- The unintended consequences of the interest limitation proposals
- A coming clampdown on the fringe benefit tax rules around twin cab utes
- Inland Revenue updates its advice on non-cash dividends
Having pored over the 143-page discussion document on the interest limitation proposals for the last few weeks and discussed them with colleagues, the summary position I’ve reached is that the Government should be very mindful that there will be some unintended consequences, and it should therefore be prepared to fine tune its proposals.
In particular, two issues seem to be emerging. One is that the interest limitation rules and the proposals to allow an interest incurred in relation to new bills, may mean that the trend which was causing concern of first home buyers being squeezed out in favour of developers and investors with access to plenty of assets and therefore leverage, is probably going to accelerate.
Developers and investors are able to outbid first home buyers for vacant plots of land or buildings where a single home might exist now but has potential for it to be converted into two, three or more dwellings. Given that under the new build proposals, interest deductions will continue to be allowed for building additional dwellings the likelihood of first home buyers being able to buy vacant land, put a building on it and move in is likely to be diminished. They’re simply going to be outbid by those who have access to greater access to finance. And I think that trend will be accentuated by these proposals.
That probably is not an intended consequence, but as in taxes everywhere, unintended consequences are often in play and the housing market is probably one where the unintended consequences of decisions taken 30 or more years ago have now come home to roost with a vengeance.
And the other unintended consequence I believe is going to come about, is that the burden of these proposed changes will fall on a group that aren’t really its target. And they also happened to be the least equipped to manage the level of detail and compliance that will be expected. And this group here are the is the so-called mum and dad investors, people who have one, maybe two investment properties which represents their retirement fund.
This is a group of people who are not really in the Government’s target, they’re not the larger investors who are able to have been able to leverage up significantly and outbid first home buyers. These are people that have decided to purchase investment property for their retirement. Or it may be that a couple have formed a relationship and they’ve moved into one property and rented out the other property,
Whatever their circumstances, this is a group that’s going to face a significant amount of compliance going forward, and for very little reward for the Government I would add, either politically or in terms of actually improving the housing market.
It seems to me the Government ought to think seriously about an exemption for such a group. Maybe to say that holders of one investment property are exempt or the rules only apply above a threshold.
Currently, the average rental income in the country is about $25,500 dollars a year. Maybe if the gross rental income is, say, $30,000 dollars or less the rules won’t apply.
Alternatively, if the Government still wants to remove this tax anomaly of a full interest deduction for a partly untaxed return in the form of capital gains, it could then say only 50% per cent of the interest is deductible. By the way that was something a previous guest John Cantin suggested could be an option. It would be a more straightforward option.
The thing that has been interesting when dealing with the discussion document proposals is that although the concept of denying interest deductions seems straightforward in itself, what has been really revealing is the level of detail we’ve had to work through, particularly in relation to the new build exemption.
The complexity means tax agents like me, other advisers and individuals are now at a greater risk of getting their tax returns wrong – for example incorrectly calculating the proportion of interest that’s deductible. Greater complexity means a greater likelihood of something happening and a client suing for negligence. It could be that professional indemnity insurance premium premiums rise as a consequence.
But anyway, both advisers and those affected by this would want to see the Government think hard about making the proposals less onerous from a compliance perspective.
Submissions close on Monday the 12th. As I have said previously, be constructive with your submissions. The Government isn’t going to listen to people moaning that these are terribly unfair. That’s a fact of life. These submissions will be considered by Inland Revenue, and we’ll know more in about four to six weeks when the final form of the proposals is released together with the draft legislation. It’s a tight timeline because all of this is meant to be in place by 1st October.
Fringe benefit tax
Moving on, the issue of twin-cab utes and FBT is back in the press with Minister of Revenue, David Parker, saying he was considering a clampdown on the fringe benefit tax rules. He has apparently received advice on how twin-cab utes were being taxed and he has confirmed that he was considering acting on it.
Inland Revenue advice was that there is no exemption to twin cabs, which I’ve previously discussed. And that’s correct, even though there’s a popular belief there was one. What Inland Revenue believes is that the existing rules aren’t being properly enforced, which is also my conclusion.
