When Harry met FATCA

Let’s talk about tax.

Or more particularly let’s talk about the taxation of US citizens living abroad.

I just love the Royal Family. Yeah I know it goes against any and every possible progressive and egalitarian ideal I hold but phish.

I grew up reading my grandmother’s Women’s Weekly and their coverage of Princess Anne’s (first) wedding and the Silver Jubilee. Over time this progressed to Diana, Fergie and their babies. And the Womens Weekly became the Hello magazine. Complete with Princess Beatrice aged two at a society wedding. So good.

And season two of The Crown has landed. Brilliant. I mean seriously- what about Philip?

Of course season one was dominated by the spectre of the abdication of a King who wanted to marry a divorced American woman. As well as the sister of the Queen who wanted to marry a divorced man.

So it was with every sense of delighted irony that I watched the recent engagement of Prince Harry to a divorced older mixed race American woman. Whose father might be catholic. ROFLMAO.

And my delight became complete when the Washington Post pointed out Meghan and Harry’s children will be subject to FATCA and US residence taxation. Oh and I have been meaning to write about the joys of US citizen taxation since like forever. So finally here was my angle.

The British Royal family – the gift that keeps on giving.

First key thing is that all people born in the United States or born to at least one US parent – like Harry’s children will be – are US citizens. And at this point such people who don’t live in America can get a little over excited. I can work in America woohoo. No green card or resident alien stuff for me! Transiting through LAX will be a breeze.

All true. But much like the British Royal Family – US citizenship is also the gift that keeps on giving.

Now dear readers we have covered tax residence of individuals before. The tests that determine whether a country can tax on the foreign income of its inhabitants. And most countries have some version of the being here or owning stuff rule to work out whether someone is tax resident.

But thanks to American exceptionalism they go one step further. The US applies residence taxation to its citizens even the ones who don’t live there. So with foreign income and US citizens it is now possible to have the country of the source of the income, the country of ‘main’ residence and the US in the mix. So for Harry’s kids: with that Bermuda dosh: there could be Bermuda; United Kingdom and the United States all with their hand out. Just as well Bermuda not big on taxation. Such a relief. That is if Hazza pays tax in the first place.

Now for lesser New Zealand mortals who might be born in the US or have a Meghan Markle equivalent mum or dad: the US/NZ tax treaty is kinda important. And if they have income from any other country that country’s US treaty will also be your friend.

Because in all those treaties is a nifty little clause called Relief of Double Taxation. Aka such a relief – no double taxation. So let’s look a a situation where a New Zealand tax resident with a US born mum – NZUSM – earns $100 Australian interest income. Australia will deduct 10% tax or $10. New Zealand will also tax that income and another $23 ($33-$10) tax will be paid in New Zealand.

Then – because who doesn’t love a party – so will the United States. Giving an Australian tax credit of $10 and a New Zealand tax credit of $23. Depending on the US tax rate for the NZUSM – they will have to pay more tax; pay no more tax; or get surplus credits to carry forward.

Now for something like interest or any other income source New Zealand taxes; this is just annoying. Maybe a bit more tax to pay but not the end of the world.

The full horror comes when NZUSM has types of income that the US taxes but NZ doesn’t. You know like capital gains? Taxable in the US. And the horror becomes squared when NZUSM realises that the US uses its – not NZ’s – tax rules and classifications to calculate the income. Who would have thought?

So that look through company or loss attributing qualifying company where income has been taxed in hands of shareholders – treated as company the US – maybe not so clever after all. Coz what about a LTC loss that was offset against the taxable income of NZUSM – coz it is all like the same economic owner? US – no loss offset allowed – full tax now due. In the US the LTC is discrete NZ company. Nothing to do with NZUSM.

And then of course there is FATCA. For like ever the US has a requirement that its foreign based citizens report their balances with foreign banks. Now quelle surprise – compliance wasn’t great. So the US then said they would collect the information from the foreign banks directly and if they didn’t comply they’d impose a 30% tax on fund flows from the US. Did concentrate the mind somewhat.

Now the US is using this information to enforce compliance. And the NZUSMs of the world are not best pleased. Finding out there was a dark side – albeit one pretty well known – to the whole I can work in the US thing. Unsurprisingly there is a wave of people seeking to renounce their citizenship. Alg except the tax thing goes on for ten years after such renunciation. And such renunciation can’t be done by parents for their children.

So while Harry may have finally found his bride; he has also found the US tax system. What could possibly go wrong?

Andrea

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My fair tax review

So the details of this government’s tax review is out.

Depending on who you read it will either be revolutionary or not radical.

Now even though this blog has come as a response to the Left’s – and fairness’s – relatively recent introduction into the tax debate – I couldn’t see anything I could competently add to the random number generator that is the current public discussion. That was until I read one commentator – who actually understands tax – talk about the last Labour government’s tax review – the McLeod Report.

He referred to that report as having analysis that stood up 16 years later. And with the underlying analysis found in the issues report I would wholeheartedly agree. But in terms of the recommendations in the final report I would say, however, that it was very much of its time.

And by that I mean that while the issues report fully discussed all issues of fairness/equity as well as efficiency – when it came to the final report efficiency was clearly queen.

Now by efficiency I am meaning ‘limiting the effects tax has on economic behaviour’. And fairness as meaning all additions to wealth – aka income – are treated the same way.

