The just concluded UK general election was the first general election held in July since 1945, when coincidentally the Labour Party also won by a landslide ending Sir Winston Churchill’s wartime prime ministership. Before he became Prime Minister again in 1951, Churchill started writing his monumental six volume history of the Second World War, the first volume of which was titled The Gathering Storm.
And if you’ll pardon the somewhat laboured analogy, this is very much what’s happening with Inland Revenue at the moment. There’s a very clear gathering storm approaching as Inland Revenue pulls together and beefs up its investigation resources. We saw signs of this a couple of weeks back with its commentary about targeting smaller liquor outlets. Now last Wednesday, an Inland Revenue media release announced it is “honing in on customers who are actively dealing in crypto assets but not declaring income from them in their tax returns.”
By way of background, back in 2020, Inland Revenue updated its guidance on the tax treatment of crypto assets. Clearly that was part of a plan to follow through and check on who was trading and investing in crypto but not reporting the income. However, first COVID and then the cost-of-living crisis got in in the way of Inland Revenue’s intentions to follow through up its guidance.
Targeting non-compliance
But those immediate crises have passed now, and it appears that Inland Revenue has been busy investigating potential non-compliance because according to the media release late last year, it wrote to “a group of high-risk customers and gave them the chance to fix any non-compliance issues before facing audit.” This is a standard tactic of Inland Revenue. It basically puts it out to taxpayers without being too specific that it is aware of potential non-compliance and “invites”, that is the terminology used, the taxpayers involved to come forward and make a voluntary disclosure. If the taxpayers do so, then the potential to be charged shortfall penalties is likely to be greatly reduced.
Following on from these “invitations”, the next stage if the taxpayers don’t come forward is directly targeted follow up action. This appears to have just happened, as Inland Revenue is saying it has “just sent another round of letters to those Inland Revenue believes are not complying.
According to Inland Revenue it has data which has enabled it to identify “227,000 unique crypto asset uses in New Zealand undertaking around 7 million transactions with a value of about $7.8 billion.” There’s a potentially sizable sum of tax on the line here.
Pay up, or else…
The media release continues with a rather veiled threat
“Cryptoasset values have reached new highs, so now is a good time for people to think seriously about tax on their crypto asset activity. The high value also means customers are well positioned to pay their tax for the 2024 tax year and earlier.”
In other words, Inland Revenue is saying as values have recovered that means taxpayers can’t plead poverty when it comes to paying the tax due on their profits.
The media release goes on to explain something that we’ve said frequently; Inland Revenue has more data available to it than people realise.
“We want customers and tax agents to know that we are stepping up our compliance activity for customers with cryptoassets. Despite popular thinking – people are not invisible on blockchain and we have the tools and analytics capabilities to identify and expose cryptoasset activities.”
So there it is, very clearly stated ‘We know more than you think we know and we are coming for you.’ Part of this, by the way, is that New Zealand and therefore Inland Revenue has signed up to the new Crypto-Asset Reporting Framework (CARF) recently developed by the Organisation for Economic Cooperation and Development. This is yet another example of the growing international cooperation on the exchange of information, a regular topic on this podcast.
Under CARF the first set of reporting is due to apply from the 2026/27 tax year which will lead through to increased tax revenue. In fact, according to the Budget, the expectation is that CARF will deliver $50 million of additional tax revenue in the June 2028 year..
That’s in the future. What’s happening right now is that Inland Revenue has used its existing network of information exchanges and data sharing almost certainly by tax treaty partners such as Australia, the UK and the US, to obtain data about transactions carried out by New Zealand based crypto-asset investors and traders. It’s now going to put the squeeze on those it considers non-compliant.
It’ll be interesting to see what comes out of it and we will watch with interest and bring you news of developments. In the meantime you have been warned and this is of course the latest sign of the gathering storm of Inland Revenue investigations.
Inland Revenue kilometre rates for 2023-24
Moving on, Inland Revenue has just published its kilometre rates for the 2023-2024 income year. Unsurprisingly, given the recent rise in fuel prices, the so-called tier one rates show an increase in vehicle running costs that are allowable for the year. These rates may be used to calculate the deductible running costs for a vehicle.
Note that the Tier 1 rate of $1.04 for the first 14,000 kilometres applies to all vehicles whether petrol, diesel, hybrid or electric. The Tier 2 rates above the first 14,000 km DO vary between vehicle type.
This is good to know, but I do wonder whether it might be a bit more useful to have this sort of information earlier in the relevant tax year. Inland Revenue obviously wants to be accurate, but a different approach perhaps might be to adopt an interim rate and index that for inflation. Anyway, these are the rates that are now applicable for the 2023-24 tax year if you wish to claim the relevant deduction.
Are we raising enough tax?
And finally, this week, the Tax Policy Charitable Trust held an event on Thursday last night to announce its four finalists for this year’s Tax policy scholarship prize. The first half of the event was a panel discussion on New Zealand’s tax revenue sufficiency. Ably chaired by Geof Nightingale, a member of the last two Tax Working Groups, the four panellists that joined him were Talia Harvey and Matt Wooley, joint winners of the scholarship prize in 2017, Nigel Jemson, the winner in 2020 and Vivian Lei, the winner in 2022. You may recall Vivien, have previously been a guest on the podcast.
L-R Matt Woolley, Geof Nightingale, Vivien Lei, Talia Harvey and Nigel Jemson
Now, this was a fascinating panel discussion conducted under Chatham House rules, focusing on the scale of fiscal challenges for the next few decades and how could we meet those? Does this mean for example, some new taxes might be required such as capital gains tax? What about boosting Inland Revenue’s investigation efforts? And then on the spending side of the equation what do we do about rising health care and superannuation costs? Do we perhaps increase the age for eligibility or (re)introduce some forms of mean testing for New Zealand Superannuation? All these points were raised for discussion.
The panel discussed ‘the tax gap’, the gap between what we think the tax collection should be and what’s not being collected. There’s a lot of work to be done in this space, because we really don’t have a clear handle on the extent of this particular issue. Some work carried out several years ago by Inland Revenue suggested that when you look at the consumption patterns between self-employed persons and employees, there might be as much as a 20% gap. In other words, self-employed people appear to have about 20% higher levels of consumption than employees on ostensibly similar levels of income. This is a topic which actually might be worth a podcast episode in itself.
