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Minister of Revenue philosophises on tax and proposes a Tax Principles Act

Minister of Revenue philosophises on tax and proposes a Tax Principles Act

2 May, 2022 | The Week in Tax

  • Minister of Revenue philosophises on tax and proposes a Tax Principles Act
  • The IRS drops the ball

Transcript

Ministers of Revenue typically deliver several speeches during the year, mostly to business audiences or at the start of tax conferences.

On Tuesday, however, the Minister of Revenue, David Parker, delivered a speech at Victoria University Wellington entitled Shining a Light on Fairness in the Tax System, which is without doubt one of the most interesting speeches made by any Minister of Revenue in many years.

After some scene setting about the purpose of tax and how the Government has been able to use tax revenues to fund its COVID 19 response, Parker then pivoted to talk about beginning what he called a fact-based discussion. He started by challenging the assumption that our tax system is progressive overall.

“What’s hidden that the effective marginal tax rate for middle income Kiwis is generally higher than it is for their wealthiest citizens. Indeed, some of their wealthier Kiwi compatriots pay very low rates of tax on most of their income.”

The Minister then dived into the question of the lack of data on the distribution of wealth and capital income in New Zealand. He highlighted the fact that according to the Household Economic Survey, the highest net worth ever reported was $20 million.

This was, he said, ridiculous, given that we know there are billionaires in the country. As he pointed out, that meant the National Business Review’s annual rich list is a better set of data than the official statistics. In fact, that’s quite common around the world as statistics on capital wealth are rare and rich lists are often used to help revenue authorities gather data in this area.

So this lack of data, Parker explained, was the rationale behind the powers granted to Inland Revenue for the purposes of conducting research into high wealth individuals. As listeners will know, this is a somewhat controversial project, even though the Minister repeatedly stated that the intent was to gather better data for research and not as had been accused, so Inland Revenue could secretly work on new taxes.

“Until we have a much more accurate picture about how much tax the very wealthy pay relative to their full “economic income”, we can’t really we can’t honestly say that our tax system is fair.” And this led on to the most surprising part of the speech his proposal for a Tax Principles Act.

He referenced four principles of taxation that Adam Smith set out in Wealth of Nations back in 1776. And he noted that the many tax working groups and other reports that New Zealand has had over the past 40 years, such as the McCaw Review in 1982, the MacLeod Review in 2001, the most recent tax working group, and the all the work that went on during the Rogernomics period all basically followed these four principles set out by Adam Smith.

“They all endorse the same principles, based in that most core value of New Zealand – fairness. The main settled principles are:

 Horizontal equity, so that those in equivalent economic positions should pay the same amount of tax
 Vertical equity, including some degree of overall progressivity in the rate of tax paid
 Administrative efficiency, for both taxpayers and Inland Revenue
 The minimisation of tax induced distortions to investment and the economy.”

He also noted that recent reviews in the UK and in Australia both adopted similar approaches. Incidentally and perhaps not coincidentally here, Deborah Russell and I adopted the same principles when we wrote Tax and Fairness back in 2017.

And as you know, Deborah is now the Parliamentary Under-Secretary for Revenue and David Parker’s number two. The proposal is that officials should periodically report to ministers on the operation of the tax system using the principles as the basis for the reporting.

The Tax Principles Act would sit alongside existing legislation, such as the Public Finance and Child Poverty Reductions Acts, which also require the Government and officials to report on specific issues. This is quite revolutionary, but in a way sits within the philosophy of open tax policy that New Zealand has adopted through what we call our generic tax policy process.

This open approach to developing tax policy is widely regarded as world leading by other jurisdictions. The proposed Tax Principles Act is not inconsistent with the existing approach. The intention is there will be consultation later this year and following that a bill would be introduced once the principles had been agreed and the reporting requirements had been established.

The resulting bill would be enacted before the end of the current parliamentary term, i.e. just in time for next year’s election. The proposal caused quite a stir and there’s plenty of good reading on it. Bernard Hickey has a very good summary of the matter. 

It’s also quite rare certainly to see Ministers of Revenue philosophise in quite a public way. David Parker referenced Thomas Piketty’s seminal work, Capital in the 21st Century. He also acknowledged the very regressive nature of GST. Somewhat controversially he noted that because GST in transactions between GST registered businesses essentially zeros out and is a final tax for those who are not GST registered, it many ways it falls on labour earners.

As he put it, “GST is really paid out of our earnings when we spend it. In economic terms, GST is mainly a tax on labour income. Who pays that cost?”

The Minister noted we have limited data on the overall rate of GST paid by New Zealanders, either by income or wealth decile. So he’s asked Inland Revenue to gather data and to provide feedback on this. I suppose from a political viewpoint this hints that potentially if there are changes to a tax mix at a later date, something may be done in relation to GST as it impacts lower income earners.

All this kicked up quite a stir. When I appeared on Radio New Zealand’s the Panel following the speech, the panellists expressed some shock about the fact that we don’t really have data about how wealthy people are. I think the reason for this, which wasn’t discussed by Minister Parker, is that it’s probably largely the unintended consequences of the abolition of stamp duties, estate and gift duties, and the absence of a general capital gains tax.

In other jurisdictions which have some or all of those taxes, this gives a reference point when a transaction occurs as to what wealth is held and by whom. Incidentally, the disclosure requirements regarding trusts I discussed last week although they are primarily an integrity measure, they also represent, in part, an attempt to gather some data about wealth held in trusts and help fill the gaps in Inland Revenue knowledge.

With National and Act already putting out their tax proposals, it looks like tax will feature quite heavily in next year’s election. So it’s very much a case of let’s watch this space.

Moving on, today is the due date for submissions on Inland Revenue’s discussion document, Dividend Integrity and Personal Services Income Attribution. This contains a couple of controversial proposals.

Firstly, that sales and share of shares in a company with undistributed retained earnings would trigger a deemed dividend.

And secondly, changes to the personal services income attribution rules, which would mean more income would be attributed to a primary income earner.

