Tax and small business (2) – company tax rate
Last week was a big week for your correspondent.
On Wednesday I got to upgrade my CA certificate to a FCA one at a posh dinner at Te Papa. As a third generation accountant I was absolutely tickled pink by that.
Interestingly of the 12 Wellington people there were 5 tax people: Me, Mike Shaw, Suzy Morrissey, Stewart Donaldson and Lara Ariel. All except Lara I have had the great pleasure to work with personally and professionally over the years.
I got to give a wee talk and so thanked my Wakefield (mother’s accountant line) genes; the balance sheet for being able to distinguish between the concept of capital as an asset or net equity – a framework other professions lack; and Inland Revenue Investigations as both the employer of my proposers and the place of some of the highlights of my personal and professional life.
I gave a slightly longer talk on the Tuesday. Twelve minutes instead of two.
The theme of that seminar was options to improve fairness now that extending the taxation of capital gains was off the table. The punchline of my talk was that the company tax rate should be raised.
I had come to that point following lots of feedback on my tax and small business post.
Very experienced tax people were sympathetic to my concerns but the ideas of mandating the LTCs rules or restricting interest deductions or even a weighted average small company tax rate sent them over the edge with the compliance costs involved. Their preference was that it was just simpler all round to increase the company tax rate with adjustments such as allowing the amount of deductible debt for non-residents.
And so on Tuesday I had a go at putting that argument.
Clearly not well as Michael Reddell described the argument as cavalier given NZ’s productivity issues.
Regular readers will know I am concerned about whether the tax system is a factor in New Zealand’s long tail of unproductive firms without an up or out dynamic. And that is before we get to any well meaning – but not always hitting the mark – collection of small companies tax debts inadvertently providing working capital for failing firms.
Although I had twelve minutes to talk on Tuesday, the company tax punchline really only got a minute or two to expand. So I’ll try and have a better go at it here. (1)
Now before we get to the arguments in favour of a company tax increase, Michael referred to this table as prima facie indicating that business income is not overtaxed.
This table absolutely shows that second to – that other well known high tax country – Luxembourg, New Zealand’s company tax take is the highest in the OECD as a percentage of GDP.
My difficulty is that – in a New Zealand context – I struggle to call the company tax collected – a tax on business income.
Absolutely it includes business income.
But it also includes tax paid by NZ super fund – the country’s largest taxpayer and Portfolio Investment Entities which are savings entities. In other countries such income would be exempt or heavily tax preferred. And yes I know there are arguments about whether they are the correct settings or not but all that tax is currently collected as company tax.
Also, for all the vaunted advantages of imputation, the byproduct of entity neutrality is the potential blurring of returns from labour and capital for closely held companies. So – and particularly with a lower company than top personal rate – there will always be income from personal exertion taxed at the company rate.
And business income is also earned in unincorporated forms such as sole trader or partnership. All subject to the personal progressive tax scale rather than the flat company rate.
Australia’s company tax is also high but less so. Possibly a function of their lower taxation on superannuation than New Zealand or even that such income is classified according to its legal form of a trust.
And all that is before we get to issues like classical taxation in other countries encouraging small businesses to choose flow through options to avoid double taxation. An example is S Corp in the US. Tax paid under such structures will not be shown in the above numbers as the income is taxed in the hands of the shareholders.
It is true that we have a similar vehicle here in the look through company. But unsurprisingly, under imputation, this is used primarily for taxable incomes of under $10k. It is quite compliance heavy and does require tax to be paid by the shareholder while it is the company that has the underlying income and cash. But it is elective and seems to be predominantly currently used as a means of accessing corporate losses.
But back to tax fairness and company taxation.
The argument put to me by my friends – with more practical experience than I have – was: if you want to increase the level of taxation paid by the people with wealth – increase the company tax rate as that is the tax rich people pay. The logical tax rate would be the trust and top personal rate – currently 33%.
That company tax is the tax rich people pay is absolutely true. The 2016 IR work on the HWI population shows exactly that:
It would also mean that the rules that other countries have like personal services companies or accumulated earnings – that we absolutely need with a mismatch in rates – no longer become necessary.
But what about foreign investment through companies?
If the focus was New Zealanders owning closely held New Zealand businesses, an adjustment could be made either by increasing the thin capitalisation debt percentage or making a portion – most likely 5/33 – of the imputation credit refundable on distribution.
However there is also an argument not to do this. The relatively recent cut in the company tax rate has not particularly affected the level of foreign investment in New Zealand. (2)
Personally I am agnostic.
