At last week’s International Fiscal Association’s Trans-Tasman conference, a lot of the discussion among New Zealand advisors outside of the seminar rooms was around the state of tax policy. There is a growing concern that a more active government with interventions and proposals such as the proposed zero rating of GST on fruit and frozen and fresh fruit and vegetables is undermining the Generic Tax Policy Process which has been in place for nearly 30 years.
Like many practitioners, I’ve been involved with the GTPP at various stages. It is well-regarded internationally and has operated since 1994. It is intended to ensure
“better, more effective tax policy development through early consideration of key policy elements and trade-offs of proposals, such as their revenue impact, compliance and administrative costs, and economic and social objectives. Another feature of the process is that it builds external consultation and feedback into the policy development process, providing opportunities for public comment at several stages.”
However, the concern is emerging that against this well-established background more recent measures such as the Tax Principles Bill, or the legislation that enabled Inland Revenue to carry out its high wealth individual research project, have happened outside the GTPP framework. The proposed GST zero rating of fresh and frozen fruit and vegetables could be another example. These developments are unsettling the previously predictable process for working through and discussing tax proposals.
I’m of the view that tax is fundamentally about politics and politicians will always make political calls. The GTPP is intended to minimise the effect of that and give more predictable tax policy outcomes. But you can’t eliminate it entirely and this dichotomy between efficient tax policy process and politics will always be there.
There is also the question raised in an interesting story this week by BusinessDesk (paywalled) in reference to the work of the Corporate Taxpayers Group (CTG) about when consultation ends and lobbying begins. The CTG includes the main corporate taxpayers such as Fonterra and the four big banks. The New Zealand Superannuation Fund, the largest single taxpayer in the country, is also a member.
The CTG meets regularly at the offices of Deloitte (more frequently than I had imagined) as the story outlines, and there is an annual membership fee which is to pay for the secretariat, which will make submissions to Parliament and to Inland Revenue.
But when does this move from consultation to lobbying. Very difficult to say. I don’t see it as lobbying although I do appreciate the risks that might be involved in that. But having been involved in the process and been in meetings with CTG representatives, Inland Revenue officials, I don’t believe that’s the case.
But as I said, I can understand why some might be concerned by this. It comes back to a key part of any democracy, and that’s transparency. But on the whole, as I said, I think New Zealand’s been very well-served by the GTPP. And I know that internationally it’s very well regarded because it has got a stability of process to it.
I think one of the issues that’s causing raising concern is because left wing governments are likely to more interventionist. But I do think this situation is exacerbated at the moment because the strain of the boundary between capital and revenue, and our general under taxation of capital, the lack of a capital gains tax, wealth, tax, death duties, are putting strains on the system. And so, politicians are trying to find shortcuts to try and deal with this issue and the need for more revenue. You can dispute how much is needed. But when I look at the state of roads and hospitals and you see the growing bill for climate change, my view is and it’s also the view of Treasury, as I pointed out a number of times, and its Long Term Insights Briefing He Tirohanga Mokopuna we need more revenue.
A whole lot of hissing
So, there are strains emerging and it’s impacting the GTPP, which makes tax advisers understandably a little unsettled about how well that process will continue. As Louis XIV’s finance minister Jean-Baptiste Colbert said in probably one of the most famous maxims about taxation: “The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” That was true in the 17th Century and remains true today. And there is quite a lot of hissing going on at the moment.
The GTPP in operation – consulting on trading stock
Moving on and still on to the topic of consultation and an example of the GDP in operation. Inland Revenue has released a paper for consultation on the treatment of trading stock disposed of below market value.
At present, whenever trading stock is given away, or disposed of for below market value it’s deemed to have been disposed of at market value. The reason for that rule is reasonably solid. It’s to counter potential tax avoidance where the stock is given away or may be used for private consumption by a business owner or sold at a deep discount to associated persons. In some cases, it could apply for a particular industry, exchanges of stock could take place at cost or less. All of those generate benefits in terms of the under taxation of revenue. So that’s why that rule exists.
But there have been instances where businesses have wanted to give away stock and make donations for charitable purposes, and that’s when this rule becomes problematic because they can’t effectively do so. Over time the practice has developed for granting temporary emergency relief in some situations as a work-around.
In 2004 a permanent override was put in place with donations to farming, agricultural and fishing businesses during what is termed an adverse event. And there have been a large number of those weather-related adverse events either for drought or like we’ve experienced this year, flooding.
Between 2010 and 2012, there was a temporary override for 18 months in response to the Canterbury earthquakes. And then again, starting in March 2020, a temporary override was put in place for four years in response to COVID 19.
That override will end on 31st March next year, and the object of this consultation paper, is to propose a more permanent solution rather than using ad hoc solutions whenever we encounter a particular scenario such as COVID or earthquakes.
The consultation paper runs to 29 pages and includes a useful appendix which summarises all the potential summary policy options and how they may play out. Overall, this is a good example of the Generic Tax Policy Process in operation. Consultation on the paper is now open and closes on 6th September.
Managing retreat & how to pay for it.
As just mentioned, temporary emergency relief from the usual stock donation rules has been granted for a number of reasons, including this year, the flooding in January and February and the impact of Cyclone Gabrielle. A constant theme of this podcast is the question of environmental taxation and the need to address the longer-term question of how we going to pay for these climate related events.
Earlier this week a Government expert working group released its report on the question of what’s termed managed retreat.
The report, which clocks in at 284 pages, is very comprehensive and raises a number of potential scenarios and alternative measures that could be needed. One of which, as the excellent Newsroom story covering the report notes, is conditional powers to basically force people to leave particular areas that are under threat.
Being a tax podcast the question we are most concerned about with environmental and climate change impacts is how we are going to pay for it. The report has two key proposals E65 and E66.
