Taking a break from TWG report proper stuff for a bit. Although very pleased to see that when the government said no further work on a Tax Advocate they actually meant no further work except for its inclusion in a soon discussion document.
Silly me and everyone else. Clearly misread the Government’s response. Recommendation 73 but getting over myself …
And there has just been a tax bill passed back in the (tax) real world.
R&D tax credits which seems largely to be a grants based system administered by IRD (1) and not anything I would recognise as a tax credit. But hey all the benefits of a grant while still calling it a tax thing. What’s not to love.
And coming up strongly behind is the GST and low value goods bill which also has the loss ring fencing for residential rental property.
Now the latter is pretty much loathed by the tax community. But as interest deductions in the face of untaxed capital gains is a bit of specialist subject/anguish for your correspondent I may write some more on that. As with no more capital gains being taxed I would say this is technology that should get a broader look.
But today I am going to have a bit of a chat about the GST stuff. Now as your correspondent’s taste in clothes tends toward vintage reproduction, she is a big online shopper from relatively obscure American and now Swedish suppliers. And my one piece of tax avoidance has always been keeping purchases below $225 so that no GST would be triggered. Often a struggle – albeit a financially useful one – when the NZ dollar is weak.
Now the $225 comes from the $60 de minimis Customs has where it won’t collect tax and duty up to that amount coz the admin to do so would be higher than the tax collected. So for clothes and shoes – another specialist subject but no anguish here – as there is a duty of 10% when you work it back this means $225 of clothes and shoes can be imported free of taxation and while for everything else it is $400.
And yeah it is not a total free ride as there is postage involved and if things don’t fit sending things back is probs not worth it.
Now this implicit tax exemption is only ever an administrative thing. It wasn’t like Parliament ever said ‘Off you go Andrea, have a foreign tax free dress, just keep it under $225 and only one at a time mind’. And so I have been expecting this loophole to be closed since forever.
And now there is a bill to do just that a select committee. The vibe is that offshore suppliers will collect GST for goods under $1000 and Customs over $1000. Cool. So far so good.
First it is the poster child for high trust tax collecting. It requires the offshore supplier to register with IRD, collect GST and then pay it to the department. Three steps where – just saying – something might go wrong. Would hate to think I pay GST and it isn’t passed on. But for the big guys at least they face ‘reputational risk’ if things go wrong.
Now yes we do have the bright, shiny, newish Convention of Mutual Administrative Assistance (2) that does include GST and yes the Department has tried hard to make the whole thing simple so yes the big people should get caught/ and or voluntarily comply.
2) Suppliers paying to GST registered buyers don’t have to charge coz that would be compliance without tax. Fair enough but I am now GST registered, how will the offshore supplier know my single dress isn’t just like a sample? Or will they even care so long as they have an IRD number?
3) Offshore suppliers only have to register if they are selling more than NZD 60k to people who aren’t GST registered. And yes this is self assessed by taxpayers outside out tax base.
But how will IRD know if the supplier or I am not compliant? There really will be limits to the whole Convention for Mutual Assistance. And anyway if they sell less than $60k no GST is totes legit.
But ultimately none of this should matter as any tax not collected by the offshore supplier will be picked up by Customs. Except …
4) De minimis raised to $1000 value of item for goods not GSTed by supplier. Sorry wot? So if GST is not charged – correctly by my new obscure foreign retailer – or incorrectly because reputational risk isn’t a thing for them – my GST free band has increased? Yup.
To be fair this is all sort of covered in the RIS (3) but I can’t find anything that discusses why the de minimis or threshold had to be increased.
Interestingly the Tax Working Group explicitly looked at these issues and concluded that the de minimis should only be NZD 400. And this is the right answer particularly when fairness is the lens. Although I would have thought there was now a case to bring the de minimis right down to incentivise collecting at source.
It is true that all the marketplaces and Youshops will get caught but anyone like me with any form of obscure foreign importing – which I am guessing is much like capital gains and a feature of a higher income/wealth profile – can now buy more tax free than before.
And why this is important is that the official primary reason for this policy change was to increase the fairness of the tax system. Not efficiency or even revenue but fairness.
