out there. So what’s your overall view of what’s going on here?  Because when you drill into it, it doesn’t seem to stack up quite as well, does it?

Andrea

Well, to be fair, when I looked at the Inland Revenue funding for an article I wrote a few weeks ago, it’s quite interesting to see that investigations funding is falling.

TB

What? Did you say investigations funding is falling?

Andrea

Yes, funding for investigations and debt management funding is falling, but you would expect Inland Revenue funding to fall overall because of all the money that’s gone into Business Transformation. But interestingly, investigations and debt management funding has fallen but processing has increased, which I don’t understand at all, because the new computer system was supposed to make processing much easier.

TB

Yes, I agree that doesn’t compute because if you’re designing a smarter system, you’d be putting the resources to where the smarts are, i.e. investigators. You’d also be wanting to put resources into debt management because it has been a longstanding problem for Inland Revenue Which to be fair to them, I think they’re now getting on top of. But now it’s got to deal with Covid-19 as well. When you think about it, Inland Revenue has got the Covid-19 fallout, a historic debt problem, so against that background falling debt management funding does not compute.

Andrea

I think it can be quite computable because if you have this idea that you’ve got a much bigger and flashier system that can take away the lower level work for debt and investigations, you could see that funding in those areas funding would fall. I always want more money in investigations, but that has a degree of logic to it. The logic of processing funding increasing, I can’t get my head around.

TB

What is the scale of the increase in processing funding?

Andrea

It’s gone from about $100 million to about $150 million.  Debt funding has gone from about $150 million down to under $100 million.  Investigations has gone from about $175 million down to just over $100 million.

TB

On debt management, I think it’s possible Inland Revenue can get certain big efficiencies if it gets into the act of chasing debt earlier.  If you’re not leaving it for years before you start asking questions, you will get some easy productivity gains.

But we’re always hearing, as you mentioned at the beginning, that investigations generally bring in seven dollars per dollar invested return. But at a time when the government’s books have been shot to bits, we are hearing these numbers are pointing to a reduction in the most valuable return the government can get from its main source. Yet there’s a 50% increase in processing funding for a new computer system on which we’ve already spent $1.2 billion dollars already.

I would want people providing oversight such as the Finance and Expenditure Committee to be asking a few more questions about this, because it does not stack up from where I’m sitting.

Andrea

Well, I just want to say one thing. We don’t necessarily know how valuable that seven dollars return we’ve been talking about is. As we’ve discussed it’s a tax position but it’s not money in the bank, it’s the amount before collection. But the other thing I would say is that debt has been rising since 2017. Looking at Inland Revenue’s June 2019 annual report, it’s gone from $2.9 billion, to $3.1 billion in 2018 and $3.5 billion in 2019.

So, I would agree with your comment. I found this out when I was preparing the Official Information Act request on behalf of the PSA and I was just, quite frankly, astounded.  Although I don’t like the fall in funding for audit investigations and debt, as a former Treasury official, I can see the logic of that, given all the capital expenditure that has gone into Business Transformation. But I was just floored that funding for processing obligations and entitlements has increased.

TB

Well, that’s quite a few bombshells just dropped in there about what’s actually going on. We have a new Minister of Revenue, David Parker, and a Parliamentary Under-secretary, Deborah Russell as well. They will get what’s known as a Briefing to Incoming Minister which will be released later this year in due course. Now, it’s going to be very interesting reading to see whether some of the issues we’ve just been talking about actually get picked up. But in the meantime, I would hope that other oversight bodies, such as the Finance Expenditure Committee, start asking some questions because it’s quite concerning that there’s a discrepancy, to use a word, between what’s being reported and what actually might be happening.

Well, I think we’ll leave it there. Andrea, thank you so much for coming on and great to have you on the show again. That’s it for this week. Thank you for listening.

I’m Terry Baucher and you can find this podcast on my website, www.baucher.tax or wherever you get your podcasts, please send me your feedback and tell your friends and clients. Until next week, ka kite āno.

Inland Revenue is contacting people about information received under Common Reporting Standards

2 Nov, 2020 | The Week in Tax

  • Inland Revenue is contacting people about information received under Common Reporting Standards
  • Company is put into liquidation for not having adequate accounting records
  • Inland Revenue research on the tax debt tipping point

Transcript

A few weeks back, I referred to the OECD’s Secretary General’s tax report to the G20 finance ministers and central bank governors, in which he referenced the impact of the Common Reporting Standards on Automatic Exchange of Information.