The astonishing thing, though, is that Inland Revenue went on to say it wasn’t so keen on chasing down this matter because it wouldn’t bring in much money. David Parker said, quote, “Inland Revenue advised me that it’s not as big an issue relative to other enforcement priorities. But we’re having a look at the issue because they are proliferating.”
There are two points to be made about this. Firstly, Inland Revenue has a duty under section 6 of the Tax Administration Act 1994 “to protect the integrity of the tax system.” including people’s perception of the integrity of the tax system.
So a public statement making it known that it really didn’t feel that this was a big issue sends completely the wrong message about enforcement for myself and other tax advisors and those conscientious taxpayers, the vast majority of which want to follow the rules. Inland Revenue basically saying,” Well, we’re not really bothered about this”. In the context of an $85-billion annual tax take saying an extra $100 million a year isn’t that significant may be true, but it does nothing for the integrity of the tax system to say so.
The other thing in here which David Parker has picked up on – he is also the Minister for the Environment – is that the climate change policies are undermined by not enforcing rules around twin-cab utes. These are high emitting vehicles and the Productivity Commission noted we are importing higher emission vehicles relative to what’s available in the rest of the world. In other words, New Zealand has become a bit of a dumping ground.
And so if we’re tackling emissions, reducing emissions is an ongoing job and in that context, not enforcing the FBT rules makes that job harder. Transport emissions are one area where New Zealand can make progress in reducing its emissions. Leaving aside the issues around reducing methane emissions from our agricultural sector, we can certainly do more in improving emissions from the transport sector.
So it will be interesting to see how this plays out. Inland Revenue I think will be upping the ante on this. Get any group of tax advisors together and we’ll all have stories about some of the abuses we’ve seen. Like Inland Revenue previously photographing or sending someone to watch popular boat ramps and boats being launched at the weekend, just to see whether a purported company vehicle was being used in a private capacity. Apparently one such boat launching ramp in Gisborne was opposite the Inland Revenue office and one company after a few weeks got a call from Inland Revenue asking if they were, in fact, correctly reporting FBT.
Transfers as ‘dividends’
Moving on, Inland Revenue has this week released a number of Interpretation Statements which give its view of how the law operates. One that people should pay particular attention to is Interpretation Statement 21/05 on non-cash dividends. Now, what this does is consider when a transfer of value from a company to a shareholder is treated as a dividend for tax purposes. These are sometimes also referred to as the deemed dividend rules.
The Interpretation Statement wisely, in my view, focuses on the type of non-cash transactions that are often entered into between small and medium companies and their shareholders. Now, sometimes FBT picks up some of these issues, but other times they don’t. A common example of a non-cash dividend would be a loan from a company to a shareholder.
So what the interpretation statement does is set out a number of examples of how these rules might work. For example, there’s a banana company which provides one of its shareholders with a large number of fresh bananas. That is a dividend. Another example would be the shareholder owes the company money and the company forgives the debt. That’s another as a dividend or a telecommunications company provides one of its shareholders with telecommunication services for free.
The interpretation statement works through various scenarios like this and clarifies which are dividends together with the rules for calculating the dividend and when the dividend is deemed to have been paid.
It’s actually a very valuable document. It’s also quite astonishing to realise it is in fact an update of a previous item on deemed dividends which dates from March 1984. I know Inland Revenue has got a lot on its plate, but it is a bit of a surprise to see it taking 37 years to update this sort of matter.
Anyway, the interpretation statement is out there. So people should be more aware of this deemed dividend issue. It obviously indicates that this is one of the areas Inland Revenue is looking at. They have, in fact, been quite interested in the area of shareholder advances, that is loans from the company to shareholders for some time. So this Interpretation Statement should serve as a warning.
Well, that’s it for today. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next week ka kite āno!
Terry Baucher and John Cantin explore that and other thorny tax issues, and the side-lining of our internationally respected tax consultation process
Kia ora koutou katoa, it’s Friday, 30th of April 2021 and welcome to The Week In Tax. I’m Terry Baucher Taxpert and director of Baucher Consulting Ltd., a tax consultancy helping individuals, small businesses and professionals navigate the tax minefield.
