Tax News

This week Inland Revenue gets tough with the construction industry over outstanding debt and tax evasion.

This week Inland Revenue gets tough with the construction industry over outstanding debt and tax evasion.

15 Apr, 2024 | The Week in Tax

  • Inland Revenue releases three special reports regarding the changes to the platform economy rules, the 39% trustee tax rate and the new 12% offshore gambling duty

Under the banner “Cut your excuses and sort your tax” Inland Revenue last Monday issued what it called a “last chance warning to the construction sector” to do the right thing and get on top of their tax obligations. The release advises that if people do the right thing, then Inland Revenue will help them. If they don’t, Inland Revenue will find them and start follow up action.

Richard Philp, a spokesperson for Inland Revenue, commented;  

“Most people and businesses in New Zealand pay tax in full and on time but there is a core group who don’t. … we also know that while some are struggling just to keep up with the everyday grind, others are actively avoiding their tax obligations.”

Tax evading tradies?

Apparently, tax debt is high in the construction sector and there’s also a fair amount of cash jobs apparently happening in the sector. The Inland Revenue release commented that across all sectors, it gets about nearly 7,000 anonymous tip offs about cash jobs and the like each year noting “Construction is the industry most anonymously reported to Inland Revenue”.  

The media release is silent about the extent of the debt within the sector, but we do know from the latest statistics as of 31st December 2023, that tax debt over two years old has increased to from $2.5 billion in December 2022 to $2.8 billion in December 2023.

ADVERTISING

Understandably, with the Government’s books under pressure, Inland Revenue is keen to collect as much of this overdue debt as quickly as possible. This is probably the first of many such campaigns where we will see Inland Revenue taking additional action. And remember, under the Coalition agreement, additional resources have been promised to Inland Revenue for investigation work.

In this particular campaign, Inland Revenue is saying it’s going to issue emails and letters to 40,000 taxpayers in the construction industry who have either outstanding tax debt or tax returns, or both. It then specifies that 2,500 of those will be contacted by text message, asking if they would like to support to get their outstanding tax sorted. There will be a follow up call if the taxpayers they respond that they do want help. Inland Revenue will also be carrying out site visits to key locations across the country.

As I said, this is likely to be the first of several initiatives we’re going to see from Inland Revenue. I would be interested in seeing some specific stats around the proportion of debt and the composition of debt and get an understanding of what sort of businesses are struggling here. It will also be interesting to see how successful this campaign turns out to be.

More on the new GST rules for online marketplaces

Last week I discussed the confusion that seems to have arisen following the introduction of new GST rules from 1st April. These rules affect people who are not GST registered but provide services through such apps as Airbnb, Bookabach and Uber.

This week, Inland Revenue released three special reports relating to the new legislation and one of these is on accommodation and transportation services supplied through online marketplaces. In fact, this is an updated version of a report previously issued in June last year. The report has been updated to include the changes that took effect as of the start of this month and in particular how the flat-rate credit scheme operates.

Changes to online marketplace operators

Under the new rules, so-called online marketplace operators such as Airbnb, Uber and Bookabach will charge GST on all bookings made through them. However, the person who actually provides the ride or the accommodation may not be GST registered. This is where the flat-rate credit scheme comes into effect as the following example illustrates:

The full report is 68 pages so there’s plenty more to dive into.

Special report on 39% trustee rate

One of the other reports that was issued is on the application of the trustee rate of 39%. Basically, trustee income is the net income of the trust, which has not been distributed to beneficiaries. The 30-page report explains the basic provisions about “beneficiary income” and “trustee income” together with a couple of useful flow charts.  

Trustee income flowchart

Beneficiary income flowchart

The report references the minor beneficiary rule which applies where the beneficiary is a natural person under the age of 16. In such a case only $1,000 of income per year can be distributed to that person as beneficiary income and be taxed at that person’s marginal tax rate, presumably below 39%. Under the new rules, any beneficiary income in excess of $1,000 paid to a minor would be taxed at 39%.

Overall, this is useful guidance. Just remember the $10,000 threshold is all or nothing: if trustee income is $10,000 or less, the trustee tax rate that applies is 33%, but if it’s $10,001 then it’s 39% on everything.

The third report is on the proposed offshore gambling duty, which takes effect from 1st of July and will apply to online gambling provided by offshore operators to New Zealand residents.

The bright-line test and tax evasion – a couple of useful real-life case studies

Finally, this week a couple of interesting Technical Decision Summaries from Inland Revenue. Technical Decision Summaries are anonymised summaries of some interesting cases that Inland Revenue’s Tax Counsel Office has encountered either through tax disputes and investigations or applications for binding rulings.  

The first one, TDS 24/06,  is an application for a ruling regarding whether the bright-line test or section CB 14 of the Income Tax Act would apply. The facts are complicated but involve three sections of land currently owned by the ruling applicant.