The tax review kicked off in 2000 at about the same time I arrived at Inland Revenue Policy. In early 2000 there was:

  • No working for families
  • No Kiwisaver
  • Top personal tax rate was about to increase to 39% but with no change to company or trust tax rate
  • Interest was about to come off student loans while people studied.

That is the settings generally were the ones that had come from the Roger Douglas Ruth Richardson years.

Also in tax land the Commissioner was having a seriously hard time as the Courts were taking a very legalistic attitude to tax structuring. High water mark was a major loss in 2001. And unsurprisingly in such an environment the banks had started structuring out of the tax base. But it would be a while before that became obvious.

Housing was affordable. Families such as mine could be supported on one senior analyst salary – and live walking distance to town.

The tax review was headed by a leading practitioner Rob McLeod; and had two economists, a tax lawyer and a small business accountant. One woman. Because that is what progressive looked like 2000.

And so what were their recommendations/suggestions?

No capital gains tax but an imputed taxable return on capital This one is both efficient and fair. And did materialise in some form with the Fair Dividend rate changes to small offshore investment. It is the basis of TOP tax proposal. At the issues paper stage it was proposed to include imputed rents but the public (over) reaction caused it to be dropped. Interestingly it is explicitly out of scope with the Cullen review.

Flow through tax treatment for closely held businesses and separate tax treatment for large business

What this is about is saying entities that are really just extensions of the individuals concerned should be taxed like individuals not the entity chosen. This is effectively the basis of the Look Through Company rules – although they are optional. It means the top tax rate will always be paid. But it also means that capital gains and losses can be accessed immediately.

Now this is definitely efficient as the tax treatment will not be dependent on the entity chosen. And it is also arguably fair for the same reason.

It does mean though that if a company structure is chosen and the business gets into trouble: the tax losses can be accessed as it is effectively the loss of the shareholder but the creditors not paid because it is a separate legal entity. Which probably wouldn’t exactly feel fair to any creditor.

But all this is unreconciled public policy rather than the McLeod report.

Personal tax scale to be 18% up to $29,500 and 33% thereafter.

The tax scale at the time ranged from 9.5% to 39% at $60,000. The proposal would have had the effect of increasing the incentive to earn income over $60,000 as so would have been more efficient than the then 39% tax rate. As the company and trust rate were also 33% it would have returned the tax nirvana where the structure didn’t matter.

However it would have increased taxes on lower incomes and decreased taxes on higher incomes. So while efficient – not actually fair according to the vibe of the Cullen review terms of reference.

New migrants seven years tax free on foreign income

At this time our small foreign investment – aka foreign investment fund – rules were quite different to other countries. While we didn’t have a realised capital gains tax – for portfolio foreign investment we could have an accrued capital gains tax in some situations. This was considered off putting to potential high skilled high wealth migrants. So to stop tax preventing migration that would otherwise happen; the review proposed such migrants get seven years tax free on foreign income.

This proposal was the other one that was enacted with a four year tax free window – transitional migrants rules.

And again a policy that is efficient but arguably not fair. As the foreign income of New Zealanders in subject to full tax. However Australia and the United Kingdom also have these rules that New Zealanders can access.

The logical consequence though is that no one with capital lives in their countries of birth anymore. And not sure that is ultimately efficient.

New foreign investment to have company tax rate of 18%

Again this is the foreign investment – good – argument. But it ultimately comes from a place where foreign capital doesn’t pay tax because it is from a pension fund, sovereign wealth fund or charity. Or if it is tax paying that tax paid in New Zealand doesnt provide any form of benefit in its home or residence country. So by reducing the tax rate by definition this reduces the effect of tax on decision making.

However doesn’t factor in the loss of revenue if there are location specific rentswhich aren’tsensitive to tax. And not exactly fair that domestic capital pays tax at almost twice the tax rate. Unsurprisingly didn’t go ahead.

Tax to be capped at $1 million for individuals

This again comes from the place of removing a tax disincentive from investing and earning income. Yeah not fair and also didn’t go ahead.

Restricting borrowing costs against exempt foreign income

This was the basis of the banks tax avoidance schemes that ended up costing $2 billion. It is only briefly mentioned in the final report with no submissions. It is to the review team’s – probably most likely Rob McLeod – credit that it is there at all. This proposal was both efficient and fair. Stopping the incentive to earn foreign income as well as making sure tax was paid on New Zealand income.

It will be very interesting to see where this review comes out with the balance between efficiency and fairness. Because both matter. Without fairness we don’t get voluntary compliance and without efficiency we get misallocated capital and an underperforming economy. But the public reaction to the taxation of multinationals and ‘property speculators’ would indicate a bit more fairness is needed to preserve voluntary compliance.

And as indicated 16 years ago – taxation of capital is a good place to start.

Andrea

Moral and Fiscal Failure – the extended dance remix

Let’s (not) talk about tax.

Let’s talk about the disaster that is our criminal justice system.

I have a number of tax things in my head atm. Past tax reviews, US tax proposals and GST on online shopping. Not to mention the slow burning IRD restructure where the top people in Investigations are either being offered their jobs back at up to $20K pay cuts (Senior Investigators) or have to apply for their jobs with up to $20k pay cuts (Principal Advisors).

Two highlights being:

  • Less capable staff getting their performance ratings increased because their untouched salaries are now a higher percentage of the lower new top salary;
  • The psychometric testing assessing one of the department’s best of best technical people as having ‘difficulties with abstract thinking’.

But that will take a while for the effects to unfold on the tax base.

