Tax News

How the interest limitation rules will apply to taxable sales of property

How the interest limitation rules will apply to taxable sales of property

6 Jul, 2021 | The Week in Tax

  • How the interest limitation rules will apply to taxable sales of property
  • Interpretation statement on income tax and GST treatment of businesses disrupted by the COVID-19 pandemic
  • Global minimum tax rate proposals

Transcript

Chapter 5 of the discussion document on the proposed interest limitation rules deals with the matter of great interest to a lot of people, and that is what happens with interest deductions which have been disallowed for a residential investment property which is subsequently sold, and the sale is taxable. Now, just to recap, the interest deductions for residential investment properties are to be restricted and eventually disallowed in full starting from 1st October this year. There is an exemption to this if the property qualifies for the development or new build exemption, which we discussed last week.

Now, amidst all the noise, it’s worth pointing out, the reason for this proposed treatment is to reduce the tax advantage for property investment and not full deductions for interest have been allowed. But the income from a capital gain has often not been taxed.

So the question that then arises is, should a deduction for interest be allowed for at the time of sale if the sale is taxable – or what we call on revenue account. As in that case, all the income from investing in the property is taxed.

Now, just as an aside on this, the terminology of revenue and capital account causes some confusion. It was interesting last week when I was presenting to the Employers Manufacturers Association and the New Zealand Chinese Building Industry Association that there was obvious confusion in the audience around the terminology of revenue and capital account.

The short answer is that land held on revenue account will be taxed on sale. So, for example, that would be properties purchased with the intention of disposal or acquired for the purposes of business relating to land such as development. It gets a little bit more confusing with the bright-line test because property is taxed under the bright-line test, become held on revenue account only once it is known that they will be sold within the bright-line period. Prior to that point they’re not held on revenue account.

Otherwise, the discussion document in Chapter 5 at paragraph 5.8 goes into some detail about what the types of properties which will be deemed to be held on revenue account and therefore taxable, but for the purpose of the interest limitation rules that the question the discussion document wants to address given that we are denying deductions from 1 October, what do we do when a property is sold, which is taxable, i.e. was held on revenue account?

Four Options are proposed. Option A deductions are denied in full. Option B interest deductions are allowed at the point of sale and under that option it would be possible for excess deductions to be offset against other income.

For example, Annette buys a house for $1 million, three years later, she sells it for $1.2 million. The house was used as a residential rental property for the whole period. Over the three years, she incurred $300,000 of accumulated interest deductions.

Under Option B she would be able to deduct $200,000 dollars against the taxable liability arising from the sale of property in the year of sale. The remaining $100,000 could be offset against other income for the year, resulting in net taxable reduction of $100,000 available to her.

Now, what the discussion document points out, and this is a problem Inland Revenue is going to have to think carefully about, is if Annette sold that property on capital account, say it wasn’t subject to bright-line test, she wouldn’t get a deduction for the interest. And that means that she has an incentive to say that she’s selling on revenue account. So, this deferred interest deduction Option sets up a tension within the new rules, which is inevitably going to lead to quite a lot of discussions between Inland Revenue and taxpayers about transactions. Anyway, that’s Option B; interest is deductible at the point of sale, and any excess can be offset against other income.

Option C allows a deduction for the accumulated interest at the point of sale, but only enough that it does not give rise to a gain or loss. So, in Annette’s case of $300,000 of accumulated interest and a taxable gain of $200,000, only $200,000 of the accumulated interest is allowed as a deduction in the year of sale. The excess $100,000 would be forfeited.

Option D is a variation on this. It says the $200,000 is allowed at the point of sale and the excess $100,000 would be ring fenced and carried forward under the ring-fencing rules for offset against property income.

Now, as mentioned above, there is this ongoing tension that this whole provision will create between sales on revenue account where interest becomes deductible and selling on capital account where interest is non-deductible. The discussion document then does consider whether some interest should be allowed for sales made on capital account.

Under Option E, no deductions would be allowed. And the paper describes this as not allowing any interest deductions as a rough offset for the benefit of the capital gains not being taxed. And it goes on to note “this would have the strongest impact on reducing investor demand for residential property”. So that’s bound to be attractive to the Government given its intentions behind the policy.

