A couple of weeks back I spoke to Susan Edmunds regarding the state of child support debt which as of 31st August amounted to $1.079 billion, $488 million of which represented penalties. I made the point that in my view the Child Support late payment penalty regime is ineffective and it’s time to rethink the system. At present Inland Revenue keeps having to write off a substantial amount of uncollectable debt.
RNZ subsequently contacted me about this issue and on Thursday morning, together with Tauranga’s Bay Financial Mentors manager Shirley McCombe, I spoke to Kathryn Ryan on Nine To Noon about the matter.
It so happens I first spoke to Nine To Noon about child support debt back in 2013 and for the year ended 30th June 2013, child support debt amounted to just under $2.8 billion, of which over $2.1 billion or 76% represented penalties. The system underwent a bit of a tweak that year, and it’s also subsequently gone through further revisions. The penalty regime which now applies is that if you miss a payment, there’s an initial 2% penalty and then if the payment is not made in full within a week a further 8% penalty is applied. Just for the record, those penalties are double what would be charged if you missed a tax payment.
To reiterate what I told Nine To Noon and Stuff, this is really odd because Inland Revenue’s role in the child support regime is acting as an intermediary. It collects the payments from what are called the “liable parents” and then passes it on to the relevant parents who have care of the children. Why therefore should late payment penalties for missed child support be twice that for someone not paying their tax on time? This was a question I was asking ten years ago and it still hasn’t been answered satisfactorily even if the level of penalties have changed.
When I was preparing for the call, I came across some quite startling statistics which indicate that Inland Revenue really has not been doing enough in this space for well over four years. Each year Inland Revenue’s Annual Report includes a report on the information sharing it has done with the Department of Internal Affairs. The latest report can be found on page 209 of the report for the year ended 30th June 2022. (The June 2023 report is due any time now).
The report sets out the number of “contact records’ received from the Department of Internal Affairs. Inland Revenue then tries to match this information with its own information regarding overseas based child support debtors. (The same principle also applies for overseas based student loan debt).
Once you start digging into the annual reports, not just for the June 2022 year, but looking back, it becomes very apparent quickly that Inland Revenue really hasn’t been doing an awful lot in this space. Keep in mind the current amount of Child Support debt is well over $1 billion and that’s after substantial amounts of debt have been written off over time.
What’s happening with chasing overseas debtors?
This report showing contacts from the Department of Internal Affairs started being first recorded in 2015, which is also when Inland Revenue acquired the ability to share and exchange data with Australia. Going through Inland Revenue’s annual reports, what we can see is for the year ended 30th June 2019, 669 overseas debtors were contacted by Inland Revenue, which was a 47% hit rate, but that resulted in the grand total of $234,541 in overdue child support. Again, keep in mind for that year the amount of child support debt at 30th June was $2.2 billion, of which $1.6 billion was penalties.
However, for the year to June 2020 only 79 overseas debtors were contacted resulting in payments totaling $21,243. In the year ended 30th June 2021 no overseas debtors were contacted, so Inland Revenue received nothing. To be fair, throughout the whole of that year Inland Revenue was very heavily engaged with the Government’s COVID 19 response. On the other hand, as things began to normalise during the year ended 30th June 2022 Inland Revenue managed to contact just 22 overseas debtors which resulted in payments totaling $2,671.
To put it simply, Inland Revenue’s enforcement in this area seems to have fallen off a cliff. Yes, the pandemic has caused enormous disruption to their systems and it’ll be very interesting to see where they’ve got to in 2023. I know they’ve been more active in the student loan debtors area, so I would expect to see a big uptick in these numbers.
Not just a COVID-19 problem
But if you go back before the pandemic, for example, for the year ended 30th June 2018, 913 debtors were contacted, which resulted in payments of $372,000. However, remember that for June 2019 that number fell to 669, resulting in $234,000 being collected. So Inland Revenue efforts in this space have been declining.
In fact as the following graph illustrates incredibly the highest amount of child support debt recovered from overseas debtors was $493,000 in the June 2016 year when the total debt was $3.3 billion, of which $2.66 billion or 80% represented penalties.
(Source Inland Revenue Annual Reports June 2015-2022)
Inland Revenue also has the ability to issue deduction notices, which we’ve talked about earlier, where they can tell someone who’s making payments to the child support debtor, to deduct 10%, 20% from any payment made to that person and pay it to Inland Revenue. In some cases, Inland Revenue can tell a bank to take money directly from a bank account and pay it to Inland Revenue.
