Category Archives: Equity

My fair tax review

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

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

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

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

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

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

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

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

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

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

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

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

And so what were their recommendations/suggestions?

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

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

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

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

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

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

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

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

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

New migrants seven years tax free on foreign income

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

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

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

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

New foreign investment to have company tax rate of 18%

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

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

Tax to be capped at $1 million for individuals

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

Restricting borrowing costs against exempt foreign income

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

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

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

Andrea

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Two bills one week

Let’s talk about tax.

Or more particularly let’s talk about the two tax bills that were introduced this week.

Some time last century dear readers your correspondent was a junior accountant for an oil company in the UK. And in that company was a low cost petrol retailer. Now one day in the early nineties all staff – yes even the accountants – were called into some marketing meeting. Purpose of meeting was to explain some new wizard marketing strategy that we could all sing and dance around. 

But before that particular experience some faceless but well dressed consultant treated us to some research. It was on customer behaviour and why customers chose one petrol station over another. Riveting stuff.  And have to say the monthly accounts I would normally be doing at this time were starting to look pretty good.

Now pretty much like every consultant presentation I have sat through before or since – the insights were off the scale. People chose our petrol stations because of: location; retail stuff and coz we were cheap. Genius. Worth every penny. So glad they got the specialists in for that.

But then they dropped an actual knowledge bomb on my 25 year old self. As well as the blindingly obvious stuff – there was an actual true story group of customers that used our stations just because we said we were low cost. And for this group it didn’t actually matter whether we were low cost or not. Saying it was enough. Twenty five year old mind blown. The facts didn’t matter.

Now all of this came back to me this week with the Budget and the Family Incomes tax bill that was introduced and passed this week. A Budget that was for low and middle income families. Or as some commentators are dubbing it – a left wing budget.

Wow. Just wow. The facts still don’t matter.

Now it was Hon Steven’s big day out. Tax cuts for everyone!!! Just under 2 bill per year on tax cuts alone.  And while there was other stuff. Vast bulk of the cost comes from tax cuts. Not entirely sure that this was what JustSpeak had in mind with its #billionbetterthings strap line but I guess tax cuts is preferable to any more bloody prisons. 

And of course anything involving tax  – even adjusting thresholds rather than rates – means more money goes to higher earners. It just does. It’s just what happens when you play around with tax stuff rather than transfer stuff. Coz higher income earners are the people who pay are the people who pay most of the income tax for individuals. So any cuts in income tax go to those who pay the income tax. 

Oh and tax stuff applies to individuals not families. But I guess the clever Treasury people were able to turn this into a family costing below.

But then taking these lovely numbers and annualising them you get this:

Soooo families with incomes over $84k get half the dosh. Very progressive.

Even if those families didn’t actually want the princely sum of $35 per week and might have preferred it to go to mental health, or more state houses or more refugees. But at least it was only one new prison not three! #smallmercies.

But hey this is the party that has been elected. They can kinda do what they like. But a raid into Labour’s territory? Really? I guess if you say it often enough it must be true.

And then for comic relief was the political equivalent of a wardrobe malfunction. Hon Steven said that only one third of those eligible for IETC claimed it in a year rationalising its repeal. But then following questioning from the Michael Wood, Tim McIndoe kindly clarified that yes it was more 30% during the tax year and another 50% at the end of the year. Right ok. 80% not 30%.

And to be fair in the like actual Budget speech Hon Steven did say ‘during the tax year’. So not like actually lying.  And in reality more likely a mix up in the bureaucracy than any intention to mislead.

But to your correspondent Budget 2017 – whole thing – deeply underwhelming. Just hope they didn’t also waste money on consultants as well.

Now ironically there was another tax bill that was also introduced last week that actually was a raid into Labour’s territory.  Making everyone pay their fair share and all that. For top earners anyway. The Taxation (Annual Rates for 2017–18, Employment and Investment Income, and Remedial Matters) Bill. Just trips off the tongue. And on the whole it is a standard dull but worthy tax bill. Except for Employee Share Schemes. A well buried piece of social justice aka base maintenance.

Now the commentary and the previous discussion document are eye wateringly technical. Even your correspondent struggled. But buried in the RIS – para 54 –  is the comment that it will raise $30 million a year. Now tiny in comparison to Steven’s big day out but quite a bit for a base maintenance item that deals with the taxation of remuneration. Especially since this is a net amount and there is an extension of a tax expenditure promoting widely offered share schemes. #workerparticipation.

Coz while yeah there are holes in the taxbase generally – all the remuneration stuff tends to be pretty water tight

It all seems to have started life with a Revenue Alert that the department issued in late 2015. There they set out two wheezes that quite honestly could really only be used by important and well remunerated employees. People for whom the top tax rate is pretty much their average top rate. Coz honestly what employer could be bothered going to this amount of effort for ordinary employees.

Now currently the law pretty much says that if employees get shares then the difference between their value and what they pay for them is income. Makes sense. 

