15 Feb, 2022 | The Week in Tax
- Terry Baucher on the latest Inland Revenue guidance on non-resident employers
- calculating foreign tax credits, and
- whether the proposed social insurance scheme could incentivise more honest tax filings
Transcript
We’re now in the third year of the pandemic and one of the things that’s emerged is our working patterns have changed as many people are working remotely, not just from home, but in completely different countries.
This has prompted Inland Revenue to issue an operational statement setting out what would be the obligations for a non-resident employer in relation to pay as you earn, FBT, and employer superannuation contribution tax. This applies where the employer is based in, say, the United States, but the employees are working remotely here. A scenario that I’ve seen quite a number of times in the past couple of years.
Basically, the operational statement confirms that a non-resident employer will have an obligation to withhold PAYE on payments to an employee if the employer has made themselves subject to New Zealand tax law by having a sufficient presence in New Zealand and the services performed by the employee are properly attributable to the employer’s presence in New Zealand.
What that means is if the employer has a trading presence in New Zealand, such as carrying on operations and employing a workforce, that’s normally sufficient for it to have PAYE obligations. And that would be, for example, it has a branch or a permanent establishment. Something always to watch out for is someone is signing contracts in New Zealand and performing those contracts in New Zealand with employees based here for that purpose. But no PAYE obligation arises where the employee decides I’m going to work/ return to New Zealand because it’s safer here, and I can work remotely. That case is not covered.
The paper gives a quick example of an architecture firm based in Boston and one of its employees, George lives in Wellington. George participates in virtual meetings, complete all his work in Wellington. But because the Boston firm has no New Zealand clients, all the work is carried out relates to American work, and the company has no obligation to deduct PAYE.
But what about George’s position here? And this is something that can slip through the details here. In some cases, he is treated as self-employed and pays provisional tax. That’s not technically correct. In fact, what he should do is to register as what they call an IR 56 taxpayer, and he files the employment information and pays PAYE to Inland Revenue. So literally he accounts for his own PAYE. Alternatively, the Boston firm could register as an employer and make the deductions on his behalf.
This is a scenario we’ve seen increasingly, so it’s useful to have some guidance from Inland Revenue in the form of this Operational Statement. It’s also worth pointing out there is also sometimes a double tax agreement applies which allows someone to work in New Zealand for up to 183 days, and there would be no obligation to withhold PAYE.
In addition to PAYE an overseas employer may also find itself with FBT and employer superannuation contribution tax issues if it decides to either voluntarily enter into the PAYE regime, or it has a sufficient presence that deems it to be an employer for PAYE purposes.
The complexities of overseas income
Moving on, it’s getting towards the mad rush for filing the March 2021 tax returns before the final date for tax agents on 31st March. The more complicated income tax returns will often involve overseas income, and Inland Revenue has just issued new guidance in the form of an Interpretation Statement on how to calculate the foreign tax credits that may be involved.
Now, this Interpretation Statement is very helpful because this is a surprisingly complicated topic. There’s a lot of detail involved in this. Firstly, we have to determine is the tax paid, for example, of substantially the same nature as the income tax that we charge. That’s not always the case. Because if the foreign tax is not covered by a double tax agreement and is not of the same nature as income tax imposed under our Act, no credit would be available.
That is something I’ve seen a little bit more of in relation to charges on pension withdrawals made by the UK and Irish governments. They’ve been imposing these charges recently where people have made early withdrawals from pension schemes. The amount imposed can be quite substantial – up to 55% in the case of the UK. The way the charges have been drafted they are outside the double tax agreements we have with the UK and Ireland. And in both cases, that means that there’s no credit for the withdrawal charge. So, a person may face a large charge from either Ireland or the UK and a tax charge here and have no relief for the charges imposed by the Irish and or UK governments. It’s a complicated topic and something to watch out for.
The first booby trap you have to watch carefully where a double tax agreement is involved is what the limits are and whether New Zealand actually has any taxing rights in relation to that income. That’s not always the case. But even when you get past those two positions in terms of calculating the credit, you then have to break it down into segments. They must be divided by country and then by type.
If you’ve had tax deducted of 20% from US sourced income and 10% from UK sourced income, you cannot just aggregate those two amounts and offset them against a single amount of overseas income that you report on your return. You have to actually break it down further than that by country and by type of income. And if you’ve got an attributing interest in a foreign investment fund income, that’s a separate calculation as well.
These are surprisingly involved calculations which although people think of as reasonably commonplace, have traps for the unwary in them. So I recommend having a thorough read of this new interpretation statement. It’s about 40 pages, and it can be found in the latest Tax Information Bulletin.
The proposed Social Insurance scheme may reduce fraud?
And finally, last week I was talking about the Government’s proposed social insurance. This proposes some form of unemployment insurance will be provided, as well as for sickness and other illnesses for employees and contractors alike. As expected, it’s generated a fair amount of interest together with some pushback about costs.
This week an article from Dr Eric Crampton, the chief economist with the New Zealand Initiative caught my eye. He suggested that the new scheme would generate a whole host of rorts. He based his commentary partly on his experience of what went on when a similar scheme was operating in Canada about 30 years ago. Firstly, he suggested employers would put seasonal contractors onto permanent contracts before making them redundant before the end of the picking season. And that would be a win for the employee because they would now qualify for up to six months support. Alternatively, an employer could sack a person who about to take paternity leave. By sacking them they’d get more than the current paternity parental leave payments of $621.76 per week.
