13 Dec, 2021 | The Week in Tax
- Inland Revenue enlists the help of the Chinese tax authorities in a tax evasion case
- OECD report reveals the impact of COVID-19 on tax revenue
- Inland Revenue turns off its old computer system
Transcript
The Taxation Review Authority last week upheld the Commissioner of Inland Revenue’s assessments on unreported income from property transactions. There’s nothing particularly unusual about the facts of this case at first sight. The taxpayer was involved with the purchases and sales of five properties. He arranged the purchase of bare land, the construction of a house on the land and then sold the house.
He maintained he was only a manager and was actually acting under a power of attorney for Chinese nationals and merely managing the properties and receiving payments for services such as arranging the land development and transactions.
But the Commissioner decided to take a look at his affairs for the three tax years ending 31 March 2014, 2015, and 2016. And it transpired that in fact, he wasn’t acting as a manager, but he personally controlled the transactions, and he made the profit from proceeds of each property over and above the management fees he had returned in his tax returns. These transactions all pre-date the introduction of the bright-line test, so the Commissioner assessed him on the basis that the properties were acquired with a purpose or intent of sale.
Ultimately, the amount that was assessed after deductions over the three years turned out to be over $1.6 million. In addition, because he had only been returning the management fees, he had actually also claimed working for families tax credits of just under $9,000 to which he wasn’t entitled. The commissioner took the view all this represented tax evasion and imposed shortfall penalties of initially 150% of the tax evaded but reduced by 50% for a first offence. Even so these penalties amounted to $407,000.
So far this is relatively routine. Inland Revenue are tracking property transactions and if something gets suspicious, they’ll look to see if a pattern emerging.
What caught my eye about this one is the Commissioner’s investigations included obtaining information from the People’s Republic of China under the double tax agreement we have with the PRC. As a result of that enquiry the registered proprietors of the land said, “Hey, we’ve got no knowledge of our involvement in these property sales, and we have not received any benefit from these sales”.
Now, one of the great unknowns that I think people aren’t aware of is how much information sharing goes on between tax authorities. But this is the first one I’ve seen where it’s been clearly acknowledged that the Chinese tax authorities in the People’s Republic of China have been involved.
So, there’s a warning for people to be very aware that Inland Revenue information gathering powers are enormous and they have discretion to ask overseas tax authorities for information in relation to any enquiry. Undoubtedly, the Chinese tax authorities would have been very interested in this as well because they would have people at their end who may have been involved in tax evasion.
A couple of years back, I asked Inland Revenue under the Official Information Act about how many requests for information were made between it and the Chinese tax authorities during the year ended 31 December 2018. The official response was
“The information above is refused because making the information available would likely prejudice the international relations of the New Zealand Government. It would also likely prejudice the entrusting of information to the New Zealand Government on a basis of confidence by the tax agency of the People’s Republic of China.”
Incidentally I asked a similar question in relation to the double tax agreements with Australia and the UK, and the information was supplied. Talking with a journalist who often deals with OIAs being declined, he was quite impressed because he hadn’t had an OIA declined on those grounds.
But international relations aside, the key point people should be aware of is that Inland Revenue has wide information gathering powers, and that includes being able to talk to other tax agencies and overseas. And in this case, that was probably pretty fatal for the taxpayer’s chances in this case. You have been warned.
The economic tax take in a pandemic
Speaking of international tax, the OECD earlier this week released its Revenue Statistics 2021, which showed the initial impact of COVID 19 on tax revenues within the 30 odd countries of the OECD.
On average tax revenues represented 33.5% of GDP in the 2020 calendar year, which is 0.1 percentage points of GDP up relative to 2019. But of course, this is against the backdrop of the impact of the pandemic which resulted in widespread falls in nominal tax revenues and nominal GDP. And that’s why the tax take relative to GDP rose because in most countries, GDP fell by more than nominal tax revenues.
As typically with OECD reports there’s heaps of interesting data that you can dive into. For example, in 2020, Denmark has the highest tax to GDP ratio of 46.5%, whereas Mexico, at 17.9%, has the lowest tax to GDP ratio. Overall, in 2020 for the 36 countries that were measured, the ratio of tax to GDP rose in 20 and fell in 16.
The largest ratio increase was in Spain, which went up 1.9 percentage points, apparently because of a large increase in social security contributions. But the largest fall, on the other hand, was Ireland, which fell 1.7 percentage points. And that was because its GST revenues fell quite substantially following a temporary reduction in GST rates as part of its response to the pandemic.
Where does New Zealand feature in all of this? Well, its ratio provisionally rose to 32.2% of GDP, which is up 0.7 percentage points from 31.5% in 2019. By the way, the tax to GDP ratio is also shown for the year 2000. Back then the ratio was 32.5% and New Zealand since then has pretty much tracked around that thirty-to-thirty two percent of GDP ratio since then. Incidentally, Denmark’s has actually been pretty stable over the same period. Its tax to GDP ratio back in 2000 was 46.9%. The average across the OECD back in 2000 was 32.9% and in 2020, it’s 33.5%. So, you can see stability across the tax take for quite some time.
The report has a breakdown between tax types and interestingly, corporate income taxes in New Zealand at 12.4% of total tax revenue in 2019 is significantly above the 9.6% average across the OECD. Similarly, GST at 30.3% is well above the 20.3% average in the rest of the OECD. (Chile incidentally collects 39.9% of its tax revenue from GST, which is the highest in the OECD. As always there’s plenty to dig into in these OECD reports.
From FIRST to START
And finally, this week, Inland Revenue has finally switched off its old FIRST computer system, as it’s now practically completed its Business Transformation programme. The total cost of this Business Transformation has come in at just under $1.5 billion, which is less than the $1.7 billion that was originally budgeted, including the leeway for contingencies.
So that has rightly drawn some praise from various sectors for managing that transition. I think you can look back at the Novopay scandal as to see how these things can go wrong. Consequently, the Inland Revenue had to make regular reports to the Cabinet about its progress.
And one of the effects for Inland Revenue of the programme and which was part of its business case, is that its workforce has gone from 5,662 in June 2016 to under 4,000 now, a quite significant change. My understanding is that back in 2016 under the old system, a significant number of processers were employed simply to re-enter everything into the system so it could actually be used.
Regular listeners to the podcast will know I’ve not always been entirely complimentary about what’s going on with Business Transformation. There have been some issues for tax agents and we’re still working through some teething problems. Generally, I think when the Business Transformation programme was being designed and implemented, the role of tax agents was not well considered. We tax agents are actually the biggest single users of the system and perhaps having tax agents involved earlier on might have made it a more user-friendly experience from our end.
However, it has to be said that this programme was much needed. FIRST was introduced in 1989, I think, and it was really showing its age. And fortunately for all of us Inland Revenue had Business Transformation well advanced when the pandemic arrived. Inland Revenue officials have told me none of assisting the Ministry of Social Development with the wage subsidy scheme, implementing the small business cashflow loan scheme and the ongoing resurgence support payment scheme could have happened under the old FIRST system.
I know the local IT sector was very unhappy at the start of the project at being shut out of the process, although some local providers have got involved as it developed. At a conference in 2014 which was a precursor to the start of Business Transformation it got bit spicy as local software providers climbed into Inland Revenue over their decision to use Accenture and other offshore companies to lead the project.
