The one thing that wasn’t in there, which I was expecting, was a move by Inland Revenue to restrict the use of portfolio investment entities with a maximum rate of 28%. These are increasingly being used by trusts and individuals subject to the 39% top tax rate. I’ve had a feeling for some time that this might be something that Inland Revenue was looking at, and maybe this bill would see some action on that part. But nothing, so far.
Preparing for emergency events
Instead, there’s a number of key initiatives and a lot of remedial measures. The first key measure relates to developing a generic response to emergency events. This sounds pretty mundane but what’s intended here is to enable Inland Revenue to be quicker in responding to provide tax relief following any emergency events.
What’s proposed is to build in tax relief measures into the legislation, which then can be activated by an Order in Council. This has been something that Inland Revenue has had to do rather a lot recently. As the commentary to the bill notes there have been three national emergencies declared in the last 15 years, where Inland Revenue’s basically had to apply some discretion to provide some measures of tax relief. Those were the February 2011 Christchurch earthquake, the COVID-19 pandemic and then the flooding in the wake of Cyclone Gabrielle last year. Cyclone Gabrielle came hot on the heels of the Auckland Anniversary weekend flood. Then there was also a huge earthquake in Hironori Kaikoura in 2016, which was a local emergency.
This bill proposes to introduce primary legislation which will enable Inland Revenue in the wake of an emergency event to use an Order in Council to activate these measures so it can respond to the emergency event.
I think it’s a good move. The COVID response in particular, showed that there was a need for greater discretion for Inland Revenue in certain areas, and in fact the Finance and Expenditure committee suggested last year that some form of this measure was needed.
It’s a fact of the times that we need such a measure, and incidentally also supports my long-standing view that it’s climate change which is going to hit the balance sheets first, and we need to be responding to that.
Crypto-asset reporting framework
The Bill also introduces the legislation required to implement the Crypto-Asset Reporting Framework (CARF), an OECD initiative, which is planned to take effect from 1st of April 2026. From that date New Zealand-based reporting crypto-asset service providers would be required to collect information on the transactions of reportable users that operate through them. The providers would then need to report any information for the year ended 31st March 2027 to Inland Revenue by 30th of June 2027. And then Inland Revenue would exchange this information with other tax authorities to the extent that it did come across information that a user of a platform in in New Zealand was actually resident elsewhere.
(Example of information reporting required)
As the commentary to the Bill notes, the market for crypto assets has grown enormously and there are now more than 22,000 crypto assets with a total market capitalisation of that is now close to NZ$4 trillion. This is up from barely US$17 billion back in 2017. According to the commentary between 6% and 10% of New Zealanders own some crypto-currency and Inland Revenue analytics show that 80% of crypto-asset activity by New Zealanders is undertaken through offshore exchanges.
There are some interesting notes in the accompanying Regulatory Impact Statement that once this is all up and running, Inland Revenue expects to be gathering about $50 million a year from it. In the meantime, a colleague has told me about a client who was using the Binance platform who has received some queries from Inland Revenue. The CARF initiative once implemented will boost Inland Revenue’s audit activities in this area.
Foreign superannuation scheme transfers – a good fix for a bad policy?
The next couple of measures relating to foreign superannuation scheme transfers and the Approved Issuer Levy are good to see, but also raise some interesting policy questions.
Under our current foreign superannuation scheme rules, if you transfer a foreign superannuation scheme into New Zealand or withdraw funds from the scheme (the money doesn’t necessarily have to reach New Zealand), you trigger a liability.
What has been an issue all along, particularly for Britons, is if they transfer their overseas scheme into a Qualifying Recognised Overseas Pension Scheme – or QROPS – they trigger a tax liability but may have no access to the funds, because they’ve not reached the age in which they’re allowed to do so under UK pension law. Any attempt to do so would trigger what’s called an unauthorised payments charge which could be up to 55%.
This was a problem that was identified with the legislation when it was first proposed back in 2013. Thanks in part to COVID, it’s taken this long to come up with a workable solution which is to kick in from 1st April 2026. From that date there will be a “Scheme Pays” option, under which the receiving scheme will calculate the tax due and pay that on behalf of the transferring client. The receiving scheme will do so at a flat rate of 28%, which is the prescribed investor rate. Transferring clients will have the option to fund the tax liability out of their own pockets, presumably because their marginal tax rate is 10.5% or 17.5%.
As I said, it’s a solution to a long standing problem. I am not a fan of the foreign superannuation scheme rules. It seems to me that we are taxing the importation of capital. People are bringing capital into the country and yes, they have benefited from an overseas tax regime. Conceptually, what we do ties in with our tax policy and in particular, the Foreign Investment Fund regime.
A ‘highly problematic’ regime?
But those of you who have been reading Dr Andrew Coleman’s recent articles will know our tax regime in relation to the taxation of savings is quite unique. I think in this area it’s highly problematic. People are bringing overseas savings and currency, into the country and we are essentially taxing them for that. Now looking at the bigger macroeconomic picture, that doesn’t seem to make a lot of sense to me. It’s conceptually correct from our taxation perspective, but it seems nonsense. This has always been my view, and I’ve still not received a satisfactory explanation other than “Well, that just fits in with our tax regime.”
My second point here is with the proposal for schemes to apply the prescribed investor rate at 28%. The Regulatory Impact Statement notes that on average the tax rate transfers is about 29%. Now the reason we tax foreign superannuation scheme transfers is so that people who have overseas pension schemes don’t have an advantage relative to their New Zealand counterparts, who would be in KiwiSaver funds, which as prescribed portfolio investment entities have a maximum prescribed investment rate of 28%.
Over taxation of transfers?
This begs the question as to why these transfers have been taxed at a person’s marginal tax rate which in some cases would be 39%. Surely if we are saying we’re looking to try and prevent a disadvantage, the top rate that should have been applied was 28%. That’s not discussed in the commentary or the Regulatory Impact Statement. But I will raise it in my submission to the Finance and Expenditures Committee and see what develops of it.
I was also interested to see the numbers of people that are affected by this seem to have been dropping off. According to the Regulatory Impact Statement, 2,700 individuals reported a foreign superannuation scheme withdrawal or transfer in the 2022 income year. For 2023 the number was 458 with 113 reporting the amount was mainly sourced from the UK. That’s quite a drop off.
The “Schemes Pay” solution has taken a long time to get here. I’ve been involved as part of the group that’s worked with Inland Revenue on this policy measure, so I’ll give it a qualified pass. But I still think the bigger issue as to why we are taxing these transfers in the first place really should be addressed properly.
Changes to the Approved Issuer Levy – fixing a problem but not addressing the cause?
Another good measure which also resolves a long-standing issue, involves the Approved Issuer Levy regime. Where a person pays interest to a non-resident lender, the payer is required to withhold non-resident withholding tax (NRWT). Alternatively, if the interest payments are being made to non-associated lenders, then you can register to apply to register the loan and instead deduct the 2% Approved Issuer Levy (AIL) and that’s what most people do.
According to the Regulatory Impact Statement about 1200 taxpayers are filing AIL returns paying AIL totalling $153 million for the year ended 30th June 2023. This represents annual interest of approximately $7.7 billion subject to the 2% AIL.
But some people haven’t registered the loan for AIL and the current rules are that they can’t register for AIL until they’ve paid the NRWT. The loan cannot be registered retrospectively. There’s an example in the Regulatory Impact Statement that one borrower had to pay $2 million in NRWT as a result. The proposal is to enable Inland Revenue to allow retrospective registrations.
Paying withholding tax on your mortgage interest
What has also emerged as an issue is that there are a number of individuals with overseas mortgages. They have moved here, but they’ve kept their overseas property and usually rented it. The UK and Australia are the two most common examples I’ve encountered. These persons are paying interest to the UK/Australian located banks on UK/Australian located properties because they have mortgages. These payments are also subject to AIL and NRWT but practically speaking it’s very hard to explain why AIL/NRWT is payable particularly when the payments are being made from an account situated in the UK/Australia.
This AIL proposal will deal with some of the problems around retrospective registration. But the question has not been asked as to whether in fact individuals in those circumstances that I’ve just described should in fact be within the scope of the regime, because that’s not why the AIL scheme was introduced.
It’s intended to help lower the cost of capital for New Zealand borrowers. As mentioned above in my view taxing foreign superannuation schemes seems to be taxing the importation of capital. This is contradictory to the purpose of the AIL regime. Both those positions can’t be correct in my view if we want to make it easier to access capital. In my view we should be changing the approach in relation to foreign superannuation schemes.
