Tax News

Land taxation

20 Jun, 2022 | The Week in Tax

  • Land taxation
  • Is the disputes process fair?
  • How much tax could legalising cannabis yield?

Transcript

Inland Revenue has just released an Interpretation Statement IS22/03 income tax – application of land sale rules to co-ownership changes and changes of trustees. Now, this is actually quite an important Interpretation Statement because it looks at whether the land sale rules in the Income Tax Act will apply when there is a change of co-ownership in an interest in land or a change of trustee.

It’s important because the Income Tax Act has provisions where a tax charge arises, where there is a disposal of land. And the question that’s been raised is whether any changes in ownership or changes in trustees represent a ‘disposal’ for the purposes of these rules, because obviously, if they do, then that could have significant implications under the bright-line test, for example.

The Interpretation Statement concludes when you consider the ordinary meaning and applied case law in context a disposal for the purpose of the land sale rules means or requires a complete alienation of the land by the disposal. In other words, that person must get rid of the land.

And helpfully the Interpretation Statement includes a number of transactions as examples. Where there’s a change in the form co-ownership, where the proportional shares or notional shares do not change, that is not a disposal for the purposes of this land sale rules. On the other hand, if there is a transfer between co-owners where neither’s interest is fully alienated, but the proportional share or notional share of a co-owner is reduced. there would be a disposal for the purpose of the land sale rules by that person to the extent that interest is reduced.

Inland Revenue’s argument in support of this is that because, although they’ve not fully alienated the whole interest in that land, they have fully alienated a part interest in that land. And similarly, if there’s a transfer that adds a new owner, there must be a disposal involved for the purposes of the land sale rules to the extent that the share or notional share of an original owner or co-owners in that land have been reduced. Similarly, a transfer that removes the co-owner would also be disposal by that departing co-owner of their interest in land.

Now on the matter of a change in trustees of a trust that will not be a disposal for the purpose of the land sales. And that’s because the Income Tax Act treats all trustees of a trust as essentially a single person. And therefore, in this case, disposal does not include a transfer to yourself, i.e. in the same capacity. Trustee swaps out, new trustee comes in, the title has to be reregistered and that’s not a disposal. On this basis, I think most people generally thought that was the case. But it’s good to see Inland Revenue come out and make that position clear.

There’s a useful table in the Interpretation Statement setting out examples of the Inland Revenue conclusions on this. There’s also a handy fact sheet available.

Heads the IRD wins, tails you lose (because you will never be able to afford to challenge their decisions)

Moving on, last week I referred to an Inland Revenue Technical Decision Summary. Now these technical decision summaries are issued by Inland Revenue’s Tax Counsel Office following an adjudication in a dispute or as part of the private rulings process. As I mentioned, they’re interesting to see because although they’re not binding on the Commissioner of Inland Revenue, they do give an indication of the types of cases Inland Revenue is encountering, and their likely thinking on an issue.

How taxpayers and Inland Revenue resolve matters where they cannot agree is an important part of any tax system. Inland Revenue has just released an exposure draft of a revised standard practice statement on the operation of the disputes process.  When finalised, this practice statement is intended to replace two previous practice statements, one which dealt with where a dispute resolution process has been commenced by Inland Revenue, and the other where the dispute resolution process is started by the taxpayer.

Inland Revenue has decided to merge the two into a single statement and include some updates to the process, taking into account some relatively minor legislative changes that have happened recently. These relate to the introduction of what’s termed “reportable income” and “qualifying taxpayers” as part of the auto calculation of assessments process. The dispute process has been tweaked to deal with the introduction of these terms concept.

This is fairly routine maintenance by Inland Revenue. However, I think it ought to have taken the opportunity to look at the dispute process much more closely and whether it works for well as everyone involved with it as it should.

It so happens this is something I looked at for the Tax Working Group back in 2018. And in researching the matter I came to the conclusion that there are quite a few issues with the present dispute regime. In particular it’s expensive, very time consuming, and its costs act as a barrier to all taxpayers, but particularly smaller taxpayers.