And the finalists are…
It was then followed by the announcement of the four finalists of this year’s Tax Policy Charitable Trust scholarship prize. Every two years the Tax Policy Charitable Trust invites young professionals (anyone under 35 on 1 January 2024) to submit proposals for review, improving any aspect of New Zealand’s tax system. Entrants submit a 1500 word overview proposal on any part of the tax system from which the judges choose four finalists will be selected to go through for the final main scholarship prize, which is worth $10,000.
Submissions are judged for their creativity, original thinking and sound and reasoned research and analysis. In addition the judges take the following factors into consideration:
Impact on the New Zealand economy, including GDP and business growth.
Social (including distributional equity) and environmental acceptability.
Feasibility of introduction, including political and public acceptability.
Impact on simplicity of tax system.
Ease of administration by taxpayers and Inland Revenue, or other relevant government agencies, and impact on compliance costs.
This year, there were 17 entrants and the four finalists chosen are
Matthew Handford, who proposes an Independent Tax Law Commission aimed at improving the Generic Tax Policy Process, or GTPP. The GTPP is a cornerstone of tax policy and is internationally well regarded, but it’s now 30 years old, so is due a reconsideration. I look forward to hearing more about Matthew’s proposal.
Claudia Siriwardena, who is suggesting a simplified FBT regime for small and medium enterprises. This gets a big tick from me, and I’m very interested in hearing more about this one.
Matthew Seddon, who proposes extending the independent contractor withholding tax regime. Mathew’s suggestion picks up the point just raised about the tax gap and deals with it by improving compliance. Again, another interesting proposal.
Finally, Andrew Paynter who is putting forward a proposal to increase the GST rate from GST but also tackle the regressivity of GST with a rebate for low and middle income earners. I’ve seen some international papers on this particular topic, so I’m very, very interested to hear more about what Andrew’s proposing here.
My intention is to get all four scholarship finalists on the podcast to talk about their ideas before the winner is announced in October, so stay tuned for developments. In the meantime, congratulations to Matthew, Claudia, Matthew and Andrew and to everyone else who entered. No doubt there were some interesting ideas put forward that did make the cut this time, but overall, it’s a great sign of the healthy state of tax policy debate in New Zealand.
And on that note, 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 to rā. Have a great day.
(Originally loaded to Soundcloud 6 July 2024. On interest.co.nz 8 July 2024).
It was a busy week in tax with Inland Revenue releasing guidance in relation to a couple of commonly encountered scenarios. The first is QB 24/04When is a subdivision project a taxable activity for GST purposes?
This covers the frequently discussed and very important issue of what is the GST treatment when you are subdividing land into two or more plots? The standard position about GST is that you must register if you’re carrying on a taxable activity and the value of those supplies exceeds the registration threshold of $60,000.
What’s a taxable activity?
Clearly many subdivisions will exceed that $60,000 threshold when they are sold so what represents a taxable activity? In order for a taxable activity to exist it must be carried on continuously or regularly. Therefore, it follows that for a subdivision to be continuous or regular, it usually needs to involve the sale of more than one lot. A subdivision which only involved one sale would usually be regarded as a one-off activity because it does not meet this threshold of continuous or regular.
Notwithstanding that the Inland Revenue guidance points out that some subdivisions which only led to one sale may in fact be continuous and regular. But that would only be if the level of activity involved was very high. Now, like so much of tax, it’s this comes down to the question of the facts of a particular case. Very high in this context might be something like construction and sale of a large office block, or more likely, because more often than not we’re talking about subdivisions of residential land, an apartment block.
The guidance continues the more subdivision plots are divided, the more likely it is to be deemed as being continuous or regular. Following the Newman decision way back in 1995, if a subdivision leads to the sale of four or more lots, that’s typically taken as the benchmark for determining that the continuously or regularly is happening and there is a taxable activity.
On the other hand, what happens when there are two or three lots? Then you have to consider the level of the activity relative to the number of lots being sold in order to determine whether or not this activity is continuous or regular. Therefore, you’d look at the level of development work, the time and effort involved, the level of financial investment and the level of repetition. This last point is probably most critical. If you’re repeating the process multiple times, this is more likely to fall into the continuously or regularly category. But as the guidance notes, everything is fact dependent.
On the other hand, the factors that are not so relevant are whether or not the subdivision is commercial. It doesn’t matter whether the subdivision has a “commercial” flavour or you are subdividing your own land to downsize. Anything done without an intention to sell the resulting land is not relevant. For example, if you build a house on a subdivided lot with the intention of living in it, but later change your mind and decide to sell, work done before you change your mind is not relevant.
Overall, this is useful guidance which comes with a helpful accompanying fact sheet. Keep in mind that the GST treatment is not tied to the income tax treatment. Your project might not be a GST taxable activity, but it could well be subject to the bright-line test or any of the other land taxation rules.
Another common issue – loans to shareholders
Moving on, the other topic, on which Inland Revenue has released useful guidance is a draft interpretation statement on the income tax position in relation to overdrawn shareholder loan account balances (sometimes called shareholder current accounts). Now, as anyone who works with small businesses will tell you this is actually a pretty common scenario. Despite this, the income tax position is not always as well understood as it should be.
In my experience, overdrawn shareholder current account balances typically arise in two scenarios. Firstly, where the owner or shareholder is taking out more in drawings than they’re being paid as a shareholder or employee or any other form of payment. This is a fairly common scenario.
The other instance is where the company has realised the substantial capital gain and shareholders extract the cash without waiting to consider the tax implications of doing so. Often in those situations, advisers don’t find out until maybe months afterwards. At that point it can become quite difficult to unwind the tax consequences because the numbers involved are quite substantial.
It’s therefore good to have Inland Revenue guidance and this comprehensive interpretation statement runs to 41 pages begins with the summary of the basic rules. A dividend is deemed to arise for a shareholder if they are paying little or low interest on an overdrawn shareholder loan account.
The amount of a dividend on an interest free or low interest loan typically represents the difference between a benchmark interest rate that should be charged and the amount of actual interest rate occurring on the loan. Benchmark for this purpose is Inland Revenue’s prescribed rate of interest, which since 1 October 2023 has been 8.41%.