And the thing about increasing fairness is that it might not reduce administrative costs. It might not improve the customer experience. But it says that tax is paid by everyone not just when it is easy to collect and people don’t get upset with you.
So a day or so after discovering I won’t be taxed on capital gains, surely I am not also up for more GST free shopping? Hope not.
Really hope this isn’t the beginning of fairness going back to Khloe or Pippa status.
(1) In year approval page 6.
(2) Article 2(b)(iii)(c)
(3) Page 5 Potential behavioural changes by consumers
Your correspondent is having a lovely Friday. Thanks for asking.
Started the day chatting to Terry Baucher on tax stuff and then Wellington is having one of its beautiful days.
Had lunch with a friend setting the world to rights which included me riffing on what a progressive tax policy could look like that was a bit radical but not completely nuts.
I have very tolerant friends.
Anyway given the relational being that I am – I thought I’d share it with you.
It starts from a place of Jacinda saying that while a CGT is off the table – nothing else is. And having spent the last 16 months or so thinking about tax stuff from a heavily constrained perspective – it is all a bit exciting to get off the leash.
So it goes!
This would apply to all estates over a (tbd) threshold. It has the advantage of involving one of life’s certainties so wouldn’t be affecting behaviour at all. Now it might mean people pass on assets before they die and they might use trusts to avoid it.
The former strikes me as a collateral benefit of the tax and the latter would need to involve rules involving death of settlors and/or beneficiaries. Next.
Closely held companies
They would become taxed at the top marginal tax rate to stop all the $70k and overdrawn current account stuff. There would be the option though of the look through company rules applying when incomes of shareholders are actually below $70k.
Very small companies
Consistent with a submission from Chartered Accountants of Australia and New Zealand (1) very small companies – tbd – would be taxed on turnover. Yes there are issues with it but it would reduce compliance costs for them and stop the revenue risk of oh gosh how did that personal expenditure get into my tax return.
The CPAG submission of a net equity tax would apply here. Yes it is similar to the TOP proposal but has the advantage of only applying to property so none of the valuation issues. Also I am not too stressed about partial family home exemptions so the types thresholds Susan St John proposes seem very pragmatic.
Personal tax thresholds
Any money collected – and quite frankly there may not be any when your focus is fairness rather than revenue raising – would go into raising the bottom threshold as per the TWG proposal.
Then either this could flow through to everyone or get clawed back by raising the tax rate for the next threshold. Also a possibility raised by the TWG.
Options not considered
Raising the top personal tax rate
Now I know this is a darling of the left and I accept I could be heavily coloured by having paid the higher rate for many years. But here’s the thing:
It is taxing the top income earners who are already in the tax system paying tax on their income. It doesn’t touch income that isn’t taxed already in a way a number of the measures above do.
Also the mismatch thing between different entities is a nightmare and to do properly would involve also an increase in the trust rate or face the use of trusts that were prolific previously.
There is already an issue with a mismatch between the company rate and top personal rate which I am hoping the proposal for closely held companies would fix.
Lowering the GST rate
Now I get that GST is regressive. Totes. No argument. But as rich people spend more in absolute terms, they pay more GST in absolute terms. And if they are not paying income tax for whatever reason – if they want to eat they have to pay GST.
So can’t recommend this I’m afraid.
However also not a fan of raising it either. See comment on regressivity.
Anyway that’s enough from me.
So would this all make the tax system fairer. Totes. Could anyone get elected on this? No idea. Well beyond my skill set.
Enjoy your weekend.
(1) Pages 28-29
Ok yes I am disappointed.
But probably no more or less than the members of the 2001 and 2008 tax reviews who also recommended greater taxation of capital. So it was always on the cards.
And to be fair the New Zealand tax system has never had a formal capital gains tax but has been taxing capital gains since whenever. All by deeming them to be taxable income.
IMHO this really hasn’t been the end of the world from a social cohesion point of view until that is – land prices went insane and somehow my generation extracted value from our children.
Now yes it would be awesome to tax that value extract – but what would be more awesome would be land prices falling. Coz something has gone gobsmackingly wrong when yopros need government intervention to buy their first home.