The applicant had initially acquired one section outright before his spouse and another co-owner acquired interests as tenants in common. Over time, the applicants proportion of the ownership changed until at the time his spouse died the property was held 50% as tenants in common with his late spouse. The second section was owned 50% each as tenants in common with his late spouse. After her death her 50% interest had passed to him under her will. The third section was owned by the applicant and his late spouse as joint tenants. Following her death, her interest was automatically transmitted to him.

The ruling applicant was concerned about the treatment of future sales. Would the bright-line test apply or failing that, would section CB 14? This section is a little used provision and applies where there’s been a disposal within 10 years of acquisition and during that time there’s been a 20% more increase in value of the land thanks to a change in zoning, or removal of restrictions.

The Tax Counsel Office concluded neither the bright-line test nor section CB 14 would apply.  This is obviously a good result for the taxpayer but it’s actually also a good example, of how you can apply for a ruling to get Inland Revenue’s interpretation on a tax issue. You don’t necessarily have to follow it, but if you don’t, you better have good reasons for not doing so.

Fiddling the books and getting found out

On the other hand, TDS 24/07 involved suppressed cash sales, GST and income tax evasion and shortfall penalties. The taxpayer carried on a restaurant business which was registered for income tax and GST. Inland Revenue’s Customer Compliance Services (CCS) investigated the company and formed the view that there was fraudulent activity going on. There was suppression of cash sales, and the taxpayer was under returning GST and income tax.

CCS reassessed the taxpayer’s GST and income tax returns for the relevant periods and they increased the taxable revenue for suppressed cash sales based on analysis of point of sale data, the taxpayer’s bank statements and industry benchmarking.

Industry benchmarking – an underused tool?

Just on industry benchmarking, I think Inland Revenue ought to be much more public about its data here and warn taxpayers there are benchmarks against which it will measure your business. It has done so in the past, but I think the combination of Business Transformation and then the pandemic interrupted progress in this space.

What people should remember is, Inland Revenue has some of the best data available anywhere about measuring industry benchmarking. I believe it should be making this much more public so that it can serve as an early warning shot for businesses that think they can suppress income. Everyone loses when this happens. Gresham’s law about bad money driving out the good is very applicable here, because businesses which are not tax compliant are undercutting those businesses which are following the rules. This is not a healthy situation as it leads to considerable frustration and anger and if not dealt with, will just simply encourage more of the same behaviour.

Tax evasion? Have a 150% shortfall penalty

In this particular case, the taxpayer’s fraud was identified, and GST and income tax reassessments followed. In addition, Inland Revenue also imposed tax evasion shortfall penalties, which are 150% of the tax involved. These evasion shortfall penalties were reduced by 50% for previous good behaviour, but that’s still represents a penalty of 75% of the tax and GST evaded.

Unsurprisingly, the taxpayer counter-filed a Notice of Proposed Adjustment under the formal dispute process, and the dispute ended up with the Adjudication Unit, which is run by the Tax Counsel Office as part of the formal dispute process. The Adjudication Unit did not accept the taxpayer’s counter arguments, including an attempt to claim an income tax and GST input tax deduction for the cost of fresh produce purchased with cash. The problem was there was no supporting evidence for this claim, so the Adjudication Unit probably found it easy to reject it. The Adjudication Unit ruled not only was the tax due, but the penalties were also correctly imposed.

Get ready for more Inland Revenue action

Circling back to our first story, this TDS illustrates what lies ahead for those in the construction industry who have been suppressing income. As I said, I do think Inland Revenue should make everyone more aware of its benchmarking data which would be a warning for would be tax evaders. It’s pretty clear from the announcement about the construction industry that Inland Revenue is gearing up for many campaigns targeting debt arrears and clamping down on tax evasion in particular industries. As always, we will keep you updated as to developments in those areas as they happen.

On that note, 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.

Using tax law against gangs

Using tax law against gangs

18 Jul, 2022 | The Week in Tax

  • Using tax law against gangs
  • OECD tax coordination on MNCs
  • Ireland’s tax risks

Transcript

Last Saturday, the ACT party leader David Seymour appeared on Newshub Nation and suggested that Inland Revenue be used to deal with the gangs.

He believed the powers currently being used by Inland Revenue as part of its high wealth individual research project could equally be applied to deal with the gangs. It did make for some entertaining viewing, as interviewer Rebecca Wright was more than a little incredulous at the suggestion that gang members wearing patches would happily submit to filling out questionnaires. On the other hand, the notorious mobster Al Capone, was ultimately jailed for tax evasion so the use of Inland Revenue against organised crime is not that unreasonable a suggestion.

Mr. Seymour does seem to have misunderstood the nature of the powers currently being used by Inland Revenue as part of its high wealth individual research project. Those powers have been deliberately limited so that the information gathered is solely for research purchase purposes. They are therefore more prescribed than the general powers available to Inland Revenue. I also think Mr. Seymour was overstating how much of a sanction non-compliance with the high worth individual research project would be.

