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The Week In Tax · International tax agreement and Professor Lisa Marriott on IRD’s debt management

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.