My guest this week is John Cantin, a vastly experienced tax partner with KPMG, who probably is one of New Zealand’s leading tax gurus. John has written one of the most astute analysis of the Government’s recent proposal to limit interest deductions that I’ve seen. I recommend you read it because it cuts right through the emotion and gets to the heart of the issue.
Here’s the opening to his post.
“The Government’s decision to deny interest deductions to residential landlords has generated much heat. A particular focus has been its labelling as “closing a loophole”.
Quite clearly current law says interest is deductible for property investors who derive taxable income. (One Twitter commentator quotes the relevant section of the Act). At a technical level, interest deductions are not a loophole.
However, the outrage misses the point.
Simply, (most) voters see a residential landlord deducting interest and making non-taxable gains. In the language of politics, that is a loophole.
“Loophole” is shorthand to describe the policy problem. Voters understand it at this level. (Equally, in the same property context, “Mum and Dad investors” and “speculators” is the language of politics and not tax policy).”
Morena John, thank you for joining us.
Thank you for those kind words of introduction, I appreciate it very much.
Not a problem, John, really appreciate you joining us. So what is the policy problem?
The policy problem in a nutshell is how do you deal with dual purpose expenditure. Money that you send out the door that has two purposes. That’s very much the issue with interest on money borrowed to acquire a residential property.
Now, that’s perfectly encapsulated and this is a long-standing problem, as you mentioned in your post, isn’t it?
It has been around for a long time period. And at a technical level, it’s the difference between use and purpose. So the interest deduction rules ask how have you used the money? Whereas when you’re looking at what’s driving the purpose of the interest, that’s a different question.
Indeed, that’s actually a very nice distinction and a proper one to bring in. And so how much of a surprise to you was the Government’s move on this?
Completely out of the blue in the sense that nothing leaked or anything of that nature ahead of time. No indications, to that extent it’s a surprise. But as you say, this issue has been around for a long time. It goes back to some cases that are referred to in my article called Pacific Rendezvous and others.
If you go back to the late 90s, it was also a policy problem of what to do with interest deductibility because of moves by Inland Revenue to state what they thought the law was at the time, which were going to cause practical compliance problems for companies and others. So it does keep raising its head. And you think back to the Muldoon era interest limitation rules and the recovery rules back in the day and in the 80s, it has been around for a long time.
You mentioned the Pacific Rendezvous case, the Court of Appeal decision from 1986. What actually happened in that case?
Relatively simply, it was, if I remember correctly, a motel Terry, and the owners had decided that they wanted to sell the property, but needed to do some, let’s call it refurbishment, redevelopment. They borrowed money, which was helping to let them do that. And they claimed all of the interest because it was used in operating the motel.
Inland Revenue said, well, actually, some of that interest relates to the sale, and you shouldn’t get a deduction for the whole lot. Court of Appeals said it’s all used in running the business, so it’s 100% deductible. So that’s where our use versus purpose question comes in. 100% use means 100% deductible, even if it will have a slightly different outcome as well or serve a different outcome.
That decision in 1986 was right in the middle of the major tax reforms being led by Roger Douglas and Trevor de Cleene. Looking back it seems to me that with all the work going on around that time, it was a very, very clear expectation that the reforms would lead to some form of comprehensive capital taxation, capital gains tax. Call it what you want. Against that background, the Pacific Rendezvouss decision seemed quite logical because it might have been playing in the background of the Court.
But after March 1990, when David Caygill, then Finance Minister, pulled the pin on capital gains tax proposal, that decision reinforced and put in place an anomalous treatment, or loophole which sooner or later would need to be addressed. Would that be a fair assumption of how we’ve got to this position?
I think that the technical response is that the Court made a decision based on use rather than purpose. The Commissioner’s argument wasn’t entirely surprising because the interest deduction is to the extent it’s used, so that that suggests some sort of apportionment.
I’m not sure that the courts actually had in mind that there might be a law change. With the greatest respect, I think, Terry, you might say that our courts are not great tax policy makers. You know, I’ve spent too much time on the Commissioner’s draft update on section BG 1 recently. And they’ve taken 100 odd pages to try and interpret what the Supreme Court said in the Ben Nevis decision. So I’m not sure that our courts are great at tax policy.