A dividend can also arise where the loan has been advanced to an associated person of the shareholder. This can lead to some quite involved tracing of shareholdings and related calculations about percentage of shareholdings. This is necessary to determine if there is an association and whether that associated company is part of the same 100% owned group and therefore potentially eligible for the exemption on intra-group dividends. This is another area where I’ve encountered situations where this associated person issue hasn’t been picked up.
Incidentally, it’s worth noting, by the way, that although for New Zealand tax purposes, the amount of the dividend is the amount of interest that should have been charged in Australia and the UK, the amount of the dividend is deemed to be the full amount of the advance made. This might be something we might see Inland Revenue take a look at as it’s something that has occasionally come up in discussions with officials.
Loans to shareholder-employees
Were the shareholder is also an employee of the company, then the low or interest free loan is not treated as a dividend but is instead subject to fringe benefit tax. The amount of the benefit is the difference between the interest paid and the prescribed rate of interest. Something to note here is that the shareholder-employee doesn’t solely mean someone within the provisional tax regime, but it also includes shareholders who are employees and whose salary are subject to PAYE There’s a couple of useful flow charts to help people determine who might be captured by these rules.
The draft interpretation statement also notes that typically interest paid by a shareholder on an overdrawn current account is generally not deductible. This is because usually the drawings are often applied for private or domestic purposes, and so there’s no link to an income earning process. However, in some cases the money might have been withdrawn to invest in a residential property or some other income producing asset, in which case the interest would become deductible, if all the other deductibility criteria can be met.
One other key point to note is what happens if a shareholder is no longer required to repay the overdrawn balance, because the company forgives or remits the debt in some way. In this case the full amount of the loan will be deemed to arise either as a dividend or under the financial arrangements regime. In either case the shareholder will usually be taxed on the amount that’s been remitted.
The interpretation statement also covers scenarios when resident withholding tax might need to be deducted and interest therefore be reported as investment income. This would be somewhat unusual, but the interpretation statement explains when it might happen.
Overall, this is an important and useful document setting out the rules pretty clearly on a topic which as I noted is frequently encountered amongst small businesses but isn’t always as policed or managed as effectively as it should be. It’s also accompanied by a more digestible 8 page fact sheet. Consultation is open until 2nd August.
A blueprint for taxing billionaires?
One of the interesting things going on around the world in the tax policy area now is something of a trend amongst international organisations such as the International Monetary Fund (IMF), the Organisation for Economic Cooperation and Development (OECD) for releasing papers for discussion on the taxation of capital and wealth.
The latest such paper A blueprint for a coordinated minimum effective taxation standard for ultra-high-net-worth individuals was commissioned by the Brazilian G20 presidency earlier this year. The report was written by the French economist, Gabriel Zucman, a protégé of Thomas Piketty. It proposes a framework the approximately 3,000 or so billionaires in the world to pay at least 2% of their wealth in individual income tax or wealth taxes each year.
Zucman’s report notes there been a vast improvement in international tax cooperation since the mid-2010s, particularly with the Common Reporting Standard on the Automatic Exchange of Information which commenced in 2017. He also pointed to the recent agreement hammered out by the OECD for a minimum tax of 15% on large multinationals. (It’s worth noting though that agreement has yet to be fully implemented as progress has slowed recently).
Zucman correctly points to this growing international cooperation and exchange of information as laying the baseline for further international cooperation in the form of what he terms a common minimum standard, ensuring an effective taxation of ultra-high net worth individuals. According to Zucman this “would support domestic policies to bolster tax progressivity by reducing incentives for the wealthiest individuals to engage in tax avoidance and by curtailing the forces of tax competition.” This would target the tax havens where much of this wealth is sheltered.
The paper estimates that a 2% tax on those 3,000 billionaires could realise between US$200 and US$250 billion U.S. dollars in revenue annually. If it was extended to those worth more than $100 million, that could generate another US$100 to US$140 billion per annum. These tax revenues would be collected from “economic actors who are both very wealthy and undertaxed today”. Those affected might not agree with this assessment that they’re presently under taxed.
The paper is realistic enough to note that there are real challenges with the proposals, such as how to value the wealth, ensure effective taxation if some jurisdictions don’t agree to implement it, and of course compliance by taxpayers. It’s a bold proposal which has attracted a lot of attention although I’m sceptical about the potential level of revenue which could be raised. We really don’t have a very detailed understanding of the composition of the wealth and where it is held of the very wealthy. That’s an issue which would need to be addressed. And as I mentioned, there are serious issues around valuations and informed enforcement, which Zucman acknowledges.
Starting a conversation?
But for me, the most interesting thing to me about this whole proposal, it’s the latest. As I said, it’s the latest in the line of papers coming out of the likes of the G20, the OECD, the IMF, the World Bank, all of whom are basically saying that we are not taxing wealth sufficiently and we need to do something about that to address inequality. As Zucman himself puts it in the Foreword of the report
“The goal of this blueprint is to offer a basis for political discussions – to start a conversation not to end it. It is for citizens to decide through democratic deliberation and the vote how taxation should be carried out.”
In other words, he is repeating my old precept that tax is politics.
My personal view is we need to have a broader discussion around the taxation of capital. One of the points to emerge from the current debate going on over replacing the Cook Strait ferries is that the new ferries represented just 21% of the total cost of Project iReX. The other 79% represented the cost of upgrading the supporting infrastructure not just for the larger ferries but also to make it climate change and earthquake resilient for the next 100 years.
Even if we dialled back the futureproofing to, say, 50 years, we’re still talking about significant sums of investment. We’re also still left with the key point of how will we pay for the vast amount of infrastructure that we will need to upgrade to deal with the continuing impact of climate change. In my view our politicians have not yet seriously engaged with us on this issue.
Meanwhile in the UK…
And finally, this week a quick note on the UK election which is next Thursday. The likelihood is that the opposition Labour Party is heading for a massive win. One of their key tax proposals is the abolition of the remittance basis or non-dom tax regime.
But not every voter has understood exactly what that means. As Labour candidate Karl Turner recounted to the Guardian
“We met a guy who said he was going to vote Labour but wouldn’t now because he had just heard that we were taxing condoms,”
“I said, ‘condoms?’ ‘Yeah,’ he said: ‘I just heard on that [pointing to the TV] that you are taxing condoms, and I’m not having it. You’re not getting my vote.’ It was Terence [Turner’s parliamentary assistant] here who worked it out.
