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.
Thousands here could be potentially subject to UK Inheritance Tax.
Airbnb and Uber are not happy about a GST law change.
GST for all its complexities, is the best example of the Broad Base Low-Rate tax principle, a single rate of 15% applied broadly. However, one of the ongoing controversies with GST is around its application to food and other basic necessities. New Zealand’s approach is at odds with many other countries, such as Australia or the UK, where food is not subject to GST (or VAT, as the UK calls it).
Frequently we see commentary that it would be a good move to help lower income earners by removing GST on food. This has been suggested as a response to the current cost of living crisis. I am opposed to such moves and many GST specialists are also in the same camp. Firstly, I don’t think this move is effective as proponents believe, and secondly, if the issue being addressed is low income, then it is better, in my view, to give more income to that target group rather than using a tax measure which would benefit more people, including some who we probably think don’t need assistance.
A report released yesterday in the UK regarding the impact of the withdrawal of the so-called tampon tax bears out these concerns of myself and other GST specialists about introducing GST exemptions. In the UK, VAT of 5% used to apply to tampons and other menstrual products until January 2021, when it was abolished. Prior to its abolition, VAT specialists predicted that the full benefit of abolition would not be reflected in lower prices. And a report by Tax Policy Associates bears this fear out. According to the report, at least 80% of the savings from the tax savings was retained by retailers. In fact the report questions whether any of the benefit of the removal of VAT ever passed through to lower prices.
Professor Rita de la Feria the chair of tax law at the University of Leeds was one of those who warned beforehand of this likely outcome. Commenting on the report she noted this was not only predictable but predicted. In her view “we have to stop confusing policy aim with policy instrument and we also need to stop using tax policy instruments to signal we care about the policy aim.”
Those are wise words and should be kept in mind next time you hear calls for tax changes for ostensibly very sensible reasons. In tax, even with well-meaning policy, there are always unintended consequences and tax is not always the most appropriate mechanism. Sometimes direct action, such as giving payments to those affected, or supplying tampons for free is the best approach.
How UK tax law applies to NZ residents
Staying in the UK, next week the latest Chancellor of the Exchequer, Jeremy Hunt, Grant Robertson’s equivalent, will be presenting the Autumn Statement. He is expected to introduce a number of tax changes and tax increases in an effort to try and restore the UK’s finances. Hunt, incidentally, is the fourth chancellor this year, whereas Grant Robertson is only the fourth New Zealand finance minister this century. So that gives you a measure of just how much upheaval has been going on up there.
I regularly advise New Zealanders and migrants from the UK about UK tax matters. Frequently there are ongoing issues for them and inevitably complexities creep in.
Based on my experience, there are probably thousands of New Zealanders and family trusts who may unwittingly have UK tax obligations. There are also former residents from the UK who are now living here who misunderstand the relationship between the UK and New Zealand tax treatments of investments. So here’s a quick summary of those people who may be affected by UK tax and the differing tax rules between New Zealand and the UK.
Firstly, if you have property in the UK, then UK capital gains tax will apply to any disposals. There are strict timelines about reporting those disposals which are unrealistic in my view, but they still apply. CGT will apply even though the disposal might not be taxable for New Zealand purposes. By the way, the bright line test does apply to overseas property.
If you were renting a property out in the UK then you must report that income both in the UK and in New Zealand. However, for New Zealand purposes, any UK tax paid will be given as a credit against your New Zealand tax payable.
As should be well-known transfers of, or withdrawals from UK pension schemes are subject to New Zealand income tax. I don’t agree with that policy but it’s the law. In addition, if you are receiving a pension from the UK then the UK pension scheme should not be deducting any PAYE. You will need to apply to H.M. Revenue and Customs through Inland Revenue to get any refund of any such tax deducted. By the way, Inland Revenue will not give you a credit for any tax deducted, it wants the tax paid here. That’s the procedure under the double tax treaty and you’ll have to go and get the PAYE back off HMRC, which can be a very frustrating experience, believe me.
