Australian Tax Office ruling on residency – time for a clearer statutory definition?
Applying for Australian citizenship? Watch out for the sting in the tail.
Submissions closed Friday on the Tax Principles Reporting Bill. Now for a bill that doesn’t actually increase the tax rates this has been a surprisingly controversial bill, mainly because it’s actually perceived as being highly political in its ambit in introducing reporting on tax principles. The speed with which with which it has been rushed through is also controversial because normally tax legislation is developed through what we call the generic tax policy process (GTPP). The GTPP is very well regarded around the world.
But every so often, for whatever reason, the process is bypassed. Sometimes as during the COVID emergency because things need to be done immediately. It’s a framework through which New Zealand tax policy has operated for the better part of nearly 30 years. And it means changes of tax policy and of the particular tax treatment of certain items are developed over time through consultation.
Controversy around the Tax Principles Reporting Bill
In this case, the Tax Principles Reporting Bill came out of left field. There’s been very little consultation about it. In fact, we’ve only had barely three weeks between its introduction alongside the Budget and today. So that’s part of the controversy around it.
The other question is what it really is setting out to do. I think most objections will centre around this question of why is this here? The idea of setting out some ideas about what tax principles might be is not unreasonable in itself. But criticism of the Bill is focusing on whether it’s very clear about what it’s trying to do. For example, Inland Revenue is required to report on certain effective principles and whether there are inconsistencies in the tax system with these principles. But then, as several tax advisors have asked, what action will be taken at that point. There is also no acknowledgement that tax policy ultimately involves trade-offs between principles and politics. To be frank, tax is politics.
I’ve seen one or two interesting comments about which agency should be reporting under the Bill. Inland Revenue or maybe Treasury? There are a whole heap of things to consider about the Bill. Although it comes into effect on 1st July, if there is a change of government, it will almost certainly be repealed.
It’s an interesting Bill because it’s attempting to clarify the basis on which we design and operate a tax system. But it’s also flawed because I don’t think it’s has actually achieved that. We’ll see plenty of pushback and I’ll be interested to read the submissions on the bill. (Shortly after the podcast was recorded, John Cantin published his submission).
Australian tax residency
Moving on, I frequently deal with issues of tax residency. It’s a core part of what I do because tax residency determines what sources of income will be taxed in Aoteaora-New Zealand. There are also rules set out in double tax agreements, and one pretty basic principle wherever you go in the world is that if you have property situated in the country, that country gets what we call the primary taxing rights to it.
But individual tax residency is a matter of great practical importance. If a person is resident in the country, then that country can tax them on their world-wide income, and that can have quite significant implications.
The Australian Tax Office (ATO) has just updated and released a tax ruling TR 2023/1, on income tax residency tests for individuals. Australia deems a person to be tax resident in Australia if they reside in Australia under what they call the ‘ordinary concepts’ test, and that includes a person whose domicile in Australia, unless they’re satisfied that they have a permanent place of abode outside Australia.
A person is also resident if they have actually been in Australia continuously or intermittently during more than half of the year of income, unless they’re satisfied that they have a usual place of abode outside Australia and they do not intend to take up residency in Australia. There’s also another series of tests, which I’ve not come across, relating whether or not they’re a member of a superannuation scheme or are covered under the Commonwealth Fund.
When you look at these tests you can see there are quite a few value judgements involved. And so there have been calls for the Australian tax residency test to be put on a more statutorily defined basis, most notably by the Australian Board of Taxation. “The Board’s core finding is that the current individual tax residency rules are no longer appropriate and require modernisation and simplification.”
Now it’s of interest here obviously for people going across to Australia, but also because our own residency test is twofold. The primary test, and this is often forgotten, is a person is tax resident in New Zealand if they have a permanent place of abode in New Zealand. You’ll note that phrase, “permanent place of abode” is actually also used in Australia.
Failing that, there’s the days present test where a person is deemed to be resident in New Zealand if they are physically present in New Zealand for more than 183 days in any 12-month period. There’s a subtle difference there between our days present test and many other jurisdictions in that it is based on a rolling 12-month period rather than a tax year. On the other hand, when you get down to defining a permanent place of abode, that involves quite a number of value judgements.
The current residency test is now over 30 years old. As noted above the Australian Board of Taxation suggested that really the Australian test perhaps should be more clearly defined in statutory legislation. And I’m coming around to the view that maybe that’s what we need to do in New Zealand as well. I’ve seen at least one academic article in the past year that’s picked up on this point.
“You can check out any time, but you can never leave”
Now, why we don’t do that is explained in the Inland Revenue Interpretation Statement on residency. Right now the permanent place of abode test does make it easy for someone to be defined as tax resident, but difficult to lose that.
Notably, the Interpretation Statement does not have an example of a time period of how many years must a person be overseas before Inland Revenue would consider that someone has lost their permanent place of abode.
So, this makes residency a very open-ended issue, which is not terribly good in terms of certainty for taxpayers. It’s become more of an issue in the past 30 years since we introduced the permanent place of abode test in 1989 because as we have seen in the last three or four years, the world’s got a lot more mobile with people moving and working around the world.
This issue of being tax resident here, perhaps inadvertently, is actually something that individuals are concerned about. They obviously want to minimise their tax obligations as far as legally possible. On the other hand, governments know that if you set out very specific tests then people will play to the letter of those rules by watching carefully the number of days present in a country.