But consider this, we have currently 700 homes which have been rendered uninhabitable following the flooding in January and February. And there’s another 10,000 homes that require flood protection. The Government has said it will split the costs over the uninhabitable homes with local councils affected. But, as far as I can tell, neither the councils nor the Government have really fully funded for these costs of maybe a cool billion or so this year and maybe every year and rising. So, it is an issue that needs to be addressed.
The report has some interesting discussion around what happened in Canterbury in relation to the earthquakes and then the first and I emphasise, first, example of managed retreat, from the Bay of Plenty settlement of Matatā
The report says, however we decide to fund this, the funding should not be subject to the usual vicissitudes of the annual budget round because that would mean it would lead deferment and dangerous delay. When it comes to kicking a football down the road, the politicians, as we know, are better than the Football Ferns at kicking it a long way out of trouble. Or so they think, but the issue still remains. I totally agree, therefore, with the report’s recommendation that there has to be a permanent funding solution.
I maintain that if we are going to do something around the lines of environmental taxation, the funds that are allocated to it should be hypothecated, and certainly not form part of the consolidated fund because we’ll then have politicians tempted to raid those funds. We’ve seen this in the recent Auckland Budget Council, by the way, where reserves built up for environmental purposes were used for other purposes.
In terms of holding politicians to account, I think we need to be asking a lot more questions about them on this matter because this is going to affect us all. We’ve had a miserable winter with extensive flooding and the ground is sodden. What happens when the next big floods come along, who pays for the clean-up?
No longer friends with Russia…
At the International Fiscal Association Trans-Tasman conference last week, we spent a lot of time discussing double tax agreements. It so happens, Russia has decided to suspend its double tax agreements with 38 countries, which it considers are now ‘unfriendly’ in the wake of the invasion of Ukraine. New Zealand is on that list. So that probably means that for someone in Russia trying to claim tax relief from under the double taxation between New Zealand and Russia, they’re out of luck and they’re probably going to be facing higher tax bills as a consequence.
TikTok and GST fraud
And finally, just on the topic du jour this week of GST, there’s an absolutely extraordinary story coming out of Australia about how social media influencers on TikTok encouraged at least 56,000 people to take part in a A$1.6 billion tax fraud scheme. Apparently these TikTok influencers explained how to get fraudulent GST refunds. The scam involved obtaining an Australian Business Number, then filing Business Activity Statements (the equivalent of GST returns) and claiming false GST refunds. In some cases, there were attempts to claim refunds of up to A$100,000.
The Australian Tax Office apparently is still grappling with the sheer size of the scandal. There’s a story in the Australian Financial Review about a Victorian woman who managed to stay out of jail, after repeated attempts to try and get A$115,000 fake GST refunds for a dog grooming business that had been set up more than a decade ago but had been largely dormant until 2020 before she attempted to pull this scam.
Fascinating story which will be interesting to see how it plays out. To me it lends support to the suggestion that we should look seriously at zero rating transactions between GST registered businesses. It should be a means of stopping such attempted frauds. Obviously, if that proposal is taken forward, it should go through the proper Generic Tax Policy Process consultation.
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.
Inland Revenue has released a draft interpretation statement on the research and developments loss tax credits regime. This is a refundable tax credit available to eligible companies when they have a loss which has arisen from their eligible research and development expenditure.
The regime was introduced in 2016 to encourage business innovation and also to address New Zealand’s poor record of R&D expenditure. According to OECD data, in 2019 New Zealand’s spending on R&D was just 1.4% of GDP, well below the OECD average of 2.56% of GDP. Over the past 20 years research and development in spending in New Zealand has been a full percentage point of GDP below the OECD average.
So given that we also have a poor record of productivity, increasing R&D expenditure is seen as critical in improving productivity and ultimately the strength of the economy.
That’s the background behind the introduction of the loss tax credits regime. It’s intended to assist the cash flow of those companies carrying out research and development. Often in the early years, these companies are running at a loss. Hopefully once the R&D matures and bears fruit, they will then have profits resulting from the expenditure.
But funding cash flow in those early years is pretty difficult. So instead of the tax losses to be used against future profits, under the regime, companies can instead receive a payment. Note, only companies can receive this R&D tax loss credit payment. That’s because losses incurred by partnerships, limited partnerships, look-through companies and sole traders can already pass those losses through to the underlying owners anyway, who will often be able to offset them against their other income. Essentially, they are already able to benefit from the ability to cash-up losses. But companies can’t do that, hence the introduction of the regime.
The Inland Revenue draft interpretation statement looks at the background to scheme, summarises the rationale for scheme and how it operates. A couple of key points about the regime: you can drop in and out of it, you can opt to choose a payment in one year but not in another year. Once you have claimed a refund by cashing up your losses, the regime operates rather like an interest free loan. You’re essentially required to repay it and it’s generally treated as being repaid when the company starts paying tax, the R&D having borne fruit.
However, there are other circumstances where the credit may have to be repaid earlier when there is, in the terminology of the regime, a loss recovery event. Now, that typically will happen if there’s a disposal or transfer of the intangible property, core technology, intellectual property, etc., which is done for either less than market value or the amount sold is a non-assessable capital gain.
Another situation, and this is actually one where I’ve been involved, is where the company is no longer tax resident in New Zealand. Some very interesting issues arise in that case. Then there’s the worst-case scenario, where a company goes into liquidation although what exactly can be recovered at that point is a moot point. But that’s still a loss recovery event.
And then finally, and similar to our other rules around the carry forward of losses and imputation credits, a loss recovery may occur if there is a loss of the required shareholder continuity. In the case of the tax loss credit regime, the relevant shareholding percentage is 10%. In other words, there’s no breach if at least 10% of the voting interests of the company are held by the same group of persons throughout the relevant period.