Inland Revenue’s Adjudication Unit is part of the disputes process. It gets involved after there has been the initial stages of a Notice of Proposed Adjustment, or NOPA, and then the Notice of Response (NOR). After those formal positions have been issued by the parties to the dispute they then try and resolve the matter through negotiation. And if they can’t, it can be referred to the Adjudication Unit and.

Geoffrey Clews QC was involved in making some minor changes to the dispute process, to improve it about ten years ago. He commented on his experience working with Inland Revenue officials “reinforced the impression that [Inland Revenue] is very conscious that it presides over a tax administration which is weighted in its favour. It is reluctant to see that change.”

This is perhaps not surprising, but it should also be a bit of an alarm bell.

And then separately, two Supreme Court justices, Justices Glazebrook and Young, raised concerns about whether the dispute process was deterring taxpayers. They both noted there’d been a significant decline of tax cases coming through the court system. It’s now down to maybe 10 or 12 a year.

Justice Glazebrook, who is a former tax lawyer commented further on the disputes process in a speech to the Chartered Accountants Australia and New Zealand Tax Conference in 2015.

“What is not so positive is the concern that the dispute resolution processes, even in simple cases, takes a lot of time, effort and therefore cost to complete. When this is coupled with the new penalty and interest regime, with its differential interest rates for taxpayers and the revenue, the concern is that taxpayers are ‘burnt off’  by the taxation disputes process. This means that taxpayers may be forced to settle legitimate tax disputes as they cannot afford the time or money necessary to continue court proceedings.”

Now, this draft statement of practice doesn’t address these issues. It’s not designed to because it’s intended to be just a largely restatement of the existing system. However, I think Inland Revenue should not be afraid to have a further look at think about how the dispute process currently works. It’s been ten years or more since we last looked at it.  As I said things that’s notable is there isn’t a lot of activity going through the courts. Although everyone’s right now waiting to hear what the Supreme Court’s going to be saying about tax avoidance in the Frucor court judgement.

According to data supplied to me by Inland Revenue back in 2018, the average number per year of NOPAs and NORs i.e. matters in dispute over a seven-year period was 517. Now, in the context of nearly 5 million active taxpayers on a pretty controversial topic where people’s opinions and interpretations differ quite markedly, 517 disputes a year seems incredibly low.

The counterargument would be the process is working properly and the issues are being resolved much earlier. To be fair, that’s certainly true to an extent. But a cynic might also say Inland Revenue is not picking up enough of this stuff either. That may come down to a question of resourcing. Inland Revenue believes it’s fully resourced, properly resourced but looking from the outside I’m not quite so sure.

Although it’s always good to see Inland Revenue clarifying matters and updating its statements of practice, I think there is a major point still to be addressed about whether the disputes process is working as it should and if it’s not, what can we do to improve it?

Tax, cannabis, and gangs

And finally, this week, a quirky story coming out of Christchurch caught my eye. Brendan Crocker appeared in a district court this week charged with cultivating cannabis and for possessing a Class C drug for the purpose of selling In the course of his hearing it emerged that he admitted to starting a company so he could pay tax on his sales. That’s one of the more unusual excuses involving tax I’ve seen, too. Crocker claims he gave away about 80% of his cannabis candy in order to help people in pain and was only selling the rest to cover the cost of making it.

Gangs are currently in the news and there’s plenty of concern about the increase in gang violence in and around Auckland. Now it’s well known that one of the things that fuels gangs and gang tension is the trade in illegal drugs. This is where tax comes into play. Why not legalise or decriminalise cannabis? By doing so, we’d take control of the supply away from gangs, and hopefully therefore reducing their influence. Many countries have done this with Thailand one of the latest, and quite a few states in the United States have done it as well.

Once the sale of cannabis is decriminalised, it can become a useful source of tax revenue. And of course, that tax revenue can be used to deal with the problem of gangs and drugs. As I see it, it’s a win-win.

Colorado in the US. has a population of about 5.8 million, roughly comparable to ourselves. It legalised cannabis way back in 2014 and it publishes monthly records of its marijuana tax take. Currently it’s around US$19 million per month, which is roughly NZ$30 million, give or take, which equates to around about $350 to $360 million a year.