A British alternative?
The British residency test, the statutory residence test, actually deals with this day count issue pretty well by specifying what it calls “ties”. Depending on how many ties to the UK you have, whether you’ve been tax resident beforehand and how many days you spent in the previous tax years, then the number of days you can spend in a in the UK in a tax year before you become resident drops.
It’s therefore not as simple as you can spend 182 days and then you’re okay. Each year it drops off quite dramatically and basically at its tightest definition you can only spend 16 days in the UK. Obviously, people will still try and manipulate their timing within these limits but the UK test is much more specific and it gives a great deal of clarity.
And I think in our case, just as the Australian Board of Taxation considers, it’s not an unreasonable objective to be looking at a statutory definition of residency which addresses the concerns Inland Revenue rightly has about people trying to game the system, but it provides certainty for people.
Becoming an Australian citizen – beware the potential tax trap
Still on Australia, there was good news recently that there’s now a pathway for Australia and New Zealanders who live in Australia to become citizens. This is very important for the huge numbers of New Zealanders over there, well over half a million. There is, however, a potential sting in the tail.
People will be aware that New Zealand has what we call a transitional residents exemption, which applies to new migrants or people who have returned to here and have not been tax resident for ten years. Under this exemption their non-New Zealand sourced investment income for the first 48 months is generally not taxable here.
Australia has a similar test if it applies to what they call temporary residents and it applies to most New Zealanders living in Australia. The sting in the tail is that if you apply for citizenship in Australia, you are no longer a temporary resident. What that means in particular is your New Zealand assets here become subject to Australian tax, including capital gains tax. The impact of Australian capital gains tax on New Zealand assets is often overlooked. It’s an issue I deal with regularly.
So that’s the trade off on Australian citizenship. Overall, it’s a good news and it puts people who have contributed significantly to the Australian economy on a level footing. But there is a wee sting in the tail for some. So, approach with caution.
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.
Facebook and Google’s results indicate scale of BEPS issue
Is the just announced Government voluntary buyout of 700 unliveable homes a harbinger of things to come?
Last week when discussing the new tax bill, which includes the proposal to lift the trust income tax rate to 39%, I mentioned that Example 20 in the accompanying commentary had raised a number of concerns amongst tax agents and advisers. It seemed to be endorsing the option of trusts distributing income to beneficiaries with lower tax rates, leaving us all wondering, is that really correct?
It transpires Inland Revenue picked up on those concerns and then released the following statement.
“We are also aware that one of the examples used in the Bill commentary and factsheet has caused some confusion. The example noted that trustees could distribute income to a beneficiary, who may then decide to resettle it on the trust. We agree that there is some uncertainty under existing law about the tax treatment of such a settlement and we will be undertaking consultation on this. To avoid creating that doubt we have changed the example in those documents.”
The accompanying commentary has been updated and re-released. This shows the area is not as cut and dried as people might imagine. Obviously, Inland Revenue and advisers alike would like to have as much certainty as possible. So, it’s good that Inland Revenue picked up on this issue. But you do wonder how it managed to slip into the commentary in the first place without someone realising it might actually be a bit of an issue.
Rate misalignment problem solved? Not quite
Separately another advisor (Aman Chand of Bentleys Chartered Accountants) has picked up an interesting comment in the Regulatory Impact Statements (“RIAs”) which are issued alongside new legislation. RIAs discuss the purpose of this legislation, the alternative options and which one was chosen and why.
The issue the increase in the trustee tax rate to 39% addresses is one of rate misalignment between trustee income being taxed at 33% and individual personal income being taxed at a top rate of 39%. This issue was well understood at the time of the introduction of the reintroduction of the 39% tax rate in 2021. In fact, Inland Revenue and Treasury both said the trustee rate should rise to 39% at the same time. And now that’s what’s happening.
But for some time, there’s also been a rate misalignment between the corporate tax rate of 28%, the portfolio investment entity (“PIE”) rate, which is also 28%, and the then top individual personal rate of 33%. Inland Revenue had been looking at this for some time and had noted that there was starting to be a steady accumulation of undistributed income in companies. This rate misalignment issue was something that had been on its radar which it had started to make moves towards addressing.
What Aman spotted is that the RIA on the increase in the trustee rate does discuss this existing misalignment issue. The RIA notes Ministers have decided to progress increasing the trustee tax rate to 39% “while considering PIE and company shareholder misalignment issues on a longer timeframe”. Even if the trustee tax rate is aligned to the top personal tax rate, there will continue to be opportunities to circumvent that rate by substituting trusts with companies or PIEs. This is something that is going is obviously has been on the Inland Revenue’s radar and will remain so.
And even if there’s a change of government following the election in October as a result of which the top rate, 39% rate will no longer apply, the issue of a current rate misalignment between 28 and 33%, assuming that remains the top personal tax rate, will remain. Inland Revenue is working on this, and the RIA has some interesting details about potential options.
Don’t be banking on a change of Government
Accordingly, people hanging their hat on a change of government to defer this particular issue of a trustee income tax rate increase to 39% should still be aware that it’s likely that Inland Revenue may well introduce or recommend the introduction of other type of tax avoidance rules to tackle rate misalignment in the future. The issue is on their radar, and it still may well be something we will encounter regardless of whoever forms the government after the election.
