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)
This week a deep dive into the Public Service Commission’s recently released Performance Improvement Review of Inland Revenue.
What makes it a “high-performing” organisation, what can it do better and what risk is it perhaps under-estimating?
Late last month, the Performance Improvement Review of Inland Revenue was released. This fascinating document concluded Inland Revenue (IR) was a “high performing organisation”.
The review had been carried out in mid to late 2023 on behalf of the Public Service Commission. This is part of the general Performance Improvement Review programme which is an initiative designed to lift agencies and system performances across the whole of public service. These reviews are intended to be forward-looking and identifying what’s expected from the relevant agency or system over the next four to 10 years.
Now that all sounds pretty dry, but once you dive into the detail of the 60-odd page report it turns out to be extremely interesting. It gives us a clear sense of where IR is at right now, where it is expected to be and where it is expected to go over the next 10 years. It’s actually one of the few occasions we get a review of IR by external reviewers. So, in that regard it’s probably carries more weight than IR’s own annual report.
The review was led by the highly experienced Belinda Clark, QSO and David Smol, QSO, both former senior public servants. And it draws from publicly available IR documents plus a number of interviews, not only with IR staff, but across professional bodies such as the Chartered Accountants of Australia and New Zealand, the New Zealand Law Society, and the Accountants and Tax Agents Institute of New Zealand. Other bodies that it spoke to include the Citizens Advice Bureau, the four big accounting firms, software providers, trade unions and other government departments notably the Ministry of Social Development and Treasury.
“A solid foundation”
The new Commissioner of Inland Revenue, Peter Mersi, who took over in July 2023, welcomed the report, saying it had come at an opportune time following the completion of the Business Transformation Programme in mid-2022, which, in his words, “has created a solid foundation for us to build on as we look to the future.”
The impact of IR’s Business Transformation Programme is something of a recurring theme to the report, which highlights the benefits that have already been achieved so far, and what could be developed in the future.
The report breaks down into several parts. First of all is the context which sets out the scope of the review and IR’s mandate and functions. It’s worth keeping in mind that not only is IR responsible for collecting 80% of all government revenue through the tax system, it also administers substantial social policies, such as Working for Families, the Student Loan Scheme and Child Support. It is an extremely wide range of responsibilities.
The report then moves on to the Future Excellence Horizon, looks at IR’s delivery and capability, and finally there are six appendices attached to the report. Appendix Three – Ratings overview and Appendix Four – List of future focus areas, are both well worth looking at.
“Delivering a world-leading tax system”
The Future Excellence Horizon section was developed by the reviewers in consultation with IR and the Public Service Commission. The purpose of that section is to answer the question
“What is the contribution New Zealanders need from the agency in the medium term?”
This section outlines the goal that IR is working towards. All ratings and discussions in the rest of the report are framed in reference to the contributions defined in this particular section. What outcomes are expected in the future, and what IR contributions are necessary to deliver these future outcomes? And the key outcomes are summarised as
“delivering a world leading tax system, remaining at the frontier for best practise for tax systems internationally, and for IR and the wider public service to leverage the capabilities delivered through Business Transformation to administer social programmes effectively and efficiently and deliver simpler and more integrated services at lower cost.”
What’s notable here is IR is also tasked with making it easier for SMEs, micro businesses and the self-employed, to calculate tax due and move towards real time tax payments. There is to be targeted engagement with what are described as “less compliant sectors”, and sufficient enforcement action to retain public confidence in the system. This is a very important statutory role, under Section 6 of the Tax Administration Act, which makes it the duty of every official and minister involved in the administration of the various tax acts to maintain public perception of the integrity of the tax system.
Integrated public services
IR is also required to help delivery of simpler, more integrated public services at lower cost. The report notes that delivery of most public services is still optimised within, rather than across agencies. And that’s something that we heard when I was on the Small Business Council. The issues around providing information to one government agency such as IR and then having to provide the same details again to another government agency. The general public tends to see the public service as a single body, rather than the collection of agencies it actually is. So here is something that all government agencies really need to work on to try and get away from their silo approach and make it easier for the public and businesses to interact across various agencies.
IR’s core functions and how it performed
Section Four then looks at how IR uses its capability to deliver key functions. The areas rated are:
Responding to Government priorities and serving Ministers
Stewardship
Core Function One – administering the collection and assessment of tax revenue
Core Function Two – administering social policy programmes
Core Function Three – providing end to end tax policy advice
Core Function Four – collaborating with other agencies to simplify and integrate government services.