Based on officials advice to the TWG (3) this group fully distributes its taxable income. So if the company tax rate increased all this would mean was that resident shareholders received a full imputation credit at 33% rather than one at 28% and withholding tax at 5%.
What happened to non-resident shareholders would depend on the decision above on non-resident investors. Either they would pay more tax on income from NZ listed companies or there could be a partially refundable imputation credit to get back to 28c.
The top PIR rate for PIEs could now also be increased to the top marginal tax rate for individuals as I keep being told the 28c rate is not a concession – more to align it with the unit trust or company tax rate. Or maybe KiwiSavers stay at 28% alongside an equivalent reduction for lower rates.
Start ups already have access to the look through company rules and so some more may access those rules if the shareholders marginal rates were below an increased company tax rate.
So an increase in the company tax rate need not have a material impact on foreign investment, listed companies and start ups.
Which then brings us to profitable closely held companies. Ones where the directors have an economic ownership of the company. A lower tax rate should, on the face of it, have allowed retained earnings and capital to grow faster. And therefore allow greater investment.
And on the face of it that is what has seemed to happen with this group. Imputation credit balances have climbed since the 28% tax rate meaning that tax paid income has not been distributed to shareholders.
However loans from such companies to their shareholders have also climbed indicating that value is still being passed on to shareholders – just not in taxable dividend form.
Now yes shareholders should be paying non-deductible – to them – interest to the company for these loans but it is more than coincidental that this increase should happen when there is a gap between the company rate and that of the trust and top personal tax rate.
And alongside this was an increase in dividend stripping as a means of clearing such loans.
So an increase in the company tax rate would reduce those avoidance opportunities and align the tax paid by incorporated and unincorporated businesses.
And with more tax collected from this sector, Business would have a strong argument for more tax spending on the things they care about. Things like tax deductions in some form for seismic strengthening, setting up a Tax Advocate, or the laundry list of business friendly initiatives that get trotted out such as removing rwt on interest paid within closely held groups.
Some of which might even be productivity enhancing.
For the next few months, I am returning to gainful – albeit non-tax – employment. As it is non-tax there should be no conflicts with this blog except for my energy and – possibly – inclination.
I am hopeful that at least two guest posts will land over this period and you may still get me in some form.
But otherwise I will be maintaining the blog’s Facebook page, and am on Twitter @andreataxyoga. I can also recommend Terry Baucher’s podcasts – the Friday Terry – when he isn’t swanning around the Northern Hemisphere.
(1) Officials wrote a very good paper for the TWG on company tax rate issues. It can be found here: https://taxworkinggroup.govt.nz/sites/default/files/2018-09/twg-bg-appendix-2–company-tax-rate-issues.pd
(2) Paragraph 33 for a discussion of this graphs limitations. These include a reduction in the amount of deductible debt and depreciation allowances at the time of the reduction to 28% which would have worked in the opposite direction to the tax cut.
(3) Paragraph 11
Tax and Small Business
Last week the Small Business Council issued its report to Government. I am sure there are many wizard things in there maybe even some tax recs.
Also last week I had a friend to stay who is helping some workers that have lost thousands of dollars of wages and holiday pay when their employer went into receivership. Her expression was Wage Theft. It is a crime in Australia but not in New Zealand. Unlike theft as a servant which totally is.
Talking to her it was obvious that there was considerable overlap between what she is seeing and the issues considered by the TWG of closely held companies where the directors have an ownership interest not paying PAYE and GST (1).
And yes my friend’s friends are worried about their PAYE and KiwiSaver deductions. So really hope tightening up on this stuff is in the Small Business report along with the expected recs on compliance cost reduction.
I am also personally very interested in what the Group comes up with as the Productivity Commission noted that NZ has a lot of small low productivity firms without an up or out dynamic (2). That is firms tieing up capital that should be released for more productive purposes with the associated benefit of not staying on too long and dragging their workers and the tax base with them.
Now ever since I found that reference I have been concerned that there may be aspects of the tax system that may be driving that. Benefits or ‘opportunities’ that don’t arise for employees subject to PAYE or owners of widely held businesses subject to audits and outside shareholder scrutiny.
And it is true that there is nothing particularly special in a tax sense here to New Zealand. However given that New Zealand rates as number one in the ease of doing business index there may be more people going into business than would be the case in other countries.
Some of these aspects can be reduced through stricter enforcement by Inland Revenue but are otherwise largely structural in a self assessment tax system where the department doesn’t audit every taxpayer. One is a policy choice possibly because the alternative would add significant complexity to the tax system and the final example is a combination of the need for stronger enforcement and/or policy changes needed now that the company and top personal rate are destined to be permanently misaligned.
