Tax News

A closer look at the new bright-line test rollover relief provisions

A closer look at the new bright-line test rollover relief provisions

26 Oct, 2021 | The Week in Tax

  • A closer look at the new bright-line test rollover relief provisions
  • Inland Revenue launches a new research project into high-wealth individuals
  • Feedback from last week’s podcast

Transcript

One of the positive matters coming out of the interest limitation rule changes is an extension of the rollover relief for bright-line test purposes. As is known, a change of ownership will often reset the timetable for the bright-line test purposes.

When the bright-line test was introduced in October 2015, the initial period was two years and so the resetting of the timetable wasn’t considered to be a great deal. But as of 27th of March this year, the bright-line period is 10 years, so it is now a very significant issue.

Accordingly, there has been pressure on Inland Revenue and the Government to include some rollover relief provisions, and the supplementary paper does include these. Now the proposals won’t go as far as people would like, but they’re a start. The key features are that certain transactions will now be eligible for rollover relief and that is mainly some transfers to family trusts and to/from look through companies and partnerships. There’s also going to be specific relief proposed for transfers to trusts constituted under Te Ture Whenua Māori Act 1993 and also transfers to land trusts as part of settling claims under Te Tiriti.

The key one for the family trusts is that rollover relief will apply. That is, the period of ownership will be combined, and not deemed to be a break for transfers of residential land to a family trust, provided that each transferor of the land is also a beneficiary of the trust. At least one of the transferors of the land must also be a “principal settlor” of the trust. That’s a loaded phrase in itself. And each beneficiary, except for those beneficiaries who are also principal settlors, has a family connection with a principal settlor, or is a company controlled by a family member beneficiary, or is a charity.

In relation to transfers to/from look through companies and partnerships, the rollover relief will also apply. The provisions are complicated but will apply where the persons transferring the residential land to or from a look through company or partnership, have ownership interests in the look through company or partnership in proportion to their individual interests in the land and their cost base relative to the total cost base of the land.

In addition to the above criteria, rollover relief is only going to be available if the transfer is made for an amount or consideration that is less than or equal to the total cost of the residential land to the transferor at the date of transfer.

All this is good, if complicated, but with care can be managed. But one issue that does stand out straight away is that the rollover relief does not cover transfers from trustees to beneficiaries. Therefore, the bright-line timetable will reset on such a transfer unless it is possible that another exemption relating to matrimonial relationship property agreements can be used. That also requires a great deal of care.

This is a little disappointing, and I would recommend people making submissions requesting that distributions or transfers of land to beneficiaries can also be included for bright-line test purposes. Or at least flush out from Inland Revenue the reason why it thinks this shouldn’t be the case.

If conditions are met for rollover relief, then under the new provisions, the trustees or the look through the companies would be deemed to have the acquisition cost and date mirrors the total cost of the land to the transferor and obviously at the same acquisition date as for the transferor. And similarly for transfers involving partnerships and look through companies.

Now this provision will come into force when the bill is passed, so that means the likely commencement date is going to be late March 2022. As I said, encouraging. But it would be useful at least, if the transfers from trusts could be covered by rollover relief as well.

A tax focus on HNW individuals

Moving on, Inland Revenue is in the early stages of starting a research project for high wealth individuals relating to their effective tax rates. And what they plan to do is to collect information to help Inland Revenue assess the fairness of the tax system.

This is something that the Government specifically allowed for in this year’s budget. Inland Revenue got five million this year to June 2022  as part of this project. Inland Revenue apparently selected some 400 individuals who are regarded as high wealth, and households in this particular group are expected to have or thought to have a net worth exceeding $20 million.

The project is based on household income, so the first stage is to confirm with the individuals selected who’s in the household. Then in stage two, which will be early next year, individuals will be sent a list of entities and business undertakings, such as trust in companies, Inland Revenue believes they have an interest in. They’ll be asked to confirm that interest and provide further details of any other entities Inland Revenue may not have identified That will similarly apply to partners and dependent children. And then finally, financial information relating to these entities must be provided.

The plan is to analyse this information and then provide a report in June 2023. And it’s all part of gathering data for better public policy in this area. The information provided will cover the 2016-2021 income tax years, and there will be an estimate of the effective tax rate based to relative economic gain over that period.

This is quite a big project for Inland Revenue, as I told others earlier. One of the unintended consequences of having abolished estate duty in 1992, is that we don’t actually have a lot of good data around wealth because grants of probate and wills are no longer made public.

But generally, around the world there’s growing concern around inequality, but also to the question around the brutal fact that most governments have been hit very, very hard by COVID-19 and are looking in the long term at the question of raising revenue. But that’s a long way off. In this particular case it’s more about “let’s find out what what’s out there.”

The revenue is using a specific provision, section 17 GB of the Tax Administration Act. And all this information is not to be shared with any operational part of Inland Revenue. According to an information sheet published, it will be held in a database separate from Inland Revenue’s main START system and will not form part of any of the individual’s tax records.

Inland Revenue must be absolutely secure in doing this. Otherwise, it will be buried in lawsuits over a breach of privacy. The Privacy Commissioner no doubt will be watching this one very carefully. Inland Revenue have had to get some sign off from the Privacy Commissioner on this so far.

It’ll be interesting to see what comes out of this. It is early stages, but I think you can expect to see and hear about some pushback. But for the moment, Inland Revenue believes it has the statutory tools to do this. So, it will be interesting to see how this exercise plays out.

Last week, Professor Lisa Marriott and I talked about Inland Revenue’s debt management, and in our discussions Lisa raised the question of maybe a tool to be considered would be publicising the names of debtors.

And one of our listeners, James (thank you, James) followed up with an email pointing out that in fact, Inland Revenue does already have some powers to communicate information to an approved credit reporting agency regarding a taxpayer’s reportable unpaid tax.  This is under section 18H and Clause 33 of Schedule Seven of the Tax Administration Act.

