The 39% Rate Change

The top personal marginal tax rate increases to 39% on income over $180,000, with effect from 1 April 2021. Businesses should consider what the flow-on effects are and forward plan to ensure they are not caught off guard. Two key areas are discussed in this article.

Simplistically put, a company pays income tax at 28%. Imputation credits arise from that tax paid and are used to reduce the tax payable by shareholders when dividends are paid. Further tax may be payable by the shareholder if the tax liability on the dividends is more than the imputation credits.

If shares in a company are ultimately held by an individual, consideration should be given to declaring a dividend prior to 1 April 2021, in which case it will be taxed to the individual at 33% (rather than 39% to the extent income would exceed $180,000 from 1 April 2021).This requires a comparison between the income tax liability that will be triggered upon declaring a dividend prior to 1 April 2021, versus the expected future income tax liability that will be triggered if a dividend is declared on or after 1 April 2021.

The FBT regime ensures tax is paid on non-cash benefits provided to employees, such as company vehicles and fuel cards. When calculating FBT, employers have the option of using one of the following methods:

  1. The single rate option, where a single rate of 49.25% is applied to all benefits provided to employees.
  2. The short-form alternate option, where rates of 49.25% and 42.86% are applied to attributed and non-attributed benefits, respectively. This appeals to employers who predominantly provide attributed benefits to employees who earn more than $70k.
  3. The full alternate rate option, where a separate calculation is undertaken for each employee who has received attributed benefits with reference to each employee’s salary. A rate of 42.86% is applied to non-attributed benefits. This appeals to employers who predominantly provide benefits to employees who earn less than $70k.

Typically, benefits that are subject to FBT are provided to higher-earners, and consequently, the 49.25% FBT rate under the default FBT method equates to the current top marginal personal tax rate of 33%, which keeps the FBT filing process simple.

The full alternate rate option takes considerably more time to calculate, and as a result, employers that value time and efficiency tend to use the single rate or short-form alternate rate option, irrespective of the cash savings that the full alternate rate can provide.

With the introduction of the 39% marginal tax rate, the 49.25% and 42.86% FBT rates will be increasing to 63.93% and 49.25% respectively from 1 April 2021. This effectively means employers that use the single-rate option will be paying FBT as if all employees earn more than $180,000, when in reality the 39% rate is expected to apply to only 2% of New Zealanders. As a result, employers may wish to consider undertaking the short-form or full alternate rate calculation from 1 April 2021, as the cash saving may exceed the additional time and effort.

In the lead up to the 2022 financial year, companies should be exploring different options to ensure tax efficiencies are achieved.

New Trust Annual Requirements

In December 2020 the legislation enacting the new 39% tax rate was passed. Within the same bill, somewhat overshadowed by the rate change, was the introduction of a new “annual return” requirement for trusts.

Not to be confused with the new Trustee Act that came into effect at the end of last month which requires certain disclosures to be made to beneficiaries, the annual return requirement included in the December 2020 bill imposes the disclosure of various trust information to Inland Revenue on an annual basis.

As enacted, the annual return for trusts will comprise:

  • an income statement and balance sheet;
  • details of any settlements made on the trust during the year;
  • the name, date of birth, country of tax residence and IRD number of any person who makes a settlement on the trust in the year, whose details have not previously been provided;
  • details on every distribution made by the trust during the year, including capital distributions, as well as details on the recipient beneficiaries; and
  • details of any person who has the power to appoint and remove trustees and beneficiaries of a trust.

The requirement will not apply to non-active, charitable or Maori authority trusts and foreign trusts that are already filing disclosures with Inland Revenue.

Although the legislation applies for the 2022 income year onward, there is a provision which allows
Inland Revenue to request the same annual return information for any period between the 2015 and 2021 income years.

Inland Revenue is likely to use the information to monitor the extent to which income is being taxed to trusts at 33%, that would have been taxed at 39% if derived by individuals. That information could then be used as a basis for the Government to either increase the trust tax rate or increase the extent that beneficiary distributions are taxed to individuals.

The information could also be used by Inland Revenue to specifically check other areas of compliance. For example:

  • Imputation streaming rules require dividends received by a trust that are then distributed to a trust’s beneficiaries to be spread proportionately across those beneficiaries, otherwise imputation credits may be forfeited.
  • Taxable income can be triggered if a trust receives the benefit of a debt forgiveness and a subsequent distribution is made to a corporate beneficiary.
  • Application of the land taxing rules can depend on whether parties are associated. The level of disclosure will enable Inland Revenue to readily determine who a trust is associated to.

As time passes and the amount of information held by Inland Revenue increases, they could proactively identify errors in a trust’s tax position. Especially if a trust has moved from one accountant to another and Inland Revenue has a clearer picture of past transactions than the new accountant has.

Election Outcome and Tax Policies

After Labour’s victory in the 2020 General Election, their proposed tax policy changes are now likely to be implemented.