Two things stand out. There isn’t much in this for the employer because it is basically fraud. I’m not sure many employers would want to be actively engaged in that. And for that matter, neither would employees. Some of the anecdotes that Dr. Crampton suggested sounded a little bit like, “Well, my friend on Facebook’s third cousin said this.”
But he does make a key point. Fraud is a potential issue for the scheme, and I see two areas where it could be a problem. Firstly, the obvious one – trying to make claims when a person is not eligible. The second area is where a person has a valid entitlement, but the amounts claimed are fraudulent because the numbers have been manipulated to over-state the person’s income.
Under the proposal, the Accident Compensation Corporation is to be responsible for the running of the scheme. Now it has a record of managing ACC fraud. Although interestingly, its latest annual report didn’t cite any numbers as to how much fraud was detected.
But I think if you are concerned about potential for fraud, then you should draw a lot of comfort from Inland Revenue’s enhanced capabilities following the completion of its Business Transformation programme, because the new START system gives Inland Revenue far more capability to analyse data.
And another thing here, which would be different from the stories of how similar schemes may have operated in the past in other jurisdictions, is that we have now Payday filing. This means there is near real time data of salary payments flowing through to Inland Revenue. So again, attempts to manipulate numbers should be picked up very quickly.
That still leaves the self-employed, where one report suggests under-reporting of income might be as much as 20% of income. But one thing that’s going on in relation to the self-employed and especially labour-only contractors, is payments to such persons are increasingly subject to pay as you earn and go through the Payday filing system. So again, Inland Revenue is monitoring payments which gives me some comfort in the matter.
But perhaps counter-intuitively, the introduction of social insurance may mean that we see a reduction in tax evasion. And that is with the opportunity that the social insurance payments represent, people will always want to make sure that they can maximise their benefits. It may well be that persons who previously underreported their income realise that although that might reduce a tax bill it’s no good if you fall sick or your contract is terminated. So, maximising their income is in their best interests.
In answer to Dr Crampton’s concerns about fraud, yes, it could happen. But I think the reality is Inland Revenue are far more sophisticated and have the tools to manage this issue than he gives them credit for. And secondly – as an economist, I’m sure he will appreciate this – perversely, there may be an incentive for people to start reporting their correct income to ensure that they maximise the benefit in case they need to make a claim.
Well, that’s it 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 send me your feedback and tell your friends and clients. Until next time, kia pai te wiki, have a great week.
9 Feb, 2022 | The Week in Tax, Uncategorized
- Terry Baucher looks at what’s ahead in the world of tax this year and finds some big issues
- some lingering from the past
- and some new ones to be grappled with
Transcript
2022 is only four weeks old, but as was the case last year and in 2020, COVID-19, this time in the form of the Omicron variant, will dominate the news and fiscal policy.
Tax responses to the pandemic
What exactly the Government’s fiscal response to Omicron will be is not yet clear. There’s no mention so far of a new round of Resurgence Support Payments or a general wage subsidy. And now, since we’ve moved into the red traffic light setting as of midnight on 23rd January, there’s concern many employees will soon be unable to work because they’re either sick or self-isolating from Omicron.
So what support is available? Well, at the moment it’s just the Leave Support Scheme or the Short-Term Absence Payment scheme. These have replaced the wage subsidy. The Leave Support Scheme is a payment for when a person or a dependent is required to self-isolate due to Covid-19 either because they’ve been exposed to it, or they’re considered high risk if they were to contract it. The Short-Term Absence Payment, on the other hand, is designed to help employees who are self-isolating while they’re awaiting the result of a Covid-19 test. In order to be eligible for the Leave Support Scheme the Short-Term Absence Payment the employee needs to be unable to work from home.
The Leave Support Scheme is paid at a rate of $600 a week for full time workers, those doing more than 20 hours a week, and $359 a week for part time workers, i.e. less than 20 hours a week. The rules around these payments are set out in the Covid-19 guidelines, and for the moment, that’s all that’s available. And by the way, both payments are administered by the Ministry of Social Development and will be made regardless of the financial position of the employer.
Industries such as hospitality, tourism and the performing arts sector have all been hit hard and will be affected by the move to the red traffic light system. But at present, nothing in the form of an updated Resurgence Support Payment or something new has been mentioned.
Any response to this issue is clearly a matter of politics although it will have a fiscal impact. Bernard Hickey, the economic commentator and journalist, has put together an analysis of the impact of the Covid-19 support to date and who has benefited from that, and the numbers are quite eye watering. In his daily newsletter, he says that the government’s interventions to print $58 billion through the Reserve Bank and give $20 billion in cash to business owners helped make owners of homes and businesses $952 billion richer since December 2019. This is one of the greatest transfers of wealth New Zealand has ever seen. It’s also highlighted the pressure on those at the other end of the scale. The poorest New Zealanders now owe $400 million more to MSD and need twice as many food parcels as they did before Covid-19.
Now as I said most of this is political, and we’ll see if the optics of such huge changes will affect how the next form of fiscal support will be designed. Will it be as generous, or, as many people have said, should the funds be going directly to employees and those infected rather than through their employer?
Taxation of capital
More importantly, the never-ending issue of the question of the taxation of capital will re-emerge on this. We’ve already had discussions with one or two other people in the policy space around what we think could be happening in the year ahead and the question of inequality and taxation of capital has popped up again. Although it seems incredible to think the last election wasn’t so long ago, there’s an election next year, and I imagine there would start to be some jockeying around positioning for that.
