how effective marginal tax rates act as disincentives
Last week was Scrutiny Week at Parliament. This is a new initiative where the select committees get to grill ministers for longer than normally would be the case. In total, there were over 134 hours of hearings across all the select committees.
(Minister of Revenue Simon Watts flanked by Inland Revenue officials during his appearance before the Finance & Expenditure Committee)
A large part of the inquiries directed at the Minister of Finance focused on the Budget and spending choices made or not made, particularly in relation to funding of cancer drugs.
Inland Revenue to review Charity Sector?
The Minister of Finance Nicola Willis was also quizzed on general tax policy and in the course of that she dropped a big hint about a sector of the economy which is going to come under inquiry. In response to a question on tax policy she commented
“We will put together a tax policy programme that looks at other issues. In particular, I have previously identified that we have some concerns around whether all charities are effectively meeting the expectations that we have [regarding] genuinely charitable activity. We don’t want to see [concessionary tax rates] being exploited for activities, which are more clearly more commercial in nature.”
This is a clear shot across the bow of the Charity Sector, although the Minister has foreshadowed this before. It’s now apparent Inland Revenue will undertake an in-depth review of the sector.
The Revenue Minister Simon Watts faced more detailed scrutiny over the operation of his portfolio. He confirmed that one of the Budget initiatives provided funding which would enable Inland Revenue to take on a further 200 full time employees. These additional staff would be directed to improve Inland Revenue’s compliance and investigation activities. This group will be expected to return $8 for every dollar spent on investigation and compliance activity. As the government has allocated $116 million over the next four years to this initiative that means it could reasonably expect to see a return of close to a billion dollars.
When he was questioned about a potential structural deficit and how the government might respond to that, he made it clear that there were no intentions at this stage of introducing new any new taxes. This is what you would expect to hear from the current coalition Government. Clearly the intention is that extra funds will be found by more efficient administration and boosting Inland Revenue’s compliance activities.
Inland Revenue checks out smaller liquor outlets
By coincidence, this week, Inland Revenue announced some insights from a hidden economy campaign which it had run focusing on smaller liquor outlets throughout the country. According to Inland Revenue the number of off-licence liquor stores has grown quite rapidly since 2020 and now there are nearly 3,000 throughout the country.
In 2020, the total sales of these outlets amounted to $1.95 billion with taxable profits of 34.7 million and income tax paid of $11.41 million with a further $29.4 million of net GST collected.
In the first stage of this campaign Inland Revenue compliance staff made 220 unannounced visits looking for signs of issues such as income suppression, unreported sales and non-registered staff. There’s nothing dramatic about what Inland Revenue do here. Their practice is to wander in quietly and have a look around a store. They may or may not buy anything, but they will certainly watch to see what happens behind the till. This is a long-standing technique that it has used for decades across many businesses and it’s highly successful. The truth is when you put boots on the ground with investigations, you get results.
What Inland Revenue found
During these visits, Inland Revenue found more than 100 employees had had PAYE deducted from their wages, but not then paid on to Inland Revenue. Inland Revenue also found issues around migrant exploitation issues with wages paid under the table and use of family labour who are not registered workers. They also found high levels of unreported cash and poor record keeping. In addition, “there was evidence of poor employee relations” None of this is particularly surprising to me as I have encountered similar issues.
Inland Revenue made 220 visits and as a result, 9 outlets have been referred for audit. That’s nearly 5% of all of those that were reviewed. It’s quite likely Inland Revenue already had suspicions about some of these outlets which is why they got chosen for an on-site visit in the first place.
There were a couple of other interesting points of note. Inland Revenue found that companies with multiple family members and changes of ownership demonstrated “less clear money trails”, and some directors appeared to be in name only with minimal knowledge of the business or their director responsibilities. By the way with such shadow, or nominal directors, if in fact someone is behind the scenes pulling all the strings that person can be treated as the director for company law purposes.
What next?
Inland Revenue said this was a “deliberate light touch campaign” and therefore only the beginning, obviously, of a wider look into smaller liquor stores nationwide. Clearly if you’ve just done a “light touch” review and you’ve basically found close to 5% of businesses are worth auditing it’s easy to imagine there’s scope for much greater investigation work if a more detailed and less light-handed approach is taken.