But back to tax.
Personally though I am surprised there wasn’t something. After all even the minority felt their was a very strong case to tax gains from residential rental and for those who were worried about valuation issues there was always the CGT lite option aka grandparenting.
But this is not to be.
So what is happening? Possible vacant land tax, cracking down of speculators and tax dodgers.
The former I am quite comfortable with as I think it has merit as a corrective tax. Needs to be better than Australia though. And yes local government is the best placed for that. Maybe a targetted rate or something.
Cracking down on speculators. Right.
Now there is the small matter of the brightline test which taxes sales within 5 years which – I would have thought – well included any speculation period.
And then there is the existing provision since whenever – bought with the intention of resale – which didn’t work very well so the Nats brought in the brightline test.
Unfortunately though compliance with these rules is a bit average and enforcement is a bit hard. (1)
And there will also be cracking down on tax dodgers. Not quite sure I know what that means.
There are our friends the closely held companies and dividend stripping . Which is essentially winding up to extract an untaxed capital gain and setting up a new company. Rather than just getting a taxable dividend from the original company.
Taxing these capital gains would have helped the issue.
And so instead strengthening enforcement for closely held companies (2) will be considered a high priority area for the next work programme.
Except enforcement is operational and the work programme is policy so not quite sure how that will work. But maybe I should get over myself, go with the vibe and wait for the actual new work programme.
But the Charities (3) stuff is all looking good.
The things I am most saddest about though are some of the more innovative obscure issues that aren’t being even considered for inclusion on the work programme. Which really only means – ‘will get to it if have time’.
They are the :
- Tax Advocate service (4) which would have helped small business and given an additional source of advice to the Minister;
- Overarching purpose clause (5) to say what the point of taxation is;
These are all potential neutral unpolitical improvements to the tax system. But didn’t hear Jacinda ruling them out – so maybe still hope.
So I might write some more about these. Oh and the OECD work on digital services. But once I have processed all this.
(1) Annex on compliance.
(1) Paragraph 17 Executive Summary
(2) Recommendation 66
(3) Recommendation 78-82
(4) Recommendation 73
(5) Recommendation 77b
(6) Recommendation 66. Although to be fair there is a suggestion this could be handled differently.
Now the most logical next post would be a discussion of the OECD digital proposals as that is the international consensus thing I am so keen on and also fits nicely into the thread of these posts.
The slight difficulty is that this requires me to do some work which is always a bit of a drag and when I am suffering badly from jetlag – an insurmountable hurdle.
So as a bit of light relief I thought I’d have a bit of a pick into the narrative around multinationals and why their non-taxpaying is particularly egregious.
You know the whole small business pays tax so large business should too thing.
Now because of the tax secrecy thing, we can never know for def whether this is the case. But there is some stuff in the public domain, so let’s see what we can do as a bit of an incomplete records exercise.
In one of the early papers for the TWG, officials had a look at tax paying of certain industries. Now while the punchline – industries with high levels of capital gains pay less tax – is well known, there are some other factoids that are worth considering.
Factoid 1 The majority of small businesses are in loss (1). Ok wow. But that could be fine if all the income was being paid out to shareholders.
Factoid 2 Spike of incomes at $70k. Ok suspicious I’ll give you that. But maybe there are lots of tax paid trust distributions.
Factoid 3 Shareholder borrowings from the company (2) – aka overdrawn current account balances – have been climbing since the reduction in the company tax rate in 2010. Oh and the imputation credit balances have been climbing over that period too (3). But that could be fine if interest and/or fringe benefit tax is paid on the balances.
Factoid 4 Consumption by the self employed is 20% higher than by the employed for the same taxable income levels. But this could be fine if the self employed have tax paid or correctly un-tax paid – like capital gains – sources of wealth that the employed don’t have.
Factoid 5 In 2014 high wealth individuals had $60 million in losses (4) in their own name. But that could be ok because if companies and trusts have been paying tax and they have been receiving tax paid distributions from their trusts.
Factoid 6 Directors with an economic ownership in their company are rarely personally liable for any tax their company doesn’t pay. Because corporate veil. And that even includes PAYE and Kiwisaver they have deducted from their employees.