So Omicron and Covid-19 and God forbid, any further variants, will play out on the economy. What type of support the Government gives and how it funds it will have tax implications. It might be, for example, the Government might have a look again at whether it allows the carry back of tax losses. They were going to push ahead with, a permanent scheme, but dropped it for fiscal costs. They may have a think again because the fiscal cost might not be so great as expected or feared, and can actually be concentrated on sectors which are getting hit hard anyway. So that’s something to look out for. So, watch this space and we’ll bring you news of developments throughout this year as they happen.
International tax reform
The next area I think we will see, and again repeating a theme from last year, will international tax reform and following through with the implementation of the agreement on the taxation of the largest multinationals and the digital tech giants. This year the detail of that agreement is to be worked out. The OECD released last week the transfer pricing guidelines for multinational enterprises and tax administrations for 2022.
140 odd jurisdictions have committed to the reforms of digital taxation and will be working on making sure that it meets these pretty ambitious deadline to be in place by the end of the year, so we’ll see a string of developments in that field.
How our tax system is run
And finally, on the domestic front, the issue which I think will dominate is what next for Inland Revenue now it’s completed its Business Transformation? Basically this is about how the tax system is run. Now, this may sound like a dry topic, but there’s already been quite a bit of manoeuvring around what is the future of tax administration.
On this, I would recommend reading a paper prepared by Business New Zealand in conjunction with tax experts (some of whom included members of the Tax Working Group, such as Robin Oliver) on the future of tax administration. I understand sometime soon we’ll see a Government Green Paper on tax administration, which would explore what tax administration could look like in future and how to make best use of Inland Revenue’s completed Business Transformation project.
What Business New Zealand and its working group have done, is put together a roadmap including a series of revised tax principles applicable for tax administration. This is talking about the delivery of tax policy and administration, not about actual tax policy settings, per se.
One of the things that’s stands out from this paper is that Business New Zealand, and from my initial discussions with Inland Revenue on the topic, see Inland Revenue moving more to focus on system management and partnering and assisting a wide range of participants in the tax system other than taxpayers themselves. This is a bit of a change in the whole approach. Inland Revenue is no longer adopted a top down “It’s my way or the highway” around how tax is administered and delivered.
The paper sets out seven tax administration principles. Firstly, “The purpose of ongoing reform is to reduce the risks and costs for all participants in the tax system and improve national wellbeing”. Nothing too controversial about that, totally agree.
Secondly, “The tax system is built to assist those who voluntarily comply, with robust enforcement for those who do not.”
I wholeheartedly agree with that. Voluntary compliance is undermined if Inland Revenue does not throw the book at those who are not complying.
One of the issues raised in this paper and which has been picked up in other papers on tax administration I’ve seen from around the world, is that sometimes this means tax authorities have to take an approach to a particular sector or area of enforcement where it might not necessarily see there’s a lot of money in it for them. For example, the fringe benefit tax issue around the infamous twin cab Ute. Inland Revenue has said, “Well, yeah, we think there’s an issue there, but we don’t know whether it’s worth our while”. Under this tax administration principle, it’s, “No, you really do need to look at that, there are wider integrity issues as to why you should do so”.
Three. “Everyone understands their rights and obligations through clear, unambiguous legislation and guidance.”
Very strong support of that principle. And as we talked about last year, one of the pressures that’s coming into the tax system is we’re getting less clear legislation and guidance. This is because the Government is doing things a little bit ad hoc as it responds to pressures, inevitable pressures sometimes, but the tax policy process has not been as robust as it could have been.
And there are two obvious example to talk about here. Firstly, the interest deduction rules and secondly, the proposals to ask high wealth individuals to provide more details about their assets and how they’re held. Both those policies have been done one would argue, a little bit on the hoof, and this certainly caused pushback as a result.
Following through on this, the fourth principle is “Tax rules are designed and administered in a way which reduces compliance and administration costs.” And again, everyone can get behind this. Business NZ paper points out this is something that’s actually much more important for small businesses and microbusinesses where the costs fall heaviest on them, and often they don’t have the tools in terms of the resources to manage their tax liabilities.
The fifth principle is “Tax policy proposals are critically evaluated against the ability to automate outcomes.” Very straightforward. No issues there.
Sixthly, “A well-functioning tax system recognises the role and importance of intermediaries.” Now, regular listeners of the podcast will know that sometimes as tax agents, we felt unhappy about how Inland Revenue had interacted with us and about how the Business Transformation process was implemented.
And what this paper points out is intermediaries such as tax agents and other software designers are incredibly important to the tax system going forward. To be fair to Inland Revenue, that seems to be also coming through on what I’m hearing from them. A very important change there and a welcome one, too.
And finally, “Taxpayers and intermediaries are held responsible only for matters within their knowledge or control.” This is a fair point setting some boundaries so that taxpayers are not held accountable for errors beyond their control or knowledge. This might happen because sometimes information wasn’t available or can never be made available to a taxpayer or an intermediary. At present the tax system can come down hard on the reporting person because they should have known, when in fact they may not have done or could not have done.
The paper suggests for example that Inland Revenue which has better knowledge should be responsible for advising taxpayers and intermediaries of incorrect tax rates and tax codes. So this is an issue of increasing fairness in the tax system.
Now I understand that Inland Revenue is going to produce a Green Paper for discussion and is considering holding a symposium later this year to discuss these matters. Although it sounds like an arcane topic it’s certainly, going to be quite an important issue for the year going forward. And as always, we will bring you developments as they happen.
Well, that’s it 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 send me your feedback and tell your friends and clients. Until next time, kia pai te wiki, have a great week.
