How to fund the rising cost of superannuation.

How to fund the rising cost of superannuation.

  • Deduction notices
  • Inland Revenue’s audit activity

Last week I joined Gareth Vaughan of interest.co.nz for a joint podcast with Andrew Coleman. He’s a New Zealand economist who has worked in academia and for the government, including Reserve Bank, Treasury and the Productivity Commission. In the last few months, he’s written a 13 part series for Interest looking at how we currently fund New Zealand Superannuation and what alternatives we should be considering.

Why we’re talking about more tax – the rising cost of New Zealand Superannuation

As I’ve mentioned previously, part of what’s driving the debate around whether New Zealand should have a capital gains tax is when you consider the government’s long term fiscal position, the conclusion you reach is that something radical will have to happen: either benefits will have to be reduced significantly, or taxes will have to be increased. If we’re increasing taxes, how are we going to go about that? That, by the way, is the subject of Inland Revenue’s long-term insights briefing consultation on which is going on at the moment.

(He Tirohanga Mokopuna 2021, Treasury)

Coleman has written extensively about the issue of funding New Zealand Superannuation and in the podcast he went through the issues behind why he wrote the series and what alternatives he proposes. It was very informative, and I highly recommend listening to the full podcast. Here are a few key takeaways.

New Zealand’s unique approach to funding superannuation

Firstly, the way New Zealand currently funds New Zealand Superannuation is very unique in that it is entirely funded out of current taxation. That means the current cost of New Zealand Superannuation, over $20 billion a year before tax, is being paid out of current taxation. This is unusual by world standards, because most other countries in the OECD adopt some form of Social Security tax to pay for their public superannuation. In Britain they have National Insurance Contributions, in America, they have Social Security. Throughout most of the EU you will see Social Security taxes in place.  Apart from us, only Denmark in the OECD has no Social Security taxes. Other countries use social security taxes to pre-fund superannuation; people pay social security taxes which are then drawn down when they reach retirement age. We fund everything out of current taxation.

Allied to that, and a matter that makes our tax system unique, is that most other jurisdictions operate what’s called an exempt, exempt tax (EET) approach to private retirement savings. That is a person gets some form of tax deduction for making a contribution to a private superannuation savings scheme. The superannuation schemes are not taxed, but when you withdraw funds on retirement age you pay tax at that point. On the other hand, since 1989 we have adopted the complete opposite approach (TTE). We don’t give a deduction for contributions to superannuation schemes such as Kiwisaver, which are subject to the ordinary rules. However, withdrawals are tax exempt.

Point of order Prime Minister…

Just as an aside, I note that one of the Prime Minister’s comebacks to questions around capital gains tax was that if introduced it would apply to KiwiSaver. (Actually, when the last Tax Working Group proposed a CGT, they didn’t actually seem to think to go there). The PM’s comment glossed over the fact that KiwiSaver funds are subject to tax. If they’ve invested in bonds, these are subject to the foreign financial arrangement regime. If they’ve invested in overseas stocks, those are taxed under the Foreign Investment Fund which because the 5% fair dividend rate automatically applies, is a quasi-wealth tax.

Time for social security taxes?

That point of order aside, Coleman’s key point remains that our treatment of private superannuation schemes and funding of public superannuation is quite unique by world standards. So how are we going to meet the growing cost of superannuation? He suggested that maybe we should look seriously at Social Security taxes.

A Capital Gains Tax won’t be enough

Gareth and I raised the question of alternative taxes, such as a capital gains tax and Coleman made the point that the likely cost of New Zealand Superannuation scheme is going to rise towards somewhere around 8-9% of GDP. Hence the need to be thinking about how to fund that cost. Capital gains taxes don’t generally raise that much, typically, somewhere between one and two percent of GDP. That still leaves a funding gap of between 6-8 percent of GDP. It’s very doubtful a wealth tax, by the way, would make that gap up. In his view, the inexorable conclusion is that Social Security taxes are going to be needed to fill the gap.

How the 1989 changes helped distort the housing market

We also had a very interesting discussion about how the changes in 1989, which by removing the incentives for private savings, drove investment into residential property. He published his research on the matter in 2017, just at the same time that myself and the Honourable Deborah Russell, published Tax and Fairness. Separately we had reached the same conclusion, that the 1989 changes to the savings regime had driven people to start over-investing in housing.