Local software providers made two points. Firstly, they had the capability and expertise. One announced it had designed and implemented Bermuda’s GST system within six months. The view was the expertise was already in the country.
But secondly, and this is a point which I think has to be kept in mind on a broader economic framework, if software companies are trying to export, but they’re not winning government contracts, that makes it a harder sell for them. That was a point which I also heard when I was on the Small Business Council.
Anyway, congratulations to Inland Revenue for migrating fully across to the new START platform. It’s onwards and upwards from here and although there will always be some teething problems, we’re working through these. So that was a welcome completion of a project.
Well, that’s it for this week. Next week, it will be my final podcast of the year. I’ll be looking back on the big stories for the year. Until then, 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 reading) and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
7 Dec, 2021 | The Week in Tax
- Latest Covid-19 developments
- How Christopher Luxon’s property portfolio is representative of the taxation of property debate
- Inland Revenue releases draft statement on charities and donee organisation
Transcript
Last week, New Zealand entered the new COVID-19 protection framework, or the traffic light system. Currently here in Auckland, we are on red and most of the rest of the country is on orange, with a few other exceptions. As part of this, the Government has made a new transition payment available, which is aimed particularly at businesses in the Auckland, Waikato and Northland regions, because these are the ones who have had the longest period under the old alert level system.
This transition period payment will be paid through the Resurgence Support Payment system starting in a week’s time from 10th December. It’s set at a higher base level than the current Resurgence Support Payments, applications for which closed last night, by the way. The payment is $4,000 per business, plus $400 per full time equivalent employee, up to a cap of 50 full time equivalent employees. The maximum that any business can receive is $24,000. Treasury estimates the likely total cost of the payment is going to be somewhere between $350-490 million.
This is a new support being made available. The Leave Support Scheme and Short-Term Absence Payment are also available. The Government will be considering further targeted support once the new Covid-19 protection framework beds in.
One other thing to note is that the rules have been changed so that recently acquired businesses can access the Resurgence Support Payment. This is because under the previous rules, the applicant had to have been operating as a business for at least one month before August 17th. So, businesses acquired after July 17th were not eligible for any payment. Although few businesses were affected by the previous criteria, it made a difficult time even worse.
The test will be that the business that was sold must have been in operation for at least a month prior to August 17th and the new business is carrying on the same or similar activity as before the change in ownership. This is a welcome little break. However, there will still be pressure on businesses. As is well known, hospitality and tourism have had a very, very hard time of it over the last 16 weeks of lockdown
Mega landlords
Moving on, there’s been quite the debate this week over the taxation of property as a number of factors came together. Stuff has been running stories on what it calls mega landlords. One story noted that the proposed changes to the interest limitation rules have led investors to start reconsidering their investment portfolio. And also there’s been changes in the Bright-line test, which is now runs for 10 years.
A survey from the Chartered Accountants Australia and New Zealand (CAANZ) and in conjunction with Tax Management New Zealand, found that the proposed tax policies had already affected many property investors’ behaviour. 70% of the 360 odd respondents reported that their clients had changed or were planning to change their investment behaviour. What exactly that might be obviously depends on individual circumstances. According to CAANZ’s New Zealand tax leader John Cuthbertson, it’s likely to be not purchasing additional properties. However, as he also pointed out there’s still some confusion and uncertainty around the complexity of the rules.
Multi property owners
And then Christopher Luxon, the new leader of the National Party, came under some fire when it was revealed that he had seven properties as part of his investment portfolio. However, as business journalist Bernard Hickey pointed out this is actually an entirely rational investment approach under current rules.
This is the crux of the matter. Property has been very tax-preferred, particularly in relation to the non-taxation of gains, and the deductibility of interest even though there are two parts to the economic return, i.e. the taxed rental income and the (usually untaxed) capital growth. Apparently, the value of Luxon’s properties increased by approximately $4 million over the last 12 months. He can reasonably expect that none of this gain will be taxed.
These themes form the background behind the new legislation to limit interest deductions. It so happened that last Monday Parliament’s Finance and Expenditure Select Committee heard oral submissions on the new tax bill, the Taxation (Annual Rates for 2021-2022, GST and Remedial Matters) Bill to give it its full title.
The FEC received 83 written submissions, which are available on its website, including a monster 216 page submission from CAANZ. The size of that submission, which was one of the largest I’ve ever seen, gives you some idea of the complexity involved in this whole matter.
Listening to the oral submissions, the constant refrain was that the proposed rules are far more complicated than people realise, and we don’t know what the unintended consequences might be. The Corporate Taxpayers Group (their submission was a more manageable 21 pages) suggested that really the introduction of the interest limitation rules should be deferred until 1st April so that people can get their head around what’s going on. I think this is a fair point and one other submitters made.
CAANZ and the Corporate Taxpayers Group were concerned about how rushed this whole process has been and how that fits in with the Generic Tax Policy Process (GTTP). I and one or two other submitters suggested that there really needs to be a thorough review of the bright-line test and this legislation in line with the GTPP, because that’s what’s supposed to happen and hasn’t been happening recently. The bright-line test, for example, was introduced six years ago so it’s time for a review as to how it’s working. Since its introduction the bright-line period has gone from two years to ten years period. How is that working? is a fair question to ask.
Talking about the distortions
In the course of the hearing Green MP Chloe Swarbrick rather mischievously raised the issue of an inheritance tax with one submitter. That promptly earned her a bit of a telling off from the chair of the FEC. In my oral submission, I took the opportunity to put forward the Fair Economic Return proposal Susan St John and myself have developed. Whether that gets any traction remains to be seen.
To perhaps unfairly reference Christopher Luxon again, the concern we have is that his $4 million of capital appreciation in the past 12 months is most likely not to be taxed. And whether that’s actually an appropriate tax setting is something we don’t believe is correct. And I think the evidence is growing about how distortionary it is and that something needs to change.
This whole debate, which went on this week and will continue, reinforces the point that Craig Elliffe made in last week’s podcast that the debate over the taxing of property or capital isn’t going away because the current position is unsustainable. A point that rarely gets made is that Aotearoa-New Zealand is really unique in not either having a capital gains tax, or a wealth tax or estate and gift duties or taxing imputed rental. All of those exist in one form in most of the major jurisdictions of the OECD and G20, but there is none of them that don’t have any of those except for ourselves. So that’s why I think this debate will continue.
Doing charity, or accumulating wealth?
Moving on, I remember listening to the late Sir Michael Cullen talking about his experience on the Tax Working Group. I asked him about whether anything had been a surprise to him, and he replied he had been surprised by the extent of what was happening in the charitable sector,
This is something that pops up from time to time with criticism and accusations of charities abusing their charitable status to get an unfair advantage over other businesses. Sanitarium is the one charity (of the Seventh-day Adventist Church) that often pops up when this happens. The Tax Working Group’s view on charitable donations was that it is a long-standing relief. In its view the issue will be around whether, in fact, those charitable organisations are making charitable donations. The concern that arises is when they’re not and they are accumulating wealth without distributing it.
Now it so happens that this week Inland Revenue released a draft operational statement on charities and donee organisations. Now this is a bit of a monster statement, it runs to 105 pages. It outlines the tax treatment and obligations that apply to charities and donee organisations and how the Commissioner of Inland Revenue will apply the relevant legislation.
