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
- James Shaw inadvertently outed this early this year and was told by the Minister of Revenue – and to an extent me – that there was nothing to see.
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.
Dividends paid between companies with the same ultimate shareholders are taxfree. Coz same economic ownership so no actual value passing.
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.
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.
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.
- Discovered on Investigation. And given how hard this stuff is – taking a wild guess here – by people that Inland Revenue are currently cutting the pay of or making reapply for their jobs. Again can’t make this stuff 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.
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.
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:
- GST registration for body corporates was made optional. Of course meaning will only register if can get refunds;
- Use of tax pooling was allowed in circumstances that weren’t previously allowed for in the legislation;
- Canterbury Earthquake employee accommodation allowances were specifically made tax free;
- crews on super yachts income was made tax free;
- 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.
Let’s talk about tax.
Or more particularly let’s continue to talk about the IRD restructure.
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.
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.
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.
I try to have a policy of not writing when I am angry. And I am currently red hot angry.
I also try to write in a way which joins dots with public stuff so that bigger more powerful people – which is pretty much everyone – can’t have a go. So that was the approach I took when I last wrote about the IRD restructure. And at that stage it was a proposal with staff consultation.
Included in the proposal was that the job I previously did and those of the transfer pricing specialists would be disestablished. There were similar jobs that could be applied for – but with up to 30% pay cuts. Now yeah we weren’t badly paid in #IamMetiria terms. But given we were the technical leaders for most of the big cases in the last decade and compared to the people we were up against – the taxpayer got serious value for money. Same for the senior lawyers we worked with and the senior investigators. Their jobs also either disestablished or reconfigured for much less money.
Now everyone has ‘equalisation clauses’ in their contracts. This means that if a job with a lower salary is taken following a restructure a payment equal to the difference in salary for two years is made. The structure of this also means they can leave the month after the payment is made and be better off. Great for them. For the taxpayer – not so much.
All because why? Because Business Transformation. What? A new computer system? Seriously a new computer means kicking or managing out the people who have delivered the returns over the last ten plus years?
All in a week where Oxfam outed Reckitt for a restructure involving profit stripping. One which looking at their accounts seems to be a transfer pricing wheeze. The same week where the Greens announced a higher top rate with no mention of the trust rate. No need for any high end tax enforcement there.
So where is the oversight of this? Is this so operational that Ministers aren’t concerned? Will they be concerned if any new BEPS rules become irrelevant as the capability to enforce them won’t be there? Or is it simply my lack of imagination? The new computer will be so flash it will be able to review accounts; conduct interviews; and analyse several countries tax laws. Digital disruption indeed.
What I do know is that my former colleagues will be just fine. They may have a truly shite period coming up. But they are all talented resourceful individuals. Whether they are still at the department in a year – is another thing entirely.
Let’s talk about tax.
Or more particularly let’s talk about tax and companies.
Well dear readers what a week it has been in the Beltway. Secret recordings down south and secret payouts from Wellington. All the more bizarre as – Mike Williams confirmed – MPs staffers pretty much have sack at will contracts. If your MP doesn’t like you – that’s it you’re out. No lengthy performance management for them. Facepalm. So maybe this factoid could get added to new MPs induction?
But as always the key issue gets missed. Exactly who under 40 years old knows what a dictaphone is?
And into this maelstom Inland Revenue released a paper on taxation of individuals and some stuff on debt. Both worthy topics of discussion. But then Ryman released its results. And their CEO said like tax is paid – just not like income tax and just like not by them.
So after last week’s post I thought I’d have a look.
Oh yes the real tax is very easily found in the Income Tax Note. Tax losses of $28.9 million in the 2017 year. Up from last year when they were only $15 million of losses. They are a growth stock after all. Quite different from the tax expense which was $6m tax payable.
To your correspondent this looks awfully like her specialist subject of interest deductions for capital profits. All mixed up in a world where interest expense isn’t in the P&L but instead added to the asset value. Complying with both accounting and tax. And yeah totes a tax loophole but one from like whenever.
And again in Ryman’s accounts the rent equivalent from the time value of money of the occupancy advances is in neither the accounting nor the tax profit. Because reasons.
Now expecting controversy the CEO front footed the issue saying that the shareholders paid tax and that Ryman had actually paid GST. He then also referred to the PAYE deducted as they were employers. Kinda going to ignore that bit tho coz the whole claiming credit for other people’s tax really gets on my nerves.