The Secretary-General noted that during 2019, nearly 100 jurisdictions exchanged information automatically relating to 84 million financial accounts covering assets of almost 10 trillion euros. And as a consequence, tax administrations so far have been able to identify for collection 102 billion euros in tax.

Inland Revenue is part of the automatic exchange of information process. And it made its first exchanges during the year ended 30th June 2019 when it sent more than 600,000 account reports and received over 700,000 in return. Prior to the arrival of Covid-19, Inland Revenue had been working through those 700,000 information accounts that it had received and had started sending letters to people who held such accounts.

Then Covid-19 arrived, and everything went quiet. Inland Revenue is now back on the case because this week a couple of clients received letters from the relevant Inland Revenue section.

The letter explains that Inland Revenue is one of many jurisdictions involved in the automatic exchange of information and then goes on to say,

“We have received information from one or more jurisdictions for the 2018 and or 2019 years, which indicates that you may have an interest in a life insurance policy overseas… If you are a New Zealand tax resident and have an interest in a life insurance policy not offered or entered into in New Zealand, it may be subject to the foreign investment fund rules.”

Now, quite apart from the reactivation of this initiative by Inland Revenue, the other thing that stood out for me about letter this was the specific reference to life insurance policies. These are, as the letter notes, covered by the Foreign Investment Fund (FIF) regime and surprise, surprise, given the complexity of the FIF regime, few people are aware of that.

So, this is something probably similar to the initiative Inland Revenue started about 10 years ago now in relation to foreign superannuation schemes when it started looking at the taxation of such schemes.  At that time, they were within the FIF regime and Inland Revenue found most people were not complying, again unsurprising given the complexity of the FIF regime.

The recommendation I would have here for clients is obviously to make disclosures if you haven’t already done so in relation to the life insurance policies. As it transpires, our clients have done so. And the other thing to be mindful of is that although the FIF regime has its problems  (in that you’re being taxed on 5% of the value of an asset which does not necessarily provide a cashflow), that treatment is possibly more favourable long term than not being within the FIF regime.  This is because the rules on the tax treatment of the proceeds of such policies on maturity is not at all clear.

If Inland Revenue is going to bang the drum about compliance with the FIF regime in relation to life insurance policies, it probably should also come out and state what it considers is the tax treatment for policies which are outside the FIF regime. That’s something we’d like, which would clarify matters greatly and probably ultimately encourage more compliance.

Why you must keep good records

As a tax agent, advising and reminding clients about the need to keep adequate records is a constant of our business. The consequences of not doing so can be extremely harsh, as Tower City Holdings Limited have just found out.

Tower is a property development company and was audited by Inland Revenue beginning in 2015.  Initially Inland Revenue was looking at GST returns and income tax for the year ended 31st March 2013. Ultimately though, Inland Revenue issued an income tax assessment for the year ended 31 March 2016 amounting to just over $4 million in respect to the sale of three properties for a total of just over $32,180,000.

Now, this is where it gets interesting as the Commissioner also assessed Tower for a tax evasion shortfall penalty of just over $3 million, which is pretty much the maximum possible for a first-time offender on the amount of tax assessed. Clearly, this company had been paying it fast and loose on some matters.

Now, you can imagine none of this went down very well with Inland Revenue. The Commissioner of Inland Revenue filed an application for an order under Section 241 of the Companies Act 1993 to place Tower into liquidation. This cited a number of grounds, including Tower’s inability to pay its debt, its failure to keep proper accounting records and breaches of various directors’ duties.

This ended up in the High Court, which has now ruled that the company can be put into liquidation on the basis that there have been serious and persistent breaches of Section 194 of the Companies Act 1993, which requires adequate accounting records be kept at all times.

It emerged that Tower had never kept any ledgers, cash books or any other such documents which would have allowed its financial position to be determined at any one time. This was apparently a deliberate policy on the part of Tower. Not sure exactly what it thought it would achieve by doing that, because as anyone well knows, if you get into a dispute with Inland Revenue, the burden of proof is reversed. If you haven’t been keeping records, it’s going to be very hard to prove to Inland Revenue that what you say is non-taxable is in fact, non-taxable.

And this case is also a reminder that Inland Revenue has plenty of powers. Every tax agent will tell you that, yes, some taxpayers can be a little slack around the matter although this is an extreme example of lack of poor record keeping. But the fact that Inland Revenue and the courts can actually put a company into liquidation on the basis of poor accounting records is something that should make directors of companies sit up and pay attention.

