Tax News

Inland Revenue gets tougher on FBT compliance

Inland Revenue gets tougher on FBT compliance

1 Dec, 2022 | The Week in Tax

  •  Inland Revenue gets tougher on FBT compliance
  • The Government ignored Treasury and Inland Revenue advice on its build-to-rent tax proposal
  • Thee British mini-budget implications for Kiwis

A few weeks back I discussed Inland Revenue’s regulatory stewardship review of FBT, and I suggested it should be looking at improving its compliance in this area.  Well this week Inland Revenue has announced that it will be launching a campaign in October which will address common errors in FBT.

Actually, a footnote in the regulatory review referenced this campaign. The footnote noted “Particular attention will be drawn to FBT on motor vehicles with the primary audience being businesses registered for FBT and tax agents.”  The footnote Information from tax filings that indicates an FBT error will also be used to determine whether particular taxpayers should review their FBT position

The common errors Inland Revenue expects to see includes calculating FBT incorrectly, applying the exemptions available incorrectly and using the best rate to suit a taxpayer’s circumstances. This latter one is now a particular issue as following the increase in the top personal income tax rate to 39% the equivalent FBT rate has risen to 64%. It’s already been noted there’s quite possibly a risk that some FBT filers may be overpaying tax.

On the other hand, as Deloitte partner Robyn Walker observed in a LinkedIn post, Inland Revenue might perhaps need to also look at some employers who are not registered for FBT. According to the regulatory review only 83% of employers with 500 or more employees are actually registered for FBT, a statistic Robyn found surprising.  It’s hard to imagine an organisation with that many employees not providing some form of fringe benefits.

Of course, sometimes what might be subject to FBT can be quite obscure. Apparently, over in Australia, the owner of a specialty shop in a shopping centre is liable for a ‘property fringe benefit’ by permitting staff to use centre toilets in common area. This is such an extreme example, it’s practically unenforceable and in fact is widely ignored.

On the other hand, as the regulatory review noted there’s a fair bit of complexity to FBT now. There are probably quite a few employers who might well have provided fringe benefits without understanding that they were in fact doing so. The campaign begins next week and will run for four weeks. It will be interesting to see what comes out it.

Rejecting advice

Last month the Government unexpectedly announced that the build-to-rent sector would be exempt permanently from the interest limitation rule so long as tenants were offered leases of at least 10 years.  Earlier this week it emerged this was contrary to advice from Inland Revenue and Treasury on the proposal.

Both agencies considered that the new build exemption which allows an interest deduction 20 years from the date a code compliance certificate is issued was sufficient. However, the build-to-rent sector was unhappy about the initial interest limitation rules and continued to lobby for a wider exemption which has now been granted. 

For the purposes of the exemption, the build-to-rent development must consist of at least 20 dwellings.  Inland Revenue advised the Government, because build-to-rent investors tend to be large institutional investors, this means the exemption “…could be viewed as inequitable, because it would benefit large investors but provide no relief for smaller investors who hold similar properties”.

On the other hand, the Ministry of Housing and Urban Development supported the tax break, arguing the 20-year “new build” exemption wouldn’t go far enough to encourage investment in purpose-built rentals. In its view,

“The initial policy (for interest limitation) did not take into full account the diversity of residential property supply and was mostly built around standalone properties. Emerging residential models such as build-to-rent were not captured in this model.”

We probably haven’t seen the end of this controversy and you can expect to see more lobbying as the new tax bill containing this measure works its way through the Finance and Expenditure Committee submission process. Submissions on the bill are now open and the final date for submission is 2nd November.

In the fog of [tax] war

Last week’s UK mini-Budget sparked massive turmoil in the UK’s financial markets, something not seen since the GFC and the 1992 crash out of the European Exchange Rate Mechanism. The proposed tax cuts are about 2% of UK’s GDP and the largest in 50 years. To put them in a New Zealand context, they are approximately equal to $7.2 billion annually or four times the size of the tax cut National are currently proposing if they win next year’s election.

Beyond the headlines of the very dramatic tax cuts for high income earners, there were a few points of interest, which I think have a New Zealand relevance. Surprisingly, for example, there was no proposal to cut either capital gains tax or inheritance tax, which for a party of tax-cutters odd, but may represent an acceptance that those tax settings are acceptable. On the other hand the nil rate threshold for Stamp Duty Land Tax was doubled to £250,000, and the threshold for first time buyers was increased to £425,000. Stamp Duty is still a significant tax in the UK (about £14.4 billion annually)

Something which has discussed quite a bit here is more generous capital allowances. The UK has what it calls the Annual Investment Allowance. This was temporarily increased to £1 million and was supposed to be reduced to £250,000 with effect from next April. Instead, it’s going to be permanently set at £1 million. What that means is there’s an immediate deduction for the full cost of qualifying plant and machinery (excluding cars) up to the £1 million threshold.

Something similar here would be very welcome. Treasury and Inland Revenue would oppose such a measure because of its revenue cost. But you can see its potential impact following the temporary increase in what we call the low value asset write off to $5,000 in 2020-21.

UK employers are also required to pay National Insurance Contributions on employee’s salary, currently at a rate of 15.05%. This is on top of the salary they pay. Inevitably, this led to attempts to work around this levy a trend accelerated by the increased use of contractors with personal service companies. This is something that’s been going on for decades, I saw it when I was working in the UK nearly 30 years ago now.

The UK government has responded with a set of rules known as the IR35 rules to clamp down on such practices. The rules ensure contractors who would have been employees if they were providing their services directly to the client, pay broadly the same National Insurance Contributions as employees.

Inexplicably, the mini-Budget has repealed those rules with effect from next April. This is actually of interest to New Zealanders in two forms. Firstly, Kiwis working over in the UK have made use of personal service companies and I’ve come across instances where they’ve been caught up in investigations into their use by HM Revenue and Customs.

