More on UK trust filings, and why are there so many trusts in New Zealand?
Financing local government, time for change?
I’ll be honest, even after 30 years in New Zealand, I miss British budgets. There’s a building sense of anticipation beforehand, as rumours circulate about bold tax plans and the abolition/introduction of new measures. Then on the day itself, we have to deal with the myriad of tax measures introduced, usually always without any warning beforehand, other than leaks to selected media. Being perfectly cynical, they are handy work-creation events, much more so than their New Zealand counterparts. (That said this year’s May Budget here is looking like it will be the exception, which proves the rule).
This year’s UK Spring Budget, which was released on Wednesday night, did not disappoint. There were a whole raft of measures, some of which, to borrow the phrase the 1974 Lions adopted in South Africa against the Springboks involved “Getting your retaliation in first”. These measures were done simply to hamper what’s expected to be the next Labour government after Britain has its General Election sometime this year.
Ending the Remittance Basis of taxation
So, there’s a lot to consider, but there were two that are of particular interest to New Zealanders, and these are to do with the so-called non-dom rules. The UK has a special set of rules called The Remittance Basis of Taxation for non-domiciled persons. That is people, generally speaking, born outside the UK, and they are able to basically exempt their non-UK sourced income from UK taxation, if they don’t remit it to the UK.
These rules have been around for a long time and there has been a lot of amendments in recent years. And I suspect there is a fair bit of non-compliance going on from people here in New Zealand, who’ve not kept up with those changes.
The UK Labour Party had indicated it would remove the regime as a fundraising measure. Instead, the Conservative Chancellor of the Exchequer, (Finance Minister), Jeremy Hunt, has gone ahead and decided to pre-empt that by abolishing the regime with effect from 6th April 2025. It will be replaced by a regime which looks very similar to the transitional residence exemption we have here. That is, individuals will not pay UK tax on foreign income and capital gains for the first four years of UK tax residence.
There will be some transitional rules which will apply to existing individuals who are claiming the remittance basis. You can claim remittance basis for up to 15 years, but after a period of ten years you have to start paying a Remittance Basis Charge of £50,000. And then after 15 years of tax residency in the UK, you’re deemed to be domiciled in the UK and the exemption no longer applies. It’s long been a very controversial measure. The wife of the present Prime Minister, Rishi Sunak, is apparently a non-dom and questions have always been asked about whether she made use of that exemption as she comes from an incredibly wealthy family.
I’ve got a number of clients moving across to the UK, or who are all already there, and we’re looking at the question of how to manage the implications of becoming UK tax residents. So, this proposal is interesting to see. More details will emerge, obviously over time, but it is significant in that it will perhaps make it a little easier for people to migrate to the UK without triggering huge tax liabilities or having to manage them extremely carefully under the remittance basis regime.
Domicile and Inheritance Tax – good news for Kiwis & UK migrants?
Related to the end of the remittance basis regime and arguably even more important, are changes to the UK’s Inheritance Tax (IHT) regime. IHT is a unified estate and gift duties, and probably should be still what it was originally called Capital Transfer Tax. At present, IHT applies to all assets situated in the UK or all assets worldwide if the person is domiciled in the UK.
The proposal is that those current rules will also be replaced from 6th April 2025 with a residency-based set of rules which will probably involve a ten-year exemption period for new arrivals and then a ten-year tail provision for those who leave the UK and become non-resident. What that tail provision may mean is that someone who’s been resident or domiciled meets the test for IHT, may have to be non-resident for ten years to escape the full effect of it.
Now, in my experience, the impact of IHT on Kiwis who’ve been over in the UK or have assets in the UK, and then Brits like myself, who’ve migrated here, is not very well understood. But as the Baby Boomer and older generations are starting to pass away now, there’s a great transfer of wealth going on. The amount of IHT that the UK government is collecting is steadily rising. It’s now up to over £7 billion a year (0.3% of GDP, about $1.2 billion in New Zealand terms), steadily heading towards 0.5% of GDP. So, it’s starting to become a more significant part of the tax take.
These new rules may mean that people who have previously been caught in the regime will be out of it, but it may also mean that people who thought they were outside the regime may be caught. There’s no indication here that the rates that apply – 40% on estates worth more than £325,000 pounds or $650,000 thereabouts – have been changed. It’s a tax that people feel needs reform in that there is plenty of scope for mitigating it. It falls very heavily on relatively smaller states rather than the larger estates where they have the wealth to do some more estate planning.
More tax breaks for the film industry – a lesson for the Government?
And incidentally, just before moving on, I notice this budget also contains a number of measures to promote the UK film industry and theatre as well as the arts. These will provide over £1 billion in additional tax relief over the next five years. One of the things that’s common amongst tax systems around the world is support for the film industry, and the film industry as a whole is pretty cynical about going to where the best incentives are.
I think it’d be interesting to see just how the Coalition Government responds in the May budget about pressures mounting on the Screen Production Rebate, whether that’s going to continue in its present form. The industry here will be lobbying for it to continue because although we can’t compete with more generous exemptions that may be provided elsewhere, the rebate still provides the skills that have been built up here thanks to the likes of Weta Workshop and others which makes New Zealand skills still highly sought after. The Screen Production Rebate is the little kicker which helps get the deals across the line.
More on UK trust statistics and a warning about the perils of overseas trustees
Larger estates in the UK will undertake a fair amount of mitigation to minimise the impact of Inheritance Tax, and that invariably tends to involve the use of offshore trusts. I mentioned in last week’s podcast the extraordinary fact that in absolute terms more tax returns are filed in New Zealand for trusts than in the UK.
This provoked a lively debate in the comments section with some pointing out the UK numbers don’t really reflect trusts that have been set up to go offshore into tax havens such as the Caymans and the Isle of Man. Well yes, that’s right, the UK numbers don’t reflect this because trusts’ tax returns, for UK purposes are generally required to file tax returns based on the residency of the trustees.
That by the way, is a matter people here need to pay more attention to. If a beneficiary or trustee migrates to the UK, this may inadvertently make a New Zealand trust with New Zealand assets subject to UK taxation. Again, this is another matter which isn’t well understood, and I suspect there’s a fair bit of noncompliance going on.
The UK also has a Trusts Registration Service. This was in response to the EU’s Fifth Anti-Money Laundering Directive from 2017, which the UK went ahead and implemented despite Brexit. The UK actually went in for a tighter regime than the EU had proposed. According to the same statistics that the HMRC held about trust tax return filings in the UK, the Trust Registration Service had 633,000 trusts and estates registered as of 31st March 2023 and which remain open as of 31st August 2023. This includes 462,000 new registrations in the 12-months to 31st March.
This surge in registrations is the result of a compliance effort by HMRC to remind people around the world that if any trust has a property in the UK, or even has made loans to beneficiaries in the UK, it may have a UK tax liability, and therefore should register under the Tax Trust Registration Service. This is regardless of where the trustees are tax resident. And again, I suspect there is a fair bit of non-compliance here.
Why are there so many trusts in New Zealand?
But even if you take these greater numbers, we’re still left with the rather astonishing fact that per capita large number of trusts in New Zealand relative to the population. How did that evolve was one of the questions asked in the comments. The short answer would be that the effective abolition of Estate Duty in late 1992 removed the impediments to setting up trusts. What we saw in response was something quite unusual in trust law, where it was now quite possible for a single person to be the settlor (or the person who settles property on the trust), a trustee responsible for managing the property, and a beneficiary. This is very unusual in trust law terms around the world.
I think it has to be said that some lawyers and other practitioners took advantage of that opportunity to market themselves and trusts extremely well. Back in the early 1990s, by putting assets in trusts it was possible to mitigate against the impact of rest home charges. The income of trusts was not then taken into account when determining eligibility for the likes of Working for Families or student allowances.
All that has changed over time and my view is that a substantial number of the estimated 500,000 trusts that we have in New Zealand are no longer necessary. That’s also the view of many other practitioners in this space. So it will be interesting to see what happens over time as people realise the complexities of using trusts and the inadvertent tax issues that are created when trustees, beneficiaries or settlors move to another jurisdiction.
Since the start of the year, I’ve seen an upsurge in requests for advice in relation to trustees, beneficiaries or settlers moving to the UK or making distributions to the UK.
I don’t expect that to slow down, and I think it’s actually the tip of the iceberg.
Beware the information exchanges
I would also add that probably because of the common reporting standards and the automatic exchange of information as various tax authorities work their way through all that information that’s being accumulated and distributed around the world, they will be realising that they many trusts are non-compliant, accidentally or not, and they’ll be starting to crack down on it.
Local government finances, time for reform?
Finally this week, local governments are now looking to set their rates for the forthcoming 2024-25 year. The fact that no replacement for Three Waters has been found and the substantial infrastructure deficit we as a country have allowed to develop, means that rates are likely to be rising quite significantly for many of us. That’s obviously going to generate some pushback.
Writing on this topic Dan Brunskill noted the quite astonishing stat that local government rates have basically not increased as a percentage of the economy in the past hundred years.
