What do the father and son landlords who own more than 100 homes say about our tax system?

What do the father and son landlords who own more than 100 homes say about our tax system?

  • Why does the New Zealand Superannuation Fund pay tax?
  • ACT’s updated alternative budget dials back its tax cut package

Last week The Post published a story about Roger and Shaun Nixon, father and son landlords who by The Post’s calculation owned at least 111 residential and lifestyle properties either in person or through a combination of trusts and companies. (In total across various entities and including commercial, industrial and retail properties the pair apparently own over 300 properties across the length of the country from Kaitaia to Invercargill, including properties on Waiheke Island and Omaha, where former Prime minister Sir John Key had a holiday home).

The story was produced as part of The Post’s Mega Landlords series, and I spoke to journalist Ged Cann on the question whether many of the homes in this property empire would ever re-enter the market for sale. As I explained, at the moment there are no tax incentives such as a capital gains tax or an inheritance tax (what we used to call Estate Duties), which could force the break-up of the Nixon’s holdings.

Estate and Gift Duties were first introduced in the 1890s, and were in part designed to provide a relatively good source of revenue for the Government, but they were also a means of breaking down large estates. The Liberal government of the time was concerned about accumulation of excess wealth and the related issue of inequality which drives a lot of discussion in this area.  Inequality will exist in any society, no matter what the tax setting settings are. I think it’s a by-product of any modern capitalist society. Some people are extremely able to use their advantages of natural and inherited capital to make fortunes. And by and large, I don’t have a problem with that at all.

The question we should be addressing is how far we are prepared to accept inequality and what strains it puts on our social system. It’s a difficult question to answer. We have seen a rise in inequality since the 1980s and the end of the post-war consensus where higher taxes were seen as means of equalising society. And I spoke to Ged about one of those tax tools used, Estate Duty which disappeared just over 30 years ago.

Estate and Gift duties were quite a substantial part of the tax revenue for New Zealand governments for a long period of time after the 1890s, right up until probably the turning point with the election of the First National Government in 1949. For the year ended 31st March 1949 the total amount of land tax, estate and gift duties amounted to just under £7 million of the government’s £130 million revenue. In other words, it was the equivalent of 5.3% of the total tax take for that year. If you were to project that forward, it would be the equivalent of $5.7 billion using the June 2022 numbers. So, these taxes were a very significant proportion of past governments’ revenue.

Whatever happened to Estate Duty?

Starting with the election of the First National Government the exemptions from Estate Duty were widened. This started to undermine the theory we’ve often discussed here and which I strongly support, of a broad based, low-rate approach to taxation. The broader the tax base, the lower the tax rate you can apply. And to a large extent this was the case with estate and gift duties.

But what happened was that exemptions for Estate Duties (and Land Tax) began to be expanded. And therefore, as the exemptions expand, the tax base is narrowing and then the tax take starts to fall away. And gradually, over time, the numbers diminished to the point of insignificance. Land tax was abolished in 1990 and Estate Duty reached its end point in 1992. Gift duties, for whatever reason, lingered on until 2011, before they went on the not on reasonable grounds that the barely $2 million revenue collected was far outweighed by the compliance costs.

The question that should come up is whether, in fact, the abolition of Estate and Gift Duties was a wise move on two points, firstly for maintaining a broader tax base. And secondly around this question of inequality, because Estate Duties are something that can hit estates very, very hard particularly where perhaps too much is tied up in illiquid assets, such as property. This is something I’ve seen quite a lot in the UK with the effect of what is now called Inheritance Tax.

To repeat a point I have made before, the absence of Estate and Gift Duties makes our system unusual because we don’t have a capital gains tax. (We’ve also removed stamp duty although by and large, tax theory has that stamp duties are pretty inefficient taxes. Still, they linger on everywhere else). So, we have no taxes which could be part of breaking down large estates. We have to accept whether that’s a good or bad thing.

Following IAG’s move do we need to broaden our tax base to deal with climate change?

My view is that we ought to be thinking about the question of broadening our tax base. And in that context, I’ve been thinking quite a bit on this question of estate and gift duties, because this week there was another reminder of an issue I keep raising – the growing costs of dealing with climate change.

The insurer IAG announced this week it will not offer ongoing insurance for properties in Category 3 of the Government’s Land Categorisation framework for regions affected by the floods earlier this year.

The cost of the property damage this year by those events is currently several billion and climbing. Of course, property owners are the persons that are most closely affected.

