Tax News

Changing tax thresholds and capital gains tax are back on the agenda

24 Feb, 2020 | The Week in Tax

    • Changing tax thresholds and capital gains tax are back on the agenda
    • Inland Revenue warns the hospitality industry
    • OECD estimates international tax reform could be worth USD100 billion annually

Transcript

Last week began with Simon Bridges, the National Party leader, outlining the party’s proposed economic platform for the coming year. And in that speech he alluded to the expectation of tax cuts before, in what was possibly a casual use of language, he said that persons on their average wage should not be paying a third of their income in tax.

This prompted a bit of a pile on because it was quickly pointed out that someone earning the average wage of about $65,000 per annum pays on average 19.2% in income tax. And in fact, some nerd calculated only a person earning $3 million or more, would actually have an average income tax rate of 33%.

And this is a reflection, as I explained to Wallace Chapman and the Radio New Zealand panel on Tuesday afternoon, of our progressive tax system. As your income rises, the tax rate rises starting at 10.5% before reaching 33% on income over $70,000. But the point I made is that the rates jump quite sharply from 17.5% to 30% at the $48,000 mark. And so, the question should be whether those thresholds and rates are appropriate.

And interestingly, when looking at this in preparation for speaking to Wallace Chapman, I went back to just see how often the tax thresholds have been changed. As I explained, 33% cent has pretty much been baked in since 1989 with the exception of the period between 1999 and October 2010, when it was increased to 39% before dropping back slightly to 38%.  The threshold has varied obviously during that time, but over the past 30-year period, the top rate threshold has only been adjusted six times by my reckoning. Six changes of thresholds in 30 years is actually quite surprisingly low.

Many other countries adjust for inflation. Britain does. And it’s a mandate in the UK tax legislation that if you are not adjusting income tax thresholds, you must specifically legislate to not do so. My view is that something like that should be in our tax legislation, because otherwise politicians are able to claim tax cuts when in fact we’re dealing with something which is no more than an inflationary adjustment.

But the tax pressure point for people is not, in my view, around the 33% top rate, even if it is perhaps low by world standards. But on that threshold, around the $48,000, when someone moves from 17.5% to 30%. That’s quite a significant jump of twelve and a half percentage points and quite a lot of other things are happening at the same time. Working for families’ abatements are kicking in at 25 cents on the dollar for income above $42,700 dollars. For someone who’s on or near average wage or possibly a bit below and maybe receiving working for families’ tax credits, they have a quite significant jump in their marginal tax rate jump.

They go from 17.5% to 30% and then they have an effective 25% on working for families’ abatements.  And it’s not inconceivable they might also have a student loan in which case they lose another 12% of their income anyway if it is just over $20,000. So, it’s not impossible for someone earning around $50,000 to have an effective tax rate of 67 % or more. That is 30% income tax, 12% on the student loan and 25% working for families’ abatement.

We’re going to see something this election from both sides of the spectrum about tax and this is an area where I believe the parties that want to sell their tax policies on need to focus on. It’s that low to middle income earner, moving up through thresholds who is definitely most in need of some form of tax adjustments.

Then at the same time, no fewer than three separate bodies popped up with the capital gains tax issue. And I can probably now say I told you so. Because those who listen to the podcast will know that I said at the start of this decade, not so long ago, that I expect that capital gains tax debate to re-emerge. I have to be honest; I didn’t think it would happen so quickly.

We had the Helen Clark Foundation releasing a paper on housing affordability in which it proposed a capital gains tax. There was an interesting snippet in there, which highlighted one of the reasons why our housing is so expensive, but I think also should be of great concern to us economically.   The report said and I quote,

Loose regulation of mortgage lending. Buyers in New Zealand are borrowing up to 7.5 their income, compared to 4.5 times in the United Kingdom has allowed prices to inflate rapidly.

Seven and a half times income is a quite frightening statistic in my mind, because it means that those people who are taking mortgages at that level have absolutely no margin for error if – actually it’s not if it’s when –  interest rates rise. So, the hope obviously from that group of people is that the equity in the house keeps ahead of the potential risks that they have an interest rate rise and that their earnings rise substantially to bring down that income ratio.

Then we had Dominic Stephens of Westpac. He highlighted the problem that house price inflation has picked up, again, as he predicted, with the non-implementation of a capital gains tax.

And finally, we had the United Nations Special Rapporteur Leilani Farha from Canada damning New Zealand’s housing crisis, calling it a perfect storm.

And she called for a capital gains tax as well. So, an interesting trifecta of opinions on the matter.