Labour has ruled out a capital gains tax and an increase in fuel taxes but is prepared to introduce a Digital Services Tax to target multinational digital businesses who have taken advantage of tax structuring options. Labour’s historical coalition partner, the Green Party, have notably been campaigning for a wealth tax, which Labour has repeatedly ruled out. Given that Labour has won enough seats to govern alone, the possibility of a wealth tax seems unlikely.

Labour’s election campaign promised no income tax changes for 98% of New Zealanders, however a new top marginal income tax rate of 39% for individuals earning over $180,000 will be implemented – expecting to raise $550 million of revenue a year.

For some of us this provides a sense of déjà vu, as we remember when we previously had a 39% tax rate from the 2001 to 2009 financial years. We saw disputes in the courts regarding the requirement to pay fair market salaries, legislation requiring income to be attributed to individuals and various policy statements from Inland Revenue.

As differences in tax rates widen, it impacts behaviour by incentivising tax planning to minimise application of top tax rates. Currently, there is little difference between the top income tax rates, 33% for trusts and individuals and 28% for companies.

It also leads to further inequity within the tax system because it is typically employees who are unable to alter how they are taxed, whilst business owners have greater flexibility to alter how their income is taxed.

For example, a distribution of accumulated income from a trust that has already been taxed at 33% may be distributed tax-free to a beneficiary who has a marginal tax rate of 39%. Individuals with investment income may also be further incentivised to invest in Portfolio Investment Entities instead of shares, where the top tax rate is capped at 28%. Conversations are likely occurring right now regarding whether shares in companies should be moved from personal ownership into trusts – and whether this is tax avoidance?

Companies will also face further costs with a 39% tax rate. Companies that currently pay fully imputed dividends at 28% are also required to withhold tax at 5% in order to reach the 33% marginal income tax rate. This withholding tax liability is likely to increase to 11%, which may place constraints on company cash flow or prevent dividends from being paid altogether. This will place further pressure on tax administration to keep accurate, up-to-date records as individuals on lower marginal tax rates may be entitled to tax refunds comprising the additional tax withheld.

Ultimately, this policy provides an opportunity for individuals to explore their different options to ensure efficient tax planning. However, utmost care should be taken when restructuring one’s affairs, in order to avoid undesirable consequences such as the breach of shareholder continuity resulting in the loss of imputation credits or tax losses, or potentially undertaking a tax avoidance arrangement.

Categories Tax

What is revenue?

“Revenue means the total amount of money a business has earned from its normal business activities, before expenses are deducted” (Work & Income, July 2020).

This core definition has been applied by thousands of businesses to apply for the Government’s wage subsidy scheme that was implemented due to the COVID-19 pandemic. Whether a 30 percent or more reduction in revenue for the original wage subsidy, or a 40 percent or more reduction for the wage subsidy extension, quantifying the reduction in ‘revenue’ was a key hurdle to be eligible.

With the potential for wage subsidy applicants to be audited, documenting the basis for an application and how the eligibility criteria have been met is
critical. In some cases, confirming eligibility should be straightforward. Retail stores, restaurants, cafes and bars that had to shut their doors overnight should be able to demonstrate a clear drop in ‘revenue’.

However, for other industries it may not be as straightforward. In some cases, the time at which an invoice is issued for GST purposes is different to the point in time at which income is recognised for tax and / or accounting purposes.

Take for example the construction industry where jobs are invoiced based on specific milestones. If invoices were raised during the lockdown, for work completed prior to the lockdown, then measuring the
change in revenue based on ‘invoicing’ would not provide a fair reflection of the effect of Covid-19 at that point in time.

It goes both ways – if a professional services firm was able to keep working during the lockdown but stopped issuing invoices for a particular period. The firm’s invoicing in that period would not provide an accurate reflection of the change in ‘revenue’.

The Work & Income definition also refers to “money”. Was this intended to have the same meaning as ‘income’ or is it intended to imply a cashflow test?

The different ways the revenue test is able to be interpreted, and not knowing what the audit process will comprise gives rise to uncertainty. A suggestion is to ensure that the method used to calculate the revenue reduction should be logical within the context of a particular business. If a standard measure, such as sales booked in the period does not align with what has occurred in practice, consider whether that is an accurate method.

Consideration should also be given to sensor checking eligibility using different approaches to ensure the outcome feels right. For example, a service-oriented business could look at hours worked by the team and cross check that against movement in WIP and sales.

If multiple measures have been used, and each supports the reduction in ‘revenue’ required to receive the wage subsidy then this suggests a reasonable approach has been taken.

Other tax changes in response to Covid-19

In addition to the tax loss carry-back scheme, the New Zealand Government has introduced a number of other tax changes to assist businesses and individuals to get through COVID-19.

Currently, if an asset is purchased for less than $500 it does not need to be depreciated. The cost is immediately deductible in the year of purchase. This ‘low-value asset’ threshold has been temporarily increased from $500 to $5,000 for assets purchased in the 12 months from 17 March 2020. The threshold will reduce to $1,000 for assets purchased from 17 March 2021.