One of the doubts I have about National’s proposed foreign buyers tax is about the type of properties foreign buyers are likely to be purchasing. In Auckland, there is a growing number of suburbs where the average price is $2million. But foreign buyers aren’t necessarily wanting to buy a rundown villa in Grey Lynn or Devonport, they’d probably be looking at flashier properties in coastal areas. However, these coastal properties could now be more exposed to climate change which could be a factor in them deciding not to purchase.

Of course property owners, maybe including the Nixons, have already been affected by climate change and if they are struggling to insure their properties, they will be looking to the Government for assistance with this. And so it seems to me we are rapidly reaching a break point because we’re not taxing capital and property in particular. This is going to create a huge issue between those on one hand who have property and want government assistance when their property is flooded out or damaged beyond repair and insurance is limited or not available. On the other hand, there is a group who don’t have property and can’t get onto the ladder, who will, through their taxes end up paying for the former. This dichotomy sets up a whole social strain, which I don’t think we really want.

To repeat, the thing about this story of the megalandlord Nixons is how it illustrates to me this dilemma we have created around the taxation of capital and the preference for property as an asset class.

So why is the New Zealand Super Fund taxed?

There were some very interesting responses to last week’s commentary about the New Zealand Superannuation Fund’s (“the Super Fund”), retiring CEO Matt Whineray’s remarks on the fund’s tax status. (Thank you again to all my readers and listeners for your contributions). The question was asked, ‘Well, why does it pay tax?’ The answer, as I indicated in last week’s podcast, it was designed as such when the Super Fund was being set up prior to when it actually started investing 20 years ago this month.

As part of the creation of the Super Fund, Treasury produced a number of papers in 2000. A key paper is Pre-funding New Zealand Superannuation from June 2000.

It noted

“There are two main issues surrounding the tax status of the proposed super fund. The first of these is the tax avoidance opportunities that would be created if the fund was tax-exempt. The second is whether poor incentives would be created regarding investment behaviour.

…By making an entity tax exempt, the government effectively gives it an asset that it can trade with taxable entities. Current tax-exempt organisations such as charities have engaged in complicated schemes to take advantage of this kind of opportunity. …

We consider that making the fund tax exempt will create an opportunity for this kind of avoidance activity.”

The driving force of this paper was concern that giving the Super Fund tax exempt status would give it poor incentives. And so, the fund was set up on that basis. (It’s also interesting to note that the paper assumed the Super Fund would be contracting out most of its fund management activity.  However, as we know, the Super Fund is now one of the largest fund managers in the country).

Changing the FIF rules

Back when the Super Fund was being established the tax treatment under the foreign investment fund regime was very different. There was what we call a “Grey list” that applied to investments in several countries such as the US, Australia, UK, Germany, Japan and others. Investments here were only taxed on dividends and capital gains would be taxed under the normal rules, similar to those we have now for investing in Australia and New Zealand. The amount of tax payable on these investment would not have been quite significant under those rules.

However, in 2006, proposals were introduced establishing the current Foreign Investment Fund regime which took effect from 1st April 2007. Now, the interesting thing is that I cannot see any commentary or submission to the Finance and Expenditure Committee by the New Zealand Super about the changes, although there’s plenty of commentary from the Corporate Taxpayers Group and others. As I mentioned last week, some 3,400 submissions opposed the changes, and only two were in favour. So of course, the measure went ahead.

From that point the New Zealand Super Fund started to pay a lot more tax. (In the year to June 2008 the fund had a loss of $704 million but had a net tax bill of $164 million because of the changes to the FIF regime). The effect of the FIF regime was described in a submission the New Zealand Super Fund made in 2018 to the last Tax Working Group. It said it would like to be tax exempt because as I noted earlier it’s the only sovereign wealth fund in the world which is taxed. Its tax status also creates some issues when it is investing overseas. In support of tax exempt status, the submission (signed off by then acting CEO Matt Whineray) noted.

“The fund’s tax position can be volatile depending on the performance of the fund and the contributors to that performance. This is often illustrated by our effective tax rate. For example, our effective tax rate was 3% in 2015, 96% in 2016 and 20% in 2017. The main driver of this volatility is how our physical global equities are taxed under the fair dividend rate regime. In simple terms, this means that in any given year, if our return in global equities exceeds 5%, then our tax rate will be lower than 28%. And if our returns are less than 5%, then our tax rate will be higher than 28%.”