Rant aside, allowing retrospective AIL registration is actually a welcome move. The bigger question still remains as to whether in fact individuals with overseas mortgages should be within the regime. As the Regulatory Impact Statement notes, we don’t really know what’s the impact for individuals. It’s pretty near minuscule overall and there’s probably more non-compliance than the Regulatory Impact Statements acknowledge.
A hefty dose of remedials…
Another policy measure is to increase the exempt employee share scheme threshold. The maximum value of market shares that can be offered will be increased from $5,000 to $7,500 with effect from 1 April 2024. Finally, there are a large number of remedial measures relating to GST, trustee tax rate changes, partnerships, land tax rules, international tax and sundries. These often pop up in tax bills, just tidying up inconsistencies in legislation.
Submissions are now open and close on 18th October.
Insights from ten years of Inland Revenue’s transfer pricing questionnaires
Every year Inland Revenue issues an international questionnaire designed to collect key information about financing debt and transfer pricing issues in regard to foreign owned businesses in New Zealand. The data request for 2023 was sent out in February 2024 and responses were required by 15th April 2024. These questionnaires generally target foreign owned groups with turnover exceeding NZ$30 million.
What’s happened is Inland Revenue’s now published a summary of the answers it received covering the10 years from 2014 to 2023 inclusive. There are some interesting little details in here. In both 2014 and 2023 years, the three countries with the highest ultimate ownership were Australia, Japan and the United States. In 2014 there were 292 foreign owned groups (excluding banks and insurers), 77 had ultimate ownership in Australia, 55 in the USA and 39 in Japan.
Flip forward to 2023 and there are now 802 groups. The top three were still the same, but the order has changed. In that now the United States with 178 groups is the country with the highest ultimate ownership Australia has 144 and Japan 71.
There’s also questions about how many groups are subject to our thin capitalisation rules which kick in where the debt to asset ratio exceeds 60%. In 2023, nine percent of the groups – that’s about 75 – would be subject to some form of interest restriction.
Back in 2014, that was much smaller. Only 14 of the 198 groups that had net finance costs were subject to thin capitalisation. That’s quite interesting because it shows that more debt has been taken on board by foreign owned groups over the ten year period.
I’m always interested to see data like this from Inland Revenue as it gives us insights into the shape of our economy.
“Who’s that knocking on the door?”
And finally, this week a reminder that Inland Revenue has upped the ante in terms of debt collection and just general enforcement across the board. I mentioned earlier on about the taxpayer who had received an inquiry in relation to their Binance account. This week RNZ ran a story about instances where Inland Revenue have actually been out door-knocking and making physical visits to people who owe them debt. It’s something we haven’t seen for about five years. Inland Revenue seemed to have dropped off using this practise prior to COVID and obviously COVID then had a huge operational impact.
Inland Revenue re-engaging in this process is to be honest welcome. You do get the sense that certain taxpayers just push the envelope and think they’ll get away with it. So, it probably was a big shock for them that Inland Revenue can actually turn up on their doorstep and say “Hey, we’d like to talk to you about your debt.” As I’ve said before we’re going to see more of this increased enforcement.
Coincidentally, but I haven’t time to cover it this week, Inland Revenue also released drafts for consultation, updating its operational statements in relation to the use of its (very) extensive search powers. That’s probably something maybe I’ll get a chance to cover later, but for now, 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.
How to deal with recipients of paid parental leave with tax underpayments
A bizarre tax avoidance case from the UK involving snails
In line with other government agencies, Inland Revenue is required to produce a long-term insight briefing once every three years. These briefings are intended to
“…help us collectively as a country think about and plan for the future. They do this by identifying and exploring long-term issues that matter for our future wellbeing. Specifically, [briefings] are required to make publicly available:
information about medium- and long-term trends, risks and opportunities that affect or may affect New Zealand society, and
information and impartial analysis, including policy options for responding to the trends, risks and opportunities that have been identified.”
This is Inland Revenue’s second long-term insight briefing, its first one released in 2022 was on tax, foreign investment and productivity and that was a fairly chunky topic. But this time around it’s proposing to take on a bigger topic “what broad structure of the tax system would be suitable for the future.” What it would do is look at this topic by reviewing our tax system through the lenses of what is the tax base and what regimes apply.
As part of the initial stage of consultation for this topic Inland Revenue has released a 50 page briefing document giving a background on the whole process. The briefing summarises the current state of the New Zealand tax system and the options for consideration. Chapter one gives a complete overview of the current system. Chapter two then gives options for a future tax system and looks at international perspective. The final chapter summarises the topic and the approach to be taken by the briefing.
A mini-tax working group review
There are a lot of interesting insights in this paper, because in essence it’s similar to the scoping paper usually prepared by a tax working group at the start of a review before the group gets into detailed analysis of particular aspects of the tax system. The briefing is a therefore a handy high level summary of the current state of the New Zealand tax system.
In summary, the level of tax revenue we currently raise relative to the size of our economy is pretty close to the OECD average. It’s in the composition of tax revenue. It’s where it gets interesting. We are almost unique in the OECD in not having any significant specific taxes on labour income such as social security contributions or payroll taxes.
Taxing labour…lightly?
Furthermore, quite a few of other OECD tax systems have what they call a schedular tax system, which means in some cases they tax capital income such as dividend, and in some cases capital gains at lower rates than taxes on labour. As a result, many OECD countries have a higher tax burden on employee labour than New Zealand.
To give an example, the UK has a 20% basic tax rate, but employees also pay National Insurance Contributions above a certain threshold (8% on income between £242 and £967 per week and 2% above £967 per week). Employers pay 13.8% on all earnings over £175 per week. By contrast we have no such taxes which means we have one of the lowest tax wedges in the OECD.
Also, where we stand out is we raise more than the OECD average on general consumptions and that’s because our GST is one of the most comprehensive in the world. We also currently have a higher company income tax rate than the OECD average.
The paper notes some concerns noted about high effective marginal tax rates on inbound investment. I have to say I do wonder whether the small size of our economy and its isolation is more of a factor than tax in attracting inbound investment.
And finally, and this is highly ironic and also relevant if, you just opened your rates bills and the comments from the Prime Minister earlier this week, New Zealand raises more than the OECD average from recurrent property taxes, mainly through local government rates.
Building fiscal pressures
As part of the background the paper explains the various fiscal pressures building up. This is something we’ve talked about before, and we’ve frequently referenced, Treasury’s He Tiro Mokopuna 2021 statement on the long-term fiscal position. The well-known pressures building in in relation of our changing demographics, rising superannuation and health costs are all mentioned again.
So too is climate change, but more in passing, although personally I think that’s the one the impact of which is going to land first for most people as we saw last year in the wake of Cyclone Gabrielle. Suddenly, climate change is not an abstract thing with targets for 2050. It’s here and now. Remember Auckland ratepayers, for example, we got a $400 million bill as a result of buying out properties rendered uninhabitable by the Anniversary Weekend floods and Cyclone Gabrielle.
A suitable tax system for the future
The paper discusses what would you do in terms of meeting these pressures. Do you expand the tax base by adding new taxes or what about increasing tax rates? The paper mentions that there are limitations about raising tax rates which is not always as straightforward as you might think. For example, we raised the rate of GST from 12.5% to 15% in October of 2010 and GST as a result is a very significant tax because our system is so comprehensive.
But GST comes at the price of being very regressive for people on lower incomes. How would you deal with that? And the paper, by the way, references an IMF Working Paper on a progressive VAT/GST which I mentioned recently.
There was also an interesting comment I’d like them to know more about in relation to company tax. The paper notes that we raise a relatively high amount of revenue from company income tax as a proportion of GDP compared with other countries.
It notes this “may be partly attributable to the level of incorporation.” I’d be interested in knowing how much more company incorporation goes on here relative to other OECD countries. I think our imputation tax system is also a factor in why we pay relatively high amounts of tax relative to other jurisdictions.
What the briefing does reinforce is something I think is agreed within the tax community that there’s pretty much little scope for increasing company income tax rates. There’s always a lot of talk about that, but I don’t think there’s much scope for actually doing so.
“New Zealand is unusual among OECD countries in not having a general tax on income from capital gains”
Unsurprisingly the paper considers the question of taxing capital, as part of reviewing the composition of taxes in other countries. There are a lot of interesting graphs and stats are in this section including an excellent section summarising the historical changes in the composition of the tax base over the past century.
As I mentioned, we raise more revenue as a share of GDP from recurrent property taxes compared to the OECD. In 2021 it amounted to about 1.9% of GDP. B comparison, the average in the OECD is 1%, ranging from 0.1% of GDP in Luxembourg to 3% of GDP in Canada.