The tax debt tipping point

And finally, this week the Inland Revenue report for June 2020 has not yet been released as I was expecting. Looking for it, I came across a report titled Identifying Sanction Thresholds among SME Tax Debtors: An Overview. Now, the PDF notation indicated it was a 2020 publication, so I thought,  good, some interesting new research. In fact, the report appears to be from 2012 and therefore the data in it is quite old and probably not directly relevant because Inland Revenue has actually been working very hard to keep its debt portfolio under control.

But looking through the report, something caught my eye that is really quite fascinating and is still very relevant. Inland Revenue’s research indicated that the median debt tipping point, at which point the taxpayer just gives up on trying to manage the tax debt, was just $10,000.

Now, that’s way less than I or any other of my tax agent colleagues might have estimated.  Even allowing for inflation since 2012 it suggests that a similar tax tipping point today might be as little as between $15, and $20,000.  What that indicates is something that we did see on the Small Business Council, and that is that many SMEs are undercapitalised. And this is a point I think has started to emerge again in the wake of Covid-19.

Now, fixing that under-capitalisation in a pandemic isn’t going to be easy, but maybe the banks, instead of lending freely on residential property – therefore adding fuel to a dangerously heated property market – might just want to direct their lending elsewhere into something more productive. That’s just a random thought.

And on that note, that’s it for this week. Thank you for listening. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Please send me your feedback and tell your friends and clients.  Until next week ka kite āno

After the election what next in tax for the Labour Government? Who will be the Minister of Revenue?

27 Oct, 2020 | The Week in Tax

  • After the election what next in tax for the Labour Government? Who will be the Minister of Revenue?
  • A future role for green taxes
  • Problems with Inland Revenue’s online functions

Transcript

So now we know the election results and the morning after the election result, I got an enquiry from a US based tax website asking what’s going to happen? And in particular, how will the Labour Government be able to manage the issue around no capital gains tax and no wealth tax?

My correspondent also asked some questions about what’s going to happen in the international tax space, referencing comments I made last week about the OECD’s new Pillar One and Pillar Two proposals and progress on international taxation.

Labour when campaigning, promised an increase in the top tax rate 39% on income over $180,000. So, one of the first orders of business will be a tax bill to have that in place from the start of the new tax year on 1st of April.

Labour was a little less conclusive about what it was going to do over the trust tax rate. My view would be that it must rise from 33% to 39% as a “base integrity” measure. Otherwise, companies and individuals will use the opportunity to move income which could be taxed at 39% into trusts where it will be taxed at 33%.

There’s also going to be an incentive for companies to hold on to profits and reduce the amount of dividends distributed, given an unchanged company tax rate of 28%. And obviously shareholders will not be keen on paying an extra 11 percentage points if the distribution is received. This actually is a matter Inland Revenue is already concerned about, given the existing gap between the company rate of 28% and the top personal rate of 33%. And that problem is going to be exacerbated when the top tax rate rises to 39%.

Therefore, one of the big orders of business for Inland Revenue and the new government is what are they going to do about addressing that particular issue? So, watch this space. There could be some stronger use of existing anti-avoidance mechanisms or maybe a specific measure is brought in.

The US correspondent did ask if the government would be able to stick to its promise not to implement either a wealth tax or capital gains tax. I fully expect that will be the case. The Prime Minister has made her reputation on sticking to her word, and although she and Grant Robertson probably feel their hands are very much tied on the matter, that will remain the case.

Other options

It doesn’t mean that there aren’t other opportunities to raise revenue. The Tax Working Group considered the possibility of applying the risk-free rate of return method to residential investment property, similar in the way that the Foreign Investment Fund regime’s fair dividend rate applies to overseas investments.

I expect to see Inland Revenue get extra funding to tackle the cash economy, where estimates of the amount of tax currently being evaded each year range between $850 million and $1 billion. I’ve mentioned it before, and I think Inland Revenue will also be looking also at the question of fringe benefit tax on work related vehicles.

I also see that the Reserve Bank governor has started to talk about loan-to-value ratios coming into place. That is something that I raised recently in a column as possibly one of the only ways left to tackling the rapidly rising house prices. A related tax measure could be the application of the thin capitalisation regime.

