Ok. So the story so far.
The international consensus on taxing business income when there is a foreign taxpayer is: physical presence – go nuts; otherwise – back off.
And all this was totally fine when a physical presence was needed to earn business income. After the internet – not so much. And with it went source countries rights to tax such income.
However none of this is say that if there is a physical presence, or investment through a New Zealand resident company, the foreign taxpayer necessarily is showering the crown accounts in gold.
As just because income is subject to tax, does not necessarily mean tax is paid.
And the difference dear readers is tax deductions. Also credits but they can stand down for this post.
Now the entry level tax deduction is interest. Intermediate and advanced include royalties, management fees and depreciation, but they can also stand down for this post.
The total wheeze about interest deductions – cross border – is that the deduction reduces tax at the company rate while the associated interest income is taxed at most at 10%. [And in my day, that didn’t always happen. So tax deduction for the payment and no tax on the income. Wizard.]
Now the Government is not a complete eejit and so in the mid 90’s thin capitalisation rules were brought in. Their gig is to limit the amount of interest deduction with reference to the financial arrangements or deductible debt compared to the assets of the company.
Originally 75% was ok but then Bill English brought that down to 60% at the same time he increased GST while decreasing the top personal rate and the company tax rate. And yes a bunch of other stuff too.
But as always there are details that don’t work out too well. And between Judith and Stuart – most got fixed. Michael Woodhouse also fixed the ‘not paying taxing on interest to foreigners’ wheeze.
There was also the most sublime way of not paying tax but in a way that had the potential for individual countries to smugly think they were ok and it was the counterparty country that was being ripped off. So good.
That is – my personal favourite – hybrids.
Until countries worked out that this meant that cross border investment paid less tax than domestic investment. Mmmm maybe not so good. So the OECD then came up with some eyewatering responses most of which were legislated for here. All quite hard. So I guess they won’t get used so much anymore. Trying not to have an adverse emotional reaction to that.
Now all of this stuff applies to foreign investment rather than multinationals per se. It most certainly affects investment from Australia to New Zealand which may be simply binational rather than multinational.
Diverted profits tax
As nature abhors a vacuum while this was being worked through at the OECD, the UK came up with its own innovation – the diverted profits tax. And at the time it galvanised the Left in a way that perplexed me. Now I see it was more of a rallying cry borne of frustration. But current Andrea is always so much smarter than past Andrea.
At the time I would often ask its advocates what that thought it was. The response I tended to get was a version of:
Inland Revenue can look at a multinational operating here and if they haven’t paid enough tax, they can work out how much income has been diverted away from New Zealand and impose the tax on that.
Ok – past Andrea would say – what you have described is a version of the general anti avoidance rule we have already – but that isn’t. What it actually is is a form of specific anti avoidance rule targetted at situations where companies are doing clever things to avoid having a physical taxable presence. [Or in the UK’s case profits to a tax haven. But dude seriously that is what CFC rules are for]
It is a pretty hard core anti avoidance rule as it imposes a tax – outside the scope of the tax treaties – far in excess of normal taxation.
And this ‘outside the scope of the tax treaties’ thing should not be underplayed. It is saying that the deals struck with other countries on taxing exactly this sort of income can be walked around. And while it is currently having a go at the US tech companies, this type of technology can easily become pointed at small vulnerable countries. All why trying for an new international consensus – and quickly – is so important.
In the end I decided explaining is losing and that I should just treat the campaign for a diverted profits tax as merely an expression of the tax fairness concern. Which in turn puts pressure on the OECD countries to do something more real.
Aka I got over myself.
In NZ we got a DPT lite. A specific anti avoidance rule inside the income tax system. I am still not sure why the general anti avoidance rule wouldn’t have picked up the clever stuff. But I am getting over myself.
Of course no form of diverted profits tax is of any use when there is no form of cleverness. It doesn’t work where there is a physical presence or when business income can be earned – totes legit – without a physical presence.
And isn’t this the real issue?
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.
Let’s talk about tax.
Or more particularly let’s talk about accounting tax expense.
Now dear readers the most unlikely thing has happened. A tax free week in the media. No Matt Nippert on charities – just for the moment I hope – no Greens on foreign trusts. No negative gearing and – thankfully – no R&D tax credits. So with nothing topical atm – we can return to actually useful and non-reactive posts. And yes I am the arbiter of this. Although the whole Roger Douglas and his #taxesaregross does warrant a chat. Need to psyche into that a bit first though.
