24 Feb, 2020 | The Week in Tax
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- Changing tax thresholds and capital gains tax are back on the agenda
- Inland Revenue warns the hospitality industry
- OECD estimates international tax reform could be worth USD100 billion annually
Transcript
Last week began with Simon Bridges, the National Party leader, outlining the party’s proposed economic platform for the coming year. And in that speech he alluded to the expectation of tax cuts before, in what was possibly a casual use of language, he said that persons on their average wage should not be paying a third of their income in tax.
This prompted a bit of a pile on because it was quickly pointed out that someone earning the average wage of about $65,000 per annum pays on average 19.2% in income tax. And in fact, some nerd calculated only a person earning $3 million or more, would actually have an average income tax rate of 33%.
And this is a reflection, as I explained to Wallace Chapman and the Radio New Zealand panel on Tuesday afternoon, of our progressive tax system. As your income rises, the tax rate rises starting at 10.5% before reaching 33% on income over $70,000. But the point I made is that the rates jump quite sharply from 17.5% to 30% at the $48,000 mark. And so, the question should be whether those thresholds and rates are appropriate.
And interestingly, when looking at this in preparation for speaking to Wallace Chapman, I went back to just see how often the tax thresholds have been changed. As I explained, 33% cent has pretty much been baked in since 1989 with the exception of the period between 1999 and October 2010, when it was increased to 39% before dropping back slightly to 38%. The threshold has varied obviously during that time, but over the past 30-year period, the top rate threshold has only been adjusted six times by my reckoning. Six changes of thresholds in 30 years is actually quite surprisingly low.
Many other countries adjust for inflation. Britain does. And it’s a mandate in the UK tax legislation that if you are not adjusting income tax thresholds, you must specifically legislate to not do so. My view is that something like that should be in our tax legislation, because otherwise politicians are able to claim tax cuts when in fact we’re dealing with something which is no more than an inflationary adjustment.
But the tax pressure point for people is not, in my view, around the 33% top rate, even if it is perhaps low by world standards. But on that threshold, around the $48,000, when someone moves from 17.5% to 30%. That’s quite a significant jump of twelve and a half percentage points and quite a lot of other things are happening at the same time. Working for families’ abatements are kicking in at 25 cents on the dollar for income above $42,700 dollars. For someone who’s on or near average wage or possibly a bit below and maybe receiving working for families’ tax credits, they have a quite significant jump in their marginal tax rate jump.
They go from 17.5% to 30% and then they have an effective 25% on working for families’ abatements. And it’s not inconceivable they might also have a student loan in which case they lose another 12% of their income anyway if it is just over $20,000. So, it’s not impossible for someone earning around $50,000 to have an effective tax rate of 67 % or more. That is 30% income tax, 12% on the student loan and 25% working for families’ abatement.
We’re going to see something this election from both sides of the spectrum about tax and this is an area where I believe the parties that want to sell their tax policies on need to focus on. It’s that low to middle income earner, moving up through thresholds who is definitely most in need of some form of tax adjustments.
Then at the same time, no fewer than three separate bodies popped up with the capital gains tax issue. And I can probably now say I told you so. Because those who listen to the podcast will know that I said at the start of this decade, not so long ago, that I expect that capital gains tax debate to re-emerge. I have to be honest; I didn’t think it would happen so quickly.
We had the Helen Clark Foundation releasing a paper on housing affordability in which it proposed a capital gains tax. There was an interesting snippet in there, which highlighted one of the reasons why our housing is so expensive, but I think also should be of great concern to us economically. The report said and I quote,
Loose regulation of mortgage lending. Buyers in New Zealand are borrowing up to 7.5 their income, compared to 4.5 times in the United Kingdom has allowed prices to inflate rapidly.
Seven and a half times income is a quite frightening statistic in my mind, because it means that those people who are taking mortgages at that level have absolutely no margin for error if – actually it’s not if it’s when – interest rates rise. So, the hope obviously from that group of people is that the equity in the house keeps ahead of the potential risks that they have an interest rate rise and that their earnings rise substantially to bring down that income ratio.