Occasionally they will point out errors in the legislation and things that might need to be fixed, but I don’t think they make decisions based on what the policy ought to be. But you’re absolutely right, that context of what was happening in the late 80s and The Consultative Document on the Taxation of Income from Capital, a comprehensive capital gains tax was the direction of travel amongst all of those reforms.
And that would certainly reduce the tension between use and purpose, because ultimately whether it was used in the business or used in the business and seeking a capital gain, well then it didn’t matter. You got a deduction for it – it would have made no difference.
But it hasn’t really been revisited as a particular issue specifically, except for the residential loss ring-fencing, that has the effect of limiting interest deductions, although not just interest, of course. So, some of those measures can be seen as responses to that.
Yes, and that sort of use and purpose is coming back a little bit in these announced changes although we haven’t got much detail to work with at the moment. But there was a hint that if a property was sold, which was subject to tax under either the Bright-line test or some other measure then interest deductions previously denied would become deductible. That seemed to be hinted at in the initial papers released on 23rd March. But that’s also something that’s going to be under consultation, so we’ll see shortly.
I suppose that leads us into this move by the Government which doesn’t really sit well within the Generic Tax Policy Process in that normally there would be a process of consultation, saying we’re thinking about doing this, what are your thoughts and feedback? And then the legislation works through issues papers and then into legislation. But that’s all been shortcutted.
Is that a concern for the Generic Tax Policy Process (GTPP) in general, or is it now dead or merely resting, to borrow a phrase?
Really big questions, Terry. Look, I sort of go back to where the GTPP started in the mid-90s out of Sir Ivor Richardson’s review of Inland Revenue. And a significant driver for that was the reaction to the entertainment tax, amongst others, introduced in the early 90s. That was a National Government changing the business tax rules. And many of its supporters were particularly unhappy about that change even though I suspect something was in the ether.
Richardson recommended the GTPP and I think ministers since have seized on that as a way of depoliticising tax policy, they find it useful to test their thinking. And occasionally they walk back from some of the rules.
But I think we need to remember that the GTPP is essentially political, that relies on the goodwill of ministers, officials and people like you and I actually contributing. I’m reluctant to say it’s either dead or merely resting because the GTPP serves to answer two questions. One is, is this the right tax policy and the second is how best to do it. And that call as to what you consult on will be made by different Governments at different times, in different phases so far.
For example, if I remember correctly, when the GST rate was increased to 15%, there was no consultation on that increase – the first question wasn’t asked. The second question about how best to do it was, and that was what was consulted on. I suspect in this case, asking the first question, the call was made. We’re just going to get a whole lot of people saying, no, don’t do it.
And that’s not really going to advance the process at all. I would have liked to have seen some consultation, because I don’t think 100% denial of a deduction is the right answer either. But we’re in that process now where the detail will be consulted on.
So you have an ability to answer the second question, how best to do it, does it actually meet the policy objective and can it be done better? So I don’t think it’s dead or resting. I think different ministers, different Governments make calls on which of those two questions they want to ask the question of. I have said to others I haven’t stood for any election at all and I doubt I’d get a vote, but those are the people that we voted in to make those calls. So you do have to sort of step back and say, well, that’s their call. They live or die by that every three years. That’s the call they make. And we need to just carry on with it.
That’s a great point you made there, John. About the GTPP you referenced the increase in the GST rate. I think at the same time they that they withdrew depreciation on buildings completely, and repealed the loss attributing qualifying regime. And we got no consultation on either of those points as well. And that was the National Government. So both sides will do it and as you say, politics, that their job depends on it. They will have to make political calls and we basically have to suck it up, putting it crudely, that’s just a fact of life.
It’s a fact of life. I do remember, though, that with those changes to GST and depreciation, LAQCs, there was the Tax Working Group led by Bob Buckle sitting in the background.
So, all of those things were not entirely unpredictable. And there was some measure of floating of those ideas through that tax working group’s report. So, some of that stuff was in the in the ether, as I call it. It wasn’t entirely unpredictable, but decisions are always made politically, often for budget measures where budget secrecy says we’re just going to make a call.
Actually, I must admit, when I started my career in Britain where budget surprises were very frequent, I’ll be honest, sometimes it’s nice to have a wee surprise in the budget, even if you’re scrambling around trying to sort it out afterwards. “What does this mean? Well, we’ll have to tell you.”