And I’ll take his word on the GST angle coz I am cr@p at GST. But with his shareholders paid the tax comment – he is talking about imputation. And as I haven’t covered that before dear readers – today you get imputation. Oh and other random thoughts on tax and companies.
Now the official gig about imputation is how – notwithstanding that they are separate legal peeps – the company is merely a vehicle for their shareholders to do stuff. So for tax purposes the company structure should – sort of – get looked through to its shareholders. And this means dividends are in substance the same income as company profits and so should get a credit for tax paid by the company.
And as a tax person this stuff is considered to be in the stating the flaming obvious category.
But as I am no longer an insider – I am increasingly finding it interesting just how public policy on companies manages to talk out of both sides of its mouth. And how – much like the sack at will contracts or milliennials using dictaphones – no one has noticed.
On one hand we have the Companies Act which sets up companies with separate legal personalities from its shareholders. Meaning that if you transact with a company and it doesn’t pay you. Bad luck bucko. Nothing to do with the shareholders. Limited liability; corporate veil and all that.
But for tax if you only have a few shareholders those losses can flow through to the shareholders and be offset against against other income. The negative gearing thing but using a company. Coz in substance the company and shareholders are like the same.
And a similar thing happens with the Trust rules. Trust law says that it is trustees that own the assets. And once you have handed stuff over to them as settlor – that’s it – that stuff isn’t yours anymore. So if that settlor owes you money – also bad luck bucko. Don’t for a second think you can approach the trustees – coz whoa – settlor nothing to do with them.
But then tax says – for trusts – as settlors call the shots; it’s the residence of the settlor that is important. Mmmm. This means that a trust with a New Zealand resident trustee and a foreigner wot gave the stuff to the trustee – foreign trust – isn’t taxed on foreign income. Coz that would be like wrong. Even though the assets are owned by a New Zealand resident. And New Zealand residents normally pay tax on foreign income.
Right. Awesome. Thanks for playing.
Anyway back to imputation.
Now put any thoughts of separate legal personalities outside your pretty heads dear readers and think substance. Think companies are vehicles for shareholders. Don’t think about small shareholders having no say or liability if anything goes wrong. Just think one economic unit.
And then you will have no problem seeing potential double taxation if profit and dividends are both taxed. Coz #doubletaxationisgross.
So as part of the uber tax reforms in the late eighties imputation was brought in. Tax paid by the company can be magically turned into a tax credit called – imaginatively – an imputation credit which then travels with a dividend. Creating light and laughter in the capital markets. Or as I have put to me – increased inequality. As when imputation came in it gave dividend recipients – aka well off people – an income boost courtesy of the tax system. Probs also a tax free boost in the share price too.
Now putting aside such inconvenient facts – your correspondent has always defended imputation. Because in order to get the light and laughter or increased inequality – companies actually have to pay tax. And of that – big fan.
But all of this is only useful if shareholders are resident. Coz the credits only have value to New Zealand residents. And this is kind of why foreign companies may not care about paying tax here. And did I mention tax has to actually be paid?
And this last point that brings me back to Ryman’s chairman. He is right. If the company doesn’t pay tax – then the shareholders do when a dividend is paid. So honestly what are we all getting excited about?
Well – profits have to be like actually distributed before that happens and shareholders have to be taxpayers. And Ryman distributes less than 25% of their accounting profit.
And the residence of shareholders? Who knows. Lots of nominee companies listed which could mean KiwiSavers or non-residents. Oh and Ngai Tahu. Who seems to be a charity.
So yeah maybe. Some tax will be paid by some shareholders. That is true. Let’s hope it exceeds the tax losses Ryman is producing.
PS. This will be the last post – except if it isn’t – for the next couple of weeks. Your correspondent is getting all her chickens back for a while. And much as I love you all dear readers – I love them more. Until Mid July. Xx
Let’s talk about tax.
Or more particularly let’s talk about accounting tax expense.
Now dear readers the most unlikely thing has happened. A tax free week in the media. No Matt Nippert on charities – just for the moment I hope – no Greens on foreign trusts. No negative gearing and – thankfully – no R&D tax credits. So with nothing topical atm – we can return to actually useful and non-reactive posts. And yes I am the arbiter of this. Although the whole Roger Douglas and his #taxesaregross does warrant a chat. Need to psyche into that a bit first though.
So I am now returning to my guilt list. Things I have been asked to write about but haven’t . That list includes land tax; estate duties; some GST things; raising company tax rate; minimum taxes; and accounting tax expense.
And so today picking from the random number generator that is my inclination – you get accounting tax expense.
