Canada loses patience and imposes a Digital Services Tax effective 1 January 2024
Inland Revenue appears to be gearing up for a fringe benefit tax initiative.
Late last week, in response to some questions about a review the charitable exemption that religious organisations enjoy, the Prime Minister responded he was “quite open” to the idea, adding “I’ve actually been thinking through the broader dimension of our charitable taxation regimes…We will certainly be looking at things like that this term.”
The hint that a review of the exemption religious organisations and churches enjoy provoked a testy response from Brian Tamaki, among others which was in turn rebuffed by the Finance Minister, Nicola Willis.
But this is a topic which keeps popping up and obviously people have some concerns about how the exemption operates. It was also reviewed in some depth by the last Tax Working Group.
So what’s the exemption worth?
Putting some numbers around the value of the charitable exemption is a little difficult. Every Budget Treasury prepares a paper on the value what are called “Tax Expenditures” that is specific tax exemptions granted under the Income Tax Act. According to the Tax Expenditure statement prepared by Treasury for Budget 2023,
the forecast value for the year ended 31 March 2023 of charitable and other public benefit gifts given by companies was $32 million. In relation to the donations tax credit for charitable or other public benefits (including to religious organisations), value for the same period was estimated to be $315 million. (Which grossed up at 33% is ~$945 million.)
The annual report of Charities Services include a snapshot of the finances for 27,000 charities registered with it. According to the report for the year ended 30th June 2023 the income of the religious activities sector was $2.39 or just under 10% of the total income across all charities.
It’s interesting to consider charities income by source for the same period. $5.29 billion represented donations, koha and fundraising activities. Based on Treasury’s Tax Expenditures statement it appears donations tax credit or charitable donations by companies has been claimed for maybe only a billion dollars of this sum. Interestingly, about half of the total income charitable sector earns during the year comes from services and trading.
Overall Charities Services estimated that the total expenditure by charities was about $22.7 billion. In other words about $2.1 billion of the funds raised were not spent or distributed for whatever reason.
Charities Services also provides a quarterly snapshot of new registrations. The latest available is for the period to 30 June 2023 when it received 388 applications (of which 78 were subsequently withdrawn). Religious activities seem to represent a fairly substantial portion of the new registrations.
What did the Tax Working Group recommend?
The last Tax Working Group took a look at this issue and the best place to consider its views is in Chapter 16 of its interim report which sets out the issues involved.
In its final report the Tax Working Group noted it had “received many submissions regarding the treatment of business income for charities and whether the tax exemption for charitable business income confers an unfair advantage on the trading operations of charities.”
The Tax Working Group responded as follows:
“[39] It considers that the underlying issue is more about the extent to which charities are distributing or applying the surpluses from their activities for the benefit of the charitable purpose. If a charitable business regularly distributes its funds to its head charity or provides services connected with its charitable purposes, it will not accumulate capital faster than a tax paying business.
[40] The question then, is whether the broader policy tax settings for charities are encouraging appropriate levels of distribution. The Group recommends the Government periodically review the charitable sector’s use of what would otherwise be tax revenue to verify that the intended social outcomes are actually being achieved.
I think if the Government is going to review the charitable sector, and religious organisations in particular, the Tax Working Group’s recommendations will be starting point. In April 2019 when the last Government responded to the Tax Working Group’s eight recommendations on charities it noted that Inland Revenue’s Policy Division was already working on five of the recommendations. Two of the remaining three were under consideration for inclusion in Inland Revenue’s policy work programme. The other, in relation to whether New Zealand should apply a distinction between privately controlled foundations and other charitable organisations, would be undertaken by the Department of Internal Affairs, which oversees Charities Services. It’s likely the COVID pandemic disrupted this proposed work programme.
We may get a clue as to the Government’s thinking in next month’s budget, but I think the Government’s focus will be on getting its tax relief package out of the way first so Inland Revenue’s resources will be applied there. The Government and Inland Revenue may then look at this exemption, but I imagine given the fuss and general controversy around such a move, it’s probably relatively low priority. Maybe we’ll see something in the Budget.
Canada loses patience and introduces a digital services tax
There was an interesting development in the Canadian budget, which was released earlier this week. The Canadian Government has decided to push ahead with the introduction of a digital services tax (DST) on large tech companies. Over a five-year period, this was expected to raise ~C$5.9 billion (about NZ$7.3 billion).
Canada had held off for two years to allow for the conclusion of the international negotiations on Pillar 1 and Pillar 2 to conclude, but they’ve dragged on with no clear conclusion in sight. The Canadians have therefore decided to push the button on a DST commenting:
“In view of consecutive delays internationally in implementing the multilateral treaty, Canada cannot afford to wait before taking action….The government is moving ahead with its longstanding plan to enact a Digital Services Tax.”
The tax would begin to apply for the 2024 calendar year, with the first year covering taxable revenues earned since January 1st, 2022. Understandably, this has provoked a pretty vigorous reaction from the United States, where the headquarters of all these tech companies are situated.
What does that mean for us down here? Well, again, we may find out more in the Budget. The Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill which was enacted just before 31st March included legislation for our digital services tax. The Government is therefore in a position that it can watch to see if other countries follow Canada’s lead and then decide whether it should follow suit.
The whole purpose of the digital services tax legislation is to act as a backstop in the event the Two-Pillar solution does not reach a satisfactory conclusion. At the moment negotiations are stalled thanks to vigorous push back by the the companies most affected, such as Alphabet, the owner of Google, Amazon and Meta, owner of Facebook. It’s interesting to see this Canadian move and I wonder if other countries will push ahead with their own DSTs. There are quite a number lot of digital services taxes around the world, with many on hold pending the outcome on the Two-Pillar negotiations.
