29 Mar, 2021 | The Week in Tax
- A closer look at the Government’s shock property tax announcements
- Four questions on the future of tax
Transcript
It would be fair to say that the shockwaves from Tuesday’s announcements are still reverberating around investors and analysts and tax professionals.
The increase in the bright-line test period to 10 years was widely anticipated. But the move to completely eliminate, over time, interest deductions for residential property investors was a complete shock and has caused quite a considerable amount of commentary.
I would say at this point, I think several people have been extremely ill guided in some of the comments they have made online. Inland Revenue monitors social media, and some of the comments I’ve seen by property investors, understandably, given the shock and the implications for them, upset about what has happened and probably reacting somewhat intemperately, may come back to haunt them.
For example, saying that rent doesn’t cover the cost of a mortgage and other costs, as one investor said in print, is an open invitation to Inland Revenue to raise questions as to why if that was the case, that person had purchased property. It opens the door for Inland Revenue to then go on and say, “Well, you must have acquired that with a purpose or intent of sale.” Which if that is argued bypasses the bright-line test. It doesn’t matter how long you’ve held it in those in those circumstances, any gain will be taxable.
Now, that’s an extreme response Inland Revenue could take. But as I said, I think some people might, to borrow a phrase, that my mother would use “Cool their heels a wee bit” and sit back and reflect on the implications of what’s going on, rather than rushing to social media and excitedly make a comment that they may regret at a later date.
But still, there are good reasons for people to respond passionately given its surprise. Under the Generic Tax Policy Process, changes like this are usually signaled in advance. The Government issues consultation papers, and there’s a back and forth between industry specialists and Inland Revenue and Treasury on the implications of these proposals. That isn’t going to happen here.
In the course of the group call made to tax agents and tax advisors before the announcement, Inland Revenue made it clear that there would be no consultation about the bright-line test period and on restricting interest deduction issue. Inland Revenue would, however, consult around a key point that is emerging. What is the definition of “new builds”?
So these proposals are all outside the normal process and have understandably drawn criticism along the lines of “Can the Government do that?” They can. And in many ways, it’s surprising this doesn’t happen more often in tax policy.
Governments around the world will move very quickly when it suits them or when they feel that they need to close off loopholes. Coming from Britain, Budgets were always full of surprises and policy announcements. Sometimes there might be some leaks ahead of the announcement, but generally speaking, every Budget always contained a few surprises.
Now, the other thing attracting criticism is how the Government has rather deliberately phrased the move against interest deductions as closing a loophole. As a few people have pointed out, this is not correct. The position is that interest borrowed to derive gross income, such as rental income is deductible.
But what has become apparent in the residential property investment market is that there’s two parts of the economic return. There is the rental and then there’s the capital gain.
And the issue was that many leveraged investors who are most affected was that they were getting a full interest deduction but would only be taxed on part of the economic return. That is the rental income. All things being equal the capital gain would not be taxed unless the bright-line test applied. Restricting interest deductions in that context is actually consistent with the general income tax rule that an expense is only deductible to the extent it’s incurred in deriving gross income.
The current treatment is therefore an anomaly. What the Government has done is closed off an anomalous position, but only in respect of a certain group of investors, which again leads to outrage about the treatment. But that group is probably losing that argument about it not being a loophole, because to borrow a political phrase, “Explaining is losing” particularly if as in this instance a very technical argument applies.
Always at risk
But the overall point should be kept in mind, and this has happened before with the removal of the loss attributing qualifying company regime, tax preferred investments or rules that give a tax advantage will always be scrutinised by government. They are always therefore at risk of being abruptly closed off.
So, if you built an economic business model around relying on that, you are actually making yourself very vulnerable to a move like this.
Work in progress?
Moving on, one other point has emerged, which is surprising, and in the context of the General Tax Policy Process, concerning, is that it appears no details of the advice that was given by Treasury and Inland Revenue on the interest deduction move has been made publicly available.
This is surprising because it implies that this policy is still being worked out. As a result of that the fiscal impact is not clear.
If the interest deductions are restricted completely, that means the Government’s tax take will increase. And me and my fellow tax advisors have been crunching the numbers for our clients who will be affected. And we are giving them projections as to the likely additional amount of tax that would be payable. And that potentially could be quite significant, although it could be that property investors deleverage as a result, which may have a wider economic impact.