But potentially the most significant tax that will apply, which is also the least known, is Inheritance Tax. Inheritance Tax applies firstly to any assets situated in the UK. So, if a New Zealander who worked over in London, bought an investment property there before moving back here, that property is in the UK Inheritance Tax net.
Secondly Inheritance Tax also applies on a global basis to all assets wherever they’re situated if you are “domiciled” or deemed to be domiciled in the UK. Domicile is a complicated concept which I am not going to get into now. But basically, pretty much anyone born in the UK who’s migrated here in the last ten years or so probably still is domiciled for UK tax purposes. If you were a Kiwi and you spent more than 15 years in the UK, you may also be deemed to be domiciled in the UK. If so, Inheritance Tax applies at a rate of 40% on all assets over the first £325,000. (The price of New Zealand property means that this threshold is comfortably exceeded).
In my experience, many migrants and returning Kiwis are completely unaware of the potential impact of Inheritance Tax. For example, UK Inheritance Tax law does not recognise de facto relationships (apparently much to the relief of several politicians a partner in a London law firm once told me). I once dealt with a scenario where the New Zealand resident survivor of an unmarried couple had to pay over £50,000 of Inheritance Tax on her share of a jointly owned New Zealand property after her Scottish partner’s death.
Finally, the UK has a trust register which arrived in the wake of anti-money laundering legislation and its use has been greatly expanded. Any trust which has property in the UK must register. Furthermore, any trust which has a UK source of income such as bank interest must register if it has beneficiaries, including discretionary beneficiaries who are resident in the UK. This is a common scenario I’ve seen. It appears this registration requirement applies even if no distributions have ever been made to the UK situated beneficiaries. There’s some controversy about that particular provision because it appears New Zealand trusts may even have to file UK tax returns even if all the UK income is being distributed to New Zealand beneficiaries.
So that’s a quick summary of some of the UK tax issues which I commonly encounter. I’ll look to update this summary next week if there are any developments from the Chancellor’s Autumn Statement. Now is maybe time to have a look at your position to see if, in fact, you might potentially have a UK tax issue. And also keep in mind that Inland Revenue is currently running an initiative where it is checking on people’s potential tax obligations from their overseas investments.
“We want to remain tax-free”
Finally, this week and back to GST, Airbnb made a submission to Parliament’s Financial Expenditure Select Committee complaining about the proposal for it to charge GST on all accommodation bookings made through its platform.
In its submission, it warned this would stifle the country’s economic recovery and cost the economy up to $500 million a year.
Now this measure was introduced in the Taxation (Annual Rates for 2022-23, Platform Economy, and Remedial Matters) Bill (No 2). Airbnb along with Uber, also affected by the new proposals, unsurprisingly, think the law changes are unfair. On the other hand, the Hospitality Association was amongst those submitting in favour of the change. Chief executive Julie White said a third of its membership consists of commercial accommodation providers adding “and a consistent frustration of theirs is a lack of level playing field when it comes to services like Airbnb”.
The comments from Uber and Airbnb are unsurprising to me. But what I did find of interest about the bill was there have been quite a considerable number of submissions made 820 so far, and quite a few from individuals who would be affected. To quote one, “this law change will result in fewer bookings to me and significantly impact my retirement plans. This will have the additional impact of higher costs of vacations for New Zealand families who are largely for larger families and cannot afford to stay in a hotel.”
Another submitter thought “This action will have a huge negative impact on a new form of tourism at a very personal, localised level.” I’m personally not sure that the impact will be quite as dramatic as those submitters suggest, but it is interesting to see the reaction to what might be seen as a relatively straightforward GST proposal.
As is often the case, many other submitters took the opportunity to push for other changes, such as several suggesting for the removal of FBT on the provision e-bikes to employees.
