Tax News

Tax and the law of unintended consequences – how perfectly rational decisions over appointment of a trustee or helping children purchase a house can have some very severe and unintended tax consequences.

Tax and the law of unintended consequences – how perfectly rational decisions over appointment of a trustee or helping children purchase a house can have some very severe and unintended tax consequences.

15 Nov, 2021 | The Week in Tax

  • Similarly how the abatement of working for families makes it harder for low-income earners to break out of poverty.

Transcript

About 10 years ago, myself and a group of other tax agents were on our way to a meeting with the then Minister of Revenue Peter Dunne. On the way someone mentioned whether we ought to raise the question of the law of unintended consequences in relation to a tax issue. Another replied that he’d never heard of such a thing law. So, we decided we shouldn’t say anything about that particular point.

We get into the meeting with Minister Dunne. And lo and behold in the course of our discussion, he brings up the law of unintended consequences, at which point we had to pause the meeting and explain to the Minister why we’d all cracked up.

(Incidentally, during that meeting, we raised a matter I discussed last week, the inequitable taxation of ACC lump sums. That was an issue which was supposed to be looked at by officials, and 10 years on, I guess they’re still looking).

The international impacts

I recalled this because last week I also talked about the Greensill decision in Australia, and the implications for trustees of New Zealand trusts.  And on Monday, I got a new enquiry from a client where the impact of Greensill could come into play and it’s a classic example of the law of unintended consequences.

A mother had decided that she wanted all three of her children to be trustees of the family trust, and this change was made for good reasons in managing a family dynamic. Problem is, one of those children lives in Australia.  As I mentioned last week under Australian tax law, if any trustee of a trust is tax resident in Australia, the trust is deemed resident in Australia. That means the Greensill decision may apply, which basically says capital gains even if realised offshore and even if distributed to a non-resident, are subject to Australian tax at the top rate of 47%.

The implications are therefore potentially quite serious for this trust. Looking into it in more detail, the trust is deemed resident from the first day a trustee is a tax resident of Australia. The trustees will have to prepare and file Australian tax returns reporting the trust’s income as calculated for Australian tax purposes.

Now, in many cases, the trusts will distribute income to beneficiaries and from an Australian perspective, if non-Australian sourced income is distributed to a non-resident, it’s not an issue. It’s just that in the law there is a technical inconsistency, which means that the Australian resident trustees are liable for Australian tax on non-Australian sourced capital gains distributed to non-residents.

This is the impact of the Greensill decision which to recap involved a capital gain of A$58 million and was held to be taxable at 47%. What’s more, with Australian trusts, the rate for retained income is 47%, and this is further complicated by rules about which beneficiaries have what is termed “present entitlement” as at the date of balance date. So overall, this is potentially quite a serious issue if substantial capital gains been raised.

Now the logical response, you’d think is, “Aha, let’s get the trustee to resign” and once the trustee resigns, that ends the connection with Australia.  A logical move, except the Australian tax legislation has thought of that point. And what happens then is there’s a deemed disposal of the trust’s assets on the date of the resignation of the trustee (This is a feature of some jurisdictions with a capital gains tax).  In other words the Australian Tax Office, believes in Blondie’s maxim, “One way or another we’re going to get you”.

We are currently working through all these issues. This is a textbook case of whenever there’s a family trust and there is family overseas if you want one of the family to become a trustee, you have to put a big pause on that and get tax advice, particularly in relation to Australian residents.

I’ve seen some trustees who are living in the UK pop up on trusts. This is not quite as potentially catastrophic but it’s still problematic. There’s this dichotomy between New Zealand’s tax treatment, which based around the settlor and many other jurisdictions, which is based around the residence of the trustee. So, to repeat the key point, if you have any trustees that are tax resident overseas, you need to get tax advice.

Helping your children

Moving on, the second instance of unintended consequences this week involves family members such as parents, grandparents or trusts trying to help children or beneficiaries purchase property, the bank of Mum and Dad as it’s sometimes called. This has become incredibly more relevant as a by-product of the horrendous escalation in housing prices.