And each of those roles is assessed and rated on a five-point scale.
IR was rated as leading in 11 categories, embedding in a further 13 and developing in just three. So overall you can understand why it got the description of being a high performing organisation.
That’s explained in a little bit more detail in the section discussing its delivery in, responding to Government priorities and serving Ministers. Page 25 of the report notes,
“there is widespread acknowledgment within the public service that they were the only agency that could have delivered these services in the required time frame (and this is in relation to the COVID-19 pandemic). Feedback from interviewees is that IR’s response was exceptional, with substantial contributions to several programmes, including the wage subsidy, small businesses loans and cost of living payments. Each of which leveraged capabilities created through Business Transformation. After the event reviews, such as the review by the Office of the Auditor General, supported this positive feedback”.
IR got a “leading” rating for how it responds to Government priorities and an “embedding” in how it provided advice and services to Ministers. An interesting comment here is that “Indirect feedback suggests that IR did a good job in developing an evidence base to enable ministers to consider potential wealth taxes.” (This was under the last Government).
Partner agencies, however, were more mixed in their feedback about IR’s responsiveness to priorities in social policy or related portfolios in the absence of COVID-19 pandemic like urgency.
It was rated as embedding in relation to the stewardship of the tax system. People were generally positive. This is where the support continues the Generic Tax Policy Process (GTPP), which underpins IR stewardship of matters. IR and interviewees see the GTPP as having provided fairly stable tax policy settings since the late 1980s, early 1990s. That’s pretty true. Listeners will well know the GTPP is well regarded and seen as absolutely crucial by all tax advisors as integral to the running of our tax system.
On the core function one, administering the assessment and collection of tax revenue, IR got leading ratings in both sections here with high praise from interviewees.
“External interviewees spoke positively of IR’s capabilities and performance, and that included interviewees with experience working in multiple tax jurisdictions.”
I deal with several tax jurisdictions and yes, I would say, IR is actually extremely efficient. We probably don’t acknowledge this enough.
An unusual situation?
There was a thought-provoking comment on something we probably don’t appreciate is that New Zealand is quite unusual in having the tax policy function sitting inside IR, the tax administration agency. In most comparable jurisdictions, the Treasury leads tax policy. That’s the case in Australia and in the UK. It’s seen as an advantage for us to have the policy sitting inside administration, as that means the dual function can be used to improve policy and delivery. I’m not quite so sure about that point, but still, it is an interesting point of difference.
“A greater data and technology capability”
Coming back to the importance of Business Transformation (BT), the report notes:
“[It] has delivered IR a greater data and technology capability than most other agencies have. BT has also strengthened IR’s capability to deliver social policy programmes. However, and this creates a risk which IR is well aware of, is that the delivery of social policy programmes compromises the role of administration of the tax system.” External parties noted a big reduction in IRs ability to engage on tax issues when its focus was on delivering initiatives related to the COVID-19 pandemic”
During the pandemic this was something we definitely noticed as tax agents, and it’s interesting to see this reflected in the report.
This speaks to something which the report fences around, which is does IR have enough resources to do what it is being asked to do? The report notes that about 1,000, roughly a quarter of IR staff, are responsible for administering the social policy programmes
The hibernating bear has woken up…
External IR interviewees stressed the importance of IR putting ‘boots on the ground’ and IR has responded to that by stepping up “the visibility of compliance and enforcement activity.” Hayden Wood of the GreenLine accounting and tax advisory firm, put it neatly on LinkedIn last week when he commented that IR having now got past all the work it had to do in relation to Business Transformation and the pandemic, was now returning to its core duties and is like a bear that has just woken up from a long hibernation and it’s hungry.
We’ve seen that in recent weeks: firstly the media announcements they’re looking into smaller liquor outlets, then the discussion we had regarding what’s happening in the cryptoasset space. This week there were a couple of media releases involving sentencing of people convicted of tax fraud and tax evasion.
Then on Friday IR released more details about what it’s proposing with the extra $29 million a year it’s receiving to improve tax compliance. $4 million dollars of that is going to go to student loan enforcement. In summary we’re going to see much more activity from IR.
Measuring the tax gap
The section regarding IR’s provision of end-to-end tax policy advice which rated it “leading” did identify one weakness in the absence of the measurement of the tax gap – the difference in the amount between taxes legally owed and the tax collected. In response IR noted the technical challenges in estimating the size of the tax gap but acknowledged that it would be valuable to do so. That’s something HM Revenue & Customs in the UK has been reporting about and I think there’s similar commentary from the Australian Tax Office/Australian Treasury on this issue.