To put that in context, that tax revenue is probably more than what is going to come from the Pillar 1 and Pillar 2 international tax reforms that I discussed last week. Now they are a big deal for international tax, but the actual cash benefit for New Zealand is probably not as significant as many people might think.

On the other hand, cannabis, illegal drugs, gangs and the accompanying violence and threats is a problem as well as great cost to us. So that’s a proposal for someone serious to consider. Legalise cannabis, get some useful tax revenue. And then use that to help deal with the problem of drugs and gangs.

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

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

Bright-line test rollover relief

Bright-line test rollover relief

11 Oct, 2021 | The Week in Tax

  •  Bright-line test rollover relief
  • Inland Revenue consults on land taxation and cross border worker issues
  • What could be the fallout from the Pandora Papers?

Transcript

It’s been a busy couple of weeks in the tax world. Last week, the relevant legislation for the interest limitation rules was released in a Supplementary Order Paper, and on the same day, probably not by coincidence as one or two other tax advisors have noted, Inland Revenue released a draft interpretation statement concerning whether, and if so to what extent, the land sales rules in the Income Tax Act 2007 apply to changes to co-ownership, subdivisions of land and changes of trustees. Coming out on the same day as the interest limitation legislation it certainly has given us plenty to chew on.

Furthermore, Inland Revenue has kept busy this week with an issues paper seeking feedback on a number of matters facing employers and payers of cross-border workers.  The whole week kicked off with the Pandora Papers, reigniting the debate over New Zealand’s controversial foreign trust regime.

Property transfers between associated people

As we discussed last week, the Supplementary Order Paper with the relevant draft legislation for the interest limitation rules was released, and submissions are open to the Finance and Expenditure Committee until 9th November.  So, you’ve got approximately five weeks to get in and make submissions on these draft rules. I expect there will be some changes as a result of submissions and certainly I encourage everyone who has an interest in this area to make submissions with the aim of trying to improve the legislation.

Included in the Supplementary Order Paper is something which begins to address an issue which has been in place since the bright-line test was introduced in October 2015. And that is when there is a transfer between associated persons. Say for example, a person holds a property and transfers it into a trust or a look through company. As the legislation presently stands, that transfer would reset the clock for the bright-line test. So, a property that might be known for many years – more than 10 years for example – which has been transferred to an associated entity and therefore economically, when you look at it, no real change of ownership has happened. But for the bright-line test purposes there has been a deemed change of ownership and therefore the clock gets reset.

Now this was a problem identified way back in 2015, and the Supplementary Order Paper begins to address it by having some new rollover relief rules, which will apply from 1st April 2022. However, the rules are very complicated, particularly in relation to the transfer for a trust. And it could be really quite problematic for trust resettlements because the transfer to the trust must be a beneficiary who is also a natural person and can qualify for the main home exclusion. There’s quite a bit of detail to unpack in there.

In fairness this is an improvement on the original proposal we saw when in consultation with Inland Revenue earlier this year, but it still has a number of complexities and traps which will make it not particularly user friendly. So, although it’s a step in the right direction, this is one area I would very definitely recommend people make submissions on.

Land sales tax rules

Now, the other thing that was released on the same day as the Supplementary Order Paper, was a draft interpretation statement – nearly 60 pages – on how the land sale rules in the Income Tax Act might apply changes to co-ownership, subdivisions and changes of trustees.

This is an extremely important paper because it addresses issues where there was some broad understanding of what the position might be, but it’s good to see Inland Revenue set out its position.

Now the starting point to bear in mind is that income tax legislation in dealing with land transactions, refers to “disposals”, not sales. And this is the issue that the draft interpretation statement is addressing – what happens if there are transfers between co-owners, for example, does that create a disposal for tax purposes?

Now, quick digression here. The paper refers to tenancy in common and joint tenancies. A tenancy in common is where each party owns a distinct share, i.e. 50% or a one third share. A joint tenancy is where the land is owned by the parties together, but there’s no specific shares, in which case each person has a notional proportional share. So, for example, if there are two joint tenants each has a notional 50% share. And if there are five joint tenants, each has a notional 20% and so on.