Under this clause, if the reportable unpaid tax is in excess of $150,000 and the Commissioner of Inland Revenue has notified the taxpayer of this amount, then the Commissioner may give an approved credit reporting agency information in relation to the taxpayer and any amount of reportable unpaid tax. But they must have made reasonable attempts to recover this unpaid tax from the taxpayer before formally notifying the taxpayer that this is going to happen.

So, this is a first step, and the threshold is reasonably high, which gives me some comfort. It’s actually quite interesting to look back on this clause and see not much was said about it at the time. And certainly, the commentary issued in the bill doesn’t really refer to this in great detail. So this clause went through without too much comment. I’m not aware of it having been used, but we’ll put in an Official Information Act request and find out more on that and update you at a later time. So, thank you James, for letting us know on that. As always, we welcome feedback, good and bad from listeners and readers.

Well, that’s it for today. Next week, I’ll be reviewing Inland Revenue’s just published 2021 annual report together with the latest developments, as always.

Until then, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax cor wherever you get your podcasts.  Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!

A ground-breaking deal on international tax

A ground-breaking deal on international tax

18 Oct, 2021 | The Week in Tax

  • A ground-breaking deal on international tax
  • A look at Inland Revenue debt collection procedures. How effective and fair are they?

Transcript.

Late last week, the OECD and G20, leading the project on addressing the tax challenges arising from digitalisation of the economy, announced that it reached agreement on a new framework for international tax. 136 of 140 countries had agreed to the proposals, which have been underway and worked on for some time now with the intention of addressing the impact of digitalisation and modern economy and basically bringing the international tax structure up to date.

The planned proposal is to have what they call a two-pillar solution comprising of Pillar One and Pillar Two. Pillar One aims to ensure that profits are more fairly distributed amongst countries with respect to the largest multinational enterprises. Pillar Two puts a floor on tax competition by introducing a global minimum tax corporate tax rate of 15%.

Now, there’s quite a bit of detail in this, and I think I will come back and explore this detail with a specialist in this field in a separate podcast. But briefly, what Pillar One will do is say that the taxing right to 25% of the residual profit of the world’s largest, most profitable multinational enterprises (that is with more than 20 billion euros in turnover) will be reallocated to jurisdictions where the customers and users of those multinationals will be located. That’s the key point in here, and approximately USD125 billion is expected to be reallocated.

New Zealand would be a beneficiary under that regime because we are small, we are basically a price taker. Interestingly, as part of this deal there’s going to be a removal of digital services taxes and a standstill on introducing such similar measures. Digital services taxes have been highly controversial. Countries around the world, have been frustrated at how the digital tech giants such as Alphabet the owner of Google, and Facebook alike have been able to use the current international tax structures to basically extract super profits and pay very little tax in the jurisdiction. We don’t know, for example, how much tax Facebook pays. New Zealand Google paid approximately $4 million, even though it’s estimated ad revenue from New Zealand is thought to be in the range of maybe $600 million. It declares substantially less than that in profit.

So this is a win for New Zealand and smaller jurisdictions. It’s also a win for the digital companies because they are increasingly concerned about the impact of digital services  taxes. India in particular, is one country that has been flexing its muscles on the matter. So, it’s a bit of a surprise that India actually signed up, and doing so probably got the deal over the line. And certainly, this pause on new digital services taxes will enable the US government to get the agreements through Congress. You can expect the digital companies to be lobbying Congress very hard in this matter.

And the plan is that early in 2022, a multilateral convention and explanatory statement will be put together for signature and introducing model rules sometime during 2022, with the effect that all this will start to take effect from 2023, which is quite a tight timetable.

Pillar Two talks about the minimum corporate tax and that’s been set at a maximum of 15%. That was the maximum so far, and that was probably the result of fierce lobbying, particularly from Europe. There, the Irish would have been playing their hand because their corporate tax rate is 12.5%. Ireland, I think, will be happy at 15% for two reasons. One, it’s not dramatically above where their current rate stands. On the quiet, once you take into account the tradeoffs that some of their own multinationals will be paying more tax, the Irish Government is expected to benefit by two billion euro a year, which in these cash straightened times is a useful boost to the country’s coffers.

And again, this is moving very quickly. By next month, there are meant to be model rules in place to define the scope of how the mechanics of this will work. And then there will be amendments to the International Tax Treaty, which is a framework by the OECD, which will also be released next month. Then in mid-2022, there’ll be a multilateral instrument for signing, and to be applied to the relevant tax treaties we exist. And again, all this will kick off in 2023.

This new agreement is a very big step forward. But it is interesting to see who paused on this. Nigeria is the largest economy in Africa by some scale. Its decision not to get involved, I think, should be taken as significant. It’s unhappy about the rate of tax which is too low for its liking, and it rather dislikes the West imposed its rules.

However, there’ll be more fighting going on there, and that pause relating to digital services tax only lasts two years. So if it doesn’t get through, then you can expect the likes of Nigeria, which was introducing its own digital services tax, and India, to pick up where they left off. Overall, though encouraging and actually of benefit to New Zealand, maybe by tens of millions. Not a big windfall, but certainly of benefit to see progress. But it’s still a question of watch this space for further developments.

My guest today is Professor Lisa Marriott from the Wellington School of Business and Governance at Victoria University, Wellington. Kia ora Lisa, welcome to the podcast. Thank you for joining us.

LISA MARRIOTT
It’s great to be here. Thank you for having me.

TERRY BAUCHER
You’re very welcome. Now, at 30th June 2020, Inland Revenue’s annual report cited that the amount of debt owed to it, for working for families or income tax debt, excluding child support debt and student loan debt, was just over $4.2 billion. Now that’s up 21% from the $3.5 billion owed in June 2018. And in fact, looking at this we can actually see that there’s been a trend line since June 2017 of the debt creeping up. It was just under $3 billion in June 2017. As of June 2020, it’s $4.2 billion. So my first question on this is Inland Revenue managing its debt well, and are its processes fair?

