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
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
Let’s tax about tax.
Or more particularly let’s talk about Australia’s proposal for a reduced tax rate for small business.
Ok yes I am excited. A new government. A Labour led government. And a young woman as a Prime Minister. Mostly what I hoped for as I climbed the millions of steps to door knock in Wellington. My left leg is almost recovered too. Thanks for asking.
And as if all of this wasn’t exciting enough two of my young friends Talia Smart and Matt Woolley won the Robin Oliver tax competition. Talia on Charities and Business and Matt on the integration of the company and personal tax. I hope to cover their papers once they become public.
Oh and Stuart Nash has won the pools and become Minister of Revenue.
So big congrats to Talia, Matt and Hon Stu. Expecting great things from you all.
We should hear about the tax working group soon. A group that as well as looking as the fairness thing for tax is also looking at housing affordability. And as of today is now looking at whether small businesses should have a lower tax rate. Like wot Australia has.
Now as hadn’t really paid any attention to this dear readers now seems like an opportune time to have a look. Apparently in 2016 the Australian government reduced the tax rate on companies with a low turnover who were in business like this:
Now there is a thing that if the turnover is more than 80% passive income – dividends and the like – the lower rate doesn’t apply. But 75% alg. And the turnover thing seems to have a group concept in it – so that is something. No splitting up companies – in theory anyway.
Tbh it looks like a fiscal thing. Reducing the company tax rate but it a way that doesn’t all go to the nasty big companies. Some of whom will be foreign. So will cost less than a simple company tax reduction.
Conceptually a tax cut for small business – not nasty big business – what’s not to love? The tax equivalent of free doctors visits. It does have a few downsides:
- At the margin may inhibit growth. Coz who wants to grow and get a higher tax rate?
- Incentivise passive holding companies. 80% is still pretty and
- (You guessed it) incentivise recharacterisation of other higher taxed forms of income. Aka alignment issues.
As we have discussed before dear readers – alignment matters. Whether it is misalignment of the trust and top rate or the company and the top rate. Income will gravitate to its lowest taxed form. Now if that income stays in the company and helps it grow. Alg. Effectively a tax subsidy for small business who might use this money to – say – help offset the higher minimum wage.
But it also might further incentivise the whole ‘salary at $70k’ thing; an overdrawn current account; and dodgy as dividend stripping. Because with small business the corporate veil in practice is pretty thin. The shareholders, the company and the senior employees are all the same people. And as we saw last week, small business isn’t as tax pure as maybe first thought.
The tax avoidance provision will help but is no way to run a tax system. Maybe we’ll need some tighter rules on getting money out of a company. That has merit regardless.
Will be interesting to see what the working group thinks about it.
Let’s talk about tax.
Or more particularly let’s talk about small business owners not paying the top marginal tax rate.
Well this has all taken much long than I expected.
Getting back to you dear readers. What else could I be taking about? Post election I was ready to go again but then had some family stuff to do. But I am here now.
Election night every part of my body hurt. And that was nothing to do with the result. After 24 years in Wellington – and as an ex runner – I thought I knew about hills. But after a couple of weeks of (almost) daily door knocking when (almost) every door in Wellington was up a vertical incline – I was spent. I was ready for it to be over. Win, lose or draw.
Except it still isn’t over.
But focussing on what is really important – my body has recovered and family stuff is sorted. So I can think about real tax again. Not what passes for tax in an election campaign.
Now while I was out destroying my aging body a very interesting paper was delivered at the Law Society’s annual tax conference entitled Dividend Avoidance. In that paper five ways were outlined for owners of closely held companies to get dosh out of their companies tax free. Aka not triggering the dividend rules.
Now this is very interesting for a number of reasons:
- The rhetoric that small businesses are ‘paying their fair share’ just might not be true;
- The 5 ways will only be used when have shareholders that earn more than $70k – ie not poor people;
- Only became an issue when company tax rate became 28% and
- James Shaw inadvertently outed this early this year and was told by the Minister of Revenue – and to an extent me – that there was nothing to see.
The imputation/dividend interface should mean that when value shifts from the company to the shareholder; tax not paid at the company level is paid by the shareholders. Aka #doubletaxationisgross. This includes use of losses. It doesn’t matter how tax is not paid. When it goes to the shareholder he or she should make up the difference.
Dividends paid between companies with the same ultimate shareholders are taxfree. Coz same economic ownership so no actual value passing.
Capital gains earned by a company can only be passed on to shareholders tax free if the company is liquidated. And liquidation should be kinda big deal. Otherwise a capital gain is simply untaxed income that will get taxed when goes to the shareholders.
The actual market value of the company – goodwill – can only come on to the the company’s books on sale. Accounting standards quite correctly stop companies increasing their accounts for their market value. Too easy to be abused.
Shareholders can take money out of their companies at any time. This is done through the shareholder current account. When they take out more money than they have earned it becomes negative or overdrawn. If the shareholder is also an employee they need to pay non-deductible interest on this loan.
But – in theory – this whole drawing more from your company than you actually earn should stop at some point. And then the extra 5c should be paid. Well at some stage.
The other thing to put into the mix is that following the Penny and Hooper case there will be lots of structures where a trust owned the business. You know the last time small business didn’t pay the top marginal tax rate.
The Law Society paper outlined five ways for small business to not pay the top tax rate. But I am just going to take you through one that neatly springs from the Penny and Hooper structures.
So here we are: a small business owner or professional person with what they thought was a totes legit way of progressive tax scale not applying to them. They’ve paid the back taxes to IRD and yelled at their accountant. What to do now?
Step one Trust sets up a new company – Holding Company
Step two Trust sells its shares in company – Company – wot earns money to Holding Company for its market value. This is likely to be significantly above the value shown on Company’s accounts as Goodwill is not allowed in them.
Step three Trust lends money to Holding Company for purchase. For the accountants reading this is Dr Loan to Holding Company Cr Investment in Company.
Step four Company now pays dividends to Holding Company. And who would have thought -they are now tax free and an intercompany dividend.
Step five Holding Company makes loan repayments to Trust.
Step six Trust distributes to beneficiaries tax free.
Voila! Tax is only paid at the company tax rate. No more risk of extra 5c. And even more beautifully – if tax is not paid at the company level; nothing is paid at all. So good.
Now to be fair this isn’t a permanent tax scheme as only works until loan is repaid. But then maybe the company has further increased in value and can be done again?
But arguably as the ultimate capital gain could be paid out on liquidation – it is simply timing and I should calm the F down? Nah I don’t buy that either. It is structuring into a concession. And what is that called? Yes dear readers tax avoidance.
Now there are a few other things that are kinda interesting here too:
- Really only became an issue in 2010 when the company tax rate dropped to 28%. By the same government that reduced the top tax rate to 33% because they were concerned about avoidance of the top tax rate. You can’t make these things up.
- Discovered on Investigation. And given how hard this stuff is – taking a wild guess here – by people that Inland Revenue are currently cutting the pay of or making reapply for their jobs. Again can’t make this stuff up.
I can only hope that if we ever get more than a caretaker Minister of Revenue – whomever he or she is – they get onto this stat. Because what is now really clear is that for small businesses earning more than 70k – the top tax rate is optional.
James – you were right.