The issue that has to be watched out for is when the parents or whichever other entity is involved, a trust, for example, actually takes a direct ownership interest in the property to be acquired. At that point, whoever it is, is probably setting themselves up for some issues further down the track in relation to the bright-line test.

And these of course have been magnified by the fact that the bright-line test as of 27th March this year now runs for 10 years. These issues were probably manageable when the two-year bright-line test was initially introduced back in October 2015 but have now been considerably magnified with the extension of the bright-line test period to 10 years.

What is emerging in some cases is that families might say, right, well, “We’ll take a 25% interest in the property. And then as the equity and your income rises you can pay us back and gradually take over our interest”. So ultimately, the children or beneficiaries will own 100% of the property. The problem is the reduction in those minority interests in the property represent a disposal for income tax purposes and for the purposes of the bright-line test.

For example, let’s say parents co-owned a house with a child and the ownership structure was initially 50:50 between them, but change it to 75:25. In that case, there’s been change in the title in the ownership interest, and therefore there’s been a disposal by the parents of a 25% interest to their child. Therefore, this disposal would be subject to bright-line test. There would be no exemptions here because they’re not living in it and it’s not their main residence. Just bear in mind that even if that property was the main residence of the child, the parents having the interest would still have made a disposal for bright-line purposes.

There’s also a potential kicker for such a transaction if the property is sold or gifted below its market value within the bright-line period, the transaction is treated as having happened at market value. So, for example, if the market value of the property had increased from $500,000 to $1 million, then the parents reducing their interest would be taxed on whatever their share of that $1 million was, rather than what actual cash they might have received. So potentially there could be some very sticky tax bills arising.

Arguably, one potential way round this might be that the parents lend the money to the child and not take a direct ownership interest, but you know, horses for courses, individual circumstances will come into play.

So, you just have to be very careful and proceed with great care if you are taking a financial interest in your child’s property to help them on the ladder. Otherwise, it could be another example of unintended tax consequences.

Lessening inequality

And the third unintended consequences that we might see in tax relates to the recent announcements from the government about changes to working for families.

What the Government has done has announced increases to the amount payable. The family tax credit is going to be increased by $5 per child. And on average, families will be $20 a week better off. But, and there’s always a ‘but’ in this, what the Government has given with one hand it has quietly decided to take on the other by raising the abatement rate to 27%.

Now abatement is what happens when a family’s annual income exceeds $42,700 then working for families credits start to be abated. And what this means is that people on average incomes actually have the highest effective marginal tax rates in the country.

For example, a family earning $48,000, the point at which the tax rate moves from 17.5% to 30%, their effective marginal tax rate, once you add in the impact of abatement is 57%. In other words, for every dollar of extra income they earn, they will lose 30% in tax and 27% of their working for families tax credits

For family’s with income just over $70,000, the marginal tax rate rise to 60%. And if you’ve got a student loan, that’s another 12% on top of that. A person earning just above $48,000 with a student loan could be facing an effective marginal tax rate of 69%. This is the unintended consequences of the abatement rates. The theory is conceptually sound, but the problem is it traps people on low income and makes it very hard for them to break out of the need to receive social assistance.

This is one of these things that is consistently glossed over by politicians and has been one of those sneaky little tax increases that that previous finance minister Bill English did. Grant Robertson is just the latest to increase the abatement rate and so quietly claw back some of the assistance. The unintended consequence is that the step up makes it harder to get out of poverty.

There is meant to be a review of working for families going on at the moment, but that’s been paused. As we know, the Welfare Expert Advisory Group recommended significant increases in benefits and that report is now nearly over two years old.

To summarise this week’s lesson, tax is full of unintended consequences. Therefore, always proceed with caution if you’re making significant changes, such as appointing a trustee or wanting to co-invest with your children on a property purchase.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website, www.baucher.tax or wherever you get your podcasts. Thank you for listening, and please send me your feedback and tell your friends and clients. Until next week, party week, have a great week and go the Black Caps.

 

We focus on trusts, in particular the new reporting requirements for trusts and a concerning court decision from Australia.

We focus on trusts, in particular the new reporting requirements for trusts and a concerning court decision from Australia.