So I am now returning to my guilt list. Things I have been asked to write about but haven’t . That list includes land tax; estate duties; some GST things; raising company tax rate; minimum taxes; and accounting tax expense.
And so today picking from the random number generator that is my inclination – you get accounting tax expense.
At the Revenue when reviewing accounts one of the things that gets looked at is the actual tax paid compared to the accounting income. This percentage gives what is known as the effective tax rate or ETR. And yes there are differences in income and expense recognition between accounting and tax but for vanilla businesses – in practice – not as many as you would think.
Now it is true that a low ETR can at times be easily explained through untaxed foreign income or unrealised capital profits. But it is also true that for potential audits it can be a reasonable first step in working out if something is ‘wrong’. Coz like it was how the Banks tax avoidance was found. They had ETRs of like 6% or so when the statutory rate was 33%.
So when I ran into a May EY report that said foreign multinationals operating in New Zealand had ETRs around the statutory rate – I was intrigued.
Looking at it a bit more – it was clear that it was a comparison of the accounting tax expense and the accounting income. Not the actual tax paid and accounting income. Now nothing actually wrong with that comparison but possibly also not super clear cut that all is well in tax land.
And I have been promising/threatening to do a post on the difference between these two. So with nothing actually topical – aka interesting – happening this week; now looks good.
Now the first thing to note is that the tax expense in the accounts is a function of the accounting profit. So if like Facebook NZ income is arguably booked in Ireland – then as it isn’t in the revenues; it won’t be in the profits and so won’t be in the tax expense.
Second thing to note is that the purpose of the accounts is to show how the performance of the company in a year; what assets are owned and how they are funded. One key section of the accounts called Equity or Shareholders funds which shows how much of the company’s assets belong to the shareholders.
And the accounts are primarily prepared for the shareholders so they know how much of the company’s assets belong to them. Yeah banks and other peeps – such as nosey commentators – can be interested too but the accounts are still framed around analysing how the company/shareholders have made their money.
And it is in this context that the tax expense is calculated. It aims to deduct from the profit – that would otherwise increase the amount belonging to shareholders – any amount of value that will go to the consolidated fund at some stage. Worth repeating – at some stage.
First a disclaimer. When IFRS came in mid 2000s the tax accounting rules moved from really quite difficult to insanely hard and at times quite nuts. Silly is another technical term. That is they moved from an income statement to a balance sheet approach. Now because I am quite kind the rest of the post will describe the income statement approach which should give you the guts of the idea as to why they are different. Don’t try passing any exams on it though.
Now the way it is calculated is to first apply the statutory rate to the accounting profit. And it is the statutory rate of the country concerned. That is why it was a dead give away with Apple – note 16 – that they weren’t paying tax here even though they were a NZ incorporated company. The statutory rate they used was Australia’s.
Then the next step is to look for things called ‘permanent differences’. That is bits of the profit calculation that are completely outside the income tax calculation. Active foreign income from subsidiaries; capital gains and now building depreciation are but three examples. So then the tax effect of that is then deducted (or added) from the original calculation.
For Ryman – note 4 – adjusting for non-taxable income takes their tax expense from from $309 million to $3.9 million. That number then becomes the tax expense for accounting.
But there is still a bunch of stuff where the tax treatment is different:
- Interest is fully tax deductible for a company. But – if that cost is part of an asset – it is added to the cost of the asset and then depreciated for accounting. And the depreciation will cause a reduction in the profits over say – if a building – 40-50 years. So for tax interest reduces taxable profit immediately while for accounting 1/50th of it reduces accounting profits over the next 50 years.
- Replacements to parts of buildings that aren’t depreciable for tax can – like interest – receive an immediate tax deduction. But for accounting a new roof or hot water tank are added to the depreciable cost of the building and written off over the life of the asset.
- Dodgy debts from customers work the other way. Accounting takes an expense when they are merely doubtful. But for tax they have to actually be bad before they can be a tax deduction.
These things used to be known as timing differences as it was just timing between when tax and accounting recognised the expense.
And then the difference between the actual cash tax and the tax expense becomes a deferred tax asset or liability. It is an asset where more tax has been paid than the accounting expense and a liability where less tax has been paid than the expense.
And the fact that these two numbers are different does not mean anyone is being deceptive. They just have different raisons d’etre. Now if anyone wants to know how much actual tax is paid – the best places to look are the imputation account or the cash flow statement. The actual cash tax lurks in those places.
But yeah it does look like actual tax. I mean it is called tax expense.