Now all of this is before you get to the ability small business has to structure their personal equity so that any debt they take on is tax deductible. Not to mention the whole accidentally putting personal expenditure through the business accounts thing.
And of course I am sure none of this has any relevance to the Productivity Commission’s concern that New Zealand has long tail of low productivity firms [without] an “up or out” dynamic. (5)
But is it all ok?
- Are there lots of taxpaid trust distributions? We know the absolute level (6) but not whether it is ‘enough’.
- Is interest or FBT being paid on overdrawn current accounts?
- Do the self employed have sources of taxpaid wealth that the employed don’t have?
- Why have some of our richest people still got losses?
- How much tax do directors of companies in which they have an economic interest walk away from?
- What is the level of personal expenditure being claimed against business income? Or at least what is the level that IRD counters?
Combination of tax secrecy and information not currently collected. But IRD are working towards an information plan and the TWG have called for greater transparency.
Coz most of this is currently totes legit. In much the same way as the multinationals structures are.
(1) Footnote 9
(2) Page 11
(3) Page 10
(4) Page 15
(5) Page 19
(6) Page 9
So the details of this government’s tax review is out.
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.
Let’s talk about tax.
Or more particularly let’s talk about the fairness v efficiency tension in tax policy.
You correspondent is now about two thirds through her gap year. There have been perks to not going to work. Meeting people I would never have met as a tax bureaucrat; working without getting out of bed; and morning yoga classes now being conceptually possible. And of course becoming your correspondent tops it out.
On the con side though is no income; a carefully curated wardrobe that just looks at me; and that not going to (paid) work is simply exhausting. I am the most demanding person I have ever worked for. There is no concept of downtime.
Another con as a chartered accountant is there is no benevolent employer meeting my training needs – and my CPD hours – without me realising it. So with this in mind earlier this year I arranged to attend – without credit – a postgrad course on International Tax. Two days which should sort out my CPD. Or at least push out the problem for another year. And after all those years in tax I know the benefit of deferral.
Now as a participant I need to give a talk. So I heroically offered to talk about the tension between the tax fairness people and the tax efficiency people. As at that time I thought I had reconciled them. Now not so sure. So I thought I’d riff to you dear readers and see how we go.
It is an internal discussion I regularly have – yes I really am that interesting. As in my heart I am a tax fairness person but one whose head worries about tax efficiency.
Let’s start with the wot these guys say:
Fairness people say: Everyone should pay their fair share; People should pay in proportion to their income; Tax is the price you pay for civilisation.
And Gareth has a nice general take on all this which can be paraphrased as an unfair economy is inefficient. But while I am quite attracted to that as I can’t explain it without hand waving – I won’t.
So going back to things I do understand.
Efficiency people say: New Zealand needs be an attractive place to invest; it is important tax doesn’t distort decisionmaking; company tax is a tax on labour.
Now in a domestic setting – New Zealanders using New Zealand capital employing New Zealanders; through the use of withholding taxes and imputation – efficiency and fairness cohabit happily. Wages are deductible by firms and taxable to employees. Tax is deducted by the employers on the wages and this offsets the tax liability of the employee. Company tax can be used as a credit when dividends are paid.
There is a progressive tax scale for individuals which applies no matter how they earn their income. There can be deferral benefits if money stays in a company; a concessionary PIE rate for top income earners; and interest is deductible when capital gains are earned. But all of this is cohabitation peace and harmony compared to the situation with foreign capital and New Zealand workers.
Now with foreign capital, tax paid here is next to worthless. The fairness argument is that it is that the tax is the price for using the infrastructure and educated workforce paid for from taxation. Reasonable argument but problem is that the use of that stuff is not conditional on paying tax. Classic public good/freerider thing in economics which is supposed to be stopped through the use of taxation. Mmmm.
And foreign countries give no credit for company tax paid here. They might give credit for withholding taxes but there is this whole ‘excess foreign tax credit thing’ that means they don’t. For serious tax nerds, yes there is the underlying foreign tax credit given by the US when dividends come back. But we all know how much they come back. So foreign tax is a net cost of doing business. And like all costs something they will minimise if they can.
