COVID-19 related measures for tax losses and AirBnBs

  • COVID-19 related measures for tax losses and AirBnBs
  • National releases its small business policy
  • Is a capital gains tax back on the agenda?


Friday was the due date for the first instalment of Provisional ax for the year ending 31st March 2021, Provisional tax is going to be payable by anyone whose net tax for this year will exceed $5,000.

Now in the past, we’ve covered the ability to use tax pooling to give more flexibility about payments of tax, and that’s going to be particularly important for the current tax year, given our ongoing uncertainties arising from the COVID-19 pandemic. My recommendation to clients at this moment is to adopt a conservative approach. Look at paying the first instalment of tax due today but keep watching your progress and how your turnover is going. And if matters move into a tax loss position as a downturn comes through soon, then we will take steps to mitigate or deal with the next two instalments of Provisional tax.

But what if you already know you’ve got losses this year and it’s not likely to get much better for the current year? Say you’re a restauranteur or you’re in the tourism business. These are two sectors which are very clearly hit hard by the pandemic and the various lockdown measures.

Well, one of the measures introduced as part of the government’s response to the pandemic was the ability to carry tax losses back. Under this measure, if you have a tax loss for the 2020 or 2021 income years, you can carry those losses back one year. And the idea is that if you carried back to a profitable year this will mean you have overpaid tax in the prior year, and that tax can be released to help smooth your time through this ongoing pandemic.

And for most larger companies the tax loss carry-back regime is pretty straightforward. Carry back the loss one year, get a tax refund at 28% percent, and then you’ve got funds, which you can either use to meet other bills you may be behind on, or bring it forward and apply it against your current tax year liabilities such as GST or PAYE, depending on how dire the situation might be.

But one of the problems that’s emerged with the tax loss carry back rules affects a lot of smaller companies where their shareholder is also an employee. And under the rules that apply to these companies, these companies can pay out their profits to a shareholder-employee who is then responsible for the tax.

For example, say a company makes a profit of $100,000.  Instead of paying tax at 28% it instead distributes it as a salary to a shareholder-employee and he or she is taxed on it at their relevant marginal rates. For someone on $100,000 with no other income, that roughly works out to about $24,000. So, there’s a tax benefit to shareholder-employees because of the gradual increase in tax rates for individuals.

But the problem that’s emerged wasn’t really addressed in the current legislation. What do you do if you carry a loss back for a company with a shareholder employee? The carried back loss is not much used to that particular company because they’ve already reduced their profit to nil by distributing it to the shareholder-employee.

And by the way, I note there was a Radio New Zealand report noting that about $2 billion dollars in wage subsidies has been paid to companies that do not appear to have paid any company income tax. It’s highly likely many of those companies have shareholder employees and it is the shareholder employee who has paid the tax using the mechanism I just explained where the whole or substantial amount of the company’s profit is paid out to the shareholder-employee.

So the tax loss carry back rules don’t work too well for small micro businesses that use a shareholder-employee mechanism. And it’s something we’ll need to be looked at if there is a permanent iteration of these rules, which I believe should happen.

But it’s also why the small business sector and accountants have not looked on this particular measure with a great deal of enthusiasm yet. Because of those complexities how do we deal with these tax losses that are brought back? Do you rewrite the whole position in the prior year? And then what does that do for other matters that are related to that person’s income, such as social assistance, ACC earner levies?  The amount of ACC you may claim if you have an accident is dependent on your salary as a shareholder-employee.

So, there’s a lot of complicated issues to work through. But the tax loss mechanism is there. It works very well for companies which don’t have shareholder-employees and individuals trading for themselves or trusts can use the loss carryback rules in either the 2020 or 2021 income years.

Converting from short-term to long-term rental accommodation.

Moving on, Airbnbs in the tourism sector will also have been hit very hard by the pandemic and the collapse in overseas tourism and the substantial decline in domestic tourism. So what has happened is some of these Airbnbs have reversed a trend that was developing, and have moved back into providing longer term residential accommodation.