On the other hand, we don’t raise anywhere near the same level as other OECD countries from taxes on financial and capital transactions, estates and gifts. I mean, many countries have a combination of estate taxes, gift duties, capital gains, taxes and wealth taxes. According to the OECD data taxes on estates, inheritances and gifts raised an average of 0.1% of GDP in 2021. That seems a surprisingly low number, although it rose to 0.2% in 2022. This take is starting to rise as the Baby Boomers, the richest generation in history are starting to pass on. In the UK Inheritance Tax, which is a combined estate and gift tax, is now over 0.3% of GDP (£7.5 billion) and rising.
What about corrective and windfall taxes?
The paper gives a background on the possible options which might deal with future cost pressures. Its focus is going to be on revenue raising taxes. The final briefing will not examine taxes that are primarily about changing behaviours (so called “corrective taxes” such as excise duty, particularly in relation to tobacco. It will not discuss environmental taxes which are another form of corrective taxes. All taxes change behaviour in different ways and I think considering the behavioural impact of certain types of taxes would be useful
The final briefing will not consider windfall taxes, which have recently popped up in discussion in relation to supermarkets and the banks. Such taxes are one-off in nature and frankly, a reactionary tax to a set of events. If the concern, correctly in my view is about responding to the pressure of ever increasing costs, then windfall taxes are not in that context a sustainable addition to the tax base.
All in all, this is very interesting and pretty digestible reading. Consultation is now open until 4th October, so my suggestion is get reading and start submitting.
A baby and a tax bill…
Moving on, Inland Revenue has mostly completed its year-end auto assessment process for the majority of taxpayers’ income for the March 2024 tax year. Subsequently, it’s emerged that some 13,261 recipients of paid parental leave, about 27% of all such recipients have finished up with a tax bill. This is causing some concern because in some of these cases, these bills are quite substantial, amounting to several thousand dollars in some cases which have to be paid.
Paid parental leave is taxable and subject to PAYE. What seems to have happened is that people haven’t factored in the effect of their other income, for example they may have continued to work reduced hours in their main employment while also receiving paid parental leave. Consequently, because PAYE is designed around one person, one job per year the parental leave has been under taxed. But this only emerges as part of the end of tax year wash up. You can deal with this by using a secondary tax code, but that often goes the other way and leads to over taxation during the year.
Tailored tax codes
An answer to all of this, and also as a means of collecting the tax paid would be a tailored tax code. Tailored tax codes are ideal for an employee with other sources of income which aren’t subject to PAYE such as overseas pensions. What you do is advise Inland Revenue of these other sources of income and ask it to adjust your PAYE tax code taking into effect this other income. It’s then taxed during the year through PAYE. By the way, this also is a good way of bypassing the provisional tax system.
This approach is something I saw a lot of when I worked in Britain. HM Revenue and Customs adjusted tax codes for the equivalent of New Zealand Superannuation and used adjusted tax codes to collect underpayments of tax for prior years. If you underpaid one year, your PAYE code for the following year would be adjusted to collect the underpaid tax. I think this is probably an easier system than expecting lump sum payments.
My view is Inland Revenue could make a lot more use of tailored tax codes and should do so proactively. It has the information to know when someone has started a second job or starts receiving paid parental leave. It can then contact that person and ask they want to have a secondary tax code or a tailored tax code. This may already be happening but people with new babies have plenty going on, so this sort of admin detail just slips off the radar. I think it’s something where Inland Revenue systems ought to be good enough to be able to actively encourage people to make greater use of these codes.
Snail farm in city office sparks tax avoidance probe
Finally, and returning to an earlier topic, rates, there’s a story from the BBC about a quite flagrant tax avoidance scheme in the UK. The story involves a commercial building in Liverpool and what’s happened is this building has been home to a snail farm for more than a year. The firm renting the premises has told Liverpool City Council that because the building is being used for agricultural use that part of the building is exempt from business rates. Otherwise, the rates bill would be about £61,000 for the whole building.
Understandably, Liverpool Council’s not impressed, and neither are other snail farmers. (Apparently snails retail for £14 a kilo). They think the scale of the operation isn’t realistic because according to the owner there are only two snails in each crate which has been done to avoid “cannibalism, group sex and snail orgies”. (Yikes!)
This seems a fairly flagrant tax avoidance case. And it’s caught the eye of Dan Neidle of the UK tax think tank Tax Policy Associates. As he notes you’d think this sort of thing would be struck down quite easily by the courts but not so. There doesn’t appear to be a specific anti-avoidance rule in the relevant legislation, and it appears that there’s quite an industry around so-called “business rates mitigation”. Astonishingly, a recent case involved a Crown organisation Public Health England attempting to bypass rates through one of these schemes. Dan has suggested that the new Chancellor of the Exchequer, (Finance Minister) Rachel Reeves, put in place legislation to strike this sort of activity down.
An opportunity here?
Under our rating legislation here I think that a similar scheme probably wouldn’t work. Based on what I understand our rating approach seems to be a bit more comprehensive. But one of the things I know about working in tax is that where people perceive there’s an opportunity to, let’s say, push the envelope, they will do so.
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.
And issues draft guidance on the taxation of share investments and tax
The Olympics, a cautionary tale involving Snoop Dogg
Earlier this year in June, we talked about Inland Revenue’s releasing insights from its first round of a hidden economy campaign focused on smaller liquor outlets around the country. It noted that in this first stage, compliance staff had made 220 unannounced visits nationwide, looking for signs of issues such as income suppression, unreported sales and non-registered staffs. And it noted that although most of the businesses had their tax affairs in order, unfortunately some hadn’t.
That was described as a deliberate light touch campaign. And Inland Revenue said at the end of that release that more unannounced visits to businesses will be made as it steps up its compliance work
Well, last week we saw the second stage of that, where it announced that from 14th of August it will be sending letters to taxpayers in the liquor industry selected for a possible visit. This time Inland Revenue community compliance teams will be visiting liquor store businesses, including independent and franchise liquor retailers, across most locations. But this does not include bars or hospitality venues. I’d surmise they’ve got a separate plan for that group of taxpayers.
These teams will be looking at income suppression, record keeping practises – including when using cash – and employer obligations. All it’s said is that they will be issuing letters as of 14th of August, which meant they started going out last week. So, if you’ve been selected for one of these visits, I suggest you review your practises to see what areas could possibly be at risk. And certainly talk to your accountant or tax agent if you have one.
This isn’t surprising, Inland Revenue foreshadowed this in June. Remember they got an extra $116. million over four years in the budget to ramp up their compliance activity. This is merely the tip of the iceberg.
Inland Revenue’s harder line
What I and other tax agents are also noticing elsewhere, is that Inland Revenue has certainly adopted, let’s say, a harder edge in its approach. We’re now getting requests for information in situations where previously that didn’t happen, and I’ve heard one or two somewhat unsettling stories of borderline bullying of taxpayers.
I’m all in favour of ramping up compliance, but it’s always worth remembering that any tax system, even one as remarkably compliant as ours is, does depend on the goodwill of the taxed to enable its smooth operation. And I would just hope that Inland Revenue would keep that in mind. Because sometimes dropping a heavy hammer on those who’ve made innocent mistakes doesn’t actually achieve very much for the wider perceptions of the integrity of the tax system.
But that said, there’s nothing really surprising in this Inland Revenue campaign. And I expect I’ll be talking more about new investigation initiatives in other areas over the coming months.
Taxing share investments – what are the rules?
Moving on, an area where we spend quite a lot of work advising clients on is the question of share investments, particularly in relation to offshore shares. Although the Foreign Investment Fund regime in its current iteration, has been in place for a very long time, nearly 17 years in fact, it’s probably not as well-known as Inland Revenue perhaps might expect.
I think what I sometimes see in this space is that people coming from other jurisdictions which have a capital gains tax regime, pretty much assume it’s much the same approach here. So, it’s helpful that Inland Revenue last week released some draft guidance on the taxation of share investments for consultation.
The draft guidance runs to 43 pages including some detailed appendices and as always, there are a couple of helpful fact sheets attached. One explains when the FIF rules apply, and the other one summarises the general treatment of share investments.
The draft Interpretation Statement covers what happens when an investor is investing in shares, what liability do they have for dividends, share sales and how these rules interact with the Foreign Investment Fund rules.
Interestingly the guidance refers to share lending arrangements and foreign currency accounts.
“the statement focuses on investments who use online investment plan platforms, although the principles in this statement apply more widely to other share forms of share investments by individuals such as through brokers”.