Taxing Google to help New Zealand media?
Just as an aside, as is well known the media in New Zealand is in desperate financial straits and a question that keeps coming popping up is taxing the digital giants more effectively. That’s because a substantial portion of the advertising revenue that in the past went to New Zealand media companies is now going overseas in the form of (little taxed) various licence payments and fees for services to the the likes of Alphabet and Meta. Watch this space I think things are about to get very interesting.
Inland Revenue gearing up for fringe benefit tax initiatives?
This week, Inland Revenue consolidated the various advice and commentary on fringe benefit tax advice it’s published over the years under a single link. This seems to me to be further signs that Inland Revenue is gearing up to launch a fringe benefit tax initiative. It follows comments by the Minister of Revenue Simon Watts, in several speeches in which he referred to Inland Revenue’s regulatory stewardship review of FBT released in 2022. I got the clear impression that he, and therefore Inland Revenue were keen to look further at this matter and investigate what revenue raising opportunities may arise through a more through stricter enforcement of the FBT rules.
As a very good article by Robyn Walker of Deloitte noted FBT is nearly 40 years old. It’s a very strong behavioural tax. It exists to stop people converting taxable salaries into non-taxable benefits. So, it never really should be an extensive tax raise revenue raiser.
That said, I think there have been issues particularly in relation to the status of twin cab utes and the work-related vehicle exemption as to whether there is sufficient enforcement going on. My expectation therefore is Inland Revenue is gearing up to launch a number of fringe benefit tax reviews and this small step consolidating its previous commentary and advice into a single space is another sign.
Got an idea to improve our tax system? Enter the Tax Policy Charitable Trust scholarship competition
Finally, this week, the Tax Policy Charitable Trust has announced its 2024 scholarship competition. This is designed to support the continuation of leading tax policy research and thinking and to inspire future tax policy leaders. Regular listeners to the podcast will know we’ve had past winners Nigel Jemson and Vivien Lei as guests, and I’m looking forward to meeting the next batch of scholarship recipients.
Entrants may submit proposals for propose significant reform of the New Zealand tax system, analyse the potential unintended consequences from existing laws and changes, and suggest changes to address them. It’s open to young tax professionals aged 35 and under on 1st January 2024 working in New Zealand with an interest in tax policy. The winning entry this year will receive a $10,000 cash prize. The runner up will receive $4000 and two other finalists will each receive $1000 each.
I look forward to seeing what comes out of this and hopefully we will have the winners on our podcast sometime in the future. In the meantime good luck to all those who enter.
On that note, 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.
Inland Revenue releases three special reports regarding the changes to the platform economy rules, the 39% trustee tax rate and the new 12% offshore gambling duty
Under the banner “Cut your excuses and sort your tax” Inland Revenue last Monday issued what it called a “last chance warning to the construction sector” to do the right thing and get on top of their tax obligations. The release advises that if people do the right thing, then Inland Revenue will help them. If they don’t, Inland Revenue will find them and start follow up action.
Richard Philp, a spokesperson for Inland Revenue, commented;
“Most people and businesses in New Zealand pay tax in full and on time but there is a core group who don’t. … we also know that while some are struggling just to keep up with the everyday grind, others are actively avoiding their tax obligations.”
Tax evading tradies?
Apparently, tax debt is high in the construction sector and there’s also a fair amount of cash jobs apparently happening in the sector. The Inland Revenue release commented that across all sectors, it gets about nearly 7,000 anonymous tip offs about cash jobs and the like each year noting “Construction is the industry most anonymously reported to Inland Revenue”.
The media release is silent about the extent of the debt within the sector, but we do know from the latest statistics as of 31st December 2023, that tax debt over two years old has increased to from $2.5 billion in December 2022 to $2.8 billion in December 2023.
ADVERTISING
Understandably, with the Government’s books under pressure, Inland Revenue is keen to collect as much of this overdue debt as quickly as possible. This is probably the first of many such campaigns where we will see Inland Revenue taking additional action. And remember, under the Coalition agreement, additional resources have been promised to Inland Revenue for investigation work.
In this particular campaign, Inland Revenue is saying it’s going to issue emails and letters to 40,000 taxpayers in the construction industry who have either outstanding tax debt or tax returns, or both. It then specifies that 2,500 of those will be contacted by text message, asking if they would like to support to get their outstanding tax sorted. There will be a follow up call if the taxpayers they respond that they do want help. Inland Revenue will also be carrying out site visits to key locations across the country.
As I said, this is likely to be the first of several initiatives we’re going to see from Inland Revenue. I would be interested in seeing some specific stats around the proportion of debt and the composition of debt and get an understanding of what sort of businesses are struggling here. It will also be interesting to see how successful this campaign turns out to be.
More on the new GST rules for online marketplaces
Last week I discussed the confusion that seems to have arisen following the introduction of new GST rules from 1st April. These rules affect people who are not GST registered but provide services through such apps as Airbnb, Bookabach and Uber.
This week, Inland Revenue released three special reports relating to the new legislation and one of these is on accommodation and transportation services supplied through online marketplaces. In fact, this is an updated version of a report previously issued in June last year. The report has been updated to include the changes that took effect as of the start of this month and in particular how the flat-rate credit scheme operates.
Changes to online marketplace operators
Under the new rules, so-called online marketplace operators such as Airbnb, Uber and Bookabach will charge GST on all bookings made through them. However, the person who actually provides the ride or the accommodation may not be GST registered. This is where the flat-rate credit scheme comes into effect as the following example illustrates:
The full report is 68 pages so there’s plenty more to dive into.