Your correspondent has memories of the public comment when the banking cases started to leak out. I still remember one morning making breakfasts and school lunches when on Morning Report some very important banking commentator was talking. He was saying that the cases seemed surprising coz looking at the accounts the tax expense ratio seemed to be 30%. [33% stat rate at the time]. But that 3% of the accounting profits was still a large number and so possibly worthy of IRD activity.
Dude – no one would have been going after a 3% difference.
In those cases conduit tax relief on foreign income was being claimed on which NRWT was theoretically due if that foreign income were ever paid out. So because of this the tax relief being claimed never showed up in the accounts as it was like always just timing.
Except that the wheeze was there was no actual foreign income. It was all just rebadged NZ income. And yeah that income might be paid out sometime while the bank was a going concern. So it stayed as part of the tax expense. Serindipitously giving a 30% accounting effective tax rate while the actual tax effective tax rate was 6%.
And a lot of these issues are acknowledged by EY on page 13 of under ‘pitfalls’.
So yeah foreign multinationals – like their domestic counterparts – may well have accounting tax expense ratios of 28%. But whether anyone is paying their fair share though – only Inland Revenue will know.
Let’s talk about tax.
Or more particularly let’s talk about the release of the recent government discussion documents on taxing the nasty multinationals.
You correspondent had spent the week before last on stage two of her yoga teacher training. No inner child this time but lots of describing poses in anatomical language. ‘The spine is flexed at the pelvis’ aka you bent over. Same lovely people though. Unfortunately my time on the course was punctuated by a day trip to Sydney – yes day trip – for a family funeral. I did however spend both legs watching a documentary on Oasis. So not entirely wasted. Also brought home number 2 son for a week’s visit.
So after all that I was seriously contemplating giving this week a pass too from posting. Coz like: ‘I am enough; I have enough; I do enough’ and other such lessons from the training. I was even looking for a cartoon to stand in its place:
Or possibly – as it is in colour:
But then Friday morning when I was working thru the details for a big family dinner for number 2 son and girlfriend – on comes the lovely Hon Judith Collins announcing the release of the discussion documents on taxing multinationals. Right. Ok. Mmm perhaps the cartoons won’t really cut it for Monday. But channelling my inner bureaucrat – where March counts as ‘early next year’ – Tuesday can count as Monday. Well broadly.
And the proposals are pretty good. Proper thin cap rules for finance companies are still missing but then a seven year time bar for transfer pricing! Whoa tiger. Even at my most revenue protective I’d never have thought of that. Lots of quite detailed techy stuff all which looks pretty effective to your correspondent.
On interest I am also pretty happy. No earning stripping rules but putting a cap on the interest rate should remove the structural flaw discussed previously and levelling the field by removing non- debt liabilities alg.
There is of course the small matter that with the House rising in July(?) and a Budget in May – there is no hope in hell it will even make a bill before this government finishes. Still no sign of any decisions on the Hybrids stuff that was released in September. And that is just as hard.
But if there is change in government this work will give Grant, Mike, James and Deborah an early taste of implementing fairness in the tax system. Coz there is nothing large well advised companies enjoy more than tax base protection. And they hardly ever lobby Ministers; harangue officials; brief journalists or turn up to select committees to advise them of the damage such tax measures will do to the New Zealand economy. So quite a good warm up for their fairness working group.
But I digress.
There are many and varied ways for non-residents to not pay tax with many and varied solutions. Most of which are in the discussion documents. But the one potential solution that gets all the airtime is the diverted profits tax. Which is a pretty narrow solution to a pretty narrow problem. But hey much like the iPhone 7 – irony intentional – even if our tax environment is different or our iPhone 5 is still fine – the UK and Australia have one so we want one too.
What is being proposed is the diverted profits tax equivalent of the iPhone SE – a 6 in a 5’s body. But when your existing phone really isn’t that bad.
And because it all gets so much media attention – this is the one techy thing I’ll take you through dear readers. But I am very sorry there is a bit of background to go through first. Kia Kaha. You can do it.
All taxpayers – resident and non – resident – are taxed on income with a New Zealand source. Our source rules however were devised in 1910 or so. Long before the internet and possibly even before the typewriter. Tbh tho they aren’t that bad and periodically get a wee tweak. They are broadly comparable to other countries. They include all income from a business in New Zealand which can include foreign income as well as income from contracts completed here.
Case law however has narrowed this to income from trading in New Zealand rather than trading with New Zealand. So foreign importers selling stuff to punters here are out of scope but a business here – even an internet business – game on.