Last week I talked about the taxation of multinationals and it is quite possible that we might see the digital services tax move forward, if nothing more than just to keep pressure up on this matter. It would be a big step for the government to take as they do like to move in lockstep with the Australians who aren’t doing anything on this. But if they’re having to wait to see progress, it might be that just simply pushing it forward to have it ready to go at a moment’s notice would be the option to take.

Also interesting to note in this week’s developments, is the antitrust action taken by the US government against Google which references the outcome of the rather damning report recently issued by the US House of Representatives.

Ex IR staff now tax minister candidate

Finally, it will be interesting to see whether Stuart Nash continues as revenue minister or a new minister is appointed. If Stuart Nash moves on, an obvious candidate would be my co-author, Dr. Deborah Russell, who is ex Inland Revenue and has been the most recent chair of the Finance and Expenditure Committee. Interestingly, one of the new Labour MPs, Barbara Edmonds, who won the Mana electorate, is also ex Inland Revenue and was seconded from Inland Revenue to work in the Minister of Revenue’s office. We should know next to by this time next week who’s going to be the Minister of Revenue.

By that time, incidentally we should also see Inland Revenue’s annual report. It will be interesting to see what’s being presented to the Minister.

Green taxes

Moving on, the Green Party’s campaigning for a wealth tax drew a lot of attention and has got pundits talking as to how much of a factor it might have been in Labour’s huge win. But putting aside the wealth tax green taxation is a matter which is going to become very, very important over the next 10 years.

Now, at the moment, jurisdictions all around the world are quite rightly reluctant to move quickly on introducing new for fear of damaging a recovery from Covid-19. However, that’s not to say that green taxes don’t have a role going forward. And another paper released a couple of weeks ago from the OECD looks at green budgeting and tax policy tools to support a green recovery.

The OECD also notes that carbon pricing is going to be important because it will encourage low carbon investment and consumption choices. And it regards carbon pricing as “a key tool for a successful recovery”. In particular, what it thinks is important about carbon pricing, such as our emissions trading scheme, is that it raises the cost of carbon intensive assets and therefore will steer investment and consumption towards greener, low carbon alternatives. And then ultimately, of course, carbon pricing can help restore public finances by bringing in tax revenues.

Although I think looking at the future role of green taxes, that’s something further down the path. And that, by the way, was also a conclusion of the Tax Working Group. It saw that there was a future in environmental taxation, but the actual tax tools had to be developed first, and that meant it didn’t see an immediate revenue gain from environmental taxation. But longer term, these would become more important.

The paper has some eye watering numbers in it. For example, it references the European Coronavirus Recovery Fund, which is worth over one trillion euros over the course of the six years between 2021 and 2027. And of that, €300 billion is specifically earmarked for green projects.

On carbon pricing, the OECD research shows that 97% of energy related carbon emissions from advanced and emerging economies, which would include New Zealand, are not taxed at a level that’s compatible with decarbonisation, according to the Paris Agreement. And there are some 70% of emissions that are entirely untaxed. That’s a hugely controversial matter here, obviously, because of our agricultural emissions.

So, what I think we will see coming from the new government going forward is, for example, a feebate scheme, which involved rebates for purchase of electric vehicles to replace fossil fuel vehicles. That was one of the projects that New Zealand First put the kibosh on. We’ll probably see that come back up on the table very quickly. And we also expect to see some other moves on this matter.

But I expect although there will be steps in environmental taxation, these will be rather cautious to begin with, for the reason I say said a few minutes ago. No government would want to increase taxation too quickly during the early stages of a recovery from the Colvard pandemic.

The IR stumbles with its ‘think big’ project

And finally, Inland Revenue’s online functions have been experiencing technical issues all week. Now, this is unusual because this time of year is not usually a time of peak demand. This is between early May and late June, when it is dealing with the wash up from the previous tax year. So, what’s going on at the moment? We don’t know but it’s certainly not a demand related area.

Now, of course, this touches on Inland Revenue’s very controversial $1.5 billion Business Transformation project. That has been a controversial project for a number of reasons. Firstly, the sheer size of it. I know that local IT providers resented being shut out of this project. One provider at a 2014 tax conference pointed out that they had successfully built and implemented a GST system for the Bahamas in barely six months. They could not understand why Inland Revenue was spending the amount of money it was on the overall Business Transformation project.