This whole policy, in fact, is a good example of something that came up at a seminar last night, which I will talk about a little later, the law of unintended consequences. This is something that hasn’t been done before and the consequences are still being worked out. One or two things I think that come to mind is we might see investors make more use of company structures because the corporate income tax rate at 28% is less than the 33% for property held in trust or possible 39% if properties are held individually.
I also wonder whether the Government should be looking carefully at the question of is the loss ring-fencing rule required any longer? One of the reasons that rule was introduced was the ability of people to leverage and get deductions for interest. But then, since interest deductions often represented the biggest single cost at a time when interest rates were higher, if they ran into losses, investors were then able to offset those losses against their other income.
Now, that loophole was closed off with effect from 1st April 2019. But the question remains now, given that the ability to leverage, which was the main issue around the need for loss ring-fencing, has been restricted, do we need the loss ring-fencing rules?
The other thing is, and this is something I think the Government will need to address as it was a stumbling block for the introduction of a capital gains tax, is that any gains will be taxed at a person’s marginal rate. In a company the rate is 28%, but for an individual from 1st April, it could be 39%. So, there’s a lot of unintended consequences and it’s understandable to see why investors feel rather picked on at the moment.
There’s interesting commentary from the Bank of New Zealand which started
its newsletter on this issue by saying that “The New Zealand government is dead set on containing soaring house prices. It has been saying so for some time now and prices have just kept soaring. So it should come as no surprise that their patience has now been exhausted and a full attack on prices is now under way.”
BNZ’s view is “Watch this space.” There will be a lot of arguments around the fall-out of this proposal.
The interest rate restriction rules, as an article in the Herald points out, are actually more restrictive than a similar measure introduced in the UK. What the British did was restrict the rate of the tax relief to the basic rate of tax, roughly 20%. These measures go completely further.
I feel that using something completely unknown whilst a shock to the system, and in line with what BNZ is saying the Government is determined to try and do, is leading the Government into untested waters.
And the alternative might have been to use an existing set of rules, the thin capitalisation rules, which might have achieved much the same sort of objective. But there will be a lot of fallout on this, and it’ll be interesting to see whether there is some tinkering around the edges of these measures.
The bright-line test
On the bright-line test itself, it’s been extended from two to 10 years. And there’s going to be a lot of questions on this about the impact of that, but particularly for people who are in the middle of settling on properties.
Extending the bright-line test period to 10 years has now been passed into law as part of a tax bill. But it has also provided some commentary with useful examples of what happens with sale and purchases underway at the time the proposals were announced.
Basically, if an offer was made before the announcement on 23rd March and accepted before 27th March, then the five-year test would apply. But if, an offer was made on 21st March, but the seller accepted the offer and signed the sale and purchase agreement on 27th March, then the extended 10-year period would apply.
Another of the examples given was of a verbal acceptance before 27th March but the agreement is not actually signed until 27th March. Then the 10-year rule will apply.
So people will have been pressured to making quick adjustments right now to finalise their sale and purchase agreements. Not ideal, and there will be a few people who have been caught on the wrong side of the new 10-year period as a result.
In relation to conditional offers, for example, someone submitted an offer on 18th March, which is accepted, and the agreement was signed prior to 27th March, conditional on finance. If the offer goes unconditional after 27th March, in this case, the 5-year rule would apply. Alternatively, there’s a change in the agreed purchase price which happens after 27th March, the 5-year rule would be applicable.
There’ll be plenty more commentary on this going forward. And it will be interesting to see the commentary in relation to the question of what expenditure becomes deductible as a result of a sale becoming taxable. We don’t know yet if interest expenditure, which has been disallowed, will then become deductible if a property is sold and it’s taxable under the bright-line test or any other measure. The implication is it should be. But we are we’re going to have to wait till May when consultation on this will arrive.
The future of tax
Moving on to an interesting bit of fun I had last night with some colleagues. The New Zealand Centre for Law and Business ran an event where myself, Paul Dunne of EY and Geof Nightingale of PWC where part of a panel.
We were asked four questions around the future of tax. Do we need more tax? Can tax help the runaway residential property market? Will changing demographics result in a changing tax mix? And reducing taxes on the wealthy is this a discredited theory? And if so, what are the implications for that?
This whole thing would be a worthwhile podcast in itself, but it was interesting to see how Paul, who was a member of the 2010 Victoria University Tax Working Group, and Geof, who was a member of that same 2010 tax working group and the recent Sir Michael Cullen-chaired group were mostly in agreement with the need for a comprehensive capital gains tax or rather better designed set of rules around that.