LISA MARRIOTT
Huge question and really nice place to start. You mentioned that trend line with debt which I find really interesting because if you go back just a tiny bit further in time, there you saw a very similar pattern. So the debt book, I think, got pretty close to six billion and then there was a really big write off one year. They wrote off a lot of debt, which in fairness was very old and probably they decided it was uncollectible. But the amount that was written off in that year, I think, was from memory around about $1.8 billion. It was a huge write off amount. And what they did was then, you saw this great big drop in the debt book. But like you say, it’s actually been creeping up again just incrementally over time.

Covid-19 clearly is going to have an impact in the area as well. But notwithstanding Covid I think your observation is absolutely right. That in the absence of having these big write offs, debt does tend to increase. Are they managing it well? It’s probably not a yes/no question actually.

Personally, I think there could be a number of different types of things that Inland Revenue could look at to try to get to a more sort of manageable level. But equally, I know that Inland Revenue want to try to be fair to taxpayers. My impression is that they don’t want to be overly punitive.

And you know, at one level  it’s great. It’s all about being kind and responsive to taxpayers. But at another level, particularly when you see the differences between government revenue that’s been collected at the moment and government expenditure, we need to be collecting every last dollar of tax that is owed to the Crown, in my view. So, I think there are other things that we could look at, and we will talk about those as we go.

But the other point I did just want to touch on was your reference to fairness here. And one of the particular things that I have been looking at is the amount of tax that is written off. We’ve talked about this, there’s write offs because the debt’s uneconomic to collect or taxpayers are suffering from serious hardship. But there is a real sort of differentiation between the types of taxpayers that can have their debt written off. If you are self-employed, you can apply to Inland Revenue if you’re suffering from serious hardship to have some of your tax obligations written off.

However, if you are a worker who is being paid a very, very low income, you’re not going to have that potential to do that because your taxes will be deducted at source, so you don’t have that same opportunity to get discretion in the tax system. So, I think there are some real fairness issues there as well.

TB
Yes. You mentioned the write off and I was looking back at June 2016. Inland Revenue debt was $4.7 billion dollars and then next year it’s $3 billion. So obviously during the year ended 30 June 2017 they decided to take a big hit.

On fairness there are a number of processes I think need looking at. I’m a long-standing critic of the late payment penalty regime, because you see the trend line here doesn’t work, and there doesn’t appear to be any discernible difference between New Zealand’s regime and other jurisdictions’ regimes about promptness of payment on time.

Inland Revenue’s own research and my casual research would point to a pattern of debt piling up as the penalties pile up and then taxpayers put their head in the sand. And that’s it, it’s gone. It’s not going to be recovered. So, one, penalty mechanisms need a look at, and two, Inland Revenue’s own processes for intervention need consideration. Then there are other tools we should be using there. What’s your view of the penalty regime that we have at the moment?

LISA MARRIOTT
I will answer that. I’ll just come back to one of the points that you just made because I think it’s really interesting. You are in essence talking about the sort of tipping point where taxpayers have a debt, but the penalties and the interest keep piling up and piling up. Quite a few years ago now, it might have been as much as 10 years ago, Inland Revenue did a bit of research to try to work out what that tipping point might be. And of course, it’s a really hard thing to try to measure and to quantify, and there’s going to be ranges. But they thought that as little as $10,000 could be the tipping point at which point taxpayers go “actually, it’s too big, I can’t pay it back, so I’m just going to ignore it.” And you know, this is when you get those debts that have been sitting on the debt book for five years and have to be written off. So yes, that’s a that’s a really interesting issue. It goes back to that penalty regime, as you say, where at some point you can penalise as much as you like. But it’s actually not going to make a difference to behaviour. So as to the different sorts of penalties that you can apply, I have been looking at this.

OECD as you know, published some really nice comparative information on the OECD and other advanced and emerging economies, and what they do by way of powers of enforcement of debt. And I’ve got a spreadsheet just open on my computer over here and there’s some things in there that are used pretty commonly in use in other countries. But we don’t use them very much here, or we don’t use them at all.

So we can talk about some of these because I think they are things that we should at least be having a discussion about. The first one I’d like to talk about are called directive penalty notices, that’s what they called in Australia. And the idea is that the direct penalty notices kick in around three to four weeks after our tax debt hasn’t been paid. So the usual example would be you’ve got a company, they’re withholding tax that’s normally related to withholding tax on GST, superannuation contributions, Kiwisaver, those sorts of things. In a short period of time, once they haven’t been paid, the directors become personally liable for that debt.

Now the thinking is that if you’ve got a business that really isn’t viable at that point in time, it would force some companies into liquidation. That’s probably going to be, in many cases, not a bad thing. And what it would do is it would stop businesses in essence continuing to trade while they’re insolvent for, we see this in New Zealand, up to a year, and often they drag down other viable companies with them because they’re not paying their other obligations. What that does is it results in much faster action being taken, and you’re dealing with the problems a lot faster. It also means that for company directors, they’re not able to use Inland Revenue as sort of (like a GST, for example) a secondary source of funding for a long period of time, and then go insolvent. The ramifications at that point are often serious for a lot of other players.

TB
Didn’t the tax working group look at this – director penalties notice? Nick Malarao was on the tax working group, he’s part of Meredith Connell, who does a lot of the enforcement activities for Inland Revenue. And I know they were looking at this issue, and I seem to recall that movement was made to consider bringing this forward and then Covid arrived. I think that’s all been parked for the moment. Sheeting home to the directors would concentrate the mind wonderfully.