Alternatively, Option F is that no deductions are allowed up to the amount of the untaxed gain, but any excess becomes deductible. This is an economic return argument. For example, Ray sells a residential rental property for untaxed gain of $200,000, but had incurred $150,000 dollars of interest, which had been disallowed for the period the property was rented. In that case, no interest deduction would be allowed, and they’ve completely forfeited.

If, on the other hand, the untaxed gain was still $200,000, but $250,000 of interest had been disallowed, Option F would allow a deduction of $50,000 for the excess interest over the gain.

So there’s a bit of detail here. I’m pretty certain people will want to see an interest deduction at the time of sale come in. And obviously the most generous option would be Option B.

The discussion document is asking for feedback on which of these proposals should apply and they’re all set out in Chapter 5. It’s reasonably readable, there’s just a lot of it. But I’d still urge everyone to have a read and make submissions as appropriate. And remember, the deadline for submissions is 12th July.

Pandemic support

Now, moving on, we’re still dealing with a pandemic, and on that point, as of Thursday, 1st July, a Resurgence Support Payment became available for those in the Wellington and greater Wellington area affected by the move to level two. Inland Revenue has opened applications for this Resurgence Support Payment and applications are open for the rest of July.

Now, at the same time, Inland Revenue has released an Interpretation Statement IS 21/4 on the income tax and GST deductions for businesses disrupted by the Covid-19 pandemic.

What this interpretation statement does is consider whether a business can claim an income tax deduction for expenditure or loss incurred when the businesses downscaled or stopped operating because of the pandemic. It also looks at GST implications of those events.

Generally, an income tax deduction will usually be allowed where a business has downscaled or ceased operating temporarily, provided no capital expenditure restriction under the Income Tax Act would apply.

However, a deduction will usually be disallowed where the business has completely ceased, even if it is possible that the business may restart later. And it gives an example of an English language school where they terminate the lease. The view taken by the Interpretation Statement is in those circumstances the business had ceased and from that point onwards, deductions are going to be restricted.

Now in determining whether a business has ceased operating temporarily or permanently it’s a question of fact, and the Interpretation Statement looks to the nature of those activities carried on and the business’s intention in engaging in those activities.

Coming back to this English language school example when it’s operating all its enrolled students are from overseas. Then it must close because the country went to Alert Level 4 and it remained closed until Alert Level 2.  What the example provides is that for the period during Level 4 lockdown, because there was an intention to operate once the lockdown was over, all deductions for expenditure incurred during this period would be allowed, such as rent rates, power, water, insurance, etc.

Likewise, GST input tax deductions would be allowable. Now, on GST, what the Interpretation Statement points out is if a GST registered person ceases to carry on a taxable activity they may be required to deregister for GST and then they’d be liable to pay output tax on the value of goods and services used in the business at the time of de-registration.

But generally speaking, if businesses have been affected by the pandemic, but had the intention to try and carry on trading, they should be okay on income tax deductions and GST input claims. But if they reached a point where they basically have stopped, issues around deductibility and availability of input, tax claims and GST registration will need to be addressed.

International tax reform – 15% or 21%?

And finally this week, 130 countries and jurisdictions have signed up for a new Two Pillar plan to reform international tax rules and ensure that multinational enterprises pay a fair share of tax wherever they operate. There’s been a statement signed establishing a new framework for international tax reform. There’s a small group of nine of nine jurisdictions that have not yet signed the statement.

And the remaining elements of this framework and how it’ll be implemented will be finalised in October. One of the key things that they’ve signed up to is Pillar Two, which seeks to put a floor on competition over corporate income tax through an introduction of a global minimum corporate tax rate.

And the proposal is that the minimum tax rate will be at least 15%.  The estimate is that that’s going to generate about USD150 billion in additional global tax revenues annually.

And Pillar One, which deals with taxing rights, will mean about another USD100 billion of profit to be reallocated to market jurisdictions.

Now, our government will be watching this with interest, but in the past, we’ve discussed whether in fact this may have a significant impact for the Government’s finances, but still it’s progress.  We’re still waiting to see whether this global minimum tax rate will settle at 15%. The US, as I’ve described previously, wants 21%. But it’s a question of wait and see. And as always, we’ll bring you developments as they happen.

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 week ka kite āno!

A look at the G7’s agreement for a minimum corporate tax rate of 15%

A look at the G7’s agreement for a minimum corporate tax rate of 15%

21 Jun, 2021 | The Week in Tax

  • A look at the G7’s agreement for a minimum corporate tax rate of 15%,
  • The role of tax in the Climate Change Commission’s final advice to the Government
  • FBT and what is a work related vehicle?