This tells me that Inland Revenue have been collecting data through the Common Reporting Standards (CRS) on the Automatic Exchange of Information. Just before COVID arrived Inland Revenue had begun marrying up the data that they started receiving in 2018 and 2019 under CRS. Based on this it had started to ask questions of taxpayers, who they knew through the CRS information, had some form of offshore investment, but did not appear to have included that in their tax return.
So, I suspect this is another development in what I just talked about a few minutes ago – Inland Revenue ramping up its compliance activities.
Which set of rules?
Now, as the guidance and the fact sheets explain, there are two treatments at play here. The Foreign Investment Fund regime generally applies to all shares outside Australasia. And not to get into too much detail about that, just always be careful that some listed stocks in Australia do actually represent FIF interests. Shares outside the FIF regime such as those listed either on the New Zealand Stock Exchange or on the Australian Stock Exchange are subject to the “ordinary rules”.
The guidance explains when the ordinary rules will apply and when the Foreign Investment Fund rules will apply. And one of the things that it picks up on is what is the tax treatment where a taxpayer has realised gains from the disposal of shares? The general rule under section CB4 of the Income Tax Act 2007 is that those amounts from selling shares are taxable, where the shares were acquired for the “dominant purpose of disposal or were part of a share dealing business or profit-making scheme.”
Determining the dominant purpose
Now deciding what an investor’s “dominant purpose” is done at the time the shares are acquired. The investor’s stated purpose is tested against a combination of objective factors. And it’s often the case, that an investor may have one purpose or more than one purpose, or not even really any clear purpose when buying shares.
The onus is on the investor to prove that their dominant purpose for buying shares was to dispose of them, or conversely, not dispose of them. The guidance notes an investor only has to prove that disposal was not their dominant purpose. They do not have to prove an alternative dominant purpose.
Generally speaking, share sales will not be taxable if an investor can show that the shares were bought with the dominant purpose of receiving dividend income, receiving voting interests, or other rights provided by shares or a long-term investment growth in assets or portfolio diversification. Other than situations “Where at the time of acquisition this is planned to be achieved through sale.”
The appendix here has some interesting commentary from case law, most notably is the Court of Appeal decision CIR v National Distributors. Inland Revenue had lost in the High Court but appealed, and their appeal was upheld two to one in the Court of Appeal, with Justice Richardson giving the main judgement.
The taxpayer National Distributors had made eight purchases and sales of shares over a two-year period. The shares were held between eight months and three years with an average of 19 months before sale. The dividend yields were inconsistent and ranged from less than 3% to over 11% year, depending on the shares. Overall, the dividend yield was 6.5% per year compared with 25%-year from gains on sales.
Richardson noted that share purchases fell into two categories. Some were purchased for family reasons, but the second group were held to have been acquired, on the facts, for the purpose of sale. The taxpayer did not in the court’s view establish that there was no dominant purpose of sale.
In summary another useful interpretation statement and fact sheets. It’s good to see Inland Revenue putting some general guides and clarifying the point around when someone is subject to the Foreign Investment Fund regime, and when the ordinary rules will apply.
Tax and the Olympics
And finally, this week congratulations again to our Olympians for their fantastic achievements. I greatly enjoyed the Olympics as I’m sure everyone did. Not just because of the great performances by so many New Zealand athletes, but also just the sheer spectacle of watching the best in their sport.
One of the more entertaining parts of the Olympics was that the American TV channel NBC sent across rapper and record producer Snoop Dogg to provide commentary on the Olympics. Some of what he got up to was quite hilarious, check out him dressed up for a dressage event for example.
All good fun but the sharp-eyed Andy Bubb, Special Counsel, Tax Disputes at the Australian law firm Clayton Utz has pointed out that Snoop Dogg has possibly ended up with a fairly hefty French tax liability.
Apparently, he was paid USD 500,000 a day for his work, and what Andy Bubb has noted, is that under Article 17 of the double tax agreement between France and America, France has the right to tax the earnings of an entertainer or sportsperson where the activities are carried out in France. Now you can’t divert the income to an entity under the tax treaty because that’s overruled as well. As France’s top marginal tax rate is 45% the multimillion dollar question arises did Snoop Dogg’s advisors deal with all the ramifications of his entertaining and well-paid gig at the Olympics?
Never mind Snoop Dogg, what about Hamish?
Now, being a nerd, I took a look at the double tax agreement between New Zealand and France and yes, a similar clause is in there for artists and athletes. Accordingly, if you are competing in France and you are paid, you will be taxed. And this might actually be of relevance for Hamish Kerr because as I understand it, the track and field gold medallists each got US$50,000. France might be looking to take a cut of that.
But there is an exception in Article 17 of the treaty where any payment made to an artist, or an athlete will only be taxed in the jurisdiction where that athlete is resident – New Zealand – if those activities (carried out in France at the Olympics) are supported substantially by public funds from New Zealand.
I’m guessing most of our Olympians are heavily supported by public funding which should mean that any payments that our athletes receive for winning medals, or in relation to their activities in Paris, are only taxable in New Zealand thanks to this exemption under the double tax agreement. It would be interesting to see what comes with this. (It’s also worth noting that although the International Olympic Committee earns billions from the Olympics, the majority of the athletes receive nothing for their efforts).
I thought it was an entertaining wee story, but it also highlights a common issue and something that people perhaps don’t appreciate. That artists and entertainers have some of the most complex tax planning issues of any individual, certainly outside the hyper wealthy and multinationals. That’s because when they trade, carry out gigs in various jurisdictions, they are potentially triggering tax liabilities in every country in which they perform. But in this particular case, although Snoop Dogg may have a tax problem, I’m hopeful that no such problem will be encountered by Hamish Kerr for his winnings.
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.
Inland Revenue has released an interesting technical decision summary in relation to the use of look-through companies. Look-through companies replaced the former qualifying and loss attributing qualifying companies with effect from 1st April 2011. They’ve therefore been around for some time, but great care is needed when using them.
The basic precept of a look-through company is a company which elects to be a look-through company for tax purposes. The company is still a separate corporate entity for all legal purposes, but for tax purposes, it’s rather like a limited partnership. Its losses and income will flow through to its shareholders. One of the key things to be in order to qualify for the look-through company status is you have to have five or fewer look-through shareholders.
Better ask Saul?
That was one of the questions at the heart of this application in this Technical Decision Summary. The company wanting to elect to be a look-through company applied to Inland Revenue for a ruling. There was quite an involved structure with three shareholder trusts with each trust benefiting the respective settlor together with a combination of their spouses, children, children’s spouses, grandchildren and other family trusts. The company had a subsidiary which was to be liquidated following the election and there was also a charity in the mix that was receiving distributions from on of the shareholding trusts.
One of the questions put to Inland Revenue in this application was whether the company qualified to make the election. There was also a question about what would be the treatment of the capital gain that arose on the liquidation of a subsidiary. All of this is highly technical, but it does highlight one of the major concerns many of us have had with the look-through company regime in that it is rife with little pitfalls. A very sensible approach was taken here by the parties involved to apply for a private ruling which was approved.
Inland Revenue said that there are only three look-through counted owners, so the company would meet the requirement of five or fewer shareholders. Each shareholding trust could make distributions to companies so a question was if a distribution went to a beneficiary company, could that compromise the status? Inland Revenue advised no and also accepted that if a subsidiary was liquated any capital gain which arose would still be available for distribution as a capital gain later.
This is quite a unique set of circumstances, but I raised it to show the great care that’s needed in dealing with look-through companies. Because if you get the timing wrong or you get the rules wrong, the election doesn’t apply and that can have quite severe tax consequences. It pays to tread carefully when making look-through company elections.
More on contractors and withholding taxes
Last week I spoke with Matthew Seddon, one of the finalists for this year’s Tax Policy Charitable Trust’s Scholarship Prize.
Readers raised a couple of questions: firstly, what happens when New Zealand companies offshore their work; and secondly wouldn’t it be simpler to make all contractors register for GST?
It so happens there is a set of rules that would apply withholding tax to payments that are made to offshore contractors, known as non-resident contractors tax. But the key point there is that the contractor must have actually performed the services in New Zealand. So, if an IT person flies into New Zealand as part of a project because they’re carrying out the services in New Zealand, non-resident contractors tax will apply even if the person is not tax resident in New Zealand. By the way, I’m sure this happened when Inland Revenue was going through its big Business Transformation project
The non-resident contractor’s regime has been around for quite some time. It was set up during the late 70s as part of the Think Big projects when the Government realised a lot of non-residents were working in New Zealand, but we had no mechanisms for capturing some of that tax revenue. So, the non-resident contractors tax regime was established, and it works pretty well.