As always, there’s a tax consequence to that and for GST purposes it means that if the GST activity is stopped, then the person is required to de-register for GST. Part of the de-registration process will mean a deemed supply of the goods that were brought into the business. You’re deemed to have sold them and pay GST output tax on the way out. And if you’ve claimed a big input tax credit for, say, a whole property, moving it over to Airbnb, that means that you could have a substantial output tax payable on de-registration, as it’s done at a market value.

Now, under the GST Act, there is a provision that where someone is no longer carrying on a taxable activity they are obliged to let the Commissioner of Inland Revenue know within 21 days of their taxable activity ceasing, and then that registration must be cancelled unless there are reasonable grounds to think the taxable activity will be carried on within 12 months. So, this could apply if you think that within 12 months-time, we could be back up and running again.

What Inland Revenue has done is extended this twelve-month period to 18 months through a special COVID-19 determination which has just been issued and this will apply until 30th September 2021. So you now have 18 months, a lot more flexibility about whether you’re going to resume your Airbnb activities or drop out of the picture completely.

Just a caveat though – if you are currently using a property for residential accommodation, but you anticipate going back to making taxable supplies in Airbnb, you have to do what’s called a change in use calculation.  This is basically an apportionment of the value of the property brought into the GST net over the expected time it’s being used for taxable activities. A little bit complicated, but you produce one of those calculations as part of your GST returns.

Political tax policy

Yesterday National released its small business tax policy.  In terms of tax rates it has come straight out and said it does not plan on increasing taxes or introducing any new taxes.

Other than tax rates, National’s tax policy has a number of other measures. Firstly, they’re going to lift the threshold for the purchase of new capital investment from $5,000 to $150,000 per asset. That is you can take a complete deduction for an asset costing up to $150,000. Now apparently this only applies to “productive assets” so there’s a question as to what that might mean.  It’s a temporary two-year change. Something similar has been done overseas.

And it’s a good idea although it is a question, of course, of what will and won’t meet the definition of ‘productive’. But you could see some fairly substantial plant and machinery being purchased and as a means of getting investment into productivity in the economy it’s a measure to be to be welcomed.

It would also have an impact on the Government’s cash flow, by the way, because it would drop quite a lot of people out of the provisional tax requirements. So the Government’s income, so to speak, was will be reduced temporarily before these payments will then come in at terminal tax time. I think $25,000 is too generous, $10,000 is probably manageable. Still it’s a measure in the right direction.

Next, they want to raise the GST threshold from $60,000 to $75,000. Big tick for that, the GST threshold hasn’t been increased since 1 April 2009. So it’s well overdue and on an inflation basis $75,000 is about right.

Businesses will be allowed to write off an asset once its depreciated value falls below $3,000 as opposed to continuing to depreciate it until its tax value reaches zero. Really good measure here. Should be done straightaway regardless of who’s in power.  Keeping a track of all these assets when they’ve fallen below that threshold is hard and causes needless complexity. So I like that a lot.

I also like this next one – change the timing of the second Provisional Tax payment for those with a 31 March balance date from 15th January to 28th February. That’s really quite sensible. It’s bizarre it’s in the middle of January when we’re all supposedly on holiday and it’s not a great time for cash flow. February makes a bit more sense.

Ensure the use of money interest rates charged by Inland Revenue more properly reflect appropriate credit rates. So right now, if you overpay your tax Inland Revenue will pay nothing. National are saying, well, we want something that’s a little bit more realistic than that. It’s not a bad move and it certainly would be popular with small businesses, but it’s rather based on an assumption that taxpayers would be using Inland Revenue as a bit of a bank. They won’t.  A better option in this case would be tax pooling which takes care of a lot of those issues.