8 Feb, 2022 | The Week in Tax
- the proposed income insurance scheme
- Inland Revenue’s view on those who respond to the 39% disincentive
- The OECD’s view on how we tax ourselves
Transcript
The big news this week was the Government’s proposed income insurance scheme. Interestingly, this is a joint approach between Business New Zealand, the New Zealand Council of Trade Unions and the Government. The idea had been floated in the run up to the 2020 election, and it appears in the wake of Covid-19 to be moving forward with some urgency.
Basically, the scheme proposes to pay members who lose their jobs up to 80% of their wages or salary for up to six months. As well as redundancy and layoffs it would also cover people who have lost their jobs due to health conditions and disabilities. It’s also intended to provide coverage for contractors and the self-employed.
How it will work is if someone loses their job, the employer would need to give the scheme four weeks’ notice and pay the departing worker 80% of their salary/wages for the first four weeks. And then if a worker doesn’t find a job, they then start getting paid by the income insurance scheme for up to six months. It’s going to be run by the Accident Compensation Corporation and operate on a similar principle to the existing ACC scheme.
How would it be paid for? Well, it’s going to be funded by levies on wages and salaries for both employees, and the proposed rate is 1.39%, which is the current ACC employee levy rate.
This proposal represents a departure for New Zealand as it’s equivalent to a Social Security tax when we don’t have those, although they’re very common overseas. In fact, according to the OECD, New Zealand is one of only five countries within the OECD that doesn’t have some form of Social Security tax. Social Security taxes overseas are used to fund schemes similar to the proposed income insurance scheme, but they may also cover other benefits such as pensions and general welfare.
As a result, the cost of these Social Security taxes can vary quite markedly. The highest as a percentage of labour costs is 26.6% in France, which is entirely borne by the employer. But there are eight other jurisdictions where the Social Security contributions can exceed 20% or more. And in five countries, including France and Germany, Social Security labour costs represent at least one third of all labour costs.
Across the OECD on average, Social Security taxes represent the equivalent of 9% of GDP. The proposed scheme is right down at the other end of the scale. It’s an initial step forward into an area where other jurisdictions have been for some time.
I know from my time working in the United Kingdom a lot of tax planning and tax avoidance went on around National Insurance Contributions. As these costs fall on employee and employers it isn’t always welcome. Quite remarkably, some of the same stuff that I was seeing nearly 30 years ago is still going on.
On the other hand, it gives employees, contractors and the others affected some form of security. And as I said, this is a joint approach coming from Business New Zealand and the Council of Trade Unions. No doubt there will be plenty of politics playing out about it, but it’s an interesting way forward and we will monitor the debate. Consultation has started and will continue until 26th April.
39% will bite a bigger group, who may respond to the disincentive
Moving on, earlier this week, it emerged that Inland Revenue had undertaken some analysis of the number of taxpayers affected by the increased 39% tax rate and had found the number of taxpayers who would be affected is some 44,000 more than initially estimated.
It initially thought it would be about 2% of the population, or about 75,000. But based on analysis of the tax returns filed so far for the year ended 31 March 2021 and current year PAYE returns and provisional tax payments, it appears the number is likely to be close to 119,000. From the Government’s perspective, this means that the tax take is going to be significantly higher than estimated.
The paper in which the Inland Revenue made this analysis has been released under the Official Information Act, and there’s some very interesting commentary from Inland Revenue about what behaviour it is seeing in relation to the increased tax rate. In the paper Inland Revenue comments
“it has extensive experience in monitoring compliance and 39% rate across 2003 circa 2010, which is the last time the individual marginal rate was significantly higher than the trust in company tax rates. Whilst we anticipate that similar trends and behaviours would be observed this year, we also have access to more real time data from which to derive insights.”
What it’s saying there is, “Yeah, we’ve been here before. We’ve learnt the lessons from what happened when we last increased the tax rate, and we are ready to take action against what we see as potential attempts to manipulate taxable income to avoid paying that top rate”.
The paper then goes on to describe what happened prior to 31st March 2021, and quite predictably, it saw a large number of increased dividend payments to shareholders. According to Inland Revenue during the year to March 2021, $9.45 billion dollars was paid out in dividends to over 46,000 shareholders, representing an average of $204,000. The total amount of dividends paid out was nearly three times higher than the amount paid for the year ended 31 March 2020 and the number of dividend recipients was up 57%.
As the paper notes the likely driver behind paying out of dividends for the March 2021 year was to ensure that they are subject to a maximum tax rate of 33%. The dividends probably represented a number of years of retained earnings rather than a higher-than-average earnings year in 2021. And then the Inland Revenue paper goes on to point out companies are entitled to pay dividends if they are in a position to do so. This was a legitimate option for them.
It’s clear that people have taken steps to avoid dividends being taxed at 39% and Inland Revenue acknowledge this as entirely unsurprising. I’ve been around long enough to remember what happened the last time the tax rate was increased to 39% in March 2000. We did exactly the same thing. Significant dividends were paid out prior to the rate change. It’s not tax avoidance. The paper makes this very clear. If companies could afford it, they could do it.
But where Inland Revenue’s analysis gets really interesting is it then starts to look to see if there’s a decrease in employment income because as obviously people might say ‘I don’t want to pay myself above the $180,000 threshold because I’m going to be taxed at 39%.’ Inland Revenue has carried out some initial analysis about what’s been happening here. It has a split between what it terms customers who don’t have an ownership or control association with their employer and those who do.