There was also criticism of the complexity of the interest,limitation and bright-line test rules. One submitter noted that the commentary to the bill had more than 28 pages devoted to remedial provisions for this legislation, and he concluded correctly, in my view, “it is simply not appropriate to expect most landlords to be able to apply the detail of tax law of this complexity.”
Incidentally, the same submitter suggested that because the interest limitation measures had been introduced partly in response to rising house prices, now house prices were falling logically the interest limitation measures should be repealed. It’s a fair point, and he wasn’t the only one to make it. But somehow I can’t see that happening. To leave off where we came in this is another situation where the policy aim and policy instruments have got confused.
Inland Revenue regularly releases Technical Decision Summaries (TDS). These are summaries from its Adjudication Unit in relation to dispute cases of interest between Inland Revenue and taxpayers. These give a good indication of Inland Revenue thinking around particular topics and how it might react to a transaction.
TDS 22/21 released last week is particularly interesting. It involves a two-lot subdivision carried out on a property by a taxpayer. He had initially purchased the property when working offshore for the purpose of renovating and extending it to live in with their extended family. Once the property was purchased, the extended family moved into the dwelling and the taxpayer joined them later on his return to New Zealand.
He then started planning to extend the property, but it emerged that there were problems with drainage and asbestos. Instead, it was suggested that the taxpayer should subdivide the property into two lots, constructing a new dwelling on each lot. And that’s what happened, during which time he was working overseas and visiting intermittently. Once one of the new properties was constructed, he occupied it for eight months. Shortly after the subdivision was completed one property was sold and the taxpayer and his extended family continued to live in the other property for a further five years.
Inland Revenue argued that the taxpayer had entered into an undertaking or scheme with the dominant purpose of making a profit under section CB 3 of the Income Tax Act. This provision is outside the normal land tax provisions, which is slightly unusual. Inland Revenue also ran the argument that the property was acquired for the purpose of intentionally disposing of it under CB 6, which is within the land taxing provisions. The question arose whether there was relief available because it was a main home. And finally, Inland Revenue also raised the question whether the sale of the subdivided lot and the property was subject to GST.
It seems part of the issue here may have been Inland Revenue just didn’t believe what they were being told. The Technical Decision Summary reasons for the decision opens with a reminder that the onus of proof is on the taxpayer to prove that an assessment is wrong, why it is wrong and by how much it is wrong.
This case turned out to have a good outcome for the taxpayer, because the Adjudication Unit ruled that the taxpayer did not enter into an undertaking or scheme for the dominant purpose of making a profit. Therefore, the gain wasn’t taxable under section CB 3. The Adjudication Unit ruled the taxpayer acquired the property for the sole purpose and with the sole intention of creating a home for themselves and their extended family. Therefore, the sale of the second lot was not taxable under section CB 6. It followed that as the property had been occupied mainly as residential land prior to subdivision, an exclusion applied. Finally, the taxpayer did not carry out a taxable activity for the purposes of the Goods and Services Tax Act, so no GST applied to the transaction.
The taxpayer won on all points. But there are several interesting points here. First is that Inland Revenue even took the case and the arguments it ran. This transaction appears to have happened before the Bright-line test was introduced, the TDS isn’t clear about the timing. The attempt to apply section CB 3 is unusual.
Secondly it highlights that Inland Revenue is paying attention to just about any property transaction and it’s prepared to use all provisions that are available to it. The case is a reminder to keep good records. I think the taxpayer struggled initially because not enough evidence was available, but they were eventually able to persuade the Adjudication Unit of what had happened.
Tax professionals vote for a Capital Gains Tax
Moving on, the Technical Decision Summary does point to an ongoing strain within the tax system around the taxation of capital gains. In many jurisdictions that have capital gains taxes the issue we’ve just been discussing would be not on whether or not the transaction was taxable, which is an all-or-nothing proposition, but what proportion might be taxable.