There was one thing about the announcement that did surprise me. There was a lack of detail supporting the fiscal costs of the interest deduction measure. That surprised me because landlords are meant to file disclosure forms an IR3R return which has a specific interest disclosure item. What was your view on that?
I think initially surprising. I think part of it suggests that this was, I won’t say necessarily hurried, but a decision that the lead time on was not particularly long. So, not unsurprising in that sense.
But when you do think about it, one of the risks with any estimate here is the final design is unknown at the time of the announcement. There will be discussions on what is a new build, there will be consultation on how you apportion between business and residential property borrowings. There will be rules around interest stacking, as they call it, for companies and other entities or shareholders and other entities.
So, the whole picture potentially is a little muddied, and I think one of the risks is you come out and say, well, it’s worth $600 million, and then when you design it, it’s worth $200 million. That criticism always seems to be played that you got the numbers wrong. So, it might have been better to just say, well, until we’ve got the design sorted, we can’t really tell you how much, I think is probably the real answer here in terms of what’s happening.
It’s as you’re saying, we don’t know how the final form will emerge and all those good questions about what a new bill, what’s the split between business and residential? I mean, what do you think would have been an appropriate policy response in this context?
I’m a Libra Terry, so I’d have gone straight down the middle 50/50.
That’s a fair working hypothesis. When the announcement was made, I referenced what had happened in the U.K. But this goes further than the U.K. because the U.K. basically restricted the interest deduction to a basic rate of tax, 19%. But what’s proposed here is much more punitive.
I think that that speaks to the difference in the approaches to the tax system. The U.K. does what I call buckets, you know, separates business from other income. You have different tax rules for different streams of income. New Zealanders for a long time simply said it all goes into your taxable income, the expenses are deductible and it’s all one marginal rate. So, I think those are the differences.
The thinking here is quite different in the sense that it doesn’t look at it necessarily in isolation. It all feeds into the one taxable income number with one tax rate at the end, or marginal tax rate. So, I think that’s the driver.
But I think it’s important that you get the base right in the first place, making sure that you are taxing what ought to be taxed, and that’s a fair reflection of what the income is. So, if you go back to the repeal of building depreciation, I’m not sure that anyone was convinced there was no depreciation at all, apart from some officials in Treasury and Inland Revenue back in the day. They have now retreated from that. But again, we keep working on those base measures to make sure that people are paying tax on what really is income.
That depreciation measure always struck me as a bit strange because the Bob Buckle group did say it was debatable whether it’s proper for residential property, but certainly for commercial property it should be in place.
In relation to the extended bright-line test period, this references a little bit to your point about how the UK approaches taxation, how appropriate is it that gains are taxed at a person’s marginal rate? Should it be a different rate maybe or maybe a person’s average rate over the period the property has been held?
I’ll probably come at that with having listened to officials for too long Terry, is from a framework of this is all income, what you’re really saying is that gain has been accruing over the number of years that you’ve held the property. An economist will say, well, it’s income and should be taxed on an unrealised basis. So, by waiting until you sell it, the Government misses out on the tax it should have collected through all of the years that you held it.
If you sold it year nine, that’s eight years’ worth of gain tax hasn’t been paid on. So if you were to average the rates, then you should probably add an interest factor to that as well to compensate the Government for not having been paid earlier. I know that’s an odd concept because, you know, I haven’t got the income, so why should I pay the tax. But that’s the economist’s view of how income accrues.
Then you start getting into the complications of saying what should the interest rate be and what should the average rate be over those years? From a simplistic perspective, you simply go with the rate that applies in the year the gain is realised.
And of course, the Bright-line test is not the only time we do that. You know, if you happen to get a big bonus in a year that’s out of the ordinary, you still get taxed on that at your marginal rate in that year that you get the bonus. So, it is just one of those features of our system.
It was actually reading about an ACC claim that had been denied and then she got a lump sum payment, which was then taxed at rates well above what would have been her normal rate, that prompted me to ask that question. That’s always struck me as an anomalous treatment in that context. But as you say, it’s built it into the system and that’s the way it stands.
