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.
3 Sep, 2019 | The Week in Tax
What are the “Unknown unknowns” of tax? Our 3 stories from the week in tax
- The financial arrangements regime and Inheritance Tax
- Wage theft and missing PAYE and KiwiSaver contributions
- National’s tax policy – indexing thresholds, changes to the bright-line test and loss ring-fencing
Podcast transcript
In February 2002, in the run up to the invasion of Iraq, then U S Secretary of Defense, Donald Rumsfeld, commented;
“Reports that say that something has happened are always interesting to me because as we know there are known unknowns. There are things we know we know. We also know there are known unknowns. That is to say we know there are some things we do not know, but there are also unknown unknowns. The ones we don’t know, we don’t know and if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.“
This quote was a core theme in my presentation last week to the Financial Advice New Zealand annual conference. The unknown unknowns are also a very difficult category in tax. And what are these unknown unknowns? The ones that trip up people because they didn’t know they were there.
Well in New Zealand the biggest culprit in this would be our financial arrangement rules. These rules have been around since 1986 and yet despite their very broad application, are largely unknown. I have come across CFOs who were completely unaware how they could apply.
Financial arrangements rules apply to just about any financial instrument you can think of. Mortgages, bank term deposit accounts, swaps, bonds, gilts in the UK phrase, all those all caught within it. It’s so broad it could apply to season tickets for public transport. And in one case I dealt with we thought that electricity contracts would be caught. Actually, we were debating whether in fact they were in the stock rules or in financial arrangement rules. Welcome to the arcane world of international tax.
But the financial arrangement rules are very broadly, largely unknown to individuals and they have particular bite in the foreign exchange field. That is where exchange rate movements such as is going on right now with Brexit which is back in the news again, so the Pound will move around.
Two groups of people get caught here. Obviously, investors who have bonds or term deposits denominated in an overseas currency, the value of the New Zealand dollar falls [that is more dollars are required to buy the offshore currency], they make an exchange gain and if the value rises, they have an exchange loss.
Then there are those with, for example, a rental property in the United Kingdom, and they have a mortgage there, it works the opposite way. The Pound may become weaker against the dollar so that in dollar terms, their mortgage diminishes, then that is income. Now on an unrealised basis for most people, this largely doesn’t matter, but very abrupt movements which add up to $40,000 on an unrealised basis will pull people into the foreign financial arrangements regime and they then will have to pay tax on unrealised gains.
The classic example I encountered was a client who had substantial property interests and mortgages in the UK. In year one there was an unrealised $300,000 foreign exchange gain, on the movement on the Sterling and had to cough up $100,000 in tax. The following year, it moved back the other way and she had a $300,000 loss but she never got that tax back. Even though there’s a wash up calculation when an arrangement matures or a mortgage rolls over and so of all the unders and overs are taken into account. But if you paid tax too soon in the piece, say you paid tax two years ago and then you find out that you actually never made any gain once everything is all closed out, you’ll never get the tax back. It’s one of the harsher parts of the financial arrangements regime.
The other trap is that the arrangements regime will apply to people who have total financial arrangements of $1 million or more and that is a gross amount. What I sometimes see is people may have $500,000 of term deposits and $500,000 of mortgages overseas mortgages and they think that after netting the two off, I’m below the threshold for the regime. Economically, your net worth comes out as nil. But financial arrangements regime takes them in aggregate so therefore the two are added together so the person actually has a million dollars in financial arrangements and is therefore within the accrual part of the regime. That person will be taxed on an unrealised basis.
The financial arrangements regime just the most common trap New Zealand advisors and clients fall into in my experience.
Following on from that, the other area that I’m seeing a lot more of is UK inheritance tax. Inheritance Tax is an estate and gift tax that applies to anyone domiciled in the UK or with assets in the UK.
Domicile, without getting in to too much detail, is a complicated concept, but basically, it’s where your permanent attachments are. I spoke in a previous podcast earlier about the unfortunate New Zealand woman whose Scottish partner died and because they weren’t married, she finished up paying £50,000 pounds inheritance tax on the transfer of his interest in the New Zealand property to her. So that’s not the first trap to watch for.
And I’m seeing more and more people caught by this, we have 300,000 Britons in the country. People like me, who’ve come from Britain, many more still have assets over in the UK. Maybe their children are going backwards and forwards to the UK and working there. And they’re all potentially all caught up in the inheritance tax regime.