Now Inland Revenue does indeed have some extensive powers of information request and where appropriate, search and seizure. And if you want an example of how it can apply those rules that can be found in the case of Tauber v Commissioner Inland Revenue.

In this case, Inland Revenue was investigating a former accountant who it believed was suppressing income. After its initial information requests were not satisfactorily answered in its view, Inland Revenue then decided to use the powers available to it under Section 16 of the Tax Administration Act.  It carried out simultaneous search and seizure operations at six separate locations, including a boat shed.

Mr Tauber responded by making an application for judicial review, claiming that the various Section 16 warrants were too widely drawn and not specific enough. The application also questioned whether the searches were necessary for carrying out the Commissioner’s functions and if the searches were carried out in an unreasonable manner. Unfortunately for Mr Tauber and the other claimants the courts upheld Inland Revenue’s use of its powers.

The case illustrates the extensive powers available to Inland Revenue. However, what it also illustrates is that applying those powers is a very intensive operation requiring a considerable number of resources. If you’re raiding six properties simultaneously with teams of investigators, you’re talking about an operation which may have involved somewhere between 40 and 50 people. Now if you think about dealing with gang members Inland Revenue would also want to be raiding several premises simultaneously. Therefore, that would require considerable resources from it and no doubt police officers to be available in case matters escalated.

It’s therefore questionable whether Inland Revenue would actually have the resources to carry out major investigations into gangs. And although tax evasion is a criminal offence, Inland Revenue would probably be of the view that the powers available to police and other authorities under the anti-money laundering legislation, which have been strengthened this week, mean those agencies are more appropriately deployed to deal with organised crime.

This isn’t to say that Inland Revenue wouldn’t pass up the opportunity to investigate tax evasion involving gangs if it felt considerable sums were involved. But as the Tauber case shows, using its full range of investigatory powers requires considerable resources, which ultimately, I think, Inland Revenue might feel better used elsewhere. In other words, “Nice idea, but yeah nah.”

Update on OECD tax reform

Moving on, the OECD delivered its latest update on the status of the international tax reform agreement to G20 finance ministers and central bank governors a couple of weeks ago. This included a progress report on the status of Pillar One, which is the proposal to ensure that market jurisdictions can tax profits from some of the largest multinational enterprises.

The OECD Secretary-General presented a comprehensive draft of what these proposed technical model rules will be for Pillar One. These are now going to go out for public consultation between now and mid-August. The intention then is to finalise a new Multilateral Convention by mid-2023 for entry into force in 2024.

In addition to updating the status of the Multilateral Convention to implement Pillar One, the Secretary-General’s Tax Report also gave an update on how an implementation of the OECD transparency agenda (the Common Reporting Standards on The Automatic Exchange of Information). And the latest update is that information on at least 111 million financial accounts worldwide covering total assets of nearly €11 trillion was exchanged automatically between tax administrations in 2021. And later this year, the OECD will finalise a new crypto-assets reporting framework, which will be included as part of the Common Reporting Standards. So things are moving ahead even if they’re going more slowly than people had expected.

In relation to the Pillar Two work, which introduces a 15% global minimum global minimum corporate tax rate, the technical work on that is largely complete and an implementation framework is to be released later this year to facilitate the implementation and coordination between tax administrations and taxpayers. All G7 countries, the European Union and several other G20 countries, along with several other economies, have scheduled plans to introduce the global minimum tax rules. New Zealand hasn’t reached that stage but consultation on the matter has just ended, so we may see something later this year.

IRELAND’S TAX RISKS

Now one of the ideas behind the Pillar Two global minimum corporate tax rate is to try and stop tax competition driving corporate tax rates lower. Now, one of the poster child’s for lower corporate tax rates is Ireland. And last week I mentioned Ireland’s strong GDP per capita growth in recent years. This appears in part to be a by-product of multinational and multinational investment in Ireland, attracted by Ireland’s low corporate tax rate of 12.5%.

Now tax is always full of unintended consequences and this week the Irish Finance Ministry highlighted a potentially huge downside of this policy for Ireland.

Apparently just ten multinational firms pay over half of Ireland’s corporate tax receipts. These are expected to be between €18 and €19 billion this year, up from an estimated €16.9 billion forecast just three months ago. And by the way, that’s nearly a five-fold increase in the last decade.

Now, on the face of it that all sounds good. But John McCarthy, the Irish finance ministry’s economist, warned that the fact that just ten multinational firms pay more than half of honest corporate tax, represents “an incredible level of vulnerability” for the Irish economy, as a shock, which impacted on the multinational sector would have severe fiscal implications for Ireland. I understand something like one in nine Irish employees are employed by multinationals such as Facebook, Google and Pfizer. Therefore, the fallout from a shock in this sector could be huge for Ireland.

Mr. McCarthy told reporters the level of concentration in such a small number of firms is something he has never seen in any other economy. He was therefore more worried about the overreliance on these types of firms than the impact of the global overhaul of corporate tax regimes could have on Ireland’s position as a hub for multinational investment. Ireland power. The same report estimates that Ireland’s tax take would be affected negatively by about €2 billion over the medium term.