Special report on 39% trustee rate
One of the other reports that was issued is on the application of the trustee rate of 39%. Basically, trustee income is the net income of the trust, which has not been distributed to beneficiaries. The 30-page report explains the basic provisions about “beneficiary income” and “trustee income” together with a couple of useful flow charts.
Trustee income flowchart
Beneficiary income flowchart
The report references the minor beneficiary rule which applies where the beneficiary is a natural person under the age of 16. In such a case only $1,000 of income per year can be distributed to that person as beneficiary income and be taxed at that person’s marginal tax rate, presumably below 39%. Under the new rules, any beneficiary income in excess of $1,000 paid to a minor would be taxed at 39%.
Overall, this is useful guidance. Just remember the $10,000 threshold is all or nothing: if trustee income is $10,000 or less, the trustee tax rate that applies is 33%, but if it’s $10,001 then it’s 39% on everything.
The third report is on the proposed offshore gambling duty, which takes effect from 1st of July and will apply to online gambling provided by offshore operators to New Zealand residents.
The bright-line test and tax evasion – a couple of useful real-life case studies
Finally, this week a couple of interesting Technical Decision Summaries from Inland Revenue. Technical Decision Summaries are anonymised summaries of some interesting cases that Inland Revenue’s Tax Counsel Office has encountered either through tax disputes and investigations or applications for binding rulings.
The first one, TDS 24/06, is an application for a ruling regarding whether the bright-line test or section CB 14 of the Income Tax Act would apply. The facts are complicated but involve three sections of land currently owned by the ruling applicant.
The applicant had initially acquired one section outright before his spouse and another co-owner acquired interests as tenants in common. Over time, the applicants proportion of the ownership changed until at the time his spouse died the property was held 50% as tenants in common with his late spouse. The second section was owned 50% each as tenants in common with his late spouse. After her death her 50% interest had passed to him under her will. The third section was owned by the applicant and his late spouse as joint tenants. Following her death, her interest was automatically transmitted to him.
The ruling applicant was concerned about the treatment of future sales. Would the bright-line test apply or failing that, would section CB 14? This section is a little used provision and applies where there’s been a disposal within 10 years of acquisition and during that time there’s been a 20% more increase in value of the land thanks to a change in zoning, or removal of restrictions.
The Tax Counsel Office concluded neither the bright-line test nor section CB 14 would apply. This is obviously a good result for the taxpayer but it’s actually also a good example, of how you can apply for a ruling to get Inland Revenue’s interpretation on a tax issue. You don’t necessarily have to follow it, but if you don’t, you better have good reasons for not doing so.
Fiddling the books and getting found out
On the other hand, TDS 24/07 involved suppressed cash sales, GST and income tax evasion and shortfall penalties. The taxpayer carried on a restaurant business which was registered for income tax and GST. Inland Revenue’s Customer Compliance Services (CCS) investigated the company and formed the view that there was fraudulent activity going on. There was suppression of cash sales, and the taxpayer was under returning GST and income tax.
CCS reassessed the taxpayer’s GST and income tax returns for the relevant periods and they increased the taxable revenue for suppressed cash sales based on analysis of point of sale data, the taxpayer’s bank statements and industry benchmarking.
Industry benchmarking – an underused tool?
Just on industry benchmarking, I think Inland Revenue ought to be much more public about its data here and warn taxpayers there are benchmarks against which it will measure your business. It has done so in the past, but I think the combination of Business Transformation and then the pandemic interrupted progress in this space.
What people should remember is, Inland Revenue has some of the best data available anywhere about measuring industry benchmarking. I believe it should be making this much more public so that it can serve as an early warning shot for businesses that think they can suppress income. Everyone loses when this happens. Gresham’s law about bad money driving out the good is very applicable here, because businesses which are not tax compliant are undercutting those businesses which are following the rules. This is not a healthy situation as it leads to considerable frustration and anger and if not dealt with, will just simply encourage more of the same behaviour.
Tax evasion? Have a 150% shortfall penalty
In this particular case, the taxpayer’s fraud was identified, and GST and income tax reassessments followed. In addition, Inland Revenue also imposed tax evasion shortfall penalties, which are 150% of the tax involved. These evasion shortfall penalties were reduced by 50% for previous good behaviour, but that’s still represents a penalty of 75% of the tax and GST evaded.
Unsurprisingly, the taxpayer counter-filed a Notice of Proposed Adjustment under the formal dispute process, and the dispute ended up with the Adjudication Unit, which is run by the Tax Counsel Office as part of the formal dispute process. The Adjudication Unit did not accept the taxpayer’s counter arguments, including an attempt to claim an income tax and GST input tax deduction for the cost of fresh produce purchased with cash. The problem was there was no supporting evidence for this claim, so the Adjudication Unit probably found it easy to reject it. The Adjudication Unit ruled not only was the tax due, but the penalties were also correctly imposed.
Get ready for more Inland Revenue action
Circling back to our first story, this TDS illustrates what lies ahead for those in the construction industry who have been suppressing income. As I said, I do think Inland Revenue should make everyone more aware of its benchmarking data which would be a warning for would be tax evaders. It’s pretty clear from the announcement about the construction industry that Inland Revenue is gearing up for many campaigns targeting debt arrears and clamping down on tax evasion in particular industries. As always, we will keep you updated as to developments in those areas as they happen.
On that note, 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.
IMF and Climate Change Commission suggest changes to the Emissions Trading Scheme are needed.
Like a never-ending Groundhog Day, every International Monetary Fund report on the New Zealand economy suggests tax reforms would promote efficiency. For example,
“There is a sense that the asset allocation in New Zealand households has a bit too much emphasis on housing versus other investments. We think a capital gains tax at the margin would help.”
That was IMF Mission Chief Thomas Helbling in 2017.