Basically, local rates have stuck around about 2% of GDP overall across the country about $8 billion in rates are paid. (Not all that you pay to a Council is actually rates based on property values, there’s also the Uniform Annual General Charge together with the various services such as consent fees that councils charge).
As the graph illustrates, apart from the spike around the Great Depression period, when councils and central governments all did more to try and help alleviate the impact of that, rates as a percentage of GDP have been stable for well-nigh 90 years. I think the present rating present funding of councils is unsustainable, because, as the article notes, central governments keep giving local governments more and more to do, but restrict them in the level of income that they can raise. That’s both good and bad. We don’t want what happened with Kaipara District Council, which essentially went bankrupt because it could not fund a wastewater system in Mangawhai.
There’s scope for reform in this space. I think the crunch points around finance are arriving now and local and central government will need to think harder about how local government can be funded and what funding mechanisms are appropriate. For small councils such as Kaipara or, Waiora over near Tairawhiti East Coast, the funding issues and scope for raising funds are not the same as for Auckland a council with a rating base of over a trillion dollars. The laws need to change in my view, but we’ll have to wait and see developments.
As always, we will bring those to you when 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.
What connects Pillar One and Pillar Two with the collapse of Newshub?
New draft Inland Revenue guidance on employee share schemes.
Today (Monday) I was (virtually) at the Accountants and Tax Agents Institute of New Zealand (ATAINZ) annual conference which, like last week’s International Fiscal Association, (IFA) Conference, was opened by the Minister of Revenue, the Honourable Simon Watts. The Minister repeated much of what he had said to the IFA conference about supporting the Generic Tax Policy Process, his wish for simplification in the tax system and improving compliance being a main driver. As the focus at the IFA conference is very much on tax policy his comments were very welcome.
By contrast, at the ATAINZ conference, the focus is slightly different because the audience there was comprised of tax agents, and we’re more focused on operational matters. So, when it came to Question Time, there were quite a number of questions around operational aspects of Inland Revenue. One of the first questions that was asked was what was going to happen with the trustee tax rate, which you may recall is proposed to rise to 39% under a bill presently before the Finance and Expenditure Committee.
Now we’re expecting to hear back from that fairly soon, but during the week the Minister of Finance, Nicola Willis, hinted that some form of carve-out might be happening, in that the 39% trustee tax rate might not apply to all trusts. So naturally, some questions were directed at the Minister seeking clarification on this point.
He wasn’t able to give more guidance, simply saying that we will have to wait until the Finance and Expenditure Committee reports back, which is expected next week. The Minister got told it is a rather frustrating scenario because we’ve got the run up to the end of the tax year on 31st March, and we will be wanting to plan payments for dividends and other distributions in before then. Unfortunately, the issue remains a bit of a grey area for the moment.
More trusts file tax returns in New Zealand than in the United Kingdom
There’s a couple of statistics that highlight the scale of this issue.According to Inland Revenue for the 2022 income year (typically the year ended 31st March 2022), the number of trusts and estates which filed a tax return totalled 237,226. That’s actually a decrease of more than 19,000 from the prior year.
It so happens that I came across statistics from the UK’s HM Revenue and Customs about the number of trust tax returns that are filed there. And according to the equivalent tax year to 5th April 2022, HMRC received 141,500 returns.
Just pause and think about that. In absolute terms, more trust and estate tax returns are filed in New Zealand than in the UK, despite the UK, with its population of some 67,000,000 being almost 13 times greater than here. So actually, on a per capita basis, it would point to the fact, for every trust tax return that’s filed in the UK, there would appear to be close to 21 filed here. The tax rate for trusts is therefore a big issue in relative and absolute terms and that’s why the tax community and trust community are really keen to get this matter resolved as quickly as possible.
What evidence is available points to the fact that for most trusts – once you include the associated families and beneficiaries that are in there – their income would not exceed $180,000, the threshold at which the 39% top tax rate kicks in. But there is a small and significant group, about 11% according to Inland Revenue, that do receive a very large amount of income. So that’s something we’d like to see resolved soon and hope it’s in time for us to get clients advised and ready for the new tax year changes.
Interestingly, on the other comments the minister made to both the IFA and the ATAINZ conferences about Inland Revenues regulatory stewardship review of fringe Benefit Tax which it did in 2022, it’s clear that there is likely to be a focus on this issue from Inland Revenue on greater audit activity. This is something promoted under the Coalition agreement. What extra resources Inland Revenue is going to have and the full direction that it’s going to take going forward are probably only going to become clearer after the Budget on 30th May. Which, as the Minister pointed out, was not that far off in reality.
How the end of Newshub and the OCED international tax deal are connected
The news that Newshub’s operations will end with effect from 30th June was a big shock to the media community. As someone who has occasionally appeared on various Newshub programmes, my sympathies go out to all those affected. And I do hope that some means is found to keep the operation going, although it has to be said, it’s very doubtful at this point. I’ve always found in all my dealings with journalists of whichever organisation, they have always been incredibly professional, and I’ve appreciated that. And so, as I said, this is not a great day for journalism, and has also been pointed out, it’s not actually a great day for democracy as a whole.
Now one of the many excellent sessions at last week’s IFA Conference was an American perspective on Pillar One digital services tax and Pillar Two, the proposed international tax agreements, which have been under negotiation for some time. The taxation of the tech giants such as Facebook and Google is a key part of Pillar One and Pillar Two, and that’s the connection with the collapse of Newshub.
Newshub is no longer financially viable according to its owners, Warner Brothers, because of collapsing advertising revenues. A couple of days after the Newshub announcement, its competitor TVNZ reported an operating loss of $4.6 million for the six months to 31st December 2023. TVNZ noted that its advertising revenue fell from $171.3 million in the six months to December 2022 to $146.8 million in the six months to December 2023, against a background of rising costs.
So where is that advertising going? Well, most of it is going offshore. From what we can pick out from the financial statements of Google and Facebook New Zealand for the year ended 31 December 2022, it would appear that close to $1.1 billion during those years was paid to offshore affiliates in so-called service fees. Now that’s a substantial amount of money, and those transactions are entirely legitimate under the present tax rules. But it has to be said, even if 10% of that $1.1 billion were to stay in New Zealand, it would be a significant boost to the industry. And arguably the difference between Newshub’s operations continuing and being closed.
The offshore advertising and the service fees and the whole issue around the taxation of tech companies, point to the pressure building on the tech companies because New Zealand is not alone on this. Over in Australia Meta, the owner of Facebook, has said it’s no longer going to go through with the deal to pay news companies who were providing content on its websites.
The presentation at the IFA Conference kept coming back to a key point that I’ve always believed, which is tax is inherently political. The French were one of the first drivers of change in this space but obviously the American companies, which would be the most affected, pushed back by putting pressure on the American government to respond. And so even though the Generic Tax Policy Process tries to depoliticise tax policy as much as possible, ultimately governments are elected with certain political objectives, and those will often trump best tax policy, and that’s just a fact of life.
A digital services tax to help media?
The whole question of the impact on democracy and journalism of Newshub’s closure is beyond this podcast. But the pressure will now mount on the Coalition Government to consider what steps it can do to help the media. On the other hand, the Public Interest Journalism Fund was highly controversial.
Does that mean that there may need to be a change in tax policy to perhaps try and claw back some of the revenues going offshore through, for example, a digital services tax which is controversial and hated by the tech companies? Does the Government press hard for a resolution to Pillar One and Pillar Two? Or does Newshub just get shut down and we have to live with the consequences of that? Whatever, pressure will be building for the Government to take some form of action. Watch this space to see whether any such action results in amended tax policy.
Inland Revenue consultation on employee share schemes
Moving on to more routine matters, Inland Revenue has released several draft consultations on employee share schemes. The taxation of employee share schemes underwent major reforms in 2018. Subsequently, there’s been a number of questions to Inland Revenue about how the law applies in certain scenarios and how it interacts with other regimes such as PAYE and FBT.
Inland Revenue has therefore released six items – five draft interpretation statements and one draft Questions We’ve Been Asked, each focusing on a specific aspect of employee share schemes. This has been done rather than producing one single interpretation statement, so that people can more easily focus on the topic of particular interest to them. Alongside this, Inland Revenue has produced a four-page reading guide briefly summarising what each interpretation statement/QWBA addresses.
This is slightly unusual but it’s an indication of the complexity involved. Employee share schemes are used by a lot of companies and particularly small growth companies in the growth phase where they don’t have cash but want to attract and keep key employees as they expand until the ultimate goal, whether it’s ultimately a share market listing or perhaps a sale to a larger company.
The first interpretation statement is one of the more important ones, as it considers what represents an employee share scheme. The critical issue is when does the share scheme taxing date arise? That’s often a critical issue because one of the things about share schemes which causes difficulties is if there’s a mismatch between when the tax is due, but when cash might be available for the person who’s being taxed to actually pay the tax due. In fact, another of the drafts looks at the questions about an employer’s PAYE, student loan and KiwiSaver obligations where an employer wants to fund the tax cost on an ESS benefit provided in shares.