Actually, that point also touches on something which several submitters made to the Small Business Council. And that is small businesses often felt shut out of government contracts because of the complicated procurement process involved. And one thing I’d like to see from the new government going forward is making it much, much easier for small businesses to bid for government contracts. And that also applies to local government.  The amount of spending across local and central government runs to tens of billions of dollars.  The risk around simpler procurement policies for, say, projects of up to, say $5 million or so are actually statistically insignificant. So that’s something I’d like to see the government move on.

Inland Revenue’s outsourcing to an American company for the upgrade project didn’t go down well with the local tech industry. And again, outsourcing overseas is something the government would need to be careful about moving forward.

‘Transformation’ gets tax community offside

Inland Revenue’s Business Transformation didn’t seem to factor in its relationship with tax agents. Although the actual transformation is largely successful from Inland Revenue’s viewpoint, it hasn’t gone down well in the tax agent community. I had a client complain to me that he had recently received a call from Inland Revenue which basically said you don’t need a tax agent anymore because we can help you manage your tax. His comment was, “I really felt I was being sold something”.

We’ve complained about that unsolicited call and we’re not the only tax agency to have had clients receive such calls.  But so far, our complaints don’t appear to have been heard.

Now, Inland Revenue has a very proper role to call clients and taxpayers who are behind on filing or tax payments. But what many tax agents have experienced is calls are made directly to their clients which are not related to these matters at all. And that is something that I think has gone on for too long and needs to be addressed. So that’s one of the headaches the incoming Minister of Revenue, will need to pick up on.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients.  Ka kite āno.

The OECD’s latest update on progress in taxing the digital economy

27 Oct, 2020 | The Week in Tax

  • The OECD’s latest update on progress in taxing the digital economy
  • The potential impact of the United States House of Representatives Judiciary Committee’s Subcommittee on Antitrust, Commercial, and Administrative Law’s report on competition in digital markets
  • An accidental new lover tax?

Transcript

This week, the election tax talk has all been about a possible wealth tax, which Jacinda Ardern has repeatedly ruled out. Personally, I found the repetitive questioning whether the tax would come in to be pointless. A better line of enquiry would have been to ask both leaders of the main parties why they don’t think a wealth tax is needed and what they’re going to do about taxing capital.

On the other hand, Labour is committed to introducing a digital services tax GST in certain circumstances, and several major reports have been released the past few days, which underline why taxing the digital economy is going to be increasingly important and something that the new government, regardless of who forms it, will need to take action about.

The first of these reports was the United States House of Representatives Judiciary Committee’s Subcommittee on Antitrust, Commercial, and Administrative Law’s report on competition in digital markets. At 449 pages this is a real blockbuster and the culmination of a sixteen-month investigation launched in June 2019 into the state of online competition

The report focuses on the dominance of the “GAFA”—Google, Apple, Facebook and Amazon and is damning.  The Subcommittee heard from the CEOs of the GAFA and concluded “Their answers were often evasive and non-responsive, raising fresh questions about whether they believe they are beyond the reach of democratic oversight.”

The report brands the GAFA “dominant platforms” as they possess monopoly power due to factors including their role as “gatekeepers” of key distribution channels, which allows them to control access to digital markets. Consequently, as the report states

 “…companies that once were scrappy underdog start-ups that challenged the status quo have become the kinds of monopolies we last saw in the era of oil barons and railroad tycoons… These firms typically run the marketplace while also competing in it—a position that enables them to write one set of rules for others, while they play by another, or to engage in a form of their own private quasi regulation that is unaccountable to anyone but themselves.”

The investigation found that the GAFA engaged in a series of anti-competitive conduct to maintain their market power, including self-preferencing and so-called “killer acquisitions” of potential competitors.  To give you some idea of how many of these have happened, an appendix to the report lists over 560 acquisitions by the GAFA, going back to 1988.  Few of these have been investigated by the US federal anti-trust agencies.

The report recommends reform of the antitrust laws and breaking up the “dominant platforms” through structural separations online of business restrictions. If implemented, it would be one of the biggest antitrust trust actions taken by the U.S. government in decades.

One of the things which caught my eye about this report was that very interestingly, it referenced the 600-page Australian Competition and Consumer Commission (ACCC) Digital Platforms Inquiry report released in July 2019. This too raised concerns about the digital giants. According to the ACCC, Facebook’s sheer size “appears to protect it from dynamic competition”.  The report estimated Facebook and Instagram’s combined share of the online display advertising market in Australia to be 51%, noting “no other online supplier of display advertising has a market share of greater than 5 per cent.”