Transcript

Last weekend in Cornwall, England, the G7 Leaders meeting confirmed what had been agreed by the G7’s Finance Ministers and Central Bank Governors over Queen’s Birthday weekend, that a minimum corporate tax rate of 15% would be introduced on a country-by-country basis.

What the Finance Ministers and Central Bank Governors have agreed to is what they describe as “an equitable solution on the allocation of taxing rights with market countries, a water taxing rights on at least 20 percent of a profit exceeding a 10 percent margin for the largest and most profitable multinational enterprises.”

Now, what’s also part of this deal and has been probably overlooked because of the commitment to the 15% rate, is that the G7 also agreed to “provide for appropriate coordination between the application of these new international tax rules and the removal of all Digital Services Taxes and other relevant similar measures on all companies.”

And that’s where it gets a little interesting, because when you look at the press conference held immediately afterwards by the US Secretary of the Treasury, Janet Yellen, it becomes apparent that this is a bit of a win for what we call the GAFA – Google, Apple, Facebook and Amazon.  When she was questioned about how, for example, the French are targeting Amazon and Facebook, Secretary Yellen replied as follows,

“It is intended to replace an approach that focused on just a few US digital giants, and the agreement is that this new approach will replace an approach that we found objectionable, that targeted large, successful US digital firms. But most of these firms are likely to be included in this new scheme the Pillar One scheme.”

Pillar One and Pillar Two are part of this international framework being built to set up how we tax digital economy in the 21st century.

And it’s quite interesting because it comes back to discussions, as we mentioned previously, about the impact of the digital economy and, for example, how much tax Google pays here relative to how much it’s actually taking out of the economy. On the basis that New Zealand gets to tax 20% of the residual profit above a 10% margin, it’s possible that Google’s tax bill may triple to maybe $9 or $10 million. And that would be based on the assumption that about $200 million or so of its estimated $800 million that it takes out in advertising becomes taxable. Is that a big win for New Zealand? I’m not so sure.

The other point that I’ve noted about Secretary Yellen’s comments, is that the 15% rate is in the US view, a minimum, with 21% as the target. Questioned, “Well, how are you going to make this work?” Yellen also pointed out that the agreement under Pillar Two contains an enforcement mechanism that would come into play and apply to jurisdictions that decide, “No, we’re happy to be tax havens and we don’t want to sign up to this agreement”. This so-called “under tax payment rule” would essentially put pressure on those countries to abide by the corporate minimum tax, whatever is eventually agreed.

And so that’s basically calling time, as the G7 communique refers to it on this race to the bottom on corporate tax rates which has been going on for about 40 years now.

The next stage is that the agreement will be worked out through the G20/OECD inclusive framework. There is a July meeting of G20 Finance Ministers and Central Bank Governors, which is hoped will get final agreement on this 15% minimum corporate tax rate and on the agreement on the Pillar One taxing rights.

I suspect as usual, politics will come into play here. And I do wonder how India is going to react to this, because it has made significant use of digital services taxes. But we’ll have to wait and see. It’s certainly a step forward in the right direction. And it is another step on the road towards ending tax havens, whose days, in my view, are numbered.

What was also interesting about the G7 Finance Ministers and Central Bank Governors communique announcing the global minimum corporate tax rate, is that that particular announcement was just one paragraph of 20. It was actually number 16 because the first focus was on “building a strong, sustainable, balanced and inclusive global economy”. And then the G7 Finance Ministers went on to talk about the transformative effort to tackle climate change and biodiversity loss. And they spent a bit of time on this, as did the G7 leaders when they released their communique.

And of course, coincidentally, in the same week as the G7 Finance Ministers made their announcements, we had the Climate Change Commission releasing its final advice to the Government on how to move forward on climate change.

Climate change and tax

Now, the Climate Change Commission actually had little to say about specific tax measures. It did note, for example, that reducing oil and gas production in New Zealand would reduce the Government’s tax revenue. As is well known, the Emissions Trading Scheme would remain the main pricing tool.

The Commission did note that tax could be used to incentivise investments and choices, although it didn’t say much specifically on this. It talks about maybe using taxes for R&D incentives. We have an R&D tax credit incentive scheme. And you may recall that last year I spoke with John Lohrentz about an interesting idea using R&D tax incentives to reduce methane emissions.