Another important draft reviews what happens with the ACC, PAYE and KiwiSaver obligations, when the employee share scheme benefit is paid in cash rather than shares. The draft concludes cash-settled ESS benefit is an “extra pay” under the general definition of extra pay and therefore a PAYE income payment, regardless of whether an employer elects to withhold PAYE in respect of the benefit.
Of the other draft consultation items, topics covered include what deductions are allowable for employers in respect of employee share schemes, and what is the treatment of dividends that are paid on shares held by a trustee for an employee share scheme.
Overall, this is very useful guidance and I do like Inland Revenue’s approach of issuing separate interpretation statements rather than consolidating all the items in a single item which would be close to 150 pages. Consultation is open until 26th April.
Thanks Chris
And finally, this week, Chris Cunniffe, CEO of Tax Management New Zealand (TMNZ) for 12 years, has just stepped down from his role. He made a brief presentation at the ATAINZ conference, explaining it coincided with the 44th anniversary of the start of his tax career at Inland Revenue. We’ve worked with Chris and his team at TMNZ for many years, helping our clients save tens of thousands of dollars. Chris has also been a past guest on the podcast. We wish him all the very best for the future.
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.
A suggestion for the new Minister of Revenue about tax simplification; and
What tax tattoo would you have?
The International Fiscal Association (IFA) tax conference is one of the premier tax conferences in the year as it is attended by most of the very senior tax specialists in the country together with senior Inland Revenue officials. Somehow, they also let me in as well.
The primary focus is on tax policy, and the conference is held under Chatham House rules, which means that comments that are made by officials cannot be directly attributed. Notwithstanding this you still get an indication of where officials’ thinking might be heading.
This year’s conference had a particularly interesting agenda covering topics ranging from, the use of trusts, international GST, the treatment of embedded royalties, limited partnerships, to a US perspective on the OECD’s international tax agreement process. It concluded with what was probably the highlight of the whole conference ‘What makes a tax good system?’ which we’ll discuss later.
Introducing Simon Watts
Traditionally the conference is opened by the Minister of Revenue the Honourable Simon Watts. A qualified paramedic, he had once worked at Inland Revenue as an intern before he moved on to later became a tax consultant with one of the Big Four firms. Coincidentally, the Commissioner of Inland Revenue Peter Mersi was also attending his first IFA conference. It was therefore interesting to see how they interacted, and they both explained to the audience how they felt they were progressing.
The Minister began by reiterating his commitment and that of the Government, to the Generic Tax Policy Process, GTPP, the open consultative process that has been a keystone of New Zealand tax policy for almost 30 years. He was aware that the business community and the tax community had become a little concerned that there was not enough certainty in the tax system as projects were being developed. In particular, he referenced the design of a wealth tax that was undertaken by the last Government but never followed through.
He wants to make sure that there is a strong degree of certainty within the tax system, so he supports the GTPP. Notwithstanding that, there will be times such as around the Budget policy process where the GTPP will be sidelined, and consultation will only begin in earnest when the budget measures are announced.
It’s also clear, he’s been getting himself up to speed very quickly. He referenced the long-term insights briefing, the Inland Revenue prepared in 2022 on the impact of tax on foreign investment and productivity. He also referenced the regulatory stewardship review of fringe benefit tax (FBT). Following on the Minister’s remarks and comments made by the Commissioner of Inland Revenue, I think we could expect to see more action following up the FBT stewardship review maybe in terms of greater enforcement but also in terms of simplification of the tax and compliance.
The Coalition Government’s is still under development, but the focus will be on tax simplification and reducing compliance costs. That’s not unexpected, and from what officials are saying, they’re all very heavily invested at the moment in working on those areas and meeting the pressures of the Government’s 100-day programme.
Bright-line test and commercial building depreciation changes confirmed
He confirmed that the bright-line test period will revert to two years with effect from 1st July 2024. From that date sales of bright-line property will not be taxed under the bright-line test, if the property has been held for two or more years. (Other tax rules may still apply). He also confirmed that commercial building depreciation will no longer be available from the start of the 2024-25 tax year.
The timing of the withdrawal of commercial building depreciation is possibly going to be controversial. The Minister confirmed it would be from the start of the 2024-25 tax year. For most taxpayers, that is 1st April 2024 so it’s a future impact. However, for what we call early balance, date payers such as those with a 31st December 2023 balance date their new tax year started on 1st January. Therefore, from that date they can longer claim depreciation on commercial buildings.
That I think is slightly controversial in that there’s a retrospective effect to it, obviously, and it may mean some tweaking around provisional tax payments. But the policy has been outlined previously. We’ll see the relevant legislation and more detail in due course maybe around the time of the budget policy process announcement towards the end of March.
(Interestingly, the issue of 39% rate for trustees didn’t actually come up in discussions with either the Minister of Revenue or the Commissioner of Inland Revenue). Apparently, the Finance Minister’s wish for a 6.5% reduction of costs is still on the table although the effect of this may be counter-balanced by the increased funding for audit activities.
The Minister came across as someone wanting to listen. He also holds the Climate Change portfolio, and he sees quite an overlap with Revenue because they’re both seen as financial portfolios. He mentioned that a lot of emphasis is developing in the climate change area around climate finance, which apparently is going to be a focus at this year’s COP 29 Conference, which will be held in Azerbaijan.
I had the impression he’s already across a lot of aspects of the portfolio and from comments from the Commissioner and others, he’s following up on past Inland Revenue asking if “we’ve done this, where are we with it? Let’s move it forward” which is good to hear.
The uses of trusts – trouble ahead?
Trust specialist Vicki Ammundsen regaled the audience with often hilarious tales of some of more extreme situations she’s encountered in her role as a trust lawyer and as a trustee. But amidst all the laughs, a serious point was made time and again: trusts are mostly established and used for non-tax reasons. However, they are not always administered well and in some cases she felt many people had set up trusts for the wrong reasons or completely incorrect reasons and had failed to understand how they would operate.
She also thought there was probably very pretty widespread, if accidental non-compliance with the impact of overseas resident trustees and the treatment of distributions to overseas resident beneficiaries. Her comments echo my own view on what’s happening in the trust space. I would also agree with Vicky that we’re likely to see more and more trusts wound up as people realise that something that was possibly useful 30 years ago is no longer relevant, and in fact the same objectives can now be achieved by holding assets outside trust.
One point she raised, which I found very relevant in relation to some decisions coming out of the Jersey Tax Court which ruled trustees should not be equalising distributions to beneficiaries to account for asymmetric tax treatment. This may arise when one beneficiary may get a distribution which is tax free in their jurisdiction, but another one has to pay tax on a similar distribution, because they live in a different tax jurisdiction. The Jersey Court’s view is that beneficiaries make a choice to live overseas, and other beneficiaries should not be indirectly affected by that. It’s an interesting point to make because issues around distributions to overseas beneficiary is something that’s going to be coming more to the fore in the future. Right now it’s an area I’m receiving more enquiries around.
Embedded royalties and the PepsiCo case, an Australian precedent?
“Embedded royalties” might sound strange, but this Australian decision is potentially very significant. To cut a very long story short, PepsiCo the American soft drinks company signed an exclusive bottling agreement with an Australian company Schweppes Australia Pty Limited. Under the agreement Schweppes Australia would make payments for concentrate which it would then turn into soft drinks such as “Pepsi”, “Mountain Dew” and “Gatorade”.
The Australian Tax Office (the ATO), which has always had a reputation for being pretty aggressive in the transfer pricing space, decided to take a case against PepsiCo on the basis that some part of those payments represented an embedded royalty. That portion was therefore subject to the Australian equivalent of non-resident withholding tax even though the payments by Schweppes Australia were actually made to another Australian company, which was a subsidiary of PepsCo. Last November the equivalent of the High Court ruled in favour of the ATO.
It’s a very interesting case, but the key point which emerged in the session was that the overlap between Australian and New Zealand legislation was strong enough that maybe Inland Revenue here might be tempted to take a similar case. (There was another aspect about Australia’s Diverted Profits Tax that’s not relevant here). The decision has been appealed and it’s thought likely PepsiCo might choose to settle. But it’s interesting to see what happens in Australia because we do tend to watch closely what’s happening with the ATO and transfer pricing.
Tax system oversight – the Australian experience
Speaking of the ATO, one big difference between New Zealand and Australia is that there are more bodies involved in tax oversight of the system in Australia. There’s the Australian Board of Taxation and then there is the Inspector General of Taxation, who also is the Tax Ombudsman for Australia.
The current Inspector General of taxation and Taxation Ombudsman for Australia, Karen Payne, presented on how these two bodies were created and what had been the experience so far. This is a particularly interesting topic for myself because I wrote a paper for the last tax working group on the issues around a tax ombudsman.
She also referenced the American experience with their Taxpayers Advocate Service raising the question whether such an independent office also be an advocate for taxpayers. This could partly resolve the disparity in powers and resources between the tax authority and the ordinary taxpayer. As Karen Payne noted, many of the clients of the partners at the conference are big enough and ugly enough to look after themselves in a dispute. But the general public isn’t, so that’s a question that comes through when considering the role of a taxpayer Ombudsman/advocate.