In my view this is a very important regime for improving the future productivity of the country. The scale of the spending is going on is quite interesting to see. We can get an idea of this because the Inland Revenue as part of the budget produces what is called a tax expenditure statement.
Tax expenditure statements are a summary of the cost of a particular tax preferred regime, which, like, for example, this regime, has been introduced for specific policy reasons. The OECD collects data on tax expenditures to get a global picture of what spending is going on in tax preferred regimes.
In the case of the R&D loss tax credit, the estimated value of the expenditure for the year to 30th June 2023 is $362 million, a little bit below 1% of GDP. The estimated expenditure for the year to June 2022 was $473 million. And you can see a steady rise since the regime was introduced in 2016.
Of course, the real importance of this regime is whether it has produced a boost in total R&D spending within the economy. And then ultimately, does that lead to increased productivity. It’ll be interesting to measure these once the data flows through in due course.
So, an interesting regime and good to see Inland Revenue give some guidance on this. It contains a few hooks but it’s well worth looking at if you’re thinking about trying to make use of the scheme. And as I said, we will watch with interest to see how it bears fruit.
Shuffling forward on internationalPillar One and Pillar Two proposals.
Moving on, we’ve talked fairly regularly about the OECD’s global minimum tax deal and Pillar One and Pillar Two. Last week the G20 met in India and the Secretary General of the OECD reported to the meeting that, “A historic milestone was reached at the 15th Plenary Meeting of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (Inclusive Framework) on 11 July 2023, as 138 members of the Inclusive Framework approved an Outcome Statement on the Two-Pillar Solution.”
In summary, what’s happened is that they’ve developed a text to a multilateral convention which will allow jurisdictions to exercise a domestic taxing right over the residual profits of the largest, most profitable multinationals. That’s what they call Amount A of Pillar One, and that will apply to multinationals with revenues in excess of €20 billion and profitability above 10%. What will happen is the scope of that taxing right will be 25% of the profit in excess of 10% of revenues. This €20 billion revenue threshold will gradually be lowered to €10 billion after seven years, conditional on the successful implementation of Amount A.
There’s a proposed framework for the simplified reporting application of arm’s length principle, which is key to transfer pricing and for baseline marketing and distribution activities. That’s what referred to as Amount B of Pillar One.
There’s a Subject to Tax Rule, again with an implementation framework, and this is really for developing countries to update their bilateral tax treaties to tax intra group income. This is where such income is subject to lower tax in another jurisdiction, in other words say one country has a 20% corporation tax rate. But that multinational shifts charges to another part of the multinational group in a jurisdiction where those charges are only taxed at a lower rate. This Subject to Tax Rule gives the first country more taxing rights in that income. Developing countries are very keen on this particular point because they feel that this is where the current tax regime has been almost predatory on their tax base.
There will be a comprehensive action plan developed by the OECD to “Support the swift and coordinated implementation of the Two Pillar Solution, coordinating with regional and international organisations”
On the face of it, all pretty much good news. But it’s interesting to read the views of those people who specialise in this field and there still seems to be quite a bit of uncertainty about whether in fact this whole thing will come to fruit.
In the meantime, for example, you’ve got lobbying going on in the United States. And it appears now that the US has managed to secure a further delay in the implementation of the Pillar Two global minimum tax 15% until 2026, according to a report coming out of the United States.
Pillar Two is the key proposal, because it applies to companies with annual revenues in excess of €750 million. Apparently, the US Treasury Department has managed to negotiate a delay in the implementation of this. It has got people watching all around the world as to what’s going on. It also means that the in the background, digital services taxes, for example, could still be ready to be deployed or introduced by jurisdictions if they feel that Pillar Two isn’t making enough progress and they want to secure their revenues. [Under the agreement just announced countries have agreed to hold off imposing “newly enacted” digital services taxes until after 31st December 2024.]
Overall, it’s a bit of a shuffling: one step forward, maybe half a step sideways and a quarter of a step back. In other words, progress is slow, but it’s still inching the way forward. Ultimately, it comes down to watching what happens in the United States and the lobbying goes on. If there’s a change of President next year all bets will be off at that point, I would say.
Smith, banged to rights, again. But should Companies Office be in the gun?
And finally, this week, the murderer and escapee, Philip John Smith, who’s been in jail since 1995 apart from the brief time he escaped to Brazil has now been sentenced to further two years imprisonment on tax fraud charges.
He was convicted for dishonestly using documents intending to gain pecuniary advantage, firstly, a application under the Small Business Cashflow Scheme and then for filing 17 false GST returns and a false income tax return. in total the attempted fraud was just over $66,000 of which was actually paid $53,593. He’s also been ordered to pay full reparations on that amount.
What he did was between October 2019 and March 2020, he registered five companies with the Companies Office with shareholders and directors, who were friends, associates or third parties unknown to him. He then he set up and activated myIR accounts for each company.
But Inland Revenue was quite quickly onto him, it seems, because it apparently detected the fraud involving the Small Business Cashflow Scheme in June 2020 only a few months after it started operating in April. So good quick work by Inland Revenue.
But the case also raises the point which an associate I bumped into this week mentioned, and that’s the actions (or inaction) of the Companies Office in allowing those five companies to get set up. New Zealand scores highly for ease of business in establishing companies. Many times, whenever I’m talking to overseas people, they are remarkably impressed about how quick it is to set up a company in New Zealand.
The question arises if people setting up companies by going directly through the Companies Office website, is it a little bit too easy? Was an opportunity to pick up Smith’s attempted fraud missed at that point by Companies Office? We don’t know. Accountants and lawyers are subject to the current anti-money laundering legislation, so we need to pay attention to what’s going on with company registrations and we have to obtain proof of ID. But my understanding is this process is a little less rigorous when you go directly through the Companies Office.
So good work by Inland Revenue picking it up quickly and catching Smith, again. But maybe some questions should be asked as to whether he should ever have been able to get that far along the line and that Companies Office should have picked it up sooner.