But they’re also of interest here because the use of contractors and personal service companies might be something that could pop up in the context of the proposed social insurance levies that are currently working their way through consultation in Parliament. It could be that companies may attempt to use a similar mechanism to avoid paying those levies. The Government here might want to watch this much more carefully if the social insurance proposals do go ahead.

And finally, the UK has an Office of Tax Simplification, which was set up in July 2010 to advise government in simplifying the UK tax system. In another surprise move it will be abolished and its role in simplifying the tax code will be taken over by the UK Treasury and H.M. Revenue and Customs. It’s an interesting move but a bit disappointing because it’s always nice to have an independent agency outside tax authorities or Treasury looking at this sort of matter. On the other hand, the UK tax year still runs to 5th April, so a cynic might say maybe it hadn’t got that far with simplification.

Well, that’s all 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 time kia pai te wiki, have a great week!

Te wiki o te tāke: Details on IRD’s handling of the cost-of-living payments. A doomed tax case highlights the need for change. The OECD on international tax policy reforms.

Te wiki o te tāke: Details on IRD’s handling of the cost-of-living payments. A doomed tax case highlights the need for change. The OECD on international tax policy reforms.

29 Nov, 2022 | The Week in Tax

Earlier this week, Nicola Willis, National’s finance spokesman, released information she had obtained from Inland Revenue regarding the cost-of-living payments. Included in this information was the fact that some 6,629 payments were made to individuals with overseas mailing addresses. Now it is possible that some of those persons did actually meet the criteria of being tax resident and also physically present in New Zealand at the time of the payment, however it seems more likely most of those payments were made to ineligible recipients.

This data supports anecdotal evidence I’ve heard from other tax agents who have reported examples of non-resident clients receiving the payment. And the fact that a significant number of payments were made to apparently readily identifiable non-residents is concerning is concerning and points to a potentially systemic error.

Nicola Willis also asked a number of questions regarding ineligible recipients. According to written answers provided by the Minister of Revenue currently, Inland Revenue is not aware of any recipients who were either in prison or under the age of 18, which is a bit reassuring.

It also emerged that 49,300 payments were made to persons who only declared investment income. Now that’s an interesting statistic itself, but as an Inland Revenue spokesman noted, the eligibility conditions did not prohibit payments to such persons so long as they met the three key criteria of their income being under $70,000 are tax resident and are physically present in New Zealand at the time of payment.

In the wake of the fallout from the first payment cycle in August, Inland Revenue has tightened up its processes before the second wave of payments made at the start of this month. As a result, the number of people receiving cost-of-living payments dropped by about 54,000. These types of checks apparently included Inland Revenue screening and questioning people who accessed their myIR accounts from an overseas Internet address.

MyIR is likely to be an extremely useful tool for Inland Revenue for spotting potential discrepancies. I do know one case where they noted that some numerous changes had been made to a draft return before it was finalised and when the return was subsequently investigated it turned out that the changes had been aimed at maximizing the available foreign tax credits in excess of what was allowable.

In relation to the cost-of-living payments errors were inevitable given that they would be made to an estimated 2.1 million recipients. For me, the bigger issue here is whether Inland Revenue is properly resourced. It estimated it required between 750 and 1,000 staff to deliver the payments.  This is the equivalent of nearly 25% of its headcount of 4210 as of June 2021. The questions I’d be raising is why are so many additional staff required, particularly when you consider that Inland Revenue has just completed a $1.5 billion Business Transformation programme?

There’s also the question that there does seem to be a systemic error in relation to those payments made to individuals with overseas mailing addresses. In short, this is disappointing and shouldn’t really have happened. No doubt we’ll hear more about this as National is firing lots of questions on the matter at the Minister of Revenue, its MPs address on average somewhere between 80 and 100 written and oral to the Minister of Revenue each month.

Doomed, but an important point made

Moving on, last year I discussed a Taxation Review Authority (“the TRA”) case in which the taxpayer wanted assessments to be amended to reverse the effect of the over-taxation of a lump sum payment of $150,000 she had received from the Accident Compensation Corporation. This payment represented backdated compensation in respect of the previous compensation, which she should have received over the period April 2014 to September 2017. Instead, the back dated compensation was eventually paid as a single sum and subject to PAYE.

At the time, the taxpayer argued that this represented over-taxation as the payment should have been treated for tax purposes as having been derived on the accruals basis and spread over the income years to which the payment related. The Taxation Review Authority dismissed her challenge, but she has taken her case to the High Court who heard it late last month.

Her appeal was pretty much doomed from the start because currently there is no authority for the payment to be treated as she wishes, although conceptually I believe it’s a reasonable approach. And it transpired that it was a doomed appeal because the High Court declined to exercise its discretion to extend the time for her to file an appeal against the TRA decision.

But as I said, I think the point she is making is valid. Subsequent to the TRA case I obtained information from ACC under the Official Information Act about how many people had received backdated compensation.

And it turns out hundreds of people each year do receive such payments. I therefore took the matter up with Inland Revenue and Parliament’s Finance and Expenditure Committee. I understand that Inland Revenue officials are currently reviewing the treatment of lump sum payments made by ACC and the Ministry of Social Development with a view to reporting to ministers in the coming months. I’ll update you on any developments as they emerge, but that does sound hopeful.

Global tax reform effort broad but it stutters

Yesterday, the OECD released its annual publication on tax policy reforms. This provides comparative information on tax reforms across countries, and this edition focuses on the tax reforms that were introduced or announced during 2021. This 2022 edition has the largest country coverage in its history. It covers the tax policy reforms made in 71 member jurisdictions of the OECD/G20 inclusive framework on the Base Erosion and Profit Shifting on international tax reform and includes all 38 OECD countries.