Now, neither of these proposals have gone down particularly well and to describe them as controversial would be a bit of an understatement. The personal services attribution rules, in fact, may well have a very much wider effect politically than the Government might want to see.

Brian Fallow, writing in a very good column in last week’s New Zealand Herald, pointed out that the attribution rules, if enacted, would affect very large numbers of small businesses quoting former Inland Revenue Commissioner Robin Oliver “It is likely to catch tradies — a plumber, say, or a landscape contractor — with a van and some equipment and just themselves or one employee doing the work,”

And Oliver raised the question, is this really appropriate? I expect a lot of submissions on this paper, and I urge you to do so because as you can gather from comments made by Oliver, it could have a quite potentially significant impact for the SME sector.

I personally think the proposals go too far. And incidentally, one of the reasons that the proposals have been made comes back to a longstanding topic in this podcast and something that wasn’t directly referenced by Minister Parker in his speech, the absence of a general capital gains tax.

Inland Revenue proposes any transfer of shares by a controlling shareholder to trigger a dividend where the company has retained earnings. In jurisdictions which have capital gains tax, that transaction is normally picked up as a capital gain. But as we don’t have a capital gains tax Inland Revenue is proposing a workaround which I don’t think is appropriate one.

I think there are other alternatives they might want to consider. The proposals on the personal services attribution rules are an integrity measure. They build on the Penny Hooper decision relating to surgeons from ten years ago.

They are understandable, but I believe go too far and are probably targeting the wrong group of people. Moving on Inland Revenue has a useful draft interpretation statement out considering what is the meaning of building for the purpose of being able to claim depreciation.

This has actually become quite relevant because back in 2011 the depreciation rate on buildings was reduced to zero. But in 2020, in the wake of the pandemic, the depreciation rate for long life non-residential buildings was increased from 0% to 2% if you use a diminishing value basis or 1.5% if you’re using straight line method.

What this draft interpretation statement explains is the critical difference between residential and non-residential buildings. it replaces a previous interpretation statement released in 2010 which has had to be updated following an important tax case in 2019 involving Mercury Energy.

A building owner will be able to claim depreciation for a ‘non-residential building’ and that can in some cases have some residential purposes. Generally, it’s aimed at commercial industrial buildings and certain buildings such as hotels, motels that could provide residential commercial accommodation on a commercial scale. It’s a useful explanation and comments on the draft close on 2nd May.

Chump change for FATCA

And finally, a quite extraordinary story from the United States, where it has emerged that a very important tax act, the Foreign Account Tax Compliance Act, better known as FATCA, hasn’t generated as much income as was expected when it was introduced in 2010. 

The projection was that over the ten years to 2020, it would raise about US$8.7 billion US. The US equivalent of Inland Revenue, the Internal Revenue Service, (the IRS) spent US$574 million implementing FATCA. But according to a report just released, all the IRS can show for all that money invested are penalties totalling just US$14 million.

Now, that’s quite extraordinary. And this is important from a New Zealand perspective, because FATCA represents a huge compliance burden for all US citizens who are required to file tax returns, even if they may be tax resident in another jurisdiction.

FATCA was the template for what became the Global Common Reporting Standards on the Automatic Exchange of Information. The rest of the world looked at FATCA and thought, “That’s a good idea. We’d like to have some information about what overseas accounts our taxpayers have”. And so, the CRS, as it’s known, was introduced and has been in force now for about four years.

I would hazard a guess that Inland Revenue probably gathered well in excess of US$14 million as a result of the introduction of CRS. But to come back to a point that David Parker made about politics and tax being inseparable. One of the reasons that the IRS has done so badly is that the Republican controlled Congress won’t give it the money to do its job. And that situation doesn’t look likely to change.

As David Parker said, politics and tax are inseparable. And we’re going to hear plenty more about the two in coming months.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients.

Until next time kia pai te wiki, have a great week!

What Inland Revenue needs to do to improve the quality of tax legislation

What Inland Revenue needs to do to improve the quality of tax legislation

22 Nov, 2021 | The Week in Tax

  • What Inland Revenue needs to do to improve the quality of tax legislation
  • Growing concerns about potential for misuse of new investigative powers for tax authorities
  • Time for a surcharge on the banking sector?

Transcript

Earlier last week, more detail emerged about a report that had been commissioned by Inland Revenue into its legislative drafting process. Apparently, there is a full report which was released to Inland Revenue in June but has not been made public. Instead, a summary of the conclusions has been made public recently, and it’s the subject of some news reports.

The news reports sound much worse than the position actually is, but it is interesting to lift the hood, so to speak, and have a look at the very important process of turning policy intentions into legislation and how that works.

What Inland Revenue wanted to do was undertake a review of how it was doing on this basis, because one of the interesting things about Inland Revenue is that it gets to draft its own legislation. Normally, legislation is prepared by the Parliamentary Counsel Office, but with tax legislation Inland Revenue does the drafting, making it the only government department with that power. Inland Revenue is quite unusual because of how extensive its powers are, and obviously these are required, being the Government’s main revenue gathering agency. Even so, it has powers that tax authorities in other jurisdictions may not necessarily have.

So this report was commissioned two years ago to look into this particular power. Looking beyond the somewhat dramatic news reports about “scathing commentary” there are definitely some concerns to be addressed. One of which I would say would be perhaps a matter of resourcing. Apparently, according to this report, it appears there is one person called Sharon, who is responsible for administering a plain English review of the legislation before it is published.

The report, prepared by Graeme Smaill of Greenwood Roche Lawyers, summarises the three broad areas that it believes should be the focus of future efforts to improve Inland Revenue’s legislative process. Firstly, the use of existing and identification of further specific drafting tools to deliver legislation that is fit for purpose and accessible for those who need to use it.

Now, one of the things to keep in mind about legislation and how it’s drafted is that by and large, the legislation is drafted for general use. New Zealand, as part of its tax simplification policy adopted in the 80s, tries to avoid special regimes where possible.