8 Nov, 2021 | The Week in Tax

  • We focus on trusts, in particular the new reporting requirements for trusts and a concerning court decision from Australia.
  • We also review a harsh but not unexpected decision from the Taxation Review Authority regarding the taxation of arrears of weekly ACC compensation.

Transcript

This week we focus on trusts, in particular new reporting requirements for trusts which have caused a stir together with a concerning court decision from Australia. Elsewhere, there is a harsh but not unexpected decision from the Taxation Review Authority regarding the taxation of arrears of weekly ACC compensation.

Last month, Inland Revenue released two papers relating to trusts, firstly, an issues paper on the reporting requirements for domestic trusts where disclosure is required under the Tax Administration Act 1994, and secondly, a detailed operational statement setting out the reporting requirements for domestic trusts.

Now, these prompted an article by Auckland barrister Anthony Grant, who specialises in trusts and estates. He was quite concerned about the papers and why this information was being gathered.  His article concluded;

“The information can be wanted only because the IRD and the present government want to tax people who lend money to trusts at less than market rates, people who get benefits from trusts, people who provide services to trust assets and people who have powers in relation to trusts, as they have never been taxed before.”

That’s quite a quite a closing statement.

The source of the two Inland Revenue papers is legislation enacted when the Government increased the individual tax rate to 39%. The Government did not also increase the trustee tax rate, even though Inland Revenue recommendation was that it should, based on bitter experience of what happened between 2000 and 2010 when such a differential existed previously.

Instead, the Government made very clear statements that it would be watching the situation carefully, and if it did see what it regarded as unacceptable tax avoidance happening, it would move to increase the trust tax rate. In the meantime, it introduced a whole new set of disclosure rules to enable Inland Revenue to have a clear look at what transactions are going on involving trusts.

Now, this was a radical departure of from previous practise. One of the weaknesses of tax administration in New Zealand, in my view, is that we don’t get to see a lot of detailed or very segmented tax statistics. If you go elsewhere in the world, tax authorities can produce very voluminous data relating to which sectors and persons are paying tax. Inland Revenue doesn’t produce those sorts of data, although if you ask for it under the Official Information Act, you should be able to obtain much of what you’re after.

That lack of tax data being made public reflects the moves made in the 1990s to ease tax administration under which most people were no longer required to file tax returns and the information to be included in most tax returns is quite limited.

The new legislation requires quite substantial amounts of information to be provided. It includes details of all settlements on a trust, which includes all transfers of value along with details identifying the entities or individuals making those settlements. Transfers of value include all things monetary and non-monetary and the provision of services below market value.  Details of all distributions, whether taxable or not, are required and including again, monetary or non-monetary together with details identifying recipients. There’s a general question wanting information about details of who has the power to appoint or dismiss a trustee, add or remove a beneficiary or amend a trusted name and finally a catch all or any other information the Commissioner of Inland Revenue wishes.

This represents a large increase in compliance for trusts. It should be said that it also reflects to some extent the impact of the new Trusts Act. Trustees can now expect to have more reporting requirements because beneficiaries now have rights of access to information about the trusts.

Trustees who may previously have been a little casual, to put it mildly, about record keeping will now need to sharpen their game. Not just for tax purposes, but basically to comply with the new Trusts Act. We don’t actually know how many trusts there are in New Zealand, the best estimates are somewhere between 500 and 600,000, and it’s one of those stats where per capita New Zealand is right up there.

The Government reporting requirements come into effect with those tax returns that have to be filed for the current year ending 31 March 2022. However, the legislation contains a provision that if Inland Revenue reviews a return and finds something of concern, it can request the same information for the previous eight income years, which means the first year could be for the year ended 31st March 2015.

As noted, the legislation represents a substantial increase in compliance costs. You should also look at it in the context of the controversial high wealth individual research project, which is going on at the moment. Both these initiatives address an area where arguably New Zealand taxpayers have not been providing a lot of information, and hence the Government and Inland Revenue are in the dark as to exactly the extent of wealth in the country.