“‘We’re taxing non-doms, not condoms,’ I said. ‘Oh,’ he said. ‘Like the prime minister’s wife? Ah.’ He calls out: ‘Margaret: they’re taxing non-doms, not condoms.’”
And on that note, 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 to rā. Have a great day.
(Loaded to Soundcloud 30 June 2024. Appeared interest.co.nz 1 July 2024).
how effective marginal tax rates act as disincentives
Last week was Scrutiny Week at Parliament. This is a new initiative where the select committees get to grill ministers for longer than normally would be the case. In total, there were over 134 hours of hearings across all the select committees.
(Minister of Revenue Simon Watts flanked by Inland Revenue officials during his appearance before the Finance & Expenditure Committee)
A large part of the inquiries directed at the Minister of Finance focused on the Budget and spending choices made or not made, particularly in relation to funding of cancer drugs.
Inland Revenue to review Charity Sector?
The Minister of Finance Nicola Willis was also quizzed on general tax policy and in the course of that she dropped a big hint about a sector of the economy which is going to come under inquiry. In response to a question on tax policy she commented
“We will put together a tax policy programme that looks at other issues. In particular, I have previously identified that we have some concerns around whether all charities are effectively meeting the expectations that we have [regarding] genuinely charitable activity. We don’t want to see [concessionary tax rates] being exploited for activities, which are more clearly more commercial in nature.”
This is a clear shot across the bow of the Charity Sector, although the Minister has foreshadowed this before. It’s now apparent Inland Revenue will undertake an in-depth review of the sector.
The Revenue Minister Simon Watts faced more detailed scrutiny over the operation of his portfolio. He confirmed that one of the Budget initiatives provided funding which would enable Inland Revenue to take on a further 200 full time employees. These additional staff would be directed to improve Inland Revenue’s compliance and investigation activities. This group will be expected to return $8 for every dollar spent on investigation and compliance activity. As the government has allocated $116 million over the next four years to this initiative that means it could reasonably expect to see a return of close to a billion dollars.
When he was questioned about a potential structural deficit and how the government might respond to that, he made it clear that there were no intentions at this stage of introducing new any new taxes. This is what you would expect to hear from the current coalition Government. Clearly the intention is that extra funds will be found by more efficient administration and boosting Inland Revenue’s compliance activities.
Inland Revenue checks out smaller liquor outlets
By coincidence, this week, Inland Revenue announced some insights from a hidden economy campaign which it had run focusing on smaller liquor outlets throughout the country. According to Inland Revenue the number of off-licence liquor stores has grown quite rapidly since 2020 and now there are nearly 3,000 throughout the country.
In 2020, the total sales of these outlets amounted to $1.95 billion with taxable profits of 34.7 million and income tax paid of $11.41 million with a further $29.4 million of net GST collected.
In the first stage of this campaign Inland Revenue compliance staff made 220 unannounced visits looking for signs of issues such as income suppression, unreported sales and non-registered staff. There’s nothing dramatic about what Inland Revenue do here. Their practice is to wander in quietly and have a look around a store. They may or may not buy anything, but they will certainly watch to see what happens behind the till. This is a long-standing technique that it has used for decades across many businesses and it’s highly successful. The truth is when you put boots on the ground with investigations, you get results.
What Inland Revenue found
During these visits, Inland Revenue found more than 100 employees had had PAYE deducted from their wages, but not then paid on to Inland Revenue. Inland Revenue also found issues around migrant exploitation issues with wages paid under the table and use of family labour who are not registered workers. They also found high levels of unreported cash and poor record keeping. In addition, “there was evidence of poor employee relations” None of this is particularly surprising to me as I have encountered similar issues.
Inland Revenue made 220 visits and as a result, 9 outlets have been referred for audit. That’s nearly 5% of all of those that were reviewed. It’s quite likely Inland Revenue already had suspicions about some of these outlets which is why they got chosen for an on-site visit in the first place.
There were a couple of other interesting points of note. Inland Revenue found that companies with multiple family members and changes of ownership demonstrated “less clear money trails”, and some directors appeared to be in name only with minimal knowledge of the business or their director responsibilities. By the way with such shadow, or nominal directors, if in fact someone is behind the scenes pulling all the strings that person can be treated as the director for company law purposes.
What next?
Inland Revenue said this was a “deliberate light touch campaign” and therefore only the beginning, obviously, of a wider look into smaller liquor stores nationwide. Clearly if you’ve just done a “light touch” review and you’ve basically found close to 5% of businesses are worth auditing it’s easy to imagine there’s scope for much greater investigation work if a more detailed and less light-handed approach is taken.
We will watch this space to see what further developments we hear from Inland Revenue. Clearly, as both the Minister of Finance and Minister of Revenue both noted in in their appearances before the Finance and Expenditure Committee, this is an area where they’re happy to give Inland Revenue more funding with the expectation that they Inland Revenue will deliver significant returns.
What about them EMTRs?
Returning to our discussion last week about high effective marginal tax rates (EMTRs) and the shocking realisation that unless something is done soon, some people on the family minimum family tax credit will be facing effective marginal tax rate of 128.6% or even more, this story got picked up by RNZ and was then circulated quite widely. This issue was raised by the Finance and Expenditure Committee, with both the Minister of Finance and the Minister of Revenue. Simon Watts, the Minister of Revenue, acknowledged that there was an issue and he had sought information from Inland Revenue on what options were available to address it. The Minister of Finance was rather more pugnacious when quizzed about the issue. Instead, she was happier to focus on the fact that only a small group of people were affected and made no particular commitment to addressing the matter.
EMTRs and the UK election
Now it so happens that effective marginal tax rates have become a bit of a political issue in the UK general election campaign. Parties are releasing their manifestos and as a result there’s been some interesting commentary emerge about the impact of high effective marginal tax rates as a result of some of the proposed policies. What stands out over there is, as here, there is a general widespread lack of knowledge about how effective marginal tax rates operate and how high they can be.