The source rules are further narrowed by any double tax agreements. Here now New Zealand business income of a non-resident is only taxable in New Zealand if it is earned by a permanent establishment aka PE. And a PE is a fixed permanentish place of business. Once upon a time it would have been pretty hard to be a real business and not to have a fixed place of business. Possibly not so much now.
So if the non-resident earns business income through a fixed place in New Zealand – taxable – otherwise not. And for historic reasons the fixed place can’t include a warehouse. Coz that is like only preparatory or auxiliary to earning the income – not like the main deal. Yeah I don’t get it either.
Tax planning Apple and Google style
So when you put together the combo of no tax when:
- contracts not entered into in New Zealand;
- income earned from trading with New Zealand;
- no fixed place of business; and
- warehouse doesn’t count.
You kinda get the most widely known of the BEPS issues. The Google and Apple thing. Tbf I think they also use treaty shopping and inflated royalties but above is also in the mix.
Diverted Profits tax UK Style
Now a diverted profits tax doesn’t deal with the ‘trading with’ thing coz that is pretty entrenched and there are limits to anyone’s powers on that. And of course this would mean our exporters who ‘trade with’ other countries would become taxable there too. But it has a go with the other bits.
In the UK their diverted profits tax pretty much deals with situations as above where there is trading in a country and a permanent establishment should arise but doesn’t. The way it works is to say : ‘oh you know the income that would have been taxable if you hadn’t done stuff to not make it taxable – well now it is taxable.’ ‘Oh and it is like taxable at a much higher rate than normal – coz like we don’t like you doing that.’
And now New Zealand
Now in New Zealand that kind of I know you have followed the letter of the law – but dude – seriously is countered by the tax avoidance provisions. And much to the chagrin of the Foreign banks; specialist doctors; and Australian owned companies it does actually work in New Zealand.
And just because the tax avoidance provisions are being successfully applied doesn’t mean that the law shoudn’t be changed. It is a bucket load of work to investigate; dispute and then prosecute successfully. And if there are lots of cases – and there do appear to be – law changes are ultimately less resource intensive.
But even given all that I am somewhat surprised that what they have proposed is very similar to the handwavy tests of the UK. A bunch of clear questions of the structure and then asks if ‘the arrangement defeats the purpose of the DTA’s PE tests.’ Ok. Not a million miles from the parliamentary contemplation test with tax avoidance. So not entirely sure what extra protection it gives us other than being a bright shiny tax thing.
But then how different was the iPhone 6 from the iPhone 5 after all? And while the iPhone 7 is newer and flasher is it actually better?
Who knows though maybe New Zealand’s version of a diverted profits tax has a signalling benefit to the Courts. And its not like it will do any harm. So long as you don’t count additional complexity as harmful.
So all in all not bad. With the earlier Hybrids and NRWT on interest – even if the diverted profits tax equivalent may not add much – all the rest of the proposals should deal to undertaxation of non- residents.
Let’s talk about tax.
Or more particularly let’s talk about Oxfam’s recent press release on inequality and tax.
Now dear readers when I moved to weekly – hah – posting it was because this blog was supposed to be my methadone programme. Getting me off tax and on to other issues. So when I posted last night – after having posted 3 times last week – I gave myself a good talking to. This had to stop. One post a week was quite enough to keep the cravings at bay. To continue in this vein would risk a relapse.
But this morning while I was getting dressed my husband came and turned on the radio. Rachel LeMesurier from Oxfam was talking about inequality and then she talked about tax and then Stephen Joyce came on and then he talked about tax and then he talked about BEPS.
Just one more little post won’t hurt I am sure and I’ll cut down next week honest.
Oxfam has compared the wealth of 2 New Zealand men Graham Hart and Richard Chandler to the bottom 30% of all adult New Zealanders. Now the inclusion of Richard Chandler seems to be a rhetorical device as from what I can tell he hasn’t lived here since 2006. So very unlikely to be resident for tax purposes.
In the interview Rachael Le M also made reference to the tax loopholes that support such wealth. So using what is public information about Graham Hart and what is public about the tax rules I thought I’d make a stab at setting out what these ‘loopholes’ are.
Now first dear readers please put out of your head anything you have heard about BEPS or diverted profit tax or any of the ways that the nasty multinationals don’t ‘pay their fair share of tax.’ None and I repeat none of this is relevant when dealing with our own people. It might be relevant for the countries they deal with but not for New Zealand. I am hoping that officials will also explain this to new MoF Steven Joyce as when he came on to reply to Rachael – he talked all about BEPS. Face palm.