It’s therefore interesting to see that at the Chartered Accountants of Australia and New Zealand’s National Tax Conference recently, a poll was conducted on the introduction of a capital comprehensive capital gains tax. The question was put would you prefer to have a comprehensive capital gains tax as proposed to the evolving status quo, which is actually a very generous description of the evolving state, still, to be frank.
(Photo by Richard McGill of PwC)
I wasn’t at the conference. I would have voted yes, although plenty of caveats around how we might go about it. It’s also tempting to respond, “Well, that is a lot of self-interest by accountants voting for such a measure.” I know that I’ve seen similar comments pointing out when I raise the issue that of course I would support it because I get extra work out of that. I find it ironic to be accused of acting out of self-interest when the flipside of it equally applies people who don’t want a capital gains tax would also be saying so out of self-interest. Self-interest arguments cut both ways, in my view.
I do happen to think that self-interest is a problem in the tax system around this whole area. It’s very difficult to see how parliamentarians owning substantial capital assets are going to ever going to vote for something which is directly against their own self-interests.
The feedback from the CAANZ conference was that it’s necessary to keep our tax system comprehensive and robust. And it would actually simplify quite a lot of measures that we see right now. For example, if you had a capital gains tax, you wouldn’t have to work through the bright line test and its various iterations. You could remove the foreign investment fund rules, another set of rules which are complex and not well understood. And you would also probably remove, or certainly reduce the need for measures such as restricting interest deductions. This has been introduced partly as a response to the absence of a capital gains tax.
In my view, there’s a lot of distortions in the tax system because we don’t tax capital gains, and we are seeing more and more of that. At last year’s International Fiscal Association’s annual conference many of the issues we were debating really revolved around the strains on the edges of the tax system produced by not taxing capital gains.
A CGT is not going to be popular with politicians or for those who would be affected. But the rest of the world manages these strains. So, to pretend that we can get by without a CGT and continue the current incoherent approach to taxing capital gains, is a position that just simply isn’t sustainable in the long term.
Updates on global tax coordination
Now, moving on, in international tax news the OECD released its latest corporate tax statistics. There’s a lot to consider here which I’ll discuss next week.
The OECD also released data relating to the latest Mutual Agreement Procedure statistics covering 127 jurisdictions and practically all the mutual assistance cases worldwide. These Mutual Agreement Procedure cases arise when two or more tax jurisdictions want to resolve the tax treatment of a transaction or entity where each jurisdiction thinks they have priority. Transfer pricing issues are often involved.
According to the OECD, approximately 13% more Mutual Agreement Procedure cases were closed in 2021 than in 2020. But fewer new cases started this year, which is a small, unusual trend given the internationalisation of the global economy. But these Mutual Agreement Procedure cases do take some time to resolve, on average, about the 32 months for transfer pricing cases and 21 months for other cases.
But amidst all this, there’s some good news, including an award for Inland Revenue which together with Ireland was awarded the prize for the most effective caseload management. The most improved jurisdiction was Germany, which closed an additional 144 cases with positive outcomes – that is, the matter was fully resolved.
These awards seem a bit of fun, but actually it’s a pretty important matter because with the Base Erosion and Profit Shifting and the hopefully soon introduction of the Two-Pillar international tax agreement, the role of Mutual Agreement Procedures in resolving disputes is going to be important. It’s encouraging to see jurisdictions are making progress and cooperating better
Paying tax and the right to vote
And finally this week, the Make it 16 win in the Supreme Court over the potential voting rights of under 18 caused quite a stir. David Seymour of ACT jumped in with a rather ill thought out comment “We don’t want 120,000 more voters who pay no tax voting for lots more spending.”
From the first time a child uses their pocket money to buy an ice cream and dairy, they’re paying tax. It’s called GST, which at over $26 billion is a quarter of the Government’s tax revenue. And as I pointed out on Twitter, lots and lots and lots of under-18s pay GST.
