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The unintended consequences of the interest limitation proposals

The unintended consequences of the interest limitation proposals

12 Jul, 2021 | The Week in Tax

  • The unintended consequences of the interest limitation proposals
  • A coming clampdown on the fringe benefit tax rules around twin cab utes
  • Inland Revenue updates its advice on non-cash dividends

Transcript

Having pored over the 143-page discussion document on the interest limitation proposals for the last few weeks and discussed them with colleagues, the summary position I’ve reached is that the Government should be very mindful that there will be some unintended consequences, and it should therefore be prepared to fine tune its proposals.

In particular, two issues seem to be emerging. One is that the interest limitation rules and the proposals to allow an interest incurred in relation to new bills, may mean that the trend which was causing concern of first home buyers being squeezed out in favour of developers and investors with access to plenty of assets and therefore leverage, is probably going to accelerate.

Developers and investors are able to outbid first home buyers for vacant plots of land or buildings where a single home might exist now but has potential for it to be converted into two, three or more dwellings. Given that under the new build proposals, interest deductions will continue to be allowed for building additional dwellings the likelihood of first home buyers being able to buy vacant land, put a building on it and move in is likely to be diminished. They’re simply going to be outbid by those who have access to greater access to finance. And I think that trend will be accentuated by these proposals.

That probably is not an intended consequence, but as in taxes everywhere, unintended consequences are often in play and the housing market is probably one where the unintended consequences of decisions taken 30 or more years ago have now come home to roost with a vengeance.

And the other unintended consequence I believe is going to come about, is that the burden of these proposed changes will fall on a group that aren’t really its target. And they also happened to be the least equipped to manage the level of detail and compliance that will be expected. And this group here are the is the so-called mum and dad investors, people who have one, maybe two investment properties which represents their retirement fund.

This is a group of people who are not really in the Government’s target, they’re not the larger investors who are able to have been able to leverage up significantly and outbid first home buyers. These are people that have decided to purchase investment property for their retirement. Or it may be that a couple have formed a relationship and they’ve moved into one property and rented out the other property,

Whatever their circumstances, this is a group that’s going to face a significant amount of compliance going forward, and for very little reward for the Government I would add, either politically or in terms of actually improving the housing market.

It seems to me the Government ought to think seriously about an exemption for such a group. Maybe to say that holders of one investment property are exempt or the rules only apply above a threshold.

Currently, the average rental income in the country is about $25,500 dollars a year. Maybe if the gross rental income is, say, $30,000 dollars or less the rules won’t apply.

Alternatively, if the Government still wants to remove this tax anomaly of a full interest deduction for a partly untaxed return in the form of capital gains, it could then say only 50% per cent of the interest is deductible. By the way that was something a previous guest John Cantin suggested could be an option. It would be a more straightforward option.

The thing that has been interesting when dealing with the discussion document proposals is that although the concept of denying interest deductions seems straightforward in itself, what has been really revealing is the level of detail we’ve had to work through, particularly in relation to the new build exemption.

The complexity means tax agents like me, other advisers and individuals are now at a greater risk of getting their tax returns wrong – for example incorrectly calculating the proportion of interest that’s deductible.  Greater complexity means a greater likelihood of something happening and a client suing for negligence. It could be that professional indemnity insurance premium premiums rise as a consequence.

But anyway, both advisers and those affected by this would want to see the Government think hard about making the proposals less onerous from a compliance perspective.

Submissions close on Monday the 12th. As I have said previously, be constructive with your submissions. The Government isn’t going to listen to people moaning that these are terribly unfair. That’s a fact of life. These submissions will be considered by Inland Revenue, and we’ll know more in about four to six weeks when the final form of the proposals is released together with the draft legislation. It’s a tight timeline because all of this is meant to be in place by 1st October.

Fringe benefit tax

Moving on, the issue of twin-cab utes and FBT is back in the press with Minister of Revenue, David Parker, saying he was considering a clampdown on the fringe benefit tax rules. He has apparently received advice on how twin-cab utes were being taxed and he has confirmed that he was considering acting on it.

Inland Revenue advice was that there is no exemption to twin cabs, which I’ve previously discussed. And that’s correct, even though there’s a popular belief there was one. What Inland Revenue believes is that the existing rules aren’t being properly enforced, which is also my conclusion.

The astonishing thing, though, is that Inland Revenue went on to say it wasn’t so keen on chasing down this matter because it wouldn’t bring in much money. David Parker said, quote, “Inland Revenue advised me that it’s not as big an issue relative to other enforcement priorities. But we’re having a look at the issue because they are proliferating.”

There are two points to be made about this. Firstly, Inland Revenue has a duty under section 6 of the Tax Administration Act 1994 “to protect the integrity of the tax system.” including people’s perception of the integrity of the tax system.

So a public statement making it known that it really didn’t feel that this was a big issue sends completely the wrong message about enforcement for myself and other tax advisors and those conscientious taxpayers, the vast majority of which want to follow the rules. Inland Revenue basically saying,” Well, we’re not really bothered about this”. In the context of an $85-billion annual tax take saying an extra $100 million a year isn’t that significant may be true, but it does nothing for the integrity of the tax system to say so.