As the report notes tackling the tax gap has the potential to enhance trust and confidence in the system. This is very true. If people perceive that there is exploitation of the system, it’s not being managed as it should be, then non-compliance will increase. So that’s a pretty big issue that IR will need to manage.
Play nice with other agencies?
IR was rated as leading in Core function three – the administration of social policy programmes. Again, rated as leading. But there’s some commentary about the difficulties of managing Working for Families payments and how recipients may find they’ve got a bill retrospectively. The review that 67% of those receiving Working For Families who received payments during the year were paid within 20% of what they’re entitled to. This suggests maybe half may have been underpaid or overpaid during the year. But accurate real time payments are difficult at the present.
The review comments that IR is legitimately protective of its IT system and data sets in order that they ensure that they keep operating effectively and efficiently. IR is also very concerned, rightly so, about data leaks.
But as the review goes on,
“IR will nonetheless need to be open to making an increased contribution in the social policy area. Feedback from other agencies was that IR is not very flexible in assuming these further rules. While IR agrees to help from the perspective of the other agencies, the help is always on IR’s terms and not always what is required.”
In other words, remember to play nicely with the other agencies.
Collaborating with other agencies – room for improvement
Those comments from other agencies feeds into core function four – collaborating with other agencies to simplify and integrate government services. IR only gets a developing capability rating here. And clearly that ties into IR’s approach. According to the review interviewees from IR and other government agencies, “had diverse views on what future collaborations might look like.” Other agencies are clearly looking at IR’s great capabilities and wanting to make more use of them. In turn, IR are saying well, maybe, but you have to do it our way. Watch this space.
The rest of the report on IR’s capability looks at what’s called a targeted consideration of each element of an agency; capability, such as leadership, culture and direction, collaboration and delivery and workforce. Generally, IR is rated as either “leading” or “embedding”, with the exception of workforce performance – what is the agency’s capability to deliver, promote and develop a high performing workforce, where it is rated as “developing”.
There was commentary from IR staff that they felt parts of the Business Transformation Programme had not been well managed and there were some “residual feelings” about how certain episodes had happened.
It’s noted by the way that the average tenure of IR staff following the completion of Business Transformation is still around 13 years, which apparently is high for the public service. And then there is a large number of staff apparently with 30 or more years of service probably including quite a few in the tax policy area.
Managing its money
In relation to public finance and resource management IR didn’t get any leading ratings here, just all embedding. There was commentary that although IR’s baseline operating costs are some 15% lower than previously, for example in 2018 it cost $0.80 to collect every $100.00 of revenue, and in 2023 that had fallen to $0.43 – it apparently has had a practise or a habit of underspending its appropriation. And because that appropriation is so multi-category, it’s then often able to take under spends in one category and allocate them to others. Basically, the reviewers are saying it can’t do that in the future because the public service is expected to manage its finances better.
That’s true, but as we noted earlier, there were some issues around IR not delivering as servicing certain areas, and there was also commentary that you can expect that is has to deliver more. So, I don’t quite see how those two comments tie up.
Furthermore, and a point of concern for me, the review noted that IR’s START computer system seems to be not quite ready enough to deliver real time tax payments.
An underappreciated risk?
This led on to a very interesting discussion on page 49 of the review around IR’s current contract and relationship with FAST Enterprises, the company that built the current START platform. FAST was established in 1997 and I understand some ex-IR staff were involved in it. It currently has products operating in 95 different government agencies across the United States, Canada and several other jurisdictions such as Finland, Laos, Malaysia and Poland.
The review has the eye-opening comment that “IR is almost entirely reliant on FAST for the platform and software to run START.”
IR currently has an agreement with FAST for seven years, which expires in June 2029. According to the review IR currently has a “close partnership” with FAST and some FAST personnel are embedded within IR but START has been configured, but not customised to accommodate all the social programmes that IR delivers.
Backtracking a bit, in June 2014 there was a tax conference in Wellington about the future of tax administration and what would IR require?
It was fascinating at the time, but one of the most interesting parts for me was watching a very spicy exchange between New Zealand based technology and software companies and IR staff about the Business Transformation project which had just been announced. The New Zealand software companies all felt that they had been locked out of the process and were rightly aggrieved about it. The feeling was that they could have done the job for less than the $1.5 billion quoted and in faster time. One cited they’d managed to get the GST system for, I think it was Bermuda, up and running inside 18 months.