I think the discussion is still there as to whether we need a comprehensive capital gains tax or should it be limited to a particularly troublesome asset class at the moment, property. All of the members of the 2018 Tax Working Group agreed with increasing capital taxes on property. And you’ll note, by the way, some of the discussions that come out about the Government’s bright-line test period, with Treasury suggesting a 20-year period with no exemption for “new builds”.
By the way, as I said we don’t yet know what the definition of “new builds” will be. We’re going to have to wait and see. And on that point, Paul and Geof both made very pertinent points that the law of unintended consequences is very applicable here. They have clients who are involved in property syndicates who were in the process of converting commercial property into residential property. The question now is, are these “new builds”? They don’t know. So, there may be a pause while everyone waits to find out. What does that mean? No-one is going to commit millions of dollars to a project with an unknown tax outcome. So that was one theme of our discussions.
Do we need more tax? The view was that at roughly 30% of GDP, we should be OK. All three of us were in agreement that the ratio of government debt to GDP was not an issue, but we were all not so enamoured of high private debt as we see that as more concerning. So we had an interesting discussion and hopefully I can make the video recording available in due course.
Error correction
And finally, last week, I talked about charging interest at the prescribed rate of interest on overdrawn current accounts. I mentioned that from 1st April 2021 that rate was going to increase from 4.5% to 5.77%.
Well, another of my listeners from Inland Revenue has been in touch and thanked me for drawing their attention to this. It turns out that was a transcription error in their website and that 5.77% rate is incorrect. It will in fact remain at 4.5% going forward. So, thank you Rowan, for getting in touch. And thank you again to all my listeners and readers at Inland Revenue.
Well, that’s it for today, 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. Until next week Ka kite āno!
24 Mar, 2021 | The Week in Tax
- First look at extension of brightline test to 10 years and restriction of interest deductions for residential property investors
Transcript
The Government on Tuesday released details of its housing package and related tax proposals. The key changes here are that the brightline test will be extended to 10 years for properties acquired on or after this coming Saturday March 27.
The brightline test will remain at five years however for new builds. In addition, there will be changes to the main home exemption for the bright-line test and also restrictions on interest deductions for rental investment properties.
Speculation beforehand had focused on the extension of the bright-line test to 10 years. And that has been confirmed. So properties acquired on or after March 27 sold within 10 years will now be taxable.
Other tax advisors and myself were briefed beforehand by Inland Revenue and I asked a question about what additional revenue would be expected to come from the brightline test. The estimate is it will be about an extra $650 million per annum. Incidentally that’s more than the increase in the top income tax rate to 39% is expected to raise.
Separately the brightline test period will remain at five years for new builds acquired on or after 27 March. The idea here is to encourage some investment in new property.
There is another change in the brightline test rules which is potentially quite significant and that’s around the treatment of the main home exemption. Currently if 50% or more of the time a property is held, it is occupied as a main home, then it is completely exempt from taxation. If it’s 49% tough! It’s going to be fully taxable. So, it was a little bit harsh, that arbitrary treatment.
The proposal is to change that for property acquired on or after 27 March – you’ll be taxed on the period it was not occupied as your main residence. So, for example, if it was your main home for 80% of the time then only 20% of the gain will be taxed, whereas currently for properties acquired prior to 27 March the rule will be that in that case it will be fully exempt.
So on one hand it means that some gains which would have been exempt would now become taxable, on the other hand some gains, say that 49% example, which were fully taxable, now become partly taxable. So, the Lord giveth and the Lord taketh on that one.
However, the big change which has been announced that’s generating quite a bit of commentary on social media is the proposal to restrict, in fact remove entirely over time, interest deductions on residential property income. And this kicks in from October 1.
For residential investment property acquired on or after 27 March no exemption will be allowed from 1 October. However, for properties acquired before 27 March interest deductions are still claimable but will be reduced over the next four income years until it’s completely phased out by 1 April.
Starting 1 October this year, only 75% of the interest will be deductible. For the full year ending 31 March 2023, 75 % will be deductible. For the year ended 31 March 2024 it will fall to 50%, and for the year ended 31 March 2025 it falls to 25%. And then from 1 April 2025 onwards no interest deduction will be allowed.
Inland Revenue will be consulting on what happens to interest deductions in the event that the brightline test applies. In other words, if a property is sold during a period and the brightline test applies then some interest deduction could be allowed. We’ll wait to see what the proposals are around that.