But what this does mean is that sometimes it’s drafting legislation, such as the hybrid mismatch rules, which will affect a very small group of taxpayers, mainly large multinationals. But they apply across the board, which comes back to the theme of last week’s podcast. Unintended consequences may mean a small business in New Zealand exporting to Australia or setting up operations to export in Australia might find itself caught up in these rules totally inadvertently.

The financial arrangements rules, by the way, are probably another good example of how these unintended consequences can apply. They’re highly complex, and they were designed in the mid-80s to deal with large corporates and complex multi-million-dollar funding arrangements. But the rules now catch people with mortgages for overseas properties. I’m pretty certain that the drafters of the financial arrangements regime in the mid-80s didn’t really think that should be the case. So that’s a good point about appropriate tools and making it accessible.

Higher skills required

The second broad area is “achieving higher skills for all those involved in the drafting unit and a team that produces collaborative and consistent results”. That is absolutely key. Inland Revenue is actually a very trusted body. People might not like paying tax, but on the whole, I think it’s an organisation that’s actually trusted to do its job fairly, even if people’s definition of fairness will vary. But broadly speaking, it is a respected organisation. But consistency is the key to Inland Revenue maintaining that trust. So making sure the legislation is consistent is very, very important.

Then finally, and this is a point where  a lot of work goes into this already,

“the development of legislation by a consultative process involving public policy analysts within Inland Revenue and other government departments and external stakeholders improved and aimed at improving the practical ability for the legislation to be understood and complied with.”

And one of the report’s criticisms is that there’s a lot of time spent on developing tax policy.  And then perhaps the legislation is not quite an afterthought but comes in at the end of the process and in some cases, not enough care has been taken with it so remedial legislation is required. This is something we see quite a bit. Every tax bill contains remedial legislation and that will always be the case. It’s basically continuous improvement. But the report was suggesting that we perhaps need to be looking more at getting the legislation more accurate first time

Looking through the whole summary report made available, there are nearly 40 recommendations across the board, so there’s a lot to go through. The Income Tax Act,  was rewritten substantially in the late 80s early 90s, as part of which it was organised into its current alphanumeric and subparts system which I have to say coming from the UK was revelatory. It was so much more coherent and better organised than what I had been used to grappling with.

And so putting things in context. yes, tax legislation could need improvement. For example, if you listen to The Panel there’s a very funny sequence yesterday where the panellists and Bridget Riley talk about this report and the use of semicolons and what do they mean. Does a semicolon mean “or” or  “and” because there can be a quite substantial difference in tax outcomes. https://www.rnz.co.nz/national/programmes/thepanel/audio/2018821093/the-panel-with-teuila-fuatai-and-jock-anderson-part-2

But by and large, New Zealand’s legislation is pretty understandable. I’ve had to grapple with the UK, Australian and sometimes US tax legislation and it holds up pretty well by comparison. But there’s always room for improvement.

Power grab?

Moving on and still about Inland Revenue and its powers, there’s an ongoing controversy over Inland Revenue’s high wealth individual research project. Putting aside self-interest, one of the concerns of those affected is Inland Revenue power-creep and whether information supplied to Inland Revenue for ostensibly research purposes will be made available to other government agencies. Apparently, it could be and more to the point it could also be available to other tax jurisdictions. That’s not what’s intended by the research project, or at least that’s my understanding of it.

But the creeping powers of tax authorities is a worldwide trend. A news report last week was about H.M. Revenue and Customs in the UK. It had been granted new powers for requesting information from financial institutions. The UK has made many of these requests subject to scrutiny by tribunals. However, HMRC can issue Financial Institution Notices, requesting financial information about a taxpayer from a third party without applying to a tribunal. And apparently reports are emerging now that HMRC has been using these notices much more widely than was ever intended.

And one of the concerns in the UK is no statutory right of appeal was granted against these notices. The only way a Financial Institution Notice could be challenged was through a judicial review court action. So UK practitioners are understandably quite concerned that HMRC appears to be more widely using powers, which were supposed to be used in a very limited basis.

And of course, down here, practitioners will watch this stuff and look around and see the same. We would have similar concerns about granting additional investigative powers to Inland Revenue. But coming back to our old friend unintended consequences, if these powers are used much more widely than was planned, how do we deal with that? That’s going to be an ongoing theme.

And broadly speaking, I think the general public is very, very unaware of just how extensive the Inland Revenue information gathering powers are and how much information is being shared with other Government agencies as well as other tax authorities throughout the world. And so there’s this dichotomy we want people to pay the right amount of tax, but then we’ve got to question the invasion of privacy. And it seems that in relation to this dichotomy the Data Commissioner up in the UK is lining up to challenge HMRC’s practices. So it’s another case of watch this space.

Our turn to add a bank profits tax?

And finally, an interesting idea from Gareth Vaughan and the enormous profits of the banks.

The latest combined annual net profit after tax for the big four banks was $5.493 billion. That’s 7% more on the previous record back in 2018. All the banks are making profits. Kiwibank was $126 million, SBS had a record profit of $41.1 million and The Co-operative Bank another record profit for it of $15.6 million.

And so Gareth raises a very good question. This wasn’t really what we were expecting to see when Covid-19 hit, when the concerns were about how the banking system would hold up, and whether there would be the liquidity to keep financing businesses. But instead, all those concerns seem to have fallen by the board and instead we’ve had a huge asset price boom, particularly in relation to property and we are now concerned with the fallout from that

And one of the things that came out of the response to Covid-19 was that the Government felt the need to introduce the Small Business Cashflow Loan Scheme, which as Gareth asks could this scheme not represent a market failure on the part of the banks? They’re not lending so much to businesses. ANZ, for example, has 70% of its total lending in housing.

So Gareth suggested what about imposing a one off Covid-19 tax on the banking sector? And his proposal is set at a percentage of individual bank’s profit and applied only to banks active in the housing market. Maybe the funds raised could then be used to help out small businesses in the sectors hardest hit by the pandemic, hospitality and tourism would obviously be the prime beneficiaries there. A 5% charge for the big four banks would raise $275 million.

