New Zealand has undoubtedly entered a slowdown economically and that’s flowing through to lower tax receipts leading to claims this week of the Governments being in a big fiscal hole. According to the Companies Office’s latest statistics for the quarter ended 30th June 2023, there were 461 liquidator appointments in the quarter.
That’s 47.8% up on the 312 for the same quarter last year.
As Professor Lisa Marriott noted in an article late last week, the ripple effect of companies going into liquidation is considerable, particularly for unpaid suppliers and employees. Her research suggests that Inland Revenue could be doing a lot more to share information about businesses that are failing. According to Professor Marriott Inland Revenue is actually less proactive than some comparable overseas government agencies such as the Australian Tax Office.
Inland Revenue initiates more than 60% of liquidations in the average year, and that sometimes happens after quite a considerable period of non-payment of key taxes such as GST and PAYE. For example, $2.6 billion or over 54% of the $4.8 billion owed to Inland Revenue as of 30th June 2022 represented GST and what it terms “employment activities” (i.e. PAYE and KiwiSaver contributions).
(Inland Revenue June 2022 Annual Report)
Professor Marriott’s research points to non-payment of these particular taxes as being a very early warning sign of businesses running into trouble. Picking up overseas initiatives she suggests three particular responses could be adopted here to help businesses be aware that a particular business they may be dealing with may represent a credit risk.
For example, in Ireland, Revenue Ireland produces a quarterly list of tax defaulters which identifies the name, address, occupation and the amount of tax owed. This is triggered when the debts exceed €50,000 or approximately $90,000.
Another option would be as the Australian Tax Office does, to advise credit rating agencies that a business has tax debts. This happens if the amount owed exceeds A$100,000 and is more than 90 days overdue.
A third option and one the Tax Working Group looked at, is following another Australian initiative and making business directors personally accountable for unpaid tax through Director Penalty Notices. These are issued in relation to the Australian equivalent of PAYE, GST and KiwiSaver. Once a Director Penalty Notice has been issued, it can only be cancelled by full payment of the tax debt within 21 days or some other action such as commencing winding up proceedings. If no action is taken, then the director becomes personally liable, effectively sidestepping creditor protection and limited liability issues.
These are sensible suggestions, but in my view perhaps another thing Inland Revenue could do would be to be much more proactive in managing debt, particularly in relation to GST and PAYE. I occasionally get involved with helping taxpayers who have fallen behind with their tax payments. And there’s invariably a couple of common points in every case.
Common problems with tax debt
Firstly, Inland Revenue’s present policy of charging interest and late payment penalties doesn’t seem particularly effective to me. In fact, arguably, I’d say it counterproductive.
Debt builds up very quickly and consequently, at a remarkably low level somewhere between $10 and $20,000, the taxpayers often just feel defeated and basically give up. At this point they haven’t engaged with Inland Revenue and all they see is just the amount owed going up and up and up resulting in a sort of death spiral procrastination spiral.
The second common factor in dealing with clients in this scenario is that the situation has been allowed to carry on and develop over a long period of time. These businesses have been going through a slow decline before Inland Revenue finally steps in and decides either to liquidate it or impose some other form of action to recover the outstanding amounts.
One of those actions is the use of “Deduction Notices”. These enable Inland Revenue to go to a customer of a defaulting taxpayer and require them to withhold a certain percentage of any payment they may make to the defaulting taxpayer, and instead pay it over to Inland Revenue. Most often Deduction Notices are issued to employees and often in relation to unpaid child support. But they can be used in other circumstances. In one case I saw a Deduction Notice applied was 100%, although I’m not entirely certain what was meant to be achieved by issuing such a notice.
Adopting the measures suggested by Professor Marriott would take some time to go through the full consultation and legislative process. Although these are tools Inland Revenue perhaps could consider adopting, given the current rise in liquidations, I consider it needs to be taking action sooner rather than wait for these additional options.
Harden up Inland Revenue?
One of the things it ought to do is toughen up its own performance measures in relation to the management of debt. Each year in its annual report Inland Revenue will publish its performance measure results broken down by various sectors. For the year ended 30th June 2022, it achieved seven out of nine measures that it set in relation to the management of debt and on file returns.