What is very now is our bursting prison population. As a consequence of political and community over reaction to sentinel events the Ministry of Justice sees a possibility of the prison muster hitting 12,000 in the next three years. Awesome. What tax IRD still collects can go directly to Vote Corrections. Suppose that is efficient.

So with all this in mind minus the tax stuff, me and my friends at JustSpeak have produced a Briefing for Incoming Ministers. Worth a read.

Andrea

‘It’s a long way to paradise from here’

Let’s talk about tax.

Or more particularly let’s talk about non-resident trustees and the non-complying trust.

Like Ivanka Trump I had a punk phase.

Unlike Ivanka mine was actually punk and not grunge. And lasted longer than a day. Largely consisted of having orangish spiky hair from late seventh form until I had to get a real job as an accountant. And yeah ‘ real job as an accountant’ not very rock and roll. But I could do the safety pin in my ear thing – albeit through my piercing. And I just loved the music. Still do.

So much so that when the Paradise Papers broke – 30 years after I grew out the spikes – all I had in my head was the Stiff Little Fingers.

And the paradise reference now is not to an alternative Ulster. It is to Bermuda.  A sunny place for shady people. Oh and the Queen.

So from British Virgin Islands to Panama to Bermuda. From Portcullis to Mossack Fonsceca to Appleby. The ICIJ strikes again. Well done boys. Rich people investing their money through complex structures involving sovereign Island nations.  

Now of course investing in such places is only illegit if it conceals income that would otherwise be taxable somewhere else. And as for HM; she is a voluntary taxpayer – oxymoronic I know – so anything she does is totes legit. For everyone else it must be the amazing fund management service that Bermuda offers. Coz you know London is such a backwater.

But what does this all mean for New Zealand? To me this is a far bigger deal than the foreign trusts. With them our reputation was at risk. Here actual New Zealand tax could be at risk.

But first some background. Breathe and take it slowly. Rest when you need.

New Zealand’s trust rules

On the whole New Zealand – like pretty much all OECD countries taxes tax residents on New Zealand and foreign income and non-residents on New Zealand income only. And the corollary of that is not taxing the foreign income of non-residents. Which is a shame as you don’t get a bigger tax base. But mutually assured distruction if anyone tried.

So far so good. But issues abound when income is earned through companies or trusts and not directly by a real person. Maybe dear readers a good time to go back and refresh.

Now with trusts there is the person who hands over the dosh to the trust – settlor; the person wot legally owns the dosh – trustee and the person for whom this is all for – the beneficiary.

Anyone of them would be a reasonable target for the ‘who should we tax’ game of residence. Most countries target the trustee. As that is the legal owner. New Zealand targets the settlor. As they apparently call the shots. Which does seems bordeline fraudulent given they have given away legal ownership. But I digress.

All which is how foreign trusts generally have resident trustees. A foreign trust – and the associated foreign sourced income exemption – only happens if it is settled by someone who isn’t a New Zealand resident. So the foreign bit relates to the person putting the money into the trust rather than the legal owner; income source or beneficiary. 

Distributions are tax free to foreigners; to New Zealanders just their normal tax rate.

The other two types of trust are:

Complying trust. Effectively full residence taxation with the wheeze that if tax is paid by the trustee; distributions can come out tax free. This is all trusts with New Zealand settlors and New Zealand trustees. Or New Zealand settlors and foreign trustees who have elected to be a complying trust.

Non-complying trust. A trust that isn’t a complying trust or a foreign trust. Effectively a trust with New Zealand settlors and foreign trustees. The potential world of the Paradise Papers.

Now distributions to New Zealand residents from a non-complying trusts are taxed at 45%. And there is often a view that so long as you don’t distribute there will be no tax consequences. Maybe. Except for:

Distributions – like dividends – have a transfer of value definition. So let’s say under a trust deed you get you to use a house rent free and that house is in a trust settled by a non-resident. Then the value of that stay is taxable at normal tax rates if it is a foreign trust. 45% if a New Zealander has given the trust any dosh as well and it is a non-complying trust. Have to assume Mojo Mathers was 100% comfortable with her tax compliance when she told her story.

Taxation of foreign income is still a thing for non-resident trustees if a New Zealander has made a settlement after December 1987. Now you might think hah – the trustee is offshore – bah hoo sux Mrs Commissioner. Well you might think that but you would be wrong. New Zealand settlors are liable – as agents – for that tax.

But surely no New Zealanders are involved?

Well that might be true. The past incarnation of this – Portcullis – picked up a Green Party donor. Now he admitted to the Trust but as he was based in the United Kingdom potentially no tax issue for New Zealand. There is also an unnamed blog that details quite interesting tax behaviour of people who look awfully like New Zealanders. And last time in 2013 IRD was pretty hot on it all. 

Can we improve the situation?

Absolutely we can dear readers. Thanks for asking. 

Disclosure

Now IMHO it is completely insane that there is no form of disclosure of settlements or interests in offshore trusts. Now the underlying law is pretty ok but should we have to rely on the ICIJ to get tax compliance? Taxpayers know if they have these interests but Inland Revenue would have no clue without the ICIJ.

There are disclosures of interests in foreign companies and now foreign trusts have to tell IRD about their inner workings. But offshore trusts of New Zealanders who just might be hiding things. Nowt.

Now there is the argument that if people want to be deceptive they also won’t disclose. And that is true. But all these people will have tax agents who as part of their compliance will need to ask each year if they have any. This will give them the opportunity to explain the law and the risks. And yeah they might lie to their agents too. But this is all narrowing the non-compliant group who then become super at risk next time ICIJ gets busy.