As I said, the statement is so big it’s been split into two parts, one for charities and one for donee organisations. I’m not proposing to run through this in detail right now, but the statement sets out briefly what exemptions are available and how Inland Revenue is expecting that process to be managed. Inland Revenue is taking submissions until the end of next February. And I would expect that this would generate quite a bit of feedback.
It’s good Inland Revenue has set out formal rules for charities and donee organisations. It is also, in my mind, an indicator that Inland Revenue has some concerns about what’s been happening in this sector, and it is now making very clear what are the rules, what it expects to see, and there will be consequences if the rules aren’t followed.
Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening (and reading) and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
29 Nov, 2021 | The Week in Tax
Transcript
My guest today is Craig Elliffe, Professor of Law at the University of Auckland. Craig has had a very distinguished and accomplished career. He was a tax partner at KPMG and then at Chapman Tripp before moving into academia at the University of Auckland. Craig was also a member of the Michael Cullen chaired Tax Working Group and in April this year published the award winning, and highly relevant book, Taxing the Digital Economy. He’s joining me today to discuss the recently announced agreements on international taxation. Kia ora. Craig, welcome to the podcast. Thanks for joining us.
So what has been agreed and how important are these agreements?
CRAIG ELLIFFE
Well, there’s been a lot of discussion, a lot of politics, and even just as recently as last month, a clear political statement by what are now at least 141 countries, representing greater than 95% of the world’s GDP. And what they’ve agreed is effectively two brand new pillars which they’re calling Pillar One and Pillar Two. They are a new consensus reached on how to tax global transactions.
TERRY BAUCHER
There’s two parts, as you say, Pillar One and Pillar Two. And Pillar Two, is the one attracting quite a bit of attention because it’s basically proposing a global minimum corporate tax rate of 15%. Is that high enough?
CRAIG ELLIFFE
Well, many commentators say no. And I guess this is the thing when you have a global consensus, you don’t get a global consensus with an extreme of one sort or another because there will be some countries who don’t want a global minimum tax at all. And there’ll be some countries who fiercely want it for a variety of different reasons. In the end, I think 15% represents an amount which is certainly lower than most developed countries’ corporate tax rates.
But we’re in a period of time when I think Corporation Tax is under quite significant focus because there will be quite a few budgets that are both in deficit and economies with substantial borrowing. So my sense is that 15% is quite a good place to have landed in the sense that for those countries for whom the tax rate is viewed as competitive, they still probably feel as though they can do something. And for those who view this as a key element of cooperation amongst different countries, it’s significantly better than the than the current position with of not having one at all.
TB
Yes, and just talking about those who haven’t joined Nigeria, Kenya and Pakistan were three of those countries. Nigeria and Pakistan are in the top 10 most populous countries in the world, and Nigeria is also Africa’s biggest economy and Kenya is also a bit of a hub for East Africa. What do you make of this or are they just simply showing a bit of muscle about the politics here?
CRAIG ELLIFFE
They might be doing that, but I often think it says more about the domestic politics than it might do about the international politics. If that’s the right way to describe it. Sri Lanka is another one that is in that situation. My sense is overall that what they are doing is they are playing to perhaps domestic incentives and domestic politics whereby they can’t commit to it because they believe that it would be giving away too much. The opportunities for incentives or for creating special hubs of a certain kind might be such that therefore they don’t want to join up. I wouldn’t focus on these holdouts. They represent such a small proportion of the world’s economy. It sounds really rude to say that they’re not big players because they are obviously much bigger than we are, that’s for sure. But notwithstanding that in terms of world economic and GDP, you know that we’re talking about minor players, really. And certainly, when you compare all the countries that have signed up to it, this represents a hugely significant change.
It’s not that the amount of money here is so dramatic. Although there are reasonable sums of money, Pillar One, which is the new regime for taxing very large multinationals and digital companies, is expected to allocate US$125 billion to market jurisdictions. Pillar Two, which is the minimum corporate tax, is expected to raise US$150 billion of tax.
Those aren’t small sums of money, but the consequence, if you like, is more strategic than it is financial because this is a change to the world order of taxation. And this is why it has been 100 years in the making, really.
The key fundamental tenants that existed in the 1920s and the 1930s when the forerunner to the OECD struck the first tax deals, were focussed really on some really important principles, such as arm’s length profits. It had the concept of permanent establishment, which came out of the 1930s for business profits to relieve double tax. And it was a whole system which was predicated on the basis that taxation largely occurred in the country of origin, where the goods or services were manufactured, or where the capital was employed, rather than in the marketplace where the consumers were, or in the modern digital economy where the users are based. And this new agreement turns that on its head and allocates a percentage to that market jurisdiction.
So this is a very big change, not in terms of dollar amounts, but in terms of opening the door, the thin end of the wedge, I suppose, would be another way to describe it. This is the opportunity for a new fundamental architecture for the international tax regime. That’s a that’s a big issue really with ultimately very large consequences.
TB
I agree. I think we’re seeing how the combination of the Global Financial Crisis and now the Pandemic has shifted all the thinking. This paradigm that we’ve been working in for the last 40 years of relatively low tax, low regulation, I think that’s gone. These agreements reflect trends I see emerging.
And one of the things I think we’ll see is the end of the traditional tax haven with zero corporation tax rates those are going to go. Most of them, really when you look at them, are such minor players they survived by grace and favour and now I think their days are numbered. It wouldn’t surprise me if in 10 years’ time they are gone, because they’re going to have to raise tax rates. For example, take the British Virgin Islands. They basically now have to have a 15% corporate minimum corporate tax as a result of this agreement.
CRAIG ELLIFFE
Well, that’s right. If they choose to operate on their existing level, then companies that own British Virgin Islands entities or individuals that are based in a jurisdiction that has signed up to Pillar Two, will be obliged to tax the profits in the British Virgin Islands up to 15% if the BVI government doesn’t decide to impose a minimum tax. So yes, a whole new change.
And I think you’re right. The big trend I see here is firstly towards more effective source taxation, I’ve just written a paper on this issue. I think that’s a by-product of more than just the big, wealthy OECD countries being involved in these agreements. The big source-based countries like India, Brazil and China, were involved and had powerful negotiation stances. So one trend will be more effective source taxation.
Next is multilateralism, which is the technique which involves not only just the process of getting the consensus, which is the group of countries operating in the inclusive framework, but also the mechanism that they achieve it by which is through multilateral treaties. These are much more sophisticated and much more effective in terms of rapidly rolling out changes.
And then lastly, away from competition and towards cooperation. And I think that’s what you were alluding to before in terms of looking at the rights to tax. What we’ve got is something which is much more cooperative and may well be that that taxation may deal with world problems in a more co-operative manner.
But these types of issues are going to emerge, you can see it already. We’ve already had the health crisis. We’ve got an environmental crisis that’s been going on for a long period of time. And so we need countries to be operating in this cooperative way, using multilateral instruments and processes to solve problems which are not just purely domestic, but are in fact international. This change stems from multinational tax and the lack of payment by some of the big multinationals became domestic politics for most jurisdictions.
You know, there were the big Senate enquiries in the US, the British parliamentary committees and the Australians had enquiries as well. So suddenly, politicians with domestic agendas were trying to grapple with issues which involved international agreements. And so we’ve seen, if you like, the popular democratic process having an impact on the need to negotiate and get consensus at a worldwide level. It’s quite a fascinating time.