Irish Finance Minister Paschal Donohoe then chipped in saying he has long shared the concerns McCarthy outlined. He said the best way to manage the risk was to return to the pre-pandemic position where corporate tax receipts are not used to fund permanent spending. This seems an incredible admission that a low corporate tax rate is actually not sustainable over the long term. So that’s something to pause to think about when you hear talk about corporate tax cuts.

By the way, these concerns of the Irish finance minister and the Finance Ministry might explain why Ireland didn’t oppose the proposed 15% global minimum tax rate. I suspect that on the quiet this represents an opportunity for Ireland to raise its corporate tax rate without too much fuss. It would be interesting to know the level of concentration here in New Zealand. I guess the big four Australian banks and the New Zealand Superannuation Fund would represent at least 20% of the corporate income tax take.

IRD BACK LIQUIDATING DEFAULTERS

Moving on, a quick follow up from last week’s items about Inland Revenue’s enforcement and collection activity increasing. As of 30th June 2021, 140,000 taxpayers had arrangements with Inland Revenue covering $3.7 billion of tax. Now, Inland Revenue would be keen to ensure those numbers don’t continue to grow. Historically, what it’s done is taken strong enforcement action including initiating liquidations. Apparently about 70% of all high court liquidations were initiated by Inland Revenue. However, during the pandemic, as part of its more sympathetic response, that number fell to just under 30%.

However, I’ve been informed that since April that there’s been a huge escalation in Inland Revenue activity in the High Court and liquidation proceedings. So that’s the clearest sign of Inland Revenue’s increased focus on debt collection and a clear warning to all those out there that if you if you’re in trouble you need to front up and try and make arrangements with the Inland Revenue before they take it further to the liquidator.

AWARDS FINALISTS

And finally, this week, the Tax Policy Charitable Trust has just announced its four finalists in this year’s Tax Policy Scholarship competition.

This competition is designed to support tax policy, research and thinking. Entrance is limited to those under the age of 35, and the intention is that people are asked to give ideas of proposals for reforms to our current tax system, to address potential weaknesses and unintended consequences of existing laws. Now there are three topics in this year’s competition: environmental taxation, tax, administration generally, or the powers granted to the Commissioner of Inland Revenue and to investigate for research policy purposes. (These are the powers that Mr. Seymour was referring to in his interview about tackling the gangs).

The four finalists are Daniel Doughty, a senior consultant with EY in Wellington. He’s proposing a small business consolidated reporting regime to simplify tax reporting for small companies. I think this is an excellent suggestion, so look forward to finding more about this. Our tax system expects a lot of administration from small businesses without really trying to adjust the compliance burden to help them with those processes.

The second finalist is Mitchell Fraser, a tax solicitor with Mayne Wetherell in Auckland. Mitchell is worried that the new powers granted to Inland Revenue for tax policy purposes may have unintended consequences. He’s suggesting alternative means to collect the information that’s wanted, including through Statistics New Zealand.

The third finalist is Vivien Lei, a group tax advisor with Fisher Paykel Healthcare. Vivien has got another interesting proposal to change New Zealand’s environmental practises by introducing an impact weighted tax regime. Under this model, organisations will be taxed on a net positive or negative impact on the environment. Now this is an area I’m very interested in and previous readers or listeners of the podcast will know that John Lohrentz, one of the runners up in the last competition, proposed a progressive tax on bio genetic biogenic and methane emissions in the agriculture sector. It’s therefore good to see there’s plenty of focus on this area.

And finally, there’s Jordan Yates, a senior tax consultant with ASB in Auckland, and he believes the tax policy landscape has been fractured and suffocated by political roadblocks. I don’t think he’s wrong there. Jordan’s proposing an independent statutory authority that would be responsible for the independent management of fiscal policy as it relates to the tax base. It’s an idea I’ve heard floated in other places and another one I look forward to hearing more about. This fracture is one reason why the Minister of Revenue, David Parker, has proposed his Tax Principles Act.

The finalists have all been asked to develop a 5,000-word submission on their proposal. They’ll then make a final presentation and answer questions at a function later this year in October, after which the winner will be announced.

This is a great initiative by the Tax Policy, Charitable Trust, and I look forward to hearing more about these proposals. And as we did with Nigel Jemson, the winner of the last competition and runner-up John Lohrentz we will hopefully have the prize winners on the podcast.

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 te wiki, have a great week!

Inland Revenue enlists the help of the Chinese tax authorities in a tax evasion case

Inland Revenue enlists the help of the Chinese tax authorities in a tax evasion case

13 Dec, 2021 | The Week in Tax

  • Inland Revenue enlists the help of the Chinese tax authorities in a tax evasion case
  • OECD report reveals the impact of COVID-19 on tax revenue
  • Inland Revenue turns off its old computer system

Transcript

The Taxation Review Authority last week upheld the Commissioner of Inland Revenue’s assessments on unreported income from property transactions. There’s nothing particularly unusual about the facts of this case at first sight. The taxpayer was involved with the purchases and sales of five properties. He arranged the purchase of bare land, the construction of a house on the land and then sold the house.