The Commission did suggest that the tax system should be examined for ways to discourage the adoption of internal combustion engine vehicles and encourage low emission options. It noted that some submitters, and I was one of them, raised concerns about how fringe benefit tax is calculated for light vehicles and in particular the question of emissions from utes and trucks.

Most of that went by the by. But then last Sunday the Government announced its feebate proposal for electric vehicles and a debate kicked off on social media, over this question of twin cab utes and their “exemption” from FBT. So I thought today I would have a look at this widely held belief that utes are exempt from FBT under the work-related vehicle exemption

To go back to basics under Section CB 6 of the Income Tax Act 2007, a fringe benefit arises when a motor vehicle is made available to an employee for their private use. However, that provision does not apply when the vehicle is a work-related vehicle.

Now, Inland Revenue’s summary of this is that FBT will not apply to a vehicle if it meets all of the following conditions:

  • it is drawn or propelled by mechanical power (this includes trailers);
  • it has a gross laden weight of 3,500 kg or less;
  • the vehicle is mainly designed to carry goods or goods and passengers equally;
  • it has prominent company branding that cannot easily be removed;
  • you tell your employees in writing that the vehicle is not available for private use; except for travel between home and work, and for travel related to the business, such as stopping at the bank on the way home from work.

And then Inland Revenue say as part of this, you must give employees a separate letter explaining this restriction rather than mentioning it in their employment agreement.

Now the statutory definition of work-related vehicle is set out in Section CX 38 of the Income Tax Act. And as just recited, there’s restriction around the display of branding, for example. And on this, sticking the branding on say the spare tyre, which is on the back of the vehicle, is insufficient because that’s fairly easily removable. The sign writing has to be prominent.

The definition of a work-related vehicle in section CX 38 does not include a car. And then there is the bit that I think is causing all the issues around fringe benefit tax. Under section CX 38(3), the motor vehicle is not a work-related vehicle on any day on which the vehicle is available for the employee’s private use, except for private use, that is travel to and from their home, that is necessary in, and a condition of their employment or other travel in the course of their employment, during which the travel arises, incidentally, to the business use.

There are a couple things to note here, for example, that it is NOT a work-related vehicle on ANY day when it’s used privately. Then on the question of private use travel to and from their home is ok if “it is necessary in, and a condition of their employment.”

Now, in my view all of those conditions are where the gap, in FBT compliance, is happening. The home to work restriction is not being followed through. I would also question, in fact, whether as many companies have the separate letters in place that Inland Revenue expects.

This home office base of business is something Inland Revenue has looked at. Increasing numbers of businesses are working from home digitally whether it’s a trade or digital business.  So it’s reasonably clear that home is a place of work and therefore travel from there which is for business purposes is covered by the exemption.

But as I’ve noted beforehand, FBT does seem to be tracking behind in payments[1]. And there are perhaps apocryphal stories of Ministers of Revenue turning up to meetings in the South Island and being greeted “Welcome to the South Island where we don’t pay FBT.”

To get across this Inland Revenue will need to devote some resources to finding out exactly what is going on in this space, because as came out through the feebate debate, the twin cab ute has become one of the most popular and best-selling vehicles in New Zealand. And the question arises particularly when you see them in an urban environment, are these really work-related vehicles and what is Inland Revenue going to do about it?

And this comes on to my final point this week as to whether Inland Revenue, in fact, has the capability to investigate the issue. It should have. It has very extensive information gathering powers. I would have thought it was a straightforward matter to obtain details of all companies which own twin cab utes or similar vehicles and then cross-reference that information with FBT returns.

Maybe that is going on, and if so it would mean Inland Revenue has decided to keep quiet that it is actually working on such a project. Although Inland Revenue has a policy of proactive enforcement on issues by announcing “We are about to look at these areas”. It’s just done so about real estate agents. So saying it’s looking at FBT would actually be conducive for getting people to look and see if they’re actually compliant.

However, I have reservations about whether that’s happening and whether, in fact, Inland Revenue does have the capability to do so. I’ve just been informed that in another round of restructuring, 77 of 138 team leaders are to be made redundant. These are the exact people who have the experience and skills to lead such investigations. Now, that doesn’t make a lot of sense to me laying off such a high proportion of your skilled labour.