Interestingly, for the group without a control interest the total employment income for the year to March 2022 is estimated to be down 13%. The number expected to be receiving over $180,000 is also expected to be down 9% to around 68,000. The average employment income of this group is going to fall from $228,000 to $217,000.
The paper then considers the group where there is an ownership control relationship with the employing entity, that is directors or shareholder-employees in the company. Inland Revenue estimates this group’s total employment income will fall by 15%, although there will be only a small change in the number of income people earning above $180,000. It’s expecting the average employment income for this group of people with control over a business will fall from $191,000 to $166,000.
At which point the paper delivers this kicker “in an ordinary arm’s length situation we wouldn’t expect an employee’s income to decrease (except to the extent in the current environment that they are impacted by COVID 19)”.
But as the paper notes in fact there is this fall in income. Inland Revenue is clearly flagging its concern, and that it’s going to be looking at this issue when the returns for the March 2022 year start to be filed in another eight weeks or so, at the earliest. These are just projections from Inland Revenue, and it may be that these projections may change because of large end-of-year bonuses and other lump sum payments made towards the end of the year through the shareholder employee mechanism then. Whatever the reason Inland Revenue is basically running up a flag and saying, “We’re watching.”
What it’s also been watching for is if there’s been any restructuring to lower tax rates in what it terms “the target population” (the group of taxpayers with income over $180,000). And the paper says that since November 2020, this group has formed 10,633 new companies, 2,630 new trusts and 362 new partnerships. This represents “a 28% increase in the volume of new entities established by this population from the prior 12 month period.”
The paper goes on “Our next steps include integrating other data to further analyse these entities to identify any specific patterns or trends”. So again, Inland Revenue’s running up the red flag and saying, “We’re watching”. The paper also points out that the new trust disclosure rules will give it further information.
And one other thing Inland Revenue has been picking up on is transfers of shares which have been previously held individually and but have been transferred to a company or a trust thing. What that is pointing out is if you held the shares individually, previously any dividend received would be taxed at 33%, but now would be taxed at 39%. But on the other hand, if it’s held by a trust, the tax rate is capped at 33%.
Again, Inland Revenue is flagging that they’re watching. As noted above Inland Revenue learnt a lot from what happened the last time the top tax rate was 39%. They were, to be frank, caught on the hop back then and the issue doesn’t appear to have been picked up on until three or four years after the tax change happened. This time, Inland Revenue told the Government, you should increase the trustee tax rate to 39% as well. Overall, the clear message here is Inland Revenue are watching and taxpayers should move with due caution as a result.
We are assessed by the OECD
And finally, in what’s been a busy week, the OECD released its latest economic survey of New Zealand. The headlines focused on the OECD’s suggestion the Government scrap the first home buyers KiwiSaver withdrawals mechanism and various other policies targeted at first home buyers. Incidentally, at the start of the year the OECD released a paper on the taxation of housing which noted how owner occupied housing is very highly tax preferred.
The OECD economic survey reviews progress on four tax changes it’s previously recommended. One has been implemented in full and that is restricting the deductibility of property losses and not only allowing them to be offset against future rental income. That’s been in place since 1st April 2019. It’s also recommended, as did the Tax Working Group, limiting KiwiSaver tax credits to low-income members.
The OECD has for a long time pushed the idea of a general capital gains tax, but as we all know, that has been knocked back repeatedly. The survey does note the bright-line test has now been extended to 10 years. The OECD’s other recommendation is for the mutual recognition of imputation and franking credits with Australia. However, that’s been held up on the Australian side because of the cost to Australia of such a move which would be of greater benefit to New Zealand companies.
Interestingly, the latest survey takes a look at environmental taxation, and it notes that revenue from environmentally related taxes in New Zealand is relatively low. This will probably come as a shock to everybody, but transport fuel costs taxes are lower than most other OECD countries, and most fossil fuel uses outside their sector are not taxed.
The OECD acknowledges more effective pricing of carbon and other greenhouse gas emissions should be pursued through the Emissions Trading Scheme. It suggests that taxation can be used to address environmental externalities that the Emissions Trading Scheme can’t address. For example, taxes for fuels used in transport could be increased to “internalise social costs linked to transport such as local air pollution and congestion.” As technology improves congestion charging could be adopted.
The survey notes the Government is expanding the national waste disposal levy and is considering other environmental taxes. One option I’ve mentioned previously is perhaps we should be looking at fringe benefit tax being charged on the basis of emissions as is done in the UK and Ireland. Anyway, there are some very interesting recommendations and we might see more on environmental taxation as the year develops.
Well, that’s it 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 send me your feedback and tell your friends and clients. Until next time, kia pai te wiki, have a great week.
20 Dec, 2021 | The Week in Tax
- A record tax take ahead, never mind COVID-19
- A ground-breaking international tax deal
- Property taxation
Transcript
On Wednesday, the Government released its Half Year Economic and Fiscal Update (HYEFU) on what was announced in May’s Budget back in May. From a tax perspective the Government’s tax take – the fiscal outlook – is expected to improve over the forecast period to 30 June 2025. Although the HYEFU expects things to weaken in the current year to June 2022, it is seeing quite stronger than expected tax revenues coming through.
Treasury expects over the five-year period for core Crown tax revenue to increase by $36.6 billion or $7.3 billion each year. This is expected to be in line with the expected economic growth. Core Crown tax revenue will remain at about 29% of GDP over the period. What it will mean is even though they expect a slight downturn in in the year to June 2022, core Crown tax revenue is expected to exceed $100 billion dollars for the first time.