(The total of local government rates is an estimate. It appears the true figure is just over $7.3 billion)
The Make It 16 group made an Official Information Act request to Inland Revenue about how much tax 16- and 17-year-olds pay. And according to Inland Revenue over 94,600 16 -and 17-year olds paid a total of $82 million in income tax during the year ended 31 March 2022. That’s not an insubstantial amount of money (and doesn’t take into consideration the GST they also paid).
Given that 16 is the age of consent and 16 year-olds may drive, I don’t see much logic in saying that’s too young to vote. The kids are all right in my book.
Until next time kia pai te wiki, have a great week!
Last week Inland Revenue issued a press release warning real estate agents that this was an area that its analysis “suggests real estate salespeople/agents commonly claim a high level of expenses relative to their income. Inland Revenue believes the issue is widespread and we must act. People are claiming private expenditure, but not keeping logbooks or other business records to support the claim.”
The release goes on to warn that if someone has over-claimed expenses in Inland Revenue’s view, “they will receive a letter from us requesting they prove the expenses claimed.”
Now, this is a little bit unusual from Inland Revenue because we haven’t heard anything in the grapevine that this was something they were looking at. But it is not entirely surprising because one thing that emerged from hearing the Commissioner of Inland Revenue speak at the excellent Accountants and Tax Agents Institute of New Zealand conference is that Inland Revenue has great faith in its Business Transformation systems. These give it the ability to analyse data and identify areas where it believes income is either being under declared or in this case, taxpayers are, shall we say, being overly generous in their calculation of the deduction available.
Although, as I mentioned, we haven’t previously had an indication Inland Revenue viewed this as an issue, it’s apparent from what they’ve said here, that they’ve done enough preliminary work to identify that expenses being claimed by real estate agents seem high relative to income.
In one way I think this is a positive development in that Inland Revenue by warning people what it can do, can clear out some of the chaff.
On the other hand, there’s a lack of specific detail in this press release which concerns me. It’s “We think there’s an issue, but we haven’t actually specified what particularly is concerning us”. And simply to say that people claim a high level of expenses relative to their income is to assume that that expenses automatically should follow income. It could well be that there is a fair amount of baseline expenditure that people would incur in this business, running around making phone calls, driving to see clients and the like sometimes without actually a great deal of success, as the real estate sector is largely commission only based.
And so one of the things that taxpayers perhaps should consider is the implications of Inland Revenue’s capability to do a great deal of analysis. One thing Inland Revenue could do is to start saying, “Well, here is a standard deduction. You can claim X amount which to we’re going to accept as deductible without the need to keep very detailed records because our indication is that is likely to be the level of expenditure you would incur in your business.”
Now, Inland Revenue will come straight back and say they don’t want to do that because people will abuse that. But on the other hand, you’ve got to wonder the benefit of the current approach when you consider the time and energy put in by people preparing their tax returns and also the effort Inland Revenue then spends investigating what may well turn out to be an entirely legitimate expenditure. Maybe just simplifying matters all around would be more efficient.
It could be yes, there could be some seepage around the edges under a different approach and Inland Revenue doesn’t get as much as it could do if the rules were applied correctly. But applying a so-called standard deductions approach deals with an issue in the tax system, in that compliance is particularly onerous for smaller businesses. The rules are written around the expectation that people have a good understanding of the law and have the systems to manage their accounting and recording income and expenditure. And with the advent of online accounting systems such as Xero and MYOB that’s largely true.
But not everyone wants or needs to spend money on accountants. And I have felt for some time that adopting a different approach to what we call micro businesses, that are businesses with a turnover of say, less than $100,000, dollars would actually benefit everyone. Make it easier to comply and encourage more people to comply.
Anyway, we’ll watch with interest to see how this plays out with Inland Revenue. As I said, I’d like to see some more specific examples of the abuse that they are clearly warning against. But until some cases hit the courts or Inland Revenue releases some more information on the matter, we’ll just have to wait and see. In the meantime, it’s a good warning for anyone involved in business that you have to keep accurate records of your business expenditure.