Increase the threshold to obtain a GST tax invoice from $50 to $500. A very generous upper limit there. I’m not sure I’d go as high as that, but that $50 threshold below which you don’t need to have a full GST invoice with all the required details on it has not been changed since 28th September 1993. So an increase in the threshold is welcome. I’d say $150 might be a better option.

Implement a business continuity test rather than an ownership test for carry-forward of tax losses. Moves in this space are already happening but the measure is to be welcomed.

Next and also welcome, review depreciation rates for investments in energy efficiency and safety equipment. That’s not a bad idea. And then consolidate the number of depreciation rates to reduce  administration costs. That’s another big tick from me on that, because there are so many different rates and there’s options to probably get it wrong more often than right. And the level of micro detail required probably isn’t really appropriate for small businesses.

So those measures I think are mostly all welcome. And frankly, they’re sort of pretty much apolitical. Whoever is in power should be adopting almost all of those proposals.

Just a matter of time?

And finally, talking of parties’ tax policies, the Greens released as part of their tax policy, a proposal for a wealth tax to apply on net wealth over $1 million. Earlier this week, former legal practitioner, Human Rights Commissioner and retired Family Court Judge Graeme MacCormick picked up on the Green Party’s proposal when he wrote about the question of a wealth tax. He suggested a one percent levy on net assets of more than $10 million per person.

He also argued that it was time for the wealthy to step up and help out in this the crisis. He was sceptical of the idea of the trickle-down effect, that wealth trickles down and dissipates out through the country. He was of the view that basically we’ve got 30 years to show that hasn’t happened.

One of the interesting points he raised was that New Zealand not only doesn’t have a comprehensive capital gains tax, it also doesn’t have an estate tax or a gift tax nor a wealth tax. It’s highly unusual in the OECD for one jurisdiction to be not have at least one of those taxes applying on a comprehensive level. Some have capital gains tax and no wealth tax or estate tax. Others have a wealth tax, but no capital gains tax and some like the UK and the US, have capital gains taxes and estate and gift taxes.

The position varies across the OECD, but New Zealand is pretty unique in not having either a comprehensive capital gains tax, estate tax, gift duty or wealth tax.

Wealth taxes have fallen out of favour in the past few years, but they’re back on the agenda because, as I discussed with Radio New Zealand panel and Patrick Smellie of Business Desk, the pandemic and Thomas Piketty has opened the door on that.

And I was very interested to see this week that former Reserve Bank governor Dr Alan Bollard said in his presentation to the New Zealand CFO summit that, like it or not, given the scale of the borrowing the Government has had to engage in, capital gains tax may be an unpalatable option for governments to consider as they want to pay down the debt.

So this matter of capital taxation hasn’t gone away. We’ll hear more from other politicians no doubt, Labour and New Zealand First have still to release their tax policies. But we’ve still got another seven weeks to go to the election so there’s plenty of time for discussion on that.

Well, that’s it for this week. Thank you for listening. I’m Terry Baucher and this has been The Week in Tax. Please send me your feedback and tell your friends and clients until next week. Ka kite āno.

The unknown unknowns in tax

What are the “Unknown unknowns” of tax?  Our 3 stories from the week in tax

  • The financial arrangements regime and Inheritance Tax
  • Wage theft and missing PAYE and KiwiSaver contributions
  • National’s tax policy – indexing thresholds, changes to the bright-line test and loss ring-fencing

Podcast transcript

In February 2002, in the run up to the invasion of Iraq, then U S Secretary of Defense, Donald Rumsfeld, commented;

Reports that say that something has happened are always interesting to me because as we know there are known unknowns. There are things we know we know. We also know there are known unknowns. That is to say we know there are some things we do not know, but there are also unknown unknowns. The ones we don’t know, we don’t know and if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.

This quote was a core theme in my presentation last week to the Financial Advice New Zealand annual conference. The unknown unknowns are also a very difficult category in tax. And what are these unknown unknowns? The ones that trip up people because they didn’t know they were there.