Time for KiwiSaver 2.1

Coleman calls his answer to funding New Zealand Superannuation KiwiSaver 2.1 It would be a compulsory savings regime, but it would be for younger taxpayers, basically those under the age of 40 who were not old enough to vote back in 1997, when a referendum on a question of a compulsory superannuation savings scheme was overwhelmingly rejected.

Coleman’s argument is that younger taxpayers are currently funding what they want and need, such as health, education and transport. But they’re also having to fund the superannuation of older taxpayers, who voted for the current system which benefits them. KiwiSaver 2.1 as a compulsory superannuation savings scheme would be a transition to a fairer system which would include some form of social security tax. The idea would be to be gradually building up savings in a similar way to Australia, which, although it doesn’t have significant social security taxes, does have a compulsory savings scheme. There would be this transitional period, as the older workforce aged out, but all new younger workers would be part of the new KiwiSaver 2.1.

Taxing older, wealthier superannuitants

As part of the transition Coleman sees it requiring more taxes from older persons, which is where our discussion got to talking about capital gains taxes and wealth taxes. He’s not a particularly big fan of wealth taxes. But he sees a capital gains tax having an efficiency aspect to it, which means it should be part of the tax system.

Incidentally, one suggestion I have seen about taxing superannuitants involves applying a separate tax rate to persons receiving New Zealand Superannuation. This would be a way of clawing back payments from those who have other means without going down the route of the deeply unpopular means testing that happened in the early 1990s.

I thoroughly recommend listening to the podcast. Coleman’s analysis highlights the need to keep in context why we’re having this discussion about capital gains and wealth taxes and that’s to do with everyone realising that we have to address the rising cost of funding New Zealand Superannuation and related healthcare costs for the elderly.  These issues are not going to go away because the demographics are inexorable, contrary to what politicians might hope as they repeatedly kick the can down the road.

Tax deduction notices

Moving on, Inland Revenue makes great use of tax deduction notices as a debt collection tool.  These enable it to require a third party to make deductions from payments due to a taxpayer with an outstanding tax liability. The power is contained in section 157 of the Tax Administration Act 1994, or related provisions of the Child Support and Student Loans Acts. I once saw a notice where a supplier to someone with tax debt was told to withhold 100% of any payment that was going to be made to the person in default.

Inland Revenue typically issues thousands of deduction notices each year.

Deduction Notice
issued to:
FYE
30 June 2020
FYE
30 June 2021
Total
Bank5,2227,38812,610
Employer21,33343,53564,868
Total26,55550,92377,479

(Figures obtained under the Official Information Act)

Inland Revenue has just issued a draft standard practice statement providing guidance on how it would use these notices.

I think it’s appropriate Inland Revenue has the power to issue deduction notices. My concern, however, is I’ve seen them issued for under $1,000 of tax debt which in my view is an inappropriate use for what is a fairly small sum of tax debt under $1,000. When a deduction notice is issued to an employer in such circumstances this essentially notifies the employer that the relevant employee is behind on their taxes.

Are these notices breaches of privacy?

In my view, a deduction notice in this situation represents a breach of privacy and employers really do not need to know about relatively small sums of tax debt owed by an employee. Instead, and I will propose this in my submission on the draft, I believe Inland Revenue should make greater use of tailored tax codes to collect the unpaid tax from an employee. The employer still has the responsibility for deducting the tax through PAYE but now all they know is the tax code has changed. They don’t know the reasons why. This preserves the privacy of the person who has been the subject of the tax deduction.

I think this is important. I discussed this issue with a previous Privacy Commissioner, and he was of the view that, yes, it seemed like a breach of privacy. But as he noted, he couldn’t really do much about it because Inland Revenue had the legislative power to issue the notices. Still just because Inland Revenue can doesn’t mean it should, and I think there are opportunities for improving matters. Looking at the UK, it’s common practice for HM Revenue & Customs to use adjusted PAYE codes to collect arrears of tax. Submissions are open until 15th November.

How many anonymous tip-offs does Inland Revenue typically receive each year?

Across the ditch the Australian Tax Office (ATO) revealed this week that in the past five years it has received over 250,000 tip offs about potential tax evasion. According to ATO assistant commissioner Tony Golding “We get on average over 3500 tip-offs a month from people who know or suspect tax evasion or shadow economy behaviour.” The ATO believes there is about A$16 billion in stolen, unpaid tax each year.

By comparison, according to Inland Revenue it receives about 7,000 anonymous tip-offs each year. These are important sources of information even if sometimes the tip-offs are malicious and stem from toxic relationship or business breakdowns or partnership breakdowns. Regardless of this issue Inland Revenue will follow up (the ATO says 90% of tip-offs lead to further investigation.