And finally, congratulations to the Football Ferns for their magnificent win last night at the start of the FIFA Women’s World Cup. I was lucky enough to be at Eden Park, which is why I might sound a little hoarse today! It was fantastic to experience such a great occasion even if the final nine minutes seemed like an hour. Congratulations again to everyone involved. Football definitely was the winner on the night!
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.
The big news last week was the release of the official advice to Ministers on tax incentives during the lead up to this year’s Budget. And it was quite a bombshell. Amongst the wealth of material provided was the surprising news that a key proposal had been until quite late in the piece a tax switch where in exchange for introducing a tax free threshold of $10,000, the Government would introduce a wealth tax.
Now, the Prime Minister immediately ruled out the wealth tax and also ruled out any capital gains tax if the government gets re-elected. So to a large extent, all this fascinating material is largely redundant. But it still provoked the continuing debate around the pros and cons of a wealth tax. And in fact, it’s really very interesting to go through the material and see how the policy developed and where they were planning to take it.
The final scheme would have applied a 1% tax rate to net wealth above a $5 million threshold under what was termed an “exemption approach”. This was initially thought it could raise between $2.7 and $2.9 billion annually and would have affected some 46,000 individuals. According to officials the wealth in scope at a $5 million threshold would be about $210 billion
A minimum tax?
Now, in the course of development the proposal started with something called a “minimum tax” under which proposal a person with high wealth would pay tax on the greater amount of either their deemed income calculated as a percentage of the net worth or the taxable income they have under existing income tax rules. The deemed income would have been based on the idea of economic income, which would include unrealised gains. If you recall when the Sapere report and the Inland Revenue High Wealth Individual research project were released, there was a great deal of controversy around this measurement because once you measured economic income and unrealised gains, it appeared the wealthy were paying an effective tax rate of 9%.
This minimum tax was the initial proposal which then got dropped over time. In the course of discussions, they moved away from what they called a “switch approach”. Under this once a person crossed the threshold, then all the deemed economic income would be subject to the wealth tax rather than just the proportion above the threshold.
And this so-called “exemption” is pretty much what we see in other wealth taxes around the world. It appears in the design of the wealth tax officials took a close look at the Norwegian system. One of the other features I found surprising was that the family home would be excluded. It seems to me that the tax preferred approach to the family home, has led to a large amount of overinvestment in housing.
Wealth taxes – profile of potential taxpayers
A key report on a wealth tax contained a very interesting discussion, around which group of taxpayers would be most affected. The projection was the age group which would be most affected at the $5 million threshold was that between 60 and 70. An estimated 2.1% of this group population has net worth over $5 million. According to these statistics, 1.5% of the over 90 year old group would be affected.
But in fact, as you might expect, more than half of the wealth tax would have been paid by the high net worth individuals with a net worth in excess of $20 million.
Officials prefer a capital gains tax
But I think the other thing that came out quite clearly from the papers was that the officials were not at all impressed by wealth taxes. They preferred a capital gains tax.
By the way, the officials view probably reflects a reasonably widely held belief if largely unspoken view amongst the tax community, that if we’re going to tax capital then a capital gains tax is probably the way forward.
Anyway politics intervened again and so a capital gains tax has now been ruled out in their prime ministerial lifetimes by two successive Labour prime ministers. However, as I said to Corin Dann on Morning Report the politicians may rule out capital gains taxes but we’ve got a lot of issues with an ageing demographic and the impact of climate change. The strains on the tax system, which have been recognised by Treasury and its Long Term Insights Briefing He Tirohanga Mokopuna in 2021 recognises that. The issues about needing more tax from somewhere haven’t gone away.
Paying for Cyclone Gabrielle
There were also suggestions as a one-off response to the impact of Cyclone Gabriel, for a levy on the banking sector. There was a comment that the four main banks have persistently “elevated levels of profitability relative to the smaller New Zealand banks and overseas and comparators in part due to the relatively low costs of the large New Zealand banks.” A temporary levy on the banks could raise somewhere between $230 and $700 million. As the Greens noted, Margaret Thatcher of all people did actually impose a surcharge on banking excess banking profits when she was Prime Minister.
There was also a suggestion of a one-off flood levy similar to what was introduced in Queensland following their catastrophic floods in 2010-11. A temporary 1% levy applied to all taxpayers would have raised $1.8 billion. But one only applied to income above $100,000 would raise $250 million.
The quid pro quo – a tax-free threshold
The quid pro quo for a wealth tax would have been a $10,000 tax free threshold. Once again Treasury and Inland Revenue weren’t enthusiastic. They suggested more significant increases in the lower thresholds including lifting the threshold at which the rate goes from 10.5 to 17.5% from $14,000 to $25,000, which is actually substantially ahead of where it would have been if had it been indexed to inflation. However, they proposed lifting the next threshold rate increases to 30% to $52,000. This is the threshold which I think is extremely problematical because of the large jump and at its current level of $48,000 is now well below both average and median wages.
There are two things of interest here. Firstly, a recognition that something has to be done. Tax free thresholds are very popular, but they’re not as efficient is the official advice. Secondly the cost of increasing these thresholds would have been over $4 billion annually. This is an acknowledgement that by not indexing thresholds since 2010, governments have given themselves a permanent headache around having to make threshold adjustments that become increasingly expensive.
A mystery policy?
A tax-free threshold is apparently out of the question. But maybe not because amidst all the papers, there’s are parts which have been redacted. These refer to another policy, whether that was capital gains tax, we don’t know. But whatever it was, it’s been redacted and not been released under the Official Information Act.
We’re now within three months of the General Election and Labour is still to release its tax policy. So maybe there’s something in that hidden part which will be revealed.
