The IMF suggests a CGT and gets rebuffed.

The IMF suggests a CGT and gets rebuffed.

  • Bright-line test red flags
  • How to tax wealth
  • IMF and Climate Change Commission suggest changes to the Emissions Trading Scheme are needed.

Like a never-ending Groundhog Day, every International Monetary Fund report on the New Zealand economy suggests tax reforms would promote efficiency.  For example,

“There is a sense that the asset allocation in New Zealand households has a bit too much emphasis on housing versus other investments. We think a capital gains tax at the margin would help.”

That was IMF Mission Chief Thomas Helbling in 2017.

This year, the IMF Mission noted:

“…tax policy reforms are needed to promote investment and productivity and growth increase, increase the progressivity of income tax and mobilise additional revenue in response to long term fiscal challenges. To achieve these objectives, reforms should combine comprehensive capital gains tax, land value tax and changes to corporate income tax.”  

And invariably the IMF’s conclusions are usually followed by a fairly dismissive response from the Minister of Finance of the day.

In 2002 it was the late Sir Michael Cullen responded to that year’s report: “The IMF’s credibility is not assisted by the fact that it tends to apply the same policy template regardless of the country’s circumstances”.  This year Nicola Willis’s retort was “There are some things that are certain in life, death, taxes and the IMF recommending a capital gains tax.”

Associate Minister of Finance David Seymour also weighed in commenting. “I see the IMF again saying, oh, you need a capital gains tax. Every country has one. The only countries that don’t have one are New Zealand and Switzerland. But I say let’s be more like Switzerland.”

However, I’m not so sure that this was quite the zinger he hoped because as someone mischievously pointed out on Twitter, Switzerland has a wealth tax and a $59 per hour minimum wage in Geneva.

Deputy Prime Minister and former Treasurer Winston Peters was apparently not available for comment.

de-facto capital gains tax – the bright-line test

Now, amidst all of the commentary about the IMF’s suggestions, one of the things that came up time and again is that in many ways, we do have a de-facto capital gains tax, except we don’t call it that.  The bright-line test is an example of the approach that we’ve adopted, which has been ad hoc and responsive based on the government of the day’s policies at the time.

As you may recall the bright-line test was brought in with effect from 1st October 2015 by the National Government and it then applied to disposals within two years. In March 2018 the Labour Government introduced a five-year period and in 2021 it was increased a 10-year period. And so, a quite confusing scenario has developed as to which bright-line test applies because some of the exemptions have changed over time as well, particularly in relation to the main family home.

In one way, therefore, the reduction of the bright-line test back to two years again from 1st July is to be welcomed because it is clarifying and simplifying what has become an incredibly complicated area.

Tax Red Flags: More than just the bright-line test to be considered

The bright-line test and taxation of land has plenty of red flags when together with the excellent Shelley-ann Brinkley and Riaan Geldenhuys and moderator Tammy McLeod, I made a presentation about tax red flags on Tuesday to the Law Association. (Formerly the Auckland District Law Society). My thanks again for the invitation to present and to my excellent co-presenters, we had a very lively session talking around this.

In short when you drill into our current land taxation rules, they are very incoherent. The bright-line test is a backup test. It applies if none of the other land taxing provisions apply. And this is something that tripped up people before the bright-line test was introduced and will continue to do so even now it’s been reduced down to two years.

For many people, the particular issue to watch out for is the question of subdivision. If you own a property and undertake a subdivision within 10 years of acquisition it may still be caught under the existing rules, outside of the bright-line test. And in some cases, you may be caught by the combination of the provisions with the associated persons test which deem transactions to be taxable if at the time you acquired the land you were associated with the builder, dealer, or developer in land.

