Tax

IRD rulings

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Over the past few years there has been a pronounced improvement in the manner in which Inland Revenue selects and conducts its investigations.

There has been an increased focus on data analysis, comparisons to statistical norms, and use of external information such as land transfer data. As a result there is an increasing need to consider how IRD might approach a particular transaction or issue.

In cases where the position is unclear or the dollars involved are material, consideration needs to be given to approaching IRD beforehand to seek their approval or view to treat something in a particular way. This can occur by approaching IRD for a ‘private binding ruling’ or a ‘non-binding indicative view’.

Both processes are positive and collaborative, as IRD generally are focused on determining the correct position under the law. In contrast, if IRD approach the matter ‘after the fact’ through the course of an investigation there may be more focus on proving a tax shortfall exists; and their view of the law can feel as though it is bending to accommodate that outcome. It can become emotional, as each party becomes increasingly entrenched in their view, giving rise to significant cost to defend a position and if the taxpayer is unsuccessful, penalties could apply. Too often the incremental cost will exceed what it would have cost to approach IRD before-hand.

A private binding ruling provides the highest degree of comfort, because if successful, the outcome is binding on IRD. This provides peace of mind that a different individual from IRD won’t take a different view in the future. The binding rulings process is not subject to a legislated timeframe within which one must be provided, however IRD work to a timeframe of 3 months and are very good at meeting that time frame. They are also willing to provide early indications of their expected view if required for the purpose of a particular transaction that may be occurring. IRD do charge a fee to provide a binding ruling, it does so at an hourly rate of approximately $160 per hour. The total IRD cost for a ruling is generally about $15k – $20k. This cost must be considered in light of the tax involved and the comfort otherwise associated with taking a particular position. When this is balanced with the downside risk of IRD disputing the treatment in the future it quickly becomes reasonable.

A further option is to acquire an indicative view. It’s understood IRD will consider issues through this process if it will take 20 hours or less. IRD don’t charge for providing an indicative view, however the outcome is not binding. Irrespective of the fact that the IRD is not bound by the outcome, from a practical point of view it should provide a high degree of comfort. It would be unusual for an alternative view to later be taken by IRD, and if this did occur, the fact that an indicative view was acquired should provide a strong negotiating position when asserting no penalties should be charged.

Slammed for Gross Carelessness

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A self-proclaimed tax agent has been found by the Taxation Review Authority (TRA) to have taken an unacceptable tax position and demonstrated a high level of disregard for the consequences of claiming GST refunds over a two and a half year period.

The taxpayer claimed a GST refund for five consecutive six month periods from March 2009 – March 2011, accumulating refunds of almost $10,000. The taxpayer argued he was eligible for the refunds as he was carrying on a taxable activity of “services to finance and investment” by (1) acting as a registered tax agent, (2) holding patent rights as a patentee, (3) devising inventions and patenting them, and (4) supplying services to two trusts.

The Commissioner denied the input tax deductions and deregistered the taxpayer on the basis that he was not conducting a taxable activity and was therefore not eligible to claim GST. The Commissioner argued that the conduct amounted to gross carelessness and therefore sought to impose shortfall penalties.

It is a fundamental rule that in order to claim GST you must engage in a taxable activity that satisfies the following four criteria:

  1. There is an activity;
  2. The activity is carried on continuously or regularly by a person;
  • The activity involves, or is intended to involve, the supply of goods and services to another person; and
  1. The supply or intended supply of goods and services is for consideration.

On review of the facts, the TRA was highly critical of the taxpayers’ alleged taxable activities. In regard to (1) acting as a tax agent, the taxpayer asserted that he provided accounting services to many clients during the disputed GST periods. His evidence however, consisted of six invoices for two clients of small sums that could not be supported by bank statements. The TRA stated that even if they accepted that the taxpayer was acting as a tax agent, the taxpayer did not prove that the activity was being carried on “continuously” or “regularly”. The TRA described the activity as spasmodic at best and therefore dismissed the claim that this was a taxable activity.

Regarding (2) holding patent rights as a patentee, the patents the taxpayer referred to expired in 1994 and 2006 respectively, which is before the start of the first disputed GST period. The taxpayer saw his taxable activity as being a “continuous attempt to enforce the equities in the patents” and his position was not affected by the expiry of the two patents. The TRA had difficulty in following this assertion and so found that this activity did not meet the required threshold for taxable activity.

The taxpayer also failed to produce evidence to support his claim that (3) devising inventions or (4) supplying services to two trusts satisfied the criteria of a taxable activity. He produced no evidence of design work or time expended on inventing, no invoices or payment evidence nor any trust deeds or engagement agreements. The TRA found it unclear whether such a trust was even in existence and dismissed both of these claims.

The TRA consequently found that there was no nexus between a taxable activity and the input tax deductions. The taxpayer had taken an unacceptable tax position and demonstrated a high level of disregard for the consequences when he filed GST returns and claimed refunds for each of the periods in dispute. The taxpayers conduct was described as a “flagrant breach of the GST regime”.

All input tax deductions claimed were denied and shortfall penalties for gross carelessness were imposed in each of the GST periods in dispute.

Changes To IRD Admin System

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The manner in which we interact with Inland Revenue (IRD) is likely to change dramatically over the next two years as the upgrade of IRD’s IT system and associated legislation comes on-line. IRD’s broad objective is to reduce the amount of time and cost it and private business spends on tax administration by modernising its software platform.

At present, both GST and PAYE processing costs are higher than necessary and there are problems with the quality and timeliness of information submitted. These issues not only impose costs on employers and the IRD, but also limit the Government’s ability to provide effective social services.