And by the way, this is a worldwide trend. Although New Zealand managed to come through the global financial crisis very well, which has enabled us to manage the COVID 19 response pretty well, for the rest of the world the double whammy of the Global Financial Crisis and now the pandemic means that governments are under enormous fiscal pressure. There’s a growing trend to request further information in relation to the wealthy and wealth taxes are being discussed elsewhere around the world. So this is actually part of a global trend here.

But that’s not to undermine the importance of the issues raised here. These represent significant compliance costs, and they are quite concerning for trustees and beneficiaries about what were apparently quite legal transactions, such as advances to beneficiaries. Details of loan advances to beneficiaries are now required together with distribution of what we call term trustee income, which is tax paid income. This is going to be particularly relevant going forward because trustee income is exempt income for a New Zealand tax resident. Therefore, for someone who’s taxed at the 39% top rate, a distribution of trustee income is a way to essentially get tax free capital distributions from a trust. And this is what one of the areas these new provisions are looking to target.

The level of detail asked in relation to beneficiaries and what is expected of trustees is incredibly high. The new rules are expected to affect about 180,000 trusts, although there’s a sort of a de minimis position for trusts which don’t have annual income exceeding $30,000 and the total value of the assets is less than $2 million. That still leaves a substantial number of trusts will required to prepare quite detailed information for submission.

For example, all interest and non-interest-bearing loans from persons associated with the trust that is the settlors, trustees and beneficiaries. Then if trust property such as a house is enjoyed by a beneficiary for less than market value, the sum is to be recorded as a drawing in favour of the beneficiary. This one in particular is going to cause a bit of a stir as it’s quite a bold step. For many trusts, properties held by the trustees are essentially let rent free to the beneficiary on the basis that the beneficiary meets the upkeep, such as rates, maintenance etc, and the interest payments relating to any mortgage over the property.

Now we see a deemed income provision in relation to assets provided by a company, but there’s no such provision for trust purposes. These particular requirements are one reason why Antony Grant sounded the alarm. It would essentially impose a deemed rental or an imputed rental on property.  This is something which has been considered by several tax working groups, but not implemented by the Government.

Another matter which is going to be a headache for trustees and initially probably may not be entirely accurate, is the requirement to break down the equity of the trust between the corpus, which is the sum of all settlements that have been made on the trust less the distribution of corpus made to beneficiaries and trust capital, which is the sum of all taxable and non-taxable income retained and gains and losses made by the trust.

There’s also to be an equity item in relation to drawings, which effectively mean the total amount of assets of value withdrawn from the trust by beneficiaries during the year, and then beneficiary current accounts are to be shown. Some of these well-managed trusts will already be doing so, but the extension across the board to most trusts is going to cause increased compliance costs as I’ve said. The implications of what happens when the Inland Revenue digests all this information we’ll have to wait and see.

Now, the officials’ issue paper is open for submissions until 15th November, and submissions on the operational statement are open until 30th November. So you might want to have a quick look at these papers and then consider making submissions.

Moving on, trusts with overseas trustees, beneficiaries or settlors can cause quite a lot of confusion. It’s something I’m seeing increasingly, particularly in relation to Australia, where the latest estimate is that maybe between four and five hundred thousand Kiwis live at the moment. And one of the issues that happens is that the trust taxation law differs from country to country. But (and I see this quite a bit in relation to various jurisdictions) people mistakenly assume that the rules are similar and don’t pay attention to the fine detail.

Now, in relation to trusts and people moving to Australia, it’s been well known for some time that if there’s any trustee resident in Australia, then the trust is deemed to be resident in Australia and therefore subject to Australian tax rules.  And so steps are taken to ensure that no trustees move there or resign their trusteeships before doing so. But that doesn’t always happen, and a case has just popped up in Australia, which although it involved a UK tax resident person it would have implications for New Zealanders.

Now, typically, distributions through a discretionary trust of current year income or capital gains are generally considered to retain those characteristics in the hands of the beneficiary. What that means for New Zealanders resident in Australian who qualify for the temporary resident’s tax exemption is if they get a distribution of foreign sourced income, that is income from outside Australia, it’s generally exempt from Australian tax. But a new decision from Australia, Greensill, makes it clear that this treatment doesn’t necessarily apply to capital gains.