Facebook, Google and BEPS
Last week I mentioned Facebook. New Zealand had released its results for the year ended 31st December 2022. And coincidentally last week we also covered the Government’s proposals for the global anti base erosion rules, the Pillar two proposals which are designed to help tackle the issue of base erosion and profit shifting (BEPS), where the New Zealand tax base is being eroded by profits shifting out of here to lower tax jurisdictions.
Facebook reported gross advertising revenue of over $154 million, but its net profit before tax was $3.3 million. And that’s because over $149 million was paid to a related company Meta Platform Ireland Ltd for the purchase of services during the year. Ireland’s corporate income tax rate is 12.5%, compared with ours at 28%. Withholding tax may be applied to some of these payments if they are treated as royalties, but you still have an idea of the scale of the issue.
It so happens that last Friday, after we recorded the podcast, Google New Zealand released its results for the year ended 31st December 2022. And in this case, it paid over $870 million in service fees to offshore affiliates. Mostly, it appears to the Singapore based Google Asia Pacific Pte Ltd. You shouldn’t be surprised to hear Singapore has a preferential tax regime. Incidentally, MasterCard and Visa New Zealand appear to route their payments through Singapore.
To put everything in context about the scale of the issue being faced by ourselves and other countries, if you look at Facebook and Google New Zealand’s 2022 results they paid more than $1 billion in service fees to overseas affiliates for the year. In theory, at a corporate income tax rate of 28%, that represents over $319 million in potential tax.
So, the Government and other governments are keen to see Pillar Two and Pillar One hopefully come into play and deal with this issue of tax and profit shifting. But as the commentary to the bill which introduced the Pillar Two legislation notes the benefit is likely to be about $40 million annually.
The impact of the GloBE rules is therefore not terribly significant. The issue of profit shifting still remains. It will always be there, by the way, because it is only appropriate that the tech companies charge for the use of their valuable IP in New Zealand. So, it’s not a question of we’re just going to disallow $1.1 billion of deductions and bingo, we’ve got $319 million. That is never going to happen.
But the difficulty with transfer pricing is really determining the value on that and just how much of it can be kept in New Zealand. And that’s going to be an ongoing struggle, whether or not Pillar One and Pillar Two actually proceed.
Cheque please
Finally, this week the government announced that in the wake of Cyclone Gabrielle, 700 homes around the country are considered unlivable.
And so homeowners will be offered a voluntary buyout through a funding arrangement between the Government and councils. Apparently, another 10,000 homes will require investment in flood mitigation around them so they can be protected when the next severe weather event hits. Note the word “when”, I think we are now in the midst of climate change.
I mention this because it reinforces the point we’ve been hammering away at for some time. Climate change is here and it’s going to have an impact on homeowners all around the country. It doesn’t differentiate between suburbs. The likelihood is that we are going to have to start thinking seriously in some cases about managed retreat, that there will be more and more houses that are unlivable. The insurers are already pricing it in, so some houses may become uninsurable over time.
The question really coming to the forefront now is who’s going to pay for this buyout and managed retreat? Councils, for example, may have allowed properties to be built in areas where they should not have been built. Auckland Mayor Wayne Browne has already spoken about this. By the way 400 of those 700 unlivable properties are in the Auckland region.
At a time when next year’s Auckland Council budget is going through a very controversial process, having to fund in some way the buyout of people from 400 properties at a time when the average price house price in Auckland is $1,000,000 is quite a significant hit to the bottom line even if the Government chips in.
This all reinforces what I’ve been saying for some time; the impact of climate change plus the demographic changes that are happening with the ageing population means that we really do have to think a lot harder about how much tax we are going to need. Either that, or what services we’re going to reduce. And the question of the taxation of capital is going to become ever more important. The politicians keep kicking it down the road, hoping it just will go away. It won’t.
The climate change bills are now starting to come in and will continue to mount. We will wait and watch to see who of the politicians in the main parties is going to grasp that nettle and say, “Hey, guys, this is this is the deal. If you want us to help you mitigate the impact of climate change, we have to spread the tax burden wider.”
In the meantime, 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.
One of the odd things about the budget process for me is that tax really doesn’t feature very much. In fact, I know some very experienced tax practitioners who don’t go to the Budget Lockup because of this. Most of the Budget and the accompanying analysis focuses on the exciting stuff – where the money being spent and the winners and losers from that funding. The source which provides most of that spending is almost an afterthought unless as in 2010 and again in 2017 tax cuts are a centre piece of the Budget mix.
In part, that’s because, unlike Australia and the United Kingdom, the legislation relating to various technical amendments to the Taxes Act is usually introduced separately. It was therefore a bit of a surprise last week when after the budget lockup period ended at 2 p.m., I discovered that there had been not one, but two tax bills published. Other than the announcement of the increase in the trustee tax rate to 39% the budget documents had not indicated there would be many significant measures.
In fact, as the bill’s title explains, The Taxation (Annual Rates for 2023–24, Multinational Tax, and Remedial Matters) Bill, it primarily relates to the introduction of the relevant legislation to support the OECD’s Pillar Two global minimum tax proposal. You may recall the Australian Budget two weeks ago included similar measures. It would have been surprising if we had not followed Australia’s lead although neither the Revenue Minister nor the Finance Minister made much reference to the proposals last week.