So what are these ‘aspects’?
Concealing income or deducting private expenses
Recent work by Norman Gemmell and Ana Cabal found that the self employed had 20% higher consumption than the PAYE employed at the same levels of taxable income.
Now it could be that for some reason the extra consumption of the self employed comes from inheritances or untaxed capital gains or taking loans from their business – more on that later – more so than those in the PAYE system or owners of widely held businesses. It might not be tax evasion at all.
But we just don’t know.
All we know is the 20% extra consumption and that there is a greater opportunity and fewer checks with closely held businesses to conceal income or deduct personal expenses. And Inland Revenue says such levels are comparable with other countries.
While things like greater withholding taxes and/or reporting can help, I am also concerned that with greater automation it also becomes much easier to have those personal expenses effortlessly charged against the business rather than recorded as personal drawings.
The second aspect is my specialist subject of interest deductions. Unlike concealing income or deducting personal expenditure – this one is totes legit.
Interest is fully deductible to a company and for everyone else it is deductible if it can be linked to a taxable income earning purpose or income stream aka tracing.
What that means is if a business person has a house of $2 million and a business of $1 million and has debt of $1 million – all the interest deductions on the debt can be tax deductible – if the debt can be linked to the business. This can be compared to a house of $2 million and debt of $1 million – and no business – where none of it is deductible.
To make this fairer with taxpayers who don’t have the opportunity to structure their debt there would need to be some form of apportionment over all assets – business and personal. So in the above example interest on only $330,000 should be allowed.
But yes – that would require a form of valuation of personal and business assets. And yes valuing goodwill brings up all the same – valid – concerns raised with taxing more capital gains.
So I guess we can say that under the status quo fairness – and possibly capital allocation – have been traded off against compliance costs.
The third is the ability to income split with partners to take advantage of the progressive tax scale. Now this is only actually allowed if the partner is doing work for the business. But verifying the scale and degree of this work – even with burden of proof on Commissioner – is a big if not impossible task for the Commissioner.
Other mechanisms include loans from the partner to help max out the lower income tax bands.
And the statistics would support an argument that there is a degree of maxing out the lower bands just not that there necessarily is a lot of income splitting.
Interestingly both Canada and Australia have rules for personal services companies where these types of deductions are not allowed.
But this is ok if this is the amount of value going to the shareholders. Maybe our firms are so unproductive that they can only support shareholder salaries of $70k and below.
If that were the case though we wouldn’t be seeing the final aspect which is taking loans from companies you control instead of taxable dividends.
Overdrawn shareholder current accounts
Now to be fair for this to occur there should also be interest paid by the shareholder to the company on loans from the company to the shareholder. And unlike the interest in point 2 – none of this should be tax deductible to shareholder if it is funding personal expenditure while the interest received will be taxable. This on its own should be enough to not do it and receive taxable dividends instead.
Unfortunately the facts also don’t seem to back this up. Imputation credit account balances – meaning tax has been paid but not distributed- have been climbing. Now this could be like totally awesome if it meant all the money was being retained in the company to grow.
Except that overdrawn current account balances – loans from the company to the shareholders- have been similarly growing too. Now sitting at about $25 billion.
And yes this all started from about 2010. And what happened in 2010? Why dear readers the company tax rate was cut to 28% while the trust rate remained at 33%.
Ironically the associated cut in top marginal rate was to stop the income shifting that went on between personal income and the trust rate.
Now one level it shouldn’t matter at all if these balances continue to climb so long as non- deductible assessable interest is paid on the debt. However an overdrawn current account is – imho – the gateway drug to dividend avoidance.
And yes that can be tax avoidance but much like the tax evasion opportunities, income splitting and interest on overdrawn current accounts – all of this requires enforcement by Inland Revenue. And as they can’t audit everyone there will always be a degree that is structural in a self assessment tax system.
But the underlying driver of people wanting to take loans from their company rather than imputed dividends is that our top personal tax rate and company tax rate are not the same. Paying a dividend would require another 5% tax to be paid.
Now other countries have always had a gap between the top rate and either the company or trust rate so this shouldn’t be the end of the world. But those countries have buttressing rules that we don’t have in New Zealand. The personal services company rules discussed above or the accumulated earnings tax in the US (3) or the Australian rule that deems such loans to be dividends.
Until recently I had been a fan of making the look through company rules compulsory for any company that was currently eligible. (4) I couldn’t see the downside. The closely held business really is an extension of its shareholder so why not stop pretending and tax them correctly.