Now this is obviously a significant change. I made a suggestion last year that maybe it was time to apply the thin capitalisation rules, but this has gone further than I expected. But it also reflects a measure that happens in the UK.
It will be interesting to see how this plays out. The obvious concern would be that landlords will increase rents. But on the other hand, if you are going to do a measure like this although there is never a perfect time for investors, interest rates having fallen so much means that the impact this time is probably significantly less for investors than it would have been say two/three years ago when interest rates were not 3% but 6% or even higher.
So there’s swings and roundabouts there, no doubt though the Government will be watching with some concern to see what happens about residential rental increases. And there is a measure, actually separate, which proposes to limit the number of increases in rent and it now does it per property rather than per tenant. The proposal is a landlord can only increase the rent once every 12 months per property rather than the current once per 12-month tenancy.
So, there’s a fair bit of detail and commentary going to happen around these proposals. The extension of the brightline test to 10 years was expected. It’s now getting to the point that because our land rules, as I’ve said, beforehand are very complicated, maybe it’s time for a comprehensive review. Maybe even saying that all land sales within 10 years are taxable apart from main homes, and also farms and businesses.
Possibly also in that time it might be worth thinking about whether it is appropriate that the gain gets fully taxed. But for now, those are the rules in place.
The fiscal impact of the interest rate deductions will be quite interesting because that may mean the Government has a little bit of a tax windfall, obviously because it’s now getting more income tax because there’s fewer deductions. We’ll have to wait and see.
Anyway, that’s it for now, I’ll probably have more commentary on the fallout from these proposals in our next podcast. Until then, 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. Until Friday Ka kite ano!
22 Mar, 2021 | The Week in Tax
- Inland Revenue fires a warning shot at real estate agents over claiming excessive deductions
- The International Monetary Fund wades into the housing debate
- Year end issues around overdrawn shareholder current accounts
Transcript
Last week Inland Revenue issued a press release warning real estate agents that this was an area that its analysis “suggests real estate salespeople/agents commonly claim a high level of expenses relative to their income. Inland Revenue believes the issue is widespread and we must act. People are claiming private expenditure, but not keeping logbooks or other business records to support the claim.”
The release goes on to warn that if someone has over-claimed expenses in Inland Revenue’s view, “they will receive a letter from us requesting they prove the expenses claimed.”
Now, this is a little bit unusual from Inland Revenue because we haven’t heard anything in the grapevine that this was something they were looking at. But it is not entirely surprising because one thing that emerged from hearing the Commissioner of Inland Revenue speak at the excellent Accountants and Tax Agents Institute of New Zealand conference is that Inland Revenue has great faith in its Business Transformation systems. These give it the ability to analyse data and identify areas where it believes income is either being under declared or in this case, taxpayers are, shall we say, being overly generous in their calculation of the deduction available.
Although, as I mentioned, we haven’t previously had an indication Inland Revenue viewed this as an issue, it’s apparent from what they’ve said here, that they’ve done enough preliminary work to identify that expenses being claimed by real estate agents seem high relative to income.
In one way I think this is a positive development in that Inland Revenue by warning people what it can do, can clear out some of the chaff.
On the other hand, there’s a lack of specific detail in this press release which concerns me. It’s “We think there’s an issue, but we haven’t actually specified what particularly is concerning us”. And simply to say that people claim a high level of expenses relative to their income is to assume that that expenses automatically should follow income. It could well be that there is a fair amount of baseline expenditure that people would incur in this business, running around making phone calls, driving to see clients and the like sometimes without actually a great deal of success, as the real estate sector is largely commission only based.
And so one of the things that taxpayers perhaps should consider is the implications of Inland Revenue’s capability to do a great deal of analysis. One thing Inland Revenue could do is to start saying, “Well, here is a standard deduction. You can claim X amount which to we’re going to accept as deductible without the need to keep very detailed records because our indication is that is likely to be the level of expenditure you would incur in your business.”
Now, Inland Revenue will come straight back and say they don’t want to do that because people will abuse that. But on the other hand, you’ve got to wonder the benefit of the current approach when you consider the time and energy put in by people preparing their tax returns and also the effort Inland Revenue then spends investigating what may well turn out to be an entirely legitimate expenditure. Maybe just simplifying matters all around would be more efficient.
It could be yes, there could be some seepage around the edges under a different approach and Inland Revenue doesn’t get as much as it could do if the rules were applied correctly. But applying a so-called standard deductions approach deals with an issue in the tax system, in that compliance is particularly onerous for smaller businesses. The rules are written around the expectation that people have a good understanding of the law and have the systems to manage their accounting and recording income and expenditure. And with the advent of online accounting systems such as Xero and MYOB that’s largely true.