The other thing in here which David Parker has picked up on – he is also the Minister for the Environment – is that the climate change policies are undermined by not enforcing rules around twin-cab utes. These are high emitting vehicles and the Productivity Commission noted we are importing higher emission vehicles relative to what’s available in the rest of the world. In other words, New Zealand has become a bit of a dumping ground.

And so if we’re tackling emissions, reducing emissions is an ongoing job and in that context, not enforcing the FBT rules makes that job harder. Transport emissions are one area where New Zealand can make progress in reducing its emissions. Leaving aside the issues around reducing methane emissions from our agricultural sector, we can certainly do more in improving emissions from the transport sector.

So it will be interesting to see how this plays out. Inland Revenue I think will be upping the ante on this. Get any group of tax advisors together and we’ll all have stories about some of the abuses we’ve seen. Like Inland Revenue previously photographing or sending someone to watch popular boat ramps and boats being launched at the weekend, just to see whether a purported company vehicle was being used in a private capacity. Apparently one such boat launching ramp in Gisborne was opposite the Inland Revenue office and one company after a few weeks got a call from Inland Revenue asking if they were, in fact, correctly reporting FBT.

Transfers as ‘dividends’

Moving on, Inland Revenue has this week released a number of Interpretation Statements which give its view of how the law operates. One that people should pay particular attention to is Interpretation Statement 21/05 on non-cash dividends. Now, what this does is consider when a transfer of value from a company to a shareholder is treated as a dividend for tax purposes. These are sometimes also referred to as the deemed dividend rules.

The Interpretation Statement wisely, in my view, focuses on the type of non-cash transactions that are often entered into between small and medium companies and their shareholders. Now, sometimes FBT picks up some of these issues, but other times they don’t. A common example of a non-cash dividend would be a loan from a company to a shareholder.

So what the interpretation statement does is set out a number of examples of how these rules might work. For example, there’s a banana company which provides one of its shareholders with a large number of fresh bananas. That is a dividend. Another example would be the shareholder owes the company money and the company forgives the debt. That’s another as a dividend or a telecommunications company provides one of its shareholders with telecommunication services for free.

The interpretation statement works through various scenarios like this and clarifies which are dividends together with the rules for calculating the dividend and when the dividend is deemed to have been paid.

It’s actually a very valuable document.  It’s also quite astonishing to realise it is in fact an update of a previous item on deemed dividends which dates from March 1984. I know Inland Revenue has got a lot on its plate, but it is a bit of a surprise to see it taking 37 years to update this sort of matter.

Anyway, the interpretation statement is out there. So people should be more aware of this deemed dividend issue. It obviously indicates that this is one of the areas Inland Revenue is looking at. They have, in fact, been quite interested in the area of shareholder advances, that is loans from the company to shareholders for some time. So this Interpretation Statement should serve as a warning.

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 āno!

Inland Revenue’s extensive powers of collection and its use of deduction notices

10 Feb, 2020 | The Week in Tax

  • Inland Revenue’s extensive powers of collection and its use of deduction notices
  • Triggering a dividend through misunderstanding tax implications of transaction
  • Terminal tax payment options

 

Transcript

As the recent story about the arrest of a student loan debtor at the border revealed, Inland Revenue has quite extensive powers to chase debt.

One of the powers it uses very frequently but which is not particularly well known, is the power to request require a person to deduct money from a payment due to another person and pass it through to Inland Revenue.

These ‘Deduction notices’ are issued under Section 157 of the Tax Administration Act 1994 and Inland Revenue makes quite extensive use of them. In the year to 30 June 2019, for example, nearly 57,000 taxpayers had deduction notices issued against them. Now these notices are usually issued to banks and employers, but the object of today’s discussion is that they can be issued to other persons such as customers and suppliers.

I recently came across one such case. A client approached me and advised they had fallen behind payments on their PAYE.  This is a not untypical story. Cash flow suddenly dries up, but you still have to pay PAYE and GST.  The amount owed was under $50,000 and was not what I would regard as terribly significant, certainly compared with other cases I’ve handled.

So, it was still at the stage where a discussion with Inland Revenue could have produced an acceptable payment plan for all concerned. But as I often see in cases like this, taxpayers put their head in the sand. And in this particular case there were some tragic personal circumstances developing which meant that the owner was understandably not quite as tuned into what was going on as he perhaps should have been.

What Inland Revenue did was it issued a deduction notice to one of his customers which said was ABC owes us $X and we require you to deduct $Y from any payment that you are to make to him. Now, can you imagine if you are a business and you receive a notice that one of your customers is behind on their tax? What are you likely to do? You’re likely to be concerned about your own payment schedule.

What happened for my client was that his customer took the decision to restrict the amount of work it was going to give in the future, effectively wiping out my client’s margin. And that will probably be the death knell for my client’s business.