“…tax policy reforms are needed to promote investment and productivity and growth increase, increase the progressivity of income tax and mobilise additional revenue in response to long term fiscal challenges. To achieve these objectives, reforms should combine comprehensive capital gains tax, land value tax and changes to corporate income tax.”
And invariably the IMF’s conclusions are usually followed by a fairly dismissive response from the Minister of Finance of the day.
In 2002 it was the late Sir Michael Cullen responded to that year’s report: “The IMF’s credibility is not assisted by the fact that it tends to apply the same policy template regardless of the country’s circumstances”. This year Nicola Willis’s retort was “There are some things that are certain in life, death, taxes and the IMF recommending a capital gains tax.”
Associate Minister of Finance David Seymour also weighed in commenting. “I see the IMF again saying, oh, you need a capital gains tax. Every country has one. The only countries that don’t have one are New Zealand and Switzerland. But I say let’s be more like Switzerland.”
However, I’m not so sure that this was quite the zinger he hoped because as someone mischievously pointed out on Twitter, Switzerland has a wealth tax and a $59 per hour minimum wage in Geneva.
Deputy Prime Minister and former Treasurer Winston Peters was apparently not available for comment.
A de-facto capital gains tax – the bright-line test
Now, amidst all of the commentary about the IMF’s suggestions, one of the things that came up time and again is that in many ways, we do have a de-facto capital gains tax, except we don’t call it that. The bright-line test is an example of the approach that we’ve adopted, which has been ad hoc and responsive based on the government of the day’s policies at the time.
As you may recall the bright-line test was brought in with effect from 1st October 2015 by the National Government and it then applied to disposals within two years. In March 2018 the Labour Government introduced a five-year period and in 2021 it was increased a 10-year period. And so, a quite confusing scenario has developed as to which bright-line test applies because some of the exemptions have changed over time as well, particularly in relation to the main family home.
In one way, therefore, the reduction of the bright-line test back to two years again from 1st July is to be welcomed because it is clarifying and simplifying what has become an incredibly complicated area.
Tax Red Flags: More than just the bright-line test to be considered
The bright-line test and taxation of land has plenty of red flags when together with the excellent Shelley-ann Brinkley and Riaan Geldenhuys and moderator Tammy McLeod, I made a presentation about tax red flags on Tuesday to the Law Association. (Formerly the Auckland District Law Society). My thanks again for the invitation to present and to my excellent co-presenters, we had a very lively session talking around this.
In short when you drill into our current land taxation rules, they are very incoherent. The bright-line test is a backup test. It applies if none of the other land taxing provisions apply. And this is something that tripped up people before the bright-line test was introduced and will continue to do so even now it’s been reduced down to two years.
For many people, the particular issue to watch out for is the question of subdivision. If you own a property and undertake a subdivision within 10 years of acquisition it may still be caught under the existing rules, outside of the bright-line test. And in some cases, you may be caught by the combination of the provisions with the associated persons test which deem transactions to be taxable if at the time you acquired the land you were associated with the builder, dealer, or developer in land.
Sometimes the tax charge can be triggered way past the 10-year timetable since acquisition. That’s particularly the case in relation to a disposal of property where building improvements have been carried out. That particular provision, section CB 11 of the Income Tax Act, deems income to arise if a person disposes of land and
“within 10 years before the disposal”, the person or an associate of the person completed improvements to the land and at the time the improvements were begun, the person or an associated person carried on a business of erecting buildings. Note, the reference to “within 10 years before the disposal.” So, you may have owned that land for considerably longer than 10 years and yet still be subject to the provision.
Just a pro tip for anyone thinking ‘Great, with a two year bright-line test coming in, I can now sign a sale and purchase agreement, make sure settlement takes place after July 1st and it’s not going to be subject to the bright-line test.’ That’s not the case. The sale point for the bright-line test in that case is when the sale and purchase agreement is signed and not when settlement happens. I had at least one client get caught by that very provision because they went for a long settlement thinking that got past the two year period. It didn’t, and it is another case of always seek advice on transactions involving land, because as I’ve just outlined, the provisions are complicated.
Could a capital gains tax be ‘simpler?’
And this was the point we reinforced during our seminar. There is a lot of complexity already in our tax system around the taxation of land and in my view, in some ways a capital gains tax would actually clear away a lot of that uncertainty. It’ll become clearer that, broadly speaking, if you buy something, and you sell it subsequently, any gain will be taxable.
Now, how the gain is calculated and the rate at which it’s taxed are two different things. But often in the debate around the capital gains tax, those two things get conflated to run as an argument against the taxation of capital gains.
In my view, the point still remains that we have a confusing hotchpotch approach to taxing capital gains and at some point, grasping the nettle with a CGT as suggested by the IMF and also the OECD, would ultimately perhaps be a better approach.
Incidentally, doing so would be consistent with the well-established principle we have of the broad-based low-rate approach. There’s nothing to say that by broadening the tax base, we could not hold tax rates at current levels or even lower. Bear in mind that the when the last tax working group recommended the capital gains tax, it was intended to keep to help keep the top tax rate at 33%.
Watch out for trustees on the move across to Australia
One of the other issues that came up in our Tax Red Flag Seminar was the question of trustees, and beneficiaries and settlors moving cross-border, particularly to and from Australia. That is something all three of us are seeing quite a bit of and it is something to watch out for as a key red flag.
The IMF on how to tax wealth
If there is a certain repetitiveness to the IMF’s discourse about taxing capital, it’s part of a global discourse on the topic. Earlier this month the IMF released a How to Tax Wealth note. These how to notes are “intended to offer practical advice from IMF staff members to policy makers on important issues.” And this this was a very interesting read as you might expect.