Karen Payne also referenced the fact that in certain certain circumstances the Australian Commissioner of Taxation has the power to take some remedial actions, in other words say, “We got this wrong and here’s how we wish to remedy it”. She noted that the Australian Commissioner of Taxation has exercised this power that seven times. On the other hand, even though the Commissioner of Inland Revenue here has a similar power, it’s never been exercised. Overall, a very interesting session on what oversight should be in place and the issues involved in setting up that oversight.
International GST, Aotearoa New Zealand leading the way?
On international GST policy, a couple of interesting notes that came out of that one, was that generally speaking in New Zealand has been a world leader in this GST space. We have one of the broadest GSTs in the world which because of much broader reach represents 30% of the total tax revenue. This is above most other countries with GST or Value Added Tax (VAT) system where it generally represents about 20% of the overall tax take.
Around the world, the average VAT/GST rate is 19.2%, whereas ours is lower at 15%. Our GST is a classic example of a very popular topic, the broad based, low rate (BBLR) approach to taxation, where a broader tax makes lower tax rates possible which just about every tax practitioner, including myself, will endorse.
Economics and the environment
We had an economic update from Michael Firth of the New Zealand Superannuation Fund. Several interesting snippets came out of session including that barely 10% of the total funds of the Super Fund are currently invested in New Zealand. Of greater importance when looking ahead to consider the impact of climate change on GDP, the outlook isn’t particularly good. In fact, every forecast seems to make previous ones look over-optimistic even if the best policy response is adopted and we do everything to lower emissions by 2050. The climate change implications around tax policy are how we’re going to fund dealing with the physical effects of climate change.
Alternative tax raising options
Michael Firth’s session led into a very interesting presentation from Young IFA about alternative options for raising revenue. The Young IFA presentation referenced the Treasury Briefing to Incoming Minister, which shows that core expenses are rising and unless changes are made, there’s going to be a growing and unsustainable deficit, the cost of which will be borne by younger generations, hence their particular interest on the topic.
Young IFA deliberately excluded capital gains tax but looked at three areas, windfall profits and a wealth tax. By OECD measurements our environmental taxes are at the the lower end of the scale, but how you define environmental taxes is elastic so once Road User Charges and Fuel Excise Duties are included, we are nearer to the OECD average.
In any case many environmental taxes are mostly behavioural in that they are levied with the aim of changing behaviour so that less of that particular activity happens. This means so they’re not actually long term sustainable because if they work as they should then revenue should decline over time.
Young IFA discussed the suggestion made in 2021 by the Parliamentary Commissioner for the Environment for a departure tax which reflects the environmental cost of flying internationally. Essentially three bands would apply, Australia and the Pacific Islands, Asia and long-haul flights to the US, Europe etc., The Parliamentary Commission for the Environment suggested it could raise about $400 million annually, based on a similar approach taken by UK passenger duty. However, $400 million although welcome still isn’t a game changer.
Windfall taxes?
What about a windfall profits tax? These target profits caused by extraordinary events. But they’re temporary, retrospective in effect and intended to correct behaviour. They’ve been used internationally the UK has had a long running bank surcharge to pay for the Global Financial Crisis bailouts.
When Treasury considered a windfall profits tax it estimated a 1.4% surcharge would raise about $230 million per annum rising to close to $700 million based on a 4.2% rate. However, forecasting can go awry when the UK recently introduced a windfall tax on the fossil fuel sector that only raised about 60% of what was expected.
Wealth tax? No thanks
On wealth taxes it would be fair to say that the audience and to be fair, the Young IFA presenters themselves, were not sold on the idea, because of the complexity, whether it would raise much revenue and concerns about capital flight. The work of Thomas Piketty around wealth taxes is often cited, but as someone from the floor noted he suggests a wealth tax should be applied on a global basis. This would then deal with the question of capital flight. As Young IFA pointed out when Norway recently raised its wealth taxes, there was some capital flight with some rich Norwegians moving overseas in response.
Although Young IFA and the audience were not sold on the merits of a wealth tax, I think it will still be raised as option because questions about wealth inequality will keep coming up and politicians being politicians see the appeal in an apparently simple solution to the problem.
What makes a good tax system?
The conference ended with a panel discussion on what makes a good system. The panellists were three of the most experienced tax practitioners in the country: Rob McLeod, Robin Oliver and Geof Nightingale. Rob chaired the 2001 McLeod Review, whilst Robin as a Deputy Commissioner at Inland Revenue worked with both the McLeod Review and the 2009-10 Victoria University of Wellington Tax Review before being a member of the Sir Michael Cullen chaired Tax Working Group. Geof Nightingale was a member of both the Victoria University of Wellington Tax Review and the Cullen Tax Working Group.
As you would expect with such a fantastic panel, it was a very lively session which deserves a whole podcast for itself. We had quotes from Dylan Thomas “Do not go gentle into that cold dark night (of bad tax policy)” and also Hunter S Thompson ‘Never turn your back on fear. It should always be in front of you, like a thing that might have to be killed.’
Rob, Robin and Geof expressed varying degrees of confidence in the New Zealand tax system although acknowledging it was under some strain. All three noted the primary purpose of a tax system was to raise money for the government at the lowest practical economic cost.
There was less unanimity around whether income redistribution really was a key role for a tax system. To some this was a distraction from good tax policy as it leads to distortions but to another panellist it was an inevitable part of modern tax systems. Determining the right level of government expenditure was important, at around 30% of GDP the present system raised sufficient funds but above that level the pressure would mount.
All three were mostly positive that the present system could raise the desired revenue but noted there isn’t a lot of low-lying fruit around. Rob McLeod referenced his time working in Australia and the complexities of the capital gains tax. He also mentioned in passing the work done on the Risk-free Rate of Return method as a possible alternative means of taxing housing. Time and again each emphasised the focus should be on keeping the tax policy process and objectives as clear as possible.
Unsurprisingly, all three favoured the BBLR broad-based low-rate approach. They recognised that divergence from this principle is causing strain in the system now. 30 years ago, the company, trustee and top individual tax rates were aligned at 33%. Now this disparity between 28% for a company and Portfolio Investment Entities and 39% for individuals was causing strain. Overall, it was a great ending to an excellent conference all round.
A suggestion for simplifying the tax system and reduce compliance
Moving on, as previously noted, the Minister of Revenue said the Government was committed to simplification. And the limited partners session raised an issue about whether the various withholding tax rules apply to a limited partnership. The policy intent might be that it shouldn’t happen, but there’s an argument it technically should. Either way some clarification would be useful. (Apparently a draft consultation on various limited partnership tax issues is happening at the moment).
This got me thinking about another area where I think simplification would be helpful, the question of non-resident withholding tax on interest payments made by New Zealand tax residents to an overseas bank in respect of interest payable on an overseas investment property. Those interest payments might be made from a UK bank account to the relevant UK bank lender. However, because they’re being made by a New Zealand resident taxpayer to a non resident, the UK bank lender, then non-resident withholding tax should be deducted. (Worth noting the UK lender’s terms will not accept having tax deducted from the payment which must be grossed up for this purpose).
Theoretically this is the correct treatment, but it involves an enormous amount of compliance and I think there’s also a massive amount of non-compliance because the policy is both unknown and seems counter-intuitive to a lay person. (It would be fun to see the Commissioner, or some MPs, try explaining to a person they must withhold tax on the interest payment they make from a UK bank account to another UK bank). This is an area where there’s a great deal of complexity and I don’t think the policy when the withholding tax rules were set up in the late 1980s was intended to catch such situations. (Separately, it’s another area where some thresholds have not been updated for inflation in some time). In summary it’s a ripe area for simplification. Over to you Minister.
What tax tattoo would you get?
And finally, what tax tattoo would you get? This was one of the less serious topics discussed at the IFA Conference and yes, alcohol was involved. For me, the winning suggestion was to tattoo Generic Tax Policy Process on one set of knuckles and BBLR Board Based Low Rate on the other, which puts a rather nice tax spin on Robert Mitchum’s sinister preacher in The Night of the Hunter.
That’s all for now. 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.
This week our guest is Tracey Lloyd, Service Leader Compliance Strategy and Innovation at Inland Revenue. We discuss how Inland Revenue’s new START system enables it to detect fraud.
TB: My guest this week is Tracey Lloyd, Service Leader, Compliance Strategy and Innovation at Inland Revenue. Kia ora Tracey, thanks for coming along.
Tracey Lloyd: Thank you for asking me.
TB: What’s your role within Inland Revenue? What does Compliance Strategy and Innovation mean?
TL: OK, so I’m the service leader of a relatively new unit in Inland Revenue called Compliance Strategy and Innovation or CSI for short. During Inland Revenue’s Business Transformation, we introduced our brand-new computer solution called START (Simplified Taxation and Revenue Technology). I oversaw the team that was responsible for utilising the analytical tools of that system once Business Transformation was finished. CSI was designed to take over and expand the work that we had been doing. It’s been in existence for about 20 months now and there’s 25 of us, including me.
TB: CSI Inland Revenue sounds very ominous but joking aside you’ve got these new tools that Business Transformation has provided and other Inland Revenue officials have told me that it has greatly enhanced your capabilities. How have you deployed those capabilities? What does CSI do in this case?