Graham Hart is a serial business owner. Buying them sorting them out and then selling off the bits he doesn’t want all with a view to building up a Packaging empire. A Rank Group Debt google search also indicates that a substantial proportion of all this buying and selling was done through debt. And at times quite low quality debt which would indicate a proportionately higher interest rate. A number of his businesses are offshore.
So then what ‘loopholes’ – or gaps intended by Parliament – could Mr Hart be exploiting?
The first and most obvious one is that there is unlikely to be any tax on any of the gains made each time he sold an asset or business. The timeframes and lack of a particular pattern – as much as Dr Google can tell me – would indicate that the gains would not be taxable.
The second is that income from the active foreign businesses will be tax exempt and any dividends paid back to a New Zealand will also not be taxed. Trust me on this. I’ll take you all through this another day.
The third relates to debt. Even though it assists in the generation of capital gains and/or the exempt foreign income it will be fully deductible. Now because of the exempt foreign income there will potentially be interest restrictions if the debt of the NZ group exceeds 75% of the value of the assets. A restriction true but not an excessive one given exempt income is being earned.
Now also in Oxfam’s press statement is a reference to a third of HWIs not paying the top tax rate. I am guessing some version of one and three plus the ability to use losses from past business failures is the reason.
Unsurprisingly Eric Crampton of the New Zealand Institute is not sympathetic to Oxfam’s views and points to our housing market as the main driver of inequality. So then in terms of tax and housing the other tax ‘loophole’ then would be the exclusion of imputed rents from the tax base.
Now one answer could be Gareth’s proposal. That is if someone could explain to me how to tax ‘productive capital as measured in the capital account of the National Income Accounts’ in a world where tax is based on financial accounts according to NZIFRS.
The second could be a capital gains tax even on realisation and the third some form interest restriction or clawback when a capital gain is realised. Oh and taxing imputed rents.
How politically palatable is this? Not very given National, Labour, Act, New Zealand First and United Future are all opposed to a capital gains tax – at least Labour for their first term.
But then maybe it is stuff for Labour’s working group. Will be interested to see this all play out.
Let’s talk about (the recent Greens’ press statement on) tax.
Recent data has shown there is a spike around $70,000 of reported taxable income for individuals – convienently the point where the top marginal tax rate of 33% starts. And according to the Greens this shows evidence of tax avoidance by rich people which can be fixed by – among other things – increasing Inland Revenue’s investigation budget. Mmm maybe.
Before I go on, I am working on the assumption that when the Greens talk about tax avoidance it is in the colloquial ‘not paying as much tax as I think you should’ kinda way rather than tax avoidance according to the actual law. All cool but unfortunately (or fortunately) the department is constrained by what Parliament has enacted and how the Courts have interpreted it.
Now in the mid 2000s – it is true – similar spikes were evidence of widespread tax avoidance among self-employed professionals. The wheeze was that they were employed by trusts which were taxed at 33% on the income the individuals earned – not the top individual’s rate of 39%. And then the trust paid the individuals a below market salary for their services to the trust.
Only the below market salary was taxed at 39% and the rest of the income at the lower trust rate. And then any tax paid income of the trust could then be distributed tax free to beneficiaries. Too easy and too good to be true. Hence tax avoidance according to the actual law.
Moving to 2017. The trust and top personal rate are the same so that particular wheeze won’t work. But now we just have misalignment between the company rate at 28% and the top personal rate of 33%.
Except that under a misalignment with the company rate there is no distributing the income tax free. When income is distributed from the company to the shareholder – a dividend – it is subject to another 5% tax. Now any ‘tax avoidance’ – in theory anyway – is just timing until the shareholder needs the money. There should be no ultimate reduction in tax. Although timing advantages can be a big deal and can also make something tax avoidance under the actual law.
But the only way I can see of moving this from tax avoidance – not paying as much tax as I think you should – to tax avoidance under the actual law is if the department can show that the $70k is not a market salary – as they did with the self employed professionals.
And while that wasn’t simple for the department last time – now all tax advisors know about the need for a market salary – possibly from painful personal experience. So anyone giving advice that $70k is an acceptable salary – when the market rate is higher – does so knowing it could be attacked by the department and will have all the supporting arguments ready.
But the Greens are right the spike is still there. Last time the spike was widespread tax avoidance according to the actual law – so why wouldn’t it be this time too? Not the first time I have lacked imagination.