But there is this pattern that I’ve seen, and you no doubt have seen as well, where companies do use GST and PAYE as sort of working capital. That $10,000 threshold tells you a lot about how undercapitalised small businesses are, how much they operate on the margin. And then the real dynamic, which is that when companies go down, they’re allowed to linger on for too long, they pull others down. You think of poor contractors in the construction industry who forever seem to be getting hit very hard. So, the burden ultimately falls on smaller players who can’t afford it. So, yes, movements to change that, they won’t be welcome. And then you’ve got to look at, and this is a whole other topic which I don’t think we should get into too much, how trusts are used to protect and insulate directors from everything there, and whether that’s actually a proper and appropriate use of trusts.

LISA MARRIOTT
And I think that’s a whole other podcast all on its own, isn’t it, Terry?

TB
It is indeed.

LISA MARRIOTT
Let me throw some other ideas at you. This is possibly a wee bit radical, but a lot of countries do this, which is about publishing the names of debtor taxpayers. You probably wouldn’t want to start publishing the names of everybody the minute they have a debt. But some countries, for example, will publish debts once they become over a certain amount or, they’ve been debts for a certain period of time, or perhaps repeated non-payment and so on. Quite a few countries do this. In fact, about a third of countries, OECD and other economies, use this as a frequently used power. And then about another 40% have it as an infrequently used power.

So the idea here is, there’s a bit of transparency for those situations that we’re talking about. If you are subcontracting to a construction company, for example, and you know, they’ve got a really large tax debt, then maybe that gives you a bit of information to make appropriate decisions.

TB
Yes, that would need to be carefully managed, but I think it is quite effective and low cost, too. And we’ve actually done that recently. If you think about the criticism of certain organisations for taking wage subsidies last year and subsequently turning out profits that weren’t so badly affected. You’ll notice that some of those companies this year haven’t applied for the wage subsidy. Whether that’s because they don’t meet the financial criterion which have been tightened. Or maybe the reputational risk isn’t worth it. You can see we actually have had a live test of that model.

Inland Revenue also makes use of it indirectly in what they call the deduction notices, which they issue. “Right, this person owes us money” so they send a deduction notice to the people they know who are paying them. This is usually for those on PAYE for example, or contractors, and they say “this person owes us money. You’re to deduct 20%.” Now I’m a bit nervous about that because sometimes these things are wrong. But secondly, you are revealing to other people in small organisations that that person owes money, it could be for child support or whatever. Child support is one area where they use it a lot. So, there’s a bit of naming and shaming so to speak in there, when perhaps a person can’t really react very well. But certainly, for larger organisations, who are big enough to manage their resourcing, it’s probably worth considering.

LISA MARRIOTT
I guess with the deduction notices, that information is pretty tightly held. So, it’s probably only within HR or a finance department of a company or even within a bank or something like that. But I think your example about the wage subsidy is a pretty good one because you do wonder if some of those organisations had known that they were going to be in the public domain, whether they would have applied in the first place. And yes, it’s like you say, you could think of it as a bit of a test to say, “we did this, what was the impact of that?” A little bit of a natural experiment. And it does appear to be that it moderated some behaviour. It certainly got some of the wage subsidy repaid where there was visibility around what they were doing. So yes, let’s continue on my list of options.

I think Inland Revenue would be approving of this next suggestion I’ve got. I genuinely think the audit and investigation function of Inland Revenue is underfunded and I know they have access to more technology, which should make things easier. However, if you look at the trend of funding to this particular part of Inland Revenue, that has had a downward trend over time. And to my mind, it’s the sort of activity that if you fund it, it’s going to pay for itself, probably multiple times over. So yes, I would really like to see increased funding given to the audit and investigation of Inland Revenue rather than cutting it back. It strikes me as being not a financially sort of sensible route to cut down on this particular function.

TB
Yes, that’s something that I’ve spoken about on the podcast previously, but it seems odd things are happening in that regard because Inland Revenue’s annual reports repeatedly state that there is a six to one ratio for recovery. In other words, for every dollar they put into it, they get at least six dollars back and often more so. Against that background you’d be thinking, “well, of course, we should be doing more of that.”

But we know, for example, as part of Business Transformation, highly experienced investigators were let go in a wage cutting process. Which is fine if the systems that you’re purportedly replacing them with are accurate enough to be drilling down and pulling out discrepancies. But we’re not seeing any evidence of that. And I’ll put a big “yet” after that because to be fair, they’re still bedding in.

But we know in the budget for appropriations for the 2021 budget, there were cuts in the investigation funding, about $10 million off hand. Which possibly because, as you said, in Covid times, you’d think “let’s see, we need to kick over every stone to find all the money we can legitimately raise.” So, putting more resources into Inland Revenue investigations seems an appropriate way to go forward, and merely even saying so puts people on notice that this is happening. But the thing about a voluntary compliance system, if people’s perception is they’re not going to get caught, they will push the boundaries beyond what’s acceptable.

LISA MARRIOTT
Absolutely. And I’m looking just at the actual expenditure on investigation, so I’ve got five years of data here. In 2015/16 it was $164 million. More or less the same the following year, then it goes down to $140 million, down to $134 million and then, well, for 2019/20 it’s not a good one to look at because it was a revised budget, so some of that money was taken out of that particular function and put elsewhere. But overall, the trend has been sort of declining and as you say it pays for itself many times over. It seems like a fairly low hanging fruit, really.

What are the other ideas that I’ve had? I don’t think we’ve talked about it before, but I’ve talked to Inland Revenue and to Treasury about it, a crown debt collection agency. We’re not that big a country that it wouldn’t make sense to have some combined debt collection across government agencies. I’ve been told that often debtors to the Crown have debtors across multiple different agencies. So, there would be some degree of potential efficiency gains by having an organisation that’s responsible for the collection. And the reason why I say that is because some of our research in the past has tended to show that different types of debtors get treated differently. Welfare debtors as opposed to tax debtors. So, if you did have a centralised debt collection agency, you would get consistency of treatment. Everybody should have the same access to have the debts written off for serious hardship or to have different types of repayment plans or whatever it is. But it’s about treating people equally when they have debts to the crown.