Then we had Dominic Stephens of Westpac. He highlighted the problem that house price inflation has picked up, again, as he predicted, with the non-implementation of a capital gains tax.
And finally, we had the United Nations Special Rapporteur Leilani Farha from Canada damning New Zealand’s housing crisis, calling it a perfect storm.
And she called for a capital gains tax as well. So, an interesting trifecta of opinions on the matter.
And like I said, at the start of the year, we’re going to see more about this. This issue isn’t going to go away. Whether or not capital gains tax is an appropriate tool for resolving the housing matter is obviously up for debate. I think it’s one of the tools that should be in the box. But I’m also wondering whether there are other options that need to be engaged as well from the tax side. But never mind that issue. That debate is going to keep strengthen over the coming years.
Moving on, we got an email from Inland Revenue who do like to keep in communication with everyone much more now under their upgraded system. It told us, quote, “We’ll be contacting your clients in the hospitality industry to thank them if they’ve been keeping their books in order.” Which I thought was a marvelously passive aggressive way of saying ‘if they’ve been keeping good books in order, great. If not, we’ll be asking questions’. And the email actually goes on to say, “we’ll also be encouraging our clients to put their records right if they’ve left anything off their past tax returns”.
Passive aggressive tones aside, this is something we’re going to see a lot more of. Inland Revenue is going to get very specific about targeting particular industries and it’s going to be very vocal about what it’s going to do and how it will go about it. The message will be sent out to tax agents, hospitality industry associations, etc. They’ll be told, ‘We’re going to look at this, so pass the word along to your members’.
And to be honest, I think that’s a good approach because to apply Gresham’s law, bad money will drive out good. Those sorts of operators who are undercutting other taxpayers who are fully compliant are a risk to the whole sector as well as simply leeching off the system, in that they expect the full availability of public services but aren’t prepared to contribute fully to that. And that, incidentally, is Inland Revenue’s messaging.
I see that, by the way when I get communications from the UK’s H.M. Revenue and Customs they have the same slightly passive aggressive tone to them, saying if you’ve not paid your tax on time, then you are not funding hospitals, roads, schools, etc.
So the messaging from tax authorities is changing in this area. But the key takeaway here, and you can’t say you weren’t warned, is that if you’re not compliant Inland Revenue will be asking questions. And I really do say that it is a question of will, not if. It would be foolish to pretend because compliance in the past has been monitored inefficiently that it will continue to be the case. That most definitely isn’t the case. Everything I see in my interactions with Inland Revenue at either an operational level or talking at the higher policy level points to much more sharply tuned tools being employed more quickly to deal with matters like this.
And talking about dealing with matters of tax compliance or in this particular case, tax avoidance, the Organisation for Economic Co-operation and Development has just published an estimate of what it thinks will be the potential benefits from reform of the digital economy.
Several matters came out of this. We have this ongoing what they call the Pillars 1 and 2 approach and so far, according to the latest report given to the G20, they are still confident they can nut out something on this matter by the end of the year. Now what is obviously going to get the tax authorities and governments interested, is that the OECD estimates the combined effect of Pillars 1 and 2 as potentially bringing in up to 4 % of global Inc corporate income tax revenues, which is equivalent of U.S. $100 billion dollars annually.
The interesting thing they also say which will also encourage buy in from governments, is that the revenue gains are expected to be broadly similar across high, middle and low-income economies.
A 4 % increase in corporate income tax take here in New Zealand would amount to if my calculations are correct over $650 million annually based on the current income company income tax take of $16.4 billion. That’s a very tidy sum of money.
I have to say, I doubt whether in fact we would benefit as much as that. We’re very much a price taker in these matters as those who deal more in this international tax space have pointed out. So, I think the benefit will be substantially less than $650 million annually, but still very much worthwhile for our government to buy into the OECD’s approach. But we shall have to wait and see, and I will keep you informed as news emerges.