Now, in this case, what happened was the trust realised A$58 million on a capital gain from the sale of a UK management company. The gains were distributed to a beneficiary living in the UK and therefore non-resident for tax purposes in Australia. The shares that were disposed of did not represent taxable Australian property for capital gains purposes.

Ordinarily, a capital gain on non-taxable Australian property made by non-residents is disregarded for Australian tax purposes. But the full Federal Court of Australia ruled that in this case, because it was distributed to a non-resident beneficiary of a discretionary trust, there was no exemption available because of the way that the legislation was drafted in relation to how trusts deal with capital gains. Therefore, the Australian trustee was required to pay income tax on behalf of the non-resident beneficiary in respect of that $58 million capital gain.

And this is where we could have problems in New Zealand. For example, a New Zealand domestic trust with three trustees, two of whom are in New Zealand, and one is in Australia. The trust is deemed an Australian tax resident and if the trust tries to distribute the capital gain, such as the realisation of the sale of a property in New Zealand then following the Greensill decision, Australian capital gains tax is payable, and it would be at 45%. So this is a major decision.

People therefore need to be very careful to be check as to the status of the trustees and settlors of the trust. Basically, what you want to try and do is minimise any link between an Australian resident and a New Zealand trust. Otherwise, you’d be looking at a substantial capital gains bill.

What wasn’t apparently argued in court was the question of whether double tax relief would be available under the double tax agreement between Australia and the UK.  This is unusual because I would have thought it would have been an issue that could have been applied in the Greensill decision, but apparently it wasn’t argued.

So we may have to wait either for another tax case or for perhaps the Australian Tax Office to decide that the Greensill decision is not really what they want and change the law. I think we might be waiting a long time for that.

Now moving on from trusts, the Taxation Review Authority (TRA) has confirmed that a taxpayer who received arrears of weekly compensation from Accident Compensation Corporation relating to an injury three years earlier was correctly taxed in the year in which she received payments. This is something that pops up quite regularly and I’ve discussed it previously.

In this case, the person was injured, made a claim for weekly compensation, and for three years there was a back and forth arguing about it. And eventually ACC paid a significant lump sum of arrears total of just over $180,000.  This payment was subject to pay as you earn as income in the year of receipt.  The taxpayer quite reasonably objected on the basis that her regular level of earnings was always quite low. Therefore, the tax that would have been payable if she had received the payments when she was entitled to do so would have been lower.

However, the law makes no adjustment for this, and it was taxed as a lump sum at higher rates.  She took her case to the to the TRA, which kicked it out on the basis the legislation provides no scope for relief. Now, this is a not uncommon problem. In fact, I wrote to ACC and asked, just how often does this happen, where arrears of ACC are paid in a subsequent income year?

And the data I got back in April said that in the year ended 30 June 2020, there were 14 166 such payments. And in each of the years ended 30 June 2017, 2018 and 2019 there were at least 1100 such cases. The average payment was around between $42,000 and $49,000 with the median pay-out around $21,000. But some very large payments were made. There’s one in the year ended 31 June 2020 of over $1.1 million.

So this is quite a significant issue which I think is something that should be amended by legislation. It seems unfair for someone who’s been injured or entitled to relief but doesn’t get it when it should happen and then has to take action to get their entitlements with more added stresses. Finally, when a person does get paid, Inland Revenue comes in and takes a big cut of it. And by the way, this is going to be a bigger problem now that we have a 39% tax rate. So, I’ve made a submission to Parliament’s Finance and Expenditure Committee on this, requesting the issue be looked at and the legislation changed.

Speaking of submissions, a reminder that submissions to the Finance and Expenditure Committee regarding the Government’s interest limitation proposals close next Tuesday, 9th November. So you’ve got until then to make submissions on that. I expect there will be quite a few submissions on the new rules. But as part of those submissions, you can actually draw the committee’s attention to other matters, which is what I am doing in relation to the ACC matter.

Well, that’s it for this week. I’m Terry Baucher and 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!