TB
Yes. Now, I seem to recall that was something again that came out of the tax working group. They did make that suggestion.

LISA MARRIOTT
You know what, it was in my submission. That’s probably why.

TB
I think you were probably preaching to the converted with Nick Malarao on that. But there is a key point there and that is consistency of approach across crown agencies. And your research on this shows a marked discrepancy between treatment of those who fall behind in welfare payments, for example, and debt write offs in the tax field. Isn’t that correct – there’s quite a significant discrepancy how people are treated? It seems ironical, and certainly not fair in my mind, that welfare beneficiaries who have the fewest resources of all seem to get a harsher treatment than other potentially wealthier taxpayers who fall behind. But consistency of approach would certainly be a big plus to a crown debt agency.

LISA MARRIOTT
If you will indulge me here and let me talk about a couple of the cases that I’ve come across recently. Pretty wealthy taxpayers who’ve had relatively significant amounts written off due to serious hardship. There is one case I heard in the High Court in 2015. This was a case of somebody who was described as a self-employed professional who has continued to work and to earn an income that well exceeds the New Zealand average income. And I did some calculations here, and I worked out that over the seven-year period that we’re looking at, about 2005, it looked like the income was well over $200,000 in each of those years.

So, in this particular case, the person was granted tax relief, they had $343,000 in tax written off in 2003. They had a further $855,000 written off in November 2008. And the case that I’m looking at here was a judicial review because the taxpayer had gone back to Inland Revenue wanting a third instalment of tax written off[1]. So this case talks about failing to structure your affairs so that you can live within your means. Here we’ve got a taxpayer, clearly a very wealthy individual, working as a professional, self-employed, and reading between the lines, taking a salary and managing to build up some pretty significant tax debts and then applying for serious hardship. Now there is something about your sense of social justice, that somebody who’s, we’re talking of the highest earners of New Zealand, that they should have twice been given relief on the basis of serious hardship. And now they’re complaining because they’re not going to get a third round of rebates on their tax.

The second example was a case of a couple who had been buying and selling properties, not declaring any of it, and I imagine, they’d been picked up on some sort of audit, because they did a voluntary disclosure that they had purchased and on sold 16 properties over about an 18-month period. When the investigation took place, it turned out that they had bought and sold 40 properties in this period, and again there was all the to-ing and fro-ing about what they would pay, claiming serious hardship and so on. There were some agreements made that they would pay monthly amounts of $5,000. Tiny amounts were paid like $1,200 over a period of five years. And the taxpayers keep going back and back and claiming serious hardship.

Basically, how it ends up is the taxpayer’s going to go into bankruptcy and will not be paying anything. This has dragged on for over 15 years at this point. So, at this point, the taxpayer’s had the advantage of the use of money for this time. They’ve also not paid any tax and by the look of it, are not going to pay any tax. I’m doing some research at the moment and where I started from was looking at those insolvency and bankruptcy provisions.  I shouldn’t really say it’s an easy out because of course it isn’t really, but it does mean for taxpayers who have been pretty belligerent about not paying the tax, it does give them a way of actually doing that.

TB
Yes, that’s one of the things that myself and many tax agents get frustrated by is the massive inconsistencies. We apply for write offs of relatively small amounts and we get knocked back, there’s a lot of frustration, or you’ve got to pay this interest and all the rest of it. And then you about hear someone who’s earning $200,000 a year from 10 years ago. So that’s probably about $300,000 in current income and $1.2 million of debt has been written off. And you think, “Wait, what’s that?”

And then the processes that you’re saying about buying and selling 40 properties, you’ve got to think that that’s got to be millions of dollars of cash flowing through their hands, but they can’t pay the tax bills, and they’re using the system to drag out settlement.

It so happened I experienced this recently with a client who called me in to help and he had a pattern of this behaviour. But this time Inland Revenue wasn’t having it and they prosecuted him, and he’s just been found guilty. By the time I got to it there was not much we could do. He consistently had this pattern of making promises to make payments but didn’t follow through on them. But this time they lost patience and he was prosecuted for wilful tax evasion, non-payment of GST and PAYE.

Summarising what your experience and research has shown, together with my experience, is that Inland Revenue has the tools, but it could do with some newer tools, perhaps, and it needs to move faster because the quicker this is dealt with, the less collateral damage to the tax base and also contractors, and other people who get caught up in it.

Well, I think that’s possibly where we might have to leave it there. Lisa, thank you so much for joining us on this. It’s been very informative. Thank you for being part of the podcast.

LISA MARRIOTT
Thank you so much for having me, Terry. As you know, it’s always great to talk about tax, I’ve really enjoyed our conversation.

TB
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 kia pai te wiki, have a great week.

Bright-line test rollover relief

Bright-line test rollover relief

11 Oct, 2021 | The Week in Tax

  •  Bright-line test rollover relief
  • Inland Revenue consults on land taxation and cross border worker issues
  • What could be the fallout from the Pandora Papers?

Transcript

It’s been a busy couple of weeks in the tax world. Last week, the relevant legislation for the interest limitation rules was released in a Supplementary Order Paper, and on the same day, probably not by coincidence as one or two other tax advisors have noted, Inland Revenue released a draft interpretation statement concerning whether, and if so to what extent, the land sales rules in the Income Tax Act 2007 apply to changes to co-ownership, subdivisions of land and changes of trustees. Coming out on the same day as the interest limitation legislation it certainly has given us plenty to chew on.

Furthermore, Inland Revenue has kept busy this week with an issues paper seeking feedback on a number of matters facing employers and payers of cross-border workers.  The whole week kicked off with the Pandora Papers, reigniting the debate over New Zealand’s controversial foreign trust regime.