Sometimes we should ask the questions of whether that should be the answer. And it sort of comes back to the article Terry. I think the loophole language is unfortunate and the defence of it in the sense that you can claim the interest deduction I don’t think answers the question because the question is, should you have that interest deduction even though the current law says you can?
And I think you should always be asking the question, albeit you can’t ask it every time of all the thousand odd sections that we have. Is it still the right answer? And as the world changes our answer might change as well.
Well, that seems a very good place to leave it John. I really appreciate you coming on and talking with me. Thank you for being our guest and have a great day.
Thanks very much, Terry. Appreciate it.
That’s it for today. I’m Terry Baucher. And you can find this podcast on my website, website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients until next week, ka kite āno.
- This week more on the state of Inland Revenue’s Business Transformation programme
- Grant Robertson’s warning to property speculators
- Inland Revenue’s latest view on tax avoidance.
Inland Revenue for the past five years has been involved in a huge upgrade of its capabilities, what it calls its Business Transformation project. This has been described by Treasury as “complex, high risk and fiscally significant”. The budget for the project is $1.8 billion and it’s now into its final stages with the expectation that it will all be complete by early 2022.
Given the sheer scale of the project, Inland Revenue has been monitored very closely on its progress by Treasury and it also has to provide regular reports to Cabinet.
The transformation status update for October and November 2020 has been published, and it makes for interesting reading.
The status of the programme is said to be light amber overall, which means that there are minor issues in some areas that can be resolved at the programme level.
What would be encouraging to Cabinet is that the project as of 30 June 2020, is $120 million dollars under budget. The cumulative spend to 30 June 2020 is $1,122 million and Stage Four, which is expected to be completed next year, is expected to cost a further $296.5 million.
IT projects will always attract a fair amount of criticism because they can and do overrun on costs substantially. It’s perhaps an unfair comparison, but it was interesting to see this morning that the costs to date of the Covid-19 tracer app have been estimated to be $6.4 million so far. Now in fairness, the Covid-19 tracer app involves a significantly smaller scale of complexity than designing a system that’s going to manage the tax affairs of six, seven or eight million taxpayers and has $80 billion plus running through it each year.
But at this stage, it would be fair to say that Inland Revenue seems pleased with the project’s progress so far given its budget and expectations. Although the latest update does state, “The temptation to overstretch Inland Revenue capability should be resisted until Business Transformation is closed.” In other words, we can do a lot more now, but don’t be expecting us to do heaps more straight away.
But the more interesting document released at the same time was the Programme Business Case Addendum on Business Transformation.
What makes this particularly interesting is it gives more detail about what’s been happening and sets out more reasons why the project is needed and the economic benefits for the Government.
These programme business cases are prepared annually, the previous one was prepared in October 2019 and this one in October 2020. The most significant update is to the economic case. The commercial and management cases have also been updated, but no changes have been made to either strategic or financial cases for the project.
Digging into the document, you get an idea of Inland Revenue’s improved capabilities. It talks, for example, at some length about how it responded to the implementation of the Small Business Cash-Flow scheme. The scheme went live at one minute after midnight on 12th May 2020. Now it was 39 working days after the initial decision to begin some work, and then was just 10 working days from when the Government confirmed its intention on April 25th to when the scheme was launched.
In its first five to 10 minutes, it received 43 applications and by 1.20 AM, i.e. just a little bit more than an hour or so after it was launched, it had already received 600 applications. As of 9th October 2020, Inland Revenue had received 104,000 applications and approved $1.6 billion in loans. As I’ve said before and am happy to say again, the Small Business Cash Flow Scheme is a very successful scheme and Inland Revenue do deserve a lot of credit for getting this up and running so quickly.
There’s a few wee snippets of things in the system that will need to be improved. The tax system overall. For example, you may remember that back in 2019 it emerged that a considerable number of people – 1.5 million in total – had the incorrect prescribed investor rate. Now, Inland Revenue got onto this and sent out 1.5 million letters saying, “Hey, you’ve got the wrong rate, either too low or too high so you need to contact your KiwiSaver provider to change it”, but only 15 per cent did so.