Where all the work is done remotely then withholding will not apply because there is no New Zealand source as the services aren’t being performed in New Zealand but overseas. Under general tax principles, the taxing point therefore is in the offshore country. Overlaying these non-resident contractor rules are double tax agreements, so it’s another area where people can trip up very easily,
As for making contractors be compulsorily GST registered, this was something Matthew and I did discuss. I think the next stage in the evolution of GST is pretty much making business to business transactions zero-rated. This would simplify administration and compliance. So thank you to the questioners, Hamish, SolarDB and Kiwis, much appreciated.
“It was twenty years ago today…”
And finally, it’s actually been 20 years this week since I started Baucher Consulting. Back then I started with a single client, and I worked from home. Now there are three of us at the moment and we have offices in Takapuna. Change is constant in tax and it’s actually one of the attractions of your career. You really don’t know what challenges you will meet in the course of the day or week. And that keeps you on your feet.
I’ve been working in tax for 40 years and even now there’s always something that turns up and makes you think “Oh, I hadn’t come across that before.” It’s a great, intellectually stimulating challenge. And you’re always having to think on your feet sometimes very, very rapidly. Such as when you’re in the middle of a meeting with Inland Revenue who suddenly fires in a question you weren’t expecting. I’ve had a few of those over the years.
“Don’t look back in anger…”
Looking back over the past 20 years it’s interesting to look back and think how much has changed and yet in some ways how little has actually changed. Back in in August 2004 the top marginal income tax rate was 39% which kicked in at $60,000. The corporate income tax rate was 33% and the trustee rate was also 33%.
As we know the corporate income tax rate is now 28% which reflects the worldwide trend we discussed recently of falling corporate income tax. rates. We’re back up to a top 39% rate, but this time on income over $180,000. And as of 1st April this year the trustee tax rate is 39% for most trusts.
In August 2004 Michael Cullen, who was also the Minister of Finance, was the Minister of Revenue. Following the 2005 General Election he was replaced by Peter Dunne, who began his second stint as Revenue Minister after a brief period in 1996. Peter Dunne actually has the distinction of being the longest serving Minister of Revenue in New Zealand History. He held the post from 2005 right through until June 2013 when he was replaced by Todd McClay. Over the past 20 years, there have been nine Ministers of Revenue, including Sir Michael and Peter Dunne.
“The Minister reads his papers”
Quite a few ministers had quite interesting tax related careers prior to becoming MPs. Judith Collins, for example, Minister of Revenue between 2016 and 2017 was a former tax partner at the law firm Simpson Grierson. Barbara Edmonds, who was briefly Minister of Revenue last year between July and November, was previously an Inland Revenue official and then later attached to the Minister of Revenue’s office. And the current Minister of Revenue, Simon Watts, started his career as a tax consultant with Deloitte.
Fortunately, I’ve got to meet many of these ministers and their officials. I remember one Inland Revenue official remarking to me “The Minister reads his papers. Not every minister does.” Now I think all the ministers I have encountered in office read their papers. I think it’s particularly true of Simon Watts, who has impressed me this year where a couple of times I’ve come across some at conferences where he’s very clearly been across the brief and the massive amount of detail involved.
Back in 2004 David Butler was halfway through his period as Commissioner of Inland Revenue. He was succeeded in 2007 by the genial Canadian Bob Russell, who lasted until 2012. His replacement was Naomi Ferguson, one of the longest serving Commissioners of Inland Revenue in recent years. Naomi oversaw the Inland Revenue’s critically important Business Transformation project which upgraded Inland Revenue’s computer system.
Business Transformation was brought in on time and under budget, although the recent Performance Improvement Review highlighted some concerns about the reliance on a single supplier. Business Transformation was just in time to cope with the COVID pandemic. As officials told me without it Inland Revenue would not have been able to handle the demands that were placed on it as a result of the pandemic.
Sir Michael Cullen – the tax reformer
Looking back over the major changes in tax, as I mentioned, Sir Michael Cullen was both Minister of Revenue and Minister of Finance when Baucher Consulting started. I think he deserves to be recognised as one of New Zealand’s most significant finance ministers in modern times. He’s probably second only to Roger Douglas in that regard.
His tax initiatives included Working for Families in 2005, but the critical ones would be the setting up of the New Zealand Superannuation Fund in 2003 and most importantly, KiwiSaver which started in 2007. KiwiSaver’s start coincided with the introduction of the portfolio investment entity or PIE tax regime and the very controversial Foreign Investment Fund (FIF) regime, which took effect from 1st April 2007. A couple of weeks back we discussed the FIF regime its impact for some migrants. All of these were significant achievements which changed the tax landscape.
Not one but two tax working groups
We’ve also had two tax working groups. The first one was the Victoria University of Wellington Tax Working Group 2009 – 2010, led by Bob Buckle of VUW. The second and much better resourced group sat between 2018 and 2019, chaired by Sir Michael Cullen. It is one of the highlights of my business career to date that I was invited to write a paper for that tax working group on whether there should be a separate tax ombudsman and a tax advocate for smaller taxpayers. My view was and remains, yes to both. In fact, it was one of the proposals that was picked up for further work by Inland Revenue’s tax policy division. But then something called COVID turned up. So those proposals are now way down the back-burner
In 2018 I also had the very good fortune to be a member of the Government’s Small Business Council. That was a great learning experience and very much a professional highlight. It also built networks which enabled me to have direct contact with Stuart Nash who was both Minister of Revenue and Minister of Small Business during the pandemic, when what became the Small Business Cashflow Scheme was being devised. Incidentally that’s an initiative I think should be picked up and expanded by the Government.
A tax switch and sneaky fiscal drag
October 2010 saw a major change to the tax system with the top income tax rate dropping from 39% to 33% as part of a tax switch with the GST rate increasing from 12.5 to 15%. That was the last time until the 31st July just gone that the tax thresholds were increased. I’ve said it before and I will keep saying it, I think it is unacceptable how successive Ministers of Finance of both parties have been allowed to get away with not regularly increasing tax thresholds.
Starting in 2010, I started writing for interest.co.nz and I’d like to take the opportunity to thank the publisher, David Chaston and managing editor Gareth Vaughan for their patience and their support through these past years. From that start I got to meet Dr Deborah Russell, who’s now the Honourable Deborah Russell MP, former associate of Minister of Revenue and our collaboration resulted in the publication in 2018 of the BWB text in 2017 Tax and Fairness, a huge personal and professional highlight.
Bright-line test and capital gains
Another significant tax milestone was on 1st October 2015 and the introduction of the bright-line test. It originally only applied to sales within two years of acquisition but during the last Labour government the period was increased to first five and then ten years. The bright-line test is significant because it recognised that having a tax provision which taxed on the basis of a person’s intention – was the property acquired for the purpose or intent of sale – was largely unenforceable.
No capital gains tax…for now
The last Labour government of course turned down the Cullen Tax Working Group’s proposed capital gains tax. However, that issue isn’t going to go away, in my view. Partly to redress that decision Labour then introduced the controversial and deeply unpopular interest limitation rules in October 2021. I could see the theory behind these rules, but I thought they were overcomplicated. Personally, if I was addressing the issue of interest deductibility, I would have gone with adapting the existing thin capitalisation regime. This has been in place since 1995 and therefore is well established.
With regards to interest limitation rules, it’s worth remembering, as I noted a couple of weeks back when talking about the OECD’s corporate tax statistics, there are over 100 interest limitation rules currently in existence around the world. So, the issue of over generous interest deductions is not one solely focused on residential property. Contrary to many of the claims made that the interest limitation rule that was a breach of business practice it’s actually quite a standard feature as the thin capitalisation rules demonstrate.
Podcasting since 2019…
Amazingly, this podcast started five years ago in 2019 with my first guest Jenée Tibshraeny then of interest.co.nz but now with the New Zealand Herald. I’d like to thank all my guests who have appeared over the years. The podcast is approaching its 250th episode. It’s something I enjoy which seems well received and it’s actually pretty handy for keeping abreast of developments.
One other professional highlight was providing data to the Finance and Expenditure Committee and Inland Revenue about the instances of over taxation of backdated ACC lump sums. Subsequent discussions with Inland Revenue led to legislative change which took effect at the start of this tax year.
A big thank you
But most of all, I’d like to thank the people who have helped me prosper over the past 20 years, starting with my wife Tina without whose endless support and patience none of this would have been possible. My colleagues here at Baucher Consulting, Judith, Eric, Darren, and Trent, my business coach Bruce Ross. David Chaston and Gareth Vaughan at interest.co.nz, my colleagues of the Accountants and Tax Agents Institute of New Zealand, where I was honoured to be on the board between 2010 and 2016. The many friends have made along the way and of course, my clients.