Inland Revenue can also, as a last resort, apply to the Family Court for a warrant for the arrest of a person to prevent them leaving New Zealand until the debt is either paid or put on to an arrangement. 22 such warrants were issued for the year ended June 2018. But for each of the June 2019 and June 2020 years only four such warrants were issued. No such arrest warrants were issued in either of the years ended 30th June 2021 and 30th June 2022. In fairness that’s probably because the pandemic made moving in and out of the country very difficult in both years.
Nevertheless, you can still see that there’s a decline in the use of these tools by Inland Revenue. And that seems to underscore my belief it has not been as across this debt issue as much as it should have been. Inland Revenue declined to be interviewed by RNZ for Nine To Noon, and I have no doubt they will say that they have been very busy with dealing with the pandemic, but that’s only since March 2020. As I explained the decline in action pre-dates that.
Notwithstanding the impact of the pandemic the question arises whether Inland Revenue has ever had the right resources dealing with this issue? Remember with Child Support running into billions of dollars and a substantial number of people apparently moving overseas and not continuing to pay their child support has Inland Revenue devoted enough resources to the problem? From the numbers I can see the answer would be no, it hasn’t.
In my view the penalty regime doesn’t work. Looking at it overall I think there’s quite a big “Please explain” to be asked by whoever becomes Revenue Minister following the election.
Time to rethink child support generally
The current Child Support system was set up in 1991, and it was designed to speed up the process and bypass the cost of going to family court to get court orders for support and maintenance when the parents can’t agree. This is why Inland Revenue was introduced as the intermediary and I think this is a good principle.
About 30% of all child support is not paid on time. One of the other issues which emerged when researching this is that apparently the majority of those using the regime are beneficiaries. And it does appear to be that if this is the case, what will be interesting to know is how much of the debt relates to beneficiaries. As I told Nine To Noon older statistics suggested it well over 50%. This debt issue is perhaps a by-product of something that’s been talked about a little bit during the election campaign that the level of benefits we are paying are insufficient for people to support themselves.
Through the combination of a means testing programme and an ineffective penalty regime we’ve created an administrative headache where the Government is charging penalties on debt it will never recover. It seems to me that after 30 years we’ve got enough experience to see that it’s time to for a rethink. This is something for a new government to pick up. However, I was speaking about these very same issues ten years ago, so I’m not holding out much hope for rapid improvement happening anytime soon.
Uncle Sam demands US$28.9 billion from Microsoft
Moving on, overnight it emerged that the United States Internal Revenue Service, the IRS, has issued what are known as Notice of Proposed Adjustments against Microsoft in relation to underpaid tax of US$28.9 billion (plus interest and penalties) for the 2004 to 2013 tax years. These were issued on 26th September and Microsoft made the news public as part of its regular public filings.
The primary issues relate to intercompany transfer pricing. Microsoft’s response is that it thinks its allowances for income tax contingencies are adequate, it doesn’t agree with the proposed adjustments and will contest them. However, it acknowledges the dispute is going to take more than 12 months to be resolved.
Microsoft has a market capitalisation of nearly US$2.5 trillion so $28.9 billion plus interest in penalties is perhaps small change in the scheme of things. But it is interesting to see that this has developed, including the period of time involved, we’re talking about transactions which occurred 19 years ago. It just shows how slow these tax dispute processes are.
I imagine Inland Revenue and other tax jurisdictions (particularly the Australian Tax Office) will be watching this very carefully. It may even be that they have been contacted by the IRS as part of this process. The information sharing which goes on between tax authorities is extensive but not well known by taxpayers. Microsoft’s transfer pricing practices will be under review ,and I guess it might have a ripple effect for other huge multinationals. The action highlights the need to find a new international tax framework. This is what the OECD is trying to do with its BEPS and Pillar One and Pillar Two initiatives. This case will be watched very closely and I will keep you up to date with developments as they arise.
Australian data on overseas purchases – a clue for National?
And finally, tax has been a fairly controversial headline throughout the election campaign for various reasons. One of the proposals which stirred up a bit of controversy was National’s proposal for a foreign buyers’ tax which would allow foreign non-resident buyers to purchase properties worth more than $2 million but they would have to pay a 15% tax for doing so. There’s been quite a bit of dispute over exactly how much revenue that will raise. I’m in the camp which thinks the numbers are very optimistic.