Unexpected tax bills

And then there was a story this week about pensioners receiving large tax bills. Now, Inland Revenue subsequently issued a press release on this. But a common theme when I spoke to journalists about the story itself was that pensioners had tried to contact Inland Revenue to confirm what PAYE tax code they should be on.

And so the question arose as to whether, in fact, they had got the correct advice from the Inland Revenue call centre. And that leads back to what we discussed a couple of weeks ago about what’s going on with Inland Revenue’s use of contractors. Because if the contractors aren’t being trained properly, then Inland Revenue is giving incorrect advice and pensioners are left cleaning up the mess, owing tax bills of up to $2,000.

And that is not good for the tax system. Because the fear I have, if I and other tax agents are saying to our clients, “These are the rules, you must comply with them”, but clients have the sense that other people are not complying with the rules and Inland Revenue is not catching those other people, then the whole basis of voluntary compliance on which our tax system is built around is undermined. And that is something that I think we should all be concerned about.

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.

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.

This week the Minister of Revenue is not happy with Google

This week the Minister of Revenue is not happy with Google

1 Jun, 2021 | The Week in Tax

  • This week the Minister of Revenue is not happy with Google
  • How many ACC lump sums may be over-taxed
  • Inland Revenue updates the square metre rate for home offices

Transcript

Last week, on the same day as the Budget, Newsroom carried a story about Google and its taxation practises and the Minister of Revenue, David Parker’s views on that. And it was surprisingly blunt. He was, as the article put it, somewhat scathing of Google’s reticence to pay more tax.

The head of Google in New Zealand, Caroline Rainsford, had given an interview to Newsroom, which coincided with the Budget, and it outlined how Google has been pushing back against the nascent plans by the government to set in place its own digital services tax. This is conditional on whether the OECD cannot reach agreement on a unified approach to taxation.

Anyway, Rainsford said that basically, although Google is for the OECD development of a simpler and unified tax system, it’s not encouraging a unilateral approach here. In other words, please don’t tax us more, but we’ll be happy to look to see about what’s happening with this international tax initiative.

Google’s parent company Alphabet reported new net profit of equivalent of US$48 bln for the year ended 31 December 2020. And that makes it the eighth most profitable company in the world.

But the Minister of Revenue, David Parker, returned fire on this. And he noted that Google New Zealand paid $3.6 million in income tax in the year to December 2019, based on a profit of $10.6 million and revenues of $36.2 million. Apparently, similar numbers can be expected for the year ended 31 December 2020, when they’re reported shortly.

The thing which appears to have got Mr Parker’s goat is that Google’s estimated ad revenue in the country is close to $800 million, he told Newsroom;

“They could voluntarily pay some tax on the profits taken out of New Zealand already, but they’ve obviously not done that. That revenue used to be earned by media companies. Media companies would have paid tax on it. And other media companies suffer competitive disadvantage competing against Google when Google does not pay a fair amount of tax. It’s not fair and something has to change. And Google is the biggest.”

He points out the ad revenue which are being delivered in New Zealand are not being reported within the New Zealand tax net.

This is an issue we’ve talked about beforehand all around the world. And one solution that governments have put forward, pending some form of international agreement on, it is a digital services tax. That is rumoured to be in the order of maybe three percent is one number that’s been outlined. And estimates of how much it might raise, maybe between $30 and $50 million.

But I think the Minister’s point about the amount of revenue that Google is taking out the country and how that might have played in the New Zealand media companies that earned it, is a valid one. Even if it were the DST of $30 to $50 mlnn, that’s still nowhere near what would be the income tax on $800 million of revenue. So this issue is clearly one that Mr. Parker is paying particular attention to. And obviously, given Caroline Rainsford’s comments on that, Google is slightly concerned about the matter.

We don’t know how much other digital companies such as Facebook, LinkedIn and Twitter take out of New Zealand through digital advertising. Google is clearly the biggest. It’s thought overall including Google’s $800 million there could be as much as one billion dollars of ad revenue going offshore. So the government will be looking at that.

It will be encouraged, no doubt, by the announcement from the US Department of Treasury this week that it is in favour of a global minimum tax rate, and it has suggested that it should be at least 15%. The US Treasury has said that 15% is a floor and discussions should be continued to be ambitious and push that rate higher – 21% is a number that’s been raised previously. But the US Treasury’s view is

“a global minimum corporate tax rate would ensure the global economy thrives based on a more level playing field in the taxation of multinational corporations and would spur innovation, growth and prosperity while improving fairness for middle class and working people”.