The IMF wants tax action on overheated housing market
Moving on, the IMF, the International Monetary Fund, has waded into the debate over housing by recommending the Government should introduce a stamp duty or a more comprehensive capital gains tax to help deal with the overheated property market.
This is part of a routine check on the New Zealand economy, what’s called the Article IV discussions. These happen periodically when IMF staff come down here, talk to Treasury and other officials and draw their own conclusions on the state of the New Zealand economy and areas for improvement.
The Government will not welcome the call for a capital gains tax or stamp duties. We haven’t had stamp duties in nearly 30 years now, but they are used a tool used elsewhere. They’ve fallen out of fashion here because they are regarded as economically inefficient taxes, and there are concerns that they increase costs for purchasers. So as a means of helping first home buyers, a stamp duty isn’t necessarily going to be a great approach according to theory.
But for those who’ve read Tax and Fairness, the book I co-wrote with Deborah Russell MP, you’ll know that in chapter four, we talked extensively about how the IMF is not the first organisation to have raised the need for a capital gains tax to deal with housing inflation. The OECD raised the idea way, way back at the start of the century in November 2000 and then again in 2011, and the IMF also made similar suggestions back in February 2016.
I was going to say it’s really quite remarkable how this issue keeps popping up, but actually it’s not because the issues around tax were identified decades ago but have not been addressed. And meantime, the pressure on the Government builds now that the housing market has accelerated again. And this week (Tuesday) the Government will announce some proposed disincentives for property investors to try and reduce demand in the sector together with some form of targeted incentives to encourage savings in other sectors.
Just a little note on this, way back in 2000 the OECD concluded there was substantial overinvesting in housing, maybe one and a half times greater than that of major OECD countries. Now, I imagine that number has actually become considerably worse. So, as I’ve said before, the capital gains tax debate is not going to go away.
And on that debate, this coming Thursday, March 25th, I’ll be on a panel alongside Geof Nightingale of PWC and the Tax Working Group and Paul Dunn of EY together with Craig Elliffe and Julie Cassidy from Auckland University. Our topic is “Taxation: the ticking time bomb of our generation. Four tax questions for 2021”. This is an event run by the New Zealand Centre for Law Business I have no doubt whatsoever we will be talking about the issue of capital taxation.
End of year prep
And finally, more on one specific issue which will require action before 31st of March, and that is the question of overdrawn shareholder current accounts.
Now, this happens when a director or a shareholder of a company takes out more in cash from the company during the year. This is traditionally treated as drawings. So, prior to year-end, we take a look to see what we can do. And most times we deal with this issue by either paying a dividend before year-end (a particularly important thing to do this year before tax rates increase on 1st April) or voting a shareholder employee’s salary.
But in some cases, that is not enough. And in those situations, a company is required to charge interest using the FBT prescribed rate of interest. Now this rate is regularly adjusted and generally reflects what’s going on elsewhere in the market. Until 30th June 2020, the rate was 5.26%. It was then reduced to 4.5%, the lowest rate I can recall. This is the rate that should apply from 1st July 2020 right through until 31st March 2021.
But from 1st April the rate increases to 5.77%, something that has slipped under the radar and possibly reflects Inland Revenue unease about the use of current accounts to get around higher tax rates. On the face of it a rate increase in this low interest economy seems anomalous.
But as I said, I think it reflects Inland Revenue concern about the use of an overdrawn current account to get around income being taxed at either 33%, or from 1st of April, 39%. In some other jurisdictions the amount of an overdrawn current account is treated as a dividend. Our rules treat only require charging of interest. So if you’ve got an overdrawn current account of $100,000 in Australia, that’s going to be taxed as income of $100,000. Here we apply the FBT prescribed rate of interest of 4.5% so the taxable income is just $4,500.