What’s sparked the debate is what happens with child benefit, the equivalent of Working for Families. There is a High-Income Child Benefit Charge which starts clawing back Child Benefit when income exceeds £60,200. The charge means for people earning above that threshold and up to about £80,000, their effective marginal tax rate jumps from 42% to 56.5%. And some of the proposals made by parties would push it even higher to over 70%.
Dan Neidle of Tax Policy Associates wrote a very interesting and informative blog post on the whole matter explaining how EMTRs operate.
Dan also referred to a very useful paper from the Tax Foundation which highlighted that these issues around EMTRs are quite common internationally.
The disincentive effect of EMTRs
Where this is relevant for all of us here is the disincentive effect of high EMTRs. What is emerging as another particular EMTR problem in the UK is there’s another threshold that kicks in at £100,000 which also triggers some very high EMTRs. As Dan Neidle noted:
“We’ve received many reports saying that high marginal rates affecting senior doctors/consultants are an important factor in the NHS’s current staffing problems – exacerbated by the fact that the starting salary for a full time consultant is just under £100,000.”
The normal marginal tax rate for someone earning £100,000 in the UK is 42%. But above that threshold there’s an income bracket where the EMTR jumps to 62% and in some circumstances even higher, before the EMTR settles down around the £150,000 mark. The state of the National Health Service (NHS) is a major election issue so if high EMTRs are acting as a disincentive to recruiting NHS that is something voters will want addressed.
The New Zealand conundrum – high EMTRs on below average incomes
As I said last week EMTRs are a feature of every tax system. What I think is interesting when you look at the UK debate over EMTRs is there’s a big difference in the level of income under discussion. £60,000 in the UK is well above the average salary in the UK and the standard marginal tax rate for people on that income is 42%. (40% income tax plus 2% National Insurance Contributions).
However, here we’re looking at EMTRs of at least 45.1% (17.5% tax plus 1.6% ACC plus 27% Working for Families clawback) kicking in at a very low level – just $42,700. That threshold is currently below what someone on the minimum wage of $23.15 per hour working 40 hours a week would earn. Our problem here is not that we have high effective marginal tax rates, that’s a common issue around the world, it is that we have people on very modest levels of income suffering those high effective marginal tax rates. And, just as in the UK, it acts as a disincentive. After last week’s podcast I had some correspondence from a relative who as a young solo mother explained that she often found it wasn’t worth her while to take additional work because of the impact of the abatement of Working for Family credits. Often 50% or more of her additional income would be lost.
Over to you politicians
This is not a new issue and from my perspective I find it rather frustrating to see to hear the Minister of Finance be very dismissive when quizzed on the topic. She does not appear to acknowledge that this is a major issue which needs to be addressed. Perhaps she’s looking at it through an entirely political lens and does not want to acknowledge the other side has a point. As I always say, tax is politics.
But the question about high effective marginal tax rates and the abatement thresholds around Working for Families is a multi-government multiparty failure. The present situation is the result of decisions taken by governments since 2009. So that involves both Labour led and National led governments.
To me this is one of those scenarios where it would be good to put the politics aside and focus on actually trying to fix the problem. The two issues around that are ‘Have we made the interaction between tax and benefits too complicated?’ and ‘What are we going to do about the abatement threshold? Are we going to let it linger or are we going to return to having it indexed regularly?’ The Minister of Revenue was noncommittal on that point and as I said, the Minister of Finance wasn’t prepared to discuss the point either.
I would hope that there’s common ground here for all the parties to try and find a more rational approach to this by focusing on the fact that if we want to get people into work, improve their lives, we need to remove the tax incentives that happen to prevent them from doing so. Fingers crossed we’ll see some movement on this issue in due course.
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 to rā. Have a great day.
(Originally loaded to Soundcloud 21 June 2024. Appeared in interest.co.nz 23 June 2024)
Welcome back everyone. Apologies for the COVID induced intermission and thank you for all those good wishes for my recovery along the way.
An awkward discussion
On the morning of the Budget lockup, I had an awkward call with the client over an unpaid bill. The matter was resolved, but it struck me then and now, as kind of symbolic of the general approach by governments to the question of tax. It’s a very awkward conversation that they really would rather not have. This seems really surprising when you consider that budgets involve spending and government expenditure in the current Budget to June 2025 will be close to $140 billion. To pay for this the expectation is that tax revenue will be about $123 billion during that same period.
Tax is by definition a big part of governments’ budgets, because it raises the majority of the revenue which enable them to run the country. But as I have realised when attending 14 Budget Lockups we never talked very much about tax. On Budget Day, it’s all about splashing the cash. The accompanying ministerial releases are about how money is spent will be spent on this or that particular project. Often you’ll find that the bad news about student loan increases interest rate increases is tucked away on the second page of a ministerial press release.
This approach strikes me as highly symbolic. And by the way it’s the same for governments of whatever hue. Whether National or Labour-led both have pretty much the same approach “Here’s all this lovely cash we’re spending and tax, well we’re doing one or two things minor things.” This year was actually quite unusual because of the focus around the tax threshold changes.
Never mind the spending, where’s the tax legislation?
The other thing which is also slightly unusual as well is the relevant tax legislation isn’t released to us as part of the Budget Lockup. Now you might think, as I do, that when you’ve got a whole pile of tax experts locked up in a room, passing them the legislation which supports the main initiatives might actually be quite a useful thing for broadening people’s knowledge, but actually no, that’s not the practice.
Consequently, some of the detail which was released after the Budget Lockup contained a few surprises. Being cynical about it, the reason why governments are a little bit wary about giving people too much information beforehand is that the required Regulatory Impact Statements contain a lot of detail about tax initiatives and some of that detail is rather awkward for governments in general. To repeat my earlier point, generally speaking discussions about tax are often an awkward conversation governments would rather not have.
The devil in the detail…
As always, Regulatory Impact Statements (RIS) contain some very interesting details, and this is very true of the two that were released in in relation to the Budget. As is well known the tax cuts announced in the Budget involved increasing thresholds for the first time since October 2010. What was not explained during the Budget Lockup and actually only emerged afterwards was that some of the secondary thresholds, such as those relating to fringe benefit tax and employer superannuation contribution tax aren’t going to be adjusted until 1st April next year. The reason given for that is complexity of doing so now.