Secrecy and the Generic Tax Policy Process
There’s been some discussion that because this was all carried out secretly and outside the Generic Tax Policy Process (GTPP) that maybe this might not have resulted in a terribly efficient tax. I’m less concerned about governments deciding they’re going to do something for electoral gain and requesting work be carried out discreetly. But I do agree that if it’s done outside the GTPP, there is a risk that the design could be faulty. We’ve seen that with the bright-line test and the continual tinkering that has to be done. Worth remembering, by the way, that the bright-line test itself was a surprise. There was no previous consultation before it was first introduced in the May 2015 Budget by Bill English.
I like tax surprises in budgets, and I believe they’re part of normal politics. As I’ve said before, tax IS politics. But I do think that if you look entirely at tax through a political lens, then you start to get this narrow view developing right now where everyone says the politics of raising taxes are too hard, but the economic question of, how are we going to pay for the coming challenges just gets sidelined.
To repeat myself, we have serious issues to address coming up. And my view is if you want to maintain the broad based, low rate approach to fund these challenges, you’re going to have to do something around capital taxation. And the sooner you do it, the better.
Inland Revenue dropping the ball on investigations?
Moving on, one of the officials’ key objections to a wealth tax was the cost of compliance. Inland Revenue would clearly need to increase its capabilities. In its advice on its Initiative Work Programme it commented “the Government’s current tax and social policy work programme will use up most of our specialist design and delivery capacity over the next three years.”
Now the question of Inland Revenue’s operational capabilities came up at the start of last week when it was raised by National’s revenue spokesperson Andrew Bayly.
Following some written questions to the Minister of Revenue, he had determined that the number of investigations conducted by Inland Revenue dropped from an average of 77 a month between February 2017 and October 2020 to only 17 a month between October 2020 and June 2022. Furthermore, the time Inland Revenue spent on hidden economy investigations has also dropped substantially, from 3094 hours in November 2020 to just 805 hours in May this year.
Mr Bayly thinks Inland Revenue is dropping the ball here. Now, he’s tried that for obvious political reasons to Inland Revenue’s work on the High Wealth Individual research project, but that was separately funded. (Incidentally, early drafts of the report were made available to Cabinet as part of the pre-budget preliminaries).
There is an ongoing operational issue, in my view, about Inland Revenue’s investigations activity. And actually, it has acknowledged it has not been doing as much work in the investigations and debt recovery field. Page 36 of its Annual Report for the year ended 30 June 2022 notes:
“We did less work than would be typical in areas such as debt collection, investigations, disputes, litigation and liquidation activity.”
Now, part of this is down to the response to COVID. There were great demands made of Inland Revenue to which it responded superbly. But note the number of investigation hours back in November 2020, which is in the heart of the pandemic, was 3,094 but now it’s down to only 805 hours when we’re supposedly post pandemic, or rather a different stage of response to it. Inland Revenue saying that the fall off in investigations is because it has had to deal with COVID and this year’s weather-related events is not a satisfactory explanation in my view.
And when you start digging into Inland Revenue’s appropriation statements which are published as part of its annual report, you can see the amount spent on investigations for the past five years has fallen quite considerably in absolute terms, let alone when adjusted for the impact of inflation.
Reduced investigation funding
In the year to June 2018, the investigations appropriation was just over $140 million. But for the year to June 2022, it was just over $113 million. That’s a significant drop of nearly 20% in absolute terms.
Inland Revenue investigations appropriation per annual reports.
30 June 2022 $113.235 million
30 June 2021 $124.325 million
30 June 2020 $109.720 million
30 June 2019 $134.706 million
30 June 2018 $140.164 million
So, what this points to is the claims being made by Mr Bayly about Inland Revenue taking its eye off the investigations ball does appear to be backed up by the evidence of where it’s been spending its money. One of the explanations for this appears to be tied into its massive Business Transformation project. Inland Revenue, once it got started on this, seems to have pretty much solely focused on getting it across the line.
Where did the investigations staff go?
Part of Business Transformation included substantial reductions in its headcount, which went from 5789 in June 2016 to 3923 in June 2022. Now, that’s nearly a third of the workforce gone. We also know that although there was a substantial number of staff (nearly 800 apparently) whose sole purpose was simply re-inputting data so it could be used, a large number of very experienced investigation and operational staff were also let go. I know that because I’ve been speaking to a few of them.
Therefore, other tax advisers and agents and I are wondering whether Inland Revenue now has a diminished Investigation capability. There’s also another matter which Andrew Bayly also picked up on, the fact that Inland Revenue has decided to adopt a completely new metric for measuring its investigation performance. That makes you wonder why it’s done that. We won’t know what they’re measuring and how effectively, as the year just ended on 30th June is the baseline for this new metric.
But it’s important in a system that relies on voluntary compliance, there is the expectation by all of those taxpayers who comply that Inland Revenue is making sure that those who are not playing by the rules will be found and investigated. The concern is if Inland Revenue’s capacity to do that is diminished and it’s not fulfilling that role, then the overall perception of the integrity of the tax system is undermined. And that’s not good long term because naturally people will start thinking “That person is getting away with it, so we can too”.
I hope this is something the new Commissioner of Inland Revenue Peter Mersi is paying a lot of attention to. It will be very interesting to see what the department says when its latest annual report is published in October.
Inland Revenue renews its focus on GST
And finally, this week and, coincidentally or not, a couple of days after the story about Inland Revenue’s lack of investigation focus, it posted a warning for tax agents about “Its renewed focus on GST compliance”
Now, you can easily interpret this as an implicit acknowledgement of Andrew Bayly’s criticisms, but it is in fact another sign which we’ve seen steadily emerging that Inland Revenue is now repositioning itself back into what you might call its regular routine.
As usual, we’ll keep an eye on what that means and bring you developments as they emerge.
And 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.
Australian Tax Office ruling on residency – time for a clearer statutory definition?