We will watch this space to see what further developments we hear from Inland Revenue. Clearly, as both the Minister of Finance and Minister of Revenue both noted in in their appearances before the Finance and Expenditure Committee, this is an area where they’re happy to give Inland Revenue more funding with the expectation that they Inland Revenue will deliver significant returns.
What about them EMTRs?
Returning to our discussion last week about high effective marginal tax rates (EMTRs) and the shocking realisation that unless something is done soon, some people on the family minimum family tax credit will be facing effective marginal tax rate of 128.6% or even more, this story got picked up by RNZ and was then circulated quite widely. This issue was raised by the Finance and Expenditure Committee, with both the Minister of Finance and the Minister of Revenue. Simon Watts, the Minister of Revenue, acknowledged that there was an issue and he had sought information from Inland Revenue on what options were available to address it. The Minister of Finance was rather more pugnacious when quizzed about the issue. Instead, she was happier to focus on the fact that only a small group of people were affected and made no particular commitment to addressing the matter.
EMTRs and the UK election
Now it so happens that effective marginal tax rates have become a bit of a political issue in the UK general election campaign. Parties are releasing their manifestos and as a result there’s been some interesting commentary emerge about the impact of high effective marginal tax rates as a result of some of the proposed policies. What stands out over there is, as here, there is a general widespread lack of knowledge about how effective marginal tax rates operate and how high they can be.
What’s sparked the debate is what happens with child benefit, the equivalent of Working for Families. There is a High-Income Child Benefit Charge which starts clawing back Child Benefit when income exceeds £60,200. The charge means for people earning above that threshold and up to about £80,000, their effective marginal tax rate jumps from 42% to 56.5%. And some of the proposals made by parties would push it even higher to over 70%.
Dan Neidle of Tax Policy Associates wrote a very interesting and informative blog post on the whole matter explaining how EMTRs operate.
Dan also referred to a very useful paper from the Tax Foundation which highlighted that these issues around EMTRs are quite common internationally.
The disincentive effect of EMTRs
Where this is relevant for all of us here is the disincentive effect of high EMTRs. What is emerging as another particular EMTR problem in the UK is there’s another threshold that kicks in at £100,000 which also triggers some very high EMTRs. As Dan Neidle noted:
“We’ve received many reports saying that high marginal rates affecting senior doctors/consultants are an important factor in the NHS’s current staffing problems – exacerbated by the fact that the starting salary for a full time consultant is just under £100,000.”
The normal marginal tax rate for someone earning £100,000 in the UK is 42%. But above that threshold there’s an income bracket where the EMTR jumps to 62% and in some circumstances even higher, before the EMTR settles down around the £150,000 mark. The state of the National Health Service (NHS) is a major election issue so if high EMTRs are acting as a disincentive to recruiting NHS that is something voters will want addressed.
The New Zealand conundrum – high EMTRs on below average incomes
As I said last week EMTRs are a feature of every tax system. What I think is interesting when you look at the UK debate over EMTRs is there’s a big difference in the level of income under discussion. £60,000 in the UK is well above the average salary in the UK and the standard marginal tax rate for people on that income is 42%. (40% income tax plus 2% National Insurance Contributions).
However, here we’re looking at EMTRs of at least 45.1% (17.5% tax plus 1.6% ACC plus 27% Working for Families clawback) kicking in at a very low level – just $42,700. That threshold is currently below what someone on the minimum wage of $23.15 per hour working 40 hours a week would earn. Our problem here is not that we have high effective marginal tax rates, that’s a common issue around the world, it is that we have people on very modest levels of income suffering those high effective marginal tax rates. And, just as in the UK, it acts as a disincentive. After last week’s podcast I had some correspondence from a relative who as a young solo mother explained that she often found it wasn’t worth her while to take additional work because of the impact of the abatement of Working for Family credits. Often 50% or more of her additional income would be lost.