But critically, one of the measures where it fell down was the percentage of collectable debt over two years old. The target for the year was 40% or less and in fact it achieved 40.5%, just above its target. That, by the way, was a considerable improvement on the 51.7% achieved for the year to June 2021.
But I would suggest that the 40% target is actually too generous. Inland Revenue really should be looking to drive that down to 20% or less. In fact, looking at this measure, it used to include student loan debt and Small Business Cashflow Scheme debt, but they were taken out and the debt target was then reduced from 50% to 40%.
(As an aside, student loan debt is a particular problem where I think Inland Revenue inaction has allowed very large sums of debt built up with people going overseas as the main issue here. But Inland Revenue, to my mind, has not been quick enough to develop the tools it needs to keep on top of that particular issue, which means often applying to overseas tax agencies for details of defaulting taxpayers.
I think it’s picking up its efforts in this space, but the scenario perhaps shouldn’t be allowed to develop to the extent it did. I’ve recently come across a case where the taxpayer left over 20 years ago but basically Inland Revenue has only now really started to take action to collect the outstanding debt.)
The other thing that’s also noticeable from Inland Revenue’s June 2022 annual report is that it did not actually spend the full amount allocated to it from the relevant budget appropriations.
Some questions for Inland Revenue
The amount allocated was just over $92 million, but in fact Inland Revenue underspent by $2.5 million for the year. A couple of questions I have about this are how did that happen and what’s being done to improve the performance and make sure that the funds allocated are effectively used? (I note that for the year to June 2023, there was an increase in the appropriations.)
It will be interesting to see how that’s played out when we see the annual report later this year. This debt management issue, by the way, points to something I’ve mentioned in previous podcasts – has Inland Revenue’s Business Transformation program deprived it of some capacity in key areas? Inland Revenue has reduced its staffing by more than 25% of your staff and not all of that might be dead wood no longer needed because of the upgrade. I think vitally important staff have gone from key areas such as investigations. And it may be that debt management is another area where key personnel have been allowed to go and the gap has been allowed to develop as a consequence.
As I said, it will be interesting to see the annual report later this year. But in summary, I’d have to agree with Professor Marriott, there’s plenty of room for improvement.
More interest rate rises…
Moving on, a key weapon for Inland Revenue in ensuring payment of tax debts is the ability to charge use of money interest on unpaid tax debt. The current rate is a fairly chunky 10.39%. But as of 29th August, the day after the next provisional tax payment date, the rate will increase to 10.91%. (Incidentally, the rate payable for overpaid tax will also rise, and that goes from 3.53% to 4.67%).
It is necessary for Inland Revenue to have a tool such as an interest charge for unpaid tax. Otherwise, people would just not take any action. But I think that is only one of the tools in its arsenal, as I just mentioned it really does need to back this up with greater enforcement and earlier interventions.
At the same time, Inland Revenue and tax advisers can all work together and let people know that when you take proactive steps on tax debt, you will find Inland Revenue is much more prepared to work with taxpayers in default than people might imagine. This has always been my experience. You front foot these issues with Inland Revenue, and you will find they will be prepared to work with you and your clients unless they are actually dealing with a serial defaulter.
For example, yesterday I was speaking with someone who’d run into some difficulties and had gone to Inland Revenue. They had been very pleasantly surprised by how proactive Inland Revenue had been in working with them on sorting out their unpaid tax. I could see clearly see that they felt a lot happier about the position. They still owed money, but they were in a position where they knew there was a way forward.
The key lesson is if you’re in trouble with Inland Revenue over unpaid debt, talk to it and your advisers and then you’ll hopefully get better results.
Incidentally, the rate of prescribed rate of interest for calculating fringe benefit tax on employer provided loans and some other measures is also being increased with effect from the quarter starting 1st October. From that date, the rate will rise from its current 7.89% to 8.41%.
Upstart Nation? Changing the tax system to boost startups
And finally this week, an interesting report called Upstart Nation from the government’s Start-Up Advisory Council.