Applying for Australian citizenship? Watch out for the sting in the tail.
Submissions closed Friday on the Tax Principles Reporting Bill. Now for a bill that doesn’t actually increase the tax rates this has been a surprisingly controversial bill, mainly because it’s actually perceived as being highly political in its ambit in introducing reporting on tax principles. The speed with which with which it has been rushed through is also controversial because normally tax legislation is developed through what we call the generic tax policy process (GTPP). The GTPP is very well regarded around the world.
But every so often, for whatever reason, the process is bypassed. Sometimes as during the COVID emergency because things need to be done immediately. It’s a framework through which New Zealand tax policy has operated for the better part of nearly 30 years. And it means changes of tax policy and of the particular tax treatment of certain items are developed over time through consultation.
Controversy around the Tax Principles Reporting Bill
In this case, the Tax Principles Reporting Bill came out of left field. There’s been very little consultation about it. In fact, we’ve only had barely three weeks between its introduction alongside the Budget and today. So that’s part of the controversy around it.
The other question is what it really is setting out to do. I think most objections will centre around this question of why is this here? The idea of setting out some ideas about what tax principles might be is not unreasonable in itself. But criticism of the Bill is focusing on whether it’s very clear about what it’s trying to do. For example, Inland Revenue is required to report on certain effective principles and whether there are inconsistencies in the tax system with these principles. But then, as several tax advisors have asked, what action will be taken at that point. There is also no acknowledgement that tax policy ultimately involves trade-offs between principles and politics. To be frank, tax is politics.
I’ve seen one or two interesting comments about which agency should be reporting under the Bill. Inland Revenue or maybe Treasury? There are a whole heap of things to consider about the Bill. Although it comes into effect on 1st July, if there is a change of government, it will almost certainly be repealed.
It’s an interesting Bill because it’s attempting to clarify the basis on which we design and operate a tax system. But it’s also flawed because I don’t think it’s has actually achieved that. We’ll see plenty of pushback and I’ll be interested to read the submissions on the bill. (Shortly after the podcast was recorded, John Cantin published his submission).
Australian tax residency
Moving on, I frequently deal with issues of tax residency. It’s a core part of what I do because tax residency determines what sources of income will be taxed in Aoteaora-New Zealand. There are also rules set out in double tax agreements, and one pretty basic principle wherever you go in the world is that if you have property situated in the country, that country gets what we call the primary taxing rights to it.
But individual tax residency is a matter of great practical importance. If a person is resident in the country, then that country can tax them on their world-wide income, and that can have quite significant implications.
The Australian Tax Office (ATO) has just updated and released a tax ruling TR 2023/1, on income tax residency tests for individuals. Australia deems a person to be tax resident in Australia if they reside in Australia under what they call the ‘ordinary concepts’ test, and that includes a person whose domicile in Australia, unless they’re satisfied that they have a permanent place of abode outside Australia.
A person is also resident if they have actually been in Australia continuously or intermittently during more than half of the year of income, unless they’re satisfied that they have a usual place of abode outside Australia and they do not intend to take up residency in Australia. There’s also another series of tests, which I’ve not come across, relating whether or not they’re a member of a superannuation scheme or are covered under the Commonwealth Fund.
When you look at these tests you can see there are quite a few value judgements involved. And so there have been calls for the Australian tax residency test to be put on a more statutorily defined basis, most notably by the Australian Board of Taxation. “The Board’s core finding is that the current individual tax residency rules are no longer appropriate and require modernisation and simplification.”
Now it’s of interest here obviously for people going across to Australia, but also because our own residency test is twofold. The primary test, and this is often forgotten, is a person is tax resident in New Zealand if they have a permanent place of abode in New Zealand. You’ll note that phrase, “permanent place of abode” is actually also used in Australia.
Failing that, there’s the days present test where a person is deemed to be resident in New Zealand if they are physically present in New Zealand for more than 183 days in any 12-month period. There’s a subtle difference there between our days present test and many other jurisdictions in that it is based on a rolling 12-month period rather than a tax year. On the other hand, when you get down to defining a permanent place of abode, that involves quite a number of value judgements.
The current residency test is now over 30 years old. As noted above the Australian Board of Taxation suggested that really the Australian test perhaps should be more clearly defined in statutory legislation. And I’m coming around to the view that maybe that’s what we need to do in New Zealand as well. I’ve seen at least one academic article in the past year that’s picked up on this point.
“You can check out any time, but you can never leave”
Now, why we don’t do that is explained in the Inland Revenue Interpretation Statement on residency. Right now the permanent place of abode test does make it easy for someone to be defined as tax resident, but difficult to lose that.
Notably, the Interpretation Statement does not have an example of a time period of how many years must a person be overseas before Inland Revenue would consider that someone has lost their permanent place of abode.
So, this makes residency a very open-ended issue, which is not terribly good in terms of certainty for taxpayers. It’s become more of an issue in the past 30 years since we introduced the permanent place of abode test in 1989 because as we have seen in the last three or four years, the world’s got a lot more mobile with people moving and working around the world.
This issue of being tax resident here, perhaps inadvertently, is actually something that individuals are concerned about. They obviously want to minimise their tax obligations as far as legally possible. On the other hand, governments know that if you set out very specific tests then people will play to the letter of those rules by watching carefully the number of days present in a country.
A British alternative?
The British residency test, the statutory residence test, actually deals with this day count issue pretty well by specifying what it calls “ties”. Depending on how many ties to the UK you have, whether you’ve been tax resident beforehand and how many days you spent in the previous tax years, then the number of days you can spend in a in the UK in a tax year before you become resident drops.
It’s therefore not as simple as you can spend 182 days and then you’re okay. Each year it drops off quite dramatically and basically at its tightest definition you can only spend 16 days in the UK. Obviously, people will still try and manipulate their timing within these limits but the UK test is much more specific and it gives a great deal of clarity.