TL: We’re basically using intelligence to lead our approach to compliance. We combine insights from our customer segments, what our customers are saying, what our people are seeing, our systems, the tax and social policy products that we administer and analytics. We then connect the dots between all those different challenges to help the leadership teams make decisions about how to prioritise compliance initiatives.
It’s not just proactive compliance activities. It’s such things as sending out query letters, following up overdue debt overdue returns, but also working on educating our customers through tailored communications marketing campaigns and of course audit work.
Basically, we look at problems where our compliance is not good or where customers are confused. And we think how we can help; how can we help our customers and how can we improve compliance with the amazing tools that we now have available?
CSI – connecting the dots and checking COVID payments
TB: Where is an initiative that you’ve been able to deploy some of these tools, which has helped clear up confusion?
TL: Probably one which we should probably touch on is how CSI interacted with the Ministry of Social Development (MSD) and some of the various COVID products that Inland Revenue administered.
MSD had the wage subsidy, and I won’t cover our interactions with them over that. I just want to clarify that if someone was in business and eligible for the wage subsidy which was administered by MSD, then that wage subsidy had to be in their income tax return.
What we found within one week of the 2021 tax returns being able to be filed was that 80% of people who’d received the wage subsidy were not returning it.
TB: 80%? Wow!
TL: Yes, 80% and obviously we can identify that but then every single one of them needs some manual action and a contact for us to ask whether people are happy for us to include it because there was the odd one where the data wasn’t quite right, but only very rarely.
What we did is we worked with MSD who were super helpful, and we were able to upload those Wage Subsidy files and pre-populate that information within 10 days into everyone’s tax returns. That meant that we went from an 80% fail rate of people including it to a 20% fail rate where it was pre-populated, but people were perhaps changing that figure or deleting that figure out of their return before they submitted it.
TB: What happened then if they deleted or amended those numbers?
TL: The return would be stopped for manual review. We would contact the person and ask if there was a reason for the change, maybe they had paid some of it back to MSD. And so we would liaise over that to check that they returned the right amount.
TB: This group of people would be self-employed or shareholder employees because everyone’s else wage subsidies should have gone through PAYE?
TL: Yes, that’s right. If you were an employee, then there was no impact to you.
TB: The other COVID support payments, those were directly Inland Revenue’s responsibility?
TL: They were, so we had Covid Support and Resurgence Support Payments and the Small Business Cashflow Scheme.
CSI in action – detecting COVID fraud early
TB: I see today there’s a report about a Waikato sharemilker who was sentenced to home detention for fraudulently claiming Covid Support Payments and the Small Business Cashflow Scheme. https://www.ird.govt.nz/media-releases/2023/waikato-sharemilker-sentenc… How might you have picked this up?
TL: Well, a lot of the work that we did was at front end based on the application rather than letting the money out the door because it’s very difficult to recover once the money’s gone out.
We are obviously doing that audit activity because we’re starting to see prosecutions following on from those reviews. We will contact people and determine whether they fraudulently applied for it or applied in error.
But what we were able to use START for was to proactively stop those applications in the system based on running them across a whole lot of rules and then stop suspicious ones for manual review.
To give you an example of some of the rules that we ran such as duplicate bank accounts, or if someone had a few entities using the same bank account, that was usually a a trigger for us that there was some sort of identity theft potentially going on. We also had examples where we had no record of that particular customer being in business at all. We stopped applications completed from offshore, as you had to be a New Zealand based business.
TB: You would have identified those offshore applications through the domain and the IP address.
TL: That’s right. All that information was available to us. We also had people putting deceased persons on their employee schedule or the number of employees over lockdown were going up, that generated some questions from us. We found employees that were either children or very, very elderly.
Sometimes the same employee was on a large number of schedules, which also raises a number of questions. Currently one of my team is preparing for a prosecution relating to a Resurgence Support Payment claim.
Just on Resurgence Support Payments, applications used to open at 8:00 AM in the morning and there five or six different iterations over time. One time, something like four out of the first five applications that arrived within a couple of minutes after 8:00 AM were fraudulent. A lot of those claims were from offshore, but our systems were able to stop all of those.
In relation to Covid Support Payments we stopped 9% of all applications for manual review. That’s actually quite low if you think about it. 91% went automatically out the door overnight and people got the money that they desperately needed.
Of the 9% that we did stop, we declined 66% which is a very high percentage. Generally speaking, the ones that we did pay out after stopping for a manual review were people who had recently started in business. So we asked them for some proof of business and that type of stuff and then the application was fine. I know that’s no help to customers who had to wait, but did get the money in the end. But we did decline about 33,032 applications and we stopped $147 million from being erroneously issued to people who weren’t entitled.
With the Small Business Cashflow Scheme loan, we declined 67% of the applications we stopped and this amounted to $550 million.
TB: I mean the Small Business Cashflow Scheme was in many ways bigger than the various Covid support payments, I think it ran to over $1.5 billion. [$2.3 billion per Inland Revenue’s Annual Report for 30 June 2022] So people attempted to borrow $550 million on top of what was already lent?
TL: Yes, that’s correct. It’s testament to the people that we had working on it and the new system that we were able to do it proactively instead of coming along afterwards and saying hey, you shouldn’t have got that money, can you pay it back because that’s very, very difficult.
TB: I mean the wage subsidy is a good example of a high trust environment. It was money out the door because we’re in the midst of the COVID crisis.
TL: That’s right, the wage subsidies were the first COVID product that was paid out.
Lessons from the Australian Tax Office TikTok GST scandal
TB: To give a comparison with another overseas tax agency that didn’t quite get it so right, there’s this ongoing scandal over the Australian Tax Office where these TikTok influencers basically said, “Here’s how to scam the ATO out of GST”. I think it’s over a billion dollars and counting. The ATO has admitted it really isn’t sure how big this scandal is, and that’s quite staggering.
I mean, what do you do about that? Could TikTok influencers do that here?
TL: We’re going to talk about Integrity Manager a little later but we’ve definitely had people send us snips of social media marketing along the lines of “Hey, give me your IRD number and I’ll get you a refund” but nothing quite to the extent of Australia.
We keep a very, very close eye on our own GST to ensure that nothing like that will happen in in New Zealand. We’ve spoken to our senior execs about it and we’re very comfortable that we would be able to react immediately if we saw any of that behaviour. But I mean that the numbers are just staggering over in Australia.
TB: To repeat a point I made earlier, conversations I’ve had with other Revenue officials is that if START hadn’t been available when COVID turned up, it would have been very difficult for Inland Revenue to have run any of these COVID support programmes. They probably would have all had to have been run out of MSD with a higher risk of fraud, perhaps.
TL: Yes. Or even just high trust model with payouts from Inland Revenue with no checking beforehand.
START and auto-assessment
TB: One of the great things that START did was to bring in the year-end auto-assessment routine. https://www.ird.govt.nz/income-tax/income-tax-for-individuals/what-happ… People no longer had to either go through a tax agent or the tax intermediaries and instead the majority of taxpayers who are salary-earners with all their income having tax withheld either through pay as you earn or through resident withholding tax are now on auto assessment.
You just mentioned Integrity Manager this is something that is part of this auto-assessment routing. How does it operate? Because you’re dealing with 2,000,000 taxpayers in six or seven weeks.
TL: I think our last auto-assessments had 3.2 million individual income tax returns were sent to customers and 88% of those required a customer to do absolutely nothing. I was one of those, I didn’t have to do absolutely anything.
We’ve discussed Decision Support Manager which we used for the COVID products and Integrity Manager is another amazing tool that we now have which stops returns with potential errors and fraud in them.
Every single tax return goes through Integrity Manager before it’s processed. We screened 10 million tax returns in the last year.
TB:Tax returns would not only be individual tax returns, but also GST returns which would be a big group and particularly the Pay As You Earn filings.
TL: The only one that doesn’t have rules through Integrity Manager are the PAYE employer schedules. That’s because we need to make sure that the deductions and entitlements get paid out as soon as possible. You know, Child Support and Student Loan, etcetera. But we will do some back work on that on those.
Basically, we review Non Resident Withholding Tax, Approved Issuer Levy, GST returns and donations. That’s another big group where we also run rules over returns. And so, while we had 10 million tax returns in the past year, over 200,000 were looked at to be manually reviewed because they hit a rule which raised some concern from us.
TB: That’s what 2% of all returns?
TL: Yes, a pretty small group. So, some of the main areas we look at are GST, income tax and donations. They’re our big ones and examples of some of the things that we review are changing pre-populated figures. You know, why are you changing them? Because we have already got that data. Another is making up figures even though we can check that against other data we hold. I think you could describe that as a frequent flyer, shall we say. Every year people just making up figures.
Snapshotting to prevent incorrect tax returns
TB: You gave an example at a recent ATAINZ conference where one person was constantly changing the online return until they got the right number and by that stage they had amended it 50 or 60 times.