He maintained he was only a manager and was actually acting under a power of attorney for Chinese nationals and merely managing the properties and receiving payments for services such as arranging the land development and transactions.

But the Commissioner decided to take a look at his affairs for the three tax years ending 31 March 2014, 2015, and 2016.  And it transpired that in fact, he wasn’t acting as a manager, but he personally controlled the transactions, and he made the profit from proceeds of each property over and above the management fees he had returned in his tax returns. These transactions all pre-date the introduction of the bright-line test, so the Commissioner assessed him on the basis that the properties were acquired with a purpose or intent of sale.

Ultimately, the amount that was assessed after deductions over the three years turned out to be over $1.6 million. In addition, because he had only been returning the management fees, he had actually also claimed working for families tax credits of just under $9,000 to which he wasn’t entitled. The commissioner took the view all this represented tax evasion and imposed shortfall penalties of initially 150% of the tax evaded but reduced by 50% for a first offence. Even so these penalties amounted to $407,000.

So far this is relatively routine. Inland Revenue are tracking property transactions and if something gets suspicious, they’ll look to see if a pattern emerging.

What caught my eye about this one is the Commissioner’s investigations included obtaining information from the People’s Republic of China under the double tax agreement we have with the PRC. As a result of that enquiry the registered proprietors of the land said, “Hey, we’ve got no knowledge of our involvement in these property sales, and we have not received any benefit from these sales”.

Now, one of the great unknowns that I think people aren’t aware of is how much information sharing goes on between tax authorities. But this is the first one I’ve seen where it’s been clearly acknowledged that the Chinese tax authorities in the People’s Republic of China have been involved.

So, there’s a warning for people to be very aware that Inland Revenue information gathering powers are enormous and they have discretion to ask overseas tax authorities for information in relation to any enquiry. Undoubtedly, the Chinese tax authorities would have been very interested in this as well because they would have people at their end who may have been involved in tax evasion.

A couple of years back, I asked Inland Revenue under the Official Information Act about how many requests for information were made between it and the Chinese tax authorities during the year ended 31 December 2018.  The official response was

“The information above is refused because making the information available would likely prejudice the international relations of the New Zealand Government. It would also likely prejudice the entrusting of information to the New Zealand Government on a basis of confidence by the tax agency of the People’s Republic of China.”

Incidentally I asked a similar question in relation to the double tax agreements with Australia and the UK, and the information was supplied.  Talking with a journalist who often deals with OIAs being declined, he was quite impressed because he hadn’t had an OIA declined on those grounds.

But international relations aside, the key point people should be aware of is that Inland Revenue has wide information gathering powers, and that includes being able to talk to other tax agencies and overseas. And in this case, that was probably pretty fatal for the taxpayer’s chances in this case. You have been warned.

The economic tax take in a pandemic

Speaking of international tax, the OECD earlier this week released its Revenue Statistics 2021, which showed the initial impact of COVID 19 on tax revenues within the 30 odd countries of the OECD.

On average tax revenues represented 33.5% of GDP in the 2020 calendar year, which is 0.1 percentage points of GDP up relative to 2019. But of course, this is against the backdrop of the impact of the pandemic which resulted in widespread falls in nominal tax revenues and nominal GDP. And that’s why the tax take relative to GDP rose because in most countries, GDP fell by more than nominal tax revenues.

As typically with OECD reports there’s heaps of interesting data that you can dive into.  For example, in 2020, Denmark has the highest tax to GDP ratio of 46.5%, whereas Mexico, at 17.9%, has the lowest tax to GDP ratio. Overall, in 2020 for the 36 countries that were measured, the ratio of tax to GDP rose in 20 and fell in 16.

The largest ratio increase was in Spain, which went up 1.9 percentage points, apparently because of a large increase in social security contributions. But the largest fall, on the other hand, was Ireland, which fell 1.7 percentage points. And that was because its GST revenues fell quite substantially following a temporary reduction in GST rates as part of its response to the pandemic.

Where does New Zealand feature in all of this? Well, its ratio provisionally rose to 32.2% of GDP, which is up 0.7 percentage points from 31.5% in 2019. By the way, the tax to GDP ratio is also shown for the year 2000.  Back then the ratio was 32.5% and New Zealand since then has pretty much tracked around that thirty-to-thirty two percent of GDP ratio since then. Incidentally, Denmark’s has actually been pretty stable over the same period. Its tax to GDP ratio back in 2000 was 46.9%. The average across the OECD back in 2000 was 32.9% and in 2020, it’s 33.5%. So, you can see stability across the tax take for quite some time.