How many audits is Inland Revenue undertaking?

On the issue of audits and my thanks to regular listener and reader, Robyn Walker of Deloitte for reminding me, Inland Revenue publishes Official Information Act responses and there are often some very interesting releases. One of the latest OIAs relates to the number of audit cases carried out on businesses between 2019 and 2023.

It’s interesting to see the impact of Covid and the quite marked drop-off in audits for those employing fewer than 50 employees.

There’s also data on the number of shortfall penalties applied as a result of audit. Now shortfall penalties enable Inland Revenue to impose penalties of up to 150% of the tax involved where tax evasion has happened although the more common range of penalties is 20%.  Again, the somewhat sparse data makes for interesting reading.

That’s all for this week. Next week, we’ll be taking a deep dive into Inland Revenue with a look at its annual report.

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 please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.

Inland Revenue guidance on the tax implications of the Clean Car Discount

Inland Revenue guidance on the tax implications of the Clean Car Discount

  • Inland Revenue guidance on the tax implications of the Clean Car Discount
  • Latest on Inland Revenue’s audit activity
  • Insights from the OECD’s latest report on Corporate Tax Statistics

Transcript

In the week that the Intergovernmental Panel on Climate Change report declared that climate change is “unequivocally caused by human activities” it is rather opportune of Inland Revenue to release its guidance on the tax implications of the Government’s Clean Car Discount Scheme.

To recap, the Clean Car Discount Scheme has been introduced to make it more affordable to buy low emission vehicles. Between 1st July 2021 and 31st December 2021, a rebate will be paid to the first registered person of an eligible vehicle or to a lessor where that person is a lessee.

Starting 1st January 2022, it’s proposed that the Clean Car Discount will be based on vehicle’s CO2 emissions and vehicles with low or zero or low emissions will qualify for a rebate and those with high emissions will incur a fee (subject to enactment of the relevant legislation).

Now obviously, if you’re in business, you need to be aware of the tax consequences if you receive a rebate or pay a fee under the Clean Car Discount Scheme, or lease a vehicle that comes under the Clean Car Discount Scheme. And obviously the outcome varies depending on what you use a vehicle for.

If you get a rebate under the scheme, you will not have to pay income tax on the rebate. It’ll either be treated as excluded income under the rules for government grants if you’re claiming depreciation on the vehicle or a capital receipt. Conversely, if a fee is paid under the Clean Car Discount Scheme, it will be treated as a capital expense and so no deduction will be available. And that’s obviously going to be something which should be watched carefully.

Now, if you’re using the vehicle in your business, and seeking to claim depreciation, then the base cost for these purposes will be either reduced by any rebate received or increased by the amount of any fee. That’s again something to watch out for.

When it comes on to FBT, and this is going to be quite critical, I would say given that we suspect there’s a fair bit of under compliance in this area, FBT will be payable if the car is made available for private use. FBT will be calculated on the cost of the car when purchased or its value if being leased. The cost will either be reduced by the amount of any rebate or increased by the amount of any fee.

For GST purposes, if you get a rebate under the Clean Car Discount Scheme for a vehicle that you use in your taxable activity, the rebate will be treated as consideration for a deemed supply under the rules relating to government grants. So that means you must the return the GST in your next GST return. Conversely, if a fee is payable, then the GST component of that may be claimed as input tax if you’re carrying on a taxable activity.

Overall, this guidance is useful. Inland Revenue have included some examples as well. As I said, it is quite opportune that it arrived at this time when there’s going to be increasing focus on the question of environmental taxation and the role it may have in enabling us to meet our targets under the Paris Accords.

Tracking Inland Revenue audit activity

Moving on, as I mentioned just now there is a suspicion that there’s perhaps non-compliance with FBT going on at the moment. And so it’s quite interesting to see the latest statistics on Inland Revenue audit activity from Accountancy Insurance.

This is the company that provides insurance against Inland Revenue audits and reviews.

For the period to 31 March 2021, they saw the total number of claims increased by 31% compared with the year ended 31 March 2020. So even though it was in the middle of a pandemic, Inland Revenue is still active in reviewing taxpayers. What is interesting to note here is that GST verification claim activity increased by 48% and that for income tax return related activity increased by 67% over the 12 months to 31 March 2021.

Now, this apparently includes two projects Inland Revenue began last year, the bright-line property rules and also the automatic exchange of financial account information programme relating to the Common Reporting Standards.