It so happens that the Australian Tax Office has just released some data relating to the number of residential real estate sales and purchases by foreigners throughout all of Australia for the year ended 30th June 2022. According to this report, there were a total of 4,228 residential real estate purchases, with a total value of A$3.9 billion. In the same period there were 2,349 real estate sales by foreign persons, realising a total of A$2.1 billion. By the way, those sales would have been subject to capital gains tax up to a pretty hefty 45%. Unsurprisingly, the majority of these transactions took place in Victoria, New South Wales and Queensland. About 86% of all purchases were in those states with 97% of all sales in the same states.
This is interesting data to see, in terms of pointers about the viability of National’s proposal, these Australian numbers may be pandemic affected. But it seems to me that given the relative size of Australia and the greater variety of property of interest to foreign buyers, I would have thought those numbers indicate National’s proposed numbers are on the whole optimistic. We shall have to see how the policy pans out.
Well, that’s all for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.
Tax continues to feature heavily in the Election with the ongoing debate over the validity or otherwise of National’s proposed foreign buyer tax. But away from the election, it has been a busy week in the tax world. By far the most interesting story, partly because of its source, but also how it speaks to the structure of our tax system, is the commentary from Matt Whineray, the outgoing chief executive of the New Zealand Superannuation Fund (NZSF), about the fund’s tax status.
In an interview with the New Zealand Herald’s Markets with Madison, he remarked on the NZSF’s tax status, noting that since the fund began investing in 2003, it had paid nearly $10 billion in tax, including $2.2 billion for the year to June 2022.
This makes it by far and away the largest single taxpayer in the country. He thought this was rather nonsensical and that the fund really should have tax immunity status in line with many other sovereign wealth funds around the world, (including ACC and the Reserve Bank of New Zealand, both quite substantial investment funds). “My wish would be that we didn’t pay tax because I think that would solve a few issues.”
A nonsensical money-go-round?
He questioned the practice of the NZSF returning money to the Crown in tax, and the Crown in return contributes to the fund annually. “If I take my wallet out of this pocket and put it into this pocket, I haven’t got richer.” The problem, in his view, was exacerbated when the Crown stopped contributing to the fund completely, as it did for almost a decade between 2009 and 2017.
Now when the NZSF was set up 20 years ago, the rationale behind it paying tax was this would help it make sound investment decisions based on investment principles and not by tax considerations. And in a broader sense, that’s not unreasonable. I always tell my clients, don’t let the tax tail wag the investment dog. Think in the longer-term investment and returns rather than the short, potentially shorter-term tax implications.
A “Fair” Dividend Rate?
Someone else this week commenting on this question of the tax status of savings was financial planner Rachelle Blanch speaking to Susan Edmonds of Stuff.
Rachelle thought it was time for a review of the Foreign Investment Fund (FIF) regime, particularly in relation to how it applies to portfolio investment entities such as KiwiSaver funds. Now, the FIF regime and the Financial Arrangement regime are the two main reasons the NZSF pays so much tax. That’s because both regimes tax unrealised gains and there will be substantial unrealised gains in investment funds.
As the story in Stuff noted, under the FIF regime KiwiSaver funds and the NZSF must use what’s called the fair dividend rate in respect of their overseas shareholdings. This deems 5% of the opening market value of the investments held at the start of the tax year to be taxable income. Now obviously as KiwiSaver funds grow in size, and they diversify out of the New Zealand market as the NZSF has done, then the amount of tax payable as a consequence of the FIF regime will increase. However, unlike individuals or trusts, who can switch methods to mitigate the impact of a drop in values of some of investment funds by adopting what we call the comparative value method, KiwiSaver funds and the NZSF can’t do that.
How much tax is payable under the FIF regime is not at all clear. The NZSF is probably the only entity which can give a pretty accurate gauge on that. But to give you some idea of the total tax that might be payable – the Financial Markets Authority produces an annual report each year on KiwiSaver funds, and it notes that for the year to June 2022, KiwiSaver funds paid over $256 million in tax for that year. Remember in the same period, the NZSF paid over $2.2 billion.
Rachelle Bland has raised a very good question as to whether, in fact, this is an appropriate tax policy response where people have long term savings. She describes it as effectively a capital gains tax. Another way of looking at this, and it’s how I describe it whenever explaining the regime to overseas clients, is that it operates as a quasi-wealth tax.
As I said, there’s no mitigation for significant falls in stock markets. Unlike a capital gains tax regime which taxes on a realisation basis you can decide to realise capital losses and offset them against capital gains. You can’t do that under a FIF regime. Therefore you have this situation where the value of investments are falling but you’re still paying tax on the value of those investments. And that’s been the scenario for quite a few funds over the past 12 to 18 months.
What about a tax exemption then?
