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
Let’s talk about tax.
Or more particularly let’s talk about tax and companies.
Well dear readers what a week it has been in the Beltway. Secret recordings down south and secret payouts from Wellington. All the more bizarre as – Mike Williams confirmed – MPs staffers pretty much have sack at will contracts. If your MP doesn’t like you – that’s it you’re out. No lengthy performance management for them. Facepalm. So maybe this factoid could get added to new MPs induction?
But as always the key issue gets missed. Exactly who under 40 years old knows what a dictaphone is?
And into this maelstom Inland Revenue released a paper on taxation of individuals and some stuff on debt. Both worthy topics of discussion. But then Ryman released its results. And their CEO said like tax is paid – just not like income tax and just like not by them.
So after last week’s post I thought I’d have a look.
Oh yes the real tax is very easily found in the Income Tax Note. Tax losses of $28.9 million in the 2017 year. Up from last year when they were only $15 million of losses. They are a growth stock after all. Quite different from the tax expense which was $6m tax payable.
To your correspondent this looks awfully like her specialist subject of interest deductions for capital profits. All mixed up in a world where interest expense isn’t in the P&L but instead added to the asset value. Complying with both accounting and tax. And yeah totes a tax loophole but one from like whenever.
And again in Ryman’s accounts the rent equivalent from the time value of money of the occupancy advances is in neither the accounting nor the tax profit. Because reasons.
Now expecting controversy the CEO front footed the issue saying that the shareholders paid tax and that Ryman had actually paid GST. He then also referred to the PAYE deducted as they were employers. Kinda going to ignore that bit tho coz the whole claiming credit for other people’s tax really gets on my nerves.
And I’ll take his word on the GST angle coz I am cr@p at GST. But with his shareholders paid the tax comment – he is talking about imputation. And as I haven’t covered that before dear readers – today you get imputation. Oh and other random thoughts on tax and companies.
Now the official gig about imputation is how – notwithstanding that they are separate legal peeps – the company is merely a vehicle for their shareholders to do stuff. So for tax purposes the company structure should – sort of – get looked through to its shareholders. And this means dividends are in substance the same income as company profits and so should get a credit for tax paid by the company.
And as a tax person this stuff is considered to be in the stating the flaming obvious category.
But as I am no longer an insider – I am increasingly finding it interesting just how public policy on companies manages to talk out of both sides of its mouth. And how – much like the sack at will contracts or milliennials using dictaphones – no one has noticed.
On one hand we have the Companies Act which sets up companies with separate legal personalities from its shareholders. Meaning that if you transact with a company and it doesn’t pay you. Bad luck bucko. Nothing to do with the shareholders. Limited liability; corporate veil and all that.
But for tax if you only have a few shareholders those losses can flow through to the shareholders and be offset against against other income. The negative gearing thing but using a company. Coz in substance the company and shareholders are like the same.
And a similar thing happens with the Trust rules. Trust law says that it is trustees that own the assets. And once you have handed stuff over to them as settlor – that’s it – that stuff isn’t yours anymore. So if that settlor owes you money – also bad luck bucko. Don’t for a second think you can approach the trustees – coz whoa – settlor nothing to do with them.
But then tax says – for trusts – as settlors call the shots; it’s the residence of the settlor that is important. Mmmm. This means that a trust with a New Zealand resident trustee and a foreigner wot gave the stuff to the trustee – foreign trust – isn’t taxed on foreign income. Coz that would be like wrong. Even though the assets are owned by a New Zealand resident. And New Zealand residents normally pay tax on foreign income.
Right. Awesome. Thanks for playing.
Anyway back to imputation.
Now put any thoughts of separate legal personalities outside your pretty heads dear readers and think substance. Think companies are vehicles for shareholders. Don’t think about small shareholders having no say or liability if anything goes wrong. Just think one economic unit.
And then you will have no problem seeing potential double taxation if profit and dividends are both taxed. Coz #doubletaxationisgross.
So as part of the uber tax reforms in the late eighties imputation was brought in. Tax paid by the company can be magically turned into a tax credit called – imaginatively – an imputation credit which then travels with a dividend. Creating light and laughter in the capital markets. Or as I have put to me – increased inequality. As when imputation came in it gave dividend recipients – aka well off people – an income boost courtesy of the tax system. Probs also a tax free boost in the share price too.
Now putting aside such inconvenient facts – your correspondent has always defended imputation. Because in order to get the light and laughter or increased inequality – companies actually have to pay tax. And of that – big fan.
But all of this is only useful if shareholders are resident. Coz the credits only have value to New Zealand residents. And this is kind of why foreign companies may not care about paying tax here. And did I mention tax has to actually be paid?
And this last point that brings me back to Ryman’s chairman. He is right. If the company doesn’t pay tax – then the shareholders do when a dividend is paid. So honestly what are we all getting excited about?
Well – profits have to be like actually distributed before that happens and shareholders have to be taxpayers. And Ryman distributes less than 25% of their accounting profit.
And the residence of shareholders? Who knows. Lots of nominee companies listed which could mean KiwiSavers or non-residents. Oh and Ngai Tahu. Who seems to be a charity.
So yeah maybe. Some tax will be paid by some shareholders. That is true. Let’s hope it exceeds the tax losses Ryman is producing.