The report has a breakdown between tax types and interestingly, corporate income taxes in New Zealand at 12.4% of total tax revenue in 2019 is significantly above the 9.6% average across the OECD.  Similarly, GST at 30.3% is well above the 20.3% average in the rest of the OECD. (Chile incidentally collects 39.9% of its tax revenue from GST, which is the highest in the OECD. As always there’s plenty to dig into in these OECD reports.

From FIRST to START

And finally, this week, Inland Revenue has finally switched off its old FIRST computer system, as it’s now practically completed its Business Transformation programme. The total cost of this Business Transformation has come in at just under $1.5 billion, which is less than the $1.7 billion that was originally budgeted, including the leeway for contingencies.

So that has rightly drawn some praise from various sectors for managing that transition. I think you can look back at the Novopay scandal as to see how these things can go wrong. Consequently, the Inland Revenue had to make regular reports to the Cabinet about its progress.

And one of the effects for Inland Revenue of the programme and which was part of its business case, is that its workforce has gone from 5,662 in June 2016 to under 4,000 now, a quite significant change. My understanding is that back in 2016 under the old system, a significant number of processers were employed simply to re-enter everything into the system so it could actually be used.

Regular listeners to the podcast will know I’ve not always been entirely complimentary about what’s going on with Business Transformation. There have been some issues for tax agents and we’re still working through some teething problems. Generally, I think when the Business Transformation programme was being designed and implemented, the role of tax agents was not well considered. We tax agents are actually the biggest single users of the system and perhaps having tax agents involved earlier on might have made it a more user-friendly experience from our end.

However, it has to be said that this programme was much needed. FIRST was introduced in 1989, I think, and it was really showing its age. And fortunately for all of us Inland Revenue had Business Transformation well advanced when the pandemic arrived. Inland Revenue officials have told me none of assisting the Ministry of Social Development with the wage subsidy scheme, implementing the small business cashflow loan scheme and the ongoing resurgence support payment scheme could have happened under the old FIRST system.

I know the local IT sector was very unhappy at the start of the project at being shut out of the process, although some local providers have got involved as it developed. At a conference in 2014 which was a precursor to the start of Business Transformation it got bit spicy as local software providers climbed into Inland Revenue over their decision to use Accenture and other offshore companies to lead the project.

Local software providers made two points. Firstly, they had the capability and expertise. One announced it had designed and implemented Bermuda’s GST system within six months. The view was the expertise was already in the country.

But secondly, and this is a point which I think has to be kept in mind on a broader economic framework, if software companies are trying to export, but they’re not winning government contracts, that makes it a harder sell for them. That was a point which I also heard when I was on the Small Business Council.

Anyway, congratulations to Inland Revenue for migrating fully across to the new START platform. It’s onwards and upwards from here and although there will always be some teething problems, we’re working through these. So that was a welcome completion of a project.

Well, that’s it for this week. Next week, it will be my final podcast of the year. I’ll be looking back on the big stories for the year. Until then, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts.  Thank you for listening (and reading) and please send me your feedback and tell your friends and clients. Until next week kia pai te wiki, have a great week!

A look at the interest limitation rules and the proposed “new build” exemption

A look at the interest limitation rules and the proposed “new build” exemption

28 Jun, 2021 | The Week in Tax

  • A look at the interest limitation rules and the proposed “new build” exemption
  • The OECD’s latest Fighting Tax Crime, how does Inland Revenue measure up
  • The new purchase price allocation rules

Transcript

The Government’s discussion document on the design of the interest limitation rules on the additional bright-line test was released a little bit over two weeks ago. Since then it’s been a hive of frantic activity amongst tax agents, accountants and lawyers as we try and digest the implications of what’s proposed and work out how we manage those changes.

As part of that, Inland Revenue has been running an external reference group made up of accountants, tax advisors, tax lawyers and industry specialists such as Fletcher Building. We’ve been going through parts of the proposals and giving Inland Revenue feedback on what we think of the proposals.

Yesterday we discussed the question of new builds. Now the new build definition is going to be incredibly important because the Government is proposing that owners of new builds will have a five year bright-line test exemption instead of the 10-year test which applies from 27th March. Also, and this is the bit that’s getting most people particularly interested, will be exempt from the proposed interest limitation rules.

The proposal is that a property should only qualify as a new built where residential housing supply has clearly increased. This, according to the discussion document,

“will occur when a self-contained dwelling with its own kitchen and bathroom has been added to residential land and the dwelling has received a Code Compliance Certificate.”

The discussion document then talks about three new build categories, simple new builds, complex new builds, and commercial residential conversions.

We were discussing these definitions with Inland Revenue as well as the question of how long should the exemption last; indefinitely or for a prescribed period of time? And if it is for a prescribed period of time, could a subsequent purchaser be able to make use of the balance of that period? A lot of details to consider there.