But the Revenue Alert talks of a situation where:

  • An employee buys shares on day one for market value. Awesome no taxable income there. No transfer of value. Alg.
  • But they buy them with an interest free loan. Nah still cool. The value is in the interest free part and that is catered for by the Fringe Benefit Tax rules. 

Except the wheeze is that the loan can be fully repaid by just handing the shares back. Ahh wot?

So if the shares go up – the difference is an untaxed capital gain but if they go down – nowt. Mmm no. Now the lovely Commissioner has quite correctly said – yeah nah – tax avoidance. And coz this is all connected to employment is looking to tax the gain as remuneration. Yep with you there Mrs Commissioner.

Now applying the tax avoidance provision all over the place is no way to run a tax system. So Hon Judith’s bill applies if you buy shares from your employer but you aren’t subject to the risk of them declining in value – aka not held ‘at risk’. In those situations when you get actual value from the transaction – that value is taxable. You know kinda like how when you are on a promise for a bonus – when that bonus actually materialises it is taxable? Yeah just like that here too.

Now yeah what ‘at risk’ means might not be super clear but tax avoidance audits aren’t super fun either. And as my late dear friend Tim Edgar would have said – just stay away from the edge. Everyone else pays tax on gains from their employer – so should the employees whose employers can be bothered to do clever stuff for them. 

And this is what a socially progressive tax bill actually looks like. Hope it survives select committee.

Andrea

Fairly efficient or efficiently fair?

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.

And who do the private equity lot include? Pension funds, sovereign wealth funds and charities who have zero tax rates.

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.

Andrea

Fairness – Take two!

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:

Untaxed income 

Capital income

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?

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. 

Imputed rents

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.

Deductions

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

Withholding taxes

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.

Personal companies

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?

Other things

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.


Andrea

Two men one press release

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.

Andrea

Let’s rendez-vous in the Pacific

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.

Impressive. 

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.

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.

Namaste

Gareth responds 

I wouldn’t normally create an entire post for a commentator. But hey it is my blog and not everyone is dedicating themselves to overhauling our country in a socially progressive way. Also I did devote an entire post to them so only seems ‘fair’  – as much as I dislike that term – to do the same for the response.

There must be a technologically prettier way to reproduce his comments – but until number one son comes home for Xmas – this is the best I can do. 

Namaste.






‘But if, baby, I’m the bottom you’re the top’

Let’s talk about tax.

Or more particularly let’s talk about the recently announced tax policy of The Oppportunities Party – TOP.  They are proposing to impose a tax on a deemed or imputed return on capital to the extent tax of that level is not paid already. Kinda like a minimum tax. With proceeds going to fund income tax reductions on labour income.


TOP is a party set up by millionaire businessman and commentator Gareth Morgan to change the political discourse in New Zealand. Your correspondent is particularly fascinated as her eighteen year old self voted for a party set up by a millionaire businessman and commentator Bob Jones who set out to change the political discourse in New Zealand. I was righty then and lefty now and both parties were set up to scratch itches on the body politick.

Bob Jones got no seats but he did get 20% of the vote. Today that would be almost the Greens and New Zealand First level of representation.

Now the New Zealand Party never really got into policy much beyond Freedom and Prosperity. TOP however is much geekier and actually plans to release policy ahead of even deciding to register. And their first released policy is one on tax. And and it seeks to tax capital more heavily and lessen the tax on labour. Woohoo. Speak to me baby.

Now New Zealand’s tax system is one designed by economists, drafted by lawyers and administered by accountants – so what could possibly go wrong. Nonetheless all three groups have their own languages and blind spots. It is a marriage that mostly works but only if all three groups keep their eye on the policy development and respect each other’s strengths.

Another perspective is that of the high level ‘strategic’ people versus the detail people. Again each have their strengths but also the ability to talk past and frustrate the snot out of each other. Working at Treasury I was surrounded by the former. To the younger members of this cohort I would always consul them to stay with the process – even when it became boring. As because detail people speak last – they speak best. And what eventuates  may not be what the high level strategic people with the higher number of hay points actually had in mind.

In tax a classic example is the Portfolio Investment Entities rules. If you look at the early high level papers it was all about taking away the tax barriers to diversified pooled investment in shares. What we ended up with was the ability to have cash PIEs, land PIEs and single equity investments. Giving us almost a nordic tax system with the taxation of savings. So somewhere the high level strategic people disengaged or conceded to technical design issues that gave some unintended and quite important consequences.

All of this came back to me when I read the TOP tax policy. Clearly designed by economists – and cleverly so – but sadly lacking in input of the other two tax disciplines. So as a tax accountant who is regularly mistaken for a lawyer I thought I’d  step up and help them out. Here goes:

General aka random irrelevant points that say more about the reviewer than the reviewee.

One. While Gareth didn’t – I enjoyed the envy tax reference. Coz does this mean taxing labour is a pity tax, or a tax on despair or a tax on barely getting ahead? I am all in favour of taxing envy. Let’s also tax greed, sloth, lust and the rest of the hell pizzas. There’s no risk of that tax distorting those human behaviours after all.