But not everyone wants or needs to spend money on accountants. And I have felt for some time that adopting a different approach to what we call micro businesses, that are businesses with a turnover of say, less than $100,000, dollars would actually benefit everyone. Make it easier to comply and encourage more people to comply.
Anyway, we’ll watch with interest to see how this plays out with Inland Revenue. As I said, I’d like to see some more specific examples of the abuse that they are clearly warning against. But until some cases hit the courts or Inland Revenue releases some more information on the matter, we’ll just have to wait and see. In the meantime, it’s a good warning for anyone involved in business that you have to keep accurate records of your business expenditure.
The IMF wants tax action on overheated housing market
Moving on, the IMF, the International Monetary Fund, has waded into the debate over housing by recommending the Government should introduce a stamp duty or a more comprehensive capital gains tax to help deal with the overheated property market.
This is part of a routine check on the New Zealand economy, what’s called the Article IV discussions. These happen periodically when IMF staff come down here, talk to Treasury and other officials and draw their own conclusions on the state of the New Zealand economy and areas for improvement.
The Government will not welcome the call for a capital gains tax or stamp duties. We haven’t had stamp duties in nearly 30 years now, but they are used a tool used elsewhere. They’ve fallen out of fashion here because they are regarded as economically inefficient taxes, and there are concerns that they increase costs for purchasers. So as a means of helping first home buyers, a stamp duty isn’t necessarily going to be a great approach according to theory.
But for those who’ve read Tax and Fairness, the book I co-wrote with Deborah Russell MP, you’ll know that in chapter four, we talked extensively about how the IMF is not the first organisation to have raised the need for a capital gains tax to deal with housing inflation. The OECD raised the idea way, way back at the start of the century in November 2000 and then again in 2011, and the IMF also made similar suggestions back in February 2016.
I was going to say it’s really quite remarkable how this issue keeps popping up, but actually it’s not because the issues around tax were identified decades ago but have not been addressed. And meantime, the pressure on the Government builds now that the housing market has accelerated again. And this week (Tuesday) the Government will announce some proposed disincentives for property investors to try and reduce demand in the sector together with some form of targeted incentives to encourage savings in other sectors.
Just a little note on this, way back in 2000 the OECD concluded there was substantial overinvesting in housing, maybe one and a half times greater than that of major OECD countries. Now, I imagine that number has actually become considerably worse. So, as I’ve said before, the capital gains tax debate is not going to go away.
And on that debate, this coming Thursday, March 25th, I’ll be on a panel alongside Geof Nightingale of PWC and the Tax Working Group and Paul Dunn of EY together with Craig Elliffe and Julie Cassidy from Auckland University. Our topic is “Taxation: the ticking time bomb of our generation. Four tax questions for 2021”. This is an event run by the New Zealand Centre for Law Business I have no doubt whatsoever we will be talking about the issue of capital taxation.
End of year prep
And finally, more on one specific issue which will require action before 31st of March, and that is the question of overdrawn shareholder current accounts.
Now, this happens when a director or a shareholder of a company takes out more in cash from the company during the year. This is traditionally treated as drawings. So, prior to year-end, we take a look to see what we can do. And most times we deal with this issue by either paying a dividend before year-end (a particularly important thing to do this year before tax rates increase on 1st April) or voting a shareholder employee’s salary.
But in some cases, that is not enough. And in those situations, a company is required to charge interest using the FBT prescribed rate of interest. Now this rate is regularly adjusted and generally reflects what’s going on elsewhere in the market. Until 30th June 2020, the rate was 5.26%. It was then reduced to 4.5%, the lowest rate I can recall. This is the rate that should apply from 1st July 2020 right through until 31st March 2021.
But from 1st April the rate increases to 5.77%, something that has slipped under the radar and possibly reflects Inland Revenue unease about the use of current accounts to get around higher tax rates. On the face of it a rate increase in this low interest economy seems anomalous.
But as I said, I think it reflects Inland Revenue concern about the use of an overdrawn current account to get around income being taxed at either 33%, or from 1st of April, 39%. In some other jurisdictions the amount of an overdrawn current account is treated as a dividend. Our rules treat only require charging of interest. So if you’ve got an overdrawn current account of $100,000 in Australia, that’s going to be taxed as income of $100,000. Here we apply the FBT prescribed rate of interest of 4.5% so the taxable income is just $4,500.