It’s of great interest, clearly, because late this past week, I made a presentation on the new rules to the Employers & Manufacturers Association and the New Zealand Chinese Building Industry Association. Some very interesting discussions came out of that – it’s apparent a lot of people clearly are focussing on what is a “new build” with many of the questions around the definition and what’s going to happen?  Clearly this is a very important part of the Government proposals.

Running through a little bit of the detail. Simple new builds involve adding one or more self-contained dwellings to bare residential land. So that would include adding a dwelling to buy land that is one of more dwellings is allotted to bare residential land. It doesn’t matter whether a new build is fully or partially constructed on site, so it will cover modular homes. It would include a dwelling that has been relocated onto the land.

It includes replacing an existing dwelling with one or more dwellings. This is where an existing dwelling is removed or demolished and then replaced with one or two or more dwellings. It’s proposed that even one for one replacement would qualify, even though strictly there’s been no increase in housing supply. But there’s been an improvement in the quality of the housing. And we’ll come back to that point in a minute.

Complex new builds involve adding one or more self-contained dwellings to residential land that already has a dwelling on it without a separate title being issued for the new build portion of the land. So that would include adding a standalone dwelling and that could be a sleep-out, for example.

Adding, or attaching a new dwelling to an existing dwelling, for example, where dwellings are added on top of or underneath or next to an existing dwelling on residential land. Splitting an existing dwelling into multiple dwellings. This is where residential land has an existing dwelling on it that is then converted into multiple self-contained dwellings, for example, where a six-bedroom house is converted into three two-bedroom units.

In our discussion with Inland Revenue, the question arose about what to do with renovations and remediation and that led into a very interesting discussion.  The same point came up at the afternoon’s seminar. What do we do, for example, where you have a house that’s previously been left as uninhabitable? Maybe, for example, it’s not up to building code or the healthy homes standard, but money is being spent to remediate these matters.

So we debated whether we think the interest portion on such work should be deductible. And the general view was broadly yes. You’ve obviously got some definitional issues about what is uninhabitable. But clearly, if the Government wants to increase the housing supply and the availability of accommodation, taking a house which was, say, previously had been left to rack and ruin and then bringing it up to healthy home standard, the view was the interest in that deduction probably should be allowable.

Of course, as a separate matter which we didn’t discuss, what about the deductibility of the actual expenditure on making a dwelling meet the healthy home standards? That’s less clear and arguably is non-deductible and that’s all part of the problem with the current tax system and how complex the whole matter has become. It’s pretty harsh on the capital treatment of buildings. Since 2011 we don’t have depreciation on residential accommodation. And I’m beginning to form the view that maybe we should restore that, because as this discussion on the question of renovation points out, buildings do fall into disrepair. There’s also the matter of leaky buildings and earthquake strengthening.

Finally, there’s commercial to residential conversions. This new-build category covers the conversion of commercial buildings into self-contained dwellings. For example, an office converted into apartments or a large commercial heritage building, such as a harbour warehouse that’s converted into townhouses. Such conversions are seen as new builds.

And the proposal is that the exemption goes to “an early owner” of new builds.  This is a person who:

  • acquires a new build off the plans before Code of Compliance Certificate is issued,
  • acquires an already constructed new build, no later than 12 months after the new build’s Code of Compliance Certificate is issued;
  • adds a new build to bare land;
  • adds a complex new built to land; or
  • completes a commercial residential conversion.

The other matter for debate on which no decision has yet been made, is how long should that exemption last? Inland Revenue have suggested this could be 20 years.

On this, an interesting point came up in yesterday’s seminar. People got up and said, “Wait a minute, you said five years there. And then you talked about 10 years and now you’ve mentioned 20 years. What’s this 20-year thing?”  But you can see that the overlapping five year bright-line test, 10 year bright-line test and possible 20-year new build exemption adds to confusion about the whole process.

And that’s something that when you’re making submissions on the matter, you should think carefully about the coherence of the tax system and how much complexity we are introducing. We’ve got another two weeks until submissions close on 12th July. And I’d urge people to do so.

Fighting tax crime

Earlier this week, the OECD released a report called Fighting Tax Crime – 10 Global Principles following a meeting of the heads of tax crime investigations from 44 countries. There are 10 principles which they describe as “essential legal, institutional, administrative and operational mechanisms necessary for putting in place an efficient system for fighting tax crimes and other crimes”.

There’s quite a lot of detail in this report to unpick. The report includes 33 country profiles detailing each country’s domestic tax crime enforcement frameworks and the progress each country has made in implementing the Ten Global Principles. Now, New Zealand is one of those countries, and its chapter makes for some very interesting reading.

The first principle is that there is a criminalisation of tax offences and that countries have to have a legal framework put in place to ensure violations of tax law are categorised as a crime and penalised accordingly. Now, tax evasion is money laundering, and it should be well known that it was tax evasion which led to the notorious gangster Al Capone’s downfall, as he was jailed for tax evasion, a.k.a. money laundering. There are some interesting stats here, but they’re not quite as comprehensive as you might expect to see: the numbers in the report only go back to 2016.