The IMF’s How to Tax Wealth note neatly coincided with the release of the UBS/Credit Suisse, Global Wealth Report for 2023. According to the report, in 2022 New Zealand ranked sixth in the world with an average wealth of US$388,760 per adult. On the basis of median adult wealth per adult, again in U.S. dollars, we ranked 4th behind Belgium, Australia and Hong Kong, with a median wealth of US$193,060.
Incidentally, these rankings were after a very sharp fall from 2021 levels, where New Zealand was only behind Sweden in the biggest loss in wealth per adult.
I am genuinely very surprised to see New Zealand rating so highly for both average wealth and median wealth. On the other hand this Credit Swisse/UBS report is another example of why there’s a great debate going on around the taxation of wealth not just here, but globally.
And this IMF How to Tax Wealth note is instructive in its approach. It starts by making a very obvious point, how much to tax wealth is a distinct question from how to tax wealth. The note argues that:
“returns to capital generally should be taxed for equity and possibly efficiency reasons. and that in many countries, wealth inequality and better tax enforcement strengthen the case for higher effective taxation than in the past.”
Now the IMF doesn’t make any particular proposal about a specific level of tax, the note is basically about ‘here are things you should consider.’ But on the question of wealth taxes, it does come down pretty much against them noting,
“Improving capital income taxes tends to be both more equitable and more efficient compared with replacing them with net wealth taxes. Countries hence should prioritise improving capital income taxation over considering the introduction of wealth taxes”.
Then it talks about – in terms of strengthening capital taxes – addressing loopholes, notably the under taxation of capital gains in many countries. There’s a passing comment, that perhaps you can use a one-off net wealth tax or maybe apply it to very, very high wealth levels.
Time for inheritance tax?
But the Note also concludes “taxing capital transfers through gifts or inheritance provides another opportunity to address wealth inequality.” The IMF comments that the efficiency costs of such taxes are modest, and notes that “inheritance taxes are better aligned with redistribution than estate taxes, since exemptions and rate structures can account for the circumstances of the heirs.”
What really makes the New Zealand tax system unique is not the absence of a capital gains tax because, as David Seymour pointed out, other countries don’t have that, namely Switzerland. It’s the complete absence of taxes on the transfer of wealth, which has been the case now since 1992. That’s what makes New Zealand unique – we have no general capital gains tax together with no estate or gift or wealth taxes.
And this is an area where I think a lot more consideration needs to go into because as the IMF noted, we’ve got fiscal challenges ahead, and where might the revenue be raised from to meet those challenges.
The IMF and Climate Change Commission suggest changes to the ETS
And finally, back to the IMF again. It concluded its mission report by noting that “New Zealand’s ambitious climate goals call for major reforms,” and it referenced the Emissions Trading Scheme, having helped limit net emissions by encouraging robust reductions and removals, particularly from afforestation.
But the IMF then went on to say that “significant reforms” are going to be needed to meet domestic and international targets, and these include reducing the number of available units in the ETS, pricing agricultural emissions and strengthening the incentives for gross emissions reductions within the ETS. The IMF finally note that given the ambition of New Zealand’s first nationally determined contribution under the Paris Agreement, the use of international mitigation i.e.; buying credits from offshore, is likely to be required.
Now the IMF report was a week after the Climate Change Commission, and pretty much said the same thing, and advised the coalition government they should halve the number of ETS units on offer in each of the next six years. The last ETS auction did not go brilliantly. That has a flow on effect in that by reducing the amount of income from emission trading unit sales, it’s going to limit crown revenue for tax cuts.
Vale Rod Oram
It’s interesting to see a confluence of opinion happening here and an appropriate time to remember the late Rod Oram someone who was a very strong environmental journalist. I was fortunate enough to know him all too briefly after we met at a panel discussion. We’d planned on him appearing as a guest on the podcast. Sadly, with his passing that will never happen now, and our thoughts go out to his family and friends.
And on that note, 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.
Inland Revenue does not consider removal of commercial buildings depreciation “to be a fair and efficient way of raising revenue”.
New 12% online Gaming Duty still leaves $500 million gap in the Government’s tax package.
It’s been a busy week in tax, beginning on Sunday when the Associate Minister of Finance, David Seymour, announced that interest deductions for residential properties would be restored to 80% deductibility from 1st April.
There had been a proposal under the Coalition Agreement for the present 50% deductibility in in the current tax year to increase to 60% with backdated effect, but that has now been dropped. The Minister also confirmed interest on residential investment property will become fully deductible with effect from 1st April 2025, in line with the Coalition Agreement.
Interest deductibility “Yeah, Nah”
The announcement reignited a long running debate over the fairness of the measure restricting interest deductibility. The crux of the argument against it being that businesses are allowed to deduct their costs when deriving income, and the change made to restrict interest deductibility by the last government was contrary to standard business and tax practice.
But when you consider this point keep in mind that under the Income Tax Act, expenses are deductible to the extent to which they are incurred in deriving gross income or to the extent they’re incurred in the course of carrying on a business deriving accessible income.
“The extent to which” is the key phrase and the argument around non deductibility revolves around the fact that the economic return for landlords comprises of fully taxable rental income, and a capital gain which is largely tax free. But legislation generally has ignored this point of possible apportionment between what is taxable income and non-taxable capital income. This leads on to the never-ending debate as to whether we should tax capital gains. And so the argument of deductibility is just another continuation of this question.
It’s also worth noting that businesses with overseas owners are subject to the thin capitalisation regime. This also restricts interest deductions where the New Zealand company’s debt to asset ratio exceeds 60%. Now this measure also contradicts standard tax and business practice, but it’s part of many jurisdictions around the world as a means of countering the risk of excessive interest charges transfer pricing money out of the country. In other words, there are arguments for and against restricting interest deductibility.