What the ACCC report did as well was take a look at the impact of Google and Facebook’s actions on Australian classified advertising revenue. It noted that classified advertising revenue has fallen in absolute terms from A$2 billion in 2001 to A$200 million in 2016. Adjusted for inflation, the decline over that period is from A$3.7 billion to A$225 million, a 94% drop in revenue.

The report pointed out that this has resulted in, amongst other things,

“a significant reduction in provision of multiple categories of reporting related to public interest journalism; that is, journalism that performs a critical role in the effective functioning of democracy at all levels of government and society. In particular, the research indicates a significant fall in the number of articles published covering local government, local court, health and science issues during the past 15 years”

I am sure that most of this will sound very familiar to everyone involved with the New Zealand media industry.  We have seen the same hollowing out of local newspapers and the struggle to financially survive.

The ACCC’s recommendations are not as potentially far reaching as those of the House Judiciary Committee subcommittee but did include changes to competition law. It also recommended Google must offer Android users the ability, as in Europe, to choose their default search engine and default Internet browser from a number of options. The ACCC also recommended that tax settings should be changed to establish new categories of charitable purposes and deductible gift recipient status for not for profit organisations that could create, promote or assist the production of public interest journalism.

Following on from these two reports, I would think that it should be an urgent matter for our own Commerce Commission to undertake a similar enquiry into the extent of the digital competition here in New Zealand.

Now, virtually the same time as the Congressional report was released the OECD released its latest tax report to the finance ministers and central bank governors of the G20 regarding its progress in addressing the tax challenges of the digital economy.

One of the matters the OECD report discussed is the progress made in relation to matters such as offshore voluntary disclosure programmes, offshore tax and investigations. And so far, these have led to the identification of an estimated €102 billion of additional tax revenues. And of course, since 2017, there has also been the automatic exchange of information under the Common Reporting Standards. So far, the exchange of information has identified 84 million bank accounts totalling almost €10 trillion.

There has been a lot of movement in investigating the tax affairs of multinational enterprises such as the GAFA. This includes almost 30,000 information exchanges on previously secret tax rulings since 2016. More than 90 jurisdictions have now become involved in the exchange of country by country reports on the activities, income and assets of multinationals since June 2018.

Now, the next big step that the OECD is currently working on is what’s called the Pillar One and Pillar Two blueprints to deal with digital taxation. Pillar One focuses on what we call the nexus and profit allocation, and Pillar Two is focussed on a global minimum tax, which is meant to address the issues arising from base erosion and profit shifting, which is the result of international tax avoidance.

Together the Pillar One and Pillar Two initiatives could increase the global corporate income tax revenues by an estimated US$50 to 80 billion per year. That’s roughly equivalent to about 4% of the global corporate income tax take. Covid-19 has delayed progress in this matter, and it is now hoped that an agreement can be reached by the middle of 2021.

The OECD also released an overview of the current taxation treatment of cryptocurrencies covering over 50 jurisdictions, including all G20 and OECD members.   It’s the first comprehensive analysis of the existing approaches and tax policy gaps across the main category of taxes applicable to cryptocurrencies.

What’s also happening in this space for cryptocurrencies is new provisions and guidelines around exchange of information relating to cryptoassets.  The OECD report estimates that as of end of September 2020 cryptocurrencies are worth US$354 billion.   And you may recall that Inland Revenue has recently targeted crypto-asset providers requesting information about customers. So this appears to be part of the OECD initiative, which we know means the information obtained will get shared at some point.

So what does all this mean for New Zealand and the new government? Well, firstly, as I mentioned, the government will be very keen to get the OECD Pillar One and Pillar Two proposals go through quickly. Interestingly, the latest is the US do not seem to be stalling action on this, but we’ll have to wait and see what happens with the American election.

What the government could do if it wanted to get things to move along, would be to apply pressure by introducing a digital services tax, which is part of Labour’s manifesto. In reality, the maximum $80 million annually it would raise isn’t terribly significant in the scheme of things, but it would be politically quite popular.

The bigger issues are whether, as in Australia and the US, the GAFA are carrying on anti-competitive behaviour in New Zealand. And if so, how do we address that? In particular, one of the issues I think the government is going to need to consider is how much financial support is needed for local media.  Allowing a tax deduction for donations to some media organisations similar to that proposed by the ACTC would be of some help.