This has been the business group looking at how to improve the rate of startups and develop more startups into major companies. On 1st August it released its report which included suggestions regarding changes to the tax system to help boost startups.
The report’s objective to “present a comprehensive strategy aimed at transforming New Zealand into a thriving hub for innovative UpStarts”. The Council identified four primary pillars as key: Capital Capability, Connectivity and Culture. Specific recommendations were made by the Council for each of those pillars to address identified gaps and leverage opportunities.
It had ten recommendations which it felt “will have the greatest impact on our ecosystem”.
Interestingly, three of those recommendations involve changes to the tax system. The first was wanting changes around the taxation treatment of share options and employee share option programs (ESOPs) in particular.
Generally, the current position is a taxable gain arises on the exercise of the options. The Council thinks it would be more appropriate to move that taxing point to when the underlying shares relating to those options are sold. ESOPs are intended to attract and retain investors and key employees as the business grows. Accordingly, hitting them with early tax charges ahead of when they actually can realise their position is a bit of an impediment. There are also questions around the compliance costs involved in getting accurate valuations in what is often an illiquid market. I hear this quite a bit.
Another was specific incentives to promote investment in UpStarts and venture funds in is some form of deduction for such investments. The Council recommends officials carefully review the Australian and UK tax concession schemes and develop something tailored to the New Zealand setting. In particular, they were looking at the Australian Early Stage Innovation Company scheme, which provides a deduction for an investment and a capital gains tax exemption.
The council suggests a deduction of maybe up to 30% of the capital invested directly in an UpStart or UpStart venture fund capped at $200,000 a year. That’s an interesting suggestion and one worth considering even though it probably won’t be accepted by fiscally prudent governments.
An urgent issue with the foreign investment fund regime
The third suggestion included in the top ten recommendations was to “Ensure international and returning Kiwi talent isn’t captured by double taxation under our foreign investment funds regime.” This issue almost exclusively affects American investors and employees with overseas investments. Once their four-year transitional residence exemption expires and the foreign investment fund (FIF) regime takes full effect, they are essentially taxed on an unrealised basis. At the same time, because America requires all its citizens to file tax returns, they are still subject to tax there and in particular capital gains tax.
This is something I’ve discussed with a number of clients. Although they can claim foreign tax credits in America in relation to the FIF tax payable, it often exceeds the equivalent amount of US tax payable on the realised gains. They are therefore accruing a tax liability, which in some cases they can never fully offset. In effect, they feel they are facing a double tax charge.
The Council recommended “this issue be investigated under urgency with a view to removing FDR on people caught under this double tax conundrum to ensure we can attract and retain them in New Zealand”.
I agree this needs reviewing. We hear frequently we are in the business of attracting talent here. In this particular case, we have an issue (somewhat ironically, a by-product of not having a comprehensive capital gains tax) which potentially hinders getting vitally important migrants.
You could argue that not this particular issue doesn’t just affect investors in the startup sector, but also any American citizen or returning New Zealanders who have acquired American citizenship or a Green Card and are among the groups of skilled migrants such as doctors or other specialist engineers, etc. This is a real impediment we need to consider.
Well, that’s all for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
This week has been a very busy week politically in the tax world, starting with a Cabinet reshuffle after David Parker relinquished his role as Minister of Revenue. In his own words, he felt that his position had become untenable in the wake of the decision by Prime Minister Chris Hipkins to rule out a wealth tax and capital gains tax for the foreseeable future.
Parker has been replaced by Barbara Edmonds, who has an interesting background in that she worked in Inland Revenue for some time prior to becoming an MP in 2020. In 2016 she was seconded from Inland Revenue to work as private Secretary to the then Ministers of Revenue, first Michael Woodhouse and then Judith Collins. (This is actually something that happens quite commonly with Inland Revenue officials working closely alongside other ministerial officials). In 2017, she then became a political adviser to Stuart Nash after he became Minister of Revenue. So, she’s got a very good background on the portfolio.