Introducing the global minimum tax rate
The intention behind Pillar Two is to impose a global minimum tax of 15% for all those multinationals with annual revenue exceeding €750 million, these are the so-called global anti base erosion (“GloBE”) rules. The legislation and commentary include a heap of new tax acronyms including DIIR (Domestic Income Inclusion Rule), POPE (Partially Owned Parent Entity) and QDMTT (Qualified Domestic Minimum Top-up Tax), which a rather cynical overseas tax advisor has suggested should be pronounced Q-Dammit.
The commentary to the tax bill explains the legislation will only take effect once a “critical mass of countries” has adopted the GloBE rules. This is thought to be “very likely, though is not certain”. If that critical mass is reached, then the rules will be phased in starting from 1 January 2024.
Assuming Pillar Two does proceed then how much will it raise? Not much. According to the Regulatory Impact Statement (RIS) released with the tax bill the GloBE proposals should be worth $25 million annually with another $16 million coming from taxes on amounts which would have otherwise been shifted to lower tax jurisdictions. The RIS explains this “modest amount” is because of a number of factors including that only 20-25 multinationals will be affected.
Now earlier this week. Facebook’s New Zealand’s accounts were public. And despite earning gross advertising revenue over $154 million its reported profit before tax was just $3.3 million, and it just ended up paying just over $1,000,000 in tax. That’s because it paid over $149 million for the purchase of services to a related company, Meta Platform Ireland Ltd. The GloBE rules are intended to counter this. But don’t expect that they will raise significant sums of money.
Raising the Trustee tax rate to 39%
The headline measure and tax measure in the budget was the proposed increase in the trustee tax rate to 39%, with effect from 1st April next year. Now, this is a conceptually logical move, and as noted last week was one that both Treasury and Inland Revenue recommended should have happened when the personal income tax rate was increased to 39% on 1st April 2021.
The commentary for the tax bill provides some more detail around the introduction of the measure, and a couple of points stand out. One of Inland Revenue’s examples appears to suggest that it would not automatically see allocation of beneficiary income by a trust to someone whose tax rate was below 39% as constituting tax avoidance. At least this appears to be implication from example 20 in the commentary, and that’s caused a few comments from other tax advisers as to whether Inland Revenue is signing off on tax avoidance.
Example 20: Mitigating over-taxation
Amy (an air traffic controller) and Anthony (a builder with his own company) have settled some income-generating assets on a discretionary family trust for the benefit of themselves, their children (both minors under the age of 16) and future grandchildren. Amy, Anthony and their accountant are the trustees.
2024–25 income year
Anthony has personal income of $70,000 and Amy has personal income of $180,000. Their trust has income of $40,000.
If the income is retained as trustee income, it will be taxed at the proposed 39% trustee tax rate. Any income allocated to their children as beneficiary income will also be taxed at 39% under the minor beneficiary rule.
However, by allocating the income to Anthony as beneficiary income, it can be taxed at his personal tax rate. This amount can be credited to Anthony’s current account, available to be called upon at any time, or he can settle it on the trust if he wishes to do so.
2025–26 income year
Barry, the older of Amy and Anthony’s children, has turned 16, so he is no longer a minor. Barry has no personal income. Anthony again has personal income of $70,000, and Amy has personal income of $180,000, while the trust has income of $50,000.
Since Bary is no longer a minor, he is not subject to the minor beneficiary rule. Income can be allocated to Barry as beneficiary income and taxed at his personal tax rate (for example, up to $14,000 at 10.5%, over $14,000 and up to $48,000 at 17.5%).
If the trustees do not want to distribute this income to Barry, it can be credited to his current account, available to be called upon at any time, or a sub-trust arrangement can be set up so that Barry’s interest in a portion of the trust assets is recognised and protected.
On the other hand the legislation specifically counters attempts to distribute income to certain corporate beneficiaries. The benefit here obviously being that instead of trustee income being taxed at 39% it would be taxed at the corporate income tax rate of 28%. The bill aims to negate potential distributions being made to closely controlled family companies.
The bill will not apply to deceased estates but only in respect of trustee income derived within 12 months of the deceased persons date of death. Based on personal experience and discussions with lawyers that 12-month period is too short, 18 to 24 months seems more appropriate
There is also an exemption for disabled beneficiary trusts which are defined as having only one beneficiary other than any residual beneficiaries who may benefit on the death of the disabled person. Critically the trustee must not allow any further beneficiaries apart from residual beneficiaries to be added. I expect that this may mean a number of existing trusts may have to be amended or be re-settled in order to comply.
A end to over-taxation of ACC lump sums
Moving on and some good news. I’ve previously covered the situation where Accident Claims Compensation Corporation has paid a backdated lump sum, representing several years compensation after the claim was initially denied before being accepted on appeal. Now, as I was explained in the past, such payments often result in over taxation relative to the tax that would have been payable if the payments had been made at the correct time. The commentary gives an example of this where the claimant would have an additional tax liability of $26,040 as a result.
The Bill proposes to change this by allowing a tax rate to be used when a backdated lump sum payment is paid to be based on the recipient’s average tax rate for the four years prior to the tax year in which they receive the backdated lump sum payment.
There will also be provisions relating to lump sum payments made paid by the Ministry of Social Developments and those will eliminate any potential further tax liability for recipients.
According to the accompanying regulatory impact statement, the effect of this over taxation is roughly about $9 million a year. This is great news, and one I’m personally pleased about because I’ve been lobbying in the background for Inland Revenue for some time to make this change.