Another interconnected issue for the Super Fund is that as so often is the case, I think Governments rather like the tax revenue from the Super Fund. However, as the Fund’s Tax Working Group submission noted if it was tax exempt it would not be forced to sell assets to pay “the Government provisional tax with the Government then turning around to pay the Fund contributions, thereby removing the need for practical work arounds in terms of offsetting provisional tax”.

As I said, way back in 2000 when they were considering the tax status of the New Zealand Super Fund, the FIF regime was very different. And I wonder whether if they had foreseen the impact of the FIF regime that was introduced from 2007, whether they might have rethought the decision to tax the Fund.

ACT Party dials back its tax cut package

And finally this week, the ACT Party has updated its Alternative Budget https://assets.nationbuilder.com/actnz/mailings/6681/attachments/original/ACT_Alternative_Budget_-_End_the_waste__fix_the_economy.pdf?1695252857 in the wake of last week’s PREFU release. Basically, in its view the state of the books means it has to dial back its tax cuts package.

ACT’s original proposal

Act is now accepting that cannot happen but instead the top rate from 2026 will be 33%. What it has also said, and this is interesting, is that the top 39% rate will remain until then.

One of the proposals in ACT’s “Alternative Budget” is the Government will stop making contributions to the New Zealand Super Fund. But what won’t change, however, is the tax status of the fund, and it will still be taxed.

Now the ACT numbers are quite detailed, and they note that the expected tax revenue from the New Zealand Super Fund will actually drop by about $100 million over the three years to June 2027 period because of lower Government contributions. (Incidentally, in measuring debt-GDP ratio ACT’s Alternative Budget excludes the $65 billion value of the NZSF which rather unfavourably distorts the ratio).

ACT also proposes winding back the KiwiSaver member’s tax credit (the Government contribution you receive if you make contributions of at least than $1,043 a year), for higher income earners. Instead, it will be capped at 5% of a participant’s taxable income. The maximum subsidy amount will reduce by 3% per dollar of income above $48,000, reducing to zero by around $65,000.

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.

Taxation Principles Reporting Bill

Taxation Principles Reporting Bill

  • New Digital Services Tax Bill
  • National’s tax policy launched

It’s been a busy week in the tax world. The Taxation Principles Reporting Bill passed its third reading in Parliament and very shortly will receive the Royal assent. Now this was the bill introduced at the time of the May Budget, the purpose of which was to provide a statutory reporting framework and required the Commissioner of Inland Revenue to provide the Minister of Revenue with an annual report on the operation of the tax system.

This report would outline aspects of the tax system against a set of tax principles such as equity, efficiency and certainty. As commentary provided by Inland Revenue to the Finance Expenditure Committee noted. “These principles are often considered when designing changes to a tax system”.

Tax being political the Government also wants this bill to

…help improve the public’s understanding of the tax system and encourage informed debate about its future. New Zealand has seen several Tax Working Groups and Committees over the last 20 years, with the most recent being the 2019 Tax Working Group These reviews have offered useful insights into the operation of the tax system and suggestions for improvement. These reviews have also highlighted areas of the tax system where information is lacking, which makes a fully informed debate on some aspects of the tax system more difficult.

The bill requires the Commissioner of Inland Revenue to prepare and publish an annual report which considers the tax system measured against the principles included in this bill.

Generally speaking, the principles in the bill are well established. The Inland Revenue commentary references the tax principles made in all three of the reports this century, the McLeod Report in 2001, the Victoria University Tax Working Group Report in 2010, and finally the most recent Tax Working Group in 2019. They all used and refer to basically the same principles of taxation.

What will happen is Inland Revenue will produce a short form report annually with a full report every three years. The first full report will be produced in 2025 with the shorter version reports produced in the interim years starting later this year. The intention is to align the requirement for this report to be produced the second calendar year of each parliamentary term.

There’s been some discussion around whether we need this bill and how does it sit within the Generic Tax Policy Process (GTPP)? You could say it’s an extension of the GTPP and of course, it does mean that we can have a look at some of the tax policies that have been put out by the various parties and compare them against the principles set out in this bill. And I’ll be doing that a little later on. The politicians may find this new bill is something of a double edged sword.

A Digital Services Tax just in case…

It so happens a digital services tax bill was introduced on the last sitting day of this parliamentary term which is a bit of a surprise. Digital services taxes (DST) have been talked about for some time but have generally not been brought into effect. They’re obviously not favoured by the targets, the digital giants such as Google and Facebook. But they are a tool that many governments around the world have been considering implementing.