TB
Oh, very much so. You would have seen this on the Tax Working Group with submissions from the public about multinationals not paying their fair share. I see this regularly in general commentary. Last week for example we had the Radio New Zealand report about Uber’s tax practises. Personally, I think Uber is an extreme worst case of tax avoidance, which is why I won’t use Uber.
But it’s an interesting point, that domestic politics is now coming to bear. Multinational companies may not like it, but they seem to be accepting that you can’t push the envelope as far as they have done without getting pushback from the politicians.
When you were on the Tax Working Group, you would have looked at the question of international taxation. And so have these changes come quicker than you expected at that time, or perhaps hoped might happen? I think you could see this trend developing, but I don’t know if you and the group were saying we’ll see big change in the next three years.
CRAIG ELLIFFE
It’s a good question. No, I didn’t expect the changes to come as quickly as they hit. But I certainly would have hoped that they may have come that quickly. And so I’ve been pleasantly surprised. When I set out to write Taxing the Digital Economy it was interesting because it was during a period of great change. But I began writing at a point in time where it had been 100 years since there had been such a significant change. So I wasn’t confident at all that I wasn’t going to be spending greater than the year writing the book doing something that was relevant.
As it turns out, and I think that the thing to remember in terms of tax changes is that when you have a status quo, an existing situation, which is unacceptable, you have to expect that there will be change. It’s just a question of what that change is. Now we had it definitely in international tax because you had the largest, most profitable and most successful businesses in the world not only not paying tax in source jurisdictions where they were operating, but they also actually weren’t paying that much tax in their home jurisdiction because of the inadequacies of residency taxation which was particularly true for the United States. So, there was always going to be some significant change.
And it’s another reason why, by the way, as a complete aside from this topic, why there’s a pretty reasonable chance that at some point in time in this country, we will have additional tax on capital because the current proposition is largely unsustainable as the population ages. The long-term Treasury forecasts suggest that something has to give. I know in discussing this with you that I’m already preaching to the converted, but there are plenty of unconverted people out there!
TB
That is indeed a whole other conversation.
When you were writing Taxing the Digital Economy was it surprising to see what was happening around for you? You sound as if you happened to hit that fortunate, Zeitgeist moment when you’re writing something and it’s becoming ever more relevant as you’re progressing.
CRAIG ELLIFFE
Yeah, look, I think that’s right, Terry. I was very lucky. I was based in Oxford alongside the Oxford International Tax Group and I spent a lot of time with people like Michael Devereaux and John Vella and they were very kind. It was only just a short trip across to Paris to talk to the OECD, and so it was a great place to be. I need to thank enormously the New Zealand Law Foundation for the fellowship that they gave me, which enabled me to live in Oxford for those six months. So that was a real advantage.
But I think to answer your specific question about what sort of dynamic was emerging, I think it was one of those sorts of situations where people were looking for alternatives to the current system and the Oxford Group in particular are very keen on change. Speaking with Michael Devereaux at dinner one night he gave an insight that he had really spent quite a lot of time considering why and how consumption taxes such as GST are so effective. And the simple answer was because they tax on the residency of the consumer, and that’s a much more difficult thing to manipulate and very hard to change.
A lot of his thinking when he began writing about destination basis of taxation for corporate taxation is linked to this idea that the place of destination is where the consumer resides. Now, it’s really important to not get this confused with consumption taxes that is, you know, they are the same groups of people, but one is a tax on consumption, the other is a corporate tax that’s on the supplier of the goods or services, not on the consumer. And the corporate is simply allocating some of its income to the demand side rather than the supply side of its of its economic chain. So it’s an allocation of income issue and it’s going to the marketplace rather than the country of origin. So that’s the logic behind it.
TB
That’s fascinating. I mean, we talked about this international agreement, and you touched on something earlier when you said the tech giants were part of this agreement. What is its likely impact for New Zealand? Are we talking tens of millions or hundreds of millions of dollars additional revenue in a year?
CRAIG ELLIFFE
Look, I don’t truly know. I suspect that we’re talking tens of millions and not hundreds of millions. I think, for New Zealand, most of the revenue, I suspect, will actually come about through Pillar One, through the allocation of mostly digital companies with their transactions with our user base and our market jurisdiction, which is currently largely escaping tax. So that, I think, is probably the area where New Zealand will pick up a bit of tax.
In terms of Pillar Two because we have very good and pretty effective controlled foreign company rules, I can’t see that the New Zealand economy will benefit greatly to the same extent. But it is possible the impact that we might actually have would be on foreign owned multinationals operating here in New Zealand and that if they don’t pay sufficient tax in New Zealand, then there is a chance that those foreign owned New Zealand based multinationals will end up with Pillar Two responsibilities elsewhere.
And probably the major issue, I think, is New Zealand capital gains made by for example, a French multinational which owns a New Zealand subsidiary that it sells and makes a huge capital gain. In this case the French multinational’s effective rate of tax here in New Zealand is going to be low, possibly lower than 15%. So, there might be some issues there. There is some talk that New Zealand might actually impose some minimum tax in such a case because if someone is going to pay tax, we might as well get it. So, there is a possibility that we might have some domestic based top up tax designed really to get in first on Pillar Two ahead some of the foreign multinational.
TB
That’s interesting. I hadn’t even considered that one.
One of the things that may have fallen by the wayside are digital services taxes (DSTs) which the Tax Working Group would have considered. Are these gone for good? I’m surprised India signed up to this agreement. I think this was significant, because it has some DSTs in place.
As the agreement stands DSTs are to go once everything is in place, but will we see them come back in a different way? We’ve just been talking about the tech companies like Google, for example. We have no idea exactly how much Google takes out of New Zealand, but estimates run to $600 million or more. Yet its reported taxable profit is about $12 million. Pillar One may increase that, but still, that’s a big discrepancy and it’s gutted our media industry.
So would we see the sneaky old “We’ll call a tax a different thing”, to get round this prohibition, something like a “Digital Advertising Levy”, which I think is what India has looked at. And I saw something about Maryland in America imposing such a charge.
CRAIG ELLIFFE
Yes, you’re right. I mean, the first thing we have to realise about DSTs is that they are extremely ugly taxes. They are ugly because they’re not creditable. [May be offset against corporate tax liabilities]. In order to be effective, they need to apply to both residents and non-residents so that they’re not discriminatory under the World Trade Organisation obligations. To work in conjunction with double tax treaties they can’t be regarded as corporate taxes, they must be turnover taxes, not income taxes.
So they are a tax of last resort if one looks at it from a purist perspective and their purpose was to bring the Americans in particular to the table in order to fit the multi-lateral consensus.
My own personal view, not the view of the Tax Working Group, nor indeed the view of the New Zealand Government, was that it was good and sensible for us to be considering the implementation of one up until the point in time, we would get a multilateral consensus. We now have that. I suppose if the consensus doesn’t work for any reason, that if the rules on the Pillar One are not what we would hope for or in some way fall away, then we will possibly end up looking at digital services taxes again.
But consensus that’s really a Plan B or Plan C, and what we’ve got is actually something which is more which is vastly superior, actually, because it is creditable, it’s designed not to have a double tax effect. It’s simply a reallocation of taxing rights for what is really the top 100 companies in the world. They all have a turnover of greater than 20 billion euros, and they’re all profitable. What’s been agreed is sort of a trial period with the big players, and then it’ll roll itself out to smaller companies.