Just in case tho I am right – I am also all about the solutions. And there is at least one way of getting rid of the spike without increasing anyone’s budget. Think of all that extra money Greens you could spend on cleaning up the rivers instead of tax inspectors.
One way is to increase the company tax rate to the top marginal rate.
Another way is to make the look-through company (LTC) rules compulsory.
Currently any company with five or fewer shareholders can choose not to be taxed as a company. Instead income and losses are taxed as if the shareholders had earned the money themselves. Except currently those rules are optional. Make them compulsory and the spike goes. No more income in more lowly taxed closely held companies as no more closely held companies for tax purposes. Simple.
And the really good news for the Greens is that there is currently a bill in the House making changes to the LTC rules; so a Supplementary Order Paper doing just that would be totes in scope. Oh and it is an ‘annual rates’ bill too so they could also have a go at the company tax rate at the same time. Awesome.
Now lots of people who haven’t made an LTC election may not like that and say so quite loudly. Coz that’s what you get when you are strong on policing tax avoidance – lots of upset people all with lots of incentive to write to you and come and tell you how upset they are.
But unless the current law with closely held companies – or company tax rate – changes I can’t see any level of increased funding will get rid of that nasty spike.
2016 has been some year.
Donald Trump; Brexit and then the deaths of Leonard Cohen; David Bowie; Prince; George Martin; Helen Kelly; Zsa Zsa Gabor, George Michael as well as the heart attack of Carrie Fisher. But one friend has had a baby and two have got engaged – although not to each other – so not a complete write off.
One death though – that has recently made the international tax community poorer – was that of Tim Edgar a Canadian tax academic.
Tim originally trained as a lawyer – and taught at law schools – but a less lawyery person you could not meet. Cases drove him mental. Once in conversation he suggested that instead of the Courts we should just use a random number generator for tax avoidance. Although to be fair it would also work for any of the objective subjective cases like capital/revenue or residence.
Odd numbers for the Commissioner – even for the taxpayer. Very fair. And would – he argued – have the effect that taxpayers would just stay away from anything that would get them put in the generator in the first place. Good policy outcomes with reduced fiscal cost. What’s not to love?
Tim came to Wellington with his family on sabbatical in early 2000s and worked in Inland Revenue policy. I can’t remember what he was supposed to be working on – GST possibly – but because of his ability and good humour very quickly became a sounding board and contributor to pretty much every team in the division. He also lived close to me and our families had a lot to do with each other over that time. We introduced the Edgar family to the joys of Fish and Chips.
After that period in Wellington, we kept in touch and our paths crossed a number of times including a joint stint presenting an OECD course in India. Again his depth of knowledge and good humour made him very popular with the participants while his North American tipping practices made him popular with the staff at the hotel.
By the mid 2000s I had become completely obsessed by hybrids in the way my children were with pokemon. So I wanted to analyse them and their effects for my masters dissertation. There was a small difficulty in that there was no one in New Zealand with the expertise who could supervise me. So I approached Tim.
With his usual good humour and generosity – although possibly it was the opportunity to earn $100 in NZ foreign exchange that clinched it – he agreed. And within 2 weeks I had a parcel of the key items of the hybrids literature in my mailbox. Not sure that is standard operating practice for most supervisors. But then Tim wasn’t most people.
At the time (2004- 2006) there were two views on hybrids. The first – dude get over it countries can do what they like aka the sovereignty argument and the second – it is double non -taxation/ bad aka the economic distortion argument. I wasn’t fully convinced by either view. Tim, however, was very firmly in the latter camp and – quelle surprise – history has proved him right.
Tim was a high level strategic person – but in the sense that he did actually have big picture insights – rather than just someone who can’t cope with complexity or detail. He was expert in Financial Arrangements; GST; international tax; tax structuring or pretty much anything he decided to have a look at.
I particularly remember him sharing his views on formulary apportionment which is touted by parts of the left as the ‘fair’ way to allocate worldwide tax revenues. The thing is – he said – there is nothing normative about allocating through source and residence. What that has going for it though – is that all the countries agree. Formulary apportionment throws all that up in the air – and who knows where you’ll end up?’
We last caught up around his fiftieth birthday – which I am embarrassed to see is almost 5 years ago. He shared with me the changes in his personal and professional life and how proud he was with how his children were doing. He was more subdued than previously but was looking forward to the next stage of his life.
I don’t think this and similar articles was what he had in mind though – particularly as he was always so fit. I struggled to find a photo that represented how I remember him. Even this one which I swiped from his uni’s obituary doesn’t show the exuberant enthusiasm he had for discussing any one of the topics around his head.