Property transfers between associated people

As we discussed last week, the Supplementary Order Paper with the relevant draft legislation for the interest limitation rules was released, and submissions are open to the Finance and Expenditure Committee until 9th November.  So, you’ve got approximately five weeks to get in and make submissions on these draft rules. I expect there will be some changes as a result of submissions and certainly I encourage everyone who has an interest in this area to make submissions with the aim of trying to improve the legislation.

Included in the Supplementary Order Paper is something which begins to address an issue which has been in place since the bright-line test was introduced in October 2015. And that is when there is a transfer between associated persons. Say for example, a person holds a property and transfers it into a trust or a look through company. As the legislation presently stands, that transfer would reset the clock for the bright-line test. So, a property that might be known for many years – more than 10 years for example – which has been transferred to an associated entity and therefore economically, when you look at it, no real change of ownership has happened. But for the bright-line test purposes there has been a deemed change of ownership and therefore the clock gets reset.

Now this was a problem identified way back in 2015, and the Supplementary Order Paper begins to address it by having some new rollover relief rules, which will apply from 1st April 2022. However, the rules are very complicated, particularly in relation to the transfer for a trust. And it could be really quite problematic for trust resettlements because the transfer to the trust must be a beneficiary who is also a natural person and can qualify for the main home exclusion. There’s quite a bit of detail to unpack in there.

In fairness this is an improvement on the original proposal we saw when in consultation with Inland Revenue earlier this year, but it still has a number of complexities and traps which will make it not particularly user friendly. So, although it’s a step in the right direction, this is one area I would very definitely recommend people make submissions on.

Land sales tax rules

Now, the other thing that was released on the same day as the Supplementary Order Paper, was a draft interpretation statement – nearly 60 pages – on how the land sale rules in the Income Tax Act might apply changes to co-ownership, subdivisions and changes of trustees.

This is an extremely important paper because it addresses issues where there was some broad understanding of what the position might be, but it’s good to see Inland Revenue set out its position.

Now the starting point to bear in mind is that income tax legislation in dealing with land transactions, refers to “disposals”, not sales. And this is the issue that the draft interpretation statement is addressing – what happens if there are transfers between co-owners, for example, does that create a disposal for tax purposes?

Now, quick digression here. The paper refers to tenancy in common and joint tenancies. A tenancy in common is where each party owns a distinct share, i.e. 50% or a one third share. A joint tenancy is where the land is owned by the parties together, but there’s no specific shares, in which case each person has a notional proportional share. So, for example, if there are two joint tenants each has a notional 50% share. And if there are five joint tenants, each has a notional 20% and so on.

What the interpretation statement goes through is what happens if there’s changes to types of co-ownership. For example, instead of owning it 50-50, they go to one party owning a one third share and the other party having a two-thirds share. Or there are two people and a third person is introduced or there are three people, and then one decides to.

What the interpretation statement says if it’s the type of co-ownership and the proportional notional changes don’t change, there isn’t a disposal under the land sale rules, so that means there’s no tax implications on the transfer. So, for example, if A and B were tenants in common with 50% each and they then moved to being joint tenants with again the notional 50%, there’s no disposal.

On the other hand, if, for example, A had 25% and B had 75% under a tenancy in common and then moved to 50:50, then B has disposed of 25% interest, and this disposal, could be taxable. And here’s where the issue gets quite tricky because this sort of transaction may be done on paper and no cash may change hands.  People have got to be very careful that if they are changing the proportions of how they own property, that they don’t trigger a tax charge and find themselves with a tax bill, but no cash has actually changed hands to enable payment of any tax which may become due.

To recap, if there’s a change in the form of ownership where the proportional and notional shares don’t change, that’s not a disposal. But if there is transfer, that adds a new co-owner, for example, that would be a disposal. And likewise, if there’s a transfer that removes a co-owner, that’s also a disposal. There’s a lot to consider in this paper and we’ll need to pore over it very carefully. But at least it gives us some guidance to work with. Submissions are open until 9th November.

Cross border workers

Earlier this week, Inland Revenue released another issues paper this time dealing with cross-border workers and identifying issues for reform. Work on this has probably been accelerated because of what’s happened with COVID, which has disrupted work and travel patterns. In the words of the issues paper,

“It has also highlighted the role of technology in enabling cross-border work arrangements. The pandemic has accelerated existing trends affecting how, when, and where people work and technologies such as artificial intelligence and the greater use of contracts. The supply of personal services will be increasingly important drivers in the future.”

Against that background, Inland Revenue have been looking at reviewing the tax obligations that apply to payers of cross-border workers. And this paper focuses on what happens for employers and payments to independent contractors. This is an issue I’ve encountered quite a bit recently, as people have migrated to New Zealand but continue to work remotely for their overseas employer.

The paper begins by looking at the current PAYE rules. And it concludes that these are inflexible. One of the big issues is that we have arrangements concerning our double tax agreements where a person who is deemed to be non-resident but working in New Zealand and can be paid by their overseas employer for up to 183 days without triggering PAYE.

But currently under the PAYE rules, when they cross that 183-day threshold then after the day count is breached, the employer is required to correct the tax position not just going forward but also from the first day the employee was present in New Zealand. So, it could be several months later when the position is realised. And this means employers get additional compliance costs and could also be potentially subject to shortfall penalties and use of money interest. All in all, pretty much a compliance nightmare.

Inland Revenue recognise this needs to be reviewed because it’s simply not always practical to collect PAYE from the income of cross-border employees. It’s hoping to allow greater flexibility for employees. And one of the things they’re proposing is a new period of time for correcting a situation, which is 28 days from the employer first becoming aware that this day count threshold that I mentioned earlier has been breached.

To use an example from the issues paper, Estella a Brazilian tax resident, comes to New Zealand on a 10-week assignment, 70 days, to work on a construction project. It’s anticipated that the 92-day exemption, which is part of our Income Tax Act, will apply. We don’t have a double tax agreement with Brazil yet, so this 92-day exemption is only one available.