Now one reason for the Government’s expected increased tax take is a stronger outlook for the labour market, but it’s expecting employees’ wages to rise. As a result, fiscal drag will lead to a higher tax take. Fiscal drag is when an individual’s tax rate increases as their income crosses a rate threshold. For example, over $48,000, the tax rate jumps from 17.5 to 30% and then at $70,000 it goes to 33% and then over $180,000 it goes to 39%.
The fiscal drag effect is expected to be quite strong. It also implies that, at least for this forecast period, the Government is not planning on making many adjustments to those thresholds, which have not been adjusted at all since 1 October 2010, other than the introduction of the new 39% rate this year.
There is also an interesting snippet about the rise in the amount of GST that’s been collected. That is apparently a by-product of the lockdowns and the inability to travel overseas. People are therefore spending more in New Zealand, whereas if they go on holidays, that spend happens outside New Zealand and there’s no GST for the Government.
The half year forecast also includes estimates of the impact of tax policy changes and the big one here is the denial of interest deductions for residential property investors. Over the period to 30 June 2025 this is expected to bring in over $1.1 billion. As you’re aware the interest deductions are limited to 75% as of now and then gradually over time deductions will be removed in full. For the period to June 2022 the impact is estimated at $80 million, and that rises to $490 million in the period to June 2025. Of course, there’s an election in between now and then and the legislation hasn’t been finalised, but we will see how that plays out over the forecast period.
These half year forecasts are interesting, they’re indicative only, and things can change quite rapidly as we found out in the last couple of years. And of course, there’s a risk another development in the pandemic will have some impact.
Still, it’s interesting to dive in and see how the tax take is expected to track over the next few years.
Income Tax on the Wage Subsidy
Moving on, and speaking of the pandemic, Inland Revenue has just issued a reminder about the tax treatment of wage subsidy and leave support payments that have been made to taxpayers by the Ministry of Social Development. If these payments didn’t pass through PAYE, then self-employed taxpayers and other individuals who received a wage subsidy or leave support payment, have to include these payments in their income tax returns. So that includes most self-employed people, but it also includes shareholder employees, partners and trustees, shareholders in look-through companies and some students and home-based childcare providers.
The fact that Inland Revenue is issuing a reminder now about what has to be included in the tax return when tax returns for many people were due on 7th July is interesting. It indicates quite a few tax returns are still outstanding and also they may be seeing mismatches between what’s been reported to them by MSD and what’s been filed. A person might have received a payment under one of these various support schemes but doesn’t appear to have been reported or included it in their tax return to March 2021.
No doubt there will be more COVID-19 developments next year. Looking back on the year, obviously COVID-19 dominated the news. Although the big wage subsidy burst happened last year, but with the progressive lockdowns the wage subsidies and resurgence support payments were all made available this year and I think we can expect that to continue. So that was clearly a story which never seemed to be out of the news.
International tax reform starts in earnest
What were the really big tax stories for the year? Well in my view there are only two that stand out. The first is the international agreement by the G20/OECD on the future of international tax. I mean, this is a huge development. 136 countries signed up to a new international framework which takes into account the rapid digitalisation of the world economy that has happened. It also starts to try and draw a line under the tax competition that has gone on for the past 40 to 50 years.
To recap quickly the agreement consists of two pillars. Pillar One is aimed at ensuring that profits are more fairly distributed between countries with respect to the largest multinational enterprises. Those are companies with a turnover greater than 20 billion euros, about $30 billion. And then there’ll be a reallocation to jurisdictions where the customers and users of those services are located. This is supposed to reallocate something like USD125 billion of tax annually. New Zealand will be one of the beneficiaries of that, particularly in relation to the likes of Google and Facebook.
Pillar Two is the one that puts a floor on the tax competition by introducing a global minimum tax corporate tax rate of 15%. At the moment, this rate is said to be a maximum, and I know the Biden administration wanted it higher. But Europe and the Irish in particular, are not keen on a higher rate. And as I mentioned when I talked about this with Craig Elliffe, there are some countries, such as Nigeria, who are not happy and did not sign up to the agreement.
So the deal isn’t completely over the line yet, but 136 out of 140 participants have agreed to it and things are starting to move along. The main plan is there will be a multilateral instrument for signing by the middle of the year. And if all things go according to schedule, the new rules will take effect from 1st of January 2023.
I agree with Craig Elliffe that this is probably just the start of international tax reform. I think the pandemic coming in the wake of the Global Financial Crisis means that governments are really looking very hard at their tax revenue and tax base and will be looking to try and basically eliminate the use of tax havens and aggressive tax planning. So it’s very much “watch this space.”
Using taxes to restrain house prices
Then the other story, which I mentioned earlier, because we already know something of its fiscal impact, is the ongoing struggle of the Government to try and rein in house prices and restore some equilibrium between investors and first home buyers.
We saw this with the dramatic and unheralded introduction of the restriction on interest deductions for residential property investors. This has come into effect from 1st October and will progressively mean that after 31st March 2025, no deductions will be available.
This was a very dramatic step that was mitigated by allowing interest deductions to continue for new builds. Clearly, the idea is to divert investment into new builds and indirectly then bring down house prices. How that plays out nobody knows, really. Clearly, some form of circuit breaker needed to happen. Whether this is the right one, only time will tell.
The other measure that came in with it as well was the increase in the bright-line period from five to ten years. Again, there’s a carve-out for new builds, and I wonder whether that may create unintended consequences.