And this may even help our National Accounts. Coz you know that thing about how New Zealanders don’t save? Maybe some of this lost money is in an undisclosed offshore trust? Just maybe.

Inland Revenue Capability

This stuff is just hard. And in a world where the department is salary cutting or simply disestablishing the jobs of the people that can do this work; I am nervous. Service just won’t deal with these people. Hard nosed enforcement is needed. Please Hon Stu fix this.

Exchange agreements

Over the last ten years or so officials in OECD countries have been signing Tax Information Exchange Agreements with countries formerly known as tax havens. Wonderful PR for Ministers who look like they are actually doing something.

And when this all broke I thought cool; the Bermuda TIEA could be used. Except while it was signed in 2009. It is not yet in force. Ie we are totally on a promise until that happens.

Now Hon Stu. Your colleagues are busy sorting out the messes from the last government. Looking forward to you fixing this after you have sorted out the restructure.

Because until this is all done, without the ICIJ, offshore Trusts really can be paradise for New Zealanders who want to hide.

Andrea

Cold as charity

Let’s talk about tax.

Or more particularly let’s talk about how charities don’t have to distribute.

Well dear readers the countdown has started to becoming a grown up again. Have been doing the ‘coffee thing’ and put my first real paid job application in on Friday. Most importantly checking my work clothes still fit after a year in active wear. And trying to blot out the horror that is womens work shoes. Not big on shoes at the best of times. Must be why I like yoga.

Now whether our remaining time together is long or short is out of my hands. But I’ll try to get up to date on some of the things I have been promising and not delivering on. And today is Charities. My past ramblings can be found herehere, here, and here

Sometime pre Jacinda Matt Nippert started a series of articles on charities. The last one was all about how charities don’t actually have to distribute to worthy causes to be a charity. The highlight of the article was of course the quote from your correspondent that this was not a good thing. All about the value add me.

So today dear readers the explanation. You get how it is that even though charities get an income tax exemption and a one third subsidy on their donations from the people of New Zealand – the dosh doesn’t actually have to get to the people the charity is serving.

And as a special bonus issue you also get how businesses don’t even have to be registered with Charities Services to get the tax exemption. So good. No wonder we have so many charities in New Zealand.

Let’s start with that.

Section CW 43 makes business income tax exempt if it is carried out directly or indirectly for the benefit of a charity. What the indirectly thing means is a company or other entity owned or controlled by a charity.  And yes the charity has to be registered but no actual like requirement that any subsidiary company is.  But it has to be for the benefit of the charity though. So maybe that means the dosh has to flow up to the actual charity?

Well maybe dear readers. Remember how with accounting tax expense – this was tax that would need to be paid at some stage? Yeah well it is kinda similar here.

The lead case on all this stuff is an Australian one called Bargwanna. At least 4 courts over at least 10 years with shambolic facts and varying legal arguments. While the Commissioner ultimately won the case and the trust was found not charitable; it was a somewhat pyrrhic victory. As along the way the ATO lost its long held view that charities had to distribute its funds in order to be a charity. That is the word applied as in applied to a charitable purpose didn’t mean distribute but more a vibey thing of consistent with its trust deed. Oh and of course it never meant distributing its capital. I mean steady on.

Now while this might be all beautifully consistent with twelve thousand million years of trust jurisprudence; it does IMHO rather take the taxpayer for a mug. Remember the donations tax credit. Remember how for every three dollars you give a charity the government gives you one dollar back? 

Now that donation could be considered capital by the charity. So no need for it to go anywhere except infrastructure  – or an investment base on which income will also be taxfree – for the charity.  And imagine if that were a charity you set up and controlled yourself? Knighthoods anyone?

Or alternatively maybe tax preferences – donations tax credit and all – are given to charities not so they can create beautiful balance sheets in perpetuity; but maybe it is to support them doing good things for the community? And yes I know it does include the advancement of religion – thank you Brian Tamaki. But maybe?

Now of course in New Zealand our word is benefit rather than applied. But not really much comfort as benefit is arguably looser than applied. So tax free income of charity businesses can continue to roll up and support the charity business’ balance sheet just so long as it benefited the charity in some undefined form.

But applied does turn up somewhere. It turns up in the deregistration tax for charities. All through consultation and the legislative process the deal was that the tax would apply unless the net assets were distributed to another registered charity.

Except at the last minute as a drafting matterdistributed became distributed or applied. While this may not have much effect in practice; it does mean that charitable companies who were previously registered with the Charities Commission and then deregister won’t have to pay the tax and won’t have to distribute their assets. Because their assets are by definition already applied for the benefit of the head charity.  Awesome thanks Bargwanna. Still tax exempt under section CW 43 and no more nasty public disclosure with Charities Services.

To be fair though – more an issue of the underlying mess that is our tax and charites law than the addition of the word applied. 

Now the last two governments have got close to the whole charities and businesses thing and then run away. No actual sign it is even on the radar with this one. 

Maybe once they’ve fixed the housing crisis?

Andrea

Alignment again

Let’s tax about tax.

Or more particularly let’s talk about Australia’s proposal for a reduced tax rate for small business.

Ok yes I am excited. A new government. A Labour led government. And a young woman as a Prime Minister. Mostly what I hoped for as I climbed the millions of steps to door knock in Wellington. My left leg is almost recovered too. Thanks for asking.