Two. For readers who have been keeping up, a regular whinge of mine is how we effectively give deductions for loss of capital when gains are not taxed. This would be overcome through the minimum tax on wealth (or assets). So under this proposal such capital losses would effectively become valueless. Rejoice.

Three. If you are going to get a bunch of extra money – instead of reducing taxes on labour income – the tax welfare interface is IMHO a much more worthy candidate for any spare money. But maybe the universal basic income is the next cab off the rank.

Specific points that might actually be helpful

One. It is true property ownership is a feature of the rich list but so is serial entrepeneurship – Graeme Hart, Diane Foreman and someone Morgan. Now a key part of entrepeneurship is loss making in the early years. There is some attempt to address this with a potental deferral of up to three years of the tax. The question I have is this long enough? Isn’t Xero still loss making? 

Now the received wisdom is that innovation is a good thing hence all the fricken R&D subsidies.  With a much less benign tax system for innovation – will this mean that some of the dosh is simply recycled back to small firms via Callaghan? And so maybe not all will go to reduce taxes on labour income? 

Two. Is it a tax based on wealth or assets? Both are mentioned in the proposal but they aren’t the same. Capital is used a lot in the proposal and depending on whether you are talking to an accountant or an economist can mean either assets or wealth. But here is why it matters. Assets is the total of all the stuff you have legal title to, wealth is the amount that no one else has claims on. And the difference between the two is usually debt but could also be trade creditors, intercompany advances or provisons or accruals. Not all of these generate tax deductions.

So if it is a tax on assets, is it fair to tax people on stuff that other have claims on? I doubt it. A bit of language tightening here would be cool.

Three. Valuation. For property and things like shares market valuations are not too hard. Businesses – however – wow. There will be what the financial accounts say but then there will be what someone is prepared to pay. Usually some multiple of  Earnings Before Interest and Tax – EBIT. And what about valuing implicit parental guarantees from non- residents. The choice then is to be completely fair between all forms of wealth and be a bit arbitrary and compliance cost heavy or not but not tax all forms of wealth evenly. Up to you.

Four. Who owns the wealth? From the vibe of the proposal I would say the intention is that the ultimate owner of the wealth pays the tax. However structurally wealth is likely to be held through many trusts, holding companies , limited partnerships and possibly in individuals own names. This is not insurmountable for design but will involve complicated grouping rules and possibly flows of notional credits to make it work. Perhaps have a look at the actual tax rules for imputation, mixed use assets or cashing out R&D losses to see if you still have the intestinal fortitude for what it will mean to make this work.

Five. Compliance costs. Now I don’t want to overplay this but comforting assurances that if you’re paying enough tax you’ll be fine means – two sets of calculations. The old rules will need to be applied which are not compliance lite and then the new rules willl need to be applied. And after addressing the issues above – they won’t be any picnic either.

But good luck. Perhaps in practice a tax solely on property might work. But after working through their policy I can’t help feeling all this is why countries just cut their losses with a realised capital gains tax.

And thanks for playing. First policy  – one on tax – still impressed.

Namaste

Unconditional – it’s what it means

Let’s (briefly) talk about tax ( and education). Again – yes I know.

The headline of today’s Dominion Post showed that in 2015 schools collected $11 million in donations more than they had previously.  Now dear readers after And another thing you all know that this means that of the extra $11 million the government subsidied this by a third. 

Also interesting if you follow the embedded Stuff links you see that decile 10 schools dominate the donations stakes.  By about $329 million to $2.8 million. Mega yuck given this just happens automatically and doesn’t go through Parliament every year as Education budget does.

Now this we have discussed before and promise I am not interrupting your Saturday to moan again about that.

The reason for this postette is the reference to how music lessons and school camps and the like are now being reclassified as donations.

No just no.

IRD guidance is very clear that donations need to be an ‘unconditional gift’. Nothing in return. A cash version of seva although they will probs never use that analogy.

The law is very clear and any ‘reclassification’ will be very easily overturned by the department. Please apply your brain. If you get anything in return – it ain’t a donation and so no donations tax credit. 

Simple. Please carry on.

Namaste

And another thing

Let’s (briefly) talk about tax (and donations to schools).

Following Monday‘s post I got to think about the other ‘advancement’ head of charity – education.

Now there is the whole controversy about whether donations that schools seek are really for extras and their role in an education system that is supposed to be free. And there is the thing about decile funding that the government gives less to higher decile schools coz they can fund raise.

But if that ‘fund raising’ comes from ‘donations’ then the government again gives one dollar for every two actually donated. So the bigger the donation and the higher level of actual payment – the more the government gives.

None of which is recorded in the education budget coz it is an off the books tax expenditure.  So the schools with richer parents get more government help. Very progressive.

Probs not actually intended. More likely to just be an interface of separate policies and never actually thought through. Shame.

Now for those of you who are properly interested in the can of worms that is tax and charity stuff I’d recommend my friend CharitywatchNZ‘s blog. Not currently being updated as he has gone back inside (the bureaucracy) for a while. But still all good stuff.

Namaste

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