A more significant action might be to follow the Indian example, imposing a digital advertising levy, which raised an estimated $200 million in the year to 31st March 2019.

One other international measure, which has been put into place quite recently is increased of GST or VAT on online sales goods. And this, according to the OECD, has resulted in the European Union reporting €14.8 billion from these measures in the first four years of their operation.  The New Zealand take from the expansion of online GST to online supplies has been quite significant, amounting to $207 million in the year to June 2020 according to the OECD report.

But the scale of the digital economy will mean that the incoming Minister of Revenue and the government will have should be paying a lot more attention to this space. And I think we’ll be facing demands from the media here, and rightly so, about the anti-competitive behaviour similar to that which has been called out in America and appears to be happening in Australia.

And finally, it has been a long election campaign and possibly it’s been too long for David Bennett, the current national MP for Hamilton East, who accidentally proposed a “lover tax” on one of his billboards.  This prompted the swift formation of a new tax working group to consider the issue on Twitter.  I will leave it to your imagination about some of the proposals, but I was very much impressed by the suggestion that clearly secondary tax must apply after the first lover.

And on that note, that’s it for this week. I’m Terry Baucher and thank you for listening. And until next time, Ka kite āno.

Inland Revenue is checking wage subsidy claims.

12 Oct, 2020 | The Week in Tax

  • Inland Revenue is checking wage subsidy claims
  • A look at the Australian Budget
  • Why GST rate cuts don’t work

Transcript

The Wage Subsidy, Wage Subsidy Extension, and the Resurgence Wage Subsidy schemes are all now officially closed for further applications. And as you may well be aware, these involved some significant sums of money. In total, there were more than 750,000 applications received across the three schemes together. That includes nearly 250,000 self-employed individuals. And to date, $13.9 billion has been spent on the schemes.

By the way, the Covid-19 leave support scheme is still open to affected organisations for employees required to stay at home because of the Covid-19 risk or employees who couldn’t work at home. That was at the same level of $585.80 for those working 20 or more hours per week, and was a maximum of four weeks per employee. The scheme was repeatable, so you could apply more than once. Now hopefully that scheme will no longer be required as we’ve now all down to Lockdown Level One.

Meantime, Inland Revenue has said it will be starting to audit and review those businesses that did take the wage subsidy and applied the money as they should have done. Was all the money paid through to its employees? Were any unusual employment scenarios dealt with correctly? How did they treat it for income tax? Remember, it was non-deductible to an employer but income for a self-employed person. And it was not subject to GST. Finally, was the subsidy all paid through to employees and PAYE correctly applied?

Now there are some questions emerging as to whether it was paid to employees and PAYE applied. There have been some cases where that has been found not to be the case. So we expect that Inland Revenue will be using its new tools and casting its eye over claims. Checking to see that employers – which it knows received the wage subsidy – did also pay/meet their PAYE obligations.

Inland Revenue will probably also be checking whether in fact, the applicant did suffer a 30% drop. They may feel that the GST returns, for example, might not support that there has been a drop in income. So as always, it’s a question of just staying alert and being aware that the questions will be asked. The wage subsidy schemes were high trust regime, and it appears that that trust has been rewarded in most cases. But undoubtedly there will be a few fringe persons that didn’t follow through as they should. And they should expect to hear from Inland Revenue in due course.

Now, related to the wage subsidy scheme was the Small Business Cashflow Scheme, which is still open for applications up until 31st December. And the Labour Party has promised that it will be extended for a further two years while a permanent regime is designed. The current Revenue Minister, Stuart Nash, said in a recent debate with Andrew Bayly the National Party spokesperson for Revenue and Small Business, he was very comfortable if companies or businesses had applied for the loan and then just simply parked it in a bank account. He felt that at this stage it was important to give those businesses some comfort that they had something there because we’re not through all of this yet. Who knows how businesses are going to react post-election and particularly during the Christmas slowdown. So that’s encouraging to hear.

As I’ve said before, I’m a fan of the Small Business Cashflow Scheme, and I would like to see a permanent iteration brought in. Funding for small businesses was something we considered when I was on the Small Business Council. Funds were usually very easily available if the borrower had equity elsewhere. But for small businesses that didn’t have access to a mortgage or equity, accessing debt finance was more difficult. And access to finance is something that small businesses will need as they, as always, lead the post Covid-19 recovery. So, it’s good to know that at this stage, the government is keeping that scheme going.