So as time goes by and we will get used to this idea, I think. The common misconception, unfortunately, is that changes everything and it sort of does, but only really for the biggest players. I mean, no companies in New Zealand will be affected by Pillar One at this point in time. I think in terms of the future, as far as Pillar Two is concerned, there certainly will be some that will be affected by it.
But you know, this is the opening of the door, the thin end of the wedges. There will be changes and generally I think it’s good they’re happening.
TB
Well, that seems to be a good place to leave it perhaps, Craig. Thank you so much. It’s exciting times, as always. We’ve both been in tax for a long time, and it’s things like this which keeps us fresh and energised and interested in what’s going on around us.
CRAIG ELLIFFE
Thank you for inviting me on. It’s been a pleasure.
TB
Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
22 Nov, 2021 | The Week in Tax
- What Inland Revenue needs to do to improve the quality of tax legislation
- Growing concerns about potential for misuse of new investigative powers for tax authorities
- Time for a surcharge on the banking sector?
Transcript
Earlier last week, more detail emerged about a report that had been commissioned by Inland Revenue into its legislative drafting process. Apparently, there is a full report which was released to Inland Revenue in June but has not been made public. Instead, a summary of the conclusions has been made public recently, and it’s the subject of some news reports.
The news reports sound much worse than the position actually is, but it is interesting to lift the hood, so to speak, and have a look at the very important process of turning policy intentions into legislation and how that works.
What Inland Revenue wanted to do was undertake a review of how it was doing on this basis, because one of the interesting things about Inland Revenue is that it gets to draft its own legislation. Normally, legislation is prepared by the Parliamentary Counsel Office, but with tax legislation Inland Revenue does the drafting, making it the only government department with that power. Inland Revenue is quite unusual because of how extensive its powers are, and obviously these are required, being the Government’s main revenue gathering agency. Even so, it has powers that tax authorities in other jurisdictions may not necessarily have.
So this report was commissioned two years ago to look into this particular power. Looking beyond the somewhat dramatic news reports about “scathing commentary” there are definitely some concerns to be addressed. One of which I would say would be perhaps a matter of resourcing. Apparently, according to this report, it appears there is one person called Sharon, who is responsible for administering a plain English review of the legislation before it is published.
The report, prepared by Graeme Smaill of Greenwood Roche Lawyers, summarises the three broad areas that it believes should be the focus of future efforts to improve Inland Revenue’s legislative process. Firstly, the use of existing and identification of further specific drafting tools to deliver legislation that is fit for purpose and accessible for those who need to use it.
Now, one of the things to keep in mind about legislation and how it’s drafted is that by and large, the legislation is drafted for general use. New Zealand, as part of its tax simplification policy adopted in the 80s, tries to avoid special regimes where possible.
But what this does mean is that sometimes it’s drafting legislation, such as the hybrid mismatch rules, which will affect a very small group of taxpayers, mainly large multinationals. But they apply across the board, which comes back to the theme of last week’s podcast. Unintended consequences may mean a small business in New Zealand exporting to Australia or setting up operations to export in Australia might find itself caught up in these rules totally inadvertently.
The financial arrangements rules, by the way, are probably another good example of how these unintended consequences can apply. They’re highly complex, and they were designed in the mid-80s to deal with large corporates and complex multi-million-dollar funding arrangements. But the rules now catch people with mortgages for overseas properties. I’m pretty certain that the drafters of the financial arrangements regime in the mid-80s didn’t really think that should be the case. So that’s a good point about appropriate tools and making it accessible.
Higher skills required
The second broad area is “achieving higher skills for all those involved in the drafting unit and a team that produces collaborative and consistent results”. That is absolutely key. Inland Revenue is actually a very trusted body. People might not like paying tax, but on the whole, I think it’s an organisation that’s actually trusted to do its job fairly, even if people’s definition of fairness will vary. But broadly speaking, it is a respected organisation. But consistency is the key to Inland Revenue maintaining that trust. So making sure the legislation is consistent is very, very important.
Then finally, and this is a point where a lot of work goes into this already,
“the development of legislation by a consultative process involving public policy analysts within Inland Revenue and other government departments and external stakeholders improved and aimed at improving the practical ability for the legislation to be understood and complied with.”
And one of the report’s criticisms is that there’s a lot of time spent on developing tax policy. And then perhaps the legislation is not quite an afterthought but comes in at the end of the process and in some cases, not enough care has been taken with it so remedial legislation is required. This is something we see quite a bit. Every tax bill contains remedial legislation and that will always be the case. It’s basically continuous improvement. But the report was suggesting that we perhaps need to be looking more at getting the legislation more accurate first time
Looking through the whole summary report made available, there are nearly 40 recommendations across the board, so there’s a lot to go through. The Income Tax Act, was rewritten substantially in the late 80s early 90s, as part of which it was organised into its current alphanumeric and subparts system which I have to say coming from the UK was revelatory. It was so much more coherent and better organised than what I had been used to grappling with.
And so putting things in context. yes, tax legislation could need improvement. For example, if you listen to The Panel there’s a very funny sequence yesterday where the panellists and Bridget Riley talk about this report and the use of semicolons and what do they mean. Does a semicolon mean “or” or “and” because there can be a quite substantial difference in tax outcomes. https://www.rnz.co.nz/national/programmes/thepanel/audio/2018821093/the-panel-with-teuila-fuatai-and-jock-anderson-part-2
But by and large, New Zealand’s legislation is pretty understandable. I’ve had to grapple with the UK, Australian and sometimes US tax legislation and it holds up pretty well by comparison. But there’s always room for improvement.
Power grab?
Moving on and still about Inland Revenue and its powers, there’s an ongoing controversy over Inland Revenue’s high wealth individual research project. Putting aside self-interest, one of the concerns of those affected is Inland Revenue power-creep and whether information supplied to Inland Revenue for ostensibly research purposes will be made available to other government agencies. Apparently, it could be and more to the point it could also be available to other tax jurisdictions. That’s not what’s intended by the research project, or at least that’s my understanding of it.
But the creeping powers of tax authorities is a worldwide trend. A news report last week was about H.M. Revenue and Customs in the UK. It had been granted new powers for requesting information from financial institutions. The UK has made many of these requests subject to scrutiny by tribunals. However, HMRC can issue Financial Institution Notices, requesting financial information about a taxpayer from a third party without applying to a tribunal. And apparently reports are emerging now that HMRC has been using these notices much more widely than was ever intended.
And one of the concerns in the UK is no statutory right of appeal was granted against these notices. The only way a Financial Institution Notice could be challenged was through a judicial review court action. So UK practitioners are understandably quite concerned that HMRC appears to be more widely using powers, which were supposed to be used in a very limited basis.
And of course, down here, practitioners will watch this stuff and look around and see the same. We would have similar concerns about granting additional investigative powers to Inland Revenue. But coming back to our old friend unintended consequences, if these powers are used much more widely than was planned, how do we deal with that? That’s going to be an ongoing theme.
And broadly speaking, I think the general public is very, very unaware of just how extensive the Inland Revenue information gathering powers are and how much information is being shared with other Government agencies as well as other tax authorities throughout the world. And so there’s this dichotomy we want people to pay the right amount of tax, but then we’ve got to question the invasion of privacy. And it seems that in relation to this dichotomy the Data Commissioner up in the UK is lining up to challenge HMRC’s practices. So it’s another case of watch this space.