Sometimes the tax charge can be triggered way past the 10-year timetable since acquisition.  That’s particularly the case in relation to a disposal of property where building improvements have been carried out. That particular provision, section CB 11 of the Income Tax Act, deems income to arise if a person disposes of land and

 “within 10 years before the disposal”, the person or an associate of the person completed improvements to the land and at the time the improvements were begun, the person or an associated person carried on a business of erecting buildings. Note, the reference to “within 10 years before the disposal.”  So, you may have owned that land for considerably longer than 10 years and yet still be subject to the provision.

Just a pro tip for anyone thinking ‘Great, with a two year bright-line test coming in, I can now sign a sale and purchase agreement, make sure settlement takes place after July 1st and it’s not going to be subject to the bright-line test.’ That’s not the case. The sale point for the bright-line test in that case is when the sale and purchase agreement is signed and not when settlement happens. I had at least one client get caught by that very provision because they went for a long settlement thinking that got past the two year period. It didn’t, and it is another case of always seek advice on transactions involving land, because as I’ve just outlined, the provisions are complicated.

Could a capital gains tax be ‘simpler?’

And this was the point we reinforced during our seminar. There is a lot of complexity already in our tax system around the taxation of land and in my view, in some ways a capital gains tax would actually clear away a lot of that uncertainty. It’ll become clearer that, broadly speaking, if you buy something, and you sell it subsequently, any gain will be taxable.

Now, how the gain is calculated and the rate at which it’s taxed are two different things. But often in the debate around the capital gains tax, those two things get conflated to run as an argument against the taxation of capital gains.

In my view, the point still remains that we have a confusing hotchpotch approach to taxing capital gains and at some point, grasping the nettle with a CGT as suggested by the IMF and also the OECD, would ultimately perhaps be a better approach.

Incidentally, doing so would be consistent with the well-established principle we have of the broad-based low-rate approach. There’s nothing to say that by broadening the tax base, we could not hold tax rates at current levels or even lower. Bear in mind that the when the last tax working group recommended the capital gains tax, it was intended to keep to help keep the top tax rate at 33%.

Watch out for trustees on the move across to Australia

One of the other issues that came up in our Tax Red Flag Seminar was the question of trustees, and beneficiaries and settlors moving cross-border, particularly to and from Australia. That is something all three of us are seeing quite a bit of and it is something to watch out for as a key red flag.

The IMF on how to tax wealth

If there is a certain repetitiveness to the IMF’s discourse about taxing capital, it’s part of a global discourse on the topic. Earlier this month the IMF released a How to Tax Wealth note. These how to notes are “intended to offer practical advice from IMF staff members to policy makers on important issues.” And this this was a very interesting read as you might expect.

The IMF’s How to Tax Wealth note neatly coincided with the release of the UBS/Credit Suisse, Global Wealth Report for 2023. According to the report, in 2022 New Zealand ranked sixth in the world with an average wealth of US$388,760 per adult. On the basis of median adult wealth per adult, again in U.S. dollars, we ranked 4th behind Belgium, Australia and Hong Kong, with a median wealth of US$193,060.

Incidentally, these rankings were after a very sharp fall from 2021 levels, where New Zealand was only behind Sweden in the biggest loss in wealth per adult.

I am genuinely very surprised to see New Zealand rating so highly for both average wealth and median wealth.  On the other hand this Credit Swisse/UBS report is another example of why there’s a great debate going on around the taxation of wealth not just here, but globally.

And this IMF How to Tax Wealth note is instructive in its approach. It starts by making a very obvious point, how much to tax wealth is a distinct question from how to tax wealth. The note argues that:

“returns to capital generally should be taxed for equity and possibly efficiency reasons. and that in many countries, wealth inequality and better tax enforcement strengthen the case for higher effective taxation than in the past.”

Now the IMF doesn’t make any particular proposal about a specific level of tax, the note is basically about ‘here are things you should consider.’ But on the question of wealth taxes, it does come down pretty much against them noting,

“Improving capital income taxes tends to be both more equitable and more efficient compared with replacing them with net wealth taxes. Countries hence should prioritise improving capital income taxation over considering the introduction of wealth taxes”.