And as if all of this wasn’t exciting enough two of my young friends Talia Smart and Matt Woolley won the Robin Oliver tax competition. Talia on Charities and Business and Matt on the integration of the company and personal tax. I hope to cover their papers once they become public.

Oh and Stuart Nash has won the pools and become Minister of Revenue.

So big congrats to Talia, Matt and Hon Stu. Expecting great things from you all.

We should hear about the tax working group soon. A group that as well as looking as the fairness thing for tax is also looking at housing affordability. And as of today is now looking at whether small businesses should have a lower tax rate. Like wot Australia has.

Now as hadn’t really paid any attention to this dear readers now seems like an opportune time to have a look. Apparently in 2016 the Australian government reduced the tax rate on companies with a low turnover who were in business like this:


Then they said in future years the threshold for what is small will go up and the tax rate will go down:


And then just to be fun, they introduced but didn’t pass another bill which would have reduced rates for everyone ultimately. At this point I just thank the tax gods I live in New Zealand.

Now there is a thing that if the turnover is more than 80% passive income – dividends and the like – the lower rate doesn’t apply. But 75% alg. And the turnover thing seems to have a group concept in it – so that is something. No splitting up companies – in theory anyway.

Tbh it looks like a fiscal thing. Reducing the company tax rate but it a way that doesn’t all go to the nasty big companies. Some of whom will be foreign. So will cost less than a simple company tax reduction.

Conceptually a tax cut for small business – not nasty big business – what’s not to love? The tax equivalent of free doctors visits. It does have a few downsides:

  • At the margin may inhibit growth. Coz who wants to grow and get a higher tax rate?
  • Incentivise passive holding companies. 80% is still pretty and
  • (You guessed it) incentivise recharacterisation of other  higher taxed forms of income. Aka alignment issues.


As we have discussed before dear readers – alignment matters. Whether it is misalignment of the trust and top rate or the company and the top rate. Income will gravitate to its lowest taxed form. Now if that income stays in the company and helps it grow. Alg. Effectively a tax subsidy for small business who might use this money to – say – help offset the higher minimum wage.

But it also might further incentivise the whole ‘salary at $70k’ thing; an overdrawn current account; and dodgy as dividend stripping. Because with small business the corporate veil in practice is pretty thin. The shareholders, the company and the senior employees are all the same people. And as we saw last week, small business isn’t as tax pure as maybe first thought.

The tax avoidance provision will help but is no way to run a tax system. Maybe we’ll need some tighter rules on getting money out of a company. That has merit regardless.

Will be interesting to see what the working group thinks about it.

Andrea

Stripped for action

Let’s talk about tax.

Or more particularly let’s talk about small business owners not paying the top marginal tax rate.

Well this has all taken much long than I expected.

Getting back to you dear readers. What else could I be taking about? Post election I was ready to go again but then had some family stuff to do. But I am here now.

Election night every part of my body hurt. And that was nothing to do with the result. After 24 years in Wellington – and as an ex runner – I thought I knew about hills. But after a couple of weeks of (almost) daily door knocking when (almost) every door in Wellington was up a vertical incline – I was spent. I was ready for it to be over. Win, lose or draw.

Except it still isn’t over. 

But focussing on what is really important – my body has recovered and family stuff is sorted. So I can think about real tax again.  Not what passes for tax in an election campaign.

Now while I was out destroying my aging body a very interesting paper was delivered at the Law Society’s annual tax conference entitled Dividend Avoidance. In that paper five ways were outlined for owners of closely held companies to get dosh out of their companies tax free. Aka not triggering the dividend rules.

Now this is very interesting for a number of reasons:

  • The rhetoric that small businesses are ‘paying their fair share’ just might not be true;
  • The 5 ways will only be used when have shareholders that earn more than $70k – ie not poor people;
  • Only became an issue when company tax rate became 28% and 


Now before we go through one of the clever – and possibly too clever – ways the top marginal tax rate isn’t being paid; a few building blocks.

BB 1

The imputation/dividend interface should mean that when value shifts from the company to the shareholder; tax not paid at the  company level is paid by the shareholders. Aka #doubletaxationisgross. This includes use of losses. It doesn’t matter how tax is not paid. When it goes to the shareholder he or she should make up the difference.

BB 2

Dividends paid between companies with the same ultimate shareholders are taxfree. Coz same economic ownership so no actual value passing.

BB 3

Capital gains earned by a company can only be passed on to shareholders tax free if the company is liquidated. And liquidation should be kinda big deal. Otherwise a capital gain is simply untaxed income that will get taxed when goes to the shareholders.

BB 4 

The actual market value of the company – goodwill – can only come on to the the company’s books on sale. Accounting standards quite correctly stop companies increasing their accounts for their market value. Too easy to be abused.

BB 5

Shareholders can take money out of their companies at any time. This is done through the shareholder current account. When they take out more money than they have earned it becomes negative or overdrawn. If the shareholder is also an employee they need to pay non-deductible interest on this loan.

But – in theory – this whole drawing more from your company than you actually earn should stop at some point. And then the extra 5c should be paid. Well at some stage.

The other thing to put into the mix is that following the Penny and Hooper case there will be lots of structures where a trust owned the business. You know the last time small business didn’t pay the top marginal tax rate. 

The Law Society paper outlined five ways for small business to not pay the top tax rate. But I am just going to take you through one that neatly springs from the Penny and Hooper structures.

So here we are: a small business owner or professional person with what they thought was a totes legit way of progressive tax scale not applying to them. They’ve paid the back taxes to IRD and yelled at their accountant. What to do now?