What the interpretation statement goes through is what happens if there’s changes to types of co-ownership. For example, instead of owning it 50-50, they go to one party owning a one third share and the other party having a two-thirds share. Or there are two people and a third person is introduced or there are three people, and then one decides to.

What the interpretation statement says if it’s the type of co-ownership and the proportional notional changes don’t change, there isn’t a disposal under the land sale rules, so that means there’s no tax implications on the transfer. So, for example, if A and B were tenants in common with 50% each and they then moved to being joint tenants with again the notional 50%, there’s no disposal.

On the other hand, if, for example, A had 25% and B had 75% under a tenancy in common and then moved to 50:50, then B has disposed of 25% interest, and this disposal, could be taxable. And here’s where the issue gets quite tricky because this sort of transaction may be done on paper and no cash may change hands.  People have got to be very careful that if they are changing the proportions of how they own property, that they don’t trigger a tax charge and find themselves with a tax bill, but no cash has actually changed hands to enable payment of any tax which may become due.

To recap, if there’s a change in the form of ownership where the proportional and notional shares don’t change, that’s not a disposal. But if there is transfer, that adds a new co-owner, for example, that would be a disposal. And likewise, if there’s a transfer that removes a co-owner, that’s also a disposal. There’s a lot to consider in this paper and we’ll need to pore over it very carefully. But at least it gives us some guidance to work with. Submissions are open until 9th November.

Cross border workers

Earlier this week, Inland Revenue released another issues paper this time dealing with cross-border workers and identifying issues for reform. Work on this has probably been accelerated because of what’s happened with COVID, which has disrupted work and travel patterns. In the words of the issues paper,

“It has also highlighted the role of technology in enabling cross-border work arrangements. The pandemic has accelerated existing trends affecting how, when, and where people work and technologies such as artificial intelligence and the greater use of contracts. The supply of personal services will be increasingly important drivers in the future.”

Against that background, Inland Revenue have been looking at reviewing the tax obligations that apply to payers of cross-border workers. And this paper focuses on what happens for employers and payments to independent contractors. This is an issue I’ve encountered quite a bit recently, as people have migrated to New Zealand but continue to work remotely for their overseas employer.

The paper begins by looking at the current PAYE rules. And it concludes that these are inflexible. One of the big issues is that we have arrangements concerning our double tax agreements where a person who is deemed to be non-resident but working in New Zealand and can be paid by their overseas employer for up to 183 days without triggering PAYE.

But currently under the PAYE rules, when they cross that 183-day threshold then after the day count is breached, the employer is required to correct the tax position not just going forward but also from the first day the employee was present in New Zealand. So, it could be several months later when the position is realised. And this means employers get additional compliance costs and could also be potentially subject to shortfall penalties and use of money interest. All in all, pretty much a compliance nightmare.

Inland Revenue recognise this needs to be reviewed because it’s simply not always practical to collect PAYE from the income of cross-border employees. It’s hoping to allow greater flexibility for employees. And one of the things they’re proposing is a new period of time for correcting a situation, which is 28 days from the employer first becoming aware that this day count threshold that I mentioned earlier has been breached.

To use an example from the issues paper, Estella a Brazilian tax resident, comes to New Zealand on a 10-week assignment, 70 days, to work on a construction project. It’s anticipated that the 92-day exemption, which is part of our Income Tax Act, will apply. We don’t have a double tax agreement with Brazil yet, so this 92-day exemption is only one available.

But the project gets delayed and now extends beyond the 92-day exemption to 98 days and a catch-up payment for PAYE is therefore required. And no penalties should arise so long as this is done within 28 days of identifying that there will be a breach of the 92-day threshold. That’s one of the issues Inland Revenue are looking at.

They’re also looking at non-resident contractors. There’s another set of rules that apply to independent contractors working in New Zealand. Currently, non-resident contractors’ tax is 15% and the New Zealand resident payer is required to withhold that from each contract payment made to a non-resident contractor.

The thresholds and rates haven’t been changed since 2003. Those thresholds, by the way, were adopted and in the wake of the Lord of the Rings when a large number of American productions came to New Zealand in the early 2000s and encountered this issue and work was done to mitigate those issues. It’s therefore probably time to have a look at these issues again. And it’s good to see that Inland Revenue putting some ideas out there. Submissions on this are open until 19th November.