Over to you politicians
This is not a new issue and from my perspective I find it rather frustrating to see to hear the Minister of Finance be very dismissive when quizzed on the topic. She does not appear to acknowledge that this is a major issue which needs to be addressed. Perhaps she’s looking at it through an entirely political lens and does not want to acknowledge the other side has a point. As I always say, tax is politics.
But the question about high effective marginal tax rates and the abatement thresholds around Working for Families is a multi-government multiparty failure. The present situation is the result of decisions taken by governments since 2009. So that involves both Labour led and National led governments.
To me this is one of those scenarios where it would be good to put the politics aside and focus on actually trying to fix the problem. The two issues around that are ‘Have we made the interaction between tax and benefits too complicated?’ and ‘What are we going to do about the abatement threshold? Are we going to let it linger or are we going to return to having it indexed regularly?’ The Minister of Revenue was noncommittal on that point and as I said, the Minister of Finance wasn’t prepared to discuss the point either.
I would hope that there’s common ground here for all the parties to try and find a more rational approach to this by focusing on the fact that if we want to get people into work, improve their lives, we need to remove the tax incentives that happen to prevent them from doing so. Fingers crossed we’ll see some movement on this issue in due course.
Well, 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.
(Originally loaded to Soundcloud 21 June 2024. Appeared in interest.co.nz 23 June 2024)
Canada loses patience and imposes a Digital Services Tax effective 1 January 2024
Inland Revenue appears to be gearing up for a fringe benefit tax initiative.
Late last week, in response to some questions about a review the charitable exemption that religious organisations enjoy, the Prime Minister responded he was “quite open” to the idea, adding “I’ve actually been thinking through the broader dimension of our charitable taxation regimes…We will certainly be looking at things like that this term.”
The hint that a review of the exemption religious organisations and churches enjoy provoked a testy response from Brian Tamaki, among others which was in turn rebuffed by the Finance Minister, Nicola Willis.
But this is a topic which keeps popping up and obviously people have some concerns about how the exemption operates. It was also reviewed in some depth by the last Tax Working Group.
So what’s the exemption worth?
Putting some numbers around the value of the charitable exemption is a little difficult. Every Budget Treasury prepares a paper on the value what are called “Tax Expenditures” that is specific tax exemptions granted under the Income Tax Act. According to the Tax Expenditure statement prepared by Treasury for Budget 2023,
the forecast value for the year ended 31 March 2023 of charitable and other public benefit gifts given by companies was $32 million. In relation to the donations tax credit for charitable or other public benefits (including to religious organisations), value for the same period was estimated to be $315 million. (Which grossed up at 33% is ~$945 million.)
The annual report of Charities Services include a snapshot of the finances for 27,000 charities registered with it. According to the report for the year ended 30th June 2023 the income of the religious activities sector was $2.39 or just under 10% of the total income across all charities.
It’s interesting to consider charities income by source for the same period. $5.29 billion represented donations, koha and fundraising activities. Based on Treasury’s Tax Expenditures statement it appears donations tax credit or charitable donations by companies has been claimed for maybe only a billion dollars of this sum. Interestingly, about half of the total income charitable sector earns during the year comes from services and trading.
Overall Charities Services estimated that the total expenditure by charities was about $22.7 billion. In other words about $2.1 billion of the funds raised were not spent or distributed for whatever reason.
Charities Services also provides a quarterly snapshot of new registrations. The latest available is for the period to 30 June 2023 when it received 388 applications (of which 78 were subsequently withdrawn). Religious activities seem to represent a fairly substantial portion of the new registrations.
What did the Tax Working Group recommend?
The last Tax Working Group took a look at this issue and the best place to consider its views is in Chapter 16 of its interim report which sets out the issues involved.
In its final report the Tax Working Group noted it had “received many submissions regarding the treatment of business income for charities and whether the tax exemption for charitable business income confers an unfair advantage on the trading operations of charities.”
The Tax Working Group responded as follows:
“[39] It considers that the underlying issue is more about the extent to which charities are distributing or applying the surpluses from their activities for the benefit of the charitable purpose. If a charitable business regularly distributes its funds to its head charity or provides services connected with its charitable purposes, it will not accumulate capital faster than a tax paying business.