So, thank you all very much it’s been a fascinating 20 years. As I said change is a constant and there’s a lot more to come. I think we’re going to see big changes with the tax system as we try to fund the challenges ahead of climate change and the changing population. And as always, we will bring you those developments as they happen.
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.
Matthew Seddon suggests imposing withholding taxes on organisations that engage independent contractors, including through electronic marketplaces
My guest this week is Matthew Seddon. Matthew is a lawyer at Bell Gully and one of the four finalists for this year’s Tax Policy Charitable Trusts Scholarship competition. He has suggested extending the withholding tax regime to include more independent contractors. Kia Ora Matthew, welcome to the podcast. Thank you for joining us. So how did you get into this and where did your proposal come from?
Matthew Seddon Hi, Terry, thanks for inviting me onto your podcast. It’s great to be here. The Tax Policy Scholarship provides young tax professionals with the ability to set out a proposal for a significant reform in the New Zealand tax system. My proposal is to extend PAYE withholding to independent contractors engaged by persons with an existing PAYE withholding obligation, i.e. employers, and also to those independent contractors engaged through an electronic marketplace.
TB Those electronic marketplaces try and match buyers and service providers. You picked up on something from the Tax Working Group in this space, is that right?
Matthew Seddon Yes, the Tax Working Group in 2018 had identified the rise of self-employed independent contractors as the most likely and most significant challenge facing the integrity and sustainability of the New Zealand tax system. The Tax Working Group’s final report had noted that withholding taxes should be extended as far as practicable in order to ensure greater levels of compliance. Furthermore, the Government’s recent focus on increased compliance activities is another reason which prompted me into this proposal.
TB Yes, because Inland Revenue got $29 million a year. I think they were saying they’re expecting a $700 million return on that. Is that right?
Matthew Seddon Yes, the $29 million I think is over each year and I think $116 million is set across for the four-year period. So their expectation is to raise $702 million over a four-year period from those increased compliance activities. Inland Revenue has also been stating recently that they’re going to focus on taxpayers who have not been complying with their tax obligations. Especially in the hidden economy.
TB Like I was saying the other week, the hibernating bear has woken up and it’s hungry and it’s making moves. Yes, I mean just picking up on that, the Performance Improvement Review recently released on Inland Revenue was quite interesting in its discussion around the tax gap, which the Tax Working Group fenced around a little but didn’t really go into specifics. But this is the area, right on scope of the tax gap, isn’t it?
A billion dollar gap?
Matthew Seddon Indeed, and Terry, just for listeners to understand, the tax gap is the difference between what Inland Revenue should receive in taxes if all taxpayers are fully compliant with their obligations compared to what tax they actually receive. The Tax Working Group had received some research that was commissioned by Inland Revenue on the tax gap for independent contractors, and that research indicated that independent contractors were under reporting their taxable income by about 20% on average. This was resulting in a loss of revenue of $850 million a year.
TB And that’s in 2018 dollars. So now we’re talking potentially over a billion dollars per year.
Matthew Seddon Exactly.
TB Well, if I was Nicola Willis, I’d be very interested in that because that’s a quarter of a percent of GDP. It’s actually a significant number now. So how does your proposal work?
Matthew Seddon So my proposal looks at imposing withholding taxes on organisations which engage significant numbers of independent contractors. For example, a large number of independent contractors operate through electronic marketplaces. A lot of employers engage independent contractors. So it’s by centralising the withholding obligation and imposing it on employers and electronic marketplaces instead of the numerous independent contractors underneath, that provides Inland Revenue with a greater ability to receive those taxes rather than having to chase independent contractors individually.
TB Yes. So I mean we have an extensive withholding tax regime. It’s something that’s I think has always been taken for granted, but we don’t realise actually how very comprehensive it is. But when you look back on it, the sort of sphagnum moss collectors, charges for directors’ fees is a 33% rate I believe. But these withholding tax obligations aren’t updated frequently or as frequently as you might imagine. As the Tax Working Group pointed out, we’ve seen a big growth in this sector. You’re saying we’ve got these existing mechanisms in place and should extend it to this particular group. Is there going to be a de minimis or is it going to be for anyone who’s already got a PAYE obligations or who has employees?
Matthew Seddon That’s right, Terry. So, the starting point is that if you’re an employee, your employer withholds PAYE. If you’re an independent contractor, generally you deal with your own tax obligations. What you’re referencing there about sphagnum moss collectors and directors’ fees are schedular payments and that imposes an obligation to withhold on the payer of those payments. My proposal would be to extend that schedule and the schedular payments regime to include those employers and electronic marketplaces that engage the independent contractors.
Now the reason why I was looking at employers in particular and the reason why I would not have a de minimis, is because employers have the systems and software in place that pay their existing employees and they also make those payments to independent contractors. So the software and systems should only require minor modification and configuration to be able to deal with withholding on payments to those independent contractors. The independent contractors that are engaged by employers and electronic marketplaces. It wouldn’t be all of those independent contractors that are subject to the withholding. It would only be those independent contractors who are principally providing services to the employer or the electronic marketplace such that they are functionally equivalent to employees.
TB Yeah, that’s a really interesting point there because often you find that someone walks out the door on Friday is contracting back on Monday. So this question of functionally acting as an employee – is that going to be a requirement, do you think? Would it perhaps just be extended if a person is providing personal services to a company, would that perhaps be a stronger approach? I think so rather than try to get to a definition that they’re doing the same as if they were an employee because all the employment lawyers listening will be twitching on that one because there is a big case going through the courts at the moment, I believe on that matter.
Matthew Seddon It’s essentially to look at who is providing services to the employer or the electronic marketplace. It’s designed to carve out people who are genuinely supplying goods to an employer or an electronic marketplace. So, you don’t have an overreach of withholding obligations. You could imagine if withholding was made on all payments to independent contractors, it would lead to chaos. There would be withholding on every single payment that’s made by an employer.
Furthermore, proposals to extend withholding to all independent contractors have a significant downside in the fact that you’d be requiring, for example, home owners to withhold tax and pay that to Inland Revenue for a painter that was engaged to paint their house. So this proposal is designed to narrow the focus to the independent contractors who are providing services to employers and electronic marketplaces.
TB That makes perfect sense. It’s a huge area though. But as I said, the scope of this with downsizing that’s been going on through Ministries, for example, this exactly is happening, as I said, some people are probably coming out on Friday as employees and coming back contracting with a different role on the Monday. A flat 20% rate, was that what you are thinking?
Matthew Seddon Yes. The default rate would be 20%. This is in recognition of the fact that independent contractors can claim deductions for income tax purposes. It also aligns with the current voluntary schedular payments regime that already exists.
TB Yes, the voluntary schedular payments regime. So right now, if you were contracting to an employer, you could say take 20% off and the employer or rather the contracting company could do that?
Matthew Seddon Yes, there is a mechanism whereby both parties can agree to undertake a withholding. The one thing I would note about my proposal is that it is simply the default rate of 20%. There is an existing regime for schedular payments which provides that an independent contractor can notify the payer of their name, IRD number and an elected rate no less than 10%. The independent contractor can essentially toggle the rate to reflect their effective tax rates so that they they’re not overpaying tax throughout the year. And they’re not underpaying as well, so that they can get a correct tax outcome by the end of the year.
TB Yes. Our pay-as-you-earn-system is more flexible than it was, but there’s scope for improvement there. I think real time payments are the next step in the evolution of our tax system. Something just popped into my mind. If I recall correctly, if a company is providing hiring, hiring contractors, they have a withholding tax obligation automatically. Is that correct?
Matthew Seddon The labour hire rules in the schedular payments regime, I think it’s a 20% rate.
TB Yes, 20%. And it wouldn’t matter, say a contractor was working individually or through a company. Generally speaking, you can under the schedular payments rules, generally speaking, if you’re working through a company, the payer doesn’t have to withhold tax. What do you think? Would you change that here?
Matthew Seddon I think there’s a company exemption in the schedular payments regime which looks through certain companies. So, I think that could also fit in with this proposal.
TB Because mainly the fact someone’s running through a company doesn’t mean that they’re actually completely up to date with their obligations, as week after week Inland Revenue tells us what’s going on. And the other thing that you touched on in there was about the fact that as contractors, they have the ability to claim deductions. I think this is where the paper prepared for the Tax Working Group was saying basically that it seems given comparable levels of income there is this gap of about 20% and they identified that on the basis that self-employed or contractors appear to have 20% more discretionary spending than their employee counterparts.