Those software companies will probably have a certain wry smile when they see these comments:
“We queried why such a critical dependency was not higher on IR’s risk radar. Expectations from IR and FAST are that the contract will roll over once the seven-year term ends. But this is not something that should be taken for granted.”
I would totally agree with that. I’d like to see this watched carefully in the future.
Overall, when you read this review, it has lots of interesting insights about IR. With its increased activities in the recent weeks, it’s fair to describe it as a high performing agency.
And 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.
Tax cuts delivered, but watch out student loan borrowers.
After what seems to have been an interminable dance of the seven veils, all has been revealed and we now know the final shape of the Government’s tax package. Nicola Willis has delivered on National’s manifesto and increased thresholds as promised.
That was unsurprising, although there’s a twist in that these changes will take effect from 31 July, four weeks later than expected. The delay is to enable payroll providers to update their systems.
The big surprise for me is the decision to increase the threshold for the Independent Earner Tax Credit (IETC) to $70,000. As I said in my Budget preview, I expected this to be cut to help pay for, or even increase, the threshold adjustments. Speaking on Breakfast TV, I expressed the hope that any threshold adjustments would focus on the group around the threshold where the tax rate jumps from 17.5% to 30%. The lift in that threshold to $53,500 together with the extension of the IETC will help, but more needs to be done in my view.
Giving with one hand, taking with the other…
The Government has also increased the in-work tax credit (IWTC) by $50 per fortnight, which is welcome. However, its effect will be mitigated by the fact that the $42,700 annual family income threshold above which the IWTC will be abated at a rate of 27 cents per dollar remains unchanged. The threshold has not been increased since 1 July 2018 which means that families with income above the threshold face an effective marginal tax rate of at least 46.1% (17.5% plus 27% abatement plus 1.6% ACC Earner Levy) which is higher than that of the Minister of Finance. It remains remarkable to me that this issue has been allowed to continue for so long, but when I raised the issue with the Minister of Finance her response was “I utterly reject the question”. (There were quite a few other questions also rejected with varying degrees of utterly).
Increased Inland Revenue funding
As also promised by New Zealand First in its manifesto, the Budget proposes an additional $29 million annually for increased compliance activities. Interestingly, the specific appropriation for investigation, audit and litigation activities will be increased from $106.2 million to $165.4 million. The Appropriation for Services to manage debt and unfiled returns will also rise from $83.5 million for the June 2024 year to $105.7 million in the coming year. Both increases indicate we should expect to see a significant rise in Inland Revenue investigation and debt management activity.
Student loans
Unlike my prediction about the IETC, my speculation that there would be some increases here was correct. The Government proposes increasing the interest rate on student loan debt payable by overseas based borrowers from 3.9% to 4.9% from 1 April 2025. Furthermore, the late payment interest for both overseas AND New Zealand based borrowers will increase by 1 percentage point.
However, as previously discussed, the amount of student loan debt has steadily increased and only 26% of overseas-based borrowers are making repayments. The Budget Appropriations include a provision for debt impairment of $633 million (up from $539 million) for the coming year.
As noted above Inland Revenue is boosting its compliance activities for student loan overseas-based borrowers, “including those returning to or visiting New Zealand”. We can therefore expect to see a few defaulters being detained at airports. It will be interesting to see if such moves result in significantly increased repayments.
Waste disposal levy changes
Elsewhere, the Government proposes increasing the level of Waste Disposal Levy but at a lower rate than initiated by the previous Government. It’s anticipated the Levy will raise a total of $1.195 billion over four years to 2027/28 which is split 50:50 with local government. The Government proposes amending the Waste Minimisation Act 2008 to expand the range of activities the levy can be used for, such as restoring freshwater catchments. This sort of recycling of environmental levies is to be supported but perhaps the split between local and central government should be shifted in favour of local government.
Calling Inland Revenue?
Wading through the detail of the Appropriation Estimates often reveals some interesting nuggets. The Vote Revenue Estimates included the following details about Inland Revenue’s expected performance when answering calls and responding to correspondence. It will be no surprise to many to note that the standard of answering calls within 4 ½ minutes was not met. Going forward Inland Revenue expects to answer 60% of all calls so I will check in next year to see how it performed.
Now what?
Having delivered on its campaign promises what next for the Government’s tax policy? The Finance Minister referenced the ACT Party’s proposals to flatten the tax scale but made no commitment as to when that might happen.