Improving the position of renters
On Thursday, the Minister of Revenue released an Amendment Paper for the current tax bill along with five Regulatory Impact Statements two of which covered the restoration of interest deductibility and the reduction of the bright-line test period to two years. There was some interesting commentary by Treasury in both impact statements noting:
“Rental affordability is a significant issue in New Zealand. Based on Household Economic Survey data for the year ended June 2022, a quarter of renting households were spending over 40% of their disposable income on rent housing, and rents have risen faster than mortgage payments. Renters also have higher rates of reporting housing issues like dampness, mould and heating.”
Treasury, Inland Revenue and the Ministry of Housing and Urban Development all agreed that restoring interest deductibility should have a long-term effect of putting downward pressure on rents, but ‘should’ is doing a lot of work in this space. Other measures are going to be needed to improve rental affordability.
But restoring interest deductibility has the benefits of simplifying matters. Restricting deductibility was an imperfect measure, with a great deal of complexity and arguably went too far in the other direction of apportioning expenses relating to the split between taxable and non-taxable income.
Trustee tax rate increase to 39% confirmed subject to $10,000 exemption
The announcement on interest deductibility was followed on Monday by the Finance and Expenditure Committee (the FEC) reporting back on the Taxation (Annual Rates for 2023-24, Multinational Tax and Remedial Matters) Bill. There’s a great deal of interest around this Bill as it included the proposed increase in the trustee tax rate to 39%.
As had been hinted by Finance Minister Nicola Willis a couple of weeks back, there is going to be a de-minimis introduced for trusts with trustee income (undistributed income) of $10,000 or less. Such trusts will continue to have the 33% trustee rate apply to trustee income. However, for all trusts where the trustee income exceeds $10,000, a flat rate of 39% will apply. Therefore, if there’s $10,000 of trustee income the 33% rate applies but if it’s $10,001 the new 39% rate will apply on everything. It’s not the first $10,000 is taxed at 33% and the excess at 39%. It’s an all or nothing.
The FEC justified introducing the de-minimis exemption on the basis that the information it had received was that the compliance costs for many trusts were in the region of between $750 and $1,000 per annum. Therefore, the potential $600 benefit of a $10,000 threshold would be swallowed up by compliance costs, which is a fair point. But the reaction among my colleagues and myself is that the $10,000 threshold, although welcome is too low because, by the FEC’s own logic, something closer to $25,000 could easily have been justified.
It’s worth noting that the compliance costs for trusts have increased substantially in the last couple of years. Firstly, following the Trusts Act 2019 coming into force. And then secondly, Inland Revenue’s greater disclosure requirement for the March 2022 year onwards. By the way, we have seen nothing about those greater disclosure requirements being dialled back by Inland Revenue now there is the 39% tax rate in place. Back in 2021 part of the argument for not increasing the trustee rate to 39% at the same time as the individual tax rate went to 39% was to allow Inland Revenue to gather data on whether there was substantial amount of potential income sheltering through trusts. That theory seems to have been ditched for the moment.
Energy Consumer and deceased estates remain at 33%
Separately the FEC confirmed that the trustee rate for energy consumer trusts would remain at 33%. It also made changes to the treatment of deceased estates following submissions. A flat rate of 33%, will apply to all deceased estates rather than the deceased persons personal tax rate as originally proposed. More importantly, the trustee rate of 33% will now apply for the year of the person’s death and three subsequent income years. That was in the in the wake of many submissions pointing out that deceased estates typically don’t get wound up inside 12 months. These changes are welcome.
The Bill also covered off a number of amendments to other key topics, including the introduction of the global anti base erosion rules, the taxation of backdated lump sum payments for ACC and social welfare, rollover relief in respect of bright-line property disposals and relief under the bright-line tests for people affected by the Nelson floods.
Those global anti avoidance rules will take effect in two parts, the so-called income inclusion rule with effect from 1st January 2025 and then the ‘domestic income inclusion rule from 1st January 2026. This is a little later than the rest of the OECD and the intention is to give the affected multinational enterprise entities (those with consolidated revenue above €750 million per annum) time to get ready.
Inland Revenue recommended against removing building depreciation
On Thursday the Minister of Revenue published an Amendment Paper containing details of the proposals regarding the restoration of interest deductibility for residential investment properties, replacing the current five and ten year bright-line tests with a two year bright-line test period, removing the ability to depreciate commercial buildings and introducing a new Casino Gaming Duty. The Amendment Paper was accompanied by a detailed commentary . and, as I mentioned earlier, the relevant Regulatory Impact Statements. Now as usual, these Regulatory Impact Statements (RIS) contain some interesting reading.
The ability to depreciate commercial buildings is being removed in order to help pay for the Coalition Government’s tax package. However, in the relevant RIS Inland Revenue recommended recommends retaining the status quo and that “the Government reconsider introducing commercial and industrial building depreciation when fiscal conditions allow.”
Citing its last Long-Term Insights Briefing Inland Revenue noted that in paragraphs 19 and 20 of the RIS, that under some assumptions made by the OECD:
“…New Zealand was likely to have had the highest hurdle rate of return for investment in and industrial buildings for the 38 countries in the OECD. This was when New Zealand allowed 2% depreciation on these buildings. Denying depreciation deductions will drive up these hurdle rates of returns even higher and make New Zealand a less attractive location for investment.
This tax distortion does not only impact building owners. To the extent the additional cost is passed on and there is less investment, it also impacts any business that needs to use a building and the customers of such a business. It thereby negatively impacts productivity more generally.”