This becomes all the more compounded when the foreign investor is a charity or pension fund or sovereign wealth fund and doesn’t pay even tax in their home country.
So then the options are invest through deductible debt or pay tax but only invest if expected return is high enough to allow for paying tax.
Right. Then so how do we get the price of civilisation thing actually paid? Working on the assumption that foreign investment is good – when I think the analysis is a bit more nuanced than that – do we just have to suck up lower foreign investment if we want more tax paid?
If only we had some New Zealand based studies to see what happened? Oh yeah we do. Company tax was cut once by Dr Cullen and then again by Hon Bill.
Did we see an uptick in foreign investment? Nah – according to Inland Revenue foreign investment as a percentage of gross domestic product pretty much didn’t change.
Now of course there is a lot of noise in that; not the least that it happened over the GFC where normal rules did not apply. And Inland Revenue did have a go at reconciling all the stuff. Maybe.
But the best expanation I ever got for tax and how it influences foreign investment came from a tax mergers and acquisitions person I met during my time inside. They said there are two types of foreign investment:
- Normal foreign businesses who are looking to buy an equivalent New Zealand business. They make their decisons to purchase based on the headline tax rate and say the headline thin capitalisation ratios. Once that decison is make the tax people then swing in and look to minimise the tax further.
- The second type was the private equity lot for whom minimising tax was very much part of their MO. They turn up with elaborate templates – which include tax savings – which then all fed into the decision to purchase and at what price.
Is this right? Dunno but it has always made sense to me. And helps explain the often ‘inconclusive results’ found when two sets of behaviours are blended in any data set.
Ok so what does all of this mean to tax fairness people? I think what it means is be aware that the zero tax rate of significant international investors combined with the internationally lighter taxation of income from capital – none of which is addressed in the OECD BEPS project – mean that getting tax off foreigners may bounce back on locals in the form of higher prices or reduced investment.
To the tax efficiency people though – settle down – any impact is not one for one. The Inland Revenue stuff does show that there is a degree of taxation that is just sucked up by the owners of capital. Coz ultimately all business income comes from people who can get a bit p!ssed if they think you are free riding on their taxes paid infrastructure. And maybe they’ll spend their money somewhere else. Assuming of course that there is a taxpaying alternative coz it’s not like domestic capital is free from loopholes.
So will I say all this in my talk this week? Dunno but thanks for the chat dear readers. My head is clearer now. Thanks for listening.
Let’s talk about tax.
Or more particularly let’s talk about tax and fairness.
On leaving the bureaucracy last year there were two issues that drove me absolutely mental and I wanted to put my energies into. The first was the rising prison population at a time of falling crime rates and the second was homelessness. Since then with the former I have become the policy coordinator for JustSpeak and a trustee for Yoga Education in Prisons Trust. For the latter – zip.
So with that in mind I went to a recent Labour Party thing on Housing stuff. But about mid way Phil Twyford said that the Labour Party in its first term of office was going to do a comprehensive review of the tax system to improve its fairness. Now I have heard them talk about this before – but comprehensive review. Wow.
Since then Andrew Little has said they aren’t putting up taxes. So maybe this means this working group will be ‘tax neutral’ in the way Bill English’s was?
Now on the basis that this isn’t simply code for a capital gains tax, I thought I’d do a bit of a scan as to what this could mean in practice. My focus will be on the revenue positive items as the tax community will have their own laundry list of revenue negative ‘unfairnesses’ they will want fixing.
But first I am going to get over myself. Yes fairness could mean a poll tax but when the Left talks about tax and fairness it is implicitly a combination of horizonal and vertical equity. Horizontal equity where all income is taxed the same way and Vertical equity where tax rises in proportion to income.
Alternatively tax and fairness to the Left can also mean using the tax system to remove or reduce structural inequities in the economy and not just in the tax system itself. So here we go:
Now the most obvi unfair thing is the way capital income is taxed more lightly than labour income. Always loved Andrew Little’s comment about the average Auckland house earning more than the average Auckland worker. Dunno why he doesn’t use it more.