These new rules will take effect from 1st April 2024. Personally, I’d like to see them in effect, from 1st April this year, and I’ll submit on that. But don’t hold your breath on that one.
There’s a number of other measures in the bill, including a proposal for the Government to pay a 3% KiwiSaver contribution on the amount of paid parental leave received by a KiwiSaver member. The this will be made providing the recipient also pays the 3% employee contribution. The idea is to help increase the KiwiSaver balances of paid parental leave recipients, many of whom are women and whose ability to save has been disrupted because they take time out of the workforce to raise children. This is a welcome measure.
As usual there’s a whole heap of technical amendments as well. Submissions on the Bill are now open and the closing date is 30th of June.
A taxation principles bill – putting the politics into tax?
Now, the other bill, which was a big surprise, was the Taxation Principles Reporting Bill. This bill is intended to “increase the public’s understanding of the tax system and promote informed debate and discussion about its future”. The Bill does this by proposing a set of generally accepted tax principles and then requires the Commissioner of Inland Revenue to report on how the tax system is tracking against those principles.
The idea is that “regular reporting will help the public better understand how our tax system is performing and over time, informed public consultation process on tax policy proposals.” The hope is tax policy is developed in line with “values which society considers desirable in a tax system.”
The tax principles set out in the bill such as horizontal and vertical equity efficiency, revenue, integrity, certainty and predictability, flexibility and adaptability and compliance and administration costs, are all well accepted principles, and they’ve been used in various tax reviews, both here and abroad.
There’s a framework by which Inland Revenue will be reporting annually then every three years it will provide a more thorough review. And the implication would appear to be that the Inland Revenue would be expected to be doing regular surveys of the type that just was carried out on the high wealth individuals. That at least is one interpretation of these reviews.
The Bill will take effect from 1st July this year, which means that there’s going to be little time for consultation. In fact, the closing date submissions will be 9th June, just two weeks ahead. This is an incredibly political bill – is it a harbinger of a wealth tax, capital gains tax, whatever? We shall see. It will be interesting to see how this plays out and of course, its future will be very dependent on the Election.
In the meantime, 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.
an increase in the trustee rate but no action, yet, on tax rates and thresholds
The big tax surprise in the Budget is that there is no tax surprise. Surprisingly, well to me at least, the Government included no changes to income tax and other thresholds and there is little indication of any such changes ahead in the Budget documents.
The destruction wrought by the January floods and Cyclone Gabrielle may have interrupted plans for such changes. Of course, the Government could be keeping its powder dry for the coming election campaign. No doubt we will find out when the campaigning begins in earnest.
On the other hand, the increase in the trustee tax rate to 39% with effect from 1 April 2024 should not have come as a surprise. Inland Revenue recommended the trustee rate should also be increased to 39% when the top personal income tax rate of 39% was introduced in 2021. It was only a matter of time before the trustee rate rose and the publication of Inland Revenue’s High Wealth Individual Research Project provided a clear opportunity for the Government to do so.
In the accompanying press release announcing the measure Minister of Revenue David Parker noted that new Inland Revenue information shows a near 50% increase in trust income taxable at the trustee rate from $11.4 billion in the 2020 tax year to $17.1 billion in the 2021 tax year. The top 5% of trusts with taxable income accounted for $13.3 billion or 78% of all trustee income in the 2021 tax year.
As a tax policy measure, it is logical and is expected to raise $350 million annually. (There will be some exemptions for disabled and deceased estates).
I expected an announcement about the OECD’s Base Erosion and Profit Shifting international tax rules similar to the initiatives included in last week’s Australian Budget. There was no such move although the forecasted tax revenue for the June 2027 includes an estimate of $25 million as the initiative takes effect. Asked about this in the Budget Lockup, Grant Robertson specifically ruled out a Digital Services Tax.
Nor did we see any moves for increased or targeted depreciation measures as was also in the Australian Budget, although the new 20% rebate for game development studios matches an Australian measure. The gaming industry is exactly the sort of low-emissions, high wage, high growth export industry we need, so the move is welcome.
Looking at the numbers, tax revenue is projected to rise from $114.6 billion for the June 2023 year to $122.6 billion for the June 2024 year. About a billion dollars of the increase is the effect of fiscal drag where wage rises crossing tax thresholds mean higher average taxes for earners. Resident Withholding Tax on interest has almost doubled to an expected $1,659 million for the current year to June 2023, a direct effect of the dramatic increase in interest rates over the past year. Proof, perhaps, that every interest rate rise cloud has a silver lining, for the Government at least.
There are a few interesting snippets from digging through the Vote Revenue Estimates of Appropriations. Last year’s Cost of Living payments were budgeted as costing $706 million, but according to the Appropriations the final cost was $50 million lower at $656 million.
Inland Revenue’s funding appropriation for June 2024 shows a $23.2 million or over 20% boost from $110.6 million to $133.8 million for its investigation, audit and litigation activities. Debt management gets a significant increase too, although the provisions for impairment and debt write off totalling $931 are actually down from the estimated $985 million for the current year.
Overall, from a tax perspective this was a surprisingly quiet Budget especially considering it’s an election year. Grant Robertson was quick to brush off questions about electioneering but on the tax front at least I think we can expect to see more in the coming months. The debate over tax rates, tax thresholds and capital gains taxes are all to come.