One of the things I think she might read with some amusement is what’s called a Briefing to Incoming Minister. Whenever there’s a change of minister the relevant department prepares a briefing to that minister, setting out their role and the key challenges ahead for as the particular ministry. I suspect Edmonds has been involved in preparing several of those. But this time she will be receiving one as recipient. The change is probably what you might call unforced, but it’s part of the fallout of the decision to not continue with the down the path of imposing a wealth or capital gains tax.
Signs of strain in the construction industry?
Moving on Inland Revenue has started a pilot programme to provide some support for those construction industry, or customers in the misguided terminology, in my view, of Inland Revenue. It’s intended to provide “tailored assistance” to help those in the industry through various stages of business. The intention is to have “meaningful discussions” with taxpayers in that industry about the business, how they’re doing, offering guidance and support about tax and entitlements. These will also involve “promoting the benefits of having a tax agent or bookkeeper”.
Long-time listeners of the podcast will know that when Inland Revenue was in the early stages of its Business Transformation program, tax agents felt, with some justification, that they’d been shut out of the process. It’s now interesting to see that Inland Revenue has realised that tax agents actually have a key role to play in the system and are encouraging their use. Good to see.
This is an interesting initiative by Inland Revenue. It probably speaks to strains that they are seeing within the construction sector, slow payments, people getting behind in tax debt, tax returns, etc.. This pilot program is an initiative to front foot those issues. I’m all in favour of Inland Revenue taking steps like this and moving forward I think it would be wrong to ever adopt the idea that any call from Inland Revenue is a bad call, that you’re in trouble. Sometimes they come in and they may have some suggestions about what to do and how to manage scenarios which can be very constructive.
In every case I’ve ever dealt with, if you front foot issues around slow payment, failure to file returns, whatever with Inland Revenue, you will find that they are receptive to those advances. A key part of their job is to promote voluntary compliance and help the smooth running of the system. As part of this it does matter if people can build trust that the Inland Revenue is actually, if not entirely on your side, a rather fairer referee than people might expect.
Te Pāti Māori go big on tax reform
Moving on, as I said, it’s been a busy week politically. We’ve had the effective resignation of David Parker as Minister of Revenue, and then yesterday Te Pāti Māori released their tax policy. Firstly you could not accuse them of being very limited in their ambition. In fact it’s a very ambitious policy.
The executive summary begins “We have a broken tax system in this country which has fuelled extreme wealth inequality that is only getting worse.” So, that’s the starting base point. In my view there are definite strains in the tax system, and we are seeing more and more of those emerge.
The key proposals are for GST to be removed from “kai”, lower income tax for those low incomes which is to be paid for by increasing income tax on those earning more than $200,000 and raising the company tax rate from 28% to 33% (also a Green Party proposal).
The key revenue raising measure, which is probably no surprise, is a wealth tax. As you know the Green Party also proposed a wealth tax on net wealth over $2 million. Under Te Pāti Māori’s proposals a 2% wealth tax on net wealth over $2 million is the starting point. However, if your net wealth is over $5 million, the rate is 4% and then if it’s over $10 million the rate rises to 8%.
From the work done for Treasury and Inland Revenue on the Government’s abortive wealth tax we have some idea of how many people might be affected by a wealth tax. An entry threshold of $3 million would have affected 99,000. The final design modelled for the Government was based on a $5 million threshold which would have affected 46,000 people. The report estimated the number of taxpayers who would have had net wealth in excess of $10 million as 16,000. So, it’s a pretty targeted group.
Te Pāti Māori have some fairly ambitious numbers on this. They believe that they their wealth tax would raise $23 billion per annum, which is a pretty significant amount of tax, in fact just a bit over 20% of the current tax take.
The wealth tax would be used to set income tax thresholds as follows:
Te Pāti Māori estimate 3.8 million people would benefit from their proposed tax cut package. They’re also, as I said, removing GST from “kai”. How that gets defined is going to be interesting and we’ll talk more about that in a minute.
There are several other new tax proposals. A proposed Overseas Financial Transfer Tax of 2%. This is to apply to overseas companies operating in New Zealand and will be additional to the company tax rate, which by the way, they propose increasing to 33%. This seems to represent some form of withholding tax. I imagine there might be quite a few double tax agreement issues involved in this.