So you can see there is some form of incentive to make use of overdrawn current accounts. In fact Inland Revenue has started paying a lot more attention to this issue and this small but quite subtle and unnoticed rate increase in the prescribed rate of interest is probably a clue it is planning to take greater action on the matter.
Well, that’s it for today, 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. Until next week Ka kite ano!
15 Mar, 2021 | The Week in Tax
- Business loss continuity test and tax loss carry back
- A review of working for families is underway and how abatement levels impact beneficiaries
- Pre 31st March tax planning tips
Transcript
Last week, I discussed the Government’s new proposed business continuity test for losses. Subsequently, a reader from Inland Revenue kindly got in touch to confirm that the new test would indeed be retrospectively applicable from the start of the current tax year, 1st April for most taxpayers.
He also pointed out that the new regime will allow losses from the 2013-2014 year to be carried forward. So that means the losses that were occurred in those years, they can continued to be used if there’s a change of shareholding, resulting in a breach of continuity and you wish to use the business continuity test to preserve those losses. So, thank you very much for that, Barry.
But in the spirit of the Lord giveth and the Lord taketh, we’ve also heard that the Government has decided not to proceed with a permanent iteration of the temporary loss carry back scheme introduced last year as part of its initial response to Covid-19. That’s disappointing news as it would have been a useful addition to the loss regime.
These regimes exist in other jurisdictions. And ironically, the British Budget, which I also discussed last week, included a measure relating to its carryback regime, temporarily extending the loss carryback period from one to three years.
Now, the official reason for the decision to not proceed with the permanent iteration of the scheme is the potential fiscal cost. That’s perhaps understandable, but it would be good to see the decision revisited sometime in the future, because I think this is an important measure to have as part of the loss regime.
A poverty benefit trap
Moving on, it emerged this week that the Government is undertaking a review of the Working for Families regime. This is a quite significant undertaking because Working for Families pays out approximately $3 billion a year. And this came out as part of a decision to increase main benefit abatement thresholds from 1st April.
Now, something which is not generally well known and appreciated is the real problem with the interaction between tax and the social welfare system and the impact of abatement thresholds. Basically, and understandably, as a person’s income increases, then the need for social assistance is reduced. And what we have is an abatement threshold above which benefits are abated.
These formulas vary quite significantly and can be actually quite savage. The decision that the Cabinet made related to the Minimum Family Tax Credit. Now, the abatement here is once you cross the threshold, you lose a dollar of credit for every dollar above the threshold. This means that the effective marginal tax rate for people who cross the threshold is effectively greater than 100%. (The dollar of income is taxed AND a dollar of benefit is lost).
And this is an area that’s always problematic because Governments must choose the threshold at which it kicks in and what abatement rate applies. The Working for Families abatement rate is currently 25% for family income above $42,700. And one of the other problems that this paper indicated is that the amount beneficiaries can earn before their benefit reduces has declined substantially over time because benefit abatement thresholds have not been increased in line with wage growth.
And so a poverty benefit trap has emerged because the financial incentives to enter the labour market and work part time are substantially reduced. To give you an idea how bad that has become, a person currently receiving the Jobseeker Support for being unemployed could work about 11.8 hours on minimum wage in 1997 before their benefit was abated. By 2019, that had reduced to around 4.5 hours on the minimum wage.
These problems exist across all of the social welfare network and one of the Welfare Expert Advisory Group’s recommendations was it needed serious overhaul. There’s always been talk about perhaps integrating a tax and welfare systems with a universal basic income seen as a solution to this particular issue. So anyway, there’s going to be a lot of work going on in that space and it will be very interesting to see what comes out of it.
Ideas to prepare for March 31
And finally, this week, the tax year end is fast approaching. So here’s a few ideas which may require action before 31st of March.
A big one, obviously, for businesses is to write off any bad debts before 31st of March. Take a good look at your debtor ledger and be realistic. And if those debts are written off before the 31st of March, you can claim a deduction for those bad debts.
Similarly, look to see what stock is obsolete, write it down to market value. Fixed assets which are no longer in use should be scrapped or otherwise disposed of to ensure you can have any available deductions. At the same time, you might want to accelerate certain types of expenditure, such as repairs and maintenance.