Then it talks about – in terms of strengthening capital taxes – addressing loopholes, notably the under taxation of capital gains in many countries. There’s a passing comment, that perhaps you can use a one-off net wealth tax or maybe apply it to very, very high wealth levels.

Time for inheritance tax?

But the Note also concludes “taxing capital transfers through gifts or inheritance provides another opportunity to address wealth inequality.” The IMF comments that the efficiency costs of such taxes are modest, and notes that “inheritance taxes are better aligned with redistribution than estate taxes, since exemptions and rate structures can account for the circumstances of the heirs.”

What really makes the New Zealand tax system unique is not the absence of a capital gains tax because, as David Seymour pointed out, other countries don’t have that, namely Switzerland. It’s the complete absence of taxes on the transfer of wealth, which has been the case now since 1992. That’s what makes New Zealand unique – we have no general capital gains tax together with no estate or gift or wealth taxes.

And this is an area where I think a lot more consideration needs to go into because as the IMF noted, we’ve got fiscal challenges ahead, and where might the revenue be raised from to meet those challenges.

The IMF and Climate Change Commission suggest changes to the ETS

And finally, back to the IMF again. It concluded its mission report by noting that “New Zealand’s ambitious climate goals call for major reforms,” and it referenced the Emissions Trading Scheme, having helped limit net emissions by encouraging robust reductions and removals, particularly from afforestation.

But the IMF then went on to say that “significant reforms” are going to be needed to meet domestic and international targets, and these include reducing the number of available units in the ETS, pricing agricultural emissions and strengthening the incentives for gross emissions reductions within the ETS. The IMF finally note that given the ambition of New Zealand’s first nationally determined contribution under the Paris Agreement, the use of international mitigation i.e.; buying credits from offshore, is likely to be required.

Now the IMF report was a week after the Climate Change Commission, and pretty much said the same thing, and advised the coalition government they should halve the number of ETS units on offer in each of the next six years. The last ETS auction did not go brilliantly. That has a flow on effect in that by reducing the amount of income from emission trading unit sales, it’s going to limit crown revenue for tax cuts.

Vale Rod Oram

It’s interesting to see a confluence of opinion happening here and an appropriate time to remember the late Rod Oram someone who was a very strong environmental journalist. I was fortunate enough to know him all too briefly after we met at a panel discussion. We’d planned on him appearing as a guest on the podcast. Sadly, with his passing that will never happen now, and our thoughts go out to his family and friends.

And on that note, that’s all for this week, I’m Terry Baucher and you can find this podcast on my website 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.

Greens wealth tax bombshell

Greens wealth tax bombshell

  • IMF suggest a CGT
  • Crypto-asset reporting
  • Auckland’s budget

The Greens announced their tax proposals a week ago, last Sunday.

 And my reaction was, “These are very bold.” They proposed major tax cuts at the lower end, meaning 95% of taxpayers will be better off under the Greens. Those cuts are paid for by increasing the top tax rate to 45% and increasing the 33% tax rate to 35% as well. These increases are part of the trade-off for the proposed nil rate band of $10,000, which no doubt will be very popular. As is well known, many other jurisdictions have something similar and given the fact that nothing has been done in relation to indexation of thresholds for well-nigh 13years now, it’s unsurprising that the pressure is built up, particularly at the lower end, to change the tax rates.

But most of that got swept away by the Greens controversial wealth tax proposal. In summary, there are two parts to it. Any individual whose net assets, net of mortgages for example, exceed $2 million will be subject to a wealth tax of 2.5% on the excess. For family trusts there is no nil rate band or threshold at all. It’s a flat 1.5% which is a deliberate anti-avoidance mechanism.

Latest Inland Revenue data on trusts

Trusts were used to avoid the impact of estate and gift duties in the past and are used in other jurisdictions to mitigate the impact of wealth and estate duties. So, the Greens have targeted this avoidance. Coincidentally, last Saturday the New Zealand Herald published a piece including details of the trust tax return filings made to Inland Revenue for the year end 31st March 2022 which indicated the value of assets held in trusts. The net assets of the 201,100 trusts which reported, was just over $300 billion. So at 1.5%, theoretically that’s $4.5 billion dollars straight up there.