The latest Covid-19 updates

The latest Covid-19 updates

1 Nov, 2021 | The Week in Tax

  • The latest Covid-19 updates
  • Extra time to file 30th September GST returns
  • A review of Inland Revenue’s June 2021 annual report

Transcript

Last Friday, the government announced a couple of changes to the resurgence support payment from 12th November. It will now be paid fortnightly and the amounts have been increased to $3,000 per business, plus $800 per full time employee, up to a maximum of 50 full time employees. The maximum fortnightly payment is now $43,000, and if you’re a self-employed or sole trader, you can receive a payment of $3,800.

This has been brought in to help with this long lockdown that has hit Auckland businesses in particular very, very hard. There are some businesses, such as all those with close contacts such as hairdressers, beauticians, gyms and personal trainers who really have not been able to trade since this lockdown began back in August. The eligibility criteria remain the same. Your business must have experienced at least a 30% drop in revenue or a 30% decline in capital raising ability over a seven-day period due to an increase in alert levels.

Now it’s available to businesses anywhere in New Zealand and will continue to do so until Auckland moves to the new COVID-19 protection framework, the traffic light system, so hopefully that will be sometime towards the end of November.

Now also as of 9a.m. today applications for a sixth round of the wage subsidy are open until 11:59 p.m. on 11th November.  The criteria remain the same here. There is a revenue test, and you must show that there’s been a decrease of at least 40% when compared with the revenues during a typical 14-day period in the six weeks immediately before there was an alert level escalation. Again, most businesses in within the Greater Auckland region would qualify for that, and no doubt a few outside Auckland would still perhaps be feeling the pinch.

Moving on, Inland Revenue has just completed its final upgrade of its Business Transformation. As part of this, it was offline for a week, and that actually was over a period when GST returns for the period ended 30th September were due. Anyone who was due to file a GST return and pay provisional tax, which would normally have been due on 28th October, now has an extra week until 4th November to complete and file the GST return and payments.

Our main topic today is a look at Inland Revenue’s annual report for the year ended 30th June 2021. Now this is an important document, obviously, and it’s a big document, running to well over 200 pages. This period covers two things –  the completion or near completion of Inland Revenue’s Business Transformation project and also how Inland Revenue operated and has continued to operate through the COVID-19 pandemic.

The report begins by setting out Inland Revenue’s mission statement which is to “contribute to the economic and social well-being of New Zealand by collecting and distributing money”. It points out that it’s responsible for collecting over 80% of the Crown’s revenue. The highlights section hammers home this point as a key result noting that Inland Revenue was responsible for collecting $93.8 billion of tax in the year to June 2021. To put that in context, that was up 21% on the period to June 2020. You can therefore see the impact of COVID and the arrival of the pandemic in in the prior year and the strong recovery.

The report has a quite an enormous amount of detail and as you would expect, it’s a mixture of the positives and the not quite so positive. Key thing is that it’s continued to operate very smoothly through its Business Transformation and through the pandemic.

Couple of key metrics here that it’s picked out, which I think do deserve highlighting and are very interesting is that 89.9% of payments from taxpayers were on time that’s up from 85.9% in 2020.

It also highlights that 90% of taxpayers feel confident that they were doing the right thing and finding with it, and 81% said that they found it easy to deal with Inland Revenue. As a tax agent, I will probably have a different view about the ease of dealing with Inland Revenue which can be a bit frustrating at times. However, the system is clearly designed to enable taxpayers to interact directly with Inland Revenue and speed the process up, and that that seems to be going quite well.

By the way, the report likes to talk about “customers”. “Customer” or “customers” are used nearly 460 times in the report, as opposed to a mere 33 times for “taxpayers”. I’m old school we’re taxpayers, not customers. But that customer centric approach that Inland Revenue is trying to adopt shouldn’t be dismissed lightly whatever we might feel about the terminology because it shapes how it interacts with taxpayers.  It’s trying to take a more proactive approach.

More accurate square up

One of the key parts that’s come out of the Business Transformation project is the automatic square up that happens after the end of each tax year throughout May and June. Now there’s always some big numbers on this. But what’s interesting to see is that there’s more accuracy coming into the system judged by the declining amount of refunds that have to be paid out.