Well, that’s it for the week in tax. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Please send me your feedback and tell your friends and clients. Until next time have a great week. Ka kite āno.
21 Jan, 2020 | Tax News
ANALYSIS: Who killed the capital gains tax proposal and why? What did that decision cost us? And is it really dead or just resting?
Tax is inherently political, so when looking at who killed the capital gains tax (CGT), the answer is straightforward: it was New Zealand First in the Beehive with its veto. Firmly slapping down Simon Bridges’ attempts to claim credit for the decision, Winston Peters declared: “We’ve heard, listened, and acted: No Capital Gains Tax.”
Curiously, one of Peters’ justifications for NZ First’s veto was that a CGT would unfairly penalise those who had been “forced” to invest in property following the stock market crash in 1987. It’s worth remembering that even if a CGT had been introduced those historic gains would not have been taxed. (This crucial fact was often rather conveniently overlooked during the debate.)
New Zealand First’s decision had the backing of a number of transparently self-interested groups such as the NZ Property Investors Federation but also many smaller businesses who were concerned about the potential impact.
The wider business concerns were a reason why three members of the Tax Working Group (TWG) — Joanne Hodge, Kirk Hope and Robin Oliver — disagreed with the group’s recommendation of a comprehensive CGT. The three considered any potential benefits would be outweighed by increased efficiency, compliance and administrative costs.
However, the TWG was unanimous that there was a “clear case” for greater taxation of residential rental investment properties.
Robin Oliver, a former Inland Revenue deputy commissioner, presented some interesting insights into the failure of the CGT when he and fellow TWG member Geof Nightingale spoke at the Chartered Accountants Australia & New Zealand (Caanz) tax conference last November.
Oliver commented on the visible lack of political support for a CGT, which was in marked contrast to how Roger Douglas and Trevor de Cleene had promoted the introduction of a goods and services tax (GST) in 1985.
Oliver also noted the proposed design was probably too uncompromisingly pure. In his view the politics were always going to be difficult and compromises would be needed to cross those hurdles.
Incorporating some form of inflation adjustment was another potential compromise. This is common in jurisdictions with a CGT. Australia, Canada, South Africa and the United States all do not tax the full amount of a gain. Instead, the gross gain is reduced by between 40 per cent and 50 per cent, with the net amount then taxed as if it was income.
The United Kingdom does tax the full amount of the gain but applies a different tax rate linked to the taxpayer’s total income. Interestingly, that tax rate can be higher if the gain relates to property.
Neither of these compromises were ever floated and so the CGT was effectively left to wither and die.
WHAT WAS THE COST?
What did the decision to shelve the CGT cost? For starters, the TWG modelled four revenue-neutral scenarios for redistributing the $8.3 billion a CGT was projected to raise over the first five years.
All four scenarios included personal income tax reductions of at least $3.8b over the five-year period, with the most generous scenario suggesting income tax reductions of $6.8b.
For many people, the decision not to adopt a general CGT meant they lose out on lower income taxes. However, a cynic might say that for residential rental investment property owners the continuing benefit of untaxed gains far outweighs any such benefit.
The decision not to adopt a general CGT does nothing to break New Zealand’s long-running pattern of over-investment in residential property.
The decision also does nothing to break New Zealand’s long-running pattern of over-investment in residential property, which means little real progress can be made on addressing housing affordability. There is therefore likely to be an ongoing cost for those Millennials and Generation Zers wanting to own their own property.
There’s a wider concern that funds which could be used for productive investment will be increasingly diverted into residential property, particularly in the wake of the increased capital holding requirements for banks.
DING DONG THE WITCH IS DEAD – OR IS IT?
New Zealand therefore remains an outlier in world tax terms in not having a generally applicable CGT. But it is not as if no capital gains are currently taxed. The tax system has nearly 30 separate provisions taxing some form of capital gain.
This includes a general provision which will tax any gains made from disposals of personal property if the property was acquired “for the purpose of disposing of it”. Critics of a CGT also ignored that it would have brought a certainty of treatment to all transactions.