It’s not surprising then that quite apart from this anomalous washing – as Matt Whineray referred to the process of cycling funds from the Crown to the NZSF and then back in the form of tax – there’s also calls for some form of tax exemptions for KiwiSaver funds. You see such tax exemptions around the world for other pension schemes. New Zealand is yet again, a bit of an outlier here. The reason such exemptions were taken away in the late 1980s is they are costly. However, in overseas jurisdictions where tax exemptions apply to pension schemes withdrawals are taxed, whereas in our system we apply what we call a tax-tax-exempt approach where the contributions are made out of after-tax income, the schemes are subject to the ordinary taxation rules, but any withdrawals are exempt.
What’s the most effective approach? Well, that’s still a matter for debate. But one thing to keep in mind is that tax does have an impact on the long-term return of funds. Now, whether anyone is going to do anything about this is very questionable. The FIF regime in its current iteration has been in place now since 1st April 2007, and it generally works pretty well. The rules were very controversial when they were first proposed. There was an absolute storm of protest when they were first proposed, with Parliament’s Finance and Expenditure select committee receiving 3,400 submissions against the introduction of what is now the FIF regime, and only two in favour. In the face of this criticism, they were actually reshaped and now everyone has got used to working with the regime.
And this perhaps is the critical point. Governments appreciate the tax paid by the NZSF and KiwiSaver funds. The total tax for the year ended 30th June 2022 from those two sources probably represents just about 2% of the total tax take for that year. Therefore, changing the tax treatment for the NZSF and for KiwiSaver Funds would be an expensive move even if as a trade-off the Government might not then need to make any more contributions to the NZSF.
Wrong sort of investment signals?
Given the short-term pressures at the moment on the Government’s books, I think any move in this area is not going to happen. But I also consider it underlines a scenario where we’re prepared to tax savings under the current tax system, but generally whole asset classes, such as property, the bright line test excepted, are outside the tax net. This treatment sends an investment signal which politicians aren’t prepared to address.
Where does investment get directed? The evidence we have points to it being directed into relatively unproductive residential property investment as opposed to the likes of KiwiSaver funds, which will invest in productive businesses.
The discussion we’re not having
Now, this is a discussion we’re not having at the moment about how the tax system and investment interacts. As I’ve said in previous podcasts when you consider National is proposing removing commercial property depreciation on non-residential property again, (as is Labour for its part) in both cases to fund some form of tax cuts this to me sends the wrong signals. We’re basically directing funds away from investment in our economy into consumption.
But this is not a discussion we’re going to have because although politicians quietly recognise that whatever we the electorate might say about the impact of tax in the back pockets – and we’ll happily all take tax relief, tax cuts, how you phrase them – we also like the services tax provides. So, this dichotomy exists. We’ve got to maintain services as far as possible but not want to pay for them. But as I’ve said repeatedly, I think the under taxation of capital is an unsustainable position long term.
Donations tax credit review announced
Moving on, Inland Revenue just carries on carrying on regardless of whether the Government is out campaigning. It has been busy churning out quite a lot of interesting material. But two particular initiatives happened this week.
Firstly, on Friday, it announced it is going to undertake a review of the rules relating to the donations rebate rule. This review is part of the Regulatory Stewardship programme required of all state agencies in respect of the rules they administer. In this case, a review is going to assess whether the donations tax credit regime is operating effectively, is achieving its policy intent, and how it compares internationally.
Inland Revenue will open up consultation with an aim of undertaking this review and completing a report, setting out its findings as well as any recommendations by mid-2024. Interested parties will be contacted on this. I imagine you can expect the Charities Commission, some more major charities, would be approached. I think the main accounting bodies, together with the New Zealand Law Society will also be approached for comment on the matter.
A fairer Government debt policy framework?
The second Inland Revenue initiative and probably something that’s going to have more immediate impact ties into the rather strange case we talked about last week involving the Nelson woman who got herself into a whole heap of trouble with Inland Revenue and decided the best way out of avoiding a $365,000 tax debt was to sell her property worth $845,000 to a UK company. The Official Assignee took a dim view of the idea and obtained a court order striking the sale down.
Leaving aside the oddities involved the case is relevant for the important question of tax debt and other debt that’s owed to the Government. According to the New Zealand Herald story reported last week, as of 30th June 2023 Inland Revenue is owed nearly $5 billion.
Now, both the Tax Working Group and the Welfare Expert Advisory Group took a look at the question of debt owed to the Government as part of their reviews, and they recommended there should be some form of all of government approach to debt. Firstly trying to prevent debt arising with the Government, but also how each relevant government agency responds and manages that issue.