Fortunately, the law has been changed so that overpaid tax can now be credited, whereas previously if you’d overpaid under the prescribed investor rate regime, you lost it. So, that’s a good result.
But more importantly, and picking up a point I made last week, that the Inland Revenue tax policy work programme includes a look what is going on with charities – the donations tax credits process has been revamped. For the year to 31 March 2020, Inland Revenue identified 31,000 claims worth $23 million that were either an error or fraud in its view. And of that, 3,000 claims totalling $4.1 million were referred to audit teams to investigate.
So Inland Revenue’s ability to pick up and identify errors earlier and respond more quickly has been enhanced as a result of Business Transformation. Again, what you would hope to see and so far, so good.
The document sets out what Inland Revenue sees as the main benefit areas for the Government and who it calls “customers.” (In this document, customers are referred to 32 times and taxpayers just once). The main benefits are that it’s going to be easier for taxpayers, and the revenue system is much more resilient. You do wonder what could have happened to the old system given its state if a determined hacker had had a go. The Government now has greater ability to implement policy and that’s very significant.
And then it gets into more nonmonetary and monetary benefits which is where it gets particularly interesting. It says the compliance effort has been reduced for small to medium sized businesses. Now, the methodology here is a little outdated. Inland Revenue hasn’t run an up to date survey, but it does estimate that the median time SMEs spent on meeting their tax obligations was 36 hours back in 2013. It’s expecting that Business Transformation will reduce that by 10 to 26 hours a year. And the cumulative value of the time saved will be over $1.3 billion dollars. It will run a new survey on this later this year.
The big expectation is that the amount of assessed crown revenue will increase $2.8 billion 30 June 2024. And that’s a result of the efficiencies brought into the system, allowing earlier identification of non-compliance as well as easier compliance.
So far, Inland Revenue estimates that to 30 June 2020 it has achieved $280 million of that $2.8 billion. This means over the next four financial years to 30 June 2024 it expects to achieve nearly $2.6 billion dollars of additional revenue. In the year that ends on 30 June this year there will be another $290 million found. Then it substantially jumps up over the next three years with $600 million in the year to June 2022, $750 million in the year to June 2023 and almost one billion dollars in the year to June 2024. That’s a fairly significant amount of money coming in over the next three or four years, which Grant Robertson will be very grateful about. So Inland Revenue has made a rod for its own back, if you like, in terms of these ambitious additional tax revenue it expects.
Now, the other big benefit, and this is a source of some controversy when I spoke about before Christmas, is the cumulative administrative savings Inland Revenue expects to deliver. By June 2024 these are supposed to amount to $495 million.
Now, as of the date of this report, it’s ahead of target, having achieved savings of $118 million compared to the target of $95 million. But it fell short by some $23 million of its target of $80 million for the year to June 2020. Inland Revenue is therefore hoping to save a further $370 million in the next four financial years, so the pressure will be on in that regard. So again, you can expect the Government and ourselves to be paying particular attention to how that is progressing.
But there’s one controversy about Business Transformation that I think’s important. The whole project cost has been enormous. And one of the concerns I would have about this is that New Zealand businesses – that is New Zealand owned businesses – have by and large not had a great deal of input into this. According to this report, about where it is spent between July 2014 and 2020 and where Inland Revenue spent more than $500,000 on contractors and consultants providing services across Business Transformation the total percentage spend on New Zealand companies was 36%.
(The contract, by the way, was awarded to a company called FAST based in the United States and Accenture Consulting, another multinational also provided assistance).
Now, if you include companies/contractors resident for tax purposes in New Zealand, then the total New Zealand percentage spend rises to 73%. In other words, although the Government has passed money through Inland Revenue to a business which is overseas owned, that income, by and large, will be taxed in New Zealand. To give you some idea of just how much might be involved according to Inland Revenue’s June 2020 annual report the total spend for contractors and consultants was just under $183 million.
That’s down, by the way, from $206 million dollars in the June 2019 year.
Now just picking up a point from my time on the Small Business Council, this is an area where we saw a lot of frustration from small businesses. They felt they could not get through to deliver services to the Government because of what they saw as excessive gatekeeping and bureaucracy involved in the industry.