A common thing that often gets overlooked is the implication of having assets in the UK or burial plots. Famously after Richard Burton died in 1984 the then HM Inspector of Taxes nailed his estate for inheritance tax on the basis that he had retained a burial plot in the village in Wales from which he came. So that was a very expensive burial plot as it turned out. I believe he actually is buried in Switzerland, but that’s how arcane the rules around inheritance tax are. It is the great unknown unknown. And as Donald Rumsfeld said, “These unknown unknowns tend to be the difficult ones.”
Earlier this week, Andrea Black who runs the excellent blog “Let’s Talk About Tax” went drinking with some young people. Actually, she was there to advise a group of hospitality workers who had been caught out as a result of Wagamama going into receivership. And the issue they were talking about is what’s called wage theft in the hospitality industry.
This is where the company, an employer, goes bust owing employees thousands of dollars in unpaid wages and salaries. There is often also a lot of unpaid pay as you earn floating around. There are several issues here. First and foremost, the employees have been left out of pocket and so they want to know what’s going on and when they can recover that. Then the tax man is very much often out of pocket. It often emerges that pay as you earn has been unpaid for several months an issue which I’ve seen this, and which Andrea talks about it as well.
You do wonder how quickly Inland Revenue reacts to this. Now I do hope that one of the things that will come out of Inland Revenue’s business transformation is much swifter responses to issues where pay as you earn falls into arears. My experience is Inland Revenue has let this go on for far too long. I’ve come across instances where there had been unpaid pay as you earn for going on for four years, which is just an absurd position. Someone there is either deliberately playing the system, in which case they should be hit with the full force of the law or is so hopelessly incompetent they should have been put out of their misery long ago.
Now the other thing that also comes into play for the employees is the unpaid employer KiwiSaver contribution and this adds up to quite a bit. Back in 2016 I spoke to Radio New Zealand about this matter.
At that time there was over $29 million dollars in outstanding KiwiSaver payments. In June 2015 1,663 employers had failed to pass on 15.3 million dollars in KiwiSaver payments deducted from employee’s salaries. Employees are missing out on this and on the employer contributions and it’s a real issue within the industry. Andrea asks whether the Small Business Council looked at this issue. We’ve delivered our report to the Minister and what I can say this matter did come into discussion during our deliberations.
One other thing on this. There is a tax bill just going through Parliament at the moment, the Taxation (KiwiSaver Student Loans and Remedial Matters) Bill.
It covers a number of matters. One is the question that we talked about previously about people with the incorrect prescribed investor rate. There’s also provisions making it easy for Inland Revenue to collect unpaid employer contributions in relation to KiwiSaver and ensuring employers pass on the employee contribution to Inland Revenue.
Hopefully employees will get the investment returns they’re missing out on because they haven’t been paid or the deductions and employer contributions haven’t yet hit their KiwiSaver account. By the way, submissions on that bill close on Monday so you’ve still got a chance to make a submission in support of that or raising other issues.
Finally, National have released their tax policy for next year. A number of things they are promising include tax cuts. Particularly they’re proposing something which I think is long overdue, and that is indexing tax thresholds. I think this is one of those quite sneaky tax increases that causes bracket creep and pushes people up into higher tax brackets gradually and it’s something which is effectively a tax increase by stealth. I think in the interest of transparency it’s a good move.
There’s a number of interesting other matters they want to deal with. That said, I’m not entirely sure if you are not a homeowner or rental investor and you’re trying to get into the investment property or to rent a property you’d appreciate what they’re proposing. They want to dial back the bright line test for residential property from five years to two years and remove loss ring fencing, which is a big break for tax investors.
That brought a fairly forthright denunciation from Jenée Tibshraeny. She also was less than impressed by the idea of removing the inflation component of interest. It’s an arcane point which has been talked about for some time which although it sounds arcane it is actually quite important.
Anyway, that will be the first shots fired in next year’s election about tax policy. All eyes will be on what the coalition will do in next year’s Budget. Given that tax thresholds haven’t been raised for more than 10 years by that time it’s hard to imagine that they wouldn’t try and do something, particularly when they’re running a surplus. I mean, cynical tax cutting budgets are not just the preserve of right wing governments. But we shall wait and see.