However some very kind friends have been in my ear and pointed out the difficulties of taxing the shareholder when all the income and cash to pay the tax was in the company. It works ok when it is just losses being passed through. So maybe I am less bullish now.
An alternative approach could be to apply a weighted average of the shareholders tax rates on the basis that all the income would be distributed. Similar to PIEs. The tax liability is with the entity but the rate is based on the shareholders. I guess you then do a mock distribution to the shareholders which can then be distributed to them tax free. And yes only to closely held companies. Wider would be a nightmare.
Kind of a PIE meets LTC.
Or you could just old school it and raise the company tax rate to 33% for all companies. Shareholders with tax rates below that could use the LTC rules and make the assessment of whether the compliance of the rules was greater or less than the extra tax.
It would require an adjustment to the thin capitalisation rules by increasing the deductible debt levels to ensure foreign investment didn’t pay more tax. But for some of you dear readers increased taxation on foreign investment might even be a plus.
But all in all I don’t think the status quo with small business is a goer. Whether it is for fairness reasons, or capital allocation reasons or simply stopping me worrying – doing something is a really good idea.
Because I would hate to think any of this was enabling behaviours that kept people in business longer than they should. And even with the most whizziest of new IRD computers – there will always be limits on enforcement.
(1) Page 116 Paragraph 68
(2) Page 19
(3) Although it would make more sense to only apply this to the extend that the income hasn’t been retained in the business and distributed in non- dividend form.
(4) Yes there is the issue that companies could start adding an extra class of share to get around this. But I don’t believe this is insurmountable with de minimis levels of additional categories and the odd antiavoidance rule for good measure. It is even the advice of KPMG so clearly not that wacky.
OVER 2,000 hack attempts and I finally broke into Andrea’s blog. (1) I should have known straight away her password would be CGT4eva. So here I am. Another rare left-leaning socially progressive tax expert.
This may be why Michael Wood, chair of the Finance and Expenditure Select Committee – politely and somewhat bemusedly – said to me: “you realise you are the only submission against this aspect of the bill….this should be interesting”.
The bill is now an Act of Parliament, the Taxation (Annual Rates for 2019–20, GST Offshore Supplier Registration, and Remedial Matters) Act 2019.
I was not the only submitter on the bill.
There were 268 submitters who opposed the ring-fencing of rental losses. Of course there were – some people might have to pay more tax. But, only one submitter (me), was opposing a tiny amendment that was also a blatant disregard for democracy and the rule of law.
And that tiny amendment created the Commissioner’s new superpower.
While Spiderman has quite an extraordinary power to climb, and Magneto has the power to control magnetic fields, much more useful than all that, the Commissioner of Inland Revenue has acquired the power to exempt taxpayers from tax law.
This power can be used to make a wide-reaching exemption for all taxpayers affected by the law, or limited to specific circumstances. You know – just special people.
The Commissioner may use her power to correct ‘obvious errors’ in the law. Or to give effect to the law’s intended purpose – as determined by the Commissioner – to resolve an ambiguity in the law, to reconcile inconsistencies between two laws or between the law and an ‘administrative practice’.
The last one is my personal favourite.
The Commissioner may grant the exemption where a tax law is inconsistent with the IRD practice on the issue. Wonderful. So unelected bureaucrats trump Parliament? Although yeah I get that Parliament has given the Commissioner this power. And this quite extrordinary superpower has been granted with little public interest.
There are two reasons for this.
First tax is apparently boring and doesn’t attract great public interest unless one’s own wallet is impacted. The usual submitters (tax geeks) generally represent business interests. The other reason is that the power is likely to operate only in a taxpayer’s interest, not against.
The provisions state that a taxpayer is not required to follow the Commissioner’s edict to exempt a law. Aha not so powerful after all. Taxpayers can choose to follow the strict letter of the law. In other words, this exemption will only be applied for the benefit of the taxpayer, not to their detriment.
So what’s my problem? My concerns are two-fold.
First, I am not comfortable with administrative functions being granted superpowers to circumvent law made by the democratically elected representatives. Second, I am concerned with who will benefit from these provisions.
Segregation of the duties of our government is one of the foundations of New Zealand’s (unwritten) constitution. Law making power is granted to the elected body – parliament – made up of members chosen by the people and crossing all spectrums of society.
Administration of the law is taken up by unelected employees of government. Granting law making (or breaking) powers to an official appointed by the State Services Commissioner crosses the segregation boundaries and undermines the process of law making.
Granting the Commissioner the ability to exempt a law because it is inconsistent with an administrative practice moves into the sphere of law making.