Willis also acknowledged Treasury’s advice of a structural deficit of about 1.5% of GDP (roughly $6 billion). This can only be addressed by spending cuts or tax increases and the expectation at present is for spending cuts to meet that gap. That means any future threshold adjustments are off the table, including the possibility of automatic indexation at some point. For the moment the Finance Minister will be happy to take the credit for the changes announced today. Let’s just hope it doesn’t take another 14 years for the next revisions.
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.
Inland Revenue releases three special reports regarding the changes to the platform economy rules, the 39% trustee tax rate and the new 12% offshore gambling duty
Under the banner “Cut your excuses and sort your tax” Inland Revenue last Monday issued what it called a “last chance warning to the construction sector” to do the right thing and get on top of their tax obligations. The release advises that if people do the right thing, then Inland Revenue will help them. If they don’t, Inland Revenue will find them and start follow up action.
Richard Philp, a spokesperson for Inland Revenue, commented;
“Most people and businesses in New Zealand pay tax in full and on time but there is a core group who don’t. … we also know that while some are struggling just to keep up with the everyday grind, others are actively avoiding their tax obligations.”
Tax evading tradies?
Apparently, tax debt is high in the construction sector and there’s also a fair amount of cash jobs apparently happening in the sector. The Inland Revenue release commented that across all sectors, it gets about nearly 7,000 anonymous tip offs about cash jobs and the like each year noting “Construction is the industry most anonymously reported to Inland Revenue”.
The media release is silent about the extent of the debt within the sector, but we do know from the latest statistics as of 31st December 2023, that tax debt over two years old has increased to from $2.5 billion in December 2022 to $2.8 billion in December 2023.
ADVERTISING
Understandably, with the Government’s books under pressure, Inland Revenue is keen to collect as much of this overdue debt as quickly as possible. This is probably the first of many such campaigns where we will see Inland Revenue taking additional action. And remember, under the Coalition agreement, additional resources have been promised to Inland Revenue for investigation work.
In this particular campaign, Inland Revenue is saying it’s going to issue emails and letters to 40,000 taxpayers in the construction industry who have either outstanding tax debt or tax returns, or both. It then specifies that 2,500 of those will be contacted by text message, asking if they would like to support to get their outstanding tax sorted. There will be a follow up call if the taxpayers they respond that they do want help. Inland Revenue will also be carrying out site visits to key locations across the country.
As I said, this is likely to be the first of several initiatives we’re going to see from Inland Revenue. I would be interested in seeing some specific stats around the proportion of debt and the composition of debt and get an understanding of what sort of businesses are struggling here. It will also be interesting to see how successful this campaign turns out to be.
More on the new GST rules for online marketplaces
Last week I discussed the confusion that seems to have arisen following the introduction of new GST rules from 1st April. These rules affect people who are not GST registered but provide services through such apps as Airbnb, Bookabach and Uber.
This week, Inland Revenue released three special reports relating to the new legislation and one of these is on accommodation and transportation services supplied through online marketplaces. In fact, this is an updated version of a report previously issued in June last year. The report has been updated to include the changes that took effect as of the start of this month and in particular how the flat-rate credit scheme operates.
Changes to online marketplace operators
Under the new rules, so-called online marketplace operators such as Airbnb, Uber and Bookabach will charge GST on all bookings made through them. However, the person who actually provides the ride or the accommodation may not be GST registered. This is where the flat-rate credit scheme comes into effect as the following example illustrates:
The full report is 68 pages so there’s plenty more to dive into.
Special report on 39% trustee rate
One of the other reports that was issued is on the application of the trustee rate of 39%. Basically, trustee income is the net income of the trust, which has not been distributed to beneficiaries. The 30-page report explains the basic provisions about “beneficiary income” and “trustee income” together with a couple of useful flow charts.
Trustee income flowchart
Beneficiary income flowchart
The report references the minor beneficiary rule which applies where the beneficiary is a natural person under the age of 16. In such a case only $1,000 of income per year can be distributed to that person as beneficiary income and be taxed at that person’s marginal tax rate, presumably below 39%. Under the new rules, any beneficiary income in excess of $1,000 paid to a minor would be taxed at 39%.
Overall, this is useful guidance. Just remember the $10,000 threshold is all or nothing: if trustee income is $10,000 or less, the trustee tax rate that applies is 33%, but if it’s $10,001 then it’s 39% on everything.