It’s not quite as unusual as it might sound. [Australia has one.] Over in the UK it has a corporation tax surcharge on profits of its banking sector which is payable on top of the standard 19% Corporation Tax. The banking sector then pays a further eight percentage points on top. This has been in place since 2009 which is quite some time. There’s also, by the way, a separate bank levy to help build up an insurance fund so it can fund another bailout if required. Fortunately, we didn’t need that here.

But the idea that super profits are being made by banks and maybe an additional levy should be charged to address the unintended consequences of these profits or a perceived market failure is something perhaps worth considering. It would run counter to what I said earlier about how, generally speaking, New Zealand doesn’t have a lot of special tax regimes. It certainly would be an interesting challenge for the drafters of any such legislation.

Well, that’s it for this week. Next week my guest will be Professor Craig Elliffe of Auckland University and we’ll be talking about the recent international tax announcements including a proposed global minimum tax rate of 15% and what that might mean for New Zealand.

Until then, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!

Latest lockdown developments

6 Sep, 2021 | The Week in Tax

  • Latest lockdown developments
  • More on allowances from Inland Revenue
  • Could a tax forgiveness programme help SMEs hit by Covid-19?

Transcript

As of today, businesses can now apply for the second round of wage subsidies if they meet the criteria for doing so.  Unlike last year, the wage subsidy is being paid in two weekly instalments, and one twist to this is that if you have not applied for the previous two-week period, you now miss out permanently.  The qualification is if you have suffered a 40% loss compared to a similar period in the six weeks immediately prior to the move to Alert Level Four on 17th August 2021.

As of August 31st, $922 million has been paid to businesses that had met the criteria, and 225,335 applications had been approved, covering over 822,000 jobs. Another 14,708 applications were declined with 73,000 still being processed as of the first of August.

The support continues to be there, and you can apply for wage subsidies in Levels Three and Four, even if you’re outside Auckland so long as you meet the eligibility criteria. There’s also the Resurgence Support Payment, which is available at levels Two, Three and Four. And there’s various other schemes such as the Leave Support Scheme, Short Term Absence Payments and the Small Business Cashflow Loan Scheme which are also available.

There will always be a few businesses that somehow don’t meet the criteria and other businesses that are slipping through. Whether these are enough to keep the business alive, is another matter, because as I’ve said previously, one of the issues Covid-19 has highlighted is how many small businesses are, in fact, relatively undercapitalised.

And just be aware that the applications are being scrutinised. There are now reports that four applicants who received a wage subsidy are now being investigated as to whether, in fact, those were valid applications.

Clarifying the home office rules

Moving on, I’ve spoken previously about allowances and Inland Revenue Determinations issued in relation to payments provided to employees to work from home. Inland Revenue has now issued a third determination, Determination EE003, which will start from 1st October and will run for 18 months through to 31st March 2023.

What this does is amalgamate and replace all the previous determinations that have been published on the topic which we covered recently. However, although this consolidates the previous determinations that have been made, there are actually no changes to the actual operating principles set out in those determinations and the amounts of payments that can be made by employers to employees as a reimbursement for home office use and use of personal telecommunication tools.

Those rates are $15 per week if they are treated as exempt income for an employee of working from home and then a further $5 a week if that employee is using their own telecommunications tool. So that’s a maximum of $20 dollars per week. As I’ve said previously, these allowances are not terribly generous, but they are at least a de minimis work around. Inland Revenue has by extending the application of the determination through till 31st March 2023, given itself time to have a further consideration of what it wants to do with the law around this practise.

At the same time, Inland Revenue’s latest Agents Answers for September sent to tax agents has caused some confusion. It had a note explaining that if a company uses a home office that is the home of one of its shareholders, it will not be able to claim a deduction for the office unless it has incurred the actual cost. This means that if a shareholder or director, runs the company’s business through a home office and pays all expenses relating to the home office, the company has not incurred any expense and cannot claim a deduction.

This came as a surprise loss to many fellow tax agents and left us scratching our heads a little bit on this. What Inland Revenue has done is set out the law, which is quite clear that the company can only claim the expense if it can prove a nexus between its business income and the home office expense and no private portion can be claimed. The company must incur the expenditure within the income year, that is, it has a liability to pay the expense either direct to the provider or to the homeowner.

And that last phrase there is where perhaps practise will probably align with the theory. What one often sees is that small businesses run out of family homes, will claim a home office expense. And in reality, what it should be is a reimbursing allowance of the type we’ve just been discussing. The director or shareholder-employee or other person should file an expense claim for the home office expenditure they’ve incurred.

Tax policy aimed at the big overwhelms the small

Now this highlights an issue that I’ve talked about previously is that our tax system doesn’t always work well for small businesses. There’s a mismatch that goes on. A lot of policy is driven by larger taxpayers who have the resources to manage their affairs properly and also make submissions when legislation is being considered. However small businesses just tend to muddle along as best they can and sometimes have matters, to put it bluntly, just dumped on them unexpectedly with an increase in compliance costs.

Managing compliance costs for SMEs is always a bit of a hard one for tax authorities. There’s a trade-off between minimising compliance costs and the potential for abuse. If I was to say where I think Inland Revenue lies on that line, I think they have always been more cautious about the opportunities for concessions to be abused.

So that’s that means that sometimes obstacles like this Agents Article note appear, which have everyone head scratching and don’t actually reflect the actual practise. Sometimes, I think policymakers at Inland Revenue would be a little surprised at how “imprecise” would probably be a polite way of putting it, some accounting records kept by small businesses are. This is, as I said earlier a reflection of how small businesses are undercapitalised or under resourced and sometimes the I’s aren’t dotted and T’s aren’t crossed.