Consequently, a policy framework for debts the Government is owed has now been developed and has been signed off by the Cabinet. Inland Revenue this week released its report and background details on this framework.
There’s quite a bit to consider in here, not just the $5 billion Inland Revenue is owed but the other debts built up, primarily with the Ministry of Social Development and also with the Ministry of Justice.
According to this report, at present 762,460 New Zealand residents collectively owe $4.68 billion of debt to these three agencies – Ministry of Social Development, Inland Revenue and the Ministry of Justice. More than a quarter of these persons owe debt to two or more agencies and 6% that’s over 45,000 people owe a debt to all three. Furthermore, around three quarters of this debt, so that’s well over $3 billion, is owed by low-income individuals, many of whom rely on government benefits as well. 13% or just over 99,000 people owe more than $10,000 to the Government.
More than 85% of those who do owe a debt have owed it for more than a year and about 45% cent, an incredible number, have owed debt for at least four years. Finally, Māori and Pacific people are overrepresented in almost all categories of debt a sadly quite typical issue.
The debt policy framework is trying to ensure is that debt recovery is fair and effective and avoids exacerbating hardship. And above all, it aims to prevent debt occurring in the first place and not exacerbate issues.
There are three main parts to the framework. Firstly, a set of overarching principles for creating and managing debt. Then secondly, a purpose centred approach which classifies debt into different groups according to the policy purpose and discusses how different settings might be appropriate for some purpose and others. And then finally, what’s called term to person centred approach, which takes into consideration the personal circumstances, with focus on consideration of financial hardships, as I said.
These debt issues tend to exacerbate and build on each other leading to a circle of despair. $10,000 of debt doesn’t sound like a lot, but for very low-income people it seems like an insurmountable mountain.
Anyway, this framework has been signed off by the Government after feedback from quite a number of interested agencies. For example, the Citizens Advice Bureau, the Methodist Alliance, the New Zealand Council of Christian Social Services, the Salvation Army, and a whole range of other non-governmental organisations. Hopefully this feedback will build a better framework for the practice of managing this debt.
Good but Inland Revenue also needs to do its part
I welcome this initiative, but I also think that as part of it, Inland Revenue needs to be also considering its approach to debt management, such as the effectiveness of the late penalty regime, and how efficiently it is on top of managing debts, because if the debts get away from people, they just give up. That’s what my experience has shown time and again and it’s also what Inland Revenue has experienced.
I think it’s still a good step forward, particularly, in trying to bring a coordinated approach because there’s nothing more infuriating to someone who might be unlucky enough to find ourselves in a position of debt with two or three agencies, and finding that the approach taken by each of those agencies is different.
The Tax Working Group recommended a single Crown agency to manage current debt should be established to deal with this issue. That does not seem to have been part of these recommendations at the moment, maybe it might be picked up at a later stage. Nevertheless, it’s a step forward in the right direction and we’ll hope that it starts to address these issues of managing the debt fairly and efficiently for people.
The $5 billion PREFU hole no-one is worried about
And finally, this week, back to the Election. We’re still hearing plenty about tax in the election campaign. Politicians are all out on the trail telling us everything that’s going to happen or not happen. This week the formal opening of the government books happened with the release of the Pre-election Economic and Fiscal Update (PREFU). There was plenty of differing interpretation about the state of the government’s finances going forward.
But there was a wonderfully interesting little snippet which Newsroom picked up on, and that was the impact of next year’s Matariki public holiday. Matariki always falls on a Friday, and next year it falls on 28th June, which is the last working day of the fiscal year to 30th June 2024. And because of that, the cash that would come in on that day, which represents about $5 billion of GST and provisional tax won’t actually hit the Government’s coffers until the following Monday, which is 1st July and the start of the following tax year. So, on the face of it, the Government’s going to be $5 billion short of cash for the current year ending 30th June 2024.
As a Treasury spokesperson said, “This public holiday effect is expected to affect the Crown’s tax receipts but not tax revenue, since Inland Revenue will calculate accrued tax revenue as at 30 June 2024 as it normally would at any other year end.”
And for the record, this won’t really affect individuals because we file tax returns to 31st March each year. Furthermore, Inland Revenue won’t penalise people for making a payment on 1st July, the first working day after it was due because Inland Revenue hasn’t switched over to a seven-day banking. So nice quirky little story to end the week.
Well, that’s all for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening and please send me your feedback and tell your friends and clients. Until next time, kia pai to rā. Have a great day.