The third branch of government, sitting alongside parliament and the executive, is the judiciary – those who interpret and enforce law.
Granting the Commissioner the power to exempt taxpayers from a law because it is inconsistent with parliament’s intention steps on the toes of the judiciary. It is the judiciary’s role to determine what the intention of parliament might be.
My second concern is somewhat more pragmatic. Who is this superpower designed to benefit?
Most New Zealanders receive all their income from salary and wages and pay their tax through the PAYE system. Most New Zealanders have no need for an accountant and do not even file tax returns.
But if you have more complex financial affairs, you may need an accountant. And if you have lots of money, you might have a very expensive accountant with a great deal of expertise in money matters – including tax. You might have a very expensive lawyer as well. This is good news and has kept me in gainful employment through my working years.
Now, I have spoken with a few of my friends (who have accountants but not the expensive sort), and they tell me they are not aware of the Commissioner’s new superpower. They tell me they are unlikely to be requesting the Commissioner to use her new power in their favour due to – well – ignorance. I have an inkling who may be inclined to use the new provisions, however.
Perhaps those with more complex tax affairs. Perhaps those who use expensive accountants and lawyers. Perhaps those with access to tax knowledge and expertise.
Now the Inland Revenue officials who have reviewed my submission have said, “don’t worry” Alison. The Commissioner’s new superpower is “intended to only be used for minor or administrative matter where there are no, or negligible fiscal implications”. Which would be fine except that’s not what the legislation says.
The superpower is not at all limited to ‘minor or administrative’ matters. It is far broader than that. And as for ‘no or negligible fiscal impact’… what would be the point of exempting a law if there was no or negligible fiscal implications?
And once again, this is not exactly what the law says. It says the Commissioner may only use her power if there are no or negligible fiscal implications for the Crown. Now the last financial year produced over $80bn of tax revenue for the Crown. So I ask, what is negligible in the context of $80bn? Is $20m negligible?
This is up to the Commissioner to determine.
Now I do not mean to suggest any corruption on the part of our tax administration or our current Commissioner. But the law must protect the people from the potential for corruption. And this law steps well over that line.
The use of this superpower will be one to watch. But who will be watching? That is a conversation for another day.
(1) I note though that Andrea prefers ‘unauthorised access’ to ‘hack’. But as she invited me in – albeit not through a search bar – she can get over herself.
PIEs, timebar and tax fairness
My lovely young friends had a great time with their guest post last week and were delighted with the reception they received. Including getting picked up by interest.co.nz – something they like to point out I have never managed.
They were really keen to post this week on the digital services tax discussion document which they think is awesome. But I need to have a little chat to them before they do.
We also had a chat about whether the Andrea Tax Party is really a goer. Much like Alfred Ngaro we have concluded it all seems a bit hard. Also the move from thinking about things to politics hasn’t been the smoothest for TOP. So as the evidence led people that we are, we have decided to conserve our emotional energy and not fall out over boring constitutional issues.
I’ll stay as your correspondent and my young friends will come back from time to time when they can fit it in between their three jobs and studying. They are also checking out Organise Aotearoa who recently put up this sign in Auckland and seem to be to the left of Tax Justice Aotearoa.
As well as the digital services tax proposal – which I’ll save for my (briefed) young friends – the other tax story this week was how thanks to the Department upgrading its computer system it has found a number of people – 450,000 – haven’t been paying enough tax on their PIE investments. And while that is the case the Department has said that it won’t chase this tax on any past years.
Behind this story are two interesting – to me anyway – tax concepts.
Portfolio investment entities (PIEs)
These are a Michael Cullen special and came in at the same time as KiwiSaver. Before their introduction all managed funds were taxed at the trust rate of 33% and were taxed on any gains they made on shares sales – because they were in business.
Alongside all this was passive investment or index funds who had managed to convince Inland Revenue that because they only sold because they had to, those gains weren’t taxable.
Individual investors weren’t taxed on their capital gains and otherwise they were taxed at less than 33% if they had taxable income below the 33% threshold. This was particularly the case for retired investors.
The status quo did though give a minor tax benefit to high income people who were otherwise paying tax at 39%.
So it was all a bit of a hot mess.
Added into the equation was that, unlike now, the Department’s computer wasn’t up to much so all policy was based on ‘keeping people out of the system’.
So where the PIE stuff landed was income of the fund would be broken up in terms of who owned it and taxed at the rate of the owners. Except for the high earners – as their alternative was a unit trust taxed at the company rate – the top rate was capped at the company rate.
Low income people were now taxed at their own rate rather than the trust rate and high income people kept their low level tax benefit.