In the absence of that certainty, taxpayers cannot always be certain that a property sale will be non-taxable. Tighter enforcement of the existing rules by Inland Revenue is very likely.
As a sign of this, I have recently become aware Inland Revenue is reviewing property transactions from as far back as 2012. Although these disposals pre-date the introduction of the bright-line test in October 2015, it appears they would have been taxable if the test had existed at the time of sale. The spectre of CGT therefore remains.
Robin Oliver concluded his comments at the Caanz tax conference by noting that although he remained opposed to a general CGT, he did not consider the present under-taxation of residential rental investment properties was sustainable in the long run.
Nightingale supported that assessment. Both were undecided as to whether a CGT was the best means of addressing the issue of under-taxation. An alternative might be to apply the deemed return approach used to tax overseas shares in the foreign investment fund regime.
It’s therefore wise to assume that CGT is not dead but merely resting. My expectation is that the debate will emerge in force towards the end of this decade as the rising cost of superannuation and health costs for the elderly puts increasing pressure on government finances.
By then inter-generational frustration with housing affordability may mean voters are ready to back change. We shall see.
This article was first published on Stuff.
17 Dec, 2019 | The Week in Tax
- The Tax Working Group report and capital gains tax
- Inland Revenue’s business transformation
- OECD’s international tax proposals
Transcript
This week, our final episode of the year takes a look back at the big tax stories of 2019 and also casts an eye over the tax events of the past decade.
The Tax Working Group report
The release of the Tax Working Group report and the Government’s decision not to follow through on the group’s recommendation for a general capital gains tax is by far and away the biggest tax story of the year. Although the Prime Minister stated that as long as she remains leader of the Labour Party, she will not be proposing a capital gains tax, the issue still excites and generates quite a degree of controversy. The reaction, for example, to a recent podcast in which I talked about Robin Oliver and Geof Nightingale’s session about why a capital gains tax didn’t happen at the recent Chartered Accountants Australia New Zealand Tax Conference is a good illustration of that.
As I’ve said many times beforehand, the frustrating thing for me about the aftermath of the Tax Working Group is that the debate around a capital gains tax completely drowned out all the other good work the group undertook. Some very interesting matters were raised and discussed. The tax system was found to be in generally good health, but there were issues. Pressures are building around the demographics and the funding of New Zealand Superannuation and rising health care costs for our ageing population.
On the other hand, the Government’s books are pretty solid and there is no immediate requirement to be raising revenue and expanding the tax base to pay for those additional costs. So, a capital gains tax is not something that’s going to be immediately necessary. But what the group did point out was those pressures are not that far off and we need at some stage to consider how the tax base will respond to that.
The other thing I thought was very interesting and I’ve talked about it before, is we started to see some movement on the question of environmental taxation. The TWG said we could do a lot more in this space. But also, and certainly this was Sir Michael Cullen’s recommendation initially, much of any changes that happened in this environmental taxation space should be in terms of recycling the funds through to enable the transition to a lower carbon emission economy. And that is something which is much more immediate and doesn’t require a capital gains tax. We should really be spending more time debating how we will implement these taxes and in which way we will allocate the funds that are raised.
Inland Revenue
The second large story for the year was Inland Revenue’s Business Transformation and in particular its Release Three, which happened in April. This is when it said, right, we are going to do auto-calculations for all taxpayers. And instead of them having to use a tax intermediary, Inland Revenue will automatically calculate the unders and overs for the year and issue appropriate refunds or demands as required.
This is a hugely ambitious project. About 2.9 million automatic assessments were processed resulting in approximately $572 million dollars of refunds being paid to taxpayers. But it threw up quite a lot of controversy. Probably in hindsight Inland Revenue was too ambitious in what they tried to do. They were bedding in the new tax system which for example involved transferring something like nineteen point seven million records into the new START (Simplified Tax and Revenue Technology) system.
Two key points emerged from the switch. Firstly, somehow over a period of time, 1.5 million people had managed to get their prescribed investor rate wrong. So those who had underpaid were expected to pay up. But those who had overpaid on average about 40 dollars each weren’t going to get a refund.