And one thing important to take note of is that the temporary increase in the low value assets to $5,000 ends tomorrow (Tuesday, 16th March). From Wednesday, 17th March, it will be $1,000. So now is the time to take a quick look at your fixed assets and think, do I need a new laptop, new computers, any any matters like that? And if so, try and take advantage of this $5,000 concession now.
There’s a lot of matters to think through at year-end, and I’ll come back to a few of these next week as well. One important one, which is tied into the increase to the 39% tax rate, which will take effect from 1st of April, is to look at imputation credit account balances. Make sure that all imputation credits are correctly recorded and perhaps consider paying a year-end dividend before March 31st particularly if you are likely to be affected by that 39% threshold change.
If you’re considering entering or leaving the look-through company regime, you need to have made the election before the start of the new tax year. So again, review your position there and make sure the relevant election is filed by March 31st.
By the way, I wouldn’t say Inland Revenue is a huge fan of the look through company regime, but it seems to want to direct individuals into that regime. There’s been one or two things I’ve seen going on, which has made me wonder that there may be a change of policy towards the use of look-through companies coming.
A very important thing to consider is to review whether the shareholders in a company have overdrawn current accounts. If so, look to take steps to either bring the current accounts into credit or charge interest on those overdrawn current accounts. And similarly, if companies have made loan advances to other related companies, then consider charging interest on those loans.
And finally, the last GST return for the tax year is also called the adjustment period for GST, such as change of use adjustments. And that’s when you need to calculate the impact of the change of use for GST purposes and account for this to Inland Revenue. So, for example, this would affect people that may have changed their Airbnb properties, to long term residential accommodation because there’s no tourists now.
They may have claimed an input tax credit and now they have to do a change of use adjustment and that obviously can cause some cashflow issues. So this is the period you need to think carefully about whether you want to do that and then look to make sure the calculation is filed in time. This is an area where I’m seeing quite a bit more work coming through as it is not well known and trips up a lot of people.
Well that’s it for today, 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. Until next week Ka kite āno and go Team New Zealand!
8 Mar, 2021 | The Week in Tax
- Government announces a new business loss continuity rule
- US drops ‘safe harbour’ demand as progress made on new international tax framework
- UK Budget has inheritance tax and capital gains tax implications for Kiwis and includes surprise Corporation Tax increase
Transcript
At last week’s International Fiscal Association conference, Revenue Minister David Parker announced that the Government would be proceeding with a new business continuity test to enable tax losses to be carried forward. The general rule is that for tax losses to be carried forward, at least 49% of the shareholding in the company must remain the same between the date the losses arise and when the losses are to be used.
Now, this is regarded as one of the most stringent loss continuity tests in the world, and it has been seen as an impediment for businesses trying to obtain capital in order to innovate and grow their growth.
Companies in their early stages may rack up a lot of losses, but if they want to attract capital and investors shareholding changes may mean a loss of accumulated tax losses. So there’s been pressure for some time to think about easing these restrictions and adding a what we call business continuity test.
The Government announced as part of its initial Covid-19 response last year that they wanted to have a new regime in place. And work has been going on in the background since April last year. They’re now saying that the legislation will be introduced later this month in a supplementary order paper for the tax bill currently going before Parliament, the Taxation (Annual Rates for 2020-21, Feasibility Expenditure, and Remedial Matters) Bill.
The idea is a similar business test will now be able to apply, and even if the 49% threshold might have been breached, the company may continue to carry its losses forward after a change in ownership as long as the underlying business continues. Now, similar tests apply in Britain and in Australia, and the Australian test has been used for the purposes of designing our legislation.
The principle is that losses will be carried forward unless there’s a major change in the nature of the company’s business activities.
In determining this, you’d look at the assets used and other relevant factors, such as business processes, users, suppliers, market supply to and the type of product or services supplied.
There is an expectation that the test will run for the time from the ownership change, which brought about a 49% breach of shareholding continuity, as we call it, until the earliest of the end of the income year in which tax losses are utilised or at the end of the income year, five years after the ownership change. This is subject to one or two exceptions as well as a specific anti avoidance measure to prevent possible manipulation of the rule.
The rule would appear to be retrospectively applicable from the start of the current tax year or 1st April, 2020 for most businesses. But that’s not absolutely specifically spelt out, but is implied by the commentary we’ve received. We’ll know for sure when we see the final legislation in the next week or so.
This is a very positive measure. It’s been one that businesses have been asking for for some time, particularly those in their high growth tech sector, where they rack up a lot of losses during development before switching to substantial profitability. But they’ve been unable to attract or had difficulty attracting investors because of the existing loss continuity rules.