Step one Trust sets up a new company – Holding Company

Step two Trust sells its shares in company  – Company – wot earns money to Holding Company  for its market value. This is likely to be significantly above the value shown on Company’s accounts as Goodwill is not allowed in them.

Step three Trust lends money to Holding Company for purchase. For the accountants reading this is Dr Loan to Holding Company Cr Investment in Company. 

Step four Company now pays dividends to Holding Company. And who would have thought -they are now tax free and an intercompany dividend.

Step five Holding Company makes loan repayments to Trust.

Step six Trust distributes to beneficiaries tax free.

Voila! Tax is only paid at the company tax rate. No more risk of extra 5c. And even more beautifully – if tax is not paid at the company level; nothing is paid at all. So good.

Now to be fair this isn’t a permanent tax scheme as only works until loan is repaid. But then maybe the company has further increased in value and can be done again?

But arguably as the ultimate capital gain could be paid out on liquidation – it is simply timing and I should calm the F down? Nah I don’t buy that either. It is structuring into a concession. And what is that called? Yes dear readers tax avoidance.

Now there are a few other things that are kinda interesting here too:

  • Really only became an issue in 2010 when the company tax rate dropped to 28%. By the same government that reduced the top tax rate to 33% because they were concerned about avoidance of the top tax rate. You can’t make these things up.

I can only hope that if we ever get more than a caretaker Minister of Revenue – whomever he or she is – they get onto this stat. Because what is now really clear is that for small businesses earning more than 70k – the top tax rate is optional. 

James – you were right. 

Andrea

Let’s tax this!

Let’s talk about tax.

Or more particularly let’s talk about sugar tax and Jacinda’s announcement about a regional fuel tax.

As of last week my gap year officially ended. Really keen now to go back to being a grownup. Trouble is still don’t know what that looks like. So as a bit of a transition path; decided tutoring tax to lovely young people at Victoria would be a good idea. Had no idea it would require seven hours of training  – don’t ask – before I could get in front of them though. But all over now and three weeks of actual tutoring has now taken place. Hence the transmission silence.

Now the first week of classes included a question on legal v economic incidence of taxation aka who bears the tax aka taxes are gross

And since I last posted the Sugar tax people have done some work and the lovely Jacinda – who may or may not have a baby as PM – has announced a regional fuel tax to fix Auckland. Well transport anyway.

So as this is what passes as topical these days for tax; today I’ll look at sugar and petrol taxes. More similar than you’d think. And both come down to who pays the tax is different to who bears the tax. TAXN 201. 

Now while a sugar tax is but a dream of public health professionals; petrol tax is currently in existence. And unlike GST which cascades; petrol tax is an excise simply applied either at the border or at the refinery. Same applies to alcohol and cigarettes – except for the refinery bit. One off charge to producers or importers which then flows through – or not – to the final consumer. 

Now there is the whole ‘paying for roads’ thing with a petrol tax but fundamentally it is a tax because we can. Petrol – almost like insulin – has a relatively inelastic demand. No or minimal dead weight loss. No triangles. What’s not to love?


And because of this no deadweight loss/inelastic demand, the tax that is paid by the oil company feeds through to the price paid by the car driver. And so my aversion to driving and cars makes it a form of legitimate tax avoidance. Sweet. But otherwise tax is raised with little change in behaviour.

Now a regional fuel tax is interesting. I guess the vibe is that petrol that is consumed in Greater Auckland gets the tax and petrol that isn’t – doesn’t. It could be that the destination can be broadly worked out once it leaves the refinery on its way to the Wiri tank farm. Auckland pipeline or something. In which case it will be a matter of the oil companies adding another set of codes to their computer system. I’m sure that they accept that without comment. Even then there’ll probs need to be a crediting system for fuel delivered outside the taxable region.

Alternatively if it can’t be worked out – then it will have to be charged by the individual petrol station. Possibly by the oil companies when they deliver to them. They’ll enjoy that too.

But one way or another because of our carbon economy, serious money will be raised. Perhaps more buses will be taken but broadly Auckland car drivers will have less money to spend on other things.

On the other hand – the Sugar Tax people’s gig is not that they want revenue raised per se. Although they do have a laundry list of stuff they want the money spent on. More that they want an increased price so that less of it is consumed. Because health reasons. And as someone who has a tricky relationship with the white stuff – am sympathetic. But whether it ends up being a corrective tax with some revenue raised  – like cigarettes – or just a tax grab all depends on the elasticity of demand for it. 

If we turn our minds back to taxes are gross. Wage income has an elasticity of 0.414; non- wage income of 0.909 – source Treasury. While cigarettes have an elasticity of 0.5 – source my aging brain.

Now working on the assumption that sugar is less addictive than cigarettes and less embedded than Auckland car driving; all things being equal there should be less of it consumed. So although it would have a similar structure to a petrol tax  it would be a corrective tax rather than a revenue raiser per se. Although with cigarettes it does a good job at being both. But as is seen with cigarettes the tax has to get to eye watering levels to actually have a significant impact. 

The complexities with a sugar tax all come with:

  • What is taxed? Sugar or soft drink
  • What is the level of the tax? Ultimately a political decision like all taxation.
  • Who collects it? Probably the importers.

Personally I am an agnostic. For people who are really interested in this stuff I’d recommend the recent book co written by Lisa Marriott on this. After reading it: still agnostic. With all taxes the compliance and administration is far more than proponents ever realise. So I’d prefer far tougher regulation on advertising to children before moving to tax. But as part of a package like cigarettes – maybe.