And no doubt Minister Parker will say amen to that.

On the other side though, the UK is the only country in the G7 which hasn’t signed up to this multilateral deal that’s being put together by the OECD. And Boris Johnson’s Government has been described as “lukewarm and evasive” on the matter. I think lukewarm and evasive is something that plenty of people have said about Boris Johnson, the latest of which being his former special adviser, Dominic Cummings, last night. But the UK also has long standing cultural or actual colonial links to many of the tax havens which are at the heart of the whole issue.

So we’ve got an interesting combination of factors going on here. Minister Parker is clearly looking at the whole Google and digital taxation matter and is obviously happy to push ahead by applying pressure and maybe push ahead with the implementation of a digital services tax. Which, by the way, the Tax Working Group said might be something to have in place if an international agreement could not be made.

On the other hand, there’s some progress on this by the US Treasury throwing its weight behind a global minimum tax. But then we have the pushback from the UK, or rather, we should say the UK not making a decision. And then there’s been pushback, as I mentioned earlier, from the likes of Ireland with its 12.5% corporate income tax. So it’s internationally the biggest thing that’s going on in tax right now. And it’s a question of just watch this space and see what develops.

Heads the IRD wins, tails the taxpayer loses

Now, moving on, a few weeks back, I discussed a case brought in the Taxation Review Authority against the Commissioner of Inland Revenue contesting the tax treatment of a lump sum paid to a claimant by ACC.

The payment was for weekly compensation for the period from the date she was injured on 22 April 2014 to 17 September 2017. And the taxpayer contended that the payment should be 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 being taxed in the year in which it was received. As is the current practice.

And this, as I mentioned at the time, is a longstanding issue I have been aware of. And it can mean for claimants that they receive a lump sum, and instead of being taxed at an average rate of 17.5%, they find the lump sum taxed at 33% or even potentially now at 39%. So, it’s an issue I think needs looking at.

I subsequently made an Official Information Act request to ACC about the number of such payments for backdated weekly compensation. ACC replied this week, and it made for some interesting reading. In the year to June 2017, the number of such claimants was 1,187. They received on average $42,482. The median amount, by the way, was $21,643. The maximum was $650,000.

And for 2018 similar sort of numbers – 1,172 claimants, 2019 saw 1,283, and in the year to June 2020 it was 1,466, who received on average $42,505. The median there was $21,146, but the maximum was an eye watering $1,180,000.

There’s a consistent trend there, and enough people in the system and big enough numbers for Inland Revenue Policy and the Minister of Revenue to have a look at that. We do some averaging, for example, it has been pointed out to me, in farming cases we average some of the income because of droughts. So, spreading income over several years in which it relates is not unknown to the tax system and our financial arrangements regime actually operates on that principle.

I propose to send these numbers off to Inland Revenue Policy and to the Minister of Revenue’s office. I’ll keep you posted as to how things develop from there.

Square metre rate up +4.7%

And finally this week, the square metre rate for the year ended 31 March 2021 has been set by Inland Revenue at $44.75 per square metre. That’s up from $42.75 per square metre for the year ended 31 March 2020.

Now, although this sounds quite a technical thing, it relates to the calculation of home office expenses and Inland Revenue’s square metre rate option provides a simplified process. Which means that taxpayers don’t have to keep detailed records of utility costs, contents, insurance, Internet on their private residence, and then have to apportion these costs between business and private use. Instead, they simply apply the rate to the area of the house that is used for business purposes.

It’s a nice, simplified process, something I think we should see more of in the system to try and simplify the process for clients. I think Inland Revenue would have the information or would be able to dig out some of the information for this expense, maybe by an analysis of GST returns. By the way, premises costs such as mortgage interest rates and rent, still have to be claimed based on the business proportion of the actual expenditure incurred by the taxpayer.

This is a sort of throw away measure it seems, but one that actually affects quite a lot of people. And as I said, I think we should see more of this setting rates, giving maybe a standard deduction for people, just to simplify the system.

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.

Small Businesses and tax compliance, PAYE for employees of overseas companies

Small Businesses and tax compliance, PAYE for employees of overseas companies

12 Apr, 2021 | The Week in Tax

  • Small Businesses and tax compliance, PAYE for employees of overseas companies
  • Managing fringe benefit tax
  • A global minimum corporate tax rate?