Aussie tax changes

Across the ditch, the Australians had their Budget this week and there were some interesting points came out of it.

The latest estimate is that the underlying cash deficit is forecast to be A$214 billion dollars (11% of GDP) for the year to June 2021, which is some A$220 billion dollars worse than the last pre Covid-19 forecast in 2019. The Australians, like all governments around the world, have thrown a lot of money at the matter. The increase in spending is four times bigger relative to Australia’s national income than it was during the global financial crisis. Spending is expected to rise by 9.5 percentage points of income in the two years to June 2021.

Net debt is forecast to reach A$900 billion (42.8% of GDP) by June 2023. Which is some $540 billion more than the pre Covid-19 forecast. But here’s the interesting thing, and this is something that Gareth Vaughan picked up this week. The forecast payments forecast for the June 2023 year on that A$900 billion dollars are A$17.3 billion dollars, whereas it paid A$19 billion interest in the June 2019 year on, much, much lower figure debt figures, only $300 billion or so. In other words, as Gareth pointed out, the cost of borrowing has dropped so much that it is now relatively insignificant.

Now, there’s a lot of interesting tax measures in the Australian budget. They’ve brought forward some tax cuts backdated from 1st July with a one-off benefit provided to low- and middle-income earners of A$1,080. They are allowing businesses with turnover of up to A$5 billion dollars to deduct the full amount of any eligible capital assets acquired since the date of the budget on 6th October which is in use or installed prior to 30th June 2022. Now is a massive investment boost which dwarfs anything I’ve ever seen before. But we’re in unprecedented times.

There’s a loss carry back regime and that again targets companies with turn over up to A$5 billion dollars. They can elect to carry back tax losses from the 2019-20, 2020-21 or 2021-22 tax years to offset previously taxed profits in the 2018-19 or later tax years. We have a similar scheme here, as you might be aware, and understand there is work going on in the background now for a permanent iteration of that loss carry back scheme.

The Australian tax regime has a number of concessions for small businesses subject to their annual turnover. And what they’ve done is increase access to those concessions by increasing the annual turnover threshold from A$10 million to A$50 million dollars.

Both National and ACT look to follow the Australian model of proposing income tax cuts to help individuals and both parties propose a temporary increase in the depreciation threshold to AUD$150,000.

Why GST cuts don’t work

ACT has also proposed a 12-month temporary cut in the GST rate from 15% to 10%. Now, cutting GST rates is something that has been tried around the world. Interestingly, the Tax Working Group, when it was putting its proposals forward last year for the capital gains tax reforms, was against GST reductions.

“This is because lowering the GST rate would not be as effective at targeting low- and middle-income families as either:

  1. welfare transfers (for low-income households), or
  1. personal income tax changes (for low- and middle-income earners).”

And that’s the main criticism of what’s proposed by National and ACT – that the proposals don’t put money in the pocket of lower income earners who historically do spend it. That’s where I sit on this matter. I think the tax cuts as proposed are at the wrong end of the scale and should be targeting much lower income earners because they are the ones that need the money most and would spend it.

But interestingly, the rate cut in the GST has been tried overseas before. Britain tried this in December 2008 when it temporarily reduced its rate of Value Added Tax (VAT) or GST from 17.5% to 15% for 13 months. And it turned out that this had some initial effect, according to research.But at least part of the pass-through effect of a cut was reversed after only a few months.

The main issue with GST cuts is whether, in fact, the full effect of the rate cut would flow through to customers. Between 2009 and 2012, France, Finland and Sweden each reduced their VAT rate on dining in at restaurants. But in all cases, significantly less than half the tax cut was passed through to customers.

Germany is the latest to give a GST cut a go. It introduced a temporary six months rate reduction on 1st July. Now, that’s expected to cost €20 billion, but the actual boost to German GDP is estimated to be just €6.5 billion, or basically a third of the tax shortfall.

So all the research seems to point out that although in theory a GST rate cut could work to boost spending, particularly in New Zealand, where we have one of the broadest GST systems in the world, the evidence is it may only provide a temporary uptick, but that the main beneficiaries are retailers who don’t pass on all the cut.

And again, that comes back to the point I made just now, and that is if we are wanting to boost spending, then giving money to people to spend seems to be the best approach. Not indirectly through tax cuts but targeting low- and middle-income earners.

Well, that’s it for this week. I’m Terry Baucher. And you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients. Ka kite āno.