At the Revenue when reviewing accounts one of the things that gets looked at is the actual tax paid compared to the accounting income. This percentage gives what is known as the effective tax rate or ETR. And yes there are differences in income and expense recognition between accounting and tax but for vanilla businesses – in practice – not as many as you would think.
Now it is true that a low ETR can at times be easily explained through untaxed foreign income or unrealised capital profits. But it is also true that for potential audits it can be a reasonable first step in working out if something is ‘wrong’. Coz like it was how the Banks tax avoidance was found. They had ETRs of like 6% or so when the statutory rate was 33%.
So when I ran into a May EY report that said foreign multinationals operating in New Zealand had ETRs around the statutory rate – I was intrigued.
Looking at it a bit more – it was clear that it was a comparison of the accounting tax expense and the accounting income. Not the actual tax paid and accounting income. Now nothing actually wrong with that comparison but possibly also not super clear cut that all is well in tax land.
And I have been promising/threatening to do a post on the difference between these two. So with nothing actually topical – aka interesting – happening this week; now looks good.
Now the first thing to note is that the tax expense in the accounts is a function of the accounting profit. So if like Facebook NZ income is arguably booked in Ireland – then as it isn’t in the revenues; it won’t be in the profits and so won’t be in the tax expense.
Second thing to note is that the purpose of the accounts is to show how the performance of the company in a year; what assets are owned and how they are funded. One key section of the accounts called Equity or Shareholders funds which shows how much of the company’s assets belong to the shareholders.
And the accounts are primarily prepared for the shareholders so they know how much of the company’s assets belong to them. Yeah banks and other peeps – such as nosey commentators – can be interested too but the accounts are still framed around analysing how the company/shareholders have made their money.
And it is in this context that the tax expense is calculated. It aims to deduct from the profit – that would otherwise increase the amount belonging to shareholders – any amount of value that will go to the consolidated fund at some stage. Worth repeating – at some stage.
First a disclaimer. When IFRS came in mid 2000s the tax accounting rules moved from really quite difficult to insanely hard and at times quite nuts. Silly is another technical term. That is they moved from an income statement to a balance sheet approach. Now because I am quite kind the rest of the post will describe the income statement approach which should give you the guts of the idea as to why they are different. Don’t try passing any exams on it though.
Now the way it is calculated is to first apply the statutory rate to the accounting profit. And it is the statutory rate of the country concerned. That is why it was a dead give away with Apple – note 16 – that they weren’t paying tax here even though they were a NZ incorporated company. The statutory rate they used was Australia’s.
Then the next step is to look for things called ‘permanent differences’. That is bits of the profit calculation that are completely outside the income tax calculation. Active foreign income from subsidiaries; capital gains and now building depreciation are but three examples. So then the tax effect of that is then deducted (or added) from the original calculation.
For Ryman – note 4 – adjusting for non-taxable income takes their tax expense from from $309 million to $3.9 million. That number then becomes the tax expense for accounting.
But there is still a bunch of stuff where the tax treatment is different:
- Interest is fully tax deductible for a company. But – if that cost is part of an asset – it is added to the cost of the asset and then depreciated for accounting. And the depreciation will cause a reduction in the profits over say – if a building – 40-50 years. So for tax interest reduces taxable profit immediately while for accounting 1/50th of it reduces accounting profits over the next 50 years.
- Replacements to parts of buildings that aren’t depreciable for tax can – like interest – receive an immediate tax deduction. But for accounting a new roof or hot water tank are added to the depreciable cost of the building and written off over the life of the asset.
- Dodgy debts from customers work the other way. Accounting takes an expense when they are merely doubtful. But for tax they have to actually be bad before they can be a tax deduction.
These things used to be known as timing differences as it was just timing between when tax and accounting recognised the expense.
And then the difference between the actual cash tax and the tax expense becomes a deferred tax asset or liability. It is an asset where more tax has been paid than the accounting expense and a liability where less tax has been paid than the expense.
And the fact that these two numbers are different does not mean anyone is being deceptive. They just have different raisons d’etre. Now if anyone wants to know how much actual tax is paid – the best places to look are the imputation account or the cash flow statement. The actual cash tax lurks in those places.
But yeah it does look like actual tax. I mean it is called tax expense.
Your correspondent has memories of the public comment when the banking cases started to leak out. I still remember one morning making breakfasts and school lunches when on Morning Report some very important banking commentator was talking. He was saying that the cases seemed surprising coz looking at the accounts the tax expense ratio seemed to be 30%. [33% stat rate at the time]. But that 3% of the accounting profits was still a large number and so possibly worthy of IRD activity.