The controversial legislation is still progressing through Parliament, and the Finance and Expenditure Committee is now working its way through all the written and oral submissions it’s received and heard on the matter.
Undermining the GTPP
But the other thing this move highlights is the deterioration in the Generic Tax Policy Process (the GTPP). New Zealand tax policy experts are very proud of the GTPP. There’s nothing really similar to it and around the world tax practitioners in other jurisdictions admire it because it sets out a framework under which tax policy will be developed.
But the problem is that this process has been eroded steadily in recent years, and the area causing this erosion is the ongoing conundrum over the taxation of capital. We have a problem in New Zealand with an immense misallocation of resources to our housing market, which has a number of unintended consequences as seen by people like Max Rashbrooke and Bernard Hickey. The Government as well, I think is worried about what’s happening in that sector, and even the banking sector seems quietly concerned at how much money is in the property sector.
The bright-line test was introduced only six years ago, and its introduction was a surprise that didn’t go through the Generic Tax Policy Process. And we’re seeing more of this with governments introducing tax legislation a little bit on the hoof. The interest limitation rules are probably the best such example even though there was a process where we were, as experts, asked for our input. But the Government had already said what it was going to do, we were merely commenting on the how that would happen. Under the Generic Tax Policy Process the Government will begin by asking we’re considering doing X, should we? What are the pitfalls and the best way of implementing our proposal?
But the interest limitation rules aren’t the only area where some people are concerned about what’s happening with GTPP. The other policy, which is also drawing some controversy, is the introduction of section 17GB of the Tax Administration Act. This is targeted at the wealthy, and it compels them to provide evidence of their financial wealth, together with a breakdown of their structures, to Inland Revenue for the purposes of determining tax policy.
Now this legislation was introduced on the quiet without any discussion about it beforehand. And again, some people have seen that this is eroding the Generic Tax Policy Process. And that move has stirred up some protest and there’s persistent talk of perhaps a legal action being taken against the legislation.
But again, you might say that comes back to the issues of the taxation of capital which is an area where I think there’s a weakness in the tax system. The taxation of capital is not comprehensive, and we need to think further about how we want to do that, and how would that tie in with ideas of inequality. Within the tax system if we are following the principle of a broad base, low rate, but we’re excluding part of the base, how does that impact the tax rate?
New Zealand is very reliant on labour taxes. I mentioned earlier about what the expected revenue to come in from PAYE and also from GST which is a fantastically efficient tax. But is that a broad enough tax base? Well, that’s a debate which I think is going on right now. I’m seeing the same debate elsewhere around the world about taxation of wealth and the expansion of GST and no doubt those will be themes that we will continue to see next year.
Well, that’s it for this year. My thanks to all my guests this year, and also to all my listeners, readers and commenters on the transcripts. Thank you so very much for tagging along and listening to me ramble on about tax.
We will be taking a break now and we’ll be back on Friday, 21st January. Until then, Meri Kirihimete, me te tau hou, Merry Christmas and a Happy New Year.
13 Dec, 2021 | The Week in Tax
- Inland Revenue enlists the help of the Chinese tax authorities in a tax evasion case
- OECD report reveals the impact of COVID-19 on tax revenue
- Inland Revenue turns off its old computer system
Transcript
The Taxation Review Authority last week upheld the Commissioner of Inland Revenue’s assessments on unreported income from property transactions. There’s nothing particularly unusual about the facts of this case at first sight. The taxpayer was involved with the purchases and sales of five properties. He arranged the purchase of bare land, the construction of a house on the land and then sold the house.
He maintained he was only a manager and was actually acting under a power of attorney for Chinese nationals and merely managing the properties and receiving payments for services such as arranging the land development and transactions.
But the Commissioner decided to take a look at his affairs for the three tax years ending 31 March 2014, 2015, and 2016. And it transpired that in fact, he wasn’t acting as a manager, but he personally controlled the transactions, and he made the profit from proceeds of each property over and above the management fees he had returned in his tax returns. These transactions all pre-date the introduction of the bright-line test, so the Commissioner assessed him on the basis that the properties were acquired with a purpose or intent of sale.
Ultimately, the amount that was assessed after deductions over the three years turned out to be over $1.6 million. In addition, because he had only been returning the management fees, he had actually also claimed working for families tax credits of just under $9,000 to which he wasn’t entitled. The commissioner took the view all this represented tax evasion and imposed shortfall penalties of initially 150% of the tax evaded but reduced by 50% for a first offence. Even so these penalties amounted to $407,000.
So far this is relatively routine. Inland Revenue are tracking property transactions and if something gets suspicious, they’ll look to see if a pattern emerging.
What caught my eye about this one is the Commissioner’s investigations included obtaining information from the People’s Republic of China under the double tax agreement we have with the PRC. As a result of that enquiry the registered proprietors of the land said, “Hey, we’ve got no knowledge of our involvement in these property sales, and we have not received any benefit from these sales”.
Now, one of the great unknowns that I think people aren’t aware of is how much information sharing goes on between tax authorities. But this is the first one I’ve seen where it’s been clearly acknowledged that the Chinese tax authorities in the People’s Republic of China have been involved.
So, there’s a warning for people to be very aware that Inland Revenue information gathering powers are enormous and they have discretion to ask overseas tax authorities for information in relation to any enquiry. Undoubtedly, the Chinese tax authorities would have been very interested in this as well because they would have people at their end who may have been involved in tax evasion.