In fact, in the RIS on the personal income tax threshold changes, Inland Revenue and Treasury officials recommended that the tax threshold adjustments didn’t take place until 1st October. This would allow time for payroll providers and Inland Revenue to get ready and have all the thresholds ready to go as of 1st October. This was what happened back in 2010, when tax thresholds were last adjusted. The announcement was made in May as part of the Budget but didn’t take effect until 1st October. Incidentally, that also gave everyone 4 1/2 months to get ready for the increase in GST from 12.5% to 15% which also took effect on 1st October 2010.
The personal income tax change RIS’s begins with the Problem Definition
“When prices and income rise from generalised inflation and wage growth, but nominal income tax thresholds remain unchanged, individuals end up paying a larger proportion of their tax of their income in tax. Over time, this may result in the amount of tax being paid at different income levels not aligning with the Government’s intentions.
As you can imagine, if you’ve not done anything in this space for 14 years, it can get very problematic. The RIS primarily discusses National’s election proposals, but also references the ACT Party’s election proposals because, as the paper notes
“In the National-ACT Coalition agreement, a commitment was made to ensure the concept of ACT’s income tax policy are considered as a pathway to delivering National’s promised tax relief subject to no earner being worse off than they would be under National’s plan.”
The starting point for Treasury and Inland Revenue officials was Nationals tax proposals, but they also considered variations on the ACT plan, which if you to quickly recall, involved compressing the five current tax brackets down to three combined with a Low and Middle-Income Tax Credit.
Officials also considered several cost savings initiatives, one of which was deferring implementation until 1st October 2024. They also recommended not proceeding with the proposed expansion of the Independent Earner Tax Credit.
“The long-standing view of officials has been the objective of improving work incentives could be achieved more effectively by removing the IETC and making other changes to tax and transfer settings for the same fiscal cost.”
Removing the IETC was something I thought was going to happen to help pay for the tax threshold adjustments. I note by the way, that subsequent to the Budget, Steven Joyce said he would have done that as in fact he proposed to do so back in May 2017.
But as we know, Cabinet went along with National’s plan and chose an implementation date of 31st July. According to the officials, the estimated cost over the forecast period to June 2028 of the threshold adjustments is $10.3 billion. Officials thought they could have reduced that cost by between $1 to $2 billion through some adjustments.
The scale of fiscal drag
Paragraphs 5 and 6 of the RIS underlined the question of just how much of an issue fiscal drag had become.
As the RIS notes, one of the objections about not making regular changes in thresholds is that the “increase in tax from fiscal drag is arguably less transparent than explicit changes to tax settings and may engender less public debate.” Furthermore, when inflation exceeds wage growth, people’s tax burdens increase, even as their ability to pay for goods and services decreases because of inflation.
The conversation we’re not having
But tax is always politics and as paragraph 17 of the RIS notes;
“The desired level of progressivity in the personal tax system is a judgement for ministers to make. Any decision to address fiscal drag by adjusting thresholds will also depend on the revenue needs of the Government and their economic goals.”
This is the discussion we’re not really having. We, the public are saying we’d like this, that and the other to be spent on various public services such as hospitals, schools, roads, pensions. The Government is saying ‘fine, we’ll do that’ but isn’t really talking to us on a serious level about the level of tax we need to meet those demands. If more services are demanded either tax is going to have to be increased or other services must be reduced. That’s a debate that’s not happening, but that’s politics and it’s the same the world over. I’m seeing the same thing play out in the current UK election.
Simplifying the tax thresholds
Interestingly, apart from considering ACT’s proposals, officials developed an alternative which would also have reduced the five tax brackets to three.
The key difference between this proposal and that of the ACT Party is that it would have retained the 39% rate. It would also not have included an extension of the IETC, or the tax offsets proposed by ACT.
Giving with one hand, and taking with the other
The RIS relating to the increase in the In-Work Tax Credit to $25 per week highlights an issue which I actually raised with the Minister of Finance in the Budget Lockup, and that’s that is the interaction of abatements and low thresholds. Currently, the family income threshold for those receiving Working for Families’ tax credits (WFF) is $42,700. This threshold has not been increased since 1st July 2018. Above that threshold WFF are abated at a rate of $0.27 on the dollar. As I told the Minister of Finance, this means that people on very modest incomes are on a higher effective marginal tax rate than her. That did not go down well, to be honest.
As the RIS shows the effect of the abatement regime for the 170,000 families benefiting from the package is that though the Government might talk about an increase of $25 per week, on average the net amount received will be $16.97 per week. The difference is the the effect of abatement.
The RIS also notes that unless something is changed the minimum family tax credit threshold, which is increased annually, will soon overlap the threshold at which WFF abatement starts. On present settings this expected to happen on 1st April 2027. As the RIS notes this will result in WFF customers “facing effective marginal tax rates of well over 100%.”
How someone earning $42,900 could have a marginal tax rate of 165.6%
Page 11 of the RIS has the following example illustrating the pending overlap problem.
If Mila was receiving the accommodation supplement, that would be another 25% and if she had a student loan 12% would be deducted. In a worst-case scenario Mila’s effective marginal tax rate would be 165.6%.
Time to regularly index income tax thresholds?
So that leads on to a question which we’re starting to hear more frequently – should we be increasing thresholds regularly? My longstanding view is yes, because it deals with this question of fiscal drag and it’s more transparent. When governments rely on fiscal drag by not adjusting thresholds regularly that is quietly increasing the tax take in the hope nobody pays too much attention to it, other than tax geeks like me. But this approach leads to an ever-increasing problem which after a while means full indexation becomes too expensive as officials noted.
Interestingly, Dr Benjamin Walker of BDO published a LinkedIn post this week with a map illustrating what happens in European OECD countries around indexation.
As you can see a number of countries do regularly adjust thresholds. Germany does it every two years. Several, such as France, the Netherlands, Denmark and Denmark, do so annually. Other jurisdictions such as the Czech Republic, Hungary and Estonia have a flat or single income tax rate so fiscal drag is less of an issue. And then there are other countries that presently don’t index thresholds such, such as Italy, Spain, Ireland and the UK.