Now, as it transpires, political pressure and the howls of outrage from the public means that work is in progress to correct this issue. Currently the Finance and Expenditure Committee is looking at a measure which will deal with the question of the overpayments not presently being able to be refunded. That’s a good outcome coming from that pressure.
We don’t need no education?
What that issue shows to me though, is something that’s been taken for granted across the system. Not just this year, but for the past decade and probably even longer. And that is a dangerous assumption – that taxpayers know how the system operates and will always act in their own best interests because they are always across what’s happening their prescribed investor rate, their PAYE codes. That’s clearly not true. And it’s something Inland Revenue and tax professionals will have to deal with going forward.
Looking ahead to what’s going to be happening over the next three or four years, I think it’s probably one of Inland Revenue’s greatest priorities to introduce an educational process to ensure people are kept up to date about what happens with their KiwiSaver and PAYE.
The other part of the fallout from Release 3 as it was called, was that Inland Revenue basically did enormous damage to its relationship with tax agents. We as a group were pretty much left out in the cold about how to manage the transition to the new tax system. As a result, our experience in using the phones when interacting with Inland Revenue was uniformly very poor. And the survey I talked about last week with Chris Cunniffe of Tax Management New Zealand shows how dissatisfied tax agents have become with Inland Revenue’s performance.
Now credit to the Commissioner of Inland Revenue Naomi Ferguson, she’s acknowledged this. And we now know that going forward, Inland Revenue will not be making auto calculations for any taxpayer who is linked to a tax agent, and is overhauling its procedures around contacting clients of tax agents directly.
This is very much a sore point. 72% of tax agents had clients approached directly by Inland Revenue. And one of the interesting points about that was a significant proportion of them were approached by Inland Revenue in relation to the Accounting Income Method AIM, which Inland Revenue has been promoting as a simpler means of paying provisional tax.
At present only two thousand or so people have taken up AIM. And the reason is they’ve done that – despite Inland Revenue’s huge push – is that we as tax agents feel that it isn’t right for many of our smaller clients’ businesses – that it requires too much information and is rather inflexible in its approach. So that’s something which is probably going to change. I know Inland Revenue is working on that.
Overall, I think this huge transformation can be regarded as a qualified success. There are issues, as I’ve just said, around how Inland Revenue’s relationship with tax agents deteriorated. At the same time this is a reflection of how open our tax policy process is. We were able to get to Inland Revenue and say, “Hey, this is not working, and you need to do something about it”. And through various sources – including also the Revenue Minister, Stuart Nash, getting his ears bent by many tax agents and accounting bodies – change is happening. And that’s actually how the system should operate. So that’s a sort of reflection of the good and the bad of how our tax system works.
Meanwhile over at the OECD…
The third story, and again, this is another one that’s been running for quite some time with huge implications, are the ongoing international developments that we’re seeing in tax now. There are two parts to this. The first is what we’re seeing right now, the impact of the Automatic Exchange of Information under The Common Reporting Standard. This is where the tax authorities around the world swap information about taxpayers’ offshore financial holdings. There’s a colossal amount of data being swapped, and it really is surprising how unaware people are about just how much data is being swapped by tax agencies. Inland Revenue has now received over the two releases made to date under CRS, one point five million account records of New Zealanders who have overseas financial accounts. It’s presently working its way through that data and starting to ask questions.
Separate from that are the developments by the OECD in international tax and how we actually calculate a multinational’s income and allocate it to various jurisdictions. The previous permanent establishment regime built around a bricks and mortar approach no longer operates in the digital economy and through initiatives such as BEPS – Base Erosion and Profit Shifting -the OECD has been working on a replacement.
And this
latest development is called the Global Anti-Base Erosion Proposal or “GloBE”. And this is proposing nothing less than a minimum tax rate for multinationals. This is a huge initiative and the OECD is hoping agreement can be reached among the 135 jurisdictions involved by the end of 2020.