So you can see there is some form of incentive to make use of overdrawn current accounts. In fact Inland Revenue has started paying a lot more attention to this issue and this small but quite subtle and unnoticed rate increase in the prescribed rate of interest is probably a clue it is planning to take greater action on the matter.
Well, that’s it for today, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week Ka kite ano!
A look ahead at the expected big tax themes in the coming year.
The arguments for taxing property, a wealth tax, what might Joe Biden’s presidency mean for international environmental taxation and how will Inland Revenue respond.
Welcome to 2021. So what lies ahead in the tax world this year? Well, firstly, housing will remain an issue and I expect we will see steady calls for radical action on this front, including a demand for a capital gains tax. I actually think it’s gone beyond the point at which a CGT would have an impact.
In terms of tax measures, as I’ve said previously, restricting interest deductions including applying the existing thin capitalisation rules to investment properties might help to even the playing field between investors and first-time buyers, a group to which the Government appears to be paying particular attention.
Susan St. John has called for the Risk-Free Rate of Return (which is similar to the Foreign Investment Fund fair dividend rate rules) to apply to investment property. And her suggestion was recently echoed by Professor Craig Elliffe, who was a member of the Tax Working Group.
The Tax Working Group looked seriously at the question of applying a Risk-Free Rate of Return to investment property. It estimated the revenue from applying a rate of 3.5% would be approximately $1 billion in the first year and was expected to rise to $2 billion per annum within 10 years. The expectation would be that such a move would,
“tax a currently undertaxed asset class more adequately and act as a curb to burgeoning house prices. Westpac economist, Dominick Stephens calculates that a 10 per cent CGT would reduce house prices by nearly 11 per cent. It is unclear what effect the RFRM, but it should stem the increase. But it’s not clear what effect a Risk Free Rate of Return method would have, but it should stem the increase.”
Now, tied to the question of housing is the issue of wealth inequality, and I expect we will continue to see calls for a wealth tax. Over in the UK just before Christmas, their Wealth Tax Commission released a report recommending a one off wealth tax for the UK, which it estimated could raise about £260 billion over five years. What was particularly interesting about this commission is the depth of the research into the topic.
Quite apart from the final report, the Commission produced a series of other working papers on the design and operation of wealth taxes around the world. And these, in the commission’s own words,
“represents the largest repository of evidence on wealth taxes globally. To date, it comprises half a million words across more than 30 papers covering all aspects of wealth, tax design and both in principle and practice.”
Just to put that in context, I estimate the Tax Working Group’s consideration of wealth taxes amounted to perhaps 10,000 words in total. So we are looking at a very significant amount of research.
Now, one other thing to keep in mind about the British Wealth Tax Commission was that it called for a wealth tax, even though the United Kingdom has a capital gains tax and an inheritance tax. Instead, it recommended a thorough review of those existing taxes. The Commission also went for a one-off tax rather than an annual wealth tax, which is the common type of wealth tax currently and what the Greens propose. The Commission saw that there were quite a few practical issues around the operation and an ongoing wealth tax. These issues together with political pressure, has meant that the use of wealth taxes has declined throughout the OECD.
The Tax Working Group also concluded that an annual wealth tax would have enormous practical issues in implementation, which is why it did not recommend it.
But what the Wealth Tax Commission’s research makes clear is just how unique New Zealand’s approach to the taxation of capital is. It’s well known that New Zealand does not have a comprehensive capital gains tax, but that’s not entirely unique within the OECD. Switzerland, for one, does not have a capital gains tax.
Where New Zealand is unique, is that it does not have comprehensive taxation of capital in any form. Switzerland has a comprehensive wealth tax. In fact, the tax it raises from wealth taxes represents one per cent of GDP, which is the highest of any country with a wealth tax. Wealth tax revenue amounts to 4% of the Swiss tax take so it’s an important part of the Swiss tax system,
Wealth taxes in the OECD do not raise significant amounts of revenue and that’s one of the reasons they’ve been declining in use. The Wealth Tax Commission’s papers are well worth reading. A particularly interesting one is about the political economy of the abolition of wealth taxes in the OECD, which those who want to promote taxation changes would do well to read closely.