Our turn to add a bank profits tax?
And finally, an interesting idea from Gareth Vaughan and the enormous profits of the banks.
The latest combined annual net profit after tax for the big four banks was $5.493 billion. That’s 7% more on the previous record back in 2018. All the banks are making profits. Kiwibank was $126 million, SBS had a record profit of $41.1 million and The Co-operative Bank another record profit for it of $15.6 million.
And so Gareth raises a very good question. This wasn’t really what we were expecting to see when Covid-19 hit, when the concerns were about how the banking system would hold up, and whether there would be the liquidity to keep financing businesses. But instead, all those concerns seem to have fallen by the board and instead we’ve had a huge asset price boom, particularly in relation to property and we are now concerned with the fallout from that
And one of the things that came out of the response to Covid-19 was that the Government felt the need to introduce the Small Business Cashflow Loan Scheme, which as Gareth asks could this scheme not represent a market failure on the part of the banks? They’re not lending so much to businesses. ANZ, for example, has 70% of its total lending in housing.
So Gareth suggested what about imposing a one off Covid-19 tax on the banking sector? And his proposal is set at a percentage of individual bank’s profit and applied only to banks active in the housing market. Maybe the funds raised could then be used to help out small businesses in the sectors hardest hit by the pandemic, hospitality and tourism would obviously be the prime beneficiaries there. A 5% charge for the big four banks would raise $275 million.
It’s not quite as unusual as it might sound. [Australia has one.] Over in the UK it has a corporation tax surcharge on profits of its banking sector which is payable on top of the standard 19% Corporation Tax. The banking sector then pays a further eight percentage points on top. This has been in place since 2009 which is quite some time. There’s also, by the way, a separate bank levy to help build up an insurance fund so it can fund another bailout if required. Fortunately, we didn’t need that here.
But the idea that super profits are being made by banks and maybe an additional levy should be charged to address the unintended consequences of these profits or a perceived market failure is something perhaps worth considering. It would run counter to what I said earlier about how, generally speaking, New Zealand doesn’t have a lot of special tax regimes. It certainly would be an interesting challenge for the drafters of any such legislation.
Well, that’s it for this week. Next week my guest will be Professor Craig Elliffe of Auckland University and we’ll be talking about the recent international tax announcements including a proposed global minimum tax rate of 15% and what that might mean for New Zealand.
Until then, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
15 Nov, 2021 | The Week in Tax
- Similarly how the abatement of working for families makes it harder for low-income earners to break out of poverty.
Transcript
About 10 years ago, myself and a group of other tax agents were on our way to a meeting with the then Minister of Revenue Peter Dunne. On the way someone mentioned whether we ought to raise the question of the law of unintended consequences in relation to a tax issue. Another replied that he’d never heard of such a thing law. So, we decided we shouldn’t say anything about that particular point.
We get into the meeting with Minister Dunne. And lo and behold in the course of our discussion, he brings up the law of unintended consequences, at which point we had to pause the meeting and explain to the Minister why we’d all cracked up.
(Incidentally, during that meeting, we raised a matter I discussed last week, the inequitable taxation of ACC lump sums. That was an issue which was supposed to be looked at by officials, and 10 years on, I guess they’re still looking).
The international impacts
I recalled this because last week I also talked about the Greensill decision in Australia, and the implications for trustees of New Zealand trusts. And on Monday, I got a new enquiry from a client where the impact of Greensill could come into play and it’s a classic example of the law of unintended consequences.
A mother had decided that she wanted all three of her children to be trustees of the family trust, and this change was made for good reasons in managing a family dynamic. Problem is, one of those children lives in Australia. As I mentioned last week under Australian tax law, if any trustee of a trust is tax resident in Australia, the trust is deemed resident in Australia. That means the Greensill decision may apply, which basically says capital gains even if realised offshore and even if distributed to a non-resident, are subject to Australian tax at the top rate of 47%.
The implications are therefore potentially quite serious for this trust. Looking into it in more detail, the trust is deemed resident from the first day a trustee is a tax resident of Australia. The trustees will have to prepare and file Australian tax returns reporting the trust’s income as calculated for Australian tax purposes.
Now, in many cases, the trusts will distribute income to beneficiaries and from an Australian perspective, if non-Australian sourced income is distributed to a non-resident, it’s not an issue. It’s just that in the law there is a technical inconsistency, which means that the Australian resident trustees are liable for Australian tax on non-Australian sourced capital gains distributed to non-residents.
This is the impact of the Greensill decision which to recap involved a capital gain of A$58 million and was held to be taxable at 47%. What’s more, with Australian trusts, the rate for retained income is 47%, and this is further complicated by rules about which beneficiaries have what is termed “present entitlement” as at the date of balance date. So overall, this is potentially quite a serious issue if substantial capital gains been raised.
Now the logical response, you’d think is, “Aha, let’s get the trustee to resign” and once the trustee resigns, that ends the connection with Australia. A logical move, except the Australian tax legislation has thought of that point. And what happens then is there’s a deemed disposal of the trust’s assets on the date of the resignation of the trustee (This is a feature of some jurisdictions with a capital gains tax). In other words the Australian Tax Office, believes in Blondie’s maxim, “One way or another we’re going to get you”.
We are currently working through all these issues. This is a textbook case of whenever there’s a family trust and there is family overseas if you want one of the family to become a trustee, you have to put a big pause on that and get tax advice, particularly in relation to Australian residents.
I’ve seen some trustees who are living in the UK pop up on trusts. This is not quite as potentially catastrophic but it’s still problematic. There’s this dichotomy between New Zealand’s tax treatment, which based around the settlor and many other jurisdictions, which is based around the residence of the trustee. So, to repeat the key point, if you have any trustees that are tax resident overseas, you need to get tax advice.
Helping your children
Moving on, the second instance of unintended consequences this week involves family members such as parents, grandparents or trusts trying to help children or beneficiaries purchase property, the bank of Mum and Dad as it’s sometimes called. This has become incredibly more relevant as a by-product of the horrendous escalation in housing prices.
The issue that has to be watched out for is when the parents or whichever other entity is involved, a trust, for example, actually takes a direct ownership interest in the property to be acquired. At that point, whoever it is, is probably setting themselves up for some issues further down the track in relation to the bright-line test.
And these of course have been magnified by the fact that the bright-line test as of 27th March this year now runs for 10 years. These issues were probably manageable when the two-year bright-line test was initially introduced back in October 2015 but have now been considerably magnified with the extension of the bright-line test period to 10 years.
What is emerging in some cases is that families might say, right, well, “We’ll take a 25% interest in the property. And then as the equity and your income rises you can pay us back and gradually take over our interest”. So ultimately, the children or beneficiaries will own 100% of the property. The problem is the reduction in those minority interests in the property represent a disposal for income tax purposes and for the purposes of the bright-line test.
For example, let’s say parents co-owned a house with a child and the ownership structure was initially 50:50 between them, but change it to 75:25. In that case, there’s been change in the title in the ownership interest, and therefore there’s been a disposal by the parents of a 25% interest to their child. Therefore, this disposal would be subject to bright-line test. There would be no exemptions here because they’re not living in it and it’s not their main residence. Just bear in mind that even if that property was the main residence of the child, the parents having the interest would still have made a disposal for bright-line purposes.