And I think in our case, just as the Australian Board of Taxation considers, it’s not an unreasonable objective to be looking at a statutory definition of residency which addresses the concerns Inland Revenue rightly has about people trying to game the system, but it provides certainty for people.
Becoming an Australian citizen – beware the potential tax trap
Still on Australia, there was good news recently that there’s now a pathway for Australia and New Zealanders who live in Australia to become citizens. This is very important for the huge numbers of New Zealanders over there, well over half a million. There is, however, a potential sting in the tail.
People will be aware that New Zealand has what we call a transitional residents exemption, which applies to new migrants or people who have returned to here and have not been tax resident for ten years. Under this exemption their non-New Zealand sourced investment income for the first 48 months is generally not taxable here.
Australia has a similar test if it applies to what they call temporary residents and it applies to most New Zealanders living in Australia. The sting in the tail is that if you apply for citizenship in Australia, you are no longer a temporary resident. What that means in particular is your New Zealand assets here become subject to Australian tax, including capital gains tax. The impact of Australian capital gains tax on New Zealand assets is often overlooked. It’s an issue I deal with regularly.
So that’s the trade off on Australian citizenship. Overall, it’s a good news and it puts people who have contributed significantly to the Australian economy on a level footing. But there is a wee sting in the tail for some. So, approach with caution.
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.
Inland Revenue has released Interpretation Statement IS 22/04 on claiming depreciation on buildings. Critical to this issue is determining the meaning of a “building” for depreciation purposes and the distinction between residential and non-residential buildings. The Interpretation Statement addresses this issue when it sets out when depreciation may be claimed for non-residential building and also for some fit outs. It confirms that no depreciation is available for residential buildings.
The Interpretation Statement then sets out where you can find the right depreciation rate for buildings when fit outs attached to buildings may be depreciable. How to treat an improvement of a building for depreciation purposes. And then finally, what happens when the building is disposed of or its use changes?
To recap, depreciation for all buildings was reduced to zero, with effect from the 2011-12 income year. Back in 2020 as part of the initial response to the pandemic, the Government reintroduced depreciation for non-residential buildings with effect from the start of the 2020-21 income year. Generally, the depreciation rate is 2% on a diminishing value basis, or 1.5% on a straight-line basis. Some other depreciation rates may be used where the building has a shorter than normal useful economic life. Examples would be barns, portable buildings or hot houses. Additionally, it’s possible to claim a special rate if the building is used in an unusual way.
Now for depreciation purposes “building’ retains its ordinary meaning which means anything that is structural to the building or used for weatherproofing the building. The Interpretation Statement emphasises that whether a building is residential or non-residential is an all or nothing test. If the building is non-residential depreciation is available, otherwise not, there’s no apportionment.
Residential buildings are any places mainly used as a place of residence. This includes garages or sheds included with that building. Places used as residential residences for independent living in retirement villages and rest homes are residential buildings are is short stay accommodation where there’s less than four separate units.
On the other hand, non-residential buildings include buildings used predominantly for commercial and industrial purposes, but not residential buildings. This also includes hotels, motels, inns, boarding houses, serviced apartments and camping grounds. Retirement villages and rest homes where places are not being used for independent living are non-residential buildings as is short stay accommodation where there are four or more separate units.
If improvements are made to a building, you must treat it as a separate item of depreciable property in the first tax year. Then you can either continue to treat it as a separate item of depreciable property or simply add it to the building by increasing the adjusted taxable value of the building.
In some cases, a fit out can be separately depreciated depending on the nature of the building and the nature of the fit out. Where the fit out is considered structural to the building or used to weatherproof the building it must be treated as part of building and not depreciated separately. Fit outs are depreciable in a wholly non-residential building and sometimes in a mixed-use building. But remember, the key point is that depreciation is not available under any circumstances for a residential building. So overall, this is a useful Interpretation Statement and is also, as has become the norm, accompanied by a very handy fact sheet.
The agencies tackling organised crime and its tax evasion
Moving on, last week I discussed a suggestion by ACT Party leader David Seymour to use Inland Revenue against the gangs. I looked at the powers available to Inland Revenue and discussed how practical his proposal was. To summarise, Inland Revenue has extensive powers which would be useful in tackling gangs and organised crime. However, this is a resource intensive approach which probably in Inland Revenue’s view, would divert its attention from other areas it considers equally important.
This prompted some discussion in the comments section and thank you again to all those who contributed. As I said, my view is Inland Revenue probably thinks other agencies, such as the Police, are better suited for this activity. But it will cooperate with those agencies. Its annual reports make clear they pass information to other agencies. So Inland Revenue is probably working on this matter in the background.
It was interesting just to take a look to see what other agencies were doing in this space and get a gauge of what’s happening. A key tool for the Police is the use of restraining orders to seize assets. According to the Police’s Annual Report for the year ended 30th June 2021 the value of restraints for the year totalled just over $100 million, including nearly $30 million seized from anti-money laundering.
The Department of Internal Affairs also has responsibilities for anti-money laundering, as it’s a key regulator on that. Its Annual Report to June 2021 indicates that perhaps it could do more in this space, as its budget for its regulatory services for the year was set at $52 million, but it only spent $44 million.
And then when you look at the DIA’s performance metrics, such as desk-based reviews of reporting entities, it’s supposed to be targeting between 150 and 350 such reviews annually, but managed only 219 for the year, up from 198 in the previous year. And on-site visits were meant to be somewhere between 70 and 180 but came in at 79. To be fair these were probably disrupted by the impact of COVID 19.
Still, there are other agencies involved in pursuing gangs including Customs who will also be very interested. Inland Revenue will be playing a role, it shares information with these other agencies. So even if it’s not wielding a very big stick publicly, it’s working in the background.