Moving on, we got an email from Inland Revenue who do like to keep in communication with everyone much more now under their upgraded system.  It told us, quote, “We’ll be contacting your clients in the hospitality industry to thank them if they’ve been keeping their books in order.” Which I thought was a marvelously passive aggressive way of saying ‘if they’ve been keeping good books in order, great. If not, we’ll be asking questions’. And the email actually goes on to say, “we’ll also be encouraging our clients to put their records right if they’ve left anything off their past tax returns”.

Passive aggressive tones aside, this is something we’re going to see a lot more of. Inland Revenue is going to get very specific about targeting particular industries and it’s going to be very vocal about what it’s going to do and how it will go about it. The message will be sent out to tax agents, hospitality industry associations, etc. They’ll be told, ‘We’re going to look at this, so pass the word along to your members’.

And to be honest, I think that’s a good approach because to apply Gresham’s law, bad money will drive out good.  Those sorts of operators who are undercutting other taxpayers who are fully compliant are a risk to the whole sector as well as simply leeching off the system, in that they expect the full availability of public services but aren’t prepared to contribute fully to that. And that, incidentally, is Inland Revenue’s messaging.

I see that, by the way when I get communications from the UK’s H.M. Revenue and Customs they have the same slightly passive aggressive tone to them, saying if you’ve not paid your tax on time, then you are not funding hospitals, roads, schools, etc.

So the messaging from tax authorities is changing in this area. But the key takeaway here, and you can’t say you weren’t warned, is that if you’re not compliant Inland Revenue will be asking questions. And I really do say that it is a question of will, not if.  It would be foolish to pretend because compliance in the past has been monitored inefficiently that it will continue to be the case. That most definitely isn’t the case. Everything I see in my interactions with Inland Revenue at either an operational level or talking at the higher policy level points to much more sharply tuned tools being employed more quickly to deal with matters like this.

And talking about dealing with matters of tax compliance or in this particular case, tax avoidance, the Organisation for Economic Co-operation and Development has just published an estimate of what it thinks will be the potential benefits from reform of the digital economy.

Several matters came out of this. We have this ongoing what they call the Pillars 1 and 2 approach and so far, according to the latest report given to the G20, they are still confident they can nut out something on this matter by the end of the year.  Now what is obviously going to get the tax authorities and governments interested, is that the OECD estimates the combined effect of Pillars 1 and 2 as potentially bringing in up to 4 % of global Inc corporate income tax revenues, which is equivalent of U.S. $100 billion dollars annually.

The interesting thing they also say which will also encourage buy in from governments, is that the revenue gains are expected to be broadly similar across high, middle and low-income economies.

A 4 % increase in corporate income tax take here in New Zealand would amount to if my calculations are correct over $650 million annually based on the current income company income tax take of $16.4 billion. That’s a very tidy sum of money.

I have to say, I doubt whether in fact we would benefit as much as that. We’re very much a price taker in these matters as those who deal more in this international tax space have pointed out. So, I think the benefit will be substantially less than $650 million annually, but still very much worthwhile for our government to buy into the OECD’s approach. But we shall have to wait and see, and I will keep you informed as news emerges.

Well, that’s it for the week in tax. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Please send me your feedback and tell your friends and clients. Until next time have a great week. Ka kite āno.

What will be the big tax issues over the next decade?

28 Jan, 2020 | The Week in Tax

  • What will be the big tax issues over the next decade?
  • Inland Revenue cracks down on Student Loan debtors
  • Is CGT really dead?

Transcript

This decade is only a few weeks old, but I consider the likely major tax themes for the years ahead are already becoming very clear.  Over the holidays, the news has been dominated by the apocalyptic visions of the Australian bushfires, and our thoughts and condolences go out to everyone affected by those fires particularly the families of those who’ve lost their lives.

Leaving aside the politics of climate change, which seem particularly toxic in Australia, New Zealand has signed up to reduce its emissions by 2050 and last year, the Zero Carbon Act became law. And in my view, over the next decade, the role of environmental taxes as one of the tools in meeting our emissions targets will become ever more important. So that is the first big theme I think we can see emerging.

Yesterday, the French government agreed to suspend collection of its digital services taxed until the end of the year.

Now, this was done in order to avoid increased tariffs with the United States government. You may recall that last year when France introduced its digital services tax America retaliated with tariffs. Now, in return for the French suspending collection, the US has now agreed to continue participating in the OECD talks aimed at achieving a generally agreed reform of the international tax system.

Therefore, the second and fairly obvious continuing theme for the next decade will be the issue of reform of international taxation, particularly for how it affects the tech giants such as Amazon, Google and Facebook. This is something that they hope to resolve this year, but I anticipate it could take longer than that. But whatever is determined it’s going to change the shape of international tax for years to come.

The third theme is wealth inequality. This has been talked about for some time. And what I think you will see coming forward is a question of how we address that. Wealth disparities have been reportedly rising over the past decade or so and various taxes are being mooted as a means of addressing that matter.