Now the lighter taxation might be there for some good reasons including:
- Long periods before it is realised. Is it fair to tax people when don’t have cash to pay the tax?
- Valuation issues. Although this goes once move to realisation based taxes.
- International norm. Soz unfortunately everyone taxes capital more lightly – sigh.
- Lock in effect. If have to pay tax would you ever sell?
- Incentive for entrepreneurship which is a good thing apparently.
Oh and not being able to get elected.
Options include a realised capital gains tax or Gareth’s wealth taxation thing. Both have issues but both would be an improvement if fairness or horizontal equity is your thing.
Alongside the not taxing capital gains is that we don’t tax imputed rents. Remember how owning your own home is effectively paying non-deductible rent to yourself and earning taxable rent? Except the value of the rent is not taxed? Awesome. But its non-taxation also offends the horizontal equity thing – even if it is your house – and so is unfair.
Active income of controlled foreign companies
New Zealand companies that earn foreign business income in their own names are taxed. New Zealand companies that earn foreign income through a foreign company aren’t. Why? International norm. Not fair but everyone else does that too. Also brought in by Michael Cullen. Nuff said.
Capital or wealth taxation
While Gareth’s thing is potentially wealth taxation it really is taxation of an imputed or deemed return on wealth rather than a tax on wealth per se. Actually taxing capital or wealth is where inheritance or gift duties come in.
Now neither of them are actually income taxes. They are outright taxes on capital. And if that capital arose from taxed income then would be very unfair to tax. However not entirely sure that is the case and these taxes are relatively painless as they tax windfalls; don’t effect behaviour and only apply to the well off. So they potentially promote fairness from a ‘reducing inequality’ sense rather than a horizontal or vertical equity sense.
There are a few things here. There are all the issues with interest and capital gains but they reduce if you ever tax capital gains or do Gareth’s thing. Others include:
- Borrowing for PIE investment can get deductions at 33% while PIE income is taxed at 28%
Donations tax credit
Now this isn’t an obvious one as everyone can get a third back of their donations up to their total taxable income. So that is pretty fair. But the more taxable income you have the more subsidy you get. And it can go to a decile 10 school; your own personal charity or a church with an interesting back story. But dude – seriously – who can afford to give away all their taxable income? Perhaps worth a little look.
Labour income that is earned as an employee is subject to PAYE and no deductions are allowed. Labour income that is earned as a contractor is only sometimes subject to withholding taxes and deductions are allowed. Aside from deductions which are likely to be pretty minimal with most employee type jobs – there is an evasion risk when people become responsible for their own tax. Spesh when such people are on very low incomes. Whole bunch of other ‘fairness’ issues too like access to employment law; but this is just a tax post.
Labour – and any income – can also be earned through a company. And a company is only taxed at 28% while the top rate is 33%. So if you don’t need all that income to live off you can decide how much stays in the company and how much you pay yourself. Is that fair?
Now of course there is always the old staple – increasing the top marginal tax rate. And yes that does enhance vertical equity but it also causes other problems elsewhere. So if you are going to make the system more misaligned please make sure that it doesn’t become the backdrop for widespread income shifting as it did last time.
Oh and secondary tax. Now there are many things that are unfair including precarious work and over taxation. Not sure secondary tax is one of them. While you have a progressive tax scale and multiple income sources – you get secondary tax. It appears that under BT – page 22 – the edges can be taken off getting a special tax code which should help but secondary tax in some form is structurely here to stay.
Look forward to it all playing out.
Let’s talk about tax.
Or more particularly let’s talk about Oxfam’s recent press release on inequality and tax.
Now dear readers when I moved to weekly – hah – posting it was because this blog was supposed to be my methadone programme. Getting me off tax and on to other issues. So when I posted last night – after having posted 3 times last week – I gave myself a good talking to. This had to stop. One post a week was quite enough to keep the cravings at bay. To continue in this vein would risk a relapse.
But this morning while I was getting dressed my husband came and turned on the radio. Rachel LeMesurier from Oxfam was talking about inequality and then she talked about tax and then Stephen Joyce came on and then he talked about tax and then he talked about BEPS.