TL: We call that Snapshot and it’s another tool in the new START system. It’s the ability for us to view activity in myIR. We also use it just as much internally. For example, every time I’m in the system it’s all recorded and for training purposes. So when we’ve got someone on the phone, I can hear the people sitting behind me saying, “OK, you’re in the wrong part of the return. You need to go to this particular tab to do what you’re trying to do”. We’re able to track where a person is and help them through the system.
But one of the sides things that’s come from that is that we’re actually able to look at what someone’s done while they’ve been filing their return. For example, we can see when people are adjusting figures, to see how big or small the refund is now and then going back and changing the figures. Doing this backwards and forwards and backwards and forwards countless times.
Now if you’re doing that type of behaviour, even either you’re really confused and you need some help from us, or you’re just making up figures. And so, we have the ability to see that and we’re also able to stop such returns.
Some of the other rules we can run identify an IP address which has been used to commit fraud in the past so we can red list that. Identity theft is an ongoing issue for us unfortunately.
Overclaimed donations and other “creative” deductions
TL: Other rules that we have include one for large school donations, which may possibly be private and therefore not allowed. Or large donations compared with total income. It may be totally legit, but let’s just ask a question about it and see how you how you go.
I mean in the past we’ve had people just making up figures and putting them in the return such as made-up employee share scheme figures. We’ve seen interest and resident withholding tax entries that are the same amount – $10,000 and $10,000. What we also see is that when people are making up figures to put in their return, they quite often make them all zeros. Nothing quite like a round number.
Over the last year to June 2023 year Integrity Manager reviews stopped $145 million of incorrect or fraudulent refunds dollars. $56 million of this was voluntarily disclosed by customers. Another $89 million of refunds were stopped after we engaged with the customer and asked them some questions.
With regards to some examples of non-business expenses, these have been a continual source of frustration for us. Under the auto-assessments system there are only four or five things that you can claim for. The one that most people claim for is for loss of income insurance. the main. But we get everything, literally everything coming through there.
One example I’ve got is someone had claimed just over $15,000 of non-business expenses and when we called to ask what it was, he said that he’d paid quite a lot of tax and his father-in-law suggested he claimed some of it back.
TB: Nothing like being honest.
TL: We did sort of point out that the amount of tax you pay is relevant to the amount of income that you and this person had earned a significant amount of income. We had another one where this person was only on salary and wages but had claimed $20,800 of non-business expenses. When we asked what they were, she said her son was at Auckland University and she was still supporting him. She thought she should be allowed to claim his expenses and added up his rent and groceries because he eats quite a lot. She did ask if we could put it in another box if that would help. But we said there was no other box that we could put that in.
But an example of a more deliberate fraud, shall we say we had someone who was receiving Working for Families but had no income at all. And then when we did some deep diving into their searches, we found fifteen other customers were linked to the same bank account. And a majority of those customers were overseas because we can do Customs checks.
TB: Yes, because you share information fairly frequently.
TL: We do very regularly.
TB: In my role we’re often determining when someone became tax-resident. We’ll tell a client go to Immigration and they’ll come back to you with the dates you arrived and left the country. Clients are often incredibly impressed how efficient Immigration is with providing those details. And I’ve been in a meeting where the file of information which had been shared from Customs and Immigration was literally about a foot high and I thought “We’re in a bit of trouble here.” Unsurprisingly, we didn’t win that case.
So, yes, a lot of information sharing regularly goes on. It’s a common theme in the podcast, but I think people do not understand just how much information is shared and how much information you can access.
TL: That was definitely something that we saw with the wage subsidy when we pre-populated returns. And you know people deleted the entry and we asked “Why?” and they actually admitted to us straight off the bat that they weren’t actually eligible for it.
And we’re just like “Well, we’re not sure what you want us to do about that because you did actually receive the money.” They didn’t obviously think that we would talk to MSD and get that information. While the pre-population was a second step, we were always getting that file with the income information.
Running information campaigns and engaging with migrant communities
TB: Inland Revenue sometimes runs campaigns based around this misinformation. Talking about expenses are I recall recently there was a campaign advising real estate agents about what they could claim. https://www.ird.govt.nz/pages/campaigns/realestateagents This arose because it had come to your attention that there seemed to be a lot of expenses being claimed. And I think the result of that campaign was the following tax year the amount of expenses claimed declined, is that right?
TL: That’s right. Integrity Manager was used because obviously we have BIC codes which tell us who’s a real estate agent. Yeah. And we’re able to look at the level of income compared with the level of expenditure. And it doesn’t necessarily always prove that there’s anything wrong, but it does beg a question and the number of very imaginative expenses that people claimed was huge.
And that’s why on our website now it’s very easy to find the real estate agents form which details what expenses you’re able to claim and what you cannot.
I think we also did that in a few different languages as well to hopefully help people understand the rules a little bit better because it can be different in other countries.
TB: Just to talk about other languages in there, there was a little snippet that came out of the report that was released in connection with the repealed Tax Principles Act. One of the comments about trust and Inland Revenue was that it was extremely high amongst migrant communities, and highest amongst Asian migrant communities. That’s credit to Inland Revenue for being able to build a level of trust there.
TL: Oh, thank you. Yes, our community compliance folks spend a lot of time working with our migrant communities and speaking to them in their own languages and going to trade fairs and community halls and so on. Helping people understand because they’re also entitled to social policy, which we need to make sure they get as well.
TB: That’s right. Inland Revenue is not just about taking tax off people. It also redistributes because it’s the key agency for distributing KiwiSaver, Working for Families, which is $2 billion and Child Support.
Inland Revenue and tax agents
TB: How important are tax agents to your role? Because we work with you on campaigns and we’ve seen increased engagement recently.
TL: Absolutely that’s certainly how it feels like to us. I mean, tax agents represent about 1.8 million customers to Inland Revenue. It’s a massive way for us to contact a huge customer group by using tax agents.
Many of the rules we’ve discussed when checking returns we don’t enable for tax agents because we just don’t see the same type of erroneous and fraudulent behaviour that we do with customers who aren’t represented by tax agents. You know, there’s always the odd one, but they’re very rare.
Tax can be really complex and tax agents are a critical part of making sure that people get it right. And as you know, we have regular meetings with Chartered Accountants Australia New Zealand and also with ATAINZ, which is how we met after I did a presentation at an ATAINZ workshop.
We share about what we’re doing with compliance, and you know how we can help. Quite often when we’re planning to do some sort of compliance campaign, the tax agents will be the first people that we contact to say, “Hey, this is what we’re gearing up to do, we’re just letting you know so that you can think about it in terms of your client base.”
Forthcoming campaigns on the shared economy and overdue Student Loan debt
TB: Speaking of which, any new compliance campaigns on the horizon?
TL: Well, there there’s a few that are sort of in the planning stages. Obviously, you would have heard about payment service providers with the new legislation. We’re getting that data and once we have that, obviously we will definitely kick off some campaigns around that.
We’ll be running a targeted campaign, focusing on raising awareness, educating and so on about ride sharing, food and beverage delivery and short stay accommodation. Trying to raise customers awareness and understanding as it applies from 1st April and some people might get caught out. We’ll soon start our next campaign on auto-assessments around just letting people know that’s coming soon.
The other big one that we’ve got on the go is about student loans. This targeted campaign is mostly focusing on overseas based borrowers who are in default. Only 26% of overseas borrowers are making the required repayments that they should be making on their loans whereas 94% of New Zealand based borrowers do.
The purpose of the campaign is to increase the overall compliance of student loan borrowing customers so that they understand their obligations when they leave New Zealand to perhaps go do their big OE and stuff that they’re still obligated to make repayments.
This particular campaign we’re slicing into nine specific segments to try and make our awareness campaigns a little bit more targeted and hopefully a little bit better at getting through to people. You might see some information on the sharing economy via LinkedIn, but you probably won’t see targeted paid advertising unless you’ve got a student loan debt or you’re doing a Uber side hustle.
TB: Quite a lot to ponder there about what CSI Inland Revenue is up to, but to wrap up what sort of message would you like to send Tracey. Like Liam Neeson in Taken we have the tools and we will find you?
TL: Pretty much. I mean obviously our first step is to make it as easy for people to get it right in the first place and we spend a lot of time reviewing how customers behave in the system so that we can help and maybe change the system to make it more intuitive for people. But you’re right, we’ve got these amazing tools and we’re using and utilising them all the time and we’re learning more and more about them. It’s a great system and it’s good for All New Zealanders.
TB: Computer projects are controversial but START has been an enormous project which was delivered on time and under budget. Just to put some numbers in context. You mentioned earlier about identifying $145 million of fraud. Inland Revenue’s annual operating budget is about $700 million so you pretty much pay for yourself very, very quickly.
On that note, Tracey, thank you so much for joining us. It’s been a pleasure having you on the Podcast.
TL: Thank you for inviting me.
TB: That’s all for now. 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.
Various Treasury Briefings to Incoming Ministers have been released in the past week including that for the incoming Finance Minister. The slide pack discussing the Economic and Fiscal Context has attracted some attention because it discussed the option of introducing more taxes on capital.