Inland Revenue conclude in paragraph 32 of the RIS:
“We do not consider the removal of building depreciation to be a fair and efficient way of raising revenue. We are particularly concerned about the efficiency impacts which will make New Zealand even more of an outlier in pushing up cost of capital for commercial and industrial buildings. We therefore recommend retention of the status quo. We note this RIS is not evaluating the merits of the Government’s tax package as a whole.”
So, why is the Coalition Government withdrawing building depreciation? Because doing so is worth $2.31 billion over four years which was understood before the election. Even so it’s fairly interesting and unusual to see such a blunt assessment.
A new Gaming Duty
National’s Election policy included a new online gaming duty which was expected to raise something like $700 million over a four-year period. I was one of the those who was a bit sceptical about the revenue forecast. And it transpires that the numbers were indeed a bit optimistic.
What is now being proposed is a new 12% gaming duty for online offshore casino websites and this is in addition to GST, which is already payable when gambling on offshore sites. This new duty would be in line with how some other countries tax offshore casino websites. It’s estimated to collect $35 million of additional tax revenue in the forthcoming year ended 30th June 2025 and expected to grow by 5% each subsequent year. This still leaves a gap of about $500 million over four-years in the original revenue forecasts.
The Budget in May is becoming more and more interesting for finding out how the Government will follow through on its commitment to increase personal income tax thresholds. Even though they won’t compensate for the effect of inflation since 2010 those threshold adjustments come at a substantial cost. I could see that further cost reductions may be imposed further down the track. Those are political matters which we’ll have to wait and see how they work out.
Foreshadowing a capital gains tax?
Some commentary in the bright-line RIS raised the prospect of a capital gains tax. Treasury, for example, proposed a 20-year bright-line test or longer as it
“…would capture more capital gains, thereby improving the fairness of the tax system and supporting more sustainable house prices.”
Inland Revenue meantime felt the 10-year bright-line test was not an efficient way of taxing capital income before adding “If the government wanted to tax the income, it would be preferable to have a tax on these gains, irrespective of when the assets were sold.” It’s interesting to see Treasury and Inland Revenue raising the bogeyman of a capital gains tax to address funding and fairness issues within the tax system.
And on that note, 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.
“As-salamu alaykum. Peace be upon you and peace be upon all of us.”
What connects Pillar One and Pillar Two with the collapse of Newshub?
New draft Inland Revenue guidance on employee share schemes.
Today (Monday) I was (virtually) at the Accountants and Tax Agents Institute of New Zealand (ATAINZ) annual conference which, like last week’s International Fiscal Association, (IFA) Conference, was opened by the Minister of Revenue, the Honourable Simon Watts. The Minister repeated much of what he had said to the IFA conference about supporting the Generic Tax Policy Process, his wish for simplification in the tax system and improving compliance being a main driver. As the focus at the IFA conference is very much on tax policy his comments were very welcome.
By contrast, at the ATAINZ conference, the focus is slightly different because the audience there was comprised of tax agents, and we’re more focused on operational matters. So, when it came to Question Time, there were quite a number of questions around operational aspects of Inland Revenue. One of the first questions that was asked was what was going to happen with the trustee tax rate, which you may recall is proposed to rise to 39% under a bill presently before the Finance and Expenditure Committee.
Now we’re expecting to hear back from that fairly soon, but during the week the Minister of Finance, Nicola Willis, hinted that some form of carve-out might be happening, in that the 39% trustee tax rate might not apply to all trusts. So naturally, some questions were directed at the Minister seeking clarification on this point.
He wasn’t able to give more guidance, simply saying that we will have to wait until the Finance and Expenditure Committee reports back, which is expected next week. The Minister got told it is a rather frustrating scenario because we’ve got the run up to the end of the tax year on 31st March, and we will be wanting to plan payments for dividends and other distributions in before then. Unfortunately, the issue remains a bit of a grey area for the moment.
More trusts file tax returns in New Zealand than in the United Kingdom
There’s a couple of statistics that highlight the scale of this issue.According to Inland Revenue for the 2022 income year (typically the year ended 31st March 2022), the number of trusts and estates which filed a tax return totalled 237,226. That’s actually a decrease of more than 19,000 from the prior year.
It so happens that I came across statistics from the UK’s HM Revenue and Customs about the number of trust tax returns that are filed there. And according to the equivalent tax year to 5th April 2022, HMRC received 141,500 returns.
Just pause and think about that. In absolute terms, more trust and estate tax returns are filed in New Zealand than in the UK, despite the UK, with its population of some 67,000,000 being almost 13 times greater than here. So actually, on a per capita basis, it would point to the fact, for every trust tax return that’s filed in the UK, there would appear to be close to 21 filed here. The tax rate for trusts is therefore a big issue in relative and absolute terms and that’s why the tax community and trust community are really keen to get this matter resolved as quickly as possible.
What evidence is available points to the fact that for most trusts – once you include the associated families and beneficiaries that are in there – their income would not exceed $180,000, the threshold at which the 39% top tax rate kicks in. But there is a small and significant group, about 11% according to Inland Revenue, that do receive a very large amount of income. So that’s something we’d like to see resolved soon and hope it’s in time for us to get clients advised and ready for the new tax year changes.
Interestingly, on the other comments the minister made to both the IFA and the ATAINZ conferences about Inland Revenues regulatory stewardship review of fringe Benefit Tax which it did in 2022, it’s clear that there is likely to be a focus on this issue from Inland Revenue on greater audit activity. This is something promoted under the Coalition agreement. What extra resources Inland Revenue is going to have and the full direction that it’s going to take going forward are probably only going to become clearer after the Budget on 30th May. Which, as the Minister pointed out, was not that far off in reality.