And no removing GST from healthy food is so not the answer. Because rich people spend far more in absolute terms on healthy food than poor people do. And like the whole tax free threshold thing – ends up being a bigger tax cut to the rich than the poor.

Now dear readers you may have noticed that my weekly postings are no longer happening. I am still fairly active on the blog’s facebook page https://www.facebook.com/Letstalkabouttaxnz/ but full blog posts – not so much. Because busy.

Coming up to the election; I have views. And as I am no longer a bureaucrat; will be doing some partisan foot soldier stuff. So maybe a transmission silence until then.

I am however fascinated by what is happening and am seeing parallels to the 1984 election. If I get time I will share that with you.

But otherwise see you all on the other side – of the election.

Andrea

#WeareallMetiria

Let’s talk about tax.

Or more particularly let’s talk about tax, debt and approach to law changes.

Twenty plus years ago I came back to New Zealand a little bit pregnant.  And before 1992  – unless you were in the public service – pregnancy meant (job) resignation. A stage up I guess from marriage or engagement meaning resignation but pretty antediluvian even with today’s – Is Jacinda having a baby? – eyes.  

Parental Leave had come in two years before I came back but couldn’t apply to me as I had left a job in the UK – not New Zealand. I was also more than a little over being an accountant – I was young what can I say – and fascinated by economics. Again young.

So decided I would use this time to retrain as an economist. I mean seriously how hard could raising children be? Again young.  And of course in reality studying was a blissful break from domesticity – not the other way around.

One of the super perks of studying was the Student creche. Super high quality childcare; very reasonable pricing and super flexible. Why sure Andrea: Tuesday 10-1; Thursday 3-5; and all day Friday is completely fine. Please pay by the hour. One child or two? 

And at that creche there were two types of mothers – yes mothers; men appeared only occasionally. There were the middle class married women – like me – late twenties early/ mid thirties doing post graduate work or retraining and then there were the late teens/early twenties single women who were at university for the first time.

The young women had a number of things in common:

  • Straight A students;
  • Determined and resourceful;
  • Highly motivated; and
  • Dirt poor.

The other thing they had in common is that pretty much all of them were lying to WINZ in some form. Part time undeclared untaxed income was very common as was parental financial help. I don’t remember extra flat mates but I am sure that was in the mix. Because resourceful.

But all of this just meant that they could have their kids nits treated as I did, pay rent and eat. Although I do remember one of them brightly telling me that just eating potatoes for a week was an easy way of managing when unexpected bills came in. Right ok.

So in other words they were all Metiria. And the actual amounts of money involved were absolutely trifling. $20 or $30 a week max for a relatively short period of time. But it was the difference between sinking and not sinking. Swimming didn’t come into it.

Of course this was when there was a training incentive allowance to help with creche fees. And while it was post Mother of all Budgets the relative value of the welfare system was more than it is now. So I guess the current generation of young women just don’t go to university. Social Investment anyone?

And from time to time I run into them. Also like Metiria they are now professionals, (re)partnered and have other (step) children. Taxpaying, respectable pillars of society.

Now into this discourse has come Lisa Marriott’s seminal work on how we as a society treat tax evasion v welfare fraud. And I have nothing to add to this. Coz yup she is right. Nailed it.

But the two things I would like to add to the conversation  – assuming there still is one now Jacinda has arrived – is a bit of a comparison with how we treat tax debt and how we treat widespread tax non-compliance.

In the early days of the last Labour government changes were made to the rules governing tax debt. Basically the intent was to get the department to calm the F down in terms of collecting tax debt. The rules were changed so that debt will not be recovered if it:

  • is an inefficient use of the Commissioner’s resources  or
  • would leave a taxpayer in serious hardship.

And note the all important or. Not only should the Commissioner not pursue debt when there isn’t a bang for the buck but even when there is – if it would be unkind. At least these are the rules that apply to Working for Families overpayments.

But looking at some of the cases taken by WINZ, clearly these criteria are not in their legislation.

The other thing that made me realise how differently tax is treated to welfare are situations where there is widespread non-compliance. Either through a misunderstanding with how the law applied; wilful blindless; or a desire to put the past in the past; the law can be changed to make the illegal legal. And at times retrospectively.

Because they are doing it already; not in the forecast; can’t audit our way out or taxpayer friendly. The latter of course meaning friendly to specific taxpayers rather than friendly to taxpayers as a whole. Examples include:

  • Use of tax pooling was allowed in circumstances that weren’t previously allowed for in the legislation;
  • The contingent liability associated with conduit relief was extinguished.

Now these are just a few examples. Most tax bills contain versions of these. And all have good reasons behind them and help make the tax system breathe. I am comfortable with – pretty much – all of them.

But all were at some stage against the legislation. In all cases, at some stage, some people were ‘incorrectly’ on the wrong side of the law. Usually individually or cumulatively with quite large amounts of money at stake. Far more than a trifling $20/ week.

But rather than ruthlessly enforce the ‘incorrect’ legislation; the legislation changed. It changed following representations made to Ministers and officials by affected parties. In the same way I see welfare advocates make similar representations. The only difference is that the tax advocates get listened to. Because structural imbalances. 

So even though tax and welfare are mirror images of each other, this is another case where public policy talks out of both sides of its mouth. And unfortunately as there is little or no overlap between the two worlds; joined up government just means easier detection of welfare discrepancies.