Housing affordability is one of those issues where wealth inequality plays out. And earlier this week, the annual Demographia report on housing affordability said that New Zealand’s eight major markets were completely unaffordable.

So, addressing housing affordability is one part of the equation which ties in with wealth inequality. And we’ll see across the coming decade stumbling attempts to try and address the issues coming from that. That’s a global trend as well.

Last week the news emerged that Inland Revenue had arrested a person at the border in relation to owing student debt. A woman had just returned to the country to visit a sick mother and she was arrested at Auckland Airport while about to fly to the United States. This is part of a law change that was made in 2014, which gave Inland Revenue the powers to arrest student loan defaulters leaving the country.

There are about 100,000 borrowers living offshore, and many of these have overdue debt. Actually, some of the numbers related to student loan debt are quite astonishing. There’s more than $16 billion dollars of total debt due and more than 700,000 currently have outstanding debt with 100,000 having overdue debt. And many of those are overseas and apparently outside the reach of Inland Revenue. So, it’s not surprising. Inland Revenue has given itself powers to arrest people. It does shake the tree quite dramatically and has produced some results.

Although it’s a very dramatic move the number of people that have been arrested for this has been actually quite low. It was three in 2016, one in 2017, two in both of 2018 and 2019 and one so far this year.

Now, this is a bit of an intergenerational matter because older people will take the view “Pay your debts” or “We’ve paid our student loans, so why shouldn’t you?”. And one response will be “You didn’t have student debt” and generally the issue dissolves into name-calling on both sides.

But leaving that aside, there are two things that concern me about this. Firstly, I think it’s another example where the current approach to penalties and interest just doesn’t work. If you’re going to charge penalties and interest, you’d hope that that actually does encourage payment. But apparently it doesn’t seem to do that.

The top 10 outstanding borrowers collectively owe $4.28 million dollars, at which point they’re going to give up. This is what I see in our business. They just simply going to give up. It then moves from being their problem to being our collective problem, because that’s now a debt that’s probably irrecoverable.

But I can’t help but think why don’t we have such a draconian policy towards arresting people who owe PAYE and GST?  Particularly in the case of PAYE because that affects the livelihoods of many people. It’s not just a case of a debt between and individual student loan debtor and the Government. In the case of someone who’s defaulting on their PAYE and maybe also on the employer KiwiSaver contributions, their employees are missing out.

So, it seems to me that if we’re going to have such a dramatically fierce tool, which admittedly, is not used extensively, why are we not applying it more often to debts where arguably the social impact is greater?

And finally, I recently raised the question about whether, in fact, capital gains tax was killed off as supposedly happened last year when the Government did not follow through on the Tax Working Group’s recommendation for a general capital gains tax.

In my article, I took the view that the issue isn’t going to go away, in part because it’s tied into the wealth and housing affordability issues that I mentioned earlier. Also, what we’re seeing is that Inland Revenue will be applying the existing rules, which are often open to interpretation about intent, much more stringently.

And I’ve already come across examples where Inland Revenue is seeking to tax transactions which would have been subject to the bright line test if the bright line test had been in place at the time of those transactions.

Now Inland Revenue has been through their Property Compliance Programme, looking at this issue for almost 10 years now. But what was interesting to note about this particular set of transactions is that many of them date back to beyond what we call the time bar limit, usually for four or five years. And in fact, one of them was a 2012 transaction. So, it’s nearly eight years old now.

What seems to be happening is two things. Firstly, Inland Revenue is applying its enhanced capability through its Business Transformation program to review transactions. But secondly, and this is a critical point if you do not include a source of income in your tax return, which you should have included, then the time bar rules don’t apply.

Generally speaking, Inland Revenue can’t go back more than four or five years after a tax return has been filed, unless there’s been fraud or willful evasion. But if the income is never included in the first place, then it can go back as far as it likes. And Inland Revenue is now making use of this tool.

So what that means is that for all those people out there who may have had a quick turnaround on a property transaction, for whatever reason, you may find that even though you think that may be beyond the time limit for Inland Revenue to look at it, don’t make that assumption. They have more tools in there to do so now. And they’re now very keen to apply those tools to investigate older transactions. So, I expect to see quite a few more cases involving transactions eight, ten years, maybe even older as the as the Inland Revenue decides to crack down on this whole question of property transactions.

Next week, picking up the theme of the big tax issues for the coming decade, I’ll be joined by 2019 Tax Policy Charitable Trust Scholarship runner up John Lohrentz. We will be discussing his fascinating proposal for a progressive tax on bio-genomic methane emissions in the agricultural sector. We’ll also be discussing the future role of environmental taxes.