Anyway, this note on home office expenses, as I said, caused some confusion. It probably could have been phrased better, it certainly caused a stir when it landed, even though ultimately when you drill down it isn’t a question of Inland Revenue changing the policy. Instead, it’s just saying there are procedures to be followed and you should do so. How helpful you might think that is in the midst of a general lockdown is another judgement you can make.

Tax forgiveness?

And finally, a very interesting article just popped up the other day from Ranjana Gupta, a senior lecturer in taxation with Auckland University of Technology.  Ranjana has suggested that a tax forgiveness policy could help many small businesses get through the financial woes that they’re dealing with a result of Covid-19.

She’s been carrying out some research and based on this suggests a voluntary disclosure programme for overseas income could protect these businesses affected by the pandemic and also promote honesty in tax matters. Essentially, what she’s pointed out is that the system, as it currently operates, tends to be quite punitive rather than encouraging compliance. Just to give an example, if you’re late with filing a return and paying tax, a late filing penalty will be imposed for the tax returns involved and there will also be late payment penalties and interest on top of that.

All the research I’ve seen shows that there is no better compliance here in New Zealand over prompt payment of tax than in other jurisdictions that may only impose an interest charge. And as a tax agent unwinding the position where late payment penalties have been imposed is very, very frustrating at times. As I said, it doesn’t seem to encourage any prompter payments.  Instead, what happens is the late payment penalties accelerate so rapidly that the debt balloons to the point where taxpayers just give up.

So, Ranjana’s point is a fair one. And she goes on to say that if a taxpayer is operating outside the tax system, the consequences of entering may be harsh because of this penalty regime. And so, this encourages even inadvertent tax offenders to remain outside the system.

And that is something I have encountered, that taxpayers who have realised they’ve made error are often quite worried about coming forward and how hard they will get hit for non-compliance. And so, the position that Ranjana is proposing, and I agree with it, if it’s made clear that there’s an amnesty going on, that may encourage people to come forward who may have stayed under cover hoping Inland Revenue wouldn’t find them.

And interestingly, she then goes on to discuss the point that currently 31% of the population are immigrants and one in 10 of those are self-employed without employees, with about 5% small businesses with employees. And her argument is that they may not be fluent in English and may be unaware of their tax obligations and are therefore unintentionally non-compliant. This was something we actually came across during my time on the Small Business Council. The migrant community is of a size that some may only deal in their own native language rather than, as you might think, in the wider community.

So anyway, as Rajana notes, they now face the ramifications of making a voluntary disclosure. And her suggestion is maybe Inland Revenue should think about some form of amnesty, or message to the public as to how it would take a more sympathetic approach to people who come forward. So, I think this is an interesting proposal.

I have found, to be fair, where people have come to me and made voluntary disclosures to Inland Revenue they’ve been treated reasonably well. There haven’t been many instances of any very heavy penalties being imposed. Tax is collected and the interest is paid and then the system carries on as normal. So, Ranjana’s proposal is something worth considering.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and colleagues. Until next time Kia Kaha! Stay strong.

An Employment Court case reveals Inland Revenue’s extensive use of contractors

An Employment Court case reveals Inland Revenue’s extensive use of contractors

8 Jun, 2021 | The Week in Tax

  • An Employment Court case reveals Inland Revenue’s extensive use of contractors
  • Is Google taking the Government for a ride?
  • A warning about the new bright-line test

Transcript

The chances are that if you ring Inland Revenue, your call will be answered by a contractor. Inland Revenue, as part of its Business Transformation programme, has been making increasing use of contractors and its use of contractors has led to a recently decided case in the Employment Court.

The Public Service Association took the case against Inland Revenue asking for more than 1,000 labour hire workers to be reclassified as direct employees of Inland Revenue. It took the case in the name of eight workers engaged by a labour hire company, Madison. And these people were mostly engaged to work as call centre staff at Inland Revenue.

Now, the case was decided by a full bench of the Employment Court, and it will be a very significant Employment Court decision. The decision itself, as published, runs to 82 pages. But what caught my eye about it was how much it revealed about the extent to which Inland Revenue is using contractors. As it transpired, Inland Revenue won the case. The court unanimously held that the labour hire workers were indeed employees of Madison and not of Inland Revenue.

But I doubt whether that’s going to be the last we hear of it, given the scale of what’s going on and the involvement of the Public Service Association. And I suspect this case will be appealed up through, the Court of Appeal and maybe ultimately to the Supreme Court. Hence probably why there was a full bench put on it of judges in the first place and the extremely extensive, and if you’re an employment lawyer, no doubt very interesting legal arguments engaged.

But the reason why the PSA took the case was, as the National Secretary of the PSA, Kerry Davies, pointed out, the scale of contractors being used was new. Inland Revenue, like many government agencies, if not all of them, I would expect, does use temporary staff from time to time. And you can look back and you can see that there’s been the use of contractors. For example, if I look back for the year ended 30 June 2015, contractors engaged by Inland Revenue cost a total of $45.3 million in that year.

But what’s been going on with this one hire company, Madison, is quite extraordinary. The eight plaintiffs who were supported in the case by the PSA, had worked in various Inland Revenue offices for periods between seven and 15 months, and they were amongst a total of 1,233 workers hired out to Inland Revenue by Madison starting in 2018. Now, to put that number in context, at 30 June 2017, Inland Revenue’s headcount was 5,519. As of 30 June 2020, its headcount is 4,831. So 1,233 temporary employees represents a very significant number of staff, getting on for almost a quarter.

Not all were engaged the same time. But we do know that under one of the agreements (what they call work orders) In October 2018, Madison agreed to provide 382 client service officers, as well as another 83 client service assistants.

Now the obvious attraction for Inland Revenue in this was some cost reductions. For example, a contractor supplied by Madison would be paid $20.00 an hour compared with an Inland Revenue employee of $23.94. If the Madison worker gained competency, that’s after a test which was taken usually after 12 weeks or so, they could go up to $22.50. Just for the record, Madison billed Inland Revenue over $40 million over two years. And it paid on average $29.25 per hour for a Madison worker who had gained competency and $26.00 per hour, exclusive of GST, if they hadn’t.