The ongoing OECD Pillar One and Pillar Two negotiations are intended to eliminate the need for these taxes. In fact, it’s a condition of the introduction of the OECD model that any digital services tax in effect would be repealed.

The Government’s actually been looking at a DST for some time. There was a discussion document back in 2019 on the topic. That said, it still was a bit of a surprise to see this bill pop up at this particular time. Arguably, you could see it as a bit of politicking. The key thing is the Government is already committed to not introducing a DST until 1st January 2025 at the earliest. Now Inland Revenue and Treasury have said it will be handy to have the legislation ready just in case the OECD deal falls over. So that’s a reason given for this bill being introduced now.

The DST would target multinational multinationals with global revenue in excess of €750 million per year from digital activities and New Zealand revenue from these activities which exceeds $3.5 million per year. The DST taxes the revenues rather than the profits, because then it doesn’t require trying to establish a connection with a multinational’s physical presence in New Zealand. The rate to be proposed is 3%, pretty standard compared with others around the world.

This bill is a more fallback measure and it’s interesting to see where it stands that they’ve made this move now. But many countries have DSTs, Britain is one, France another and India is probably the biggest exponent of them. And as I said, the Government’s basically saying, ‘We want this in our back pocket in case the OECD Pillar One and Pillar Two deals fall over.’  These are still very much up in the air for discussion, as we’ve mentioned in previous podcasts.

National unveils its tax policy

But the big news this week would have been the launch of the National Party’s tax policy on Wednesday, and it landed with quite a thump and contained quite a few surprises. National had already signaled well in advance that it proposes to increase thresholds by 11.5%. As regular listeners to this podcast will know my view is tax threshold increases are long overdue.

What about Working for Families abatement?

National has an identical proposal to that of Labour to increase the Working for Families In-Work Tax Credit by $25 to $97.50 per week starting next April. There’s a commitment that the current $42,700 abatement threshold for Working for Families will rise to $50,000 from 1st April 2026. This is also a Labour Party commitment.  But as I said to a number of media outlets, the problem is that the Working for Families abatement threshold already kicks in at very low level and in fact if they had been adjusted for inflation since the last adjustment in July 2018, it would now be $51,800.

Both parties promising to raise the threshold to $50,000 in three years’ time is frankly a little off in my view. It just compounds the problem these families at the lower end of the income scale face with what we call high effective marginal tax rates because of the abatement level of 27 cents per dollar above the $42,700 threshold. This issue isn’t being addressed but instead the can has been kicked down the road.

But on the other hand, there is the proposed FamilyBoost childcare tax credit, which is worth up to $150 per fortnight for couples with childcare costs. This will be no doubt welcome, but the trade-off is the loss of the proposed extension of the Early Childhood Education subsidy that Labour included in its May Budget.

All good but how are you paying it?

In fact, the controversy around National’s plan has broken out over how it’s going to fund this program and of these proposed tax adjustments. There are several surprises here, the first of which was this proposed foreign buyer tax. Currently no one who does not have permanent residency can buy property.  National are proposing to keep that in place for properties worth less than $2 million, but to allow properties worth more than $2 million to be purchased. But that would be subject to a 15% tax, which sounds a bit like a stamp duty. We haven’t had stamp duty, by the way, since 1999.

The controversy is around the numbers involved, which do seem very optimistic. Revenue of $700 million a year would imply sales of at least $6 billion in property. I’ve seen a report in the New Zealand Herald which suggests that actually something like 60 to $65 million is more reasonable. But the proposal also runs up against questions that certain of our double tax treaties and trade agreements have clauses that would not allow such a clause to be a tax to be introduced, notably Singapore and Australia.

But now it’s been pointed out that what we call non-discrimination clauses in double tax agreements may apply to this. In which case these income assumptions of tax revenue would be well short.

There is a proposal to close an online casino gambling tax loophole as its described. This would require offshore operators to pay GST and register and report their earnings for tax purposes. The suggested penalty for non-compliance would be IP geo blocking of services. It subsequently emerged that the Government got $38 million in online GST for the year ended 31st March 2023. This is a result of the so-called “Netflix Tax” which, ironically, was introduced by the National Government in 2016.

National assume the measure will raise $180 million, and I admit I raised my eyebrows when I saw that suggestion. This seemed high to me particularly when I considered that the proposed DST I mentioned earlier is expected to raise about $55 million a year. Online gambling would seem to be a similar type of activity, if not quite identical, so assuming they’re going to raise 2 to 3 times as much as a DST struck me as optimistic.