I would add in relation to the UK, they’re statutorily they are required to increase thresholds and personal allowances each year, but Parliament may override that as part of its annual budget. And that’s actually been done recently and has been in place for several years. The Conservative Government has therefore deliberately relied on fiscal drag to help increase the tax take. As a result, there are increasing pressures around some very high effective marginal tax rates.
Incidentally, some of the tax discussion coming out of the British election is quite interesting and I’ll probably cover it off in a future podcast. As an aside, I’ve had three UK related assignments come in this week, so UK tax is not as an abstract an issue for New Zealanders as you might imagine.
Another awkward conversation to be had
My view is that thresholds should be regularly indexed for inflation. But we also really need to have a serious discussion about the relationship between abatement rates on benefits and tax credits and the resulting very high effective marginal tax rates for workers on fairly low and sometimes below average wages.
As Geof Nightingale said in the recent podcast with him, Rob McLeod and Robin Oliver, the biggest surprise for him about our tax system is how little discussion goes on around this particular issue which is quite scandalous. When people hear a lot about high tax rates they think of 39% and happening to people on very high incomes. I believe most people would be absolutely staggered to find out that someone on $42,900 per annum could have a marginal tax rate of up to 165%.
GST and landlords supplying properties for use as transitional housing
Finally this week, Inland Revenue has released an interesting Operational Position together with three public rulings on the GST treatment of landlords who supply properties for use as transitional housing. Organisations that provide transitional housing services on behalf of the Ministry of Housing and Urban Development (HUD) generally lease properties from landlords under a head lease and pay market rent. Then those organisations will enter into various agreements with the transitional housing tenants.
As always housing is a big topic, and the arrangements involve somewhat tricky GST issues. These binding rulings and Operational Position have been issued to clarify the GST position because it appears that several landlords adopted an incorrect position.
Essentially the Operational Position draws a line under what’s gone on previously and gives guidance on how Inland Revenue is going to apply the technical view set out in the three associated rulings where landlords have previously taken incorrect tax positions. In most cases Inland Revenue is unlikely to issue assessments regarding incorrectly claimed input tax deductions. Each situation will be fact dependent.
As is now standard practice, there’s a helpful fact sheet which summarises the position in the three binding rulings. The GST treatment depends on whether the buildings leased are “commercial dwellings” and the terms of the housing agreement. If the properties are provided to the tenants with the right to quiet enjoyment as defined in section 38 of the Residential Tenancies Act, then it’s an exempt supply and GST will not apply. If there is no right to quiet enjoyment, then GST will apply. (In some circumstances it may be possible to use the reduced 9% or 60% of the full GST rate).
So that’s a quick summary of the of the position. Obviously Inland Revenue has encountered a number of issues here and decided to clarify its view on the proper interpretation of the legislation.
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 to rā. Have a great day.
The aim is to develop a corporate tax database which is going to be available to tax policy researchers and policy makers about corporate tax rates, effective tax rates, tax incentives for research and development and other topics such as withholding taxes. Increasingly, the amount of information includes anonymised and aggregated country by country reporting data, which provides an overview of the global tax and economic activities of thousands of large multinational enterprises operating worldwide. This year’s report covers 8000 such enterprises.
The detailed statistics in the report are mostly from the 2021 calendar year although some 2022 data is included. The report does take into account the statutory tax rates currently in force.
Increased country by country reporting and more reporting generally is part of the 15 actions within BEPS. The report sets out why this is important:
“Action 11 noted the lack of available and high-quality data on corporate taxation is a major limitation to the measurement and monitoring of the scale of BEPS and the impact of the measures agreed to be implemented under the OECD/G20 BEPS Project.”
Corporate tax rates are stabilising
The headline summary is that corporate tax revenues remain important, but statutory corporate tax rates as the report are now showing signs of having stabilised after pretty near two decades of decline. During the period between 2000 and 2024 the average statutory tax rate declined from about 28% in 2000 to 21.7% in 2019. However, between 2019 and through to 2024, it has remained relatively stable at a rate of 21.7% in 2019 and 21.1% in 2024. I think stabilisation is a trend that’s going to continue.
Who knows, though, if the possible re-election of Donald Trump may change this. But I think governments balance sheets worldwide have been weakened considerably by the double whammy of the Global Financial Crisis and then the pandemic. I therefore think the opportunities to actually cut corporate tax rates further are quite limited, but we shall see.
Just to put New Zealand in context, back in 2000, our corporate tax rate was 33%. With effect from 1st April 2008, it was reduced to 30% and then on 1st April 2011 it was reduced to its current level of 28%. Across the ditch Australia has had a 30% corporate tax rate since 2001.
There’s interesting data about the importance of the corporate tax take. On average for the 2021 year, which was also a pandemic affected year, corporate tax revenue represented 16% of all tax revenues. New Zealand is in line with that average, but as a percentage of GDP, the OECD average was 3.3% whereas here it was considerably higher at 5.7%.
The report also considers effective average tax rates (EATRs) and examines the effect of tax incentives such as more generous tax depreciation compared with true economic deprecation. Again, according to the report effective average tax rates have remained relatively stable falling slightly from 20.9% in 2019 to 20.2% in 2023. Median effective average tax rates were 22.8% in 2019 and practically unchanged at 22.7% in 2023. Meanwhile, New Zealand’s effective marginal effective average tax rate is still relatively close to our statutory tax rate of 28%.
But…a narrowing tax base?
Chapter 4 of the report discusses effective and marginal tax rates and has some interesting commentary around declines of effective marginal tax rates (EMTRs). The report notes
“The stability of EATRs combined with declines in EMTRs suggests a narrowing of tax bases in the sample, notably through an increase in the generosity of depreciation provisions. Examining the asset breakdown shows these trends have been driven by increased generosity of depreciation of tangible and intangible assets, as opposed to buildings and inventories.”
I think some of this might be part of the response to the pandemic. New Zealand is noted being alongside Argentina, Japan, Papua New Guinea and Peru as having a higher effective marginal tax rate because we’ve got less generous depreciation rules. (This has become more so with the imminent withdrawal of building depreciation).
Research and development incentives
Chapter 5 looks at tax incentives for research and development, noting that they’ve become more generous over the past 20 years or so. 33 out of 38 OECD jurisdictions offer tax relief from R&D expenditures in 2023, compared with 19 in 2000. New Zealand is one of the new jurisdictions now offering R&D incentives. These are becoming more generous over time.