Happiness all round.
But it all depended on the individual investor telling the fund what the correct rate was and boy did the funds send out lots of reminders. I got totally sick of them.
Particularly when not filling them out meant you got taxed at 28% which was the top rate anyway.
So the people getting caught out this week would have once told the fund to tax them at a lower rate. It wouldn’t have happened by accident.
Although it is entirely possible they were on a lower rate at the time – because they had losses or something – and then ‘forgot’ to update it. Such people though would probably had a tax agent who would normally pick this stuff up. So not these people,
The caught people I would suggest are people, without tax agents, who accidentally or intentionally chose the wrong rate at the time or are PAYE earners whose income has increased over time and didn’t think to tell their fund.
But really only a tax audit would tell the difference between the two groups even if the effect is the same.
The other thing this week has shone light on is something known in the tax community as timebar (2).
It is a balance between the Government’s right to the correct amount of revenue and taxpayer’s ability to live their lives not worrying about a future tax audit. The deal is that if you have filed your tax return and provided all the necessary information – but you are wrong in the Government’s favour – Inland Revenue can only go back and increase your tax for four years.
If you haven’t filed and/or provided the necessary information – usually in cases of tax evasion – game on. The Department has no time constraints.
But the thing is none of this is an obligation on Inland Revenue. It is a right but not an obligation.
Under the Care and Management provisions (1) – the Commissioner must only collect the highest net revenue over time factoring in compliance costs and the resources available to her.
And so on that basis – I must presume – she has decided to not go back and collect tax for the last three years underpaid PIE income. In the same way he – as it was then – decided to only pursue two years of tax avoidance that arose from the Penny and Hooper tax avoidance cases.
Now I am sure this is completely above board legally in much the same way as the use of current accounts or the non-taxation of capital gains.
But with a tax fairness lens, it makes discussions with my young friends quite tricky.
They only have their personal labour which, to them, is taxed higher than I was at the same age. They don’t have capital and see this recent story as another way the tax system is slanted against them.
So I am not sure we have seen the last of the motorway signs.
(1) Section 6A(3)
(2) Section 108
Tax and politics (2)
Kia ora koutou
Andrea has handed over to us on the youth wing of the Andrea Tax Party for this week’s blog post so we can set out our views on tax.
What she proposed is ok but we can’t help feeling it was more than a little influenced by her Gen X, neoliberal, tax free capital gain and imputed rent earning privilege. A bit like the recent Budget – more foundational than transformational.
But we have also worked out that – by definition – any capital gains tax that applied from a valuation day or worse still grandparenting would have hit any gains our generation would have earned rather than the gains that have arisen to date.
And don’t get us started about the exemption for a family home. The only members of our generation who will buy a house – with exorbitant mortgages – are those whose parents can help financially. Again more revealed Gen X privilege.
So we aren’t super sad it is off the table.
TOP are still promoting an alternative minimum tax and CPAG want to tax a risk free return on residential property. Both reasonable and we may yet move over to them but it the meantime we are seeing if we can do better.
This is what we are thinking:
Land tax on holdings over $500,000. Limited targetted exemptions.
This was a proposal under National’s tax working group (1) in 2009/10 that was also then ignored by the Government at the time.
The deal is that there would be a tax on the value of land. That’s pretty much it. There could be exemptions for conservation land, maybe land locked up for ecological services and Maori freehold land.
The last one might be controversial but we are completely over the race baiting that goes on anytime different treatment for Maori assets comes up. Settlement assets were a fraction of that taken by the Crown and until such time as Maori indicators – not the least the prison population – gets anywhere near non-Maori, we are open to different treatment to improve outcomes.
As this tax is certain what tends to happen is that the price of land falls by an NPV of the tax. The effect therefore is the same as a one off tax on existing landowners. And to be honest – we’d be open to that. Seems much lower compliance cost something Andrea and her friends get so excited about.
Now we know there is an argument that because of the effect on existing land owners – this is unfair.
However to a generation locked out of land ownership in any form due to the high prices – we are deeply underwhelmed by that argument. It was equally unfair that existing owners got the unearned gains over the last 10 years or so. And yes they might not be the same people who are affected – but again – underwhelmed.
So all holdings of land over $500,000 – other than those mentioned above – will be subject to a land tax. And honestly maybe we have the threshold too low.
GST – no change
This one causes us pain.
We really want to drop the rate as poor people spend so such more of their income than rich people. But rich people who might be living off tax free capital gains still have to buy food – and they spend more on food than poor people. So a cut in GST is – in absolute terms – a greater tax cut for the rich.