For example, in the year to June 2020, 3.1 million automatic assessments were issued resulting in $688 million in refunds. For the same period to June 2021 the refunds totalled $455 million. And by the way, 90% of those went to people earning $70,000 or less. So that drop off indicates to me that Inland Revenue is getting more accuracy during the year around tax payments, and that’s actually to people’s benefit if they’re paying the right amount of tax through the year.

That’s a good example of Inland Revenue taking a proactive approach, and the then, of course, Inland Revenue had to work closely with the Ministry of Social Development in the distribution of money through the wage subsidy scheme. And then has also been given responsibility for the new resurgence support payment. And the report notes that $200 million was paid out to businesses impacted by the February lockdown.

Inland Revenue’s normal duties include collecting and distributing KiwiSaver payments and that amounted to almost $8 billion in the year. According to the report 95% of that amount was collected and passed to the relevant scheme providers within two days.

106,000 $16,225 SME “loans”

Inland Revenue also has to monitor the small business cashflow scheme, and as of June 2021, that totals $1.72 billion to 106,000 businesses and taxpayers. So, in its core job of distributing and collecting money, Inland Revenue is doing very, very well. Its response to COVID-19 has been exemplary. Yes, there will always be isolated instances where things didn’t happen quickly enough. But on the whole, the system has worked very, very well in cases like the wage subsidy and the Small Business Cashflow Scheme that basically had to be designed from scratch and get up and running inside six weeks. So, Inland Revenue deserves a lot of credit.

IRD has fewer staff, still experienced

Poking around under the hood and looking at some of the more interesting metrics I have concerns with a couple of areas. One of the things that has come out of the Business Transformation project, and it was inevitable, by the way, was that Inland Revenue would be more efficient in its use of staff. As a result, its staff numbers have dropped off quite significantly. As of 30th June, it had 4,210 employees down 600 from June 2020, when the headcount was 4,831.

During the year, 700 people left Inland Revenue and only 97 new hires started. Looking at the workforce profile over the past five years, over 3,700 staff have left, but there’s been 2,000 new hires during that time. The turnover in staff to me seems a little high, and you hear varying stories about the type of staff who are leaving.  But the average length of service within Inland Revenue for those remaining is 15.5 years which points to a core of relatively very experienced people still being part of it.

And that actually should give some reassurance that there’s still the technical grunt around. By the way, the report, does highlight that turnover for staff in tax technical roles is very low at about 3.1% for the year, which I think would be pretty good for any large business. Approximately 825 technical staff or 19.6% of Inland Revenue’s workforce are in this tax technical area.

But reading between the lines, morale at Inland Revenue is a bit mixed. Staff engagement was a metric that was in the June 2020 report, and in that report, it was 25%, which was way below other public service agencies. But the June 2021 report, does not actually have a specific measurement of where staff engagement is at the moment. There is some discussion of the topic, “We know that change can affect engagement” and it notes that a June 2021 survey said 60% of the staff felt very good or good about their recent work experience, with 29% being strong advocates for recommending Inland Revenue as a place to work.

Inland Revenue, by the way, has made progress on bringing down the average gender pay gap, but at 18.3%, it is near double the wider public service position of 9.6% as of June 2020. And apparently there’s a starting services gender pay gap as well of 14,9% which I find a bit strange. I can’t see why that should be happening, but apparently this is driven by the proportions of women and men in high and low paying roles.

IRD performance as a debt collector

Inland Revenue’s core role is to collect revenue and administer the enforcement of the various Taxes Acts. So how is it done there? Well, as I said earlier on, the tax revenue is up to a record $93.8 billion. But when you dig into debt collection and investigations, a different picture emerges.

The percentage of collectable debt by value, which is now over two years old, has risen to 51.7%. That said, the amount of debt outstanding as of 30th June 2021 rose only 3.2% to just under $4.4 billion. According to the report that reflects the impact of COVID-19.

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Interestingly, one of the line items is “Other tax” which amounts to $157.7 million that’s a big jump from $45.8 million in June 2020. The increase reflects the finalisation of a high profile audit case, which I suspect must be the one involving Eric Watson.