How the GFC changed international tax
And that leads on to what has been happening over the past decade. Back in 2010, the OECD was starting to look at the implications for tax jurisdictions of international tax planning in the wake of the global financial crisis, which in 2008 had pretty much smashed to bits the budget balances of most jurisdictions around the world.
All around the world, countries tax take took a huge hit in the wake of the GFC. And countries then started looking very closely at where all the money was going and the scale of tax avoidance, and in some cases outright tax evasion, became ever more apparent. And so, this is the most important tax story over the past decade because it is transforming the way international tax operates.
You can run but you can’t hide…
And the implications for our tax base have been twofold. One, as a result of the global financial crisis and the initiatives that the OECD started, we now have Automatic Exchange of Information and the Common Reporting Standard and as I mentioned a minute ago, vast amounts of information sharing. We are also seeing moves to determine how multinationals will be taxed and that will not only affect how we tax multinationals, but also how our multinationals are taxed. Fonterra is the one that’s most often mentioned in this regard.
But it was the Americans that kicked this all off in 2010 with the Foreign Account Tax Compliance Act. What FATCA did was it required other jurisdictions to report to the US Internal Revenue Service – the IRS – details of American citizens who held bank accounts in their jurisdictions.
FATCA was the blueprint for what we have now CRS and Automatic Exchange of Information.
American exceptionalism
But there was one other thing that the Americans also did which is still playing out. The Americans are not part of the CRS initiative. In effect they said, “Well, we’ve got FATCA. we don’t need to be part of this.”
And American unilateralism is a continuing issue for the global tax base, because in the wake of the OECD proposal for the Global Anti-Base Erosion Proposal, the American Treasury Secretary just last week said, “Well, actually, we might not join that. Instead, we’ll just rather keep going with our old international tax rules”. The suspicion is that’s because the digital giants are putting pressure on the Treasury Secretary and the American government. So, a decade ago, America took unilateral action to introduce FATCA, which then led to the CRS. And now a decade on, it is throwing a large amount of grit into attempts to reform the taxation of multinationals.
A tax groundhog day
Here in New Zealand, back in 2010, Peter Dunne was the Revenue Minister, the Canadian Robert Russell was Commissioner Inland Revenue. The top income tax rate was 38% and the threshold at which it kicked in had just been increased to $70,000. GST was then 12.5% and the registration threshold had also just recently increased to $60,000.
Now those thresholds haven’t been increased since then. I think one of our faults in our system is we do not review the tax thresholds regularly enough and it causes distortions. And then suddenly politicians are making grandiose claims about massive tax cuts, which are nothing more than inflation led adjustments.
But in a real case of Groundhog Day, back in January 2010, the Victoria University of Wellington Tax Working Group, issued its report. The group (which included recent podcast guest and member of the latest Tax Working Group Geof Nightingale) shied away from recommending a capital gains tax. But it was in favour of increasing the amount of taxation from property, particularly in the form of a low rate land tax. And it also wanted to see more taxation of residential rental properties, suggesting they could be taxed in a similar manner to the fair dividend rate and foreign investment fund regime. So, there you have it, ten years ago, we were also talking about capital gains and the taxation of investment property.
The other thing that was raised by the Bob Buckle led group in 2010 was a recommendation for “a comprehensive review of welfare policy and how it interacts with the tax system with an objective being to reduce high effective marginal tax rates”. Both the Welfare Expert Advisory Group, which reported earlier this year, and the TWG commented on this situation. And I suspect that in another 10 years we will still be talking about this issue. It doesn’t go away, even if governments are unwilling to deal with some of the political consequences of action.
Well, that’s it for the Week in Tax for this year. I’d like to thank all our listeners and my guests throughout the year. I’d also like to thank David Chaston and Gareth Vaughan at www.interest.co.nz for publishing these transcripts.
We’ll be back next decade on Friday, the 17th of January. Until next time. Meri Kirihimete me te Hape Nū Ia. Merry Christmas and a Happy New Year. Thank you.