The report (not available as a download) breaks down into four parts. The first looks at the macroeconomic background and includes an overview of developments in the global economy. Part two presents the latest trends in tax revenues and in the composition of taxes and also identifies how these were affected by the arrival of the pandemic in 2020. Part three provides detailed description of those tax reforms that were introduced in calendar year 2021. Part four is a special feature which examines measures countries have introduced in response to rising energy prices and also has some policy recommendations.

The key policy trends identified are that personal income taxes and Social Security contributions reduced in most countries, as policymakers tried to boost economic growth and promote equity. That said, changes in personal income tax rates were less common than in previous years. Measures were targeted towards low- and middle-income households, particularly those with children aimed at promoting employment and providing in-work benefits.

Corporate income tax rates were cut in four countries. And the general convergence of corporate income tax rates across the countries continues. However, the big development last year was the agreement of 137 jurisdictions to the Two Pillar solution to reform international tax rules. Now, that seems to be stalling at the moment, but still, as I said, represents a major development.

With regard to VAT (Value Added Tax or GST), not many changes happened last year other than the reversal of most of the temporary VAT reductions introduced in the wake of the pandemic in 2020.

In the field of environment related taxes, the OECD report some progress, but at a slower pace than previously. The effect of carbon prices remains low overall because of the temporary cuts to energy taxes that started to come in with effect towards the end of 2021.

In relation to property taxes there were some measures introduced promoting progressivity and fairness. These predominantly involved tax rises either through increases in tax rates or base broadening measures. The bright-line test being extended from 5 to 10 years last year is one such example of that. The report points out that such measures are often trying to promote the efficient use of existing housing stock as well as greater fairness of property taxation, a long running theme of this podcast.

Part Four on the support measures introduced by governments to try and protect households and firms from the impacts of high energy prices is interesting reading. Here in Aoteaora New Zealand, the major energy issue has been the impact of petrol prices. Fortunately, because of our high renewable sector, we’ve been somewhat shielded from the impact of higher energy prices. But if you’ve seen reports coming out of Europe and Britain in particular, you will know that some horrific energy price rises are either on the horizon or are happening right now.

The OECD report recommends a shift towards more targeted measures aimed at helping those on lower incomes. This “may require improvements to existing transfer and social welfare systems.” So as often with a lot of the stuff we see coming out of the OECD it’s very interesting to see international trends and consider those in a New Zealand context.

Well, that’s all 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 time kia pai te wiki, have a great week!

Te wiki o te tāke: Watch out for those tax traps, Treasury points the finger at current tax settings for housing, a long overdue AML ruling, and the Queen avoids hundreds of millions in tax.

Te wiki o te tāke: Watch out for those tax traps, Treasury points the finger at current tax settings for housing, a long overdue AML ruling, and the Queen avoids hundreds of millions in tax.

29 Nov, 2022 | The Week in Tax

We frequently discuss Binding Rulings issued by Inland Revenue and a couple issued this week illustrate why you need to be thinking of potential tax issues in what might seem relatively routine transactions.

Binding Rulings are Inland Revenue’s interpretation of how the tax law applies to a particular arrangement.  The whole purpose behind the binding ruling process is to provide greater clarity. Most of those we discuss are public Binding Rulings but there are also product binding rulings where a product provider wants to get clarity on the tax consequences of the particular product or transaction that’s happening.

Two such product rulings this week illustrate the point. The first one is for Sustainable Mobility Limited trading as Zilch. What Zilch does is provides electric vehicles to a business customer who uses the vehicles for business purposes. Under the arrangement, the driver–employee of the business customer to pay Zilch for the use of the vehicles for their private purposes.

Zilch was concerned about whether this arrangement might give rise to a fringe benefit for anyone who uses these vehicles. In the product ruling Inland Revenue confirmed subject to meeting all the conditions set out in the ruling the use of the vehicles would not be regarded as a fringe benefit.

The second ruling is in respect of a Westpac mortgage offset arrangement. Westpac customers can elect to use the balance of eligible transaction and savings accounts to offset against home loan accounts. And the idea is more efficient use of those funds will reduce the interest payable on the home loan accounts. The concern here was whether this would give rise to issues under the financial arrangements regime, the quantum physics of New Zealand tax where there are plenty of hidden tax traps.

Inland Revenue ruled that the offsetting in itself does not give rise to any income or expenditure under the financial arrangement fees. Furthermore, no requirement to deduct resident withholding tax on offset transactions arises. Technically, if there had been a payment for the purposes of the Income Tax Act does that represent a payment of interest? And therefore do resident withholding tax or non-resident withholding tax apply? Subject to meeting the conditions, no, according to the ruling.

Now, you can look at what we’re seeing here is just examples of the traps you can find in what appears at first sight to be relatively routine transactions. Offsetting credit balances to minimise interest, you would think, “Oh yeah, that makes a lot of sense.” But then you drill into it and you hit the financial arrangements rules, and then suddenly there’s a number of issues you have to consider.

There are two key points. One, organisations offering products need to be careful about the tax consequences involved. Secondly, once they have done that asking Inland Revenue for clarity around the arrangements is a good first step. Product Rulings do involve a fee payable to Inland Revenue ad they can take a bit of time. They do provide certainty and you can probably use the ruling as a marketing tool as well. So as always, with taxes, plenty of unintended consequences to be mindful of.

House deposit unaffordability

Moving on, a few weeks back, I mentioned a report that had been produced by The Treasury, the Reserve Bank, the Ministry of Housing and Urban Development. In the form of the Housing Technical Working Group had published an assessment of the housing system with insights from the Hamilton-Waikato region.