How would you counter that? I know as a small business, when you are dealing with small businesses, people are very keen to claim everything they can, and they don’t always tell you what they’ve claimed or they’re not always as straight up or as accurate as we would all like in this space. I’ve wondered whether we should have standard deductions. What’s your view on that? I know in the UK they did that for self-employed individual. Any thoughts on that particular idea?
Matthew Seddon My proposal primarily focuses on the withholding obligation, that is on the income side of the equation, so by being able to report and withhold on these payments, Inland Revenue is going to see exactly what these independent contractors are earning.
I guess to the extent that independent contractors are claiming sizable amounts of deductions relative to their industry peers. It would allow Inland Revenue to go and look and audit those independent contractors. On the deduction side, it’s something that I have thought about. I know in the GST rules for listed services there are flat rate credits for non-GST registered persons. So, there could be a similar flat rate deduction for independent contractors to align themselves across the board.
TB I deal with quite a number of American clients and their tax returns have what they call a standard deduction of $12,000. But you don’t have to claim that, you can go for what they call itemised deductions which presumably you do so on the basis that you’ve got more to claim.
It just crossed my mind that one of the things coming out of the Performance Improvement Review of Inland Revenue which we discussed a couple of weeks back, they talked about the tax gap, and I think they also talked about making one of its objectives to make the tax system easier and simpler and particularly for small businesses micro businesses. Your proposal basically is in that space, isn’t it? And it does have that benefit.
Matthew Seddon Exactly. It provides greater levels of compliance for those small businesses, those independent contractors. There’s going to be less need for them to engage accountants and third-party providers. There’s going to be less engagement with the provisional tax system. That’s going to be a much simpler experience for those independent contractors. My proposal also recognises that there will be some costs imposed on employers and electronic marketplaces. But by leveraging off the existing PAYE rules and schedular payments rules, it is designed to minimise those compliance costs as much as possible requiring them to just modify and configure their software and systems.
I think it’s important as well to notice that prior to any implementation of this proposal, there should be a sufficient period of time in which engagement can take place between Inland Revenue and these payroll software providers. I know this has recently taken place for the personal tax cut changes which had effect from 31 July.
TB That’s actually quite critical, and wider consultation is always welcomed in this space. Something just came to mind. I mean, obviously what we’re talking about here, this could be a measure that helps to close the tax gap and raise revenue, which is great from Inland Revenue’s perspective and for Treasury, but it’s actually as I see it, and what I find attractive about this is that it’s also a benefit to contractors.
I deal a lot with small businesses here and you know, managing their tax isn’t always easy and everyone is not as diligent about managing their tax as they should be. I’m a big believer in making payments regularly, and in this case, withholding payments seems to me would contribute quite a bit to that. That was something you had that in mind when you were looking at the proposal weren’t you, because that’s one of the judging criteria of the competition.
Matthew Seddon Exactly, minimising compliance costs for taxpayers and also minimising administration costs for Inland Revenue as well.
I think independent contractors, while they might have the benefit of the time value of money by only making provisional tax payments three times a year, as they currently have no withholding may allow them to have less tax obligations in the first place, as it’s all dealt with by their employer or the electronic marketplace and really allows them to focus on doing what they do best, and that’s running their own business.
TB Yeah, I’d endorse that approach. I do recommend to a lot of my clients, they run businesses, they’re shareholder-employees, we don’t often use the shareholder-employee regime and I tell them, go through the pay-as-you-earn system making your payments regularly, so you keep on top of your tax payments. That’s one of the things, as I mentioned a minute or two ago, I like about the more frequently people make their tax payments, they’re going to be more compliant, get up to date and they will have less stress about it. It’s one of the things about managing small businesses. There’s a lot to deal with and there’s not much that you can actually do, there’s an irreducible minimum you’re dealing with at times and withholding payments helps in that space.
Slightly related topic, what about GST? Now it’s not directly in scope, but to me, I think this is the next frontier of tax could be compulsory zero-rating which would be easy for both the employer or the contracting company and the contractor. What’s your thoughts on that?
Matthew Seddon Yeah, that’s right. It’s not directly included in my proposal, but I think when thinking holistically about the tax obligations of these independent contractors and how they can be automated as much as possible. GST is obviously another area to consider. I think zero-rating, there might be some scope for that. It would mean there’s less obligations on the independent contractor and would not be required to return the GST amount and they’d still be able to claim some GST credits.
The alternative I was thinking about was potentially having the carve out for employment apply to these independent contractors who are functionally equivalent to employees. You should ideally end up with a scenario where if you’ve got an employee and an independent contractor sitting across from the table from one another at their employers’ offices, they should be treated as similarly as possible so that there’s horizontal equity between the two.
TB So what’s next for you? 1500 words was your initial proposal. So now you’ve got the 4000 words which means you’re in the money, you’re going to come away with a medal of some sort. As they say, it’s always good to make the medal rounds. So it’s in mid-October sometime. You’ve got to finalise your entry and what’s involved in that?
Matthew Seddon The final oral presentation is in October and our 4000-word submission is due in September. The 4000 words is essentially branching out and expanding on our initial 1500-word proposal. The 1500-word proposal was a teaser to the judges to set out what the concept was and how it met the relevant judging criteria. The 4000 words will expand on this initial idea.
TB It’s not many though, 4000 words, really when you think about it and then obviously your oral presentation, you’ll be in front of several gurus of tax. That would be interesting, I’d say.
Matthew Seddon Indeed, it will be interesting to hear the judge’s comments and questions in person.
TB Well, I’m sure you’re looking forward to it. I am. I think it’s a very interesting proposal. It sounds mundane, but it’s actually quite important. Thank you very much, Matthew Seddon. Thank you for coming along. Good luck for October for this scholarship, we’ll watch with interest.
Matthew Seddon Thanks Terry.
TB And on that note, that’s all for this week. We’d like to thank Matthew Seddon again for joining us and wish him all the best for the scholarship. 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.
Last week, as part of its continuing drive to increase compliance, Inland Revenue released an updated property tax decision tool.
What this does is help people work out when a property might be taxable under any of the land taxing rules, including the bright-line test. It’s been updated to take account of the bright-line test changes which took effect on 1st July this year.
The growing issue of helping families into housing – what are the tax implications?
Generally speaking, since 1st July, the bright-line test only applies where the end date for sale as determined under the rules is within two years of when the property was deemed to have been acquired. The aim of the tool is to work through all the various scenarios that might apply. So that’s something worthwhile, and I think we’re going to see more of people wanting to make more use of this because of a developing trend around shared home ownership where people who are not necessarily couples are coming together to purchase properties. There are also families wanting to help elderly parents.
We’re seeing some very interesting scenarios develop as a result. One of those scenarios was the subject of last week’s Mary Holm’s column for the New Zealand Herald.
“We’ve bought my wife’s parents’ house. They had a small mortgage on it, with no income, just super, coming in. They didn’t have enough money to keep paying the mortgage, hence they were going to start a reverse mortgage to keep things afloat.
If they sold the house they would’ve struggled to get into a retirement village and stay near family etc. So we bought the house so they don’t ever have to leave – so let’s say they will be there for at least another 10 years.
They pay us $750 rent per week. We took out a 30-year $800,000 mortgage, with just the interest on it at $1977 a fortnight, so we are topping up mortgage payments as the rent does not cover it. We also pay the rates, insurance and any maintenance costs.
How do we treat this in terms of any possible tax or claims as such?”
Mary asked Inland Revenue and me for comment. Notwithstanding that a net loss was foreseeable, my advice was you never always know what the full story is as there may be a detail which for whatever reason, the correspondent has overlooked. The basic approach I took was you should report it. Inland Revenue were much of the same view but noted that any excess deductions would be ring fenced.
As I mentioned to Mary, I think we’re going to see a lot more of this. Because they’re coming from both ends of the generational spectrum. In this case we’ve got the elderly parents wanting to stay near family and then at the other end, young people trying to get on the housing ladder.
Is shared home ownership an answer to housing affordability?
Over the last 20 years or so I’ve seen the practice develop quite rapidly of parents, grandparents and other relatives helping their children or grandchildren get their foot on the property ladder. This was the subject of an interesting report on shared home ownership released by Westpac called Next Step Forward. The report notes that the housing market is increasingly difficult, and “the home ownership dream is increasingly out of reach for some New Zealanders”. The report’s analysis is that shared home ownership will become increasingly common and how might that develop.
The report describes the housing market as “distorted”. To give you some idea of the scale of the problem, the report notes “As of February 2024, the median house price was 6.8 times the median income compared to 5.4 times in 2004 and roughly 2.3 times in 1984.” So over 40 years, the median house price relative to median income has practically trebled.