The interaction of tax and abatements on social assistance
Now tax has been in the news a lot recently with the election coming up even though it’s still just over a year away probably. National and the ACT Party have both set out they would proposed some tax cuts. Last Saturday, Max Rashbrooke, a senior associate at the Institute of Governance and Policy Studies, who has written quite a lot on wealth and taxation put out some counter proposals to National and ACT’s proposals.
He suggested that really the focus should be on middle income earners. And he made a suggestion, for example, that we could have a $5,000 income tax free threshold, something we see in other jurisdictions. Britain’s is just over £12,500, Australia’s is A$18,200 and the US has a slightly different thing. It gives you a standard deduction of US$12,000. But anyway, let’s take that comment elsewhere. And Max suggested that something could be done in that space.
But it got me thinking about the question of who does actually pay the highest tax rates in the country. And the answer isn’t those on over $180,000 where the tax rate is 39%, it’s actually more around $50,000 mark if those people are receiving any form of government assistance, such as Working for Families. If they have a student loan as well, then an additional 12% of their salary after tax gets deducted.
The interaction of tax and abatements on social assistance, such as the family tax credit and parental tax credit can mean in some cases, the effective marginal tax rate for some families is more than 100% on every extra dollar they’re earning. This is an issue which the Welfare Expert Advisory Group touched on, but the Tax Working Group wasn’t allowed to address. But it’s a huge problem.
Take, for example, someone earning $50,000, just above the $48,000 threshold where the tax rate goes from 17% to 30%. And that, by the way, is the rate where I think we need to focus our attention on adjustments to thresholds and tax rates. At that level every extra dollar they’re earning is taxed at 30%. If they’ve got a student loan then they pay a further 12%. If they have a young family and are receiving Working for Families tax credits, then these are abated at 27%. Incidentally, the abatement threshold is $42,700. So that means that that person is on a marginal tax rate of 69%. Definitely not nice.
Then there’s a separate credit, the Best Start tax credit which has a separate abatement regime in addition to the Working for Families abatement regime I just explained. So that’s why people could be suffering an effective marginal tax rate of over 100%.
In my view, this is the area where we really need to be thinking about changing the tax system, because to compound matters, governments have been very cynical about not adjusting thresholds for inflation, something I’ve raised repeatedly in the past.
Working for Families thresholds were adjusted for inflation every year until National was elected in 2008. Starting in the 2010 Budget they started freezing thresholds. They also increased the abatement rate which used to be 20% and is now 27%. The current Working for Families abatement threshold is $42,700, which is less than what someone working full time on the minimum wage will earn annually
Looking at student loans the threshold where repayments start in 2009 was $19,084. That is now $21,268 but for a long period of time under the last government it was frozen. National also increased the repayment rate from 10% to 12% in 2013.
So this is an area where governments of both hues have been really quite cynical in my view, and where a lot of serious thought needs to go in about trying to address the inequities that have arisen. The Welfare Expert Advisory Group suggested the abatement rate should be 10% on incomes between $48,000 and $65,000, then increase to 15% before rising to 50% on family incomes over $160,000. (Yes, large families with that level of income could be receiving social assistance in some instances).
There’s a lot of work to be done in this space and inflation adjustments to thresholds is something that should be done anyway. But I think we need to think carefully around the thresholds and how the interaction with social assistance works. At the moment we’re not getting that sort of analysis from either any of the main parties and that’s disappointing, as it’s something that really needs to be addressed.
Why the FER deals with recurrent taxes better
And finally this week, just hot off the press is an OECD report on Housing Taxation in OECD countries. This makes for some interesting reading. Briefly, the report is concerned about how housing wealth is mostly concentrated amongst high income, high-wealth and older households. And in some cases, they believe that a disproportionately large share of owner-occupied housing wealth is held by this group. There’s been unprecedented growth in house prices, not just in New Zealand, but across the whole OECD, making housing market access increasingly difficult for younger generations.
In terms of suggestions the OECD believes that housing taxes are “of growing importance given the pressure on governments to raise revenues, improve the functioning of housing markets and combat inequality.” The report notes the way housing taxes are designed often reduces their efficiency. Recurrent property taxes, such as rates, are often levied on outdated property values, which significantly reduces their revenue potential. This also reduces how equitable they are because where housing prices have rocketed up, people are underpaying based on current values. And conversely people in places where prices are falling or have been stagnant are paying more relative to those in richer areas.
One of the suggestions the report makes is that the role of recurrent taxes on immovable property should be strengthened, by ensuring that they are levied on regularly updated property values. And this is one of these reasons why Professor Susan St John and I have been promoting the Fair Economic Return approach. One of the strongpoints of our proposal would be strengthening the role of recurrent taxes.
Capping a capital gains tax exemption on the sale of a primary residence
Another proposal would not at all popular. It is to consider capping the capital gains tax exemption on the sale of main houses so that the highest value gains are taxed. This should strengthen progressivity in the system and reduce some of the upward pressures. This is what happens the U.S. There is a US$250,000 exemption on the main home per person, and above that the gains are taxed. There’s no reason why we shouldn’t have a similar type exemption here if we want to introduce a capital gains tax. But as I said, that would be particularly unpopular.
The OECD also believes there should be better targeted incentives for energy efficient housing, because housing, according to this report has a significant carbon footprint, maybe 22% of global final energy consumption and 17% of energy related CO2 emissions.
So, there’s a lot to consider in this report, and we come back to it and consider it in more detail. But again, it sort of comes to this point we’ve talked about repeatedly on the podcast, the question of broadening the tax base and the taxation of capital. These issues aren’t going to go away, particularly when you consider, as I mentioned a few minutes ago, how very high effective marginal tax rates are paid by people on modest incomes who may not have any housing. No doubt we’ll be discussing all these issues sometime again in the future.
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!