A couple of years back, I asked Inland Revenue under the Official Information Act about how many requests for information were made between it and the Chinese tax authorities during the year ended 31 December 2018. The official response was
“The information above is refused because making the information available would likely prejudice the international relations of the New Zealand Government. It would also likely prejudice the entrusting of information to the New Zealand Government on a basis of confidence by the tax agency of the People’s Republic of China.”
Incidentally I asked a similar question in relation to the double tax agreements with Australia and the UK, and the information was supplied. Talking with a journalist who often deals with OIAs being declined, he was quite impressed because he hadn’t had an OIA declined on those grounds.
But international relations aside, the key point people should be aware of is that Inland Revenue has wide information gathering powers, and that includes being able to talk to other tax agencies and overseas. And in this case, that was probably pretty fatal for the taxpayer’s chances in this case. You have been warned.
The economic tax take in a pandemic
Speaking of international tax, the OECD earlier this week released its Revenue Statistics 2021, which showed the initial impact of COVID 19 on tax revenues within the 30 odd countries of the OECD.
On average tax revenues represented 33.5% of GDP in the 2020 calendar year, which is 0.1 percentage points of GDP up relative to 2019. But of course, this is against the backdrop of the impact of the pandemic which resulted in widespread falls in nominal tax revenues and nominal GDP. And that’s why the tax take relative to GDP rose because in most countries, GDP fell by more than nominal tax revenues.
As typically with OECD reports there’s heaps of interesting data that you can dive into. For example, in 2020, Denmark has the highest tax to GDP ratio of 46.5%, whereas Mexico, at 17.9%, has the lowest tax to GDP ratio. Overall, in 2020 for the 36 countries that were measured, the ratio of tax to GDP rose in 20 and fell in 16.
The largest ratio increase was in Spain, which went up 1.9 percentage points, apparently because of a large increase in social security contributions. But the largest fall, on the other hand, was Ireland, which fell 1.7 percentage points. And that was because its GST revenues fell quite substantially following a temporary reduction in GST rates as part of its response to the pandemic.
Where does New Zealand feature in all of this? Well, its ratio provisionally rose to 32.2% of GDP, which is up 0.7 percentage points from 31.5% in 2019. By the way, the tax to GDP ratio is also shown for the year 2000. Back then the ratio was 32.5% and New Zealand since then has pretty much tracked around that thirty-to-thirty two percent of GDP ratio since then. Incidentally, Denmark’s has actually been pretty stable over the same period. Its tax to GDP ratio back in 2000 was 46.9%. The average across the OECD back in 2000 was 32.9% and in 2020, it’s 33.5%. So, you can see stability across the tax take for quite some time.
The report has a breakdown between tax types and interestingly, corporate income taxes in New Zealand at 12.4% of total tax revenue in 2019 is significantly above the 9.6% average across the OECD. Similarly, GST at 30.3% is well above the 20.3% average in the rest of the OECD. (Chile incidentally collects 39.9% of its tax revenue from GST, which is the highest in the OECD. As always there’s plenty to dig into in these OECD reports.
From FIRST to START
And finally, this week, Inland Revenue has finally switched off its old FIRST computer system, as it’s now practically completed its Business Transformation programme. The total cost of this Business Transformation has come in at just under $1.5 billion, which is less than the $1.7 billion that was originally budgeted, including the leeway for contingencies.
So that has rightly drawn some praise from various sectors for managing that transition. I think you can look back at the Novopay scandal as to see how these things can go wrong. Consequently, the Inland Revenue had to make regular reports to the Cabinet about its progress.
And one of the effects for Inland Revenue of the programme and which was part of its business case, is that its workforce has gone from 5,662 in June 2016 to under 4,000 now, a quite significant change. My understanding is that back in 2016 under the old system, a significant number of processers were employed simply to re-enter everything into the system so it could actually be used.
Regular listeners to the podcast will know I’ve not always been entirely complimentary about what’s going on with Business Transformation. There have been some issues for tax agents and we’re still working through some teething problems. Generally, I think when the Business Transformation programme was being designed and implemented, the role of tax agents was not well considered. We tax agents are actually the biggest single users of the system and perhaps having tax agents involved earlier on might have made it a more user-friendly experience from our end.
However, it has to be said that this programme was much needed. FIRST was introduced in 1989, I think, and it was really showing its age. And fortunately for all of us Inland Revenue had Business Transformation well advanced when the pandemic arrived. Inland Revenue officials have told me none of assisting the Ministry of Social Development with the wage subsidy scheme, implementing the small business cashflow loan scheme and the ongoing resurgence support payment scheme could have happened under the old FIRST system.
I know the local IT sector was very unhappy at the start of the project at being shut out of the process, although some local providers have got involved as it developed. At a conference in 2014 which was a precursor to the start of Business Transformation it got bit spicy as local software providers climbed into Inland Revenue over their decision to use Accenture and other offshore companies to lead the project.
Local software providers made two points. Firstly, they had the capability and expertise. One announced it had designed and implemented Bermuda’s GST system within six months. The view was the expertise was already in the country.
But secondly, and this is a point which I think has to be kept in mind on a broader economic framework, if software companies are trying to export, but they’re not winning government contracts, that makes it a harder sell for them. That was a point which I also heard when I was on the Small Business Council.
Anyway, congratulations to Inland Revenue for migrating fully across to the new START platform. It’s onwards and upwards from here and although there will always be some teething problems, we’re working through these. So that was a welcome completion of a project.
Well, that’s it for this week. Next week, it will be my final podcast of the year. I’ll be looking back on the big stories for the year. Until then, 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 reading) and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!