However the prevailing wisdom that increases in GST don’t matter if you increase benefits is also BS. This is for a couple of reasons:
Benefits – until this Budget kicks in – are increased by CPI but low income households have higher inflation than high income households.
Benefit increases do not survive National Governments. The associated rise in benefits from the GST introduction were unwound by the benefit cuts in 1992 and more recently benefits were eroded through changes to the administration by WINZ.
And even Andrea witnessed the changed behaviour of WINZ as she was in receipt of the Child Disability Allowance from 2007 to 2012. She went from having a super helpful empathetic case manager to having the allowance stopped when they lost her paperwork.
If anyone wants to argue instead that the last government increased benefits – bring it on – because if that is how Andrea was treated by them just imagine how WINZ behaved to people who weren’t senior public servants.
So we are recommending no change here unless there was some way of making it progressive.
Inheritance tax on all estates over $500,000
Andrea might be fixated with taxing people when they are alive but all this means is that the huge untaxed gains that have been earned get to be passed on to the next generation. And yes that might be some of us but anything to reduce the wealth inequality in New Zealand has to be considered.
We take Andrea’s point about this also applying to death of settlors (and maybe beneficiaries) but all estates over $500,000 will be taxed at the GST rate as it is inherently deferred consumption.
Make the personal tax scale more progressive
When Andrea started work in 1985 – as an almost grad – she earned $15,000 and paid $5,000 of that in tax. That is an average tax rate of 33% and probably a marginal tax rate of something like 45%.
She had no student loan because University was free. In fact she also got a bursary of about $700 three times a year. There was no GST.
Grads in 2019 start on about $50,000. Income tax is about $9,000. This is an average tax rate of about 18% and a marginal tax rate of 30%. Student loan repayments are 12% and GST is probably about 10% allowing for rent and savings. This gives a marginal tax rate of 52% which will then climb to 55% if they ever get a well paying job. So 10% higher tax than 1985 on pretty middling incomes.
We get that including student loans might upset Andrea’s tax friends but we are also guessing none of those people have 12% of their earnings going to Inland Revenue every pay day.
Team if it looks like a duck and quakes like a duck….
In fairness we also know her father in 1985 had a marginal tax rate of 66% although he got deductions for life insurance and ‘work related’ expenses. Now parents top out at 33% plus say 10% for GST – 43%.
We guess then parents should pay more but 1) not everyone has middle class parents 2) declining labour share of GDP and 3) the ones who can are already helping us and that is a recipe for entrenched privilege.
So our policy proposal is:
1) Make the changes Andrea suggests to stop all the tax avoidance and tax evasion.
2) Extend the bottom tax rate of 10.5% to $40,000
3) Increase the next tax rate to 25% from $40,000 to $70,000
4) Bring in a new threshold of 40% at $100,000
Or something like that.
The bottom threshold needs extending to include anyone who can still receive any sort of welfare benefit while also earning income. That reduction in tax then needs to be clawed back for higher earners and really high earners just need to pay more.
Emissions trading scheme
And please if there isn’t going to be any sensible carbon tax or any environmental taxes could we at least put a proper price on carbon in the Emissions Trading Scheme.
It is only human life on this planet we are talking about.
We think that is it for us. Andrea and her Gen X biases will be back next week.
Young friends of Andrea
(1) Page 50
Tax and politics
Your correspondent is back from Sydney. Had a great time because – well – Sydney.
Managed to score a gig on a panel at the TP Minds conference talking about international policy developments for transfer pricing. An interesting experience as I am pretty strong in most tax areas except GST – and you guessed it – transfer pricing.
But it was ok as I did a bit of prep and all those years of working with the TP people paid off. And of course I do know a little bit about international tax and BEPS so alg.
Even a techo tax conference again reminded me just how different – socially and culturally – Australia is to New Zealand. Examples include: the expression man in the pub being used without any sense of irony or embarrassment and one of the presenters – a senior cool woman from the ATO – wearing a hijab.
Can’t imagine either in tax circles in NZ.
My particular favourite though was watching the telly which showed a clip of Bill Shorten describing franking (imputation) credits as something you haven’t earned and a gift from the government. Now Australia does cash out franking credits but – wow – seriously just wow. Kinda puts any gripes I might have about Jacinda talking about a capital gains tax into perspective.
And in the short time I have been away yet another minor party has formed as well as the continuation of the utter dismay from progressives over the CGT announcement.
In the latter case I am fielding more than a few queries as to what the alternatives actually are to tax fairness is a world where a CGT has been ruled out pretty much for my lifetime.