Well in New Zealand the biggest culprit in this would be our financial arrangement rules. These rules have been around since 1986 and yet despite their very broad application, are largely unknown.  I have come across CFOs who were completely unaware how they could apply.

Financial arrangements rules apply to just about any financial instrument you can think of. Mortgages, bank term deposit accounts, swaps, bonds, gilts in the UK phrase, all those all caught within it. It’s so broad it could apply to season tickets for public transport. And in one case I dealt with we thought that electricity contracts would be caught.  Actually, we were debating whether in fact they were in the stock rules or in financial arrangement rules. Welcome to the arcane world of international tax.

But the financial arrangement rules are very broadly, largely unknown to individuals and they have particular bite in the foreign exchange field. That is where exchange rate movements such as is going on right now with Brexit which is back in the news again, so the Pound will move around.

Two groups of people get caught here. Obviously, investors who have bonds or term deposits denominated in an overseas currency, the value of the New Zealand dollar falls [that is more dollars are required to buy the offshore currency], they make an exchange gain and if the value rises, they have an exchange loss.

Then there are those with, for example, a rental property in the United Kingdom, and they have a mortgage there, it works the opposite way. The Pound may become weaker against the dollar so that in dollar terms, their mortgage diminishes, then that is income. Now on an unrealised basis for most people, this largely doesn’t matter, but very abrupt movements which add up to $40,000 on an unrealised basis will pull people into the foreign financial arrangements regime and they then will have to pay tax on unrealised gains.

The classic example I encountered was a client who had substantial property interests and mortgages in the UK.  In year one there was an unrealised $300,000 foreign exchange gain, on the movement on the Sterling and had to cough up $100,000 in tax. The following year, it moved back the other way and she had a $300,000 loss but she never got that tax back. Even though there’s a wash up calculation when an arrangement matures or a mortgage rolls over and so of all the unders and overs are taken into account. But if you paid tax too soon in the piece, say you paid tax two years ago and then you find out that you actually never made any gain once everything is all closed out, you’ll never get the tax back.  It’s one of the harsher parts of the financial arrangements regime.

The other trap is that the arrangements regime will apply to people who have total financial arrangements of $1 million or more and that is a gross amount. What I sometimes see is people may have $500,000 of term deposits and $500,000 of mortgages overseas mortgages and they think that after netting the two off, I’m below the threshold for the regime. Economically, your net worth comes out as nil. But financial arrangements regime takes them in aggregate so therefore the two are added together so the person actually has a million dollars in financial arrangements and is therefore within the accrual part of the regime. That person will be taxed on an unrealised basis.
The financial arrangements regime just the most common trap New Zealand advisors and clients fall into in my experience.

Following on from that, the other area that I’m seeing a lot more of is UK inheritance tax. Inheritance Tax is an estate and gift tax that applies to anyone domiciled in the UK or with assets in the UK.

Domicile, without getting in to too much detail, is a complicated concept, but basically, it’s where your permanent attachments are. I spoke in a previous podcast earlier about the unfortunate New Zealand woman whose Scottish partner died and because they weren’t married, she finished up paying £50,000 pounds inheritance tax on the transfer of his interest in the New Zealand property to her.  So that’s not the first trap to watch for.

And I’m seeing more and more people caught by this, we have 300,000 Britons in the country. People like me, who’ve come from Britain, many more still have assets over in the UK. Maybe their children are going backwards and forwards to the UK and working there. And they’re all potentially all caught up in the inheritance tax regime.

A common thing that often gets overlooked is the implication of having assets in the UK or burial plots. Famously after Richard Burton died in 1984 the then HM Inspector of Taxes nailed his estate for inheritance tax on the basis that he had retained a burial plot in the village in Wales from which he came. So that was a very expensive burial plot as it turned out. I believe he actually is buried in Switzerland, but that’s how arcane the rules around inheritance tax are. It is the great unknown unknown. And as Donald Rumsfeld said, “These unknown unknowns tend to be the difficult ones.”