[40] The question then, is whether the broader policy tax settings for charities are encouraging appropriate levels of distribution. The Group recommends the Government periodically review the charitable sector’s use of what would otherwise be tax revenue to verify that the intended social outcomes are actually being achieved.
I think if the Government is going to review the charitable sector, and religious organisations in particular, the Tax Working Group’s recommendations will be starting point. In April 2019 when the last Government responded to the Tax Working Group’s eight recommendations on charities it noted that Inland Revenue’s Policy Division was already working on five of the recommendations. Two of the remaining three were under consideration for inclusion in Inland Revenue’s policy work programme. The other, in relation to whether New Zealand should apply a distinction between privately controlled foundations and other charitable organisations, would be undertaken by the Department of Internal Affairs, which oversees Charities Services. It’s likely the COVID pandemic disrupted this proposed work programme.
We may get a clue as to the Government’s thinking in next month’s budget, but I think the Government’s focus will be on getting its tax relief package out of the way first so Inland Revenue’s resources will be applied there. The Government and Inland Revenue may then look at this exemption, but I imagine given the fuss and general controversy around such a move, it’s probably relatively low priority. Maybe we’ll see something in the Budget.
Canada loses patience and introduces a digital services tax
There was an interesting development in the Canadian budget, which was released earlier this week. The Canadian Government has decided to push ahead with the introduction of a digital services tax (DST) on large tech companies. Over a five-year period, this was expected to raise ~C$5.9 billion (about NZ$7.3 billion).
Canada had held off for two years to allow for the conclusion of the international negotiations on Pillar 1 and Pillar 2 to conclude, but they’ve dragged on with no clear conclusion in sight. The Canadians have therefore decided to push the button on a DST commenting:
“In view of consecutive delays internationally in implementing the multilateral treaty, Canada cannot afford to wait before taking action….The government is moving ahead with its longstanding plan to enact a Digital Services Tax.”
The tax would begin to apply for the 2024 calendar year, with the first year covering taxable revenues earned since January 1st, 2022. Understandably, this has provoked a pretty vigorous reaction from the United States, where the headquarters of all these tech companies are situated.
What does that mean for us down here? Well, again, we may find out more in the Budget. The Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill which was enacted just before 31st March included legislation for our digital services tax. The Government is therefore in a position that it can watch to see if other countries follow Canada’s lead and then decide whether it should follow suit.
The whole purpose of the digital services tax legislation is to act as a backstop in the event the Two-Pillar solution does not reach a satisfactory conclusion. At the moment negotiations are stalled thanks to vigorous push back by the the companies most affected, such as Alphabet, the owner of Google, Amazon and Meta, owner of Facebook. It’s interesting to see this Canadian move and I wonder if other countries will push ahead with their own DSTs. There are quite a number lot of digital services taxes around the world, with many on hold pending the outcome on the Two-Pillar negotiations.
Taxing Google to help New Zealand media?
Just as an aside, as is well known the media in New Zealand is in desperate financial straits and a question that keeps coming popping up is taxing the digital giants more effectively. That’s because a substantial portion of the advertising revenue that in the past went to New Zealand media companies is now going overseas in the form of (little taxed) various licence payments and fees for services to the the likes of Alphabet and Meta. Watch this space I think things are about to get very interesting.
Inland Revenue gearing up for fringe benefit tax initiatives?
This week, Inland Revenue consolidated the various advice and commentary on fringe benefit tax advice it’s published over the years under a single link. This seems to me to be further signs that Inland Revenue is gearing up to launch a fringe benefit tax initiative. It follows comments by the Minister of Revenue Simon Watts, in several speeches in which he referred to Inland Revenue’s regulatory stewardship review of FBT released in 2022. I got the clear impression that he, and therefore Inland Revenue were keen to look further at this matter and investigate what revenue raising opportunities may arise through a more through stricter enforcement of the FBT rules.
As a very good article by Robyn Walker of Deloitte noted FBT is nearly 40 years old. It’s a very strong behavioural tax. It exists to stop people converting taxable salaries into non-taxable benefits. So, it never really should be an extensive tax raise revenue raiser.