Last Friday, Dominick Stevens, (formerly the Chief Economist at Westpac but now the Deputy Secretary and Chief Economic Adviser to Treasury), delivered the opening comments at the Economic Policy Centre’s Workshop on Housing Affordability at the University of Auckland.

He referenced the Housing Technical Working Group report and then expanded on Treasury’s conclusions were on the implications for policy.

His speech is very worthwhile reading because it does cover the whole ambit of economic policy on housing, with plenty of interesting insights. For example, apparently there’s very little relationship between where house prices have risen the most and the regions with the most population growth or the most acute housing shortages, which is an interesting conclusion in itself.

I think one of the real major insights generally is that high house prices and low interest rates affect deposit affordability more than mortgages for affordability or rent affordability. Basically, mortgages are affordable because we’re in a low interest regime, but accumulating the deposit in order to purchase a property is not so manageable and there are some fairly alarming looking graphs illustrating that particular issue.

Treasury’s conclusion was we already knew “that houses are income tax advantaged relative to many other forms of investment due partly to our lack of a comprehensive capital gains tax.” But then he expanded on this by noting

“…the more restricted the supply of land, the more that changes to the tax system will be capitalised into the value of urban land, rather than affecting housing supply or rents. Our Assessment concluded that tax distortions have added significantly to the price of scarce urban land in New Zealand. In the current context, reducing these tax distortions would make land cheaper, and would have less effect on rents or housing supply. Indeed, last year’s change to the tax treatment of some investment properties may have influenced urban property values.”

A couple of really interesting conclusions here. Firstly, tax settings really have made an impact on house prices and the changes last year may have eased those issues to some extent. When you consider that you’re only getting a full interest deduction for new builds, that directs investment towards concentrating housing in urban area and hopefully both brings down house prices and increases the supply of housing.

Plenty more to watch in this space and no doubt there will be some controversy about the matter. And there is actually a few more interesting papers from that conference which we will try and pick up on another time.

DIA still traveling at a snail’s pace

Tax agents and Accountants have been subject to the Anti-Money Laundering and Countering Financing of Terrorism provisions for a number of years. To be honest these measures weren’t entirely welcomed. In the run up to the introduction of the provisions in 2018 I was at a couple of conferences where the Department of Internal Affairs officials telling us what we must do and this was the way it was going to be, were greeted with a fair amount of scepticism, to put it mildly.  One of the issues raised was how the compliance costs were going to fall on small businesses.

One of the other issues identified, but which at that time DIA officials did not have answers for, was in relation to tax transfers in two scenarios. One is where the taxpayers may have overpaid tax and they want to transfer that overpayment to a related party or associated party. The other scenario was transfers made by tax pooling agents, such as Tax Management New Zealand, Tax Traders and Tax Solutions. These are all companies to which you make tax payments which sit in a pool and are transferred across to Inland Revenue to meet tax liabilities.

We wanted to know whether these were subject to the AML regulations and initially, the advice was that they were subject to the AML regulations. We raised this issue more than four years ago questioning whether this was proper. Is that really what the AML legislation should be targeting?

And finally this week the Associate Minister of Justice granted a class exemption from most of the AML regulations for accounting practices (including accountants, bookkeepers, tax agents, and insolvency practitioners) carrying out “most” types of tax transfers under the Tax Administration Act 1994 or “most” types of tax transfers.  The question of transfers from tax pooling companies is still to be decided.

This class exemptions is a good thing to have, but the question remains why has it taken four years to get this to this position? This was an issue identified, as I said, many years ago, before the legislation started to apply to accountants and tax agents. And yet it’s only now that particular matter, which is something we do all the time has been resolved.

So, one step forward, one step sideways. But you do wonder whether the agencies are resourced well enough to be managing these questions and what other businesses have been raising questions, saying, “Here’s a standard business practise which we think shouldn’t be covered. Can you give us a ruling on that?” We’ll have to wait and see.

Monarchs go tax-free

And finally, with the Queen’s death dominating the news headlines a bit more on the Royal finances. It’s quite fascinating to see all the rituals on the death of the Queen. For example, the King’s Duchy of Cornwall Estate, which is apparently worth £1 billion, passed automatically to Prince William. The Duchy of Cornwall goes back to 1337 and owns some centuries old assets including the Oval Cricket Ground in London as well as Dartmoor Prison.

Apparently, the total crown estate is worth £15.2 billion. As for the Queen’s own estate, this is quite substantial for example, she received £70 million free of inheritance tax from her mother back in 2002. Although the UK has inheritance tax, under an agreement reached with the Queen in 1993, it does not apply to sovereign-to-sovereign transfers.  The majority of the Queen’s estate will pass to the King without inheritance tax.

However, if any bequest was made by the Queen to anyone other than King Charles, then inheritance tax at 40% would apply. It will be interesting to see what the Queen’s final inheritance tax bill will be.

Well, that’s all 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 time kia pai te wiki, have a great week!

Inland Revenue wins an award but loses a case, tax advisers overwhelmingly support a CGT and how much tax do 16 and 17-year-olds pay?

Inland Revenue wins an award but loses a case, tax advisers overwhelmingly support a CGT and how much tax do 16 and 17-year-olds pay?

29 Nov, 2022 | The Week in Tax

Inland Revenue regularly releases Technical Decision Summaries (TDS). These are summaries from its Adjudication Unit in relation to dispute cases of interest between Inland Revenue and taxpayers. These give a good indication of Inland Revenue thinking around particular topics and how it might react to a transaction.

TDS 22/21 released last week is particularly interesting. It involves a two-lot subdivision carried out on a property by a taxpayer. He had initially purchased the property when working offshore for the purpose of renovating and extending it to live in with their extended family. Once the property was purchased, the extended family moved into the dwelling and the taxpayer joined them later on his return to New Zealand.