Incidentally, what that Inland Revenue report doesn’t show is the non-reporting trusts, those are likely to be quite significant. We really don’t know how many trusts there are in New Zealand, the best estimates are somewhere between 500,000 and 600,000. Many of the non-reporting trusts don’t do so because they have no income, but they hold assets such as the family home. So, family homes that have been held in trusts may now be subject to the Greens’ proposal.

Now this kicked off quite a storm, which I watched with a little bemusement because the Greens first of all have to put themselves in a position of such leverage that its coalition partners, almost certainly Labour and Te Pati Māori, agree to the proposal. And then somehow between 14th October, the date of the election, and 1st April next year, the legislation to introduce all of this is drafted and passed through Parliament. So ,it’s a big challenge ahead.

But it caused quite a stir, and I fielded several calls from people concerned about what they saw here, trying to get an understanding about it and my views on it. At our Accountants and Tax Agents Institute New Zealand’s regional meeting on Tuesday we had a very lively debate around the question of this wealth tax.  Normally, a lot of the time we’re talking about what’s in the legislation and whether Inland Revenue ever answer their phones again. All this I think shows the impact of the proposals, even though in theory they affect only a small group of people, the top 1%.

But there is substantial wealth locked up in property. We know that from digging around the official figures. For example, Auckland Council estimates the rateable value for all property within the Auckland Council region will be over one trillion dollars as of 30th June. Obviously, not all of those would be subject to a wealth tax.

What’s being suggested by other parties?

But I thought it was interesting that people are taking the Green’s proposals very seriously. The income tax shift to 45% on income over $180,000 won’t be terribly popular. But at present, the proposals that they’ve put out for the income tax cuts would affect many more people and benefit many more people, all those earning under $125,000, which is something like just over 4 million people. This has a broader impact than either National or Act’s proposals.

It’s quite interesting now as the election comes ever closer, we can start to see the tax policies of the various parties taking shape. The Greens are raising a substantial amount of tax to deal with poverty. Act is proposing tax cuts and it’s taking the ideologically opposite approach of substantial cuts to spending in order to achieve its top rate of 28%.

TOP, The Opportunities Party, are putting out a policy which has a land value tax, and they also propose tax increases at the higher end together a nil rate band and also substantial tax cuts at the lower end.

We haven’t yet heard from Labour on what they would do.  Over on Twitter @binkenstein put together a graph comparing the various parties’ proposals so far.

So, the debate has ramped up quite a bit. Obviously, the Greens wealth tax is the most controversial part of it, but the other part which really got very little commentary but is equally controversial, was a proposal to raise the income tax rate for companies from 28% to 33%. More than most of the Greens’ proposals, that would probably produce a certain frisson of tension amongst multinationals. They may look and think “Maybe we might not increase our activities in New Zealand” or they may ramp up what they try and do under profit shifting.

Anyway, it all made for a very lively discussion all round. As I told people, wait and see. But it is interesting to see the pressure point for those are likely to be affected around a wealth tax.

What does the IMF think?

With almost impeccable timing, the IMF, the International Monetary Fund, were in town and it suggested that maybe it was time for a capital gains tax.

The Concluding Statement of the 2023 Article IV Mission noted:

Well-designed tax reform could allow for lower corporate and personal income tax rates by broadening the tax base to other more progressive sources, such as comprehensive capital gains and land taxes, while also addressing fiscal drag and improving efficiency.

It’s not the first time the IMF has suggested changing the tax system. They did so in 2021. In fact, there’s a regular pattern of the IMF and/or the OECD coming here looking around saying, “Well, guys, the country is in good shape, generally government policy is pretty sound, but you need to do something about capital gains taxes.”  Regardless of whichever party is in power the Government’s reaction is quite funny. They like the bit about everything being under control. But at the mention of capital gains tax, they all throw up their hands in horror. And yet, as we know all around the world, capital gains taxes are a common feature of tax policy.