I had him on my list of people to contact now I have left the reservation but sadly this post will have to do instead. I will however always remember the laughter, the low ego/high ability combo and the non-standard approach to thinking about tax.
So go well my dear friend. Hail and farewell.
Let’s talk about tax (and tax avoidance).
Last week the government announced it was building yet another prison. Another moral and fiscal failure. Skilfully continuing to over turn the falling crime rate dividend we had in 2013 before the bail laws changed.
Also last week a reader made a comment about how wasn’t tax avoidance ‘legal’.
Another such observation on tax avoidance came from Denis Healey who said that the difference between tax avoidance and tax evasion is the thickness of a prison wall. She said trying to link two quite independent things together.
Now both maybe right in the United Kingdom but they really don’t directly translate to the New Zealand situation. So being the public spirited individual I am I thought I’d have a go at a layman’s guide to tax avoidance for New Zealanders. And no more mention of prison stuff – promise.
First of all tax avoidance is a term defined in the Income Tax Act. It comes in and overrides everything else in the Income Tax Act. So any provison in the Act theoretically runs the risk of tax avoidance coming in and saying – ‘you know what’ just kidding – bog off.
And it is defined in a way – directly or indirectly altering the incidence of tax – that could mean that anything you do that has the effect of reducing your tax could be caught. This could mean cutting your hours; paying off your mortgage instead of putting the money on term deposit; selling dividend paying shares to buy a car all could be classed as tax avoidance. As they were all plans or understandings – where the result was less tax was paid than before or less tax was paid than could have been.
Now as that couldn’t possibly be right the courts – helped by the Commissioner taking cases – has said it only applies when the outcome wouldn’t have been intended by Parliament. Right. Awesome. So much clearer now. Thanks for playing.
To be fair there is a little more to it than that. But largely it all boils down to:
1) strip away the clever stuff
2) work out tax result on stripped down ‘arrangement’
3) compare 2) to what went of tax return
4) Difference is tax avoidance.
Now most of the dispute between taxpayers and Commissioner is over what if any is the ‘clever stuff’.
In our friend Penny and Hopper putting a business into a trust was never challenged – coz you know creditor protection or keeping it from the missus wasn’t ‘clever’ it was just like ‘commercially acceptable’. In that case what was challenged as ‘clever’ was the trust paying the highly skilled doctors the same salary as they would earn in the public system – I mean Dude seriously who works for that?
The other recent case that made the tax community super mad – Alesco – involved the New Zealand business being funded by an optional convertible note. Now dear readers you may say ‘ ah yes I’ve read I choose you Pikachu ‘ an optional convertible note now that is ‘clever’ and so that is tax avoidance. Glad you are keeping up – but no. No what was clever here was that the option should have no value as Alesco Australia already owned all the shares – Duh. Other highlights of that case included the taxpayer arguing that while it was tax avoidance – it was Australian not New Zealand tax avoidance. All class.
Compare these then to the cutting your hours; paying off your mortgage or buying a car from savings. Nothing clever there – so long as that is all you are doing. Bit like our gentlemen below.
Now of course there is a line between a bit of tax planning – paying off your mortage before earning taxable income; funding a project with deductible debt or even investing offshore and receiving an exempt dividend – and tax avoidance. And because there is this line there will always be a Tax Administration and tax practitioners.
The thing is though that even if it is ‘tax avoidance’ it is a Civil thing and so no one goes to jail. They can lose the tax benefits; get hit with a 100% penalty plus interest of 8% – but no prison wall. Not even Home D.
Tax evasion however game on – Criminal charges defo in the mix. Now generally there is nothing clever with tax evasion. Just dirty fraudulent or deceptive behaviour: taking money out of the till; cashies – yes cashies; billing for a lower/higher number than is actually the case. Here jail time is totes on the cards and does happen. As well as a penalty of 150% and interest. And yes there is a line between avoidance and evasion too.
So is tax avoidance legal if Wikiquote says so too? Dunno it certainly isn’t criminal but does have high penalties.
So keep away from the clever sh@te and my former colleagues will probs keep away from you.
Let’s talk about tax.
Or more particularly let’s talk about tax; interest deductions and private expenditure in companies.
Your correspondent has returned from her ‘retirement cruise’; is recovering from jetlag and has returned to what passes for work these days. That will dear readers include a return to twice weekly posting. As a change from some of the more political posts I thought I’d return to a technical issue for a bit of light relief.