Just one more little post won’t hurt I am sure and I’ll cut down next week honest.
Oxfam has compared the wealth of 2 New Zealand men Graham Hart and Richard Chandler to the bottom 30% of all adult New Zealanders. Now the inclusion of Richard Chandler seems to be a rhetorical device as from what I can tell he hasn’t lived here since 2006. So very unlikely to be resident for tax purposes.
In the interview Rachael Le M also made reference to the tax loopholes that support such wealth. So using what is public information about Graham Hart and what is public about the tax rules I thought I’d make a stab at setting out what these ‘loopholes’ are.
Now first dear readers please put out of your head anything you have heard about BEPS or diverted profit tax or any of the ways that the nasty multinationals don’t ‘pay their fair share of tax.’ None and I repeat none of this is relevant when dealing with our own people. It might be relevant for the countries they deal with but not for New Zealand. I am hoping that officials will also explain this to new MoF Steven Joyce as when he came on to reply to Rachael – he talked all about BEPS. Face palm.
Graham Hart is a serial business owner. Buying them sorting them out and then selling off the bits he doesn’t want all with a view to building up a Packaging empire. A Rank Group Debt google search also indicates that a substantial proportion of all this buying and selling was done through debt. And at times quite low quality debt which would indicate a proportionately higher interest rate. A number of his businesses are offshore.
So then what ‘loopholes’ – or gaps intended by Parliament – could Mr Hart be exploiting?
The first and most obvious one is that there is unlikely to be any tax on any of the gains made each time he sold an asset or business. The timeframes and lack of a particular pattern – as much as Dr Google can tell me – would indicate that the gains would not be taxable.
The second is that income from the active foreign businesses will be tax exempt and any dividends paid back to a New Zealand will also not be taxed. Trust me on this. I’ll take you all through this another day.
The third relates to debt. Even though it assists in the generation of capital gains and/or the exempt foreign income it will be fully deductible. Now because of the exempt foreign income there will potentially be interest restrictions if the debt of the NZ group exceeds 75% of the value of the assets. A restriction true but not an excessive one given exempt income is being earned.
Now also in Oxfam’s press statement is a reference to a third of HWIs not paying the top tax rate. I am guessing some version of one and three plus the ability to use losses from past business failures is the reason.
Unsurprisingly Eric Crampton of the New Zealand Institute is not sympathetic to Oxfam’s views and points to our housing market as the main driver of inequality. So then in terms of tax and housing the other tax ‘loophole’ then would be the exclusion of imputed rents from the tax base.
Now one answer could be Gareth’s proposal. That is if someone could explain to me how to tax ‘productive capital as measured in the capital account of the National Income Accounts’ in a world where tax is based on financial accounts according to NZIFRS.
The second could be a capital gains tax even on realisation and the third some form interest restriction or clawback when a capital gain is realised. Oh and taxing imputed rents.
How politically palatable is this? Not very given National, Labour, Act, New Zealand First and United Future are all opposed to a capital gains tax – at least Labour for their first term.
But then maybe it is stuff for Labour’s working group. Will be interested to see this all play out.
Let’s talk about tax (and interest deductions for capital gains).
While your correspondent is a confirmed Anglican – Episcopalian actually – I don’t consider myself a Christian anymore and haven’t taken communion for over twenty years. The same cannot be said for the rest of my extended family which is pretty hard core christian and includes three ordained priests. It used to be overrun with lawyers so priests is definitely pareto improvement.
From time to time at family gatherings when my darling christian family is discussing something theological – yes it is fun but I love them a lot – one of them will say ‘but of course it all went wrong at the Council of Nicaea’. That I think was when the Christian Church became a proper institution and started telling its followers what to do. And having seen public institutions operate at times for themselves rather than the people they are serving I am sympathetic to that view.
But for tax – in New Zealand – its Council of Nicaea was the 1986 Pacific Rendezvous case.
Pacific Rendezvous was – and is – a motel. They wanted to sell the business but to get a better price they decided they needed to do some capital works. They borrowed money to do that and claimed most of the interest as a tax deduction.