In my view, the leaky building saga is an underappreciated factor in how our housing market got so expensive. At a time when population growth was accelerating, builders and resources had to be diverted to remediation work on buildings, many of which were fewer than 10 years old. These are expensive and time-consuming processes for all involved, and a major question has always been are these costs tax deductible where the building being remediated is being used for deriving rental income?
Inland Revenue doesn’t have a specific measure dealing with leaky buildings, but instead it’s covered in the general analysis under Interpretation Statement IS12/03 Income tax deductibility of repairs and maintenance expenditure general principles. Generally speaking, each case is really looked at on its merits.
That’s what makes a Technical Decision Summaryfrom the Inland Revenue’s Adjudication Unit released this week quite interesting.
The background is that the taxpayer owned a rental property which was part of a block of six units. This block of six was a freestanding building within a larger complex. Units within the block were connected by inter-tenancy walls. The block was largely clad with monolithic cladding but required remediation work to resolve weather tightness issues.
The work was carried out by the body corporate, and they levied special levies payable by each unit holder calculated by reference to their expected portion of the total expenditure. While the remediation work was being done, the unit was unoccupied, so the taxpayer independently organised for internal painting to be done during that time.
The question was whether this expenditure was deductible. The taxpayer, not unreasonably, claimed the levies were repairs and maintenance, as were the separate costs he paid for painting the unit. Inland Revenue didn’t agree, and the dispute finished up before Inland Revenue’s Adjudication Unit. It determined the levies paid for the remediation were capital, however, the painting was deductible.
The Technical Decision Summary has a good analysis of how Inland Revenue goes through the process of determining whether the expenditure is capital or deductible. This analysis is based on the Privy Council decision in the Australian case of BP Australia Limited v Commissioner of Taxation. Based on that case there are three key elements:
Whether the work done resulted in the reconstruction, replacement, or renewal of the asset, or substantially the whole of the asset.
Whether the work done had the effect of changing the character of the asset.
Whether the work was part of one overall project or was a series of projects that merely happened to be undertaken at the same time.
Whether the work was part of one overall project or was a series of projects that merely happened to be undertaken at the same time.
Overlaying that case is another Privy Council case, this time involving Auckland Gas from 1999, which suggests a two-stage process to determine whether the expenditure is of a revenue or capital nature. You first identify the asset being repaired and then analyse the nature and extent of that work.
In relation to the painting, the Adjudication Unit considered it wasn’t part of the overall repair project for the block of units, and it was therefore considered separately. Ultimately, they concluded it was a repair and deductible.
As for the remediation work, this is quite interesting because they saw that it was a block of six units all under repair. But there’s also a discussion about whether the fact that several other blocks in in the complex also required remediation work, whether the complex should be seen as the total asset. They discounted this in the end because although the units within each block were physically connected to each other, the blocks were not. Therefore, the block of six units represented an asset, but the complex of blocks overall did not.
This case, I think, might go further because over here the Adjudication Unit said although there was extensive work done the remediation did not result in the reconstruction, replacement or renewal of the block or substantially the whole of the block. The work was not so significant it could constitute reconstruction. However, they did consider the scale of the work was such that it changed the character of the block, because the cost of the remediation was high, around 20% of the value of the unit in the complex. (There are no numbers quoted in this TDS, they do that because of these are meant to be anonymous). And there were some significant improvements to the affected areas, and in the Adjudication Unit’s view, these were structurally significant and important to the operation of the asset.
There’s a comment here that in addition the remediation of the block was necessary to prevent water ingress and protect the overall structural integrity and income earning capacity of the unit in the rest of the block. My view on that would be that’s very true. But it’s also true of any building and buildings are built with that in mind. So, enabling it in the first place, or making sure that doesn’t happen, seems to me it’s more of a repair.
But I do wonder whether this might be taken further by the taxpayer. We shall see. Anyway, it’s a useful case. It’s good the way it runs through the principles involved. The taxpayer will not be entirely happy about that, I daresay, and my own view is the remediation issues around leaky buildings are one where erring on the side of deductibility would longer term be a good policy. But we are where we are at the moment, and we’ll just have to see what turns up in other decisions.
Moving on, last Tuesday night it was the Australian budget and that first of all produced a surprise. There was a small surplus, apparently the tax take was above expectations. The Australians are actually going to proceed with the so-called Stage Three, tax cuts package. This is controversial because they are weighted to benefit the top end earners above A$120,000.
From a New Zealand perspective looking at the Australian budget, there are a few interesting snippets in there. They’re going to give extra funding to boost skilled migration.
Part of this is they’re increasing the temporary skilled migration income threshold of A$70,000 and additional places for the so-called Pacific Australia Labour Mobility Scheme, for workers in priority sectors for the Pacific and Timor-Leste regions. I think that’s interesting because putting it in context, we’re not the only country looking for skilled migrants.
There’s a huge increase in rent assistance and I wonder whether we might see something in that. It’s the largest in nearly 30 years. And there’s also moves to encourage investments in build-to-rent projects. We’ve seen something similar to this because of our interest deductibility rules. The depreciation rate for build-to-rents has increased from 2.5% to 4% per annum. By contrast, residential buildings over here do not attract depreciation.
There’s also a measure to support small businesses, including what they call a small business instant write off. This enables small businesses with an annual turnover of less than $10 million Australian to be able to immediately deduct eligible assets, which cost less than $20,000 for a one-year period starting 1st July 2023. Now, that’s something that’s often called for here.