Earlier this week, Andrea Black who runs the excellent blog “Let’s Talk About Tax” went drinking with some young people. Actually, she was there to advise a group of hospitality workers who had been caught out as a result of Wagamama going into receivership. And the issue they were talking about is what’s called wage theft in the hospitality industry.

This is where the company, an employer, goes bust owing employees thousands of dollars in unpaid wages and salaries.  There is often also a lot of unpaid pay as you earn floating around. There are several issues here. First and foremost, the employees have been left out of pocket and so they want to know what’s going on and when they can recover that. Then the tax man is very much often out of pocket. It often emerges that pay as you earn has been unpaid for several months an issue which I’ve seen this, and which Andrea talks about it as well.

You do wonder how quickly Inland Revenue reacts to this. Now I do hope that one of the things that will come out of Inland Revenue’s business transformation is much swifter responses to issues where pay as you earn falls into arears. My experience is Inland Revenue has let this go on for far too long. I’ve come across instances where there had been unpaid pay as you earn for going on for four years, which is just an absurd position. Someone there is either deliberately playing the system, in which case they should be hit with the full force of the law or is so hopelessly incompetent they should have been put out of their misery long ago.

Now the other thing that also comes into play for the employees is the unpaid employer KiwiSaver contribution and this adds up to quite a bit. Back in 2016 I spoke to Radio New Zealand about this matter.

At that time there was over $29 million dollars in outstanding KiwiSaver payments.  In June 2015 1,663 employers had failed to pass on 15.3 million dollars in KiwiSaver payments deducted from employee’s salaries. Employees are missing out on this and on the employer contributions and it’s a real issue within the industry. Andrea asks whether the Small Business Council looked at this issue. We’ve delivered our report to the Minister and what I can say this matter did come into discussion during our deliberations.

One other thing on this. There is a tax bill just going through Parliament at the moment, the Taxation (KiwiSaver Student Loans and Remedial Matters) Bill.

It covers a number of matters. One is the question that we talked about previously about people with the incorrect prescribed investor rate. There’s also provisions making it easy for Inland Revenue to collect unpaid employer contributions in relation to KiwiSaver and ensuring employers pass on the employee contribution to Inland Revenue.

Hopefully employees will get the investment returns they’re missing out on because they haven’t been paid or the deductions and employer contributions haven’t yet hit their KiwiSaver account.  By the way, submissions on that bill close on Monday so you’ve still got a chance to make a submission in support of that or raising other issues.

Finally, National have released their tax policy for next year.  A number of things they are promising include tax cuts. Particularly they’re proposing something which I think is long overdue, and that is indexing tax thresholds. I think this is one of those quite sneaky tax increases that causes bracket creep and pushes people up into higher tax brackets gradually and it’s something which is effectively a tax increase by stealth. I think in the interest of transparency it’s a good move.

There’s a number of interesting other matters they want to deal with. That said, I’m not entirely sure if you are not a homeowner or rental investor and you’re trying to get into the investment property or to rent a property you’d appreciate what they’re proposing. They want to dial back the bright line test for residential property from five years to two years and remove loss ring fencing, which is a big break for tax investors.

That brought a fairly forthright denunciation from Jenée Tibshraeny.  She also was less than impressed by the idea of removing the inflation component of interest. It’s an arcane point which has been talked about for some time which although it sounds arcane it is actually quite important.

Anyway, that will be the first shots fired in next year’s election about tax policy.  All eyes will be on what the coalition will do in next year’s Budget. Given that tax thresholds haven’t been raised for more than 10 years by that time it’s hard to imagine that they wouldn’t try and do something, particularly when they’re running a surplus. I mean, cynical tax cutting budgets are not just the preserve of right wing governments. But we shall wait and see.