But the project gets delayed and now extends beyond the 92-day exemption to 98 days and a catch-up payment for PAYE is therefore required. And no penalties should arise so long as this is done within 28 days of identifying that there will be a breach of the 92-day threshold. That’s one of the issues Inland Revenue are looking at.

They’re also looking at non-resident contractors. There’s another set of rules that apply to independent contractors working in New Zealand. Currently, non-resident contractors’ tax is 15% and the New Zealand resident payer is required to withhold that from each contract payment made to a non-resident contractor.

The thresholds and rates haven’t been changed since 2003. Those thresholds, by the way, were adopted and in the wake of the Lord of the Rings when a large number of American productions came to New Zealand in the early 2000s and encountered this issue and work was done to mitigate those issues. It’s therefore probably time to have a look at these issues again. And it’s good to see that Inland Revenue putting some ideas out there. Submissions on this are open until 19th November.

New Zealand’s controversial foreign trust regime

As I mentioned the week kicked off with the Pandora Papers revelations. This reignited the debate over New Zealand’s foreign trust rules. Now, when the extent of the use of New Zealand based foreign trusts was revealed in 2016 in the wake of the Panama Papers, the then government moved very quickly to tighten regulations.

And as a result of that, the estimated numbers of foreign trusts registered with Inland Revenue fell from about 13,000 back in 2016 to just over 4,000 now. The Pandora Papers will reignite debate about these rules.

These foreign trusts exist as a by-product of changes made to New Zealand’s taxation regime for trusts in 1988. That’s when New Zealand switched from taxing trusts based on the residency of the trustees to taxing on the basis of the residency of the settlor (the person who established it).

Now the reason behind this was to tackle what was seen as quite substantial tax avoidance by New Zealand tax residents, and by and large, that move was highly successful. It is practically impossible now for any New Zealand tax resident to set up a trust now in a tax haven and shelter income from New Zealand tax.

But an accidental by-product of the regime was that non-New Zealand residents are able to establish such trusts. What they would do is settle a trust under New Zealand law with New Zealand trustees. Under the foreign trust regime, income from outside New Zealand would not be taxable. Which, by the way, is legal and consistent with general tax principles around the world – that is you tax residents on a global basis, or you tax income with a source in the country. So, for example, New Zealand taxes income with a New Zealand source and New Zealand residents.

If you have rules as New Zealand established, which say, “Well, we don’t deem this trust to be tax resident in New Zealand”, then offshore income becomes tax exempt in New Zealand. And so, this is quite attractive because it meant that New Zealand essentially became an onshore tax haven for sheltering income.

So, it’s quite controversial, and started to attract quite a lot of attention.  In part because of growing unease with tax havens we saw the introduction of the Common Reporting Standards on the Automatic Exchange of Information. New Zealand’s current foreign trust disclosure rules are in line with those standards.

The Panama Papers gave a boost to those rules, and I’m sure the Pandora Papers will also lead to further tightening as well. Although the Minister of Revenue didn’t seem particularly enthusiastic about moving very quickly on the matter, there’s a lot going on as we have discussed.  In any case, the position is that the number of trusts registered with Inland Revenue has fallen by two thirds since 2016 to just over 4,000.  The argument would be that a fair amount of the more dubious entities have been weeded out.

But what’s common in moves around the world and it ties into anti-money laundering moves particularly in Europe is for establishment of trust registers which is where details of these trusts are held.  Now whether they are held publicly like the Companies Office register, or privately and available only to Inland Revenue which is essentially what we are doing at the moment, needs considering.

For those who are calling to tax these trusts what needs to be kept in mind is that often these foreign trusts are established partly on grounds of secrecy but also to ensure assets held in such a trust are outside two taxes, both of which New Zealand doesn’t have. That is capital gains tax and estate duties.  Now these are transactional taxes, which are triggered by death or disposal.

So, when considering calls for New Zealand to tax foreign trusts we need to think about how we would practically do that given we don’t have a general capital gains tax or estate duty. Basically, we would then be looking at a wealth tax or something akin to the foreign investment fund regime.   Whatever, there’s going to be quite a bit of debate on this going forward and it’s not going to die down very quickly.

Applications open

And finally, in Covid related news you have until 11:59pm on Thursday 14 October to apply for the fourth round of the August 2021 Wage Subsidy Scheme.  And applications for a third round of the Resurgence Support Payment are now open. To be eligible, your business must have experienced at least a 30% drop in revenue or a 30% decline in capital-raising ability over a 7-day period, due to an increase in Alert Levels.

  • You can receive $1,500 per business plus $400 per full-time employee (FTE), up to 50 FTE.
  • The maximum payment is $21,500.
  • If you’re a sole trader, you can receive a payment of up to $1,900.

If you’ve applied for previous Resurgence Support Payments and you’re eligible you can apply for this one.

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 kia pai te wiki, have a great week!

Draft interest limitation legislation including 20 year new build exemption

Draft interest limitation legislation including 20 year new build exemption

4 Oct, 2021 | The Week in Tax

  • Draft interest limitation legislation including 20 year new build exemption
  • Interest deductions on taxable disposals
  • The view of the Ministry of Housing and Urban Development

Transcript

The draft legislation for the interest limitation rules was finally released on Tuesday through a Supplementary Order Paper to the Taxation (Annual Rates for 2021-22, GST and Remedial Matters) Bill. This Supplementary Order Paper (SOP) introduces amended sections CB 6A and CB 16A, which cover the changes to the bright-line test rules, and also to cover the interest limitation rules is a new subpart DH with sections DH 1 to DH 12. There are also new sections FC 9B to FC 9E which relate to the ability to roll over for the bright-line test purposes. In addition, there was a release of the regulatory impact statement and some very useful information sheets, six in all covering the basics of the changes.