The Crypto-Asset Reporting Framework, the latest expansion of the Common Reporting Standards

Now, the Greens wealth tax proposal will probably be music to the ears of the French economist Thomas Piketty, who has proposed a global wealth tax, as one of the core points of his monumental work, Capital in the 21st Century. And at the time of publication in 2014, the opportunities for that global wealth tax to ever eventuate were probably just about zero or maybe marginally above zero.

But since then, we’ve had the introduction of the Common Reporting Standards which I think is actually revolutionising the tax world quietly because an enormous amount of information sharing is now happening on. We know from what’s been reported under the Automatic Exchange of Information that there’s something like €11 trillion held in offshore bank accounts. The Americans have got their FATCA, the Foreign Account Tax Compliance Act, and as a result of that, they know that American citizens have got maybe US$4 trillion held offshore.

Now, the latest part of the Common Reporting Standards is extending the framework to crypto-assets and I talked about this last year when the proposals first came out. Those proposals have now been finalised and the Crypto-Asset Reporting Framework is now in place. There have also been some amendments to the Common Reporting Standards. I’m going to cover all these changes in a separate podcast because I think they’re worth looking at in a bit more detail.

The tightening noose of information exchange

But the key trend in international taxation that’s going on, which I think is going to have a long-term impact around the world, and particularly for tax havens, is this growing interconnectedness, the sharing of information that goes on between tax authorities through mechanisms such as the Common Reporting Standards. I asked Inland Revenue about what information they had been supplied under the CRS in relation to the numbers of taxpayers and the amounts held in overseas bank accounts. Inland Revenue turned down my Official Information Act request on the basis that much of this is obviously confidential, but also would be compromising to the principles under which the information is shared.

Now, I’m not entirely sure about that. I think the more openness we have about what is being shared, the better the likelihood of tax enforcement once people cotton on to what’s happening. They will not think “Yeah, well, I’m just going to leave it over in the UK or the US or wherever, and Inland Revenue will never find out.” My view, as I tell my clients, is they always find out and they know much, much more than you can imagine.

And outside of the CRS there appears to be a regular exchange of information about property purchases between the United States Internal Revenue Service and Inland Revenue here. So be advised, the Crypto-Asset Reporting Framework is just the latest in a building block of international information exchange.

The Auckland Budget – what about climate change?

And finally, the Auckland budget got signed off last week. I’ve been in the press disagreeing with the sale of any part of the Auckland airport shares, and I still stand by that. I think it’s a short-term fix for a long-term problem, but that’s now done and we move on.

What I did think was quite surprising as you delve into the budget is some of the numbers that come out. As I mentioned earlier, the rating base for Auckland and according to the Auckland Council’s documents is over $1 trillion.

But the thing that really surprises me, which wasn’t addressed in the budget so we’re going to have to address it next year, is the question of climate change. Towards the end of the process, the Government announced that in the wake of Cyclone Gabrielle 700 homes around the country are too risky to rebuild. The Government and councils will offer a buyout option to those property owners.

400 of those are in the Auckland region and apparently it doesn’t also take into account what is going to have to happen out at Muriwai because of the slips and the dangerous cliffs over there. As Deputy Mayor Desley Simpson pointed out, “If you say it’s 400 [Auckland homes] times $1.2 million, give-or-take just like the average house price, you’re talking half a billion dollars.”

The question arises how is that split between Auckland ratepayers and the rest of the country? Yet there was nothing in the Auckland budget about this, and that’s just this year’s damage. What happens if we get another Cyclone Gabrielle, next year?