Now finally in case I have been a little too subtle:

To all the people baying for Metiria’s blood – did you ever do babysitting; lawnmowing or car washing when you were younger and not put it on your tax return? I know that is me.

Well that is what tax evasion looks like. We committed a tax crime. We lied to Inland Revenue. FFS #WeareallMetiria.

Should we fall on our swords. No. We should get on with our taxpaying lives. And section 176(2)(b) – the bang for buck provision – quite correctly stops the department from chasing us.

Shame the same approach can’t be taken to Welfare.

Andrea

Right From The Start

Let’s talk about tax.

Or more particularly let’s continue to talk about the IRD restructure.


There are so many things I would rather talk about: how charities don’t have to distribute; exactly what was Roger Douglas going on about; and Labour Party’s family package

But last week’s post was really a rant. And I don’t like ranting. So I thought this week I’d take a more considered look. In large part to work through how exactly had I got Business Transformation just so wrong?

The Business Case signed off by Cabinet was a reasonable place to start. Except didn’t that simply say in the brave new world there would be fewer errors, less manual processing, and fewer IT staff? And aren’t these customer facing people the ones being confirmed in their jobs?

And yes it did talk about a reduction in audit staff because there would be better screening. But that always seemed reasonable. Less low end work consistent with a more knowledge based department.

But then I had a look at what actually said:

Now with the dot point on audit staff, I had thought that level was simply a synonym for number or volume. You know the words that had been used in the other dot points. Using level makes the language less repetitive as any good editor will do.

But looking and thinking again – level is also a synonym for grade or capability. And this is exactly what is happening. A reduction in the pay bands of the senior people is due to a reduction in the capability required across the audit cohort.

HR 101.

So right from the start – the information was always there. Hiding in plain sight. Just as well I am no longer employed for my ability to do detail.

One thing though that is very clear in the restructure is just how important data analytics people will be in the department. So important that in the specialist group only about a quarter of the positions are for tax technical people. So important that it appears the additional technical people referred to in the Commissioner’s press statement are data intelligence people.

Ok. Fair enough. But while these people and the flash new computer could be very helpful in identifying issues; resolving them – not so much. 

So why is the department tilting its focus in this way? Over the last week I have been (over) thinking about this and this is what I have come up with. It’s not great but it is the best I can do.

Everything is ok – and if it’s not – service will fix it

When I rejoined the department in 2015 there was a theme of Right from the Start. This came from OECD work in 2012 of the same name. The gig was simply – for small and medium businesses – it is better for revenue authorities to help them get it right from the start rather than audit non or poor compliance. In large part – stating the flaming obvious but it was a good way to think about allocating resources. I was – and still am – very supportive of this approach.

From time to time I would hear that RFTS could ultimately mean – no audits – for anybody large or small. But as that was just silly I didn’t pay much attention to it. The OECD work after all was all about small businesses for whom the tax law can get a bit overwhelming.  It didn’t apply to the types of big business that actively structure into the tax law.

Or so I thought until last December when the Large Enterprises Update came out using RFTS language. Largely harmless I thought and mostly a rebadging of the long standing direct compliance work undertaken by Senior Investigators in the Large Enterprises section. I then clicked through to the Multinationals Compliance Document. Again largely a standard breakdown of the issues worked on by the section.

What did catch my eye was the foreword from the Commissioner. In it she said:

The 600 largest taxpayer groups, whose tax affairs we review every year, contribute more than $6 billion tax to NZ annually.
But this is no time to rest on our laurels. Internationally there are serious challenges in collecting tax from multinationals. New Zealand needs to play our part in addressing that. And while I am confident that most are paying the tax they should in New Zealand, the public appears less convinced. We each need to conduct ourselves in a way to correct that misperception.

Mmm $6 billion. Possibly includes a large slice of PAYE and GST which is more collected than contributed. But I digress.

Oh right. So everything is ok. Good to know. 

Not exactly sure why then there are at least three discussion documents on the problems with international taxation. And even with all that the Leader of the Opposition is writing to companies telling them to get their tax act together.

Of course who were the people that uncovered the issues in the first place? Yes you guessed it. The audit staff whose level is  being reduced.

But the computer is like really smart

Now the other thing I haven’t really factored in is just how useful a super smart computer will be for finding risks and doing stuff.  And maybe if the lawyers aren’t messed around too much, maybe they with the lower level Investigators – or Customer Compliance Specialists as they will become – can do the job. Particularly if the computer is like totally wicked.

Maybe. 

But computers can’t work without material. And what they currently have for large business is the Basic Compliance package which includes financial statements. This is cool but financial accounts are prepared for their shareholders and it is all about communicating information to them. One company’s accounts can follow a different format and structure to another company. 

So some person at IRD will still need to do something to turn this into comparable information.

In all the BT stuff that has come out – I haven’t seen anything that requires/mandates business information to be provided in a particular format. And in terms of public stuff remember now even Facebook doesn’t have to file accounts. So for big companies IRD has the most information. And that is currently financial accounts following a non-standard format.

But maybe – you know – machine learning or Artificial Intelligence can sort this out. HMRC is apparently getting into it.  In areas that include case work – ‘to enhance decision making’. Great. Good to know.

A tax accountant, however, commenting in that article is less convinced. Because facts and circumstances. 

But then dear readers – much like this tax accountant – let’s just hope it is her lack of imagination. And it is all part of a well thought out plan. Fingers crossed.

Andrea

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