Dude – no one would have been going after a 3% difference.
In those cases conduit tax relief on foreign income was being claimed on which NRWT was theoretically due if that foreign income were ever paid out. So because of this the tax relief being claimed never showed up in the accounts as it was like always just timing.
Except that the wheeze was there was no actual foreign income. It was all just rebadged NZ income. And yeah that income might be paid out sometime while the bank was a going concern. So it stayed as part of the tax expense. Serindipitously giving a 30% accounting effective tax rate while the actual tax effective tax rate was 6%.
And a lot of these issues are acknowledged by EY on page 13 of under ‘pitfalls’.
So yeah foreign multinationals – like their domestic counterparts – may well have accounting tax expense ratios of 28%. But whether anyone is paying their fair share though – only Inland Revenue will know.
Let’s talk about tax.
Or more particularly let’s talk about the tax rules for deregistering charities.
It has been a big intellectual week for your correspondent. Tuesday night White Man Behind a Desk. No tax. An interesting riff on immigration that Michael Reddell clearly wasn’t the tech checker for. Wednesday night Aphra Green Harkness Fellow on US criminal justice reform coz States just ran out of money. I tried to run an argument that this was the good side of low taxes. Didn’t resonate – go figure. And Wednesday morning – Roger Douglas on turning taxes into savings coz #taxesaregross.
And it was on the lovely Roger I planning to write but on Friday was the Greens on how there were bugg@r all foreign trusts reregistering. So I thought I’d write about that and the genius decision to require disclosure rather than taxation.
And as if that wasn’t enough. Saturday morning the latest Matt Nippert on a US and charities thing. An elderly couple with no heirs wanting to transfer wealth to a charitable institution – awh lovely. So nice they chose NZ. But also Panama, low distributions and references to the IRS. Ok. Initial reaction was it looks like FATCA avoidance coz NZ charities are outside its scope of reporting to IRS. Really must get on to my ‘US citizenship is not a good thing for tax’ post. It has been in the can for longer than this blog has been running. So embarrassed.
But one thing really caught my eye. The charities had voluntarily deregistered. Mmm interesting.
Your correspondent now moves a tiny bit in the Charities NGO sector. And from time to time I hear ‘should we stay a charity? Coz need to be careful over advocacy and ActionStation isn’t a charity and it is alg for them.’
To which I try to reply in my best talking to Ministers language: ‘ That’s one option. It would mean handing over a third of your reserves in taxes or all of your reserves to another registered charity. But totes – if that is what you want.’
Strangely the conversation doesn’t continue.
Coz the law changed in 2014 to stop the rort of charities getting lots of lovely tax subsidised donations, not distributing; deregistering and then keeping all that lovely taxpayer dosh for themselves. Go Hon Todd!
Now on the face of it this should apply to our friends here very soon. Section HR 12 applies a year after deregistration and turns the reserves – less wot go to another charity – into taxable income.
Except there doesn’t seem to be anything explicit that makes it New Zealand source income. Possibly personal property or maybe indirectly sourced from New Zealand. But the source rules are kind of old school and want to bite on real stuff not deemed income. No matter how worthy of New Zealand source taxing rights it should be.
And of course none of this matters dear readers if the entity is New Zealand resident. Coz everything gets taxed! And as the trustees are a New Zealand company – high chance it will be. So alg.
Coz if the dosh in the charity all came completely from non-residents – the trust rules make it a foreign trust. And foreign source income aka income wot doesn’t have a New Zealand source is not taxed. So initial view – unless the source rules can bite on this deemed income or the trust isn’t a foreign one – there will be no wash up for our friends here.
Now on one level that is cool. The final tax was all about clawing back the tax benefits given on the initial donations and the charitable tax exemption on income. Here it would have been tax exempt anyway. So alg.
The other argument is that these guys intentionally registered as a New Zealand charity. Got all the good stuff like potentially non- disclosure to IRS as well as being to say they are a legit NZ charity. But now don’t get the bad stuff.
And NZ gets the bad name but not the income. What does that sound like? Oh yes the NZ Foreign Trust rules.
So glad that – according to the Greens – is coming to an end. Shame it had to be such a resource intensive way of doing it.
Let’s talk about tax.
Or more particularly let’s talk about the deadweight costs of taxation.