New Zealand’s controversial foreign trust regime

As I mentioned the week kicked off with the Pandora Papers revelations. This reignited the debate over New Zealand’s foreign trust rules. Now, when the extent of the use of New Zealand based foreign trusts was revealed in 2016 in the wake of the Panama Papers, the then government moved very quickly to tighten regulations.

And as a result of that, the estimated numbers of foreign trusts registered with Inland Revenue fell from about 13,000 back in 2016 to just over 4,000 now. The Pandora Papers will reignite debate about these rules.

These foreign trusts exist as a by-product of changes made to New Zealand’s taxation regime for trusts in 1988. That’s when New Zealand switched from taxing trusts based on the residency of the trustees to taxing on the basis of the residency of the settlor (the person who established it).

Now the reason behind this was to tackle what was seen as quite substantial tax avoidance by New Zealand tax residents, and by and large, that move was highly successful. It is practically impossible now for any New Zealand tax resident to set up a trust now in a tax haven and shelter income from New Zealand tax.

But an accidental by-product of the regime was that non-New Zealand residents are able to establish such trusts. What they would do is settle a trust under New Zealand law with New Zealand trustees. Under the foreign trust regime, income from outside New Zealand would not be taxable. Which, by the way, is legal and consistent with general tax principles around the world – that is you tax residents on a global basis, or you tax income with a source in the country. So, for example, New Zealand taxes income with a New Zealand source and New Zealand residents.

If you have rules as New Zealand established, which say, “Well, we don’t deem this trust to be tax resident in New Zealand”, then offshore income becomes tax exempt in New Zealand. And so, this is quite attractive because it meant that New Zealand essentially became an onshore tax haven for sheltering income.

So, it’s quite controversial, and started to attract quite a lot of attention.  In part because of growing unease with tax havens we saw the introduction of the Common Reporting Standards on the Automatic Exchange of Information. New Zealand’s current foreign trust disclosure rules are in line with those standards.

The Panama Papers gave a boost to those rules, and I’m sure the Pandora Papers will also lead to further tightening as well. Although the Minister of Revenue didn’t seem particularly enthusiastic about moving very quickly on the matter, there’s a lot going on as we have discussed.  In any case, the position is that the number of trusts registered with Inland Revenue has fallen by two thirds since 2016 to just over 4,000.  The argument would be that a fair amount of the more dubious entities have been weeded out.

But what’s common in moves around the world and it ties into anti-money laundering moves particularly in Europe is for establishment of trust registers which is where details of these trusts are held.  Now whether they are held publicly like the Companies Office register, or privately and available only to Inland Revenue which is essentially what we are doing at the moment, needs considering.

For those who are calling to tax these trusts what needs to be kept in mind is that often these foreign trusts are established partly on grounds of secrecy but also to ensure assets held in such a trust are outside two taxes, both of which New Zealand doesn’t have. That is capital gains tax and estate duties.  Now these are transactional taxes, which are triggered by death or disposal.

So, when considering calls for New Zealand to tax foreign trusts we need to think about how we would practically do that given we don’t have a general capital gains tax or estate duty. Basically, we would then be looking at a wealth tax or something akin to the foreign investment fund regime.   Whatever, there’s going to be quite a bit of debate on this going forward and it’s not going to die down very quickly.

Applications open

And finally, in Covid related news you have until 11:59pm on Thursday 14 October to apply for the fourth round of the August 2021 Wage Subsidy Scheme.  And applications for a third round of the Resurgence Support Payment are now open. To be eligible, your business must have experienced at least a 30% drop in revenue or a 30% decline in capital-raising ability over a 7-day period, due to an increase in Alert Levels.

  • You can receive $1,500 per business plus $400 per full-time employee (FTE), up to 50 FTE.
  • The maximum payment is $21,500.
  • If you’re a sole trader, you can receive a payment of up to $1,900.

If you’ve applied for previous Resurgence Support Payments and you’re eligible you can apply for this one.

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 kia pai te wiki, have a great week!