There’s a small business energy incentive, as well as more tax breaks to help small and medium businesses electrify and save on energy bills. And these target businesses with an annual turnover of less than $50 million. They get special depreciation claims.
Interestingly, a couple of things have happened in relation to international tax. More work on anti-avoidance is happening and they’re implementing a global and domestic minimum tax – the two pillars international tax solution.
Basically, from 1st January 2024 large Australian multinationals and the Australian operations of large foreign multinationals will pay an effective tax rate of at least 15%. And then from 1st January 2025, Australia will also be able to tax the foreign operations of large foreign multinationals that operate in Australia to ensure they’ve paid at least 15%. This is following through from the international measure.
Then there’s changes around tax breaks for the superannuation scheme system. This is something I’m seeing all around the world actually. Governments are looking at dialing back some of the generous tax relief they’ve given. In Australia from 1st July 2025, earnings on super funds balances exceeding $3 million will be taxed at 30%, whereas those earnings and balances below $3 million will continue to be taxed at the concessional 15% rate.
As always with the Australian budget, because they have a bigger economy and a more interventionist approach there’s a lot of little details where they’re happy to tinker around the edges with the tax system.
Budget predictions
Our Budget is this Thursday. Now generally speaking, there are typically very few tax measures in a budget. You could always rely on Bill English sneaking in a tax increasing measure normally in the form of non-indexation. But another example would be introducing superannuation withholding tax on KiwiSaver employer contributions from 1 April 2012.
On the other hand, Grant Robertson seems almost averse to mentioning the word tax. That said, because this government and the last National government have done nothing about tax thresholds since October 2010, there is a huge amount of pressure for something to happen in that space. Robertson’s problem is that he’s also trying to manage inflation, and reducing taxes isn’t generally seen as a positive inflation fighting move.
For all that, my guess is that we might see some action directed at lower income families. That might include some changes to thresholds especially for those earning around the $48,000 threshold. We might also see some changes in the Independent Earner Tax Credit and adjustments to the Working for Families thresholds and possibly abatement rates.
Businesses have long called for higher thresholds for instant write-offs as has just happened in Australia, but I don’t see that happening. There might be some Cyclone Gabrielle related reliefs, perhaps an extension of the Small Business Cash-Flow scheme or a temporary reinstatement of the ability to carry back tax losses to earlier years.
Whatever, I sense it is going to be a more interesting budget than usual. And as usual, we will be in the Budget lockup, and you’ll have our views on it soon after 2 p.m. this Thursday.
In the meantime, I’m Terry Baucher and you can find this podcast on my website 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.
At the end of last week, the Government announced a surprise tax measure for North Island businesses hit by recent flood damage. The measure means that they will not have to pay tax on insurance or compensation they might receive for any damaged buildings or plant or equipment.
As the Revenue Minister David Parker pointed out, generally speaking such payments are treated as taxable income. Recognising another tax bill is the last thing any businesses affected by the floods needs, the Government has decided to adopt a measure which was used previously following the Canterbury earthquakes and the Hurunui-Kaikoura earthquakes. It essentially allows a deferral of the tax on the compensation payments received to replace damaged or lost buildings and plants and equipment.
What happens is instead of a depreciation recovery (income) happening because you’ve received a payout, there’s a rollover relief which will defer the recognition of that income on the basis that there is a commitment to rebuild or replace the destroyed buildings or plant. There is a key difference here as to the measures used previously for the earthquakes, and that is there is no requirement for any replacement buildings to be located in the same region. This is because in some cases managed retreat is now being considered. For example, where a building which is in the Hawkes Bay has been destroyed or severely damaged by Cyclone Gabrielle, the business owner may decide to relocate to a different region. In this case the rollover relief would apply an exemption.
This is a good measure to see. The formal legislation will be introduced shortly probably around the time of the Budget, I might imagine, along with the other budget measures.
What happens if you rent a room to a flatmate?
Moving on, Inland Revenue has released an interesting draft Questions We’ve Been Asked consultation on how the bright-line test might apply to where a person rents out a room in their home to a flatmate. Alongside that there’s another Draft Questions We’ve Been Asked relating to the extent to which a person can claim deductions for expenditure incurred in deriving the rental income, when they’ve rented a room to in their home to a flatmate.
As always, there’s a bit of detail in these, but in summary, in relation to claiming deductions or costs incurred in renting a room out to a flatmate, the draft consultation concludes that deductions can be claimed to the extent that they’re incurred in deriving gross income. The rental income will be assessable and the amount of expenditure needs to be apportioned between private use living in the house and income earning use, rental income from a flatmate.
The draft consultation suggests that apportionment, based on the use of physical space, is a reasonable basis on which to determine what represents an income earning component of expenditure and therefore calculating the deduction available.
Interestingly, the interest limitation rule will not apply, if the land is used predominantly for the person’s main home. Similarly the residential ring fencing rule won’t apply if more than 50% of the land is used for most of the income made by the person as their main home.
The general rule here is that it’s a matter of fact, whether the dwelling is the person’s main home. You must consider all the circumstances. But the fact that you are renting out a room in, in your home to a flatmate while you are living there will not preclude the home being the person’s main home. And on that basis, the interest limitation and residential ring-fencing rules should not apply.
Which leads on to the second question as to whether then the bright-line test might apply. If so, would a person who is living in a home and rents out a room to a flatmate, qualify for the main home exclusion.