For those of you who have liked this blog’s Facebook page you will know that your correspondent was recently a little over excited at getting a credit for tech checking White Man Behind a Desk‘s video on Tax Avoidance.
For those who have yet to watch it. Do it now! Like immediately. The rest of this post can wait.
There are a number of videos in their stable including indigenous rights; prisons and now Tax. My world is complete.
Particular favourite is the one on Social Bonds. ‘That’s friendly Pierce Brosnan and friendly Daniel Craig’. Again its like they made it specially for me. It has tax and prisons. Including a brilliant discussion of contracting out and Serco’s role. Who are now apparently also bidding for: ‘the nighttime; the colour Magenta; and the feeling of hope.’
If I could just like teach Robbie some more tax – he could so take over this blog.
Anyway no more spoilers – go and watch this one too. Please come back though. You can like us both. Wellington peeps WMBAD is live at Circa. Go and see him!
Now in Social Bonds is a quite inspired discussion of tax economics – aka taxes are gross. And also a pretty good imitation of tax economists. Robbie – if you are reading this change ‘incentives’ to ‘distortions’ and you will have totally nailed it.
For the rest of you as a bit of a public service I thought I might unpack the ‘nya, you know ahh, mnew, gross’ discussion at 1 minute 30. Coz in that Robbie is talking about the deadweight cost of taxation.
Now we all know about the compliance cost aspect of taxation. And should we ever doze off on that one the Business lobby groups will be more than happy to remind us. And we all also know about the administrative costs of taxation – aka the great public service that is Inland Revenue. But the cost of taxation through behavioural changes is often hidden or not acknowledged.
And these behavioural changes are called deadweight losses or excess burden or efficiency losses. They relate to the activity or production or purchase that won’t happen simply because there is a tax on it. The other costs – compliance and administration – are still real ones but in these diagrams they are assumed away to explicitly show the economic costs.
This is to be contrasted with the loss of income or wealth that has simply been transferred to the government in the form of taxation. In our diagram the deadweight cost is in red and the tax collected in blue. Interesting colours politically. Possibly an American diagram.
Now the degree to which this happens is a function of the ‘elasticity’ of whomever or whatever is subject to the tax. Aka the slope of the demand or supply curve.
And the textbook example of a product that is highly inelastic is insulin for diabetics. The demand for it will occur irrespective of its price. Taxing it will be a one for one transfer from the diabetic to the consolidated fund. This is the theory. And as the mother of a Type 1 diabetic can confirm it is also totes the practice. In this case the demand curve will be completely vertical meaning no deadweight cost. Woohoo or total tax grab – up to you which one.
All blue now no nasty red.
Income tax is much harder. I do know in the early 2000s when I returned to work and still had young children, the 39% tax rate actually made my decision to cut my hours easier.
And Treasury looked at this for the natural experiment that was the 39% tax rate. They found for wage income the elasticity was 0.414 – so more elastic than insulin but less than cigarettes. And for non-wage income it was 0.909. Although with non-wage income the genius decision not to lift the trust rate at the same time means it could be recharacterisation of the income rather than no longer earning it.
And yeah I know I have mixed up demand and supply in the chat above but the guts is all the same. More inelastic the whatever is – if you impose a tax on it the lesser the behavioral change and the lower the deadweight cost.
Now the decision to talk about all this stuff dear readers isn’t just a mind w@nk on my part. Last week as you may remember the lovely Hon Steven announced that his benevolent government was planning to cut taxes through the increase in thresholds. Well only if you like vote them back in. Coz its not like the red team will give it to you even if the green team voted for it …? Too hard for me. Think I’ll stick to tax.
So with $2 billion a year to spend – what are the efficiency gains/reduction in deadweight losses? Turning to the – focus group named – line item Consequential Adjustments. Page 26. Nothing. There is a discussion of an increase in consumption and higher business profits coz people get more money to spend. But no actual mention of any increase to labour supply as a result.
But looking at the RIS though page 28 – there is expected to be a 0.28% increase in labour supply aka reduction in deadweight cost from the package chosen.
Yep. 0.28%. Aka 0.0028. Not quite sure my aging focal length can pick up something so small.
But then that makes sense. The deadweight loss thing operates on the marginal rate and there wasn’t much of a change in all of this.
Now let’s all take a moment to think about what they could have done. Smooth out the tax and transfer interface. Here the effective marginal tax rates are pretty nasty.
And with $2 billion a year to spend it wouldn’t have been too hard to have created quite meaningful efficiency gains from focussing on those.
Then that really would have been a budget for low and middle income families.