That said, I think there have been issues particularly in relation to the status of twin cab utes and the work-related vehicle exemption as to whether there is sufficient enforcement going on. My expectation therefore is Inland Revenue is gearing up to launch a number of fringe benefit tax reviews and this small step consolidating its previous commentary and advice into a single space is another sign.
Got an idea to improve our tax system? Enter the Tax Policy Charitable Trust scholarship competition
Finally, this week, the Tax Policy Charitable Trust has announced its 2024 scholarship competition. This is designed to support the continuation of leading tax policy research and thinking and to inspire future tax policy leaders. Regular listeners to the podcast will know we’ve had past winners Nigel Jemson and Vivien Lei as guests, and I’m looking forward to meeting the next batch of scholarship recipients.
Entrants may submit proposals for propose significant reform of the New Zealand tax system, analyse the potential unintended consequences from existing laws and changes, and suggest changes to address them. It’s open to young tax professionals aged 35 and under on 1st January 2024 working in New Zealand with an interest in tax policy. The winning entry this year will receive a $10,000 cash prize. The runner up will receive $4000 and two other finalists will each receive $1000 each.
I look forward to seeing what comes out of this and hopefully we will have the winners on our podcast sometime in the future. In the meantime good luck to all those who enter.
On that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
Last week, New Zealand entered the new COVID-19 protection framework, or the traffic light system. Currently here in Auckland, we are on red and most of the rest of the country is on orange, with a few other exceptions. As part of this, the Government has made a new transition payment available, which is aimed particularly at businesses in the Auckland, Waikato and Northland regions, because these are the ones who have had the longest period under the old alert level system.
This transition period payment will be paid through the Resurgence Support Payment system starting in a week’s time from 10th December. It’s set at a higher base level than the current Resurgence Support Payments, applications for which closed last night, by the way. The payment is $4,000 per business, plus $400 per full time equivalent employee, up to a cap of 50 full time equivalent employees. The maximum that any business can receive is $24,000. Treasury estimates the likely total cost of the payment is going to be somewhere between $350-490 million.
This is a new support being made available. The Leave Support Scheme and Short-Term Absence Payment are also available. The Government will be considering further targeted support once the new Covid-19 protection framework beds in.
One other thing to note is that the rules have been changed so that recently acquired businesses can access the Resurgence Support Payment. This is because under the previous rules, the applicant had to have been operating as a business for at least one month before August 17th. So, businesses acquired after July 17th were not eligible for any payment. Although few businesses were affected by the previous criteria, it made a difficult time even worse.
The test will be that the business that was sold must have been in operation for at least a month prior to August 17th and the new business is carrying on the same or similar activity as before the change in ownership. This is a welcome little break. However, there will still be pressure on businesses. As is well known, hospitality and tourism have had a very, very hard time of it over the last 16 weeks of lockdown
Mega landlords
Moving on, there’s been quite the debate this week over the taxation of property as a number of factors came together. Stuff has been running stories on what it calls mega landlords. One story noted that the proposed changes to the interest limitation rules have led investors to start reconsidering their investment portfolio. And also there’s been changes in the Bright-line test, which is now runs for 10 years.
A survey from the Chartered Accountants Australia and New Zealand (CAANZ) and in conjunction with Tax Management New Zealand, found that the proposed tax policies had already affected many property investors’ behaviour. 70% of the 360 odd respondents reported that their clients had changed or were planning to change their investment behaviour. What exactly that might be obviously depends on individual circumstances. According to CAANZ’s New Zealand tax leader John Cuthbertson, it’s likely to be not purchasing additional properties. However, as he also pointed out there’s still some confusion and uncertainty around the complexity of the rules.
Multi property owners
And then Christopher Luxon, the new leader of the National Party, came under some fire when it was revealed that he had seven properties as part of his investment portfolio. However, as business journalist Bernard Hickey pointed out this is actually an entirely rational investment approach under current rules.
This is the crux of the matter. Property has been very tax-preferred, particularly in relation to the non-taxation of gains, and the deductibility of interest even though there are two parts to the economic return, i.e. the taxed rental income and the (usually untaxed) capital growth. Apparently, the value of Luxon’s properties increased by approximately $4 million over the last 12 months. He can reasonably expect that none of this gain will be taxed.