Transcript

Friday was Small Business Day. If you spent money with a participating small business and posted your interchange on social media, you and the business could have won a share of $200,000 dollars. Now, this is part of an initiative underlining the importance of small businesses in the New Zealand economy.

MBIE defines a small business as one with fewer than 20 employees. And according to Stats New Zealand, there are approximately 530,000 small businesses in New Zealand meeting that definition. They represent 97% of all firms, account for 28% of employment and just over a quarter of New Zealand’s GDP.

So they’re very important to the economy, but most importantly, also for the community. When small businesses move out, the community suffers. So this sort of initiative and the work we were doing during my time with the Small Business Council is important for the economy.

However, when it comes to the tax system there’s actually very few concessions for small businesses. That is part of a deliberate policy, which generally I and most tax experts support, of minimising special exemptions and in doing so, focusing on the basics. And by minimising removing special exemptions, you eliminate the opportunities for people to try and rort the system.

But that comes at a cost for small businesses of greater compliance costs. Compliance costs will always fall heavily on small businesses because they are generally quite under-resourced to deal with this matter.

Now as I said currently our tax system generally makes no concessions for small businesses. However, there is one such example which does apply, and that is the shareholder-employee regime. Under this regime a shareholder who is also an employee of a company can instead of having their salary taxed through pay as you earn, opt to pay provisional tax. Their taxable income can then be determined after the end of the tax year.

It’s a very flexible regime, but it doesn’t always fit well with the general scheme of the Income Tax Act. And I think Inland Revenue may be thinking in terms of such businesses should actually be in the look through company regime. The problem is these special regimes add complexity.

The tax loss carryback regime, which is temporarily in place for the 2020 and 2021 income years, proved unworkable for shareholder employees. They’d already taken profits out of the business by way of a salary. So if the company had a loss in either of those later years and tried carrying it back, it had no income to offset against the loss. So, it was of no use to shareholders employees.

When other tax practitioners and I were discussing a permanent iteration of the current loss carryback regime with Inland Revenue policy a huge stumbling block was the question of the treatment of shareholder employees. In fact, it proved unworkable in the end. And last month the Minister of Revenue revealed a permanent iteration of the scheme is not going to be implemented.

In my view one of the side effects of not having specific small business regimes, is that Inland Revenue policymakers don’t pay enough attention to what’s going on in the small business sector, and that means compliance costs creep up for the sector as issues are not addressed. And in the last week, we’ve had a couple of good examples of how this has played out.

Covid-19 has revealed, a number of things that should have been addressed in relation to employer employee relationships, but for whatever reason had been parked as there was always something more interesting to work on. These strains have started to come through recently.

There was a story in the Herald (paywalled) about a very common thing, Kiwis coming back to New Zealand, but continuing to work for overseas based employers. And what’s happening is that a number of these are potentially facing double taxation, hopefully temporarily, and they understandably are confused about how much they own to which government.

One key concern is if an employee of an overseas employer is in New Zealand for more than 183 days, then technically the employer will need to start accounting for pay as you earn. However, in the meantime, that overseas jurisdiction may still be applying its equivalent of pay as you earn to the employee’s earnings. So there’s a risk of double taxation risk.

And one of the other problems is with foreign tax credits. Technically, under double tax agreements employment is taxable only in the jurisdiction in which it’s being exercised. So as the Herald article pointed out, in a worst case scenario, what can happen is that someone working in New Zealand for an overseas employer may have earned $100,000 dollars and paid UK pay as you earn, but won’t get any credit for it in New Zealand. Inland Revenue’s view is “Well, you’ve earned $100,000. This is the tax bill, pay it.” Meantime, the problem that particular employee faces is that he or she have to then go and get the overpaid UK tax refunded. And of course, that can take some time.

And it may also involve getting assistance through what we call the mutual agreement procedures between Inland Revenue here and the UK’s HM Revenue & Customs.  All this takes a lot of time and a lot of stress. It’s a very good example of how the system is evolved, where it really isn’t terribly flexible, and issues arise. One answer is to put people into the Provisional tax regime. Another one is for such employees of overseas companies to register themselves for pay as you earn or what they call an IR56 taxpayer.

Now just to clarify, we’re assuming that the employees of the overseas company, is just an employee, and we’re not dealing with the issues of that employee having sufficient authority to create what we call a permanent establishment, which is a whole other raft of issues, but are not relevant to this particular discussion.