All this is of great interest to me and my other tax agents because we have been experiencing a great deal of difficulty getting through to Inland Revenue and working with them under the new system. I’m also very curious as to where the benefits are flowing through on Business Transformation.

To give you an example, a lot of systems have been automated, but there’s a great deal of inflexibility built into the system. Every tax agent I know, like myself, has encountered an issue where we directed a client to make a payment for a specific tax year, say, the 2019 income tax year, only to find Inland Revenue’s system had redirected that to another period. That then means that we have to pick up the phone, try and get through on a dedicated agent line – which has been cut back – and sort out the mess. Every tax agent I’ve spoken to has reported the same issue.

Therefore, the competency with which Inland Revenue approaches of its staff and the level of training they used is of great import to us as tax agents. We handle the more complex clients who also happen to bring in some significant amounts of tax revenue. So that’s why I’ve looked very closely at this case and am very interested to see how it played out.

And I was very surprised by the numbers I encountered. I then decided to take a closer look at exactly what Inland Revenue has been doing in terms of its personnel costs. Looking at its annual reports covering the six-year period ending 30 June 2020 – that is the year ended 30 June 2015, just before Business Transformation started – through to 30 June 2020.

The numbers are revealing about what has been going on in terms of Inland Revenue staff levels and its personnel costs. On 30 June 2015, Inland Revenue had 5,820 employees, 98% of which were permanent. As of 30 June 2020, the headcount was now 4,831, a reduction of nearly a thousand. But the number of permanent employees had fallen to 84%, indicating quite a marked degree of temporary contracting going on.

Now total personnel costs for Inland Revenue, including contractors, for June 2015 were $463.7 million. In the year to June 2020 that had gone up to $547.8 million. Now, that is a surprise, given that over the same period, as I’ve just pointed out, the headcount at Inland Revenue has fallen by a thousand. And by the way, these numbers do not include the contractors engaged in relation to the Business Transformation project, which is about another $70 million annually.

in June 2015 year, the contractors and consultants cost Inland Revenue $45.3 million. In the year to June 2020 that had risen to $111.5 million. That was actually down from the peak year of June 2019 when it was $136.8 million. Interestingly, Inland Revenue personnel costs for June 2020 at $436.3 million are little changed from June 2015, when they were $418.4 million.  But what’s important is if you look at the total personnel contracting costs. In June 2020 year, more than 20% of those costs represent contractors.

Summary contracting & personnel costs six years ended 30 June 2020

2015 2016 2017 2018 2019 2020
$ mln $ mln $ mln $ mln $ mln $ mln
Contractors & consultants 45.3 77.2 106.5 124.2 136.8 111.5
Salaries & wages 388.3 399.8 399.0 391.0 389.8 384.9
Other personnel costs 30.1 26.8 19.3 29.9 33.3 51.4
——————————– ——– ——– ——– ——– ——– ——–
Total personnel costs $463.7 $503.8 $524.8 $545.1 $559.9 $547.8
Percentage costs contracting 9.8% 15.3% 20.3% 22.8% 24.4% 20.4%
Percentage of staff permanent 98% 97% 95% 89% 87% 84%
Headcount 5,820 5,789 5,519 5,250 5,009 4,831

(Source Inland Revenue Annual Reports)

And by the way, over this six-year period, Inland Revenue has paid out more than $47 million in termination benefits. In the year to June 2020, it was $19.3 million and the year to June 2018 it was another $21 million.

There are a number of things that really concern me about what’s gone on here. Inland Revenue does not seem to be showing significant improvements in cost efficiencies. It has a great reliance on temporary contractors beyond what you might expect for a short period. As I said at the beginning, use of contractors by Inland Revenue is not unusual. But here it seems to have become very, very significant.

And so that raises for me questions about whether, in fact, the Business Transformation programme is delivering what it should be or was intended to. And then there is the question that despite engaging all these temporary contractors in the call centres, Inland Revenue has been diverting resources from other parts to handle calls.

You will recall when I spoke with Andrea Black last year we talked about how the funding of investigations had fallen, the hours spent on investigations had fallen, and we knew that many investigation staff, who are very, very experienced, had been diverted to handle calls on the main call lines.

Now, interestingly, in the recently announced Budget Appropriations for 2021/22, the funding for investigations and management of debt and unfiled tax returns collectively were cut by $15.9 million going forward. However, the appropriation for processing costs has gone up by $10.4 million or 8% to $138 million. Now, again, this is a question which Andrea raised during our podcast. ‘Wait a minute, with this new system, should we not be seeing reduction in processing costs?’ But instead, we’re seeing increasing processing costs.

So overall, although Inland Revenue won this case in the Employment Court, I think it has opened a can of potentially very interesting issues as to its use of contractors, and whether Business Transformation is delivering what it says it’s supposed to be delivering.

So, I think we’ll hear more on that in the coming weeks. I have no doubt that some questions will be raised around this at various levels. Certainly, the PSA will continue to pursue the case now.

Act now or wait for the OECD?

Moving on, last week I talked about how the Minister of Revenue David Parker had climbed into Google in particular over its tax practices. Now, it so happens this week, Google New Zealand’s results for the year ended 31 December 2020 were released.

The data contained in there prompted one accountancy expert, Dr Victoria Plekhanova, to say that she considered that the government at present may be giving to big tech companies like Google and Facebook, a free ride on tax while it’s waiting to see whether a coordinated OECD process we mentioned before, will bring a new order into the tax international tax regime.

Dr Plekhanova noted that the service fee paid by Google New Zealand to related parties offshore had increased from $511.4 million in 2019 to $517.1 million in 2020. Google reported revenue in New Zealand of $43.8 million, which was up from $36.2 million in 2019, and that its net profit for the year was $7.8 million, slightly down on last year’s $8.12 million. In the end, it would be paying about $3.3 million in taxes, which was roughly the same as in 2019.