IRD is currently working with third party software providers to design digital solutions that will integrate tax obligations into everyday business practices. To ensure the changes are well designed and beneficial to all parties, feedback is being sought on potential changes via discussion documents.

One of the most recent discussion documents outlines potential changes to GST and PAYE. The IRD is currently requesting feedback on proposed changes and poses several questions that are designed to challenge our thinking on the current approach. For example, whether changes should be made to the calculation of PAYE on extra pays, holiday pay and years that include an extra pay period?

GST related changes include the ability to allow GST return filing and payment processes to be integrated with digital accounting platforms. This would allow GST-registered persons to submit their GST returns through their chosen accounting software programme as they fall due, effectively eliminating the requirement to file a separate GST return as a separate process. Such changes would remove the need to double-enter information, and reduce the potential for error. IRD’s proposals also include making GST refunds via direct credit to a customer’s bank account compulsory, unless it would cause undue hardship or is not practicable.

PAYE could shift to a semi-automated process. Similar to the GST proposal above, businesses would be able to submit payroll information to the IRD direct from their accounting system and make necessary payments to the IRD at that time. For example, PAYE information could be submitted to IRD at the same time that a ‘pay run’ occurs. Under this design, employers’ PAYE obligations would be integrated with their current business procedures, eliminating certain processes such as the need to file nil employer monthly returns. PAYE payments to IRD might be due at the same time the employee is paid.

By increasing the quality and timeliness of the information provided, IRD should have greater capability to improve individual’s access to social entitlements and identify and prevent errors; such as overpayments of family assistance.

The changes represent a shift to a framework in which IRD’s system would no longer work on a stand-alone basis. Instead, IRD would ‘talk’ to software providers, ensure their system worked in accordance with its view of applicable legislation and would then accept what it was sent. Such changes would provide the business and IRD with greater confidence regarding the accuracy and correctness of a tax return.

GST On Foreign Supplies

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Imposing Goods and Services Tax (GST) on the digital economy has been a hot topic this year as New Zealand retailers push for equal GST treatment between local and foreign suppliers.

At present, foreign providers of cross-border services and intangibles (including music, e-books, videos and software purchased from offshore websites) do not have to pay GST on sales to New Zealand based consumers. This puts local based providers at a substantial disadvantage because they have to charge GST, which will, at a minimum, increase their prices by 15% when compared to foreign competitors.

Currently, whether or not GST applies to a particular transaction depends on a number of factors, such as the location of the supplier or where the services are performed. Because most e-tailers are not based in New Zealand, and their services are not performed from New Zealand, GST does not apply.

This issue is not isolated to New Zealand with many countries facing similar GST/VAT non-collection issues. Given the significant revenue at stake, governments worldwide have a vested interest in reform. The Organisation for Economic Co-operation and Development (OECD) has released guidelines on GST/VAT treatment, which countries are considering adopting.

The New Zealand Government has now released its own discussion document titled ‘GST: Cross-border services, intangibles and goods’ which broadly proposes to align New Zealand with the general direction of reforms undertaken by a number of countries.

The key suggestions include:

  • Introducing a new ‘place of supply’ rule so that services and intangibles supplied remotely by an offshore supplier to New Zealand-resident consumers will be treated as performed in New Zealand and therefore subject to GST.
  • The new rules to apply to a wide range of ‘services’, which capture both digital and traditional services.
  • A requirement for offshore suppliers to register and return GST when they supply services and intangibles to New Zealanders if their services exceed a given threshold in a 12 month period.
  • In situations where offshore suppliers do not directly supply services to their customers, and instead use electronic market places to market and sell their services or intangibles, the electronic marketplace may be required to register for GST instead of the principal offshore provider.

While not confirmed in the discussion document, the expectation is that the proposed changes will not require offshore providers to return GST when they make supplies to New Zealand businesses (who would normally be able to claim the GST back). The new rules would focus on taxing business-to-consumer supplies.

At present, GST not collected on low-value goods imported into New Zealand is also an issue. The Government intends to align, where possible, the collection of GST on imported goods with the changes relating to cross-border services and intangibles. The New Zealand Customs Service is looking at options for simplifying the collection mechanism and reducing the threshold before GST is charged on imported goods (currently $400), while balancing the cost to collect that GST.

As e-commerce continues to grow, the volume of services and imported goods on which GST is not collected is becoming increasingly significant. It has passed the tipping point where the Government is now moving to capture that lost tax revenue.

Businesses should also be mindful of similar changes being implemented in other countries that may result in GST/VAT being required to be paid.

Modernising New Zealand’s Tax System

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The Government has released two discussion papers to engage in public consultation on options for simplifying and modernising New Zealand’s tax system. The documents introduce taxpayers to the general direction the Government intends to take to improve administration of the tax system.

Basically, the Government wants to simplify tax for individuals and businesses by reducing compliance costs, and making interactions with the IRD faster, more accurate and convenient with a greater use of electronic and online processes. As the IRD puts it, “tax obligations should be easy to comply with and hard to get wrong”.

The first discussion paper ‘Making tax simpler – A Government green paper on tax administration’ outlines the overall direction of the tax administration modernisation programme. Key elements of potential change include:

  • Simplifying tax for businesses, for example by streamlining the collection of PAYE, GST and other withholding taxes and integrating these obligations into business processes. Options will be investigated for simplifying the calculation of provisional tax – with more emphasis on real time information, together with payment options that better reflect taxpayer’s cash flows.
  • Simplifying tax for individuals by providing online income tax statements for individuals pre-populated with income details, so that