Earlier this year while I was still inside I went to a dinner party in a provincial city. At the party was a delightful gentleman I had met previously and was more than pleased to see again. The feeling appeared to be mutual and our conversation broadly went like this:
DG – Now Andrea tell me – which is better? To pay my mortgage or to pay my tax?
Me – cough, splutter, mumble – well the thing is it isn’t a choice as tax is a legal obligation.
DG- oh don’t be silly of course I know that. What I mean is it better to have a mortgage on my house get the tax deductions and then have money to invest in shares and things for capital gains or have no mortgage not get the tax deductions but have more disposable income?
Me – Ah what makes you think you get a tax deduction for the mortgage on your house?
DG- This is the country – we get tax deductions for all sorts of things and besides I’m the director of a land owning company!
Me – Is that wine over there?
Now dear readers I am sure after Zen and the art of tax compliance you all know that to get tax deductions the expenditure has to be:
- Connected to the earning of income or in the ordinary course of a business and
- not private or domestic expenditure.
So therefore if DG owns his house in his own name – or in a family trust – as neither 1) or 2) is met there is no deduction for interest expenditure.
There is the possibility that if the money were borrowed on his house and used to buy shares THAT WERE DIVIDEND PAYING then the interest would be deductible. But if the money is borrowed to construct the house for him to live in – nuh.
The complication though is the comment about being a director of a land owning company. The rules above do not apply to a company and interest deductions. From about 2000 or so the rule broadly became:
- Are you a company resident in New Zealand?
- Have you incurred an interest expense?
If yes to both, then ‘would you like interest deductions with that?’
The private and domestic test still applies to such expenditure but I have always struggled to align any concept of private and domestic to a company.
So at first pass – yep – if DG holds his house in a company – in your correspondent’s view – he will get an interest deduction.
And yeah the Mixed Use Asset rules won’t apply here because ironically it isn’t a mixed use asset – it is wholly private and domestic.
But – not so fast – the music hasn’t stopped.
While there are special rules for companies and interest deductions there are also special (dividend) rules for transactions involving companies and shareholders aka ‘are policy makers really that dumb?’
These dividend rules say where ever there has been a transfer of value from a company to a shareholder there is a taxable dividend to the shareholder to the extent of the value transfer.
Ok again in English.
If a company gives a shareholder stuff – goods or services – that is a taxable dividend for the shareholder. Here the company has given the shareholder use of a house – so the shareholder DG – gets a taxable dividend.
And by ‘taxable dividend’ yes this means you need to put that value on your tax return and pay tax on it. And yes I know you didn’t get any actual cash but that doesn’t matter. You know how when you tick the box for dividend reinvestment on your publicly listed shares – you know how the dividend is still taxable even though you didn’t get any actual cash. Consider this as the same.
So what is the value that DG has received from the ‘land owning’ company? He has received the benefit of living in that house. And what do people usually pay for the benefit of living in a house they don’t own? You’re onto it – rent.
DG is then up for tax on the value of the rent not paid to the company as a dividend. And once more with feeling – it doesn’t matter that no cash has been paid from the company to the shareholder.
So the benefit DG received – use of the house without paying rent – is taxable to DG.
Now if DG has a tax rate of 33% – as the company tax rate is 28% – there will be a net 5% tax paid on the ‘imputed’ or deemed rent. That is he pays tax at 33% on the deemed rent and the company gets a deduction at 28% on the interest expense. In other words a gift to the people of New Zealand and how tax planning can go wrong. And if he didn’t know this was the case until my former colleagues come along – it will be 33% tax plus interest at about 8% plus a penalty of between 10% and 100%.
Awesome. Can only hope he didn’t also pay an agent for this wizard advice.
If his tax rate though is lower than the company rate this is where it could get really interesting. Technically even with DG putting the value of rent on his tax return there will still be a net tax deduction that ostensibly can be offset against other income.
In this case though the structure – or ‘arrangement’ as my former colleagues may start to call it – is really putting pressure on the whole ‘companies can’t have private expenditure’ thing. And from here we move into a complete world of pain – or ‘good case’ depending on which side you are on this – known as tax avoidance. Now the entire interest deduction is at risk with tax avoidance penalties of between 50% and 100%. Fun huh.
And don’t even think of paying rent to your company and making it a look through company so you get the deductions directly against your other income. The department was very clear with look through companies – the prequel – that this was tax avoidance too.
So DG I am not sure there really is any ‘country immunity’ for interest on your personal mortgage. Pay it but step away from the tax system. There be dragons.