National Party documents seem to be saying this is essentially a corporate income tax. In which case, it appears this particular tax could also be caught by the anti-discrimination articles in double tax agreements. And that could mean a $140 million shortfall in National’s projections.

Good news for singletons…ironically

On the other hand I do think the proposal to increase the Independent Earner Tax Credit threshold to $70,000 from its current $48,000 is a good initiative. I’ll be honest, I was a bit surprised that Labour didn’t think to do something similar as part of its budget earlier this year. But there is actually a little bit of an irony in that this Independent Earner Tax Credit was actually going to be abolished by National under the last budget it published in May 2017. But that measure never went through because of the change of government later that year.

A counter-productive proposal and more irony

But I think one of the measures that should attract more controversy, is the proposal to remove depreciation for commercial property which includes factories. Now this is something that Labour have also proposed to pay for the proposed removal of GST on fresh and frozen fruit and vegetables.

This is a counterproductive move in my view. The proposal refers to “commercial building” but  the depreciation deduction covers all sorts of property such as factories, farming sheds etc. These all depreciate. It was recognised by the last tax working group, that depreciation on commercial and industrial buildings should really be re-introduced, introduced and is actually quite common around the world.

A measure that takes it away seems to be counterproductive particularly if we’re talking about encouraging investment in productive assets. There’s also the added irony that this would be the second time that a National government had removed that depreciation to pay for tax cuts.

Overall there’s an awful lot to pick apart here and the devil is always in the detail. This does seem to point to the revenue forecasts being on the optimistic side, certainly in relation to the foreign buyer online gambling taxes.

Good news for landlords…mostly?  

On the other hand, there was also no surprise about the reintroduction of interest deductibility for residential properties. But what is interesting about this move is that’s it’s not simply being fully restored as of a change of government. What’s proposed is for it to be brought back in over a two-year period from 1st April 2024. At present the proportion which would become non-deductible is due to rise to 75%. Instead it will stay at 50% non-deductible and then starting 1 April 2025 the non-deductible proportion will year drop down to 25% before becoming fully deductible with effect from 1st April 2026.

Reducing the bright-line test back down to two years will be welcome for a lot of people. The unintended consequences arising from the extension of the period to first five and then ten years were giving me and plenty of other advisors a lot of work as we try to unpick where the boundary was, and what transactions were caught. So that’s probably quite welcome.

On the other hand, there’s a surprise that nothing has been said about allowing losses from residential property investment (“loss ring-fencing”) to again be offset against other income. This hasn’t been allowed since 2019. It also appears that the proposed increase in the trustee tax rate to 39% will still go ahead. I had heard whispers to that effect, and although there’s been plenty of pushback on the proposed increase it will be interesting to see what eventually emerges.

Now about those Tax Principles…

Having just got a new Tax Principles Reporting Act in place, it is interesting to compare the principles set out in there against these policies. You’d have to say for now, not entirely a big pass. Indexing the thresholds is a reasonable measure, as I said, but that’s a minor point. The tax on foreign homebuyers probably could be said to be questionable in terms of equity. Why should one group of people suddenly get a far higher tax charge than other groups of people in reasonably similar circumstances.

The removal of depreciation for commercial and industrial buildings doesn’t seem to fit with the tax principles. And since we’re talking about things that wouldn’t pass that bill, I’d have to say removing GST on fresh and frozen fruit and vegetables wouldn’t pass muster either.

Sucks to be a student…and an Auckland ratepayer?

But to summarise, tax is politics, so we can expect plenty of politicking. There’s no doubt that the tax relief in terms of the changes in the thresholds will be welcome, but there’s going to be quite a few losers as well. Following the announcement I spoke to a student radio station in Christchurch who were wondering about the impact for students. The answer was not very much and if the proposal to remove the 50% discount on public transport goes ahead, students would be worse off as a consequence.

Auckland ratepayers are also probably worse off with the proposed abolition of the Auckland Regional Fuel tax. Mayor Wayne Brown has already said that could mean a $2 billion funding shortfall. How is that gap going to be funded?

Overall National’s proposals are very much a sort of the Lord giveth and the Lord taketh. And where you sit on that spectrum depends on how well you end up. If you’re a landlord and high-income earner, and you don’t use public transport, you’ll be reasonably okay.

On the other hand, if you’re on lower incomes, perhaps receiving Working for Families income and you do use public transport, you’re going to be worse off. But this is politics, the electorate will decide in six weeks exactly which tax policy is fair.

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.