Child Support, on the other hand, continues to be a problem and Inland Revenue wrote off $998 million, a substantial portion of which is penalties. I’m a longstanding critic of the penalty regime used in child support which doesn’t work. But fortunately, there’s changes happening here. And I think the debt write-off this year was to get ready for that.

And there’s also an increase of 8.9% on overdue student loan debt, which sits at $1.72 billion. Much of this debt is owed by overseas based borrowers and “is difficult for us to collect”.

A couple of weeks ago Professor Lisa Marriott and I discussed Inland Revenue’s debt collection efforts and we were reminded last week that Inland Revenue has the ability to refer “reportable debt” to credit reporting agencies.

So, I took the opportunity to dig into Inland Revenue’s reports and see how that has gone. This is a relatively new option and according to the June 2019 report, the Commissioner notified seven taxpayers that they had reportable debt and that it might give an approved credit reporting agency information in relation to them. The report for the year to June 2020 notes that the Commissioner communicated information to an approved credit reporting agency in relation to only one taxpayer. It appears of those seven threatened, six of them promptly paid up, so you could argue the system actually works.

But for the year to June 2021, the Commissioner did not communicate any information to an approved credit reporting agency and doesn’t appear to have warned any taxpayers. Now, as I said a few minutes ago, aged debt is on increase, so I wonder why didn’t Inland Revenue make use of this provision?  That’s something that we will continue to monitor, and no doubt some explanation will come forward too.

Smaller focus on audits and investigations

But the other area I have concerns with is on the investigations front, where there has been a declining return. And as I mentioned previously, the June 2022 budget actually has a cut of $10 million in this field. (There’s also a cut of $6 million for funding for management of debt and unfiled returns).

According to its June 2019 annual. Inland Revenue investigations identified $985 million in tax position differences. That amount fell in June 2020 to $959 million, and it’s fallen again in this report to $854 million.

Now Inland Revenue is still getting a return on investment of more than its target measure of $7 per dollar invested. But it didn’t meet the targets for the specifically budget funded measures. Only $122.8 million was assessed for the year against a target of $174 million. And the explanation given for this was a decision to “defer our campaign work and reprioritise compliance activities to best support customers during COVID-19, has influenced our results.”

Supporting taxpayers through the COVID-19 is an incredibly important thing to do, and as I said, it’s done a very good job. At the same time the money has to be collected to meet those support payments.  However, I’m not convinced that Inland Revenue was right to take the foot off the pedal on its investigation efforts. There’s lot of murmurs about the loss of highly experienced investigation staff and this declining return on investigation differences might reflect that.

This is an area where we want Inland Revenue to keep up its efforts because the whole core of our tax system is that it relies on voluntary compliance. It also relies on the assumption that Inland Revenue is working in the background to pick up and detect the those who are not complying.

By the way, a tax position difference may not necessarily equate to extra tax. It may be just as simple as “actually, you got the wrong amount of losses brought forward. Instead of $100,000 to carry forward, you’ve only got $50,000 of losses available.” That doesn’t equate to $50,000 extra tax, it’s actually the value of the tax payable on those losses.

Incidentally, there’s been some reports recently about the bright-line test, and one of the key metrics in the report is that 695 people made voluntary disclosures relating to a property tax obligation which resulted in about $43 million of tax. The number of people making voluntary disclosures for bright-line test obligations was 397 quite significantly up from the 91 in the June 2020 year.

However, when you look at the tax revenue raised by these voluntary disclosures, it’s not actually terribly significant, which points to whether there is non-compliance which isn’t being detected or actually there’s not a lot of revenue out there to be collected from the property sector. Given the volume of property investment that would be surprising.

Well, overall, you’d have to give Inland Revenue a solid pass mark, but you would be wondering, I think when Inland Revenue comes up for its annual review before the Finance and Expenditure Committee, there should be questions asked about what is happening around collections and investigations and the state of Inland Revenue staff morale. It could be now that Business Transformation is complete, that morale will improve. We’d like to see that because it’s important for a tax system, that the person you’re dealing with on the other end of the line has faith in the system and believes in their job. Because that means people get treated fairly. This is why I pay particular attention to this point.

Well, that’s it for this week. I’m Terry Baucher and 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!

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.