Where is this going?

On 2nd December 2020, legislation was introduced by the Government that increased the top personal marginal tax rate to 39% on income over $180,000 from the start of the 2021/22 income year.

Three other changes were included in that legislation. It introduced:

  • new information-gathering powers for the purpose of tax policy development,
  • a new requirement for most trusts that derive assessable income to prepare financial statements, and
  • increases the information that trusts must disclose as part of the income tax return filing process.

This legislation was enacted under urgency and did not go through the usual consultation process. At the time, David Parker signaled that if trusts are being used for the sole purpose of paying a lower tax rate “we will move on it”.

Fast forward one year and three things have happened.

Firstly, Inland Revenue has initiated a research project in which it is examining the lives of 400 New Zealand taxpayers worth in excess of $20m to estimate their effective tax rate on economic income (which is broader than taxable income).

A range of information will be demanded for the 2016-2021 income years including details of partners and dependants, significant personal assets (how much they cost and the date acquired), real estate interests, details of companies and trusts, and other financial flows.

This information is being demanded under the new legislation referred to above, with requests separated into three tranches due in November 2021, January 2022 and May 2022, each delving further into the lives of these taxpayers to enable Inland Revenue to measure the ‘households’ total income. The results of Inland Revenue’s research project will be released in an anonymised form in mid 2023.

Secondly, on 15th October 2021 Inland Revenue released an Officials Issues Paper seeking feedback on what level of detail should be required within a trust’s financial statements pursuant to a future Order in Council. A draft operational statement was also released by Inland Revenue on the same day which proposes how the new information gathering
powers will apply to trusts. Based on the draft statement the following types of information will need to be submitted each year:

  • a statement of profit or loss and a statement of financial position,
  • details of taxable and non-taxable distributions and who they have been paid to, and
  • the nature and value of any settlements onto a trust, and who a settlement has been made by.

The third element to factor into this picture is that the increase in information to be provided is occurring at a time when Inland Revenue has
implemented a new IT system that provides them with an unprecedented ability to analyse and manipulate data.

During the build up to the general election in 2020 Jacinda Ardern ruled out Labour bringing in a capital gains tax under her leadership. However, as the new information that is being gathered is analysed, it might reveal a segment of income being used for the necessities and luxuries of life that have not been taxed; which could open the door for a generational change to the basis on which income tax is levied.

New Tax Legislation

On 9 September 2021, the Government introduced the Taxation (Annual Rates for 2021-22, GST and Remedial Matters) Bill (“the Bill”) into Parliament, containing over 100 tax amendments. Changes of note are summarised as follows.

One significant amendment is in relation to purchases from associated persons. Under current law, if a GST registered person (‘the purchaser’) acquires second-hand goods from an associated person who has not used them to make
taxable supplies, and that associate originally purchased the goods from a non-GST registered person, the purchaser’s second-hand goods deduction is zero. This has been a frustrating and illogical rule that has caught out numerous taxpayers over the years – they will know who they are. In what is an arguably overdue amendment, it is proposed that the purchaser (in the above situation) will be allowed to claim an input tax deduction equal to the tax fraction of the original purchase price of the associated person.

When the top marginal tax rate increased to 39%, there was a flow on increase to the default FBT rate from 49.25% to 63.93%, which has meant employers applying one of the default or short form options are arguably overpaying FBT in the first three quarters. Under the proposed new pooled alternate option, employers would only pay FBT at the increased rate for employees with all-inclusive pay of $129,681 or more, which generally equates to employees that are subject to the top marginal income tax rate (i.e. for employees that earn over $180,000). On the other hand, FBT would be payable at the 49.25% rate in relation to employees with all-inclusive pay of under $129,681 (i.e. employees that earn less than $180,000). Consequently, this should prevent employers from overpaying FBT during the year.

Reflecting how complex the residential bright-line provisions are becoming, the Bill also contains further refinements to these rules. For example, one amendment proposes that where a main home takes longer than 12 months to construct, the construction period will continue to be treated as “main home days” for bright-line purposes.

The average person may not realise that sales suppression software exists. However, this is a key point of contention for Inland Revenue, as this software alters point-of-sale data to manipulate revenue – facilitating tax evasion. While not necessarily commonly used, Inland Revenue considers the spread of such software to be a major risk to the integrity of the tax system. Thus, criminal and civil penalties of up to $250,000 are being introduced for the supply or possession of such software.

Finally, in what seems to be the end of an era for ‘baby boomers’ and late adopters of technology, fax as an approved method of communication with Inland Revenue is being removed.

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.