PS. This will be the last post – except if it isn’t – for the next couple of weeks. Your correspondent is getting all her chickens back for a while. And much as I love you all dear readers – I love them more. Until Mid July. Xx
Let’s talk about tax (and interest deductions for capital gains).
While your correspondent is a confirmed Anglican – Episcopalian actually – I don’t consider myself a Christian anymore and haven’t taken communion for over twenty years. The same cannot be said for the rest of my extended family which is pretty hard core christian and includes three ordained priests. It used to be overrun with lawyers so priests is definitely pareto improvement.
From time to time at family gatherings when my darling christian family is discussing something theological – yes it is fun but I love them a lot – one of them will say ‘but of course it all went wrong at the Council of Nicaea’. That I think was when the Christian Church became a proper institution and started telling its followers what to do. And having seen public institutions operate at times for themselves rather than the people they are serving I am sympathetic to that view.
But for tax – in New Zealand – its Council of Nicaea was the 1986 Pacific Rendezvous case.
Pacific Rendezvous was – and is – a motel. They wanted to sell the business but to get a better price they decided they needed to do some capital works. They borrowed money to do that and claimed most of the interest as a tax deduction.
They were pretty open that the building works were because they wanted to get a better price for the sale of their business. And of course we all know dear readers that the proceeds from a sale of a business that was not started with the intention of sale is tax free.
Unsurprisingly the Commissioner – who was a he at the time – was not best pleased. Deductions to earn untaxed income you cannot be serious. And so he took Pacific Rendezvous to court to overturn the deductions associated with the tax free capital bit.
But the Courts were like ‘nah totes fine’. Coz – get this – the interest was also connected with earning taxable income. You know the like really small motel fees even tho the whole gig was an ‘enhancing the business ahead of sale’ thing.
And that dear readers is why I am so not a lawyer. Having to hold such stuff in my head as legit would totally make it explode.
But I digress.
Now of course Parliament or the government at the time still had the chance to overturn that case coz of course Parliament, not the courts, has the final say. Or it could have simply taxed the capital returns – sorry now I am just being silly.
What actually happened was some 13 years later after a fruitless interpretative tour of the provisions Bill English – when he was just a little baby MoF and long before his two stints at the leader thing – proposed and Michael Cullen enacted – that companies could have as many interest deductions as they wanted because compliance costs. You know coz otherwise ‘they’ll just use trusts’.
It was subject to the thin capitalisation rules and as the banks were to discover to their chagrin – the anti avoidance rules – but deductions to earn capital profits game on.
Now the capital profits thing was considered at the time – chapter 4 – and quite a compelling economic case was made for some form of interest restriction. But by Chapter 6 there became insurrountable practical issues that made this not possible. Those issues included:
- The need for rules to ensure that the deduction was not separated from the capital income;
- Difficulties with bringing in unrealised gains;
- If done on realisation – potential issues with retropective adjustments along period capital gain was earned;
- Need to factor in capital losses.
And it was true that in the past Muldoon – well then must be wrong – had attempted to do something by clawing back interest deductions to the extent a capital gain was made. Imaginatively it was called ‘clawback’ and everyone hated it. And yes people did use trusts and holding companies to avoid it. Oh and soz can’t find a decent link to reference this so you will just have to trust me on this.
But you know what? Tax policy is so much cleverer now and we group companies and treat them as one entity for losses and lots of other stuff all which could get around these issues. In fact the recent National governments in a bipartisan and a thinking only of the tax system way have enacted rules that mean interest restrictions for capital gains are no longer the insurrountable issue they apparently were in 1999. Who says John Key doesn’t have a legacy?
So working up the list.
- Can’t see the issue with capital losses as if that capital was lost in a closely held setting on deductible expenses it is already fully deductible. Outside that any interest limitation for capital gains would only apply to the extent there was untaxed capital income. And as we are talking about losses – not income – no interest restrictions. Simple.
- Would only do it on realisation. Taxing unrealised stuff while technically correct is a compliance nightmare. But the new R&D rules which claw back cashed out losses when a capital gain is made – from page 24 – could totes be made to work here. Interest deductions could be allowed on a current year basis but if a capital profit is made – they are clawed back in the year of sale. If deferral was still a big deal – a use of money charge could be added in too. Personally I would give up the interest charge. Simpler and an acknowledgement of the earning of taxed income.
- And the whole deduction being separated from income was fixed with the debt stacking rules for mixed use assets. So let’s use that.
Coz the thing is while no one seems to be bringing in a capital gains tax anymore it is still massively anomalous that deductions are allowed for earning untaxed income just coz some incidental income was earned as well.
Now Labour is planning to have a bit of a go in this area by going after negative gearing through ringfencing losses. Better than nothing I guess. But still kinda partial as only touches people with not enough rental income to offset the deductions. And Grant, Phil and the new Michael – even for this – you totes will need the debt stacking rules or else ‘they’ll just use trusts’ or holding companies.
And yeah extending the brightline test to 5 years. Again better than nothing but there is still lots of scope to play the whole deductions for untaxed gains for property holdings over 5 years or – as with Pacific Rendezvous themselves – businesses.
But for any other political party with an allergy to a capital gains tax but big on the whole tax fairness thing perhaps you might want to look again at interest clawback on sale? This time thanks to the foresight and the public spirited nature of the John Key led governments – it would actually work.