He then started planning to extend the property, but it emerged that there were problems with drainage and asbestos. Instead, it was suggested that the taxpayer should subdivide the property into two lots, constructing a new dwelling on each lot. And that’s what happened, during which time he was working overseas and visiting intermittently. Once one of the new properties was constructed, he occupied it for eight months. Shortly after the subdivision was completed one property was sold and the taxpayer and his extended family continued to live in the other property for a further five years.

Inland Revenue argued that the taxpayer had entered into an undertaking or scheme with the dominant purpose of making a profit under section CB 3 of the Income Tax Act. This provision is outside the normal land tax provisions, which is slightly unusual. Inland Revenue also ran the argument that the property was acquired for the purpose of intentionally disposing of it under CB 6, which is within the land taxing provisions. The question arose whether there was relief available because it was a main home. And finally, Inland Revenue also raised the question whether the sale of the subdivided lot and the property was subject to GST.

It seems part of the issue here may have been Inland Revenue just didn’t believe what they were being told. The Technical Decision Summary reasons for the decision opens with a reminder that the onus of proof is on the taxpayer to prove that an assessment is wrong, why it is wrong and by how much it is wrong.

This case turned out to have a good outcome for the taxpayer, because the Adjudication Unit ruled that the taxpayer did not enter into an undertaking or scheme for the dominant purpose of making a profit. Therefore, the gain wasn’t taxable under section CB 3. The Adjudication Unit ruled the taxpayer acquired the property for the sole purpose and with the sole intention of creating a home for themselves and their extended family. Therefore, the sale of the second lot was not taxable under section CB 6.  It followed that as the property had been occupied mainly as residential land prior to subdivision, an exclusion applied.  Finally, the taxpayer did not carry out a taxable activity for the purposes of the Goods and Services Tax Act, so no GST applied to the transaction.

The taxpayer won on all points. But there are several interesting points here. First is that Inland Revenue even took the case and the arguments it ran. This transaction appears to have happened before the Bright-line test was introduced, the TDS isn’t clear about the timing. The attempt to apply section CB 3 is unusual.

Secondly it highlights that Inland Revenue is paying attention to just about any property transaction and it’s prepared to use all provisions that are available to it. The case is a reminder to keep good records. I think the taxpayer struggled initially because not enough evidence was available, but they were eventually able to persuade the Adjudication Unit of what had happened.

Tax professionals vote for a Capital Gains Tax

Moving on, the Technical Decision Summary does point to an ongoing strain within the tax system around the taxation of capital gains. In many jurisdictions that have capital gains taxes the issue we’ve just been discussing would be not on whether or not the transaction was taxable, which is an all-or-nothing proposition, but what proportion might be taxable.

It’s therefore interesting to see that at the Chartered Accountants of Australia and New Zealand’s National Tax Conference recently, a poll was conducted on the introduction of a capital comprehensive capital gains tax. The question was put would you prefer to have a comprehensive capital gains tax as proposed to the evolving status quo, which is actually a very generous description of the evolving state, still, to be frank.

(Photo by Richard McGill of PwC)

I wasn’t at the conference. I would have voted yes, although plenty of caveats around how we might go about it. It’s also tempting to respond, “Well, that is a lot of self-interest by accountants voting for such a measure.” I know that I’ve seen similar comments pointing out when I raise the issue that of course I would support it because I get extra work out of that. I find it ironic to be accused of acting out of self-interest when the flipside of it equally applies people who don’t want a capital gains tax would also be saying so out of self-interest. Self-interest arguments cut both ways, in my view.

I do happen to think that self-interest is a problem in the tax system around this whole area. It’s very difficult to see how parliamentarians owning substantial capital assets are going to ever going to vote for something which is directly against their own self-interests. 

The feedback from the CAANZ conference was that it’s necessary to keep our tax system comprehensive and robust. And it would actually simplify quite a lot of measures that we see right now. For example, if you had a capital gains tax, you wouldn’t have to work through the bright line test and its various iterations. You could remove the foreign investment fund rules, another set of rules which are complex and not well understood. And you would also probably remove, or certainly reduce the need for measures such as restricting interest deductions. This has been introduced partly as a response to the absence of a capital gains tax.

In my view, there’s a lot of distortions in the tax system because we don’t tax capital gains, and we are seeing more and more of that. At last year’s International Fiscal Association’s annual conference many of the issues we were debating really revolved around the strains on the edges of the tax system produced by not taxing capital gains.

A CGT is not going to be popular with politicians or for those who would be affected. But the rest of the world manages these strains. So, to pretend that we can get by without a CGT and continue the current incoherent approach to taxing capital gains, is a position that just simply isn’t sustainable in the long term.

Updates on global tax coordination

Now, moving on, in international tax news the OECD released its latest corporate tax statistics. There’s a lot to consider here which I’ll discuss next week.

The OECD also released data relating to the latest Mutual Agreement Procedure statistics covering 127 jurisdictions and practically all the mutual assistance cases worldwide. These Mutual Agreement Procedure cases arise when two or more tax jurisdictions want to resolve the tax treatment of a transaction or entity where each jurisdiction thinks they have priority. Transfer pricing issues are often involved.

According to the OECD, approximately 13% more Mutual Agreement Procedure cases were closed in 2021 than in 2020. But fewer new cases started this year, which is a small, unusual trend given the internationalisation of the global economy. But these Mutual Agreement Procedure cases do take some time to resolve, on average, about the 32 months for transfer pricing cases and 21 months for other cases.

But amidst all this, there’s some good news, including an award for Inland Revenue which together with Ireland was awarded the prize for the most effective caseload management. The most improved jurisdiction was Germany, which closed an additional 144 cases with positive outcomes – that is, the matter was fully resolved.