Prepared on 24th November, the Briefing sets out
“Treasury’s view on New Zealand’s economic and fiscal context, including some of the key policy issues you will likely grapple with. It’s intended to provide context for subsequent, more detailed conversations between you and the Treasury.”
The summary section has a really fascinating slide not just about this podcast’s focus, tax and the fiscal outlook for the country, but about the Treasury’s snapshot of the present state of the New Zealand economy and the challenges ahead. And the summary gets straight to the point, “a substantial fiscal consolidation is required to bring revenue and expenses back into balance and support fiscal sustainability.”
The Briefing discusses the state of the economy and how a clear economic and fiscal strategy will create a strong base for growth. Although fairly routine in some ways it’s very well worth a read.
Fiscal pressures are building…
But what has caught people’s eyes are references in the Briefing to the fiscal pressures that are building. Now I’ve talked about this previously, and in particular He Tirohanga Mokopuna the statement on the long-term fiscal position from 2021. Incidentally, the 2016 precursor of that 2021 statement heavily influenced the last Tax Working group in its decision to propose a capital gains tax.
As the Briefing notes fiscal pressures are building. Gross New Zealand Superannuation costs have increased from 4.6% of GDP in 2011/12 to 5% of GDP in 2022/2023 and are forecast to rise to 5.4% in 2026/27. Then there’s the issue of weather-related events such as Cyclone Gabrielle which are increasing in intensity. The Briefing includes this really chilling quote
“In addition, New Zealand is exposed to a very high level of risk from its natural environment. Lloyds, the insurance marketplace, assesses New Zealand as having the second highest risk of annual losses in the world, behind Bangladesh and ahead of Japan.”
There’s also this interesting graph which shows the extent to which insurance claims have been increasing in recent years.
The Briefing references 2021’s He Tirohanga Mokopuna I just mentioned noting it
“…illustrated that at historic rates and policy settings, New Zealand’s core Crown expenditure will significantly outpace revenue over coming decades (Figure 8). The most significant spending pressures come from a combination of healthcare and NZ Superannuation.”
Core Crown expenditure was at a multi-decade high in response to the COVID pandemic, but is now outstripping the rise in revenue, even though core Crown tax revenue has been rising as a percentage of GDP since 2012/13. Treasury forecasts tax revenue will increase to 30% of GDP by 2026/27 on an unchanged policy. However, after stripping out one-off expenditures Treasury calculates the government is currently running a structural operating balance before gains and losses deficit of around 2% of GDP, which is roughly $8 billion.
But the Briefing notes the problem with tightening expenditure at this time in response to this structural deficit is the demographic change now occurring. This increases the fiscal pressure to deal with an ageing population, including increasing superannuation costs and demand for health services.
A heavy reliance on personal tax
Treasury notes one option would be to increase revenue at which point a government will need to consider a capital gains tax. Because as the Briefing comments “New Zealand relies more heavily on personal tax compared with most OECD countries”. The reason for this is that many other OECD countries have significant Social Security taxes, and they’re used to pay for the likes of New Zealand Superannuation. We don’t have that. We have a very clean system, but because we don’t have Social Security, we rely more on income tax and GST.
Constraints on the tax system – including the lack of a capital gains tax
On the state of the tax system Treasury’s Briefing comments
“However, there are constraints on our personal tax system which are creating increasing pressures and constraining our options for reform. These constraints arise due to the difference between our personal and company tax rates, and the lack of taxes on capital and capital gains. These limit options to raise revenue alter the mix of taxes or make changes that would meet distributional and economic objectives.”
The comment that the lack of capital gains taxation “has also contributed to higher house prices” will be disputed by some, but it’s interesting to see Treasury come out and say it.
Overall Treasury sums up that “At a high-level there are several options to support a return to surplus while delivering priorities” including:
“Increasing revenue through structural reforms of the tax system policy changes to increase revenue or letting fiscal drag continue to increase revenue raised through personal income tax.”
We’ve talked about fiscal drag ad nauseam and last week I referenced the draft report produced under the Tax Principles Act which showed how fiscal drag increases average tax rates over time. We think the Government is still committed to increasing the current income tax thresholds, whether they will index them regularly for inflation is another matter.
As always, these briefings contain a wealth of little detail. They’re fascinating, really, one little detail that hasn’t picked up by many was on page 19. This was discussing the Budget 2024 operating allowance, which was set at $3.5 billion. The Briefing discusses the existing pre-commitments and included in those pre-commits is revenue of $80 million from a Digital Services Tax.
This seems a little bit optimistic because I understood the DST wasn’t actually being introduced although it possibly reflects the effect of the expected changes in the international tax base. Either way it’s a little detail I was a bit surprised to see. However, $80 million in the context of $3.5 billion operating allowance and over $130 billion annual Government expenditure it’s a drop in the ocean. Still, it’s interesting to see it there.
Inland Revenue consultation on charities’ business income exemption
Mentioning tax working groups, I remember asking the late Sir Michael Cullen the chair of the last Tax Working Group whether there was anything that surprised him. He replied that it was the extent of the charitable sector what was going on there. This is something I see fairly frequently in comments on these transcripts, it seems to be a bit of a sore point that certain charities have a business income exemption (By the way, thank you to everyone who comments, I do read them even if I don’t always respond).
Inland Revenue have just released a 46-page consultation document on to what extent is business income a charitable entity derives exempt from tax. As has become the habit and it’s very welcome, it’s accompanied by a useful little five-page fact sheet on the matter.
The main business income exemption is in section CW 42 of the Income Tax Act 2007. There’s a related section CW 41 treating non-business income as exempt for charities.
But this particular draft interpretation statement is consulting on what constitutes business income and to the extent to which it will be exempt. How the exemption applies is set out in a very handy flow chart produced in the in the fact sheet.
OK.
In summary, if the charity’s charitable purposes are limited to New Zealand, then all its business income is exempt. But if the charitable purposes are limited to overseas, then all business income is taxable. If it so happens that the charitable purposes aren’t limited to New Zealand, so charitable services are provided both in New Zealand and overseas, then there’s a need to apportion.
The interpretation statement runs through with some good examples what meets the criteria to be business income. It also considers how a charity would about apportioning between business and non-business income and services in and outside New Zealand. Much of this is relatively routine and it’s been standard practice for some time.
I think the thing that concerned the last tax working group, and which prompted the late Sir Michael Cullen’s comment is that there isn’t necessarily a follow through on whether a charity which may meet all these criteria is actually applying its spending to the community. A charity may have an exemption; therefore, they’re not paying income tax. Excellent. But are they applying funds for charitable purposes? If so that’s all well and good. That’s what we want to see. But what if that’s not happening? This is when issues arise about charitable exemptions when the funds are being accumulated and not distributed. That’s a whole topic for another time.
CSI Inland Revenue?
And finally, a little story just came out this week regarding Gordon Kenneth Morris, a Waikato sharemilker, who fraudulently claimed COVID support money which he then spent on online gambling. After he was caught, he was sentenced to nine months home detention.
What happened was he submitted fraudulent applications for the Small Business Cashflow Scheme and also for Resurgence Support Payments. He received a total of $27,200 from the Small Business Cashflow Scheme. But his application for $8,800 in Resurgence Support Payments was declined.
When Inland Revenue investigated it found Morris had also filed false GST and income tax returns and in the period between 1st April 2018 and 20th October 2020, he and his wife had spent over $336,000 on online casinos.
It’s a bit of a tragic case, but it’s also a good introduction for my guest next week, Tracy Lloyd from Inland Revenue, who is Service Leader Compliance Strategy and Innovation. We will be discussing how Inland Revenue detects fraudsters such as Mr Morris.
That’s all for now. 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 guidance on the new 39% trustee rate
Briefing the Minister
Tax credits or threshold adjustments?
The Finance Minister signed off 2023 rather like a Shortland Street season finale, leaving us all guessing as to the exact extent of the proposed tax cut package and when it might apply. We were told at the Half Year Economic Fiscal Update Mini-Budget on 20th December we could expect more details shortly. But now it’s February and we’re no wiser. It now appears likely we’ll have to wait until the Budget in May for full details.
A 39% trustee tax rate?
On the other hand, the business of government carries on and we will know early next month whether the coalition government will proceed with increasing the trustee tax rate to 39%. That’s when the Finance and Expenditure Committee reports back on the Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill. This is the annual tax bill currently before Parliament which proposed the increase to 39%. It must be passed by 31st March.
The FEC heard oral submissions last week, and I note that (previous podcast guest) John Cantin thinks it’s most likely that the tax rate will go ahead. This is even though such evidence as we’ve seen suggests that a 39% tax rate for trusts probably represents over taxation of many trusts once the wider family context is considered.
I tend to agree with John that the rate increase will go ahead, in part because it is a base protection measure as it aligns the trustee rate with the top individual tax rate. But also, the Government will probably be grateful for some additional revenue to counterbalance the lost revenue from the proposed tax threshold adjustments. That said, I know a number of submissions proposed that some sort of de minimis threshold is introduced, and the rate of 39% will only apply on the excess.
Inland Revenue’s view on tax planning for the new 39% rate
Meantime, and rather helpfully, Inland Revenue released last Friday some high-level guidance about how it might perceive taxpayer transactions and structural changes ahead of a rate change. General Article GA 24/01 proposed increase in the trustee tax rate to 39% has been released in response to requests since the rate was proposed for guidance on how Inland Revenue might perceive some transactions.
GA 24/01 contains several examples of possible transactions and how Inland Revenue would view the transaction. The first example is a company owned by a trust which changes its dividend paying policy. Inland Revenue considers a company is entitled to change its dividend paying policy and while taking into account the funding needs of shareholders and applicable tax rates, it “is unlikely without more (such as artificial or contrived features) to be tax avoidance.”
The example then notes Inland Revenue might have concerns if the company could pay a dividend by crediting shareholder current accounts, but “objectively has no real ability to pay those credit balances if it was to be liquidated.” In other words, the company tries to pay a dividend ahead of the trustee rate increase but doesn’t have the funds to pay the dividends in cash in full.
Another example is of a trustee choosing to wind up a trust. Again, GA 24/01 suggests such a step is “unlikely without more (such as artificial or contrived features) to be tax avoidance.” GA 24/01 also looks at the question of trustees investing in Portfolio Investment Entities instead of other available investment options. The advantage here is that the maximum rate applicable to Portfolio Investment Entities is 28% Again, Inland Revenue concludes such a step is unlikely without artificial or contrived features to be tax avoidance.
That said, Inland Revenue is going to continue to gather information on trusts and something it has said would be of concern to it is where income is allocated to a beneficiary taxed at a lower rate, and then instead of actually being paid out or being fully available to the beneficiary, is resettled back on the trust. In effect, the beneficiary has not benefited from the distribution.
The allocation of income to a beneficiary, where the beneficiary actually doesn’t know of an allocation or has no expectation of receiving the income together with replacing dividend income with loans “in an artificial manner”, are other alternatives which would concern Inland Revenue if there’s no real commercial reality behind the arrangement. And then artificially altering the timing, ie: bringing forward or deferring any taxable deductible payment, particularly it’s linked to existing contractual terms or practise for the date of payment.
These are just a number of scenarios which might play out. And clearly Inland Revenue’s watching. As I said, we really won’t know what the state of play will be until early next month when the FEC reports back, and when it does, we’ll let you know. But as I said, the expectation I have is we should see that tax rate increase.
The Tax Principles Act may be gone but its first draft report lives on
Moving on, one of the first things the coalition government did was repeal the controversial Tax Principles Act. Nevertheless, the draft report that was due to be produced under the Tax Principles Act has been proactively released and it makes for some interesting reading.
The report gives a background as to why it’s being prepared, its reporting obligations, and it explains what are the tax principles that were measured. These were included in the Act – efficiency, horizontal equity, vertical equity, revenue integrity, compliance and administration costs, flexibility and adaptability and certainty and predictability. Incidentally, a lack of certainty and predictability was one of the objections that was made about the Tax Principles Act because didn’t go through the full generic tax policy process.
Inland Revenue was required to assess the principles, against four measurements:
Income distribution and income tax paid;
Distribution of exemptions from tax and of lower rates of taxation;
Perceptions of integrity of the tax system, and
Compliance with the law by taxpayers.
The report has lots of interesting graphs including the taxable income distribution for individuals for the 2022 tax year which shows a wee spike around the $180,000 mark.
I think that’s rather revealing even if there are apparently only 4,000 individuals involved. But still for those taxpayers you may need to have a good explanation of what’s going on.
There’s a graph showing how average tax rates rise as income rises. This graph tops out at $300,000, by which point the average tax rate has risen to 32.3% for someone of that income.
But what I thought was quite interesting were the graphs looking at the average tax rates from 2012 to 2022. In particular the graphs illustrated the effect of inflation combined with the non-adjustment of thresholds. That’s an issue I’ve talked about frequently and threshold adjustments we think will be at the core of the Government’s proposed tax relief package expected to be rolled out later this year.
The report notes between 2012 and 2017, the average tax rate for the most common regularly employed worker increased by 0.1 percentage points. Not too bad. But from 2017 to 2022 it increased by 1.2 percentage points. That’s quite a more significant example. Overall, in the period between 2012 and 2017 it rises from 14.9% to 15% and then rose between 2017 and 2022 to 16.2%.
This is the fiscal drag (or bracket creep) I discussed with Susan Edmunds of Stuff. It’s been an issue for quite some time. As wages rise faster, they drag persons on average incomes into a higher tax bracket. It will be interesting to see how the Government addresses it, and I’ll talk about that in a few minutes.
There’s plenty of other material to consider. There’s an interesting stat that the top decile of taxable income earners paid 44% of personal income tax. The report notes that the same group earned 33% of total income and suggests this is a better indicator of progressivity in the tax system than the fact that 44% of tax is paid by the top decile.
The arguments will rage around the progressivity and fairness, David Seymour of the Act Party for one has been talking about this area. Overall, there’s a lot to consider in the report. Interestingly, in the note to Cabinet regarding the repeal of the Tax Principles Act, the new Minister of Revenue Simon Watts suggested that much of this data could be made separately available, perhaps as part of Inland Revenue’s annual report. I hope we do see that, because for some time I’ve felt that the discussion around bracket creep, fiscal drag and thresholds has been sort of sidelined because governments have been not too keen to discuss it in great detail.
Briefing the Minister
Mentioning the new Minister of Revenue Simon Watts, another report released last Friday was the Briefing to the Incoming Minister. I think some of the data that’s been included in this draft report under the Tax Principles Act, would normally go into the Briefing for Incoming Minister.
What I found interesting in the Briefing was Inland Revenue’s discussion around where it’s at and the effect of the completion of the Business Transformation Programme which has allowed it to “deliver significant cost savings”. For example, the Briefing notes the amount of revenue collected for the year ended 30 June 2023 grew by 62.5% compared with the year ended 30 June 2016, the last full year before transformation began. Over the same period, the number of Inland Revenue full-time equivalents reduced by 29%.
There’s been a lot of talk about government cuts for the public sector, but I think the Briefing subtly, or not too subtly, you might say, raises a good question – if an organisation has managed to reduce its headcount by 29% and its funding is not tracked with inflation since 2017, which appears to be the measure for the basis of these public spending cuts, why would you add further cuts?
My view would be, and I think I wouldn’t be alone in thinking this amongst tax practitioners, is that Inland Revenue is under a bit of strain. We know it probably needs to boost its investigations efforts. So why it should be on the chopping block when it’s already done much of what any government would want it to do – more with less. But we’ll see how that plays out.
I thought the amount of commentary in the Briefing around the question of funding this point was quite interesting. It notes that for the year, to June 2024, the department gets about $800 million a year. And at October 31st 2023 its workforce was 4,231. Whereas back in June 2016 it was 5,662. And by the way, the report also notes the department has planned for taking a $13.9 million reduction for the year to June 2025, which was announced by the previous government in August 2023.
According to the Briefing funding would be running around about $700 million going forward, but then adds something the government should probably pay attention to.
“Our primary cost pressures in out years will be remuneration and inflationary cost pressures on technology as a service contracts, accommodation, leases and other operating costs. We are currently developing options for meeting these costs and we’ll report back to you on these matters.”
I know speaking as an employer and along with other colleagues, finding staff is difficult at the moment, so that puts pressure on salaries, obviously. And Inland Revenue is not immune to that because it needs to pay near market rates to attract good quality people, because as the gamekeeper, so to speak, it needs to match the poachers on the other side. Like so much in the year ahead it will be interesting to see how the Minister settles in and what happens with Inland Revenue’s funding.
The shape of things to come – tax credits or threshold adjustments?
And finally, coming back to what lies ahead, as I mentioned at the start, the Half Year Economic Forecast Update left us none the wiser as to the nature of the threshold adjustments, which we think are going to happen. In that gap. David Seymour of ACT has come forward and talked about the ACT policy, which is to simplify the tax rate structure down from the current five rates down to three, with a top rate of 33%. This is moving back to the rate structure which applied from 1989 through to 2008. Basically, until 1 April 2000 (when the 39% rate was introduced) there were two main rates with a tax credit adjustment for low-income earners.
David Seymour talked about tax credits similar to the existing Independent Earner Tax Credit. But as I told RNZ while the concept’s not uncommon, there’s still the issue we discussed earlier. What about adjustments for inflation and keeping the true value of that, otherwise lower rate/ lower income earners will face higher effective marginal tax rates.
There’s also a certain complexity with tax credits. The thing about applying thresholds across the board to everybody, it’s pretty straightforward. Whereas with tax credits, if there’s a claim process that’s involved, not everybody will claim that. It introduces a bit of complexity at the bottom end, which Inland Revenue’s Business Transformation was determined to do the opposite in order to try and make it as easier for most taxpayers to comply.
As mentioned, we have the independent earned tax credit, but it starts cutting out at $44,000 and then drops out at $48,000 once income crosses that threshold. We’ll have to wait to see what happens and in the meantime there will be plenty of debate ahead. We will bring all of those developments to you as usual.
In the meantime, that’s all for now. 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.