We’ve got an interesting scenario developing where we’re talking about reducing emissions and we’ve got a distant horizon 2030 or whatever farmers and other parties want to extend it to. But in the meantime, we are picking up the bill now for increased damage and we don’t seem to be thinking in terms of how does that affect our taxes and rates? And this is going to be an ongoing issue. So, the question of paying for that, whether it’s a wealth tax, capital gains tax, whatever, is going to become ever more present, in my view.

That’s all for this week. I’m Terry Baucher and you can find this podcast on my website 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.

Inland Revenue fires a warning shot at real estate agents over claiming excessive deductions

  • Inland Revenue fires a warning shot at real estate agents over claiming excessive deductions
  • The International Monetary Fund wades into the housing debate
  • Year end issues around overdrawn shareholder current accounts


Last week Inland Revenue issued a press release warning real estate agents that this was an area that its analysis “suggests real estate salespeople/agents commonly claim a high level of expenses relative to their income. Inland Revenue believes the issue is widespread and we must act. People are claiming private expenditure, but not keeping logbooks or other business records to support the claim.”

The release goes on to warn that if someone has over-claimed expenses in Inland Revenue’s view, “they will receive a letter from us requesting they prove the expenses claimed.”

Now, this is a little bit unusual from Inland Revenue because we haven’t heard anything in the grapevine that this was something they were looking at. But it is not entirely surprising because one thing that emerged from hearing the Commissioner of Inland Revenue speak at the excellent Accountants and Tax Agents Institute of New Zealand conference is that Inland Revenue has great faith in its Business Transformation systems. These give it the ability to analyse data and identify areas where it believes income is either being under declared or in this case, taxpayers are, shall we say, being overly generous in their calculation of the deduction available.

Although, as I mentioned, we haven’t previously had an indication Inland Revenue viewed this as an issue, it’s apparent from what they’ve said here, that they’ve done enough preliminary work to identify that expenses being claimed by real estate agents seem high relative to income.

In one way I think this is a positive development in that Inland Revenue by warning people what it can do, can clear out some of the chaff.

On the other hand, there’s a lack of specific detail in this press release which concerns me. It’s “We think there’s an issue, but we haven’t actually specified what particularly is concerning us”. And simply to say that people claim a high level of expenses relative to their income is to assume that that expenses automatically should follow income. It could well be that there is a fair amount of baseline expenditure that people would incur in this business, running around making phone calls, driving to see clients and the like sometimes without actually a great deal of success, as the real estate sector is largely commission only based.

And so one of the things that taxpayers perhaps should consider is the implications of Inland Revenue’s capability to do a great deal of analysis. One thing Inland Revenue could do is to start saying, “Well, here is a standard deduction. You can claim X amount which to we’re going to accept as deductible without the need to keep very detailed records because our indication is that is likely to be the level of expenditure you would incur in your business.”

Now, Inland Revenue will come straight back and say they don’t want to do that because people will abuse that. But on the other hand, you’ve got to wonder the benefit of the current approach when you consider the time and energy put in by people preparing their tax returns and also the effort Inland Revenue then spends investigating what may well turn out to be an entirely legitimate expenditure. Maybe just simplifying matters all around would be more efficient.

It could be yes, there could be some seepage around the edges under a different approach and Inland Revenue doesn’t get as much as it could do if the rules were applied correctly. But applying a so-called standard deductions approach deals with an issue in the tax system, in that compliance is particularly onerous for smaller businesses. The rules are written around the expectation that people have a good understanding of the law and have the systems to manage their accounting and recording income and expenditure. And with the advent of online accounting systems such as Xero and MYOB that’s largely true.

But not everyone wants or needs to spend money on accountants. And I have felt for some time that adopting a different approach to what we call micro businesses, that are businesses with a turnover of say, less than $100,000, dollars would actually benefit everyone. Make it easier to comply and encourage more people to comply.

Anyway, we’ll watch with interest to see how this plays out with Inland Revenue. As I said, I’d like to see some more specific examples of the abuse that they are clearly warning against. But until some cases hit the courts or Inland Revenue releases some more information on the matter, we’ll just have to wait and see. In the meantime, it’s a good warning for anyone involved in business that you have to keep accurate records of your business expenditure.