They were pretty open that the building works were because they wanted to get a better price for the sale of their business. And of course we all know dear readers that the proceeds from a sale of a business that was not started with the intention of sale is tax free.
Unsurprisingly the Commissioner – who was a he at the time – was not best pleased. Deductions to earn untaxed income you cannot be serious. And so he took Pacific Rendezvous to court to overturn the deductions associated with the tax free capital bit.
But the Courts were like ‘nah totes fine’. Coz – get this – the interest was also connected with earning taxable income. You know the like really small motel fees even tho the whole gig was an ‘enhancing the business ahead of sale’ thing.
And that dear readers is why I am so not a lawyer. Having to hold such stuff in my head as legit would totally make it explode.
But I digress.
Now of course Parliament or the government at the time still had the chance to overturn that case coz of course Parliament, not the courts, has the final say. Or it could have simply taxed the capital returns – sorry now I am just being silly.
What actually happened was some 13 years later after a fruitless interpretative tour of the provisions Bill English – when he was just a little baby MoF and long before his two stints at the leader thing – proposed and Michael Cullen enacted – that companies could have as many interest deductions as they wanted because compliance costs. You know coz otherwise ‘they’ll just use trusts’.
It was subject to the thin capitalisation rules and as the banks were to discover to their chagrin – the anti avoidance rules – but deductions to earn capital profits game on.
Now the capital profits thing was considered at the time – chapter 4 – and quite a compelling economic case was made for some form of interest restriction. But by Chapter 6 there became insurrountable practical issues that made this not possible. Those issues included:
- The need for rules to ensure that the deduction was not separated from the capital income;
- Difficulties with bringing in unrealised gains;
- If done on realisation – potential issues with retropective adjustments along period capital gain was earned;
- Need to factor in capital losses.
And it was true that in the past Muldoon – well then must be wrong – had attempted to do something by clawing back interest deductions to the extent a capital gain was made. Imaginatively it was called ‘clawback’ and everyone hated it. And yes people did use trusts and holding companies to avoid it. Oh and soz can’t find a decent link to reference this so you will just have to trust me on this.
But you know what? Tax policy is so much cleverer now and we group companies and treat them as one entity for losses and lots of other stuff all which could get around these issues. In fact the recent National governments in a bipartisan and a thinking only of the tax system way have enacted rules that mean interest restrictions for capital gains are no longer the insurrountable issue they apparently were in 1999. Who says John Key doesn’t have a legacy?
So working up the list.
- Can’t see the issue with capital losses as if that capital was lost in a closely held setting on deductible expenses it is already fully deductible. Outside that any interest limitation for capital gains would only apply to the extent there was untaxed capital income. And as we are talking about losses – not income – no interest restrictions. Simple.
- Would only do it on realisation. Taxing unrealised stuff while technically correct is a compliance nightmare. But the new R&D rules which claw back cashed out losses when a capital gain is made – from page 24 – could totes be made to work here. Interest deductions could be allowed on a current year basis but if a capital profit is made – they are clawed back in the year of sale. If deferral was still a big deal – a use of money charge could be added in too. Personally I would give up the interest charge. Simpler and an acknowledgement of the earning of taxed income.
- And the whole deduction being separated from income was fixed with the debt stacking rules for mixed use assets. So let’s use that.
Coz the thing is while no one seems to be bringing in a capital gains tax anymore it is still massively anomalous that deductions are allowed for earning untaxed income just coz some incidental income was earned as well.
Now Labour is planning to have a bit of a go in this area by going after negative gearing through ringfencing losses. Better than nothing I guess. But still kinda partial as only touches people with not enough rental income to offset the deductions. And Grant, Phil and the new Michael – even for this – you totes will need the debt stacking rules or else ‘they’ll just use trusts’ or holding companies.
And yeah extending the brightline test to 5 years. Again better than nothing but there is still lots of scope to play the whole deductions for untaxed gains for property holdings over 5 years or – as with Pacific Rendezvous themselves – businesses.
But for any other political party with an allergy to a capital gains tax but big on the whole tax fairness thing perhaps you might want to look again at interest clawback on sale? This time thanks to the foresight and the public spirited nature of the John Key led governments – it would actually work.