Issues are starting to emerge where the IRS is expecting the US employer to deduct the US equivalent of pay as you earn. Meanwhile Inland Revenue here wants its cut and although the double tax agreement will give most taxing rights to New Zealand the IRS is very cumbersome in moving to say to the US employer, “Oh, yes, that’s now foreign sourced income so you no longer need to deduct tax.”

And then there’s the other issue I mentioned that the overseas company, could be treated as an employer and required to deduct PAYE in New Zealand. Now, fortunately, in that respect, Inland Revenue has a draft operational statement, which was released for consultation last year which deals with this issue of non-resident employers’ obligations to deduct pay as you earn, pay FBT and deduct employer superannuation contribution tax. The deadline for comments closed on it on 1st September so we ought to be seeing it fairly soon in final form.

And basically, Inland Revenue is saying an overseas employer isn’t going to need to apply PAYE so long as the employee’s presence does not create a permanent establishment or as the operational statement has it, “a sufficient presence.” So that’s a good solution. But I think this illustrates the problems with small businesses overseas and here of dealing with issues around tax systems that weren’t designed with such matters and are slow to respond.

And that leads on to a second related point, the question of fringe benefit tax and the new 39% tax rate, which came into effect on 1st April. As a consequence of the change in the tax rate, a new flat rate of FBT of 63.93% applies to non-cash employee benefits such as discounted goods and services and private use of company cars. But that only applies in in reality to employees earning more than $180,000, which is only 2% of earners.

But the FBT system expects employers to pay using a single rate which prior to 1st April was 49.25%. And so the increase to 63.93% represents a substantial burden. Now, it’s possible to work around that and not use the flat FBT rate by filing quarterly FBT returns and calculating FBT on an attributed basis, i.e. for each employee.

So, yes, that’s a solution, but it leads back to my point at the start of this podcast, it adds to complexity of the tax system and also increases the burden of compliance with small businesses. So I think the point has been reached in our system that going forward, Inland Revenue really should have a hard think about the fringe benefit tax compliance costs for small businesses.

Leaving aside the separate issue of how well FBT is being complied with, particularly in relation to work related vehicle, it does involve a fair amount of compliance for small businesses. The FBT regime dates from the mid-80s and I think it’s time for a rethink. In the 1980s it was probably a sensible approach that the employer paid FBT. Maybe now with better procedures in place, what should happen is that the employer calculates the value of the fringe benefit and that amount is then included as part of an employee’s salary and taxed at the relevant rate. This would immediately deal with the issue of applying this new 63.93%rate.

But that’s something that needs to be considered, perhaps as part a whole package of looking at compliance for small businesses. And I understand there is something in the works on that which we will be watching with great interest and report back on when we hear something in due course.

And finally this week, we’ve talked in the past about the international tax regime striving to try with the digital economy and each tax jurisdiction trying to find an appropriate level of taxation relative to a company’s economic activity in a country. The focus is on the GAFA, as they call Google, Apple, Facebook and Amazon.

Here in New Zealand these companies pay very little tax. Facebook does not publish financial statements in New Zealand, and Google’s accounts to December 2019 show that its revenue in New Zealand was  $36.2 million. And it finished up, paying $3.6 million in income tax. That was actually an increase in from the 2018 year, where it paid around $400,000. But Google’s revenue from New Zealand is considerably more than $36 million.

And what’s happening here is replicated all around the world. So the OECD has been looking at this in conjunction with the G20 group of nations. This is part of a shift to try and stop the aggressive use of tax havens to minimise multinationals’ corporate tax bills. And this past week after a meeting of G20 finance ministers there appears to have been a breakthrough in that they are now exploring the equivalent of a global minimum tax on corporate profits.

What’s encouraging about this is that the US Treasury Secretary Janet Yellen, initiated the proposal, and this is a rapid, significant change from the Trump administration. There will be pushback on this, obviously, because certain jurisdictions and Ireland has been mentioned as one who already have a fairly low tax rate, concerned that their current 12.5% corporate tax rate may rise.

And obviously, tax havens will be looking at this with some unease. But my personal view is that the days of the tax havens are numbered because of the double impact of the Global Financial Crisis and Covid-19 anyway. It remains to be seen how well this will develop, but it is an encouraging sign. It might not actually make a great deal of difference to the New Zealand Government’s books, but it will certainly be a step forward in the right direction. As always, we will bring you developments as they happen.

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 ano!