There’s also a potential kicker for such a transaction if the property is sold or gifted below its market value within the bright-line period, the transaction is treated as having happened at market value. So, for example, if the market value of the property had increased from $500,000 to $1 million, then the parents reducing their interest would be taxed on whatever their share of that $1 million was, rather than what actual cash they might have received. So potentially there could be some very sticky tax bills arising.
Arguably, one potential way round this might be that the parents lend the money to the child and not take a direct ownership interest, but you know, horses for courses, individual circumstances will come into play.
So, you just have to be very careful and proceed with great care if you are taking a financial interest in your child’s property to help them on the ladder. Otherwise, it could be another example of unintended tax consequences.
Lessening inequality
And the third unintended consequences that we might see in tax relates to the recent announcements from the government about changes to working for families.
What the Government has done has announced increases to the amount payable. The family tax credit is going to be increased by $5 per child. And on average, families will be $20 a week better off. But, and there’s always a ‘but’ in this, what the Government has given with one hand it has quietly decided to take on the other by raising the abatement rate to 27%.
Now abatement is what happens when a family’s annual income exceeds $42,700 then working for families credits start to be abated. And what this means is that people on average incomes actually have the highest effective marginal tax rates in the country.
For example, a family earning $48,000, the point at which the tax rate moves from 17.5% to 30%, their effective marginal tax rate, once you add in the impact of abatement is 57%. In other words, for every dollar of extra income they earn, they will lose 30% in tax and 27% of their working for families tax credits
For family’s with income just over $70,000, the marginal tax rate rise to 60%. And if you’ve got a student loan, that’s another 12% on top of that. A person earning just above $48,000 with a student loan could be facing an effective marginal tax rate of 69%. This is the unintended consequences of the abatement rates. The theory is conceptually sound, but the problem is it traps people on low income and makes it very hard for them to break out of the need to receive social assistance.
This is one of these things that is consistently glossed over by politicians and has been one of those sneaky little tax increases that that previous finance minister Bill English did. Grant Robertson is just the latest to increase the abatement rate and so quietly claw back some of the assistance. The unintended consequence is that the step up makes it harder to get out of poverty.
There is meant to be a review of working for families going on at the moment, but that’s been paused. As we know, the Welfare Expert Advisory Group recommended significant increases in benefits and that report is now nearly over two years old.
To summarise this week’s lesson, tax is full of unintended consequences. Therefore, always proceed with caution if you’re making significant changes, such as appointing a trustee or wanting to co-invest with your children on a property purchase.
Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website, www.baucher.tax or wherever you get your podcasts. Thank you for listening, and please send me your feedback and tell your friends and clients. Until next week, party week, have a great week and go the Black Caps.
8 Nov, 2021 | The Week in Tax
- We focus on trusts, in particular the new reporting requirements for trusts and a concerning court decision from Australia.
- We also review a harsh but not unexpected decision from the Taxation Review Authority regarding the taxation of arrears of weekly ACC compensation.
Transcript
This week we focus on trusts, in particular new reporting requirements for trusts which have caused a stir together with a concerning court decision from Australia. Elsewhere, there is a harsh but not unexpected decision from the Taxation Review Authority regarding the taxation of arrears of weekly ACC compensation.
Last month, Inland Revenue released two papers relating to trusts, firstly, an issues paper on the reporting requirements for domestic trusts where disclosure is required under the Tax Administration Act 1994, and secondly, a detailed operational statement setting out the reporting requirements for domestic trusts.
Now, these prompted an article by Auckland barrister Anthony Grant, who specialises in trusts and estates. He was quite concerned about the papers and why this information was being gathered. His article concluded;
“The information can be wanted only because the IRD and the present government want to tax people who lend money to trusts at less than market rates, people who get benefits from trusts, people who provide services to trust assets and people who have powers in relation to trusts, as they have never been taxed before.”
That’s quite a quite a closing statement.
The source of the two Inland Revenue papers is legislation enacted when the Government increased the individual tax rate to 39%. The Government did not also increase the trustee tax rate, even though Inland Revenue recommendation was that it should, based on bitter experience of what happened between 2000 and 2010 when such a differential existed previously.
Instead, the Government made very clear statements that it would be watching the situation carefully, and if it did see what it regarded as unacceptable tax avoidance happening, it would move to increase the trust tax rate. In the meantime, it introduced a whole new set of disclosure rules to enable Inland Revenue to have a clear look at what transactions are going on involving trusts.
Now, this was a radical departure of from previous practise. One of the weaknesses of tax administration in New Zealand, in my view, is that we don’t get to see a lot of detailed or very segmented tax statistics. If you go elsewhere in the world, tax authorities can produce very voluminous data relating to which sectors and persons are paying tax. Inland Revenue doesn’t produce those sorts of data, although if you ask for it under the Official Information Act, you should be able to obtain much of what you’re after.
That lack of tax data being made public reflects the moves made in the 1990s to ease tax administration under which most people were no longer required to file tax returns and the information to be included in most tax returns is quite limited.
The new legislation requires quite substantial amounts of information to be provided. It includes details of all settlements on a trust, which includes all transfers of value along with details identifying the entities or individuals making those settlements. Transfers of value include all things monetary and non-monetary and the provision of services below market value. Details of all distributions, whether taxable or not, are required and including again, monetary or non-monetary together with details identifying recipients. There’s a general question wanting information about details of who has the power to appoint or dismiss a trustee, add or remove a beneficiary or amend a trusted name and finally a catch all or any other information the Commissioner of Inland Revenue wishes.
This represents a large increase in compliance for trusts. It should be said that it also reflects to some extent the impact of the new Trusts Act. Trustees can now expect to have more reporting requirements because beneficiaries now have rights of access to information about the trusts.
Trustees who may previously have been a little casual, to put it mildly, about record keeping will now need to sharpen their game. Not just for tax purposes, but basically to comply with the new Trusts Act. We don’t actually know how many trusts there are in New Zealand, the best estimates are somewhere between 500 and 600,000, and it’s one of those stats where per capita New Zealand is right up there.
The Government reporting requirements come into effect with those tax returns that have to be filed for the current year ending 31 March 2022. However, the legislation contains a provision that if Inland Revenue reviews a return and finds something of concern, it can request the same information for the previous eight income years, which means the first year could be for the year ended 31st March 2015.
As noted, the legislation represents a substantial increase in compliance costs. You should also look at it in the context of the controversial high wealth individual research project, which is going on at the moment. Both these initiatives address an area where arguably New Zealand taxpayers have not been providing a lot of information, and hence the Government and Inland Revenue are in the dark as to exactly the extent of wealth in the country.
And by the way, this is a worldwide trend. Although New Zealand managed to come through the global financial crisis very well, which has enabled us to manage the COVID 19 response pretty well, for the rest of the world the double whammy of the Global Financial Crisis and now the pandemic means that governments are under enormous fiscal pressure. There’s a growing trend to request further information in relation to the wealthy and wealth taxes are being discussed elsewhere around the world. So this is actually part of a global trend here.
But that’s not to undermine the importance of the issues raised here. These represent significant compliance costs, and they are quite concerning for trustees and beneficiaries about what were apparently quite legal transactions, such as advances to beneficiaries. Details of loan advances to beneficiaries are now required together with distribution of what we call term trustee income, which is tax paid income. This is going to be particularly relevant going forward because trustee income is exempt income for a New Zealand tax resident. Therefore, for someone who’s taxed at the 39% top rate, a distribution of trustee income is a way to essentially get tax free capital distributions from a trust. And this is what one of the areas these new provisions are looking to target.