From a New Zealand perspective, we discuss the importance of R&D in boosting our productivity and we still could do more in that space. I’m inclined to the view I heard recently expressed that it’s better to give a tax incentive for it rather than get involved in the grant process. Because with a grant process, the companies can be restrained in what they have to spend because of the application process. Also, there’s a lot of effort involved with applying grants, less so with an R&D tax incentive, subject to Inland Revenue monitoring.
According to the report the level of direct government funding and tax support for business R&D in 2021 was about .12% of GDP, well below the OECD average of .2 of GDP. So, there’s still room for improvement although that’s something that’s been acknowledged across the board.
Chapter 6 looks at BEPS actions and notes that there’s a large number of controlled foreign corporation or control foreign company rules with apparently 53 jurisdictions having it in place in 2024. There’s also growth in the use of interest limitation rules. This is part of a growing trend in tax policy around the world to consider imposing restrictions on the deductibility of interest. Apparently, there are now over 100 interest limitation rules in place up from 67 jurisdictions back in 2019.
The dangers of following Ireland’s example
Chapter 7 has a breakdown of country by country reporting statistics with 52 jurisdictions out of a possible 101 submitting statistics to the OECD. As I mentioned earlier, this report includes the activities of over 8000 multinationals so there’s a lot of detail in here.
Several commentators including the New Zealand Initiative have recently mentioned Ireland as a potential model to follow. As is well known, Ireland has a very low corporate tax rate. I was therefore very intrigued by figure 7.2 on page 81 of the report, which illustrates the multinational enterprises contribution to local corporate income tax revenues in 2020.
As can be seen, 87% of Ireland’s corporate tax came from multinationals, and the vast majority of those multinationals were local affiliates owned by foreign multinationals. In fact, the Irish Treasury and the European Commission have expressed concern about the sustainability of Ireland’s corporate tax revenue because of the dependency on a few large multinationals.
New Zealand is near the opposite end of the scale with only 24% of corporate tax revenue coming from multinationals, probably three-quarters of which look to be from overseas owned. I think this is an extremely interesting stat which makes me wonder about whether New Zealand is attracting enough investment and whether we should have more multinationals of our own based overseas.
Yes, but is BEPS working?
In summarising key insights on BEPS from the Country by Country Report data the report makes this observation”
“There is evidence of misalignment between the location where profits are reported and the location where economic activities occur. The data show continuing differences in the distribution across jurisdiction groups of employees, tangible assets, and profits.” [page 87]
In other words, the report is basically saying there appears to be some profit shifting going on, but we don’t quite know enough about it. This gets to the heart of the idea behind the BEPS initiative, find out more about what’s happening and then fix it.
As I said the OECD’s corporate database is constantly being expanded so if you’re a bit of a stats guru there’s plenty to dive into and research. Overall, another interesting report highlighting how New Zealand’s corporate tax rate is at the higher end, but noting it also raises a lot of revenue relative to other jurisdictions.
Is that asset depreciable?
Moving on and picking up on depreciation one of the issues covered by the OECD stats, Inland Revenue has just released a draft interpretation statement for comment on identifying the relative relevant item or property for depreciation purposes. This is quite important because our depreciation regime is extremely detailed with a myriad of available rates across several categories.
This draft ties into several other related items of guidance such as residential rental properties depreciation, the question of deductibility of repairs and maintenance – if expenses are not deductible are they depreciable instead? There’s also QB 20/01 – can owners of existing residential parental properties claim deductions for costs incurred to meet healthy home standards? And finally, Interpretation Statement IS 22/04 relating to claiming depreciation on buildings. The imminent withdrawal (again) of building depreciation makes it very important now to maximise depreciation and to identify whether in fact that asset is part of the building or can be claimed separately. This draft is therefore pretty relevant.
The draft runs to 40 pages the last 15 or so pages of which are examples. There’s also a useful 6 page fact sheet accompanying it. Submissions are open until 29th August.
A post-hibernation bear is hungry…
Finally, as we discussed last week, one of the things that came out of Inland Revenue’s recent performance improvement review was for it to be more prominent in promoting what actions it has taken against non-compliant taxpayers. We’re seeing more of that this week when Inland Revenue was announced that an Auckland couple have been sentenced to three years in prison on tax evasion charges. The pair committed 69 tax related offences involving income tax and GST evasion amounting to about $750,000, together with another $80,000 in unaccounted for PAYE. The judge described it as very deliberate offending including deliberate under reporting of business income filing false returns, and even failing to file false returns once under investigation. The couple withheld information from their accountants and concealed the existence of what were described as “highly relevant bank accounts.” So pretty clear case here of tax evasion.
One thing of note that does slightly concern me is this offending occurred over a six year period between 2010 and 2015. That’s quite some time ago and I think Inland Revenue is much more on the case now. Even so you would hope that it doesn’t take 7-8 years or more to bring people to justice on this in the future.
The taxman cometh…
For an idea of how Inland Revenue’s increased activities might play out for your average person, this week’s episode of RNZ’s podcast The Detail discussed how Inland Revenue plans to utilise its additional funding. The episode focuses on the construction industry because of the sector’s long association with the proliferation of the “cashie”. Inland Revenue apparently gets 7,000 anonymous tip offs a year, many of which relate to tradies.
There’s some very interesting commentary from Malcolm Fleming, the New Zealand Certified Builders Association chief executive. He rightly points the finger back at the public for this issue. As he notes, nobody asks their accountant or lawyer ‘Well, how much is it for cash?’ On the other hand, the public seems to be happy to try this tactic with builders and others in the construction industry. On the question of tax evasion and cashies, maybe quite a few people should be looking in the mirror about that rather than pointing the finger elsewhere. It’s a very valid point.
The episode is well worth a listen; it highlights more of what Inland Revenue is currently doing. It’s now doing unannounced site visits to construction sites, for example, which I’m sure would alarm some businesses. But to be fair it also points out most small businesses are run on the straight and narrow. They are perhaps poorly capitalised with overworked owners who are also the main administrator. In many cases the question of tax arrears is more one of poor administration rather than in the case of the couple who were jailed, deliberate malfeasance.
And on that note, 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 to rā. Have a great day.