A Land Banking Tax will be payable on all land that has not begun to be developed within four years of purchase. In addition, there will be a Vacant House Tax which would be payable on all properties that do not have a tenant after a six-month period.
Tackling tax evasion
One other interesting proposal is to tackle tax evasion which they say is “approximately $7 billion” annually. I think this number might also include tax avoidance which has an important distinction from tax evasion. Te Pāti Māori propose to invest $500 million into adequately resourcing the Serious Fraud Office and Inland Revenue to investigate and address these issues. This would be a colossal funding boost to both organisations. In the case of Inland Revenue, it would more than double its capacity and it would be a massive lift also for the Serious Fraud Office. So that’s an interesting one proposal, which is probably off the radar, but might be one of those things that actually gets pushed through when parties sit down to negotiate after the Election.
A Government leek?
Te Pāti Māori proposals got overshadowed by an apparent leak from within the Labour Party, immediately denied, that they were considering removing GST from food.
I’m often asked about the question of removing GST from food because on the face of it, it seems a fairly obvious thing to do. This happens in Australia and in many other GST/Value Added Tax (VAT) jurisdictions around the world food is zero rated to use the correct terminology. So if it can be done elsewhere, why can’t we do it here?
I’m in the group of tax policy advisers who are pretty much unanimous in thinking that after establishing a comprehensive GST, which included everything, we shouldn’t be tinkering too much around the edges and introducing exemptions, particularly ones such as food, which will turn out to be pretty costly. Te Pāti Māori estimates the cost of GST free kai to be between $3 and $5 billion.
Marshmallows and Max Jaffa
Our objections are firstly around the principle of not upsetting the purity of GST (and it’s one for which we get a fair bit of flak). There are actually really practical reasons around this matter. Like it or not, there are definitional issues around here and listeners to the podcast will recall when I discussed a recent UK VAT case involving marshmallows which because of their unusual size they qualified to be zero rated. There’s also the famous Max Jaffa VAT case which I explained on TVNZ on Friday.
Over in Australia they’ve had zero rating issues boundary issues around bread. In every jurisdiction around the world with GST/VAT these issues all arise. So, thinking because this is such a good thing to do, doesn’t bypass those problems.
Secondly, as I mentioned, it’s expensive. What do you do elsewhere? You’re giving away revenue as a tax cut so that’s got to be funded. In Britain, for example, the standard rate of VAT is 20%, and across Europe you will see rates of 20-25% and more as common. This trade off has to be taken into consideration, which is not considered too much by proponents.
And then finally, there is a very flawed assumptions that the full benefit of a cut will flow through to the customers. There is little evidence of that actually happening. The Tax Working Group looked at this issue and was not a fan.
Interestingly, the evidence it gathered from Europe was that whilst the majority of any general rate in cut in VAT (for example reducing the rate to 12.5%) did flow through to benefit consumers, in relation to specific incentives the estimate was that only 30% passed through.
Podcast listeners will know that I’ve cited Dan Neidle and Tax Policy Associates in the UK’s review of a couple of initiatives where VAT was reduced to zero. In one case the reduction in e-books, they saw no benefit passing through to consumers.
Well meant but poorly targeted policy?
Removing GST from fresh fruit and vegetables is a good example which VAT/GST specialist Professor Rita de la Feria of the University of Leeds has pointed out is a well-meant but ultimately poor policy.
Ultimately in my view the question about wanting to do something about cutting GST comes back to giving people some more money. Now we can do that through income tax cuts or with properly targeted payments to assist the low-income groups that are hardest hit.
This is something for our politicians to actually front up and address, because when you read the officials’ analysis (and it was in the papers relating to a tax-free allowance), they usually suggest it’s better to give more targeted reliefs in the form of direct benefits rather than widespread initiatives. And every time the politicians shy away from such proposals for whatever reason, maybe they think there’s no votes in it or whatever, but the principle still stands.
So, it will be interesting to see what Labour’s actual tax policies will be, whether they will run with removing GST on fresh fruit and vegetables. The proposal certainly seems popular.