The level of detail asked in relation to beneficiaries and what is expected of trustees is incredibly high. The new rules are expected to affect about 180,000 trusts, although there’s a sort of a de minimis position for trusts which don’t have annual income exceeding $30,000 and the total value of the assets is less than $2 million. That still leaves a substantial number of trusts will required to prepare quite detailed information for submission.
For example, all interest and non-interest-bearing loans from persons associated with the trust that is the settlors, trustees and beneficiaries. Then if trust property such as a house is enjoyed by a beneficiary for less than market value, the sum is to be recorded as a drawing in favour of the beneficiary. This one in particular is going to cause a bit of a stir as it’s quite a bold step. For many trusts, properties held by the trustees are essentially let rent free to the beneficiary on the basis that the beneficiary meets the upkeep, such as rates, maintenance etc, and the interest payments relating to any mortgage over the property.
Now we see a deemed income provision in relation to assets provided by a company, but there’s no such provision for trust purposes. These particular requirements are one reason why Antony Grant sounded the alarm. It would essentially impose a deemed rental or an imputed rental on property. This is something which has been considered by several tax working groups, but not implemented by the Government.
Another matter which is going to be a headache for trustees and initially probably may not be entirely accurate, is the requirement to break down the equity of the trust between the corpus, which is the sum of all settlements that have been made on the trust less the distribution of corpus made to beneficiaries and trust capital, which is the sum of all taxable and non-taxable income retained and gains and losses made by the trust.
There’s also to be an equity item in relation to drawings, which effectively mean the total amount of assets of value withdrawn from the trust by beneficiaries during the year, and then beneficiary current accounts are to be shown. Some of these well-managed trusts will already be doing so, but the extension across the board to most trusts is going to cause increased compliance costs as I’ve said. The implications of what happens when the Inland Revenue digests all this information we’ll have to wait and see.
Now, the officials’ issue paper is open for submissions until 15th November, and submissions on the operational statement are open until 30th November. So you might want to have a quick look at these papers and then consider making submissions.
Moving on, trusts with overseas trustees, beneficiaries or settlors can cause quite a lot of confusion. It’s something I’m seeing increasingly, particularly in relation to Australia, where the latest estimate is that maybe between four and five hundred thousand Kiwis live at the moment. And one of the issues that happens is that the trust taxation law differs from country to country. But (and I see this quite a bit in relation to various jurisdictions) people mistakenly assume that the rules are similar and don’t pay attention to the fine detail.
Now, in relation to trusts and people moving to Australia, it’s been well known for some time that if there’s any trustee resident in Australia, then the trust is deemed to be resident in Australia and therefore subject to Australian tax rules. And so steps are taken to ensure that no trustees move there or resign their trusteeships before doing so. But that doesn’t always happen, and a case has just popped up in Australia, which although it involved a UK tax resident person it would have implications for New Zealanders.
Now, typically, distributions through a discretionary trust of current year income or capital gains are generally considered to retain those characteristics in the hands of the beneficiary. What that means for New Zealanders resident in Australian who qualify for the temporary resident’s tax exemption is if they get a distribution of foreign sourced income, that is income from outside Australia, it’s generally exempt from Australian tax. But a new decision from Australia, Greensill, makes it clear that this treatment doesn’t necessarily apply to capital gains.
Now, in this case, what happened was the trust realised A$58 million on a capital gain from the sale of a UK management company. The gains were distributed to a beneficiary living in the UK and therefore non-resident for tax purposes in Australia. The shares that were disposed of did not represent taxable Australian property for capital gains purposes.
Ordinarily, a capital gain on non-taxable Australian property made by non-residents is disregarded for Australian tax purposes. But the full Federal Court of Australia ruled that in this case, because it was distributed to a non-resident beneficiary of a discretionary trust, there was no exemption available because of the way that the legislation was drafted in relation to how trusts deal with capital gains. Therefore, the Australian trustee was required to pay income tax on behalf of the non-resident beneficiary in respect of that $58 million capital gain.
And this is where we could have problems in New Zealand. For example, a New Zealand domestic trust with three trustees, two of whom are in New Zealand, and one is in Australia. The trust is deemed an Australian tax resident and if the trust tries to distribute the capital gain, such as the realisation of the sale of a property in New Zealand then following the Greensill decision, Australian capital gains tax is payable, and it would be at 45%. So this is a major decision.
People therefore need to be very careful to be check as to the status of the trustees and settlors of the trust. Basically, what you want to try and do is minimise any link between an Australian resident and a New Zealand trust. Otherwise, you’d be looking at a substantial capital gains bill.
What wasn’t apparently argued in court was the question of whether double tax relief would be available under the double tax agreement between Australia and the UK. This is unusual because I would have thought it would have been an issue that could have been applied in the Greensill decision, but apparently it wasn’t argued.
So we may have to wait either for another tax case or for perhaps the Australian Tax Office to decide that the Greensill decision is not really what they want and change the law. I think we might be waiting a long time for that.
Now moving on from trusts, the Taxation Review Authority (TRA) has confirmed that a taxpayer who received arrears of weekly compensation from Accident Compensation Corporation relating to an injury three years earlier was correctly taxed in the year in which she received payments. This is something that pops up quite regularly and I’ve discussed it previously.
In this case, the person was injured, made a claim for weekly compensation, and for three years there was a back and forth arguing about it. And eventually ACC paid a significant lump sum of arrears total of just over $180,000. This payment was subject to pay as you earn as income in the year of receipt. The taxpayer quite reasonably objected on the basis that her regular level of earnings was always quite low. Therefore, the tax that would have been payable if she had received the payments when she was entitled to do so would have been lower.
However, the law makes no adjustment for this, and it was taxed as a lump sum at higher rates. She took her case to the to the TRA, which kicked it out on the basis the legislation provides no scope for relief. Now, this is a not uncommon problem. In fact, I wrote to ACC and asked, just how often does this happen, where arrears of ACC are paid in a subsequent income year?
And the data I got back in April said that in the year ended 30 June 2020, there were 14 166 such payments. And in each of the years ended 30 June 2017, 2018 and 2019 there were at least 1100 such cases. The average payment was around between $42,000 and $49,000 with the median pay-out around $21,000. But some very large payments were made. There’s one in the year ended 31 June 2020 of over $1.1 million.
So this is quite a significant issue which I think is something that should be amended by legislation. It seems unfair for someone who’s been injured or entitled to relief but doesn’t get it when it should happen and then has to take action to get their entitlements with more added stresses. Finally, when a person does get paid, Inland Revenue comes in and takes a big cut of it. And by the way, this is going to be a bigger problem now that we have a 39% tax rate. So, I’ve made a submission to Parliament’s Finance and Expenditure Committee on this, requesting the issue be looked at and the legislation changed.
Speaking of submissions, a reminder that submissions to the Finance and Expenditure Committee regarding the Government’s interest limitation proposals close next Tuesday, 9th November. So you’ve got until then to make submissions on that. I expect there will be quite a few submissions on the new rules. But as part of those submissions, you can actually draw the committee’s attention to other matters, which is what I am doing in relation to the ACC matter.
Well, that’s it for this week. I’m Terry Baucher and can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