The report also notes that home ownership rates in New Zealand have been declining steadily since peaking in 1991 at 73.8%. They’re down to 58.7%, so a 15 percentage point drop over 30 years is pretty substantial. But the report projects that within 25 years, the proportion of homeowners will have dropped to 47.9%. (The report notes the outlook is even worse for Māori and Pacific peoples, where the home ownership rate is lower, at 47% and 35%, respectively, as of 2023).
What are we going to do about this? Well, as the report suggests shared home ownership is going to become more common. This in turn is going to trigger all sorts of tax issues. Which is why something like Inland Revenue’s property tax tool is handy. The report, incidentally, doesn’t really discuss tax other than mentioning tax free capital gains do play a part in people’s investment decisions and may have an impact on the housing market
There’s no real short answer to this issue. Raising incomes would be one thing, freezing or slowing the rate of house prices would be another, and building more homes would be a vital third factor. Pulling all this together is a huge problem and each solution comes with secondary effects.
International tax deal in trouble?
Moving on, an equally complicated scenario and one we’ve been covering for several years, is the question of the taxation of multinationals. Back in 2021, the OCED/G20 declared a breakthrough international tax deal over the taxation of the largest multinationals in the world. The deal proposed a Two-Pillar solution over the question of taxing rights. Ultimately this is where the idea of a minimum corporate tax rate of 15% emerged.
Agreeing in principle was one thing, but the negotiations have been going on since then and increasingly it seems to be that they’re running into difficulty. A key 30th June deadline has now passed, and it appears that some governments are starting to lose patience with the whole process.
One of the ideas behind the agreement was to head off the implementation of digital services taxes (DSTs). As part of the process these DSTs were put on hold by several jurisdictions, including the UK, Austria, India and others. In the meantime, as negotiations have dragged on, other countries such as Canada have said “Well, we’ve had enough of this, we’re going to go ahead and impose a digital services tax.”
Meantime, the United States whose companies such as Alphabet and Meta are at the heart of the issue have threatened retaliatory tariffs on countries imposing DSTs. Nobody wants a trade war, but someone has to blink in terms of getting a deal past this impasse. So, they’re continuing to negotiate, even though the deadline theoretically has expired.
Time to go back to first principles?
On the other hand, as Will Morris, PWC’s Global Tax Leader points out in this short video. Maybe we should just go back to first principles instead of trying to hammer out a deal through the existing Pillar 1 process which some consider is not really fit for purpose.
It’s not a bad idea but it would delay further progress in the matter, and I think that’s where governments who’ve got elections to win may not be prepared to wait much longer. I think generally the public is a bit antsy about the question of corporate taxation. As I noted last week, when we looked at the OECD’s latest corporate tax statistics, statutory corporation tax rates have pretty much stabilised after 20 years of falling.
However, there are still substantial gaps in public finances as a result of first the Global Financial Crisis, then the pandemic and increasingly we’re having to deal with the impact of climate change as well. When the insurers are leaving the market, who picks up the tab? In my view, that’s going to be we the taxpayers.
There will be pressure to get some sort of deal across the line, but I also think although we may see corporate tax rates elsewhere in the world rise, I think with our 28% rate, we haven’t really got much room for manoeuvre for an increase at this point.
A place where talent does not want to live?
Finally, the New Zealand Institute of Economic Research released a fascinating report on Thursday. Provocatively titled The place where talent does not want to live, it looks at the question of New Zealand’s immigration policy and how that sits alongside our international tax regime.
The report was prepared for the American Chamber of Commerce in New Zealand, the Auckland Business Chamber, the Edmund Hillary Fellowship and the NZUS Council. It’s a fascinating document because it pulls together points, we don’t always hear discussed when we’re looking at immigration policy, how does our tax system interact with that policy?
The report notes that conceptually, we have developed tax rules which make sense in a tax context. However, they lead to wider issues once they start operating in a broader context. In particular the report really focuses on the Foreign Investment Fund (FIF) regime which it considers disadvantages many investors who come here hoping to use their skills and their capital to help build the economy and the tech sector in particular.
I’ve seen comments on this topic previously from entrepreneurs, and it’s easy perhaps to be cynical and say, “Well, they’re speaking out of self-interest” but 40 years of tax experience also tells me that behavioural responses to tax are very observable and policymakers should pay attention to such responses.
An in-depth examination of the Foreign Investment Fund regime
What makes this report particularly interesting are the authors, Julie Fry and Peter Wilson. Julie is a dual New Zealand and U.S. citizen who in her bio notes that “her location and financial decisions have been impacted by the tax rules covered in the report.” Peter was Manager of International Tax at the New Zealand Treasury from 1990 to 1997 and then Director of Tax Policy from 1998 to 2002. As such “He was responsible for advising the government on many of the tax issues contained in this report.” Consequently, outside of anything prepared for a tax working group, this report is one of the most in-depth examinations we’ve seen of our international tax regime and FIF regime.
The report notes that although we have a fairly open flow of migrants, “New Zealand has never been a particularly popular destination for talented people”. (Interestingly, we have no data on how long people on the various investor and entrepreneur visas stay).
As the report notes there’s a competition for global talent and New Zealand is not attracting as many as we would like. We should therefore be thinking hard about the implications of this.
The report hones in on the FIF regime as being a particular problem for many investors because of the way that it taxes unrealised gains. This creates a problem of a funding gap where an investor is expected to pay tax on an investment which very often isn’t producing cash because as a growth company cash is being reinvested. (By the way, this is often a common argument against wealth taxes).
As the report notes, “New Zealand’s tax rules were not designed with the idea of welcoming globally mobile talent in mind.” For example, as Inland Revenue’s interpretation statement on residency makes clear it’s deliberate policy to make it’s easy to be deemed tax residency in New Zealand, and hard to lose. This has long term flow implications because as the report points out, people who would perhaps want to commit to New Zealand are reluctant to do so because of the tax consequences of doing so.
Chapter Three is the very, very interesting section of the report as it explains the development of our current international tax regime and the rationale for the various FIF regimes and their design. The overall objective was to protect the tax base, but they didn’t really think about what was happening with migrants. As Ruth Richardson and Wyatt Creech then the respective Minister of Finance and Minister of Revenue explained in 1991:
“The objective of the FIF regime, where it applies, is to levy the same tax on the income earned by the FIF on behalf of the resident as would be levied if the fund were a New Zealand company. Because the FIF is resident offshore with no effective connection with New Zealand, the only way of levying the tax is on the New Zealand holder.”
This is conceptually correct from a tax perspective but as the report keeps pointing out, it doesn’t really take into account what happens with migrants who made investment decisions long before they arrived in New Zealand only to find their accumulated savings are being taxed here under the FIF regime. I have a similar problem with the taxation of foreign superannuation schemes. Although the tax treatment conceptually ties in with our system, it seems to me we are effectively taxing the importation of capital and this paper is basically saying the same thing in relation to FIF.
How much tax does the FIF regime raise?
Section 3.5.1 on page 26 of the report has an interesting analysis of how much revenue the FIF regime raises. Because our tax reporting statistics aren’t very detailed, the answer is we don’t really know. The report concludes
“The high-level finding is that the level of overseas investment is small compared to total financial assets at the national level. Portfolio foreign investment is, in some years, one-thousandth of domestic investments. This suggests that the current FIF tax base is likely only to make a minor contribution to direct revenue.”
A suggested reform
The report concludes that in an international context where we were trying to attract the right talent, maybe we should be looking at the FIF regime. What it suggests is to separate the tax treatment of people who have always been tax resident from those of new and returning tax residents. The existing FIF rules would continue to be applied to those have always been New Zealand tax resident. Meantime a new regime should be designed for new and returning tax residents.
The report does touch on the question of a general capital gains tax regime (which could be an answer) but considers the development of a comprehensive CGT is a long term political consensus building project.
In discussions I’ve had with other colleagues on this matter we’ve noted how our American clients in particular are very affected by the current FIF regime. As American citizens they are required to continue to file American tax returns and are therefore subject to capital gains tax. This creates a mismatch between when they pay New Zealand income tax and the final US tax liability on realisation. Although the FIF regime creates foreign tax credits for US tax purposes, clients are frequently not able to utilise the foreign tax credits.
As people told the report authors this is extremely frustrating and there is no doubt that people are upping sticks and moving because of it. (I’ve also seen other clients switch into property investment instead).
Overall, this is a very interesting and highly recommended report considering the intersection of tax driven behaviour with wider economic issues.
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.