These awards seem a bit of fun, but actually it’s a pretty important matter because with the Base Erosion and Profit Shifting and the hopefully soon introduction of the Two-Pillar international tax agreement, the role of Mutual Agreement Procedures in resolving disputes is going to be important. It’s encouraging to see jurisdictions are making progress and cooperating better

Paying tax and the right to vote

And finally this week, the Make it 16 win in the Supreme Court over the potential voting rights of under 18 caused quite a stir.  David Seymour of ACT jumped in with a rather ill thought out comment “We don’t want 120,000 more voters who pay no tax voting for lots more spending.”

From the first time a child uses their pocket money to buy an ice cream and dairy, they’re paying tax. It’s called GST, which at over $26 billion is a quarter of the Government’s tax revenue. And as I pointed out on Twitter, lots and lots and lots of under-18s pay GST.

(The total of local government rates is an estimate. It appears the true figure is just over $7.3 billion)

The Make It 16 group made an Official Information Act request to Inland Revenue about how much tax 16- and 17-year-olds pay. And according to Inland Revenue over 94,600 16 -and 17-year olds paid a total of $82 million in income tax during the year ended 31 March 2022. That’s not an insubstantial amount of money (and doesn’t take into consideration the GST they also paid).

Given that 16 is the age of consent and 16 year-olds may drive, I don’t see much logic in saying that’s too young to vote. The kids are all right in my book.

Until next time kia pai te wiki, have a great week!

PM’s Department warns Inland Revenue off looking at a CGT

12 Sep, 2022 | The Week in Tax

  • PM’s Department warns IRD off looking at a CGT
  • The IRD admits not having the data on non-compliance with fringe benefit tax
  • Residential property investment looks very undertaxed compared to other investments

Transcript

After the dramas of last week’s tax bill being introduced and then withdrawn within 24 hours, it’s been a calmer week in tax. On Thursday the tax bill was reintroduced without the offending provisions relating to GST on fund manager services. Interestingly, there has been some more measured discussion as to the merits of that proposal, and I do wonder whether a government might introduce an amended proposal at a later date, perhaps this time with any GST raised use to boost incentives for lower income Kiwi savers, such as the proposal made by the Tax Working Group.

Elsewhere this week, I got involved in some interesting debates over the question of whether the tax thresholds should be raised. My view is yes, but on the Today FM show, Max Rashbrooke made the alternative case for better targeting of low-middle income earners. I agree with host Tova O’Brien that tax is going to be a big issue in next year’s election. And like many of us she was looking forward to seeing what the tax policies of the various parties would be.

Whatever policies we’ll see next year will be they’re almost all certain to address the issue of raising productivity in New Zealand and what part tax and economic policy will play in achieving that goal. And that is the subject of an interesting paper released by Inland Revenue just a couple of weeks back. This is the first long-term insights briefing which public service agencies are required under the Public Service Act 2020 to publish at least once every three years. These briefings are designed to provide information on medium and long-term trends, risks and opportunities and provide, “impartial analysis on possible policy options”.

Inland Revenue’s chosen subject was Tax, foreign investment and productivity. A really meaty topic and the whole paper runs to 111 pages. As the briefing explains, it examines how New Zealand’s tax settings are likely to affect incentives for firms to invest into New Zealand and also benchmark our tax settings against those in other countries.

The initial evidence is that, compared with other OECD countries, we appear to have relatively high taxes on inbound investments. This then gets down to the question whether those tax settings are

“likely to mean higher costs of capital (or hurdle rates of return) for investment into New Zealand than for investment into most other OECD countries. High taxes on inbound investment have the potential to reduce economic efficiency and be costly to New Zealanders by reducing New Zealand’s capital stock and labour productivity.”

I think economists would be looking at this paper with some great interest as well. Now, the OECD analysis that is often used for comparison purposes looks at company tax provisions. But this paper also notes that there are other broader tax issues that should be taken into consideration. And when you take a broader perspective, maybe New Zealand isn’t as much as an outlier as it first appears.

What the briefing is intended to do is, “initiate a process of discussion on these sorts of issues.” The briefing considers several possible tax changes, namely:

  • a cut in the company tax rate
  • accelerated depreciation provisions
  • inflation indexation of the tax base
  • a higher thin capitalisation rule safe harbour
  • an allowance for corporate equity
  • special industry-specific or firm-specific incentives, and
  • a dual income tax system.

These measures are all possible ways of lowering the costs of capital. And some of those can also promote tax neutrality. However, there is unlikely to be a single best option, and choices between the options will ultimately depend on what weightings are given to the possible objectives of reforms.  Of course, politics comes into play, for example, a lowering corporate company income tax rates for non-resident investors isn’t going to be terribly popular because that might mean higher tax rates for individuals. Therefore, there are these series of tradeoffs that have to be considered.

The briefing is accompanied by 45 pages of appendices. Some of the papers referenced are quite interesting. One in particular caught my eye, was prepared in 2016 by a couple of American economists relating to accelerated depreciation allowances, a measure that’s often promoted. As there’s a wealth of data available in America, these economists and analysed data for over 120,000 firms.

They presented three findings. First, accelerated depreciation raised investment in eligible capital relative to ineligible capital by 10.4% between 2001 and 2004 and then by 16.9% when it was reintroduced between 2008 and 2010. Their second finding was that small firms responded 95% more to that incentive for accelerated depreciation than larger firms. I think this is particularly important in the New Zealand context. Finally, firms responded strongly whether these policies of depreciation in generated immediate cash flows, but not necessarily when cash flows were in the future. In other words, firms were very interested in short term quick return investment. Now, given that I think our smaller firms are under-capitalised and we have lower productivity, obviously one of the points for future discussion from this briefing is about the role of accelerated depreciation.