There has been no change to the basic position, which was outlined in March, that interest limit deductibility would be limited for residential investment properties. As of today, between now and 31st March 2023, 25% of interest relating to residential property investment is non-deductible. And then that proportion of non-deductible interest will rise steadily over the next following years until it’s fully non-deductible with effect from 1 April 2025.

To quickly recap, the main home is not affected by these proposals. It’s been confirmed that the limitation would not apply to interest related to any income earning use of the owner occupier’s main home, such as flatting. Commercial property which is not related to the provision of accommodation isn’t affected either.  Farmland, certain Māori land, emergency, transitional, social and council housing are all exempt. So too is commercial accommodation but not short-stay accommodation which could provide a residential dwelling (Airbnb would be the target here).  Care facilities, retirement villages and rest homes are exempt, as are employee accommodation, student accommodation and land outside New Zealand.

Now, the big exception to this is an exemption for a “new build.” This is going to last for 20 years from the date on which a Code of Compliance Certificate is issued. These provisions are in the proposed section DH 4. An interesting thing about this new build exemption is that it applies for the 20-year period, regardless of the number of owners. So, it’s not just the first owner, the builder perhaps, who has the exemption, but all subsequent owners up to a 20-year period. So that’s probably as simple as they could make it which is generous.

It’s interesting when you look at the accompanying regulatory impact statement to see that the Ministry of Housing and Urban Development was opposed to limiting interest deductions for residential property because it thought it was concerned about the negative impact this could have on new housing supply. The Ministry of Housing and Urban Development said it preferred a long new build exemption, at least 20 years, which it saw as crucial to ensure that the new supply of houses was not reduced.

I would actually recommend a good read of the regulatory impact statement, it’s got a lot of fascinating insights. So, the Ministry of Housing and Urban Development got its wishes, but I do know from consultation that there was a general hope that there will be a longer period granted for this new build exemption.

A new build doesn’t actually have to be a completely new material. It can include modular or relocated homes, which is excellent. And it also covers converting an existing dwelling into multiple new dwellings. And critically, because this was a sticking point when the announcements were first made, it also covers converting commercial building into residential dwellings.

When does the new build exemption apply? Well, it applies either from when you acquire your new build, if it already has a Code of Compliance Certificate or you acquired off the plans or when your new build receives a Code of Compliance Certificate. I imagine there will be submissions wanting to extend that period on that, but at least it’s a line in the sand. I do think it’s probably on balance, allowing it to cover run for 20 years, regardless of the number of owners it might run through is also sensible.

The rules clarify that there’s a land business exemption if you hold the land as part of a developing, subdividing or land dealing business or if you’re in the business of erecting buildings. Also, interest relating to remediation work and other expenses relating to the ownership and development of land also qualifies for the land business exemption.

There’s a development exemption which will apply for interest on land you develop, sub-divide or build on to create a new build. And again, that exemption will apply from when you start developing the land and it ends when you sell the land or receive a Code of Compliance Certificate for your new build, at which point it flips over to the new build exemption.

Now, what happens if you sell the property and you’ve had interest deductions denied, but the gain is taxable for whatever reason, either under the bight-line test or another reason? In most cases, you’ll be allowed to treat the non-deductible interest as a cost for the purposes of calculating the gain. However, the deduction will be limited to the gain on sale. In other words, if the total interest costs not previously deducted, exceed a taxable gain that may that arises on the sale, only the interest to the point of the total amount of the gain will be allowed.

The new subpart DH deals with the issue of existing loans and rules around borrowing. If you borrowed funds on or after 27th March 2021, the interest is no longer allowed from 1st October 2021. Except if you used the funds to purchase a property acquired before 27 March or for a new build. In relation to refinancing, amounts up to the level of the original loan will not affect the deductibility of interest. And if that original loan was subject to being phased out over time, then the same treatment applies.

There are also provisions covering the question of deductions for interest on variable loans, such as a revolving credit or overdraft facility. If the amount outstanding is higher than the amount outstanding on 27 March, only the interest on the amount outstanding at 27th March will be deductible under the phased approach. The interest on the rest will be deemed to be non-deductible. There’s going to be a special transition rule to help work out what happens if you took out a loan prior to 27, the March 2021.

What if you can’t work out exactly how much the loan was used for residential property and how much was used for other business purposes? The example they give here is buying a truck for a transport business. What will happen is that loan will be treated as being used to acquire other business property first, based on the market value of that business property, and then the balance will be applied to residential property. That’s actually quite a generous treatment.

So, as I said, the regulatory impact statement makes for some interesting reading, you can see the arguments between Treasury, which supported this initiative, don’t allow deductions and don’t think there should be a newbuild exemption. On the other hand the Ministry of Housing and Urban Development and Inland Revenue took the completely opposite approach to Treasury arguing we really we don’t think these rules should be adopted.

According to Inland Revenue, the option which has been adopted, Option Three, is expected to raise $1.12 billion over the forecast period from 1st October 2021 through to 31 March 2025. It will be interesting to see how those extra funds are deployed. You’d hope that they would be used to build more social housing and help ease the crisis, but we shall see.

As you can imagine, it wasn’t just the Ministry of Housing and Urban Development and Inland Revenue who were a bit sceptical of the proposals. A total of 484 submissions were received from various bodies. The majority came from private landlords, but also included tax advisors, property investors, representative groups, real estate agents, iwi groups, property developers and engineers. This has stirred up quite a significant amount of debate and will continue to do so. We’ve got a long way ahead of us as we work through all these provisions. And no doubt, as we drill down into the detail, more points of contention will emerge.

The process going forward is that the Finance and Expenditure Committee should call for submissions very shortly and it’s expected there will be about six weeks to respond. Now, according to the Parliamentary timetable, the actual report on the tax bill of which this legislation is now part is due to be released next March. So, as I said, there’s some way to go before we might see the final form of the legislation. But at the moment it’s applicable and these rules are in force. We’ll obviously keep you updated on developments along the way.

Well, in the meantime, 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 kia pai te wiki, have a great week!