The IMF wants tax action on overheated housing market

Moving on, the IMF, the International Monetary Fund, has waded into the debate over housing by recommending the Government should introduce a stamp duty or a more comprehensive capital gains tax to help deal with the overheated property market.

This is part of a routine check on the New Zealand economy, what’s called the Article IV discussions. These happen periodically when IMF staff come down here, talk to Treasury and other officials and draw their own conclusions on the state of the New Zealand economy and areas for improvement.

But for those who’ve read Tax and Fairness, the book I co-wrote with Deborah Russell MP, you’ll know that in chapter four, we talked extensively about how the IMF is not the first organisation to have raised the need for a capital gains tax to deal with housing inflation. The OECD raised the idea way, way back at the start of the century in November 2000 and then again in 2011, and the IMF also made similar suggestions back in February 2016.

I was going to say it’s really quite remarkable how this issue keeps popping up, but actually it’s not because the issues around tax were identified decades ago but have not been addressed. And meantime, the pressure on the Government builds now that the housing market has accelerated again. And this week (Tuesday) the Government will announce some proposed disincentives for property investors to try and reduce demand in the sector together with some form of targeted incentives to encourage savings in other sectors.

Just a little note on this, way back in 2000 the OECD concluded there was substantial overinvesting in housing, maybe one and a half times greater than that of major OECD countries. Now, I imagine that number has actually become considerably worse. So, as I’ve said before, the capital gains tax debate is not going to go away.

And on that debate, this coming Thursday, March 25th, I’ll be on a panel alongside Geof Nightingale of PWC and the Tax Working Group and Paul Dunn of EY together with Craig Elliffe and Julie Cassidy from Auckland University. Our topic is “Taxation: the ticking time bomb of our generation. Four tax questions for 2021”. This is an event run by the New Zealand Centre for Law Business I have no doubt whatsoever we will be talking about the issue of capital taxation.

End of year prep

And finally, more on one specific issue which will require action before 31st of March, and that is the question of overdrawn shareholder current accounts.

Now, this happens when a director or a shareholder of a company takes out more in cash from the company during the year. This is traditionally treated as drawings. So, prior to year-end, we take a look to see what we can do. And most times we deal with this issue by either paying a dividend before year-end (a particularly important thing to do this year before tax rates increase on 1st April) or voting a shareholder employee’s salary.

But in some cases, that is not enough. And in those situations, a company is required to charge interest using the FBT prescribed rate of interest. Now this rate is regularly adjusted and generally reflects what’s going on elsewhere in the market. Until 30th June 2020, the rate was 5.26%. It was then reduced to 4.5%, the lowest rate I can recall. This is the rate that should apply from 1st July 2020 right through until 31st March 2021.

But from 1st April the rate increases to 5.77%, something that has slipped under the radar and possibly reflects Inland Revenue unease about the use of current accounts to get around higher tax rates. On the face of it a rate increase in this low interest economy seems anomalous.

But as I said, I think it reflects Inland Revenue concern about the use of an overdrawn current account to get around income being taxed at either 33%, or from 1st of April, 39%. In some other jurisdictions the amount of an overdrawn current account is treated as a dividend. Our rules treat only require charging of interest. So if you’ve got an overdrawn current account of $100,000 in Australia, that’s going to be taxed as income of $100,000. Here we apply the FBT prescribed rate of interest of 4.5% so the taxable income is just $4,500.

So you can see there is some form of incentive to make use of overdrawn current accounts. In fact Inland Revenue has started paying a lot more attention to this issue and this small but quite subtle and unnoticed rate increase in the prescribed rate of interest is probably a clue it is planning to take greater action on the matter.

Well, that’s it for today, I’m Terry Baucher and you can find this podcast on my website or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week Ka kite ano!