I think pressure will continue to mount on the Government on the taxation of wealth because of this ongoing anomalous position where we don’t tax capital on transfers by way of an inheritance tax or even a stamp duty, and not tax increases in value generally will feed into the debate around inequality.
And there’s an interesting point a client made to me on this topic. It’s been a long-standing New Zealand policy to attract high net worth individuals to come to New Zealand. Such immigrants may well qualify for a four-year tax holiday on their non-New Zealand investment income. These people being wealthier tend to have very diverse investment portfolios.
But as the client pointed out to me, it seems wrong that their investments would be taxed on their capital growth under the Foreign Investment Fund regime whereas property investors are not taxed on that growth at all. My client thought that was an anomaly that sooner or later would start to act as a disincentive for high-net-worth migrants to New Zealand. This may lead to growing political pressure to level the playing field, so to speak.
So anyway, the taxation of wealth, whether through a capital gains tax and/or a wealth tax or some other mechanism, is going to remain on the agenda.
A week before the British Wealth Tax Commission issued its report, our Government declared a climate change emergency, joining 32 other nations who have made such a declaration.
Now in my first podcast of last year, I said that the role of environmental taxes as one of the tools in the meeting our emissions targets will become ever more important. And that remains the case.
But we now have a new American president, and one of the first actions of President Biden after his inauguration was an executive order confirming the United States would re-join the 2015 Paris agreement. Now, several people have pointed out this may well act as an indirect trigger for the government to take further action on reducing emissions.
More than a few columns have pointed out that there is a discrepancy between the government’s declared intentions and the actual steps being taken to reduce emissions and meet our commitments under the Paris agreement. One estimate is that New Zealand exceeded its national share of consumption-based emissions by more than a factor of 6.5.
So this year I expect we should start to see some movement on taxing emissions more thoroughly and a place they might well start because the transport sector is the biggest source of emissions is to change the taxation of motor vehicles, maybe by following the UK’s example of applying FBT on the basis of emissions.
The government should also look at eliminating anomalies in the tax system, which effectively penalise low carbon activities such as employers paying FBT on providing free public transport. Another would be as a paper prepared for the NZTA suggested was maybe applying FBT to employer provided parking.
Biden’s inauguration could mean swifter resolution to the issue of international taxation. I think this is one where we will have to wait and see because there will be fierce lobbying in the US by the so-called GAFA – Google, Apple, Facebook and Amazon. I think progress will be made, but it will be slower than people expected.
And finally, the third trend I think we’ll see this year is Inland Revenue coming out from its rather inward-looking attitude in recent years as it completes the final stage of its controversial Business Transformation programme. With the immediate requirement to respond to the COVID pandemic now over, (please people remember to scan) Inland Revenue can get back to its more regular work.
Already before Christmas we started to see a number of new initiatives including one in relation to following up on the information Inland Revenue received under the Common Reporting Standards on the Automatic Exchange of Information.
Another is reviewing all transactions potentially within the bright-line test. You may recall that Inland Revenue fired out emails to tax agents advising “These clients appear to have made transactions within the bright-line test” which caused quite a stir. I expect we’ll see more work going into that space, which coming back to the start of the podcast ties into the taxation of property.
And finally, I think we’ll also see more activity going after the so-called cash economy. I think we’ll see Inland Revenue start following up on cash transactions, such as tradies offering a discount for cash.
So we’re going to have a busy year ahead, as always, and I will bring you the news as it develops. Next week, I’ll take a closer look at Inland Revenue, and its annual report which was released just before Christmas.
In the meantime, that’s it for today. I’m Terry Baucher and you can find my podcast on website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients until next week, Ka kite āno.