GST verification activity actually accounted for 90% or more of all claim values in New Zealand, even though actually only 55% of all claims related to GST verification. So that’s a timely reminder that Inland Revenue is still keeping a watchful eye on matters.

It’s actually a little encouraging to hear that Inland Revenue is still actively reviewing GST returns. I’ve seen one or two instances where I’ve wondered how claims got through including one warranty case going on right now where I am really surprised why Inland Revenue was not onto what was happening much, much sooner.

But the fact is, despite the pandemic and the impact it had on general operations for Inland Revenue last year, GST activity has still been maintained. You have been warned

Interntional benchmarking

The OECD recently released its third edition of its corporate tax statistics. It’s a treasure trove of information relating to corporate tax around the world and with the topics covered and statistics reported being steadily expanded. And there’s some very interesting insights in the report which is based on 2018 numbers.

For that year, the average corporate tax revenue as a share of total tax revenues, was 15.3%. New Zealand was just above that at about 15.5%.

Interestingly, that the percentage of corporate tax revenues has risen since 2000 from an average of 12.3% then to 15.3% in 2018. Similarly, you see a rise in the average corporate tax revenues as a percentage of GDP from 2.7% in the year 2000 to an average of 3.2% in 2018. New Zealand by the by at 5.2%. is well above that average for 2018.

This is an interesting statistic because over that same time period since 2000, the average statutory tax rate has fallen by 8.3 percentage points from 28.3% in year 2000 to 20% in the year 2021. Over that time the rate has fallen in 94 jurisdictions, stayed the same in another 13, but increased in only four jurisdictions. And that supports the argument that was made that lowering the statutory tax rate and broadening the base would lead to higher revenues.

I do think that we probably now plateaued out with tax cuts. I don’t see corporate tax rates continuing to fall. Over in the United States, they’ve signaled that they will rise.

The report drills down into the statistics by considering effective marginal tax rates as well. And that’s where it gets interesting from New Zealand’s perspective, again, because we adopted more thoroughly than most and the broad-based low-rate approach to corporate taxation by stripping away a lot of preferential regimes, our effective marginal tax rate is at just over 20% is amongst the highest in the OECD. Apparently, that is because we have less general fiscal depreciation rules than other most other jurisdictions, although the report notes that we are now more generous after increasing rates in 2020 in the wake of the arrival of the pandemic.

The report also has details of the impact of the implementation of BEPS and statistics relating to anonymised and aggregated country by country reporting although New Zealand doesn’t feature in this part of the report.

But it also has something that I think policymakers here would want to perhaps think hard on, and that is the question of tax incentives for research and development.

What the report notes is that R&D tax incentives are increasingly used to promote business, with 33 of the 37 OECD jurisdictions offering tax relief and R&D expenditure in 2020, compared with just 20 in 2000. New Zealand is one of those countries now doing that.

And perhaps we need to think very hard about that because in the statistics showing what the direct government funding and tax support for business R&D as a percentage of GDP in 2018, New Zealand is way down the list at just over 0.1% of GDP. You see countries like France and Russia at 0.4% and the United Kingdom, Korea and Israel close to 0.3%.

So we are way off the pace here. And it has been noted for some time that we do not invest enough in R&D. It was one of the reasons the R&D tax incentive scheme was introduced. So, as I said, there’s plenty to consider in this report with heaps of detailed appendices that you can trawl through.

Robin Oliver tax policy scholarships

And talking about tax policy, this week the Tax Policy Charitable Trust announced its annual Robin Oliver tax policy scholarships worth $5,000 for students majoring in tax at either Victoria University of Wellington or at the University of Auckland.

And later this year the Tax policy Charitable Trust will be launching its 2021 competition scholarship competition for tax policies. You may recall that we had the 2019 winner, Nigel Jemson, as well as one of the runner ups John Lohrentz on the podcast. I’m looking forward to seeing what comes out of these policy submissions in due course.

Well, that’s about it for this week. But before I go, it so happens that it is now 17 years since Baucher Consulting started. And as some of you may know, we recently undertook a slight reorganisation carving out some of our compliance functions to Agentro Limited. Big step that, it’s been a great journey for the last 17 years. And I’m looking forward to the future.

I’d just like to take this opportunity to thank my colleagues Eric, Darryn and Judith for helping me get here together with all our clients and many well-wishers who responded to our latest newsletter covering this news. Thank you very much. We really couldn’t have done it without you.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my 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.