This draft consultation concludes that, yes, that person should qualify for the main home exclusion. Again, whether it’s a home is a matter of fact, and you consider where the person resides and has a fixed presence. Just a reminder, though, that there is a slight twist in for land acquired between 29th March 2018 and 26th March 2021. The main home exclusion applies where for most of the days in that bright-line period, the land is mainly used as a residence by the person.
But there may be situations where that in fact is actually incidental to the main purpose of carrying on rental activity. I think one of the questions there would be if you are starting to rent out more than one room if say there are four bedrooms and you’re renting three out. The question might then start to arise as to whether the main home exemption would be available. Anyway, it’s good to see some guidance on this as this question no doubt is going to pop up from time to time.
It’s provisional tax payment time
Monday is the due date for payment of the final instalment of Provisional tax for the March 2023 income year. The key thing to keep in mind here is if you think your residual income tax for the year to 31st March 2023 is going to exceed $60,000, then you need to make the full payment on Monday. Otherwise, use of money interest will apply on the unpaid provisional tax.
Incidentally, the interest rate on tax paid late rises to 10.39% with effect from Tuesday. Also, bear in mind, in some cases, you may also face late payment penalties, an initial 1% on the tax paid late. And then if it’s not paid in full within seven days, a further 4% is levied. Use of money interest continues to apply on top of these penalties. So, paying your tax late is an expensive proposition.
I’ve been dealing with Provisional tax for almost 30 years now, and it’s still something that confuses me from time to time. But the key point to always keep in mind about the latest iterations of these rules is that if your residual income tax is going to exceed $60,000 for a tax year then you need to pay the liability in full on the third provisional instalment date.
Not self-employed? You might still have to pay provisional tax
Usefully, Inland Revenue have released a Question We’ve Been Asked QB 23/05 on the impact of provisional tax for salary and wage earners who receive a one-off amount of income without tax deducted.
For example, this sort of income could be the gain from the exercise of shares granted under an employee share scheme, or from the transfer of a pension from overseas or a gain from a sale subject to tax under the bright-line test.
The general provisional tax rules are if your prior year residual income tax was less than $5,000, then this question you’ve been asked doesn’t apply. However, if it it’s more than $5,000, then you will be liable to pay terminal tax. No interest will run on that tax if it’s paid by the terminal tax due date, which is typically the 7th February following the end of the tax year for those without a tax agent, or the following 7th April for those with a tax agent.
As always in tax there’s a but, and the big but is what I mentioned a few minutes ago. What happens if your residual income tax exceeds more than $60,000? Then use of money interest at 10.39% will apply to any underpayment from the date of the third instalment, typically 7th May.
This is a really critical point if you have an untaxed gain such as those I mentioned, a gain under the bright-line test, transfer of a foreign superannuation scheme or as a result of exercising shares under an employee share scheme, and your tax liability exceeds $60,000, then you’re into the provisional tax payment regime straightaway and you have pay the tax in full on the third instalment date, typically 7th May, or this year, Monday 8th May.
Provisional tax does trip up a lot of people and but generally speaking, unless you’ve made a big gain, in which case you probably should have the funds available (or at least I’d hope so), you’ve got until the terminal tax date to meet those requirements.
One thing you need to do, by the way, if you are a salary earner and you have realised one of these untaxed gains, you should notify Inland Revenue as soon as possible before it starts its auto calculation assessment process. Otherwise, what might happen then is that they calculate you may be due a refund. They will make that refund and then you will have to repay the refund and the correct amount of provisional tax.
More feedback on taxing wealth
And finally, the controversy continues to around the Inland Revenue High Wealth Individual Research Project and the various related reports such as the Sapere report. There’s some fairly interesting commentary flying around on the topic. I thought Damien Venuto in the New Zealand Herald was on point when he said whether we like it or not, there is a reckoning coming around how we deal with tax.
The DomPost has an article by Susan Edmunds, which wasn’t online at the time of the podcast, talking about what was happening here and getting the views of Robyn Walker of Deloitte. Previous podcast guest John Cantin, as always, has some very insightful commentary. I think John makes an interesting comment about how the Sapere report and some other commentary brings in the question of benefits paid to taxpayers to provide an overall economic view. And he thinks that rather confuses the matter.
We don’t tax unrealised gains? Think again.
I want to repeat a point I made last week in the podcast and on RNZ’s The Panel. We currently do tax unrealised gains. The Foreign Investment Fund regime is the very best example of that. The taxation of pension transfers is another. When someone transfers an overseas pension to New Zealand, they’re not always realising it. In some cases, people are taxed on the value of the pension transfer but they can’t access it until they reach age 55. So that’s not really a realised gain. There are the financial arrangements rules which tax unrealised foreign exchange gains and losses. Overseas, estate taxes in essence tax unrealised gains. So, the concept is not unusual.
I remember looking at the various commentary reports from the 1980s and early 1990s when New Zealand was overhauling its tax system. There was a real debate going on around whether it was practical to have an accrual-based capital gains system. Wisely, the reports concluded that much as that might be economically accurate, it simply was practically impossible. Wealth taxes, quasi do that in a way, but a capital gains tax on an unrealised basis is, to all intents and purposes, a non-starter.
So, the debate will continue, and we’ll see a lot of politicking around that. Like Damien Venuto I’d like to see some hard answers on this from politicians about how they are going to address the issues of demography, demographic change and climate change.
And on that bombshell, 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.