Tax depreciation on industrial and commercial buildings has been re-introduced for the 2021 tax year and onward. The diminishing value rate will be 2%, while the straight-line rate will be 1.5%. This is a permanent measure which will have a flow-on effect and improve the balance sheet of some large companies through the partial reversal of deferred tax liabilities.

The residual income tax threshold, which determines whether a taxpayer has a provisional tax obligation has been permanently lifted from $2,500 to $5,000 for the 2020-21 income year and onward. This is expected to remove 95,000 taxpayers from the provisional tax regime, assisting cash-flow and compliance related issues faced by individual taxpayers and small businesses.

Taxpayers affected by COVID-19 that are unable to physically or financially make tax payments will not be charged use of money interest (UOMI) on late payment of taxes from 14 February 2020. However, taxpayers will need to demonstrate to IRD that they have been “significantly adversely affected”. IRD is further offering taxpayers the opportunity to set up instalment arrangements to meet outstanding tax liabilities to those facing difficulty in paying outstanding amounts. Amendments to the Tax Administration Act 1994 have been made to give IRD greater discretion over its ability to allow extension of due dates and filing timeframes for taxpayers affected by COVID-19.

Changes to the tax loss continuity rules will be introduced. At present, an entity is only able to carry forward tax losses if shareholder continuity of 49% is maintained from the time a loss amount is incurred, until it is utilised. A ‘same or similar business’ test has been proposed, whereby a business can carry forward tax losses provided it continues to operate in the same or similar way, irrespective of a change in ownership. This test is being modelled on the current Australian loss carry forward rules. The change is targeted at taxpayers who are seeking new capital to stay afloat, without tax losses being forfeited due to a change in ownership. A ‘same or similar business’ test aims to instil confidence in prospective investors as to future cash-flow benefits from utilising the current period losses against future profits.

Finally, the extension of the new R&D tax credits rules to companies that incur tax losses, initially intended to be enacted effective from the 2020-21 tax year, has been brought forward to the 2020 tax year to allow timely access to the regime.

The package contains a number of measures designed to provide cashflow advantages. Hopefully there is something for everyone.

Carry back of tax losses

Ordinarily, if a taxpayer incurs a tax loss within a particular year, they are able to carry that loss forward and offset it against income derived in a future year, thereby reducing the taxpayer’s future tax payable. As part of the Government’s Covid-19 response, on 30 April 2020 legislation was passed under urgency which allows tax losses to be offset against income derived in a previous year, thereby enabling the taxpayer to obtain a refund comprising prior year income tax paid. This temporary tax loss carry-back scheme is available to most taxpayers, e.g. trusts, companies and individuals.

A permanent scheme to replace the temporary rules is under development and will apply from the 2022 income year, however, the current scheme applies for a two-year period as follows:

  • A tax loss incurred in the 2020 income year is able to be carried back and offset against taxable income derived in the 2019 income year.
  • A tax loss incurred in the 2021 year is able to be carried back and offset against taxable income derived in the 2020 year.

A tax loss cannot be carried back multiple years, instead it applies to the “net loss year” and the immediately preceding “taxable income year”.

Taking each year in succession, most taxpayers will have already filed their 2019 income tax return, but a request to amend that return can be made via MyIR or a letter can be sent to IRD requesting a reassessment (pursuant to section 113 of the Tax Administration Act 1994). The loss amount can be determined by either preparing a 2020 tax calculation based on ‘actual’ results or preparing an estimate. The ability to make an estimate allows taxpayers to access the refund faster. However, if an estimate of the 2020 tax loss is later found to exceed the actual loss amount, tax will need to be repaid to IRD, on which interest will apply.

With respect to utilising expected losses in the 2021 year against profits derived in the 2020 income year, in most cases the 2020 income tax return would not have been filed and may not be filed for some time, however 2020 provisional tax may have been paid to IRD. To enable provisional tax payments to be refunded, taxpayers will have the option of submitting an estimate of their 2020 provisional tax liability (that takes into account expected losses for 2021) – the time to do so has been extended to when the tax return is filed. Excess tax paid, based on the provisional tax estimate, will be refunded.

If a company incurs a loss and it is a member of a wholly owned group of companies, it can only carry back the amount that can’t first be offset against the income of other companies in the group.

If taxable income for the 2019 year was paid by way of shareholder salary, this cannot be reversed under the tax loss carry back initiative. However, provisional tax paid for the 2020 year in relation to an expected shareholder salary could be refunded under the initiative.

Under ordinary rules, 49% shareholder continuity must be maintained from the time a loss is incurred until it is utilised. A similar rule will apply to the loss carry back scheme, i.e. if there has been a change in ownership that breaches the threshold, a tax loss cannot be offset against income derived prior to the breach. However, part period calculations can be completed, as applicable.

The pragmatism underpinning this scheme will be appreciated as it allows sound businesses to secure a refund of tax paid in better times.