New Zealand has a great IT industry just picking up and getting that point about the Covid-19 app that cost $6.4 million which is absolute peanuts. Apparently in Britain, they’ve spent £10 million on one app which was abandoned and do not appear to have anything that works as efficiently as our app. So, the capability is here.
And I feel that there was a great missed opportunity with Business Transformation. Hopefully going forward the percentage of New Zealand businesses that do get involved with the tail end of this work or new work as it arises, will be increased.
But the overall state you can take from this report is Inland Revenue considers Business Transformation is moving in the right direction. We’ll need to pay attention to whether it will achieve its ambitious goals. But certainly, it feels it has the tools available to achieve what the Government will want, that is additional tax revenue to pay down the massive debt that’s been run up because of Covid-19 and no doubt the huge spend going forward for maintaining our infrastructure and health services, as well as regular costs such as superannuation and education.
Robertson on property speculation
Moving on, the Finance Minister Grant Robertson made a speech to the BNZ on Tuesday, about the forthcoming Budget Policy Statement. In the course of his speech he said,
But we can do more or more to manage demand, particularly from those who are speculating New Zealanders are seeing family members being crowded out of the opportunity to purchase a home of their own by speculators and investors.
The housing boom and the resulting pressure on the rental market and vastly increased prices is a concern to the Government as it is getting shot at from all sides. So clearly, this statement from Grant Robertson was a reminder that Inland Revenue does have the tools, which I’ve just explained, it feels it can do a lot more to look into the speculators.
And that leads on to the inevitable discussion of the bright-line test, which to quickly recap applies when any residential property is sold within five years of acquisition. The sale will be taxed unless an exemption applies.
Now, the bright-line test is one of a number of other property taxation clauses within the Income Tax Act. There is Section CB 6 which taxes property bought with an intention or purpose of sale. The problem with the tax laws around the taxation of property is the absence of a comprehensive capital gains tax. There’s a lot of subjective clauses involved. The bright line test is very largely unique in that it very specifically says if this happens, then it’s taxable subject to exemptions.
On the other hand, section CB 6, which I just mentioned, talks about purpose or intent. There’s also section CB 12 which taxes a subdivision which involves work not of a minor nature.
And so, of course, you’ve got these subjective phrases. And just to compound those issues is that when you drill into these sections, sometimes they will apply if that particular activity happens within 10 years of acquisition, but maybe within 10 years of a building being completed, the timeline isn’t always the same.
And the exemptions that may be available because it’s a residence or business premises for example, vary as to who can use them. For example, there are four possible exemptions available to someone who’s taxable under section CB 12, which is a subdivision which is not of a minor nature. But two of those exemptions don’t apply if the person involved is a trust.
And so these inconsistencies and details around the varying times of which rules may apply and when give plenty work for people like myself. But notwithstanding that, they also point to the need for a complete rethink of those rules to bring clarification and some form of internal consistency. Why should one exemption apply to a property owned by a trust, but another exemption not? You would expect it to be consistent across the board. Now that it so happens that Inland Revenue does have such a project on its on its policy work programme. So, we can expect to see something maybe later this year or early next year.
Updating Inland Revenue’s view on what is tax avoidance
And finally, with the increase in the tax rate to 39% coming up, it’s timely to consider the implications of trying to take steps to mitigate that. The Income Tax Act has a number of tax avoidance provisions which Inland Revenue can apply. Sections BG 1 is the general anti avoidance provision and for those with very long memories who may recall the Penny Hooper case, involving a couple of surgeons, this was the provision applied.
Inland Revenue has got an Interpretation Statement on anti-avoidance but it was issued in 2005. It has now released an updated version for consultation.
And that update came with a five page information sheet, which when something like this comes with an information sheet, you know you’re in for some particularly dense reading.
There’s too much to cover right now so I’ll pick it up at a later podcast when we have had a chance to consider it closely. But this is a reminder that the temptation will be to start making plans to mitigate the impact of the 39% rate. But you need to be aware of Inland Revenue’s possible response. I’d therefore recommend every tax advisor has a close look at what this new draft interpretation statement is saying.
Well, on that happy note, that’s it for this week. Thank you for listening. I’m Terry Baucher you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Please send me your feedback and tell your friends and clients. Until next week, ka kite āno.