But I’m actually quite glad to see political parties thinking big about tax and saying we need to do something radical in the area. Te Pāti Māori is the latest alongside Act, the Greens and TOP. All have made serious suggestions about significant changes to our tax system, whereas the two main parties seem to be just offering little more than fiddling around the margins. Anyway, we’ll no doubt see more in the coming weeks. And as always, we will bring you the news as it develops.
That’s all for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
Are extra expenses and use of personal assets to work from home deductible against your taxable income? As usual with tax, its complicated.
We’re in week three of the Lockdown, and although the Prime Minister has indicated there may be a possible shift to Level 3 from 22nd April, a majority of employees may still be required to work from home even after that shift.
Naturally, employees will be incurring expenses in carrying out their employment duties. And the question arises, can they claim a deduction for these expenses? And the short answer is no. The Income Tax Act specifically precludes a deduction for “An amount of expenditure or loss to the extent to which it is incurred in deriving income from employment. This rule is called the employment limitation.”
This is a longstanding prohibition which has been in place since the mid-1990s. It was introduced as part of a simplification of tax return filing requirements. Instead, what is to happen is that the employer needs to reimburse employees for such expenditure. The employer will be given a deduction for the relevant expenditure and it will be treated as exempt income of the employee.
But what potentially could be deductible? The Inland Revenue guidelines for businesses with home offices are equally applicable for employees working remotely.
These guidelines allow a deduction of 50% for the rental of a telephone line, if it is also a private line which is used for business. Obviously specific business calls would be deductible. With regard to Internet costs this depends on the plan and the business proportion. How that is determined is a matter of some judgement. In addition to these costs, the business proportion of household expenses such as rates, power, rent or mortgage interest expense could be claimed.
Generally, the business proportion is calculated as the area set aside for use as an office over the total area of the house. For example, if an employee has an office which is say, 10 square metres of a 100 square metre house, then the deductible proportion is 10%.
There’s an alternative option of using a fixed rate as determined by Inland Revenue based on the average cost of utilities per square meter of housing for an average New Zealand household and applying it per square metre of the office area.
For the 2018-19 income year the rate was $41.70 per square metre so in the example above the deduction would be $41.70 x 10 or $417. It does not include the costs of mortgage interest rates or rent and rates. These must be calculated based on the percentage of floor area used for business purposes.
All of the above is perhaps easy enough where a person has a dedicated office at home, but as no doubt is happening all over New Zealand right now, employees are working on kitchen tops, dinner tables and out of bedrooms. What happens in these instances?
As the area being used cannot be said to be entirely dedicated to office use, a full deduction based on these apportionments is probably not available. The area of the room used for non-business purposes for example a bed or other furniture should be excluded. Arguably the deduction would be time-limited (for example, if it was only in office use for 8 hours a day, then only one-third could be claimed).
For the employer, they may be able to claim GST on the relevant proportion of GST expenditure claimed using the standard apportionment methodology, if the employee provides invoices. At this point the employer is probably thinking this is getting needlessly complicated.
A more practical approach would be for the employer to simply pay a flat rate allowance to employees. This is allowable if the allowance is based on a “reasonable estimate”.
The other potential issue is fringe benefit tax. Theoretically, FBT applies on the private use of tools such as mobile phones and laptops. Fortunately, there is an FBT exemption if the laptop or mobile phone is provided mainly for business use and the cost of those laptops and mobile phones is no more than $5,000 including GST.
All of the above represents a compliance nightmare for employee employers and possibly a target rich environment for Inland Revenue in a future date where it considers that the allowances paid, or deductions claimed for home office expenditure, have been excessive. In this instance the employer will be liable for the PAYE which should have been deducted from the amount determined to be excessive/non-deductible.
In practical terms, Inland Revenue might simplify clarify a lot of issues for employers and employees alike by issuing a determination setting out a flat rate amount of expenditure it would consider acceptable. An employer could pay above that amount but then PAYE would be applicable.
Of course, all of the above is somewhat hypothetical, if the employer has no cash flow to pay any such allowances. I suspect that is the matter employers are most concerned about right now. In the meantime, let’s hope we can return to a new normality soon.