Now while I have previously had a bit of a riff as to what the options could be, I have been having a think about what I would do if I were ever the ‘in charge person’ – as my kids used to say – for tax.
To become this ‘in charge person’ I guess I’d also have to set up a minor party although minor parties and tax policies are both historically pretty inimical to gaining parliamentary power.
But in for a penny – in for a pound what would be the policies of an Andrea Tax Party be?
Policy 1: All income of closely held companies will be taxed in the hands of its shareholders
First I’d look to getting the existing small company/shareholder tax base tidied up.
On one hand we have the whole corporate veil – companies are legally separate from their shareholders – thing. But then as the closely held shareholders control the company they can take loans from the company – which they may or may not pay interest on depending on how well IRD is enforcing the law – and take salaries from the company below the top marginal tax rate.
On the other hand we have look through company rules – which say the company and the shareholder are economically the same and so income of the company can be taxed in the hands of the shareholder instead. But because these rules are optional they will only be used if the company has losses or low levels of taxable income.
My view is that given the reality of how small companies operate – company and shareholders are in effect the same – taking down the wall for tax is the most intellectual honest thing to do. Might even raise revenue. Would defo stop the spike of income at $70,000 and most likely the escalating overdrawn current account balances.
So look through company rules – or equivalent – for all closely held companies. FWIW was pretty much the rec of the OG Tax Review 2001 (1).
Now that the tax base is sorted out – if someone wants to add another higher rate to the progressive tax scale – fill your boots. But my GenX and tbh past relatively high income earning instincts aren’t feeling it.
Policy 2: Extensive use of withholding taxes
The self employed consume 20% more at the same levels of taxable income as the employed employed. Sit with that for a minute.
Now the self employed could have greater levels of inherited wealth, untaxed capital gains or like really awesome vegetable gardens.
Or its tax evasion. Cash jobs, not declaring income, income splitting or claiming personal expenses against taxable income.
Now in the past I have got a bit precious about the use of the term tax evasion or tax avoidance but I am happy to use the term here. This is tax evasion.
IRD says that puts New Zealand at internationally comparable levels (2). Gosh well that’s ok then.
Not putting income on a tax return needs to be hit with withholding taxes. Any payment to a provider of labour – who doesn’t employ others – needs to have withholding taxes deducted.
Cash jobs need hit by legally limiting the level of payments allowed. Australia is moving to $10,000 but why not – say $200? I mean who other than drug dealers carries that much cash anyway?
Claiming personal expenses is much harder. This we will have to rely on enforcement for.
Policy 3: Apportion interest deductions between private and business
Currently all interest deductions are allowable for companies – because compliance costs. Otherwise interest is allowed as a deduction if the funding is directly connected to a business thing.
What it means though is that for someone with a small business and personal assets such as a house, all borrowing can go against the business and be fully deductible.
Options include some form of limitation like thin capitalisation or debt stacking rules. I’d be keen though on apportionment. If you have $2 million in total assets and $1 million of debt – then only 50% of the interest payable is deductible.
Policy 4: Clawback deductions where capital gains are earned
Currently so long as expenditure is connected with earning taxable income it is tax deductible. It doesn’t matter how much taxable income is actually earned or if other non-taxable income is earned as well.
Most obvious example is interest and rental income. So long as the interest is connected with the rent it is deductible even if a non-taxable capital gain is also earned.
One way of limiting this effect is the loss ringfencing rules being introduced by the government. Another way would be – when an asset or business is sold for a profit – clawback any loss offsets arising from that business or asset. Yes you would need grouping rules but the last government brought in exactly the necessary technology with its R&D cashing out losses (4).
Policy 5: Publication of tax positions
And finally just to make sure my party is never elected – taxable income and tax paid of all taxpayers – just like in Scandinavia will be published. Because if everyone is paying what they ought. Nothing to hide. And would actually give public information as to what is going on.
Options not included
What’s not there is any form of taxation of imputed income like rfrm. It isn’t a bad policy but taxing something completely independent of what has actually happened – up or down – doesn’t sit well with me.
Also no mention of inheritance tax. Again not a bad policy I’d just prefer to tax people when they are alive.
And for international tax I think keep the pressure on via the OECD because the current proposals plus what has already been enacted in New Zealand is already pretty comprehensive.
Now I know none of this is exactly exciting and so I’ll get the youth wing to do the next post.
(1) Overview IX
(2) Paragraph 6
(3) Treatment of interest when asset held in a corporate structure
(4) Page 11 onward
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
An alternative progressive tax policy
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
The next day
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.
Coz everyone else pays their taxes
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