But as Dr Plekhanova pointed out, there’s this significant amount of service fees going offshore, which is one of the matters that I’m sure Minister Parker is well aware of.

The other thing that caught my eye as well in this is that there’s an amount due to related parties, which as of 31 December 2020, amounted to just over $78 million. And curiously, it’s not like Google doesn’t pay income tax it also pays a fairly significant amount of GST it appears. There’s GST payable as of December of $8.5 million. Assuming it files GST returns monthly, which it should do, based on its turnover, that would point to maybe a total of $100 million of GST being payable annually, which is good. But that’s probably being paid by businesses who will be claiming an input tax credit, so maybe there’s no net revenue gain there.

Whatever it is, Dr Plekhanova made the argument that this is why digital services tax has become more attractive to various countries. India, for example, has a 6% equalisation levy and has recently imposed a further digital services tax, which drew the ire of the United States. Although India’s response has pretty much been well, if you want to get access to 1.4 billion customers, this is how it’s going to be. India is big enough to be able to tell the tech companies you play by our rules or else, but New Zealand can’t.

So, the issue for us is whether the government is going to wait on the OECD rules coming in on a global minimum tax, which we talked about before, and agreeing a new basis for taxation or it decides to push forward with a digital services tax. I imagine that seeing Google’s latest results may well prompt Mr Parker to move up the progress of a digital services tax.

Bright-line fish hook

And finally this week, there’s a warning from the Chartered Accountants Australia and New Zealand’s head of tax, John Cuthbertson, about an issue with the revised bright-line test.

What he’s pointing out is that the changes are not just in the extension of the period to 10 years, but the revised rules will now explain how long homeowners can stay away from the main home before the bright-line test kicks in.

Under the new rules, as proposed, they are able to be away from the family home for a continuous period of up to a year. However, for some people, if they’re seconded overseas or have a longer secondment down country, that might not be long enough. It may mean that if they sell within the 10-year period, they could find that some part of any capital gain could be taxed.

We’re expecting a discussion document on these property tax changes very shortly. But as I’ve said beforehand, and this is another example, we know these rules are going to be complex. And this is why I’ve raised the argument that maybe we should be starting to think differently, adopting a completely different approach to the taxation of investment property. Anyway, when the new discussion document on these property tax changes emerges, we’ll look at it in detail.

Well, that’s it for today. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients until next week, ka kite āno.

Inland Revenue launches construction industry campaign

Inland Revenue launches construction industry campaign

24 Apr, 2021 | The Week in Tax

  • Inland Revenue targets the construction industry
  • The unfair tax treatment of ACC lump sum payments
  • The latest OECD data on carbon pricing

Transcript

This week, Inland Revenue launches a construction industry education campaign, an odd case highlights the continuing unfair tax treatment of lump sum payments, the OECD data around the use of taxes on carbon.

On Tuesday, Inland Revenue launched an education campaign for the construction industry. As its press release to tax agents indicated, “The purpose of the campaign is to engage with those in the construction industry, to ensure they’re getting it right from the start and support them in understanding their tax obligations if they undertake cash transactions.”

The release goes on “Our customer research indicates that people are more likely to engage in hidden economy activity e.g., cash jobs, in an environment of economic uncertainty such as the current Covid-19 environment. We want to reduce the risk of this through awareness, education and compliance.”

And what it proposes to do is place Inland Revenue ads around building sites and hardware stores, together with online ads. Now, as part of this, Inland Revenue has put together a website called Rebuild NZ, and it’s to highlight to those in the construction industry how they can ensure they meet their tax obligations as well as doing their bit to help rebuild New Zealand.

Now, this is a useful initiative from Inland Revenue. They do these campaigns regularly. This one actually is quite interesting in that it is tackling the question of cash, jobs and cashies, but it’s not too heavy handed in its approach. Its website’s heading is “Cashies won’t rebuild our country”. So it’s playing on emotional strings. And this is actually quite standard practice now. You notice a play on what’s the consequences of not contributing to the tax take. The website declares every “undeclared cash job hurts our economy and the greater New Zealand.” So it’s really pulling the emotional triggers.

A couple of things of note on that. The website wisely, in my view, points out it’s OK to do cashies. You just need to declare them on your annual tax return. What Inland Revenue is saying is that per se, these aren’t illegal, but they become problematic if you don’t declare the revenue from them.

There will be some persons who, for whatever reason, want to be paid cash. And you can draw your own conclusions as to why they might want that. But if they are following the rules, make the necessary declarations then Inland Revenue is unconcerned, relatively speaking.

The other thing the website highlights here is, and I quote, “Can cash jobs really be tracked”? And it underlines this absolutely, giving the following example.

If two tradies work together, one declares a job, the other doesn’t. They can be dobbed in without realising it. If we audit one person, it might indicate another business or contractor that needs to be audited. Also, there’s always a chance of a random audit. We can see when tradies buy supplies such as paint, carpet or timber without a corresponding declared job. We can also access information held by other government departments, banks, loyalty cards, casinos and many other organisations to make sure all income is being declared.

Interesting reference to casinos in there, because clearly casinos are a place where cash is handy for gambling. And if you’ve read many tax cases down the years you’ll know an excuse for unexplained income is often, “Oh, I got lucky on the horses or down at a casino.”

So what they’re saying is it’s never too late to do the right thing, come forward, make voluntary disclosures, or if you wish, report tax or tax evasion or tax fraud anonymously.

As I said, we’ve seen a number of these campaigns before.  As Inland Revenue works through the final part of its Business Transformation programme and gets fully back up to speed we’ll see more and more resources deployed into taxing the hidden economy. The estimate is that it could be worth a billion dollars a year in undeclared GST and income tax.

ACC lump sum tax unfairness

Moving on. A case before the Taxation Review Authority, the tax equivalent of the District Court, caught my eye the other day. A taxpayer had commenced challenge proceedings against the Commissioner of Inland Revenue contesting the tax treatment of a lump sum paid to her by ACC on 9th November 2017. The payment was for weekly compensation due to her for the period from the date of her injury on 22nd April 2014 to 17th September 2017.