How the end of Newshub and the OCED international tax deal are connected
The news that Newshub’s operations will end with effect from 30th June was a big shock to the media community. As someone who has occasionally appeared on various Newshub programmes, my sympathies go out to all those affected. And I do hope that some means is found to keep the operation going, although it has to be said, it’s very doubtful at this point. I’ve always found in all my dealings with journalists of whichever organisation, they have always been incredibly professional, and I’ve appreciated that. And so, as I said, this is not a great day for journalism, and has also been pointed out, it’s not actually a great day for democracy as a whole.
Now one of the many excellent sessions at last week’s IFA Conference was an American perspective on Pillar One digital services tax and Pillar Two, the proposed international tax agreements, which have been under negotiation for some time. The taxation of the tech giants such as Facebook and Google is a key part of Pillar One and Pillar Two, and that’s the connection with the collapse of Newshub.
Newshub is no longer financially viable according to its owners, Warner Brothers, because of collapsing advertising revenues. A couple of days after the Newshub announcement, its competitor TVNZ reported an operating loss of $4.6 million for the six months to 31st December 2023. TVNZ noted that its advertising revenue fell from $171.3 million in the six months to December 2022 to $146.8 million in the six months to December 2023, against a background of rising costs.
So where is that advertising going? Well, most of it is going offshore. From what we can pick out from the financial statements of Google and Facebook New Zealand for the year ended 31 December 2022, it would appear that close to $1.1 billion during those years was paid to offshore affiliates in so-called service fees. Now that’s a substantial amount of money, and those transactions are entirely legitimate under the present tax rules. But it has to be said, even if 10% of that $1.1 billion were to stay in New Zealand, it would be a significant boost to the industry. And arguably the difference between Newshub’s operations continuing and being closed.
The offshore advertising and the service fees and the whole issue around the taxation of tech companies, point to the pressure building on the tech companies because New Zealand is not alone on this. Over in Australia Meta, the owner of Facebook, has said it’s no longer going to go through with the deal to pay news companies who were providing content on its websites.
The presentation at the IFA Conference kept coming back to a key point that I’ve always believed, which is tax is inherently political. The French were one of the first drivers of change in this space but obviously the American companies, which would be the most affected, pushed back by putting pressure on the American government to respond. And so even though the Generic Tax Policy Process tries to depoliticise tax policy as much as possible, ultimately governments are elected with certain political objectives, and those will often trump best tax policy, and that’s just a fact of life.
A digital services tax to help media?
The whole question of the impact on democracy and journalism of Newshub’s closure is beyond this podcast. But the pressure will now mount on the Coalition Government to consider what steps it can do to help the media. On the other hand, the Public Interest Journalism Fund was highly controversial.
Does that mean that there may need to be a change in tax policy to perhaps try and claw back some of the revenues going offshore through, for example, a digital services tax which is controversial and hated by the tech companies? Does the Government press hard for a resolution to Pillar One and Pillar Two? Or does Newshub just get shut down and we have to live with the consequences of that? Whatever, pressure will be building for the Government to take some form of action. Watch this space to see whether any such action results in amended tax policy.
Inland Revenue consultation on employee share schemes
Moving on to more routine matters, Inland Revenue has released several draft consultations on employee share schemes. The taxation of employee share schemes underwent major reforms in 2018. Subsequently, there’s been a number of questions to Inland Revenue about how the law applies in certain scenarios and how it interacts with other regimes such as PAYE and FBT.
Inland Revenue has therefore released six items – five draft interpretation statements and one draft Questions We’ve Been Asked, each focusing on a specific aspect of employee share schemes. This has been done rather than producing one single interpretation statement, so that people can more easily focus on the topic of particular interest to them. Alongside this, Inland Revenue has produced a four-page reading guide briefly summarising what each interpretation statement/QWBA addresses.
This is slightly unusual but it’s an indication of the complexity involved. Employee share schemes are used by a lot of companies and particularly small growth companies in the growth phase where they don’t have cash but want to attract and keep key employees as they expand until the ultimate goal, whether it’s ultimately a share market listing or perhaps a sale to a larger company.
The first interpretation statement is one of the more important ones, as it considers what represents an employee share scheme. The critical issue is when does the share scheme taxing date arise? That’s often a critical issue because one of the things about share schemes which causes difficulties is if there’s a mismatch between when the tax is due, but when cash might be available for the person who’s being taxed to actually pay the tax due. In fact, another of the drafts looks at the questions about an employer’s PAYE, student loan and KiwiSaver obligations where an employer wants to fund the tax cost on an ESS benefit provided in shares.
Another important draft reviews what happens with the ACC, PAYE and KiwiSaver obligations, when the employee share scheme benefit is paid in cash rather than shares. The draft concludes cash-settled ESS benefit is an “extra pay” under the general definition of extra pay and therefore a PAYE income payment, regardless of whether an employer elects to withhold PAYE in respect of the benefit.
Of the other draft consultation items, topics covered include what deductions are allowable for employers in respect of employee share schemes, and what is the treatment of dividends that are paid on shares held by a trustee for an employee share scheme.
Overall, this is very useful guidance and I do like Inland Revenue’s approach of issuing separate interpretation statements rather than consolidating all the items in a single item which would be close to 150 pages. Consultation is open until 26th April.
Thanks Chris
And finally, this week, Chris Cunniffe, CEO of Tax Management New Zealand (TMNZ) for 12 years, has just stepped down from his role. He made a brief presentation at the ATAINZ conference, explaining it coincided with the 44th anniversary of the start of his tax career at Inland Revenue. We’ve worked with Chris and his team at TMNZ for many years, helping our clients save tens of thousands of dollars. Chris has also been a past guest on the podcast. We wish him all the very best for the future.
And on that note, 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.