But throughout the report, there’s some very interesting snippets. For example, the report mentions the tax gap, that is the difference between what tax should be expected to be collected and what actually is collected. The report notes that New Zealand does not calculate an overall tax gap. That’s actually not out of line with other countries. Some countries can report on what they think the GST or VAT gap is, but generally not every country can say “We’ve got a reasonable idea of what the tax gap is”.

The report then goes on to say that New Zealand has estimated that on average, the self-employed population under-report approximately 20% of their income. That’s quite a statement. You’d then be thinking “Well, what is Inland Revenue going to do about that and how much might that be?”  In Australia, for example, they estimate their tax gap is about AU$31 billion, or about 7% of the tax take. A similar number here in New Zealand would be over NZ$5 billion, however that’s thought to be unlikely because unlike Australia, we have a very comprehensive GST. But the Tax Working Group did take into consideration a number of around between $850 million and $1 billion dollars annually.

The country reports discuss various principles, like a strategy for addressing tax crimes, investigative powers, the ability to freeze and seize and confiscate assets, and it notes between 2015 and 2019 New Zealand authorities seized $90 million dollars of assets in connection with criminal tax matters. And in fact, one of the highlights for New Zealand in this report was we have a strong legal framework for recovery of assets related to tax crimes.

The questions in my mind start to arise, and I disagree with the report on this particular point, is around Principle Six – adequate resources. The report notes that Inland Revenue’s hidden economy work for the year to June 2019 raised $108.8 million of tax revenue. And it notes

“[Inland Revenue] has no staff dedicated entirely to tax crime investigations, but rather maintains an agile workforce of specialist accountants and lawyers who operate under broad rules, enabling them to investigate tax crime cases either referred to them a suspected tax offending or revealed a suspected tax offending in the course of standard audits.”

That is the process, but the statement is a little too pat for my liking. And the question that keeps coming up in my mind is, is Inland Revenue directing its resources appropriately? Because when it’s saying, “We think the self-employed are underreporting 20% of their income” my question is, “What are you going to do about that?” And if you follow the money in the budget appropriations and you see that the investigations budget has been cut by $10 million, a cynic might answer “Maybe not enough”.

One of the things that the report suggested New Zealand could do better would be using enhanced forms of cooperation such as secondments and colocation of staff and joint intelligence agencies and centres. That actually would be helpful in terms of also working with anti-money laundering. I have my reservations about that, but we shall see.

Valuing business assets

Finally this week, there’s a new set of tax rules coming into place on 1st July in relation to how business assets are valued when they’re sold. And these are what we call the purchase price allocation rules. These rules apply to the sale of assets such as commercial property, forestry, land or business.

What the new rules do is make it clear that both the buyer and seller have to make the same allocation, the rules set out a process that must be followed. And if they can’t balance an account, agree on an allocation, they will have to notify Inland Revenue who they then make the allocation for them.

The idea is to bring consistency to agreements for the disposal of acquisition of property in businesses. What was happening was buyers and sellers were adopting different allocations for assets that were sold. This process would mean then for a vendor, allocating as much to tax free capital gain, such as goodwill, was to be preferred. Whereas for the purchaser, they’d want to be allocating as much as possible to taxable and depreciable assets because then, for example, stock and fixed assets, they can then expense or depreciate.

There were various estimates about how much this might be costing the Government – up to $50 million dollars a year was one estimate. The result was these rules have been introduced and take effect from 1st of July.  They’re not terribly popular because they add a lot of detail and complexity to a process which is already quite stressful.

But the key thing is if you’re selling or purchasing a business you will need to pay more attention to what’s happening and how you’re allocating the costs between the various asset classes. The rules also apply to sales of residential land for $7.5 million or more, but only if neither buyer nor seller is an owner-occupier in relation to the land. As I said these rules are effective as of 1st July.

Well, that’s it for this week. I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts.  Thank you for listening and please send me your feedback and tell your friends and clients. Until next week ka kite āno!

Don’t end up in court for tax evasion

10 May, 2019 | The Week in Tax

  • How not to end up in court defending a $4m tax evasion charge
    – Investigators from Inland Revenue should not be under-estimated as they are highly skilled, motivated and are looking for pattens e.g. gross profit ratios for similar businesses.
  • Welfare Expert Advisory Group Report released
    – Up to $5.2 Billion pa needed to overhaul New Zealand’s social welfare system to incentivise people back into work among other changes
    – Tax implications for clients claiming Working for Families Tax Credits. Major changes proposed around amounts paid and abatement rates.
  • Problems with overseas mortgages and investments
    – These are part of the FIF regime – a topic so complex there’s no Inland Revenue guide to it! Due to changes in currency exchange rates income has arisen so the £ mortgage value hasn’t changed but the equivalent in NZ$ has created a change in relative valuation. There’s hope on the horizon.
  • Inland Revenue business transformation release 3 has gone live – the team apparently consumed a significant volume of pizza and chocolate!

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