Issuing a deduction notice is quite a big step. As I said, it involves going to a third-party supplier and saying basically this customer is in trouble. So, naturally the recipient of such a notice will take steps to protect themselves. It’s also, you could say, a massive breach of privacy, but you could probably also make a counterargument that businesses don’t want to be acting as unpaid bankers for other businesses that are struggling.

Now, the issue that has emerged in this instance is that Inland Revenue did not follow its own procedures.  When we asked for a copy of the deduction notice in question Inland Revenue did not have it on file. This was a “manual notice” and Inland Revenue don’t issue many of these. For the year to June 2019, there were some seventeen hundred such notices issued, according to an Official Information Act request I made to Inland Revenue on the matter.

Generally speaking, Inland Revenue’s processes around the use of deduction notices require that the debt must have existed for 12 months before they take what is a fairly extreme step. That wasn’t the case either for my client. These cash flow issues had emerged quite recently.

So, we have an issue here where Inland Revenue haven’t followed the procedures at all. Furthermore, no attempt appears to be made to try and organise an arrangement plan, and after the notice was issued no copy was actually sent to a client. Copies of such notices are by law meant to be sent to a defaulting taxpayer.

Now Inland Revenue needs to have powers to enforce debt collection, and it does have extensive powers. But those powers must be applied properly and in accordance with the law and Inland Revenue’s own procedures. And that didn’t happen in this case. And the consequences are that the business has been hit hard, basically losing one of its major customers. And that will probably be sufficient to put the company out of business. And as a consequence of that, Inland Revenue is possibly not likely to recover the full amount that it was owed. So, it will probably turn out to be a rather counterproductive action on its part.

Now there’s a fine line to be drawn between Inland Revenue making proper use of its extensive powers and abusing those powers. And in my view, Inland Revenue crossed that line in this case.  Of equal concern is the likelihood that it will bear no consequences for those actions. And that is simply wrong.

Tax assumptions

Now, moving on, you may have seen in last Saturday’s Herald a story about the unfortunate taxpayer who invested in a overseas exchange traded fund, and then had 33%, or over two thousand dollars deducted in tax when the fund was wound up.

Now, this is one of those situations involving unintended consequences which I see quite frequently. It so happened this week I encountered three similar cases where taxpayers had made assumptions about how a particular transaction would be taxed and then found out that wasn’t the case.

“It ain’t so much the things you don’t know that get you in trouble. It’s the things you know that just ain’t so.”  
(Artemus Ward is the nom de plume of Charles Farrar Browne sometimes regarded as America’s first stand up comic.)

And that quote probably should be written into the Tax Act, because that’s exactly what I see regularly.

All the problematic transactions I encountered this week involved companies. In each case, the New Zealand tax implications of the structure were either ignored or widely misunderstood. And as a result, the effect was to trigger a dividend and a substantial tax liability. Fortunately, we’re probably going to be able to manage the fallout from each of these cases.

Two of the cases involved companies with an overseas element.  Now, the provisions in the Income Tax Act around dividends are extremely broad and taxpayers frequently misunderstand how broad those provisions are.

The golden rule for any payment made by a company to a shareholder or an associate of a shareholder is that it is probably a taxable dividend and therefore withholding taxes may apply. Keeping that in mind would have saved my clients a considerable amount of bother. The warning is if you’ve got any transactions involving distributing money or changing shareholdings by using, say, the company to buy back shares as was attempted in one of these cases, you are likely to trigger adverse tax consequence.  I know it sounds like a plug for my services but get advice before you do so. And incidentally, watch out for any Companies Act implications because these were also overlooked.

And finally, Friday was the due date for payment of terminal tax for the year ended 31st March 2019. That’s for anyone who is not linked to a tax agent or who has had the extension of time arrangements available to taxpayers linked to tax agencies withdrawn.

Following up from my first story this week if you are having difficulties with making your payments today, get in touch with Inland Revenue and explain the circumstances and see if you can enter into an arrangement. Inland Revenue, believe it or not, is actually quite flexible around these issues and can be quite reasonable if approached quickly enough.

Secondly, another alternative is to use tax pooling to manage the payment.  Check out the podcast episode I had with Chris Cunniffe of Tax Management New Zealand about tax pooling.

For example, right now cash flow is tight for a lot of people in the wake of Christmas. But through Tax Management New Zealand, and other tax pooling entities, the opportunity exists to make use of their services and mitigate the impact of paying the tax late and reduce the interest payable.

Just finally, a quick note that people should be aware that as of 1st March, Inland Revenue will no longer accept cheques for payment of taxes.

Now the last time I looked cheques were still legal tender under the Bills of Exchange Act. And yes, cheques might be greatly inconvenient for Inland Revenue, but it is a government agency and a substantial proportion of its ‘customers’ (as it likes to call them), are elderly or either don’t actually make extensive use of, or are uncomfortable, using online payments.

So, I think the arbitrary withdrawal of cheques is something that should never have been allowed to happen. It’s discriminatory. Although I can see Inland Revenue’s point of view, if we are all now customers and as we all know the customer is always right, then if customers want to pay by cheque that should be good enough.

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.