Now, the object of the briefing isn’t to propose a single solution. It is, “…to start a conversation on what people see as the most important objectives for reform and whether particular reforms are worth considering further.”

When Inland Revenue initially put out an issues paper saying this was the proposed subject of its briefing it asked for responses. A few replied raising the issue of how the absence of a capital gains tax just reduces the coherence of the tax system, and there may be productivity concerns because of the light taxation of property. The briefing addressed these issues as follows:

“The Department of Prime Minister and Cabinet has advised that briefings should not focus on issues that have already been subject to considerable analysis. Capital gains tax was considered by the recent tax working group and the government decided against a general tax on capital gains. Therefore, we, the briefing, are not making a capital gains tax on property or a more general tax on capital gains a central focus because it has been the subject of recent debate and policy consideration.”

The problem with this approach is this is a meant to be a long-term insights briefing, and taking capital gains out of the picture immediately circumscribes its value. And by the by, in most cases, any foreign investors are subject to capital gains tax in their own country. Capital gains tax is a factor anyway for offshore investors and so maybe we should be factoring it in here.

To be fair, once you’ve gone through the paper and you understand what is driving it, the absence of commentary on capital gains tax although disappointing, shouldn’t be a distraction from what is a very interesting and valuable paper with plenty to digest. I do recommend reading this as it contains some very interesting issues, such as the idea of a dual income tax system which individually could be the subject of a podcast.

FBT reviewed

Moving on Inland Revenue has also released its 49-page Fringe Benefit Tax regulatory stewardship review. This is something else required under the Public Sector Act 2020 which requires regulatory stewardship reviews to ensure that policy and operational responsibilities are effective and operating as intended. Last week I mentioned how the new tax bill reintroduced this week gives an exemption from FBT for the provision of public transport. I noted the current treatment as an example where one set of tax policies probably doesn’t sit well with a wider set of objectives

FBT was chosen for review because it hasn’t been fully reviewed since some minor changes were made nearly 20 years ago. And as the review notes, over time, stakeholders have raised problems with the design and operation of FBT. The review is seen primarily as a diagnostic exercise investigating three questions:

  • Does the design of FBT meet the policy intent?
  • What is the employer and business experience of complying with FBT?
  • How does Inland Revenue administer FBT?

The review also considers whether FBT as in its current format is fit for the future, taking current workforce trends into account with more and more people working from home now.

The summary conclusions are that it does perform its primary task of ensuring that remuneration from employment is taxed, whether it’s paid in cash or provided by way of a non-cash benefit. FBT is one of those taxes which is as much designed to support the tax base by tackling anti avoidance behaviour as well as raise tax. But as the review then notes

“However, it is not clear that FBT is a tax that functions well. Consistently, views expressed to the review team were that FBT is complex and that it imposes a high administrative and compliance burden relative to the tax at stake.”

There was also this interesting feedback “many interview participants felt that any intuitive connection with remuneration had been lost.”

FBT was introduced in 1985 to counter an avoidance of PAYE on salaries by providing people with non-cash benefits. Initially it had a very important role, particularly since back then tax the top tax rate was still 66%. However, a lot has changed in the last 37 years.

One of the main points that comes out of the report is that submitters feel FBT is not being complied with by all businesses and it’s not being enforced by Inland Revenue. This is seen as unfair by those who shoulder the compliance burden. The official response is “Inland Revenue is unable to comment on the amount of non-compliance with the FBT rules using existing data, although the use of START at its new computer will enable a more timely and targeted compliance approach.”

That is a hell of an admission. The review then points out if non-compliance with FBT rules is perceived to be risk free, then that perception could undermine the integrity of the tax system as a whole. Therefore, this risk needs to be addressed.

The review then puts up a couple of proposals to do so. Firstly, which many might see as a bureaucratic answer, commission a policy project to act on the findings of the review. This would be to conduct an enquiry into fundamental reform, for example moving benefits-in-kind into the PAYE system. That was something not supported by interviewees. Secondly, “requiring operations to take steps to address the concerns raised about compliance and enforcement”, which might be more crudely and accurately expressed as “Do your damn job Inland Revenue”. And that is where I would begin.

We probably should have a review of fringe benefit tax and how it operates and whether the current system is fit for purpose. It definitely is compliance intensive. And there’s also this widespread perception of non-compliance, particularly in in in in regard to the definition of work-related vehicle and the rise of the twin-cab ute and whether such vehicles are genuine work-related vehicles. At the same time, I believe you have to enforce the current law because the perception might arise that the integrity of the tax system is being undermined. That’s actually in breach of official’s duties under the Tax Administration Act. I think it does no harm to show that compliance of the rules is required. Plus, it might raise a little bit of extra revenue.

There is some interesting commentary about how much revenue FBT does raise. For example, in the 2019/20 tax year, the Inland Revenue collected $592 million of FBT, which is 24% up on the $479 million collected in the 2009/10 tax year. However, back in the early 1990s FBT revenue was close to 5% of PAYE revenue and around 3% of direct income tax revenue. But now it’s closer to 1.6% of total PAYE revenue and about 0.9% of total direct income tax revenue.

FBT revenue rose steadily between its introduction and 1989 but then significantly reduced between 1990 and 1995. This decline may be the result of changes to the definition of benefits subject to FBT, but it may also reflect employers responding to its advent and switching to cash only salary packages. There may also have been some tax planning around trying to mitigate FBT.

FBT is paid by a relatively small number of taxpayers. Nearly 69% is paid by employers of 101 or more people. And in fact, that according to Inland Revenue data. Employees with 501 or more employees represent just 2% of all FBT filers, but 41.4% of all FBT paid for the year ended 31st March 2020.