The third report is on the proposed offshore gambling duty, which takes effect from 1st of July and will apply to online gambling provided by offshore operators to New Zealand residents.
The bright-line test and tax evasion – a couple of useful real-life case studies
Finally, this week a couple of interesting Technical Decision Summaries from Inland Revenue. Technical Decision Summaries are anonymised summaries of some interesting cases that Inland Revenue’s Tax Counsel Office has encountered either through tax disputes and investigations or applications for binding rulings.
The first one, TDS 24/06, is an application for a ruling regarding whether the bright-line test or section CB 14 of the Income Tax Act would apply. The facts are complicated but involve three sections of land currently owned by the ruling applicant.
The applicant had initially acquired one section outright before his spouse and another co-owner acquired interests as tenants in common. Over time, the applicants proportion of the ownership changed until at the time his spouse died the property was held 50% as tenants in common with his late spouse. The second section was owned 50% each as tenants in common with his late spouse. After her death her 50% interest had passed to him under her will. The third section was owned by the applicant and his late spouse as joint tenants. Following her death, her interest was automatically transmitted to him.
The ruling applicant was concerned about the treatment of future sales. Would the bright-line test apply or failing that, would section CB 14? This section is a little used provision and applies where there’s been a disposal within 10 years of acquisition and during that time there’s been a 20% more increase in value of the land thanks to a change in zoning, or removal of restrictions.
The Tax Counsel Office concluded neither the bright-line test nor section CB 14 would apply. This is obviously a good result for the taxpayer but it’s actually also a good example, of how you can apply for a ruling to get Inland Revenue’s interpretation on a tax issue. You don’t necessarily have to follow it, but if you don’t, you better have good reasons for not doing so.
Fiddling the books and getting found out
On the other hand, TDS 24/07 involved suppressed cash sales, GST and income tax evasion and shortfall penalties. The taxpayer carried on a restaurant business which was registered for income tax and GST. Inland Revenue’s Customer Compliance Services (CCS) investigated the company and formed the view that there was fraudulent activity going on. There was suppression of cash sales, and the taxpayer was under returning GST and income tax.
CCS reassessed the taxpayer’s GST and income tax returns for the relevant periods and they increased the taxable revenue for suppressed cash sales based on analysis of point of sale data, the taxpayer’s bank statements and industry benchmarking.
Industry benchmarking – an underused tool?
Just on industry benchmarking, I think Inland Revenue ought to be much more public about its data here and warn taxpayers there are benchmarks against which it will measure your business. It has done so in the past, but I think the combination of Business Transformation and then the pandemic interrupted progress in this space.
What people should remember is, Inland Revenue has some of the best data available anywhere about measuring industry benchmarking. I believe it should be making this much more public so that it can serve as an early warning shot for businesses that think they can suppress income. Everyone loses when this happens. Gresham’s law about bad money driving out the good is very applicable here, because businesses which are not tax compliant are undercutting those businesses which are following the rules. This is not a healthy situation as it leads to considerable frustration and anger and if not dealt with, will just simply encourage more of the same behaviour.
Tax evasion? Have a 150% shortfall penalty
In this particular case, the taxpayer’s fraud was identified, and GST and income tax reassessments followed. In addition, Inland Revenue also imposed tax evasion shortfall penalties, which are 150% of the tax involved. These evasion shortfall penalties were reduced by 50% for previous good behaviour, but that’s still represents a penalty of 75% of the tax and GST evaded.
Unsurprisingly, the taxpayer counter-filed a Notice of Proposed Adjustment under the formal dispute process, and the dispute ended up with the Adjudication Unit, which is run by the Tax Counsel Office as part of the formal dispute process. The Adjudication Unit did not accept the taxpayer’s counter arguments, including an attempt to claim an income tax and GST input tax deduction for the cost of fresh produce purchased with cash. The problem was there was no supporting evidence for this claim, so the Adjudication Unit probably found it easy to reject it. The Adjudication Unit ruled not only was the tax due, but the penalties were also correctly imposed.
Get ready for more Inland Revenue action
Circling back to our first story, this TDS illustrates what lies ahead for those in the construction industry who have been suppressing income. As I said, I do think Inland Revenue should make everyone more aware of its benchmarking data which would be a warning for would be tax evaders. It’s pretty clear from the announcement about the construction industry that Inland Revenue is gearing up for many campaigns targeting debt arrears and clamping down on tax evasion in particular industries. As always, we will keep you updated as to developments in those areas as they happen.
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.