The taxpayer contended that the payment should have been treated for tax purposes as having been derived on an accruals basis and spread over the income years to which the payment related, rather than on a cash basis as assessed by the Commissioner.

As you can see, although she received over three years compensation in one sum, Inland Revenue treated it as income for the one year, even though it actually related to nearly three years, and taxed it at the relevant rate. And because of the way the tax system applied, a large chunk of that lump sum would have been taxed at 33%, when in fact probably it would have been taxed at lower rates had it been received when it should have been.

It’s not the first time I’ve seen this. It’s actually something I have raised directly with then Minister of Revenue Peter Dunne almost 10 years ago. It’s a well-known problem of the tax system, that whenever ACC denies a claim or is slow paying out, often the recipients lose out on the tax side of it, because when they finally get the correct amount of compensation, it’s paid as a lump sum and taxed accordingly.

The taxpayer in this case understandably outraged, then tried to take a case through the Taxation Review Authority. And in response, Inland Revenue – the Commissioner –  applied for an order striking it out as there was no cause of action as it was clearly untenable and could not succeed. And the TRA agreed there was no tenable prospect of success.

But that doesn’t get past the issue that the taxpayer had a very fair point, and it’s something, as I said, I’ve seen before. And it is frustrating that this continues to happen, and Inland Revenue and  successive Ministers of Revenue are inclined to do nothing about it.

In the interests of equity and fairness, this is an issue that should be addressed. By the way, the lump sum taxation of redundancy payments should also be addressed for the same reasons: a taxpayer may normally have their earnings taxed at 17.5%, but instead, when a lump sum, the tax system will tax it at 33%. And now with an increase in the tax rate to 39%, there is a likelihood that an even higher rate of tax – more than double in fact – could apply to a lump sum payment.

So addressing this is well overdue in my mind. But it’s funny, there’s a lot of stuff goes on in the tax world. But basic stuff like this which affects ordinary people, seems to just get left on the “Can’t be bothered” or “Too hard” piles.

Tax threshholds

And interestingly, yesterday an article came out in Stuff, which ties into this.  It pointed out how tax rates for those middle-income earners are too high relative to their income because the thresholds have not been adjusted since April 2008.

As Geof Nightingale of PWC and the Tax Working Group pointed out, most attention needs to be paid to the tax rate applicable to middle income earner:

“I think our harshest tax rate isn’t at 39% or 33%. It’s 30%, which cuts in at 48,000 dollars. That’s below the median wage. That jump from 17.5% to 30% in the dollar is a steep one. It seems tough to be hit with that tax rate when you’re earning below the median income”.

I agreed with that, as did Robyn Walker, a partner at Deloitte.

And we also gave examples that if thresholds had been raised in line with wage inflation, the threshold at which 33% kicks in, which is currently $70,000, would probably be nearer to $100,000. And the $48,000-dollar threshold, when it rises to  30%, would be about $67,000.

So the thresholds are now well out of whack. But again, governments of both hues seem inclined to not do much about it or, kick it down the road and pretend when they do something, it’s a tax cut. Something I think they’ve been allowed to get away with for too long.

And that’s why Simon Bridges has put in this private member’s bill to change that. It will be interesting to see what exactly happens to it. You can bet that politics will come into play and what is actually quite a sensible measure will probably be stifled.

Taxes on carbon

And finally, yesterday, 22nd April was Earth Day. And obviously there were a number of events in recognition of that event.  As part of the run up to Earth Day, the OECD released a brochure talking about effective carbon tax rates and how the 44 OECD and G20 countries price carbon emissions from energy use.

The OECD points out that carbon pricing is an effective decarbonisation policy because it makes low and zero carbon energy more competitive compared to high carbon alternatives by pricing carbon emissions properly. And it highlights what’s happened in the UK’s electricity sector, which used to be primarily coal and gas fired. The UK has increased effective carbon rates in that sector from seven euros per tonne of CO2 to more than 36 euros per tonne between 2012 and 2018. As a result, emissions in the electricity sector fell by 73% over that time.

And so what the OECD is saying is we should be looking at emission permit prices, carbon tax, or as we do here, an emissions trading scheme and fuel excise taxes. Fuel excise taxes always come with a caveat in that they are very regressive for low-income earners. One of the biggest problems we have with our transport policy here is the fuel taxes will hit low-income earners quite hard, particularly when we haven’t yet developed sufficient alternatives in public transport to enable alternatives

The OECD report wasn’t particularly complimentary about how the top 44 countries have been doing. It notes that three countries, Switzerland, Luxembourg and Norway, have reached a carbon pricing score rated on 60 euros per ton, which is the price expected by 2030 to be needed for carbon decarbonisation. Those three countries are close to 70% on that. And that’s mainly because of fuel taxes on the road sector.

But elsewhere, progress is patchy. Brazil and India are right down at one end of the scale. The USA is at 22%. New Zealand sits roughly just below the average at 33%.

There’s a lot of work to do and as we know, we’re now starting to get into the debate led by the Climate Change Commission as to how we deal with this matter. Tax is going to play a part in that.

As I said, fuel taxes are a problem for until we develop adequate alternative transport policies, public transport. Building more roads doesn’t help because that actually increases emissions. But the infrastructure deficit New Zealand has needs to be addressed and, tax will play a part in this.

As I’ve mentioned before, I think fringe benefit tax on high emission vehicles, as they do in the UK and Ireland, is something that we should be looking at. But I also feel very strongly that any taxes raised by this should be recycled back into ameliorating the impact for those who cannot choose alternatives to using their car.

Well, that’s it for today. Next week, I’ll be joined by John Cantin, a tax partner at KPMG who made some very interesting observations about the tax policy process and implications of the recent property tax proposals. We’ll be discussing this and the implications for the Generic Tax Policy Process.

I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week Ka kite āno!