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.
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 here, here, 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 matter – distributed 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
Let's Talk About Tax NZ 