For me the key takeaway here is that Inland Revenue really needs to begin to put some resources into management of FBT. I have heard commentary that it didn’t feel it was worthwhile, but there are spin-off effects. As noted, the perception of the integrity of the tax system is undermined. And also, there’s the wider policy objectives we mentioned. If FBT isn’t being monitored, how does that fit with the wish to reduce emissions? If it turns out people think, well, actually, work-related vehicles don’t pay FBT, then people might continue to use relatively inefficient vehicles. We’ve seen, by the way, with the green car discounts, how much an incentive in terms of cashback has made a difference with new registrations.  Moving FBT perhaps to an emissions-based charge such as they do in Ireland and the UK, might have some interesting implications and help drive down emissions.

One of the drivers behind the long-term inside’s briefing is that changes to the tax settings will drive foreign investment. It’s not a particularly revolutionary insight. There’s no doubt tax affects investment decisions.

Tax affects investment decisions

A very clear example of that, in my view, is when we consider the taxation of residential investment property, which I discussed with RNZ’s The Panel on Wednesday. This stemmed from an Official Information Act request I made to Inland Revenue asking for details of the number of taxpayers returning residential property investment income, how many reported net positive income, how many reported losses and what was the net income returned.

I shared my information with Geraden Cann of Stuff who ran the story.

In summary for the year ended 31st March 2019, 36% of all those filing individual tax returns and reporting rental income incurred a loss. For the year ended 31st March 2020 that proportion fell to 32%, and in the year ended 31st March 2021, it fell further to 27%. As you can see in the year ended 31st March 2021 about 240,000 people reported rental income with 173,500 in profit but 63,600 with losses amounting to $358 million. The net income rental income reported for the year was $1.428 billion. According to the Reserve Bank of New Zealand’s statistics, the valuation of residential investment property as of 31st March 2021 was $369 billion. That represents a pretty poor 0.4% return pre-tax.

So why are investors investing in residential property then? Because that return is not much better than you might have got if you put your money in the bank. The obvious answer to that is hoped-for tax-free capital gains plays a part in their decision-making. that. To be fair, that’s an understandable investment decision. If property prices are going to rise 20%, and you’re not being taxed on that 20% gain and you’re generating sufficient income to manage your costs, which is what two thirds of taxpayers seem to manage, then that’s not an unreasonable investment decision.

But at some point you have to realise that investment, which does beg the question which has been addressed in another academic paper, can you actually say that you did not purchase with an intent of sale. How otherwise does the investment makes sense without having to sell it?

I also asked for a breakdown of the number of residential properties held. Inland Revenue ‘doesn’t have comprehensive information’ so it responded

“We do, however, hold partial information based on the IR3R calculation worksheets used by a subset of around 60,000 property owners who use this form as an input to their filing. Proportions calculated from this subgroup of taxpayers for the 2020-21 tax year are provided in Table 2.

The IR3R calculation worksheet tends to be used by unincorporated taxpayers (individuals or trusts) who are likely to have smaller investment portfolios. The supplied proportions are not necessarily representative of the wider picture incorporating all residential rental taxpayers and all entity structures.”

As you might expect, 25% of all those holding between one and three properties report a loss. The proportion holding between 4 and 9 drops to 0.42%. Quite remarkably, among those with ten or more properties, 0.1% do report losses. One suspects that group are extremely heavily leveraged, and probably these positions are likely to change as interest limitation rules take effect.

Context

To put this in context, the Financial Markets Authority publishes a KiwiSaver Annual Report. This details the number of KiwiSaver schemes, the value of those schemes and actually the income reported and tax paid by all KiwiSaver schemes. The total value of KiwiSaver schemes was $81.6 billion and the total tax paid by KiwiSaver schemes was $474.6 million.

As I mentioned, the net pre-tax profit for the year ended 31st March 2021 for investment properties was $1.42 billion. Assuming a maximum 33% tax rate, that would equate to roughly $470 mln in tax. In fact, it’s almost certainly a lot lower because of not every taxpayer with investment property would be taxed at 33%.

When you look at the amount of capital invested in housing, $369 billion and the amount of capital invested in KiwiSaver, $81.6 billion, there’s approximately 4.5 times more capital invested in housing. But the taxable returns are so much lower that relatively speaking, they’re a quarter of KiwiSaver returns so the tax take ends up being broadly similar.

A really big question therefore arises around the efficiency and allocation of capital. That is why it is a bit disappointing Inland Revenue’s long-term insights briefing didn’t address that matter. But I understand that Treasury has been looking the housing issue and has come to the conclusion that tax settings have been a real driver of house price inflation. As I said on RNZ people have made rational decisions to invest in property but those also come with consequences.

And in my view, one of those consequences is inefficient allocation of capital. We also have rising inequality and essentially the arrival of a landed gentry, which means that if you do not have parents or family that can help you into housing, you’re likely to be unable to ever get on the property ladder. That’s not a particularly great scenario to have and coming back to the point Tova O’Brien made is something that next year we should be seeing the politicians talk about the sort of tax policies which address all these issues.

Revisiting 1952

And finally, our condolences to the Royal Family on the passing of the Queen. Just to put her 70-year reign in context, the population of New Zealand in 1952, when she became Queen, was just under 2 million. The Government’s total tax receipts for the year ended 31 March 1952 were just over £200 million or approximately 25% of GDP.

Some interesting taxes used to apply back then including an ‘Amusement tax’ which collected £308,000. The top tax rate was 60% and there was also Social Security in addition. Income tax represented 49% of all tax collections (it’s now nearly 67%). Incidentally, Land Tax, Death and Gift Duties, all now repealed, collected more than £9 million or 4.6% of the tax take. Taxes change over time. But it’s interesting to be coming back to the question of taxing capital. We didn’t have a capital gains tax in 1952, but we did tax capital. Maybe the pendulum is swinging back again.

Well, that’s all 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 time kia pai te wiki, have a great week!