These themes form the background behind the new legislation to limit interest deductions. It so happened that last Monday Parliament’s Finance and Expenditure Select Committee heard oral submissions on the new tax bill, the Taxation (Annual Rates for 2021-2022, GST and Remedial Matters) Bill to give it its full title.
The FEC received 83 written submissions, which are available on its website, including a monster 216 page submission from CAANZ. The size of that submission, which was one of the largest I’ve ever seen, gives you some idea of the complexity involved in this whole matter.
Listening to the oral submissions, the constant refrain was that the proposed rules are far more complicated than people realise, and we don’t know what the unintended consequences might be. The Corporate Taxpayers Group (their submission was a more manageable 21 pages) suggested that really the introduction of the interest limitation rules should be deferred until 1st April so that people can get their head around what’s going on. I think this is a fair point and one other submitters made.
CAANZ and the Corporate Taxpayers Group were concerned about how rushed this whole process has been and how that fits in with the Generic Tax Policy Process (GTTP). I and one or two other submitters suggested that there really needs to be a thorough review of the bright-line test and this legislation in line with the GTPP, because that’s what’s supposed to happen and hasn’t been happening recently. The bright-line test, for example, was introduced six years ago so it’s time for a review as to how it’s working. Since its introduction the bright-line period has gone from two years to ten years period. How is that working? is a fair question to ask.
Talking about the distortions
In the course of the hearing Green MP Chloe Swarbrick rather mischievously raised the issue of an inheritance tax with one submitter. That promptly earned her a bit of a telling off from the chair of the FEC. In my oral submission, I took the opportunity to put forward the Fair Economic Return proposal Susan St John and myself have developed. Whether that gets any traction remains to be seen.
To perhaps unfairly reference Christopher Luxon again, the concern we have is that his $4 million of capital appreciation in the past 12 months is most likely not to be taxed. And whether that’s actually an appropriate tax setting is something we don’t believe is correct. And I think the evidence is growing about how distortionary it is and that something needs to change.
This whole debate, which went on this week and will continue, reinforces the point that Craig Elliffe made in last week’s podcast that the debate over the taxing of property or capital isn’t going away because the current position is unsustainable. A point that rarely gets made is that Aotearoa-New Zealand is really unique in not either having a capital gains tax, or a wealth tax or estate and gift duties or taxing imputed rental. All of those exist in one form in most of the major jurisdictions of the OECD and G20, but there is none of them that don’t have any of those except for ourselves. So that’s why I think this debate will continue.
Doing charity, or accumulating wealth?
Moving on, I remember listening to the late Sir Michael Cullen talking about his experience on the Tax Working Group. I asked him about whether anything had been a surprise to him, and he replied he had been surprised by the extent of what was happening in the charitable sector,
This is something that pops up from time to time with criticism and accusations of charities abusing their charitable status to get an unfair advantage over other businesses. Sanitarium is the one charity (of the Seventh-day Adventist Church) that often pops up when this happens. The Tax Working Group’s view on charitable donations was that it is a long-standing relief. In its view the issue will be around whether, in fact, those charitable organisations are making charitable donations. The concern that arises is when they’re not and they are accumulating wealth without distributing it.
Now it so happens that this week Inland Revenue released a draft operational statement on charities and donee organisations. Now this is a bit of a monster statement, it runs to 105 pages. It outlines the tax treatment and obligations that apply to charities and donee organisations and how the Commissioner of Inland Revenue will apply the relevant legislation.
As I said, the statement is so big it’s been split into two parts, one for charities and one for donee organisations. I’m not proposing to run through this in detail right now, but the statement sets out briefly what exemptions are available and how Inland Revenue is expecting that process to be managed. Inland Revenue is taking submissions until the end of next February. And I would expect that this would generate quite a bit of feedback.
It’s good Inland Revenue has set out formal rules for charities and donee organisations. It is also, in my mind, an indicator that Inland Revenue has some concerns about what’s been happening in this sector, and it is now making very clear what are the rules, what it expects to see, and there will be consequences if the rules aren’t followed.
Well, that’s it 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 reading) and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