The fiscal cost is actually quite modest. It’s estimated to be about $60 million per annum, which still does beg the question that perhaps this could have been addressed much sooner. It’s certainly been on the wish list for a lot of investors for some time and was a matter we raised on the Small Business Council. It’s a good development and I imagine that it will be taken up with some enthusiasm.
The US changes its tune
Moving on, I’ve recently discussed the issues around the taxation of digital companies, particularly in relation to Facebook’s stoush with the Australian government. The OECD, as I mentioned in previous podcasts, has been working through what it called a new global framework and two options to this Pillar One and Pillar Two.
This week, there was a major development with the US Treasury Secretary, Janet Yellen, (the equivalent of the finance minister), telling G20 officials that Washington was going to drop the Trump administration’s proposal to allow some companies to opt out of the new global digital tax rules. And this was clearly seen as an impediment to getting these rules through. But the fact that these have now been dropped and that the US is no longer advocating for a safe harbour in relation to Pillar One is very important.
The OECD has been working through matters in relation to the development of the new global framework. This week it announced it now believes it’s got the 10 components of Pillar One put together on which it can now start to build a consensus. Drafts of these Pillar One proposals are expected to be released in the next few months. The hope is still to have this all wrapped up sometime this year.
So that’s a very positive development. As I said, in relation to the Facebook and Australia stoush, some form of taxation probably would have been a better approach to the matter than what has been proposed by the Australian government.
UK Budget implications
And finally, on Wednesday night, our time, the UK Budget for 2021 was released. Now, this is of more importance to Kiwis than people might realise because of the global reach of UK capital gains tax and inheritance tax in particular.
To recap, anyone who owns property, commercial or residential in the UK is subject to capital gains tax on a disposal of that property. So this would affect the some 300,000 Britons or people of British descent like myself who live here in New Zealand. But it also affects Kiwis who come back from their OE but have retained a property for whatever reason in the UK.
The other significant UK tax issue, which I’m seeing a lot more of, is Inheritance Tax. And this applies globally to anyone who has a UK domicile (which is a different concept from tax residency) or assets situated in the UK. Inheritance Tax applies at a rate of 40% on the value of an estate greater than £325,000 (what we call the Nil Rate Band).
But the UK budget has frozen the Inheritance Tax nil rate band at £325,000 right through until 2026. The annual capital gains allowance is also going to be frozen for a further five year period.
One of the things that is perhaps not really appreciated is anyone who is deemed to have a UK domicile are taxed for Inheritance Tax purposes on their global assets. And with the fall in the value of sterling to below two dollars to the pound, combined with the incredible rise in the value of New Zealand property, what I’m seeing is that people now have potentially significant Inheritance Tax issues. Property prices in the UK have not accelerated anywhere near to the fashion that has happened here. To give you an example, I came across this week a client with a London property valued in April 2015 at £775 ,000. Its current value is just £765,000 pounds. In other words, over six years it’s gone backwards. Compare that with what’s going on in the New Zealand market.
So there’s an increasing number of New Zealanders and Britons who have potentially Inheritance Tax liabilities. And they also will face capital gains tax if they decide to dispose of those properties. One of the things that’s also increasingly coming into play will be the information sharing under the Common Reporting Standards and The Automatic Exchange of Information. This means the UK HM Revenue & Customs and Inland Revenue here will have a greater understanding of who owns property in which jurisdiction.
So, as I said, this British budget may seem far away, but it’s actually incredibly important to a significantly greater number of people than you might imagine.
There’s also one other thing that’s come into play, which has been a surprise to the tax community and that is the British Government have signalled an increase in the corporation tax rate from its current rate of 19% to 25% for businesses with net profit in excess of £250,000 from 1st of April 2023. That’s a very significant increase. The other thing that the British have also kept in place is what they call a diverted profits tax, of which remains at 6%. This is an anti-avoidance measure aimed at multinationals.
Incidentally if Grant Robertson and Treasury are looking for ideas the UK also has a bank corporation tax surcharge of 8%. This is something which if introduced here would probably be quite popular.
The proposed increase in corporation tax rates is a surprise. But I think this is something that’s gradually become inevitable. In the wake of both the GFC and Covid-19, government budgets are so badly shot that they need to restore them with significant tax increases at some point. Whether any such increases flow through here to the extent of what’s just happened in the UK remains to be seen. But as always, we’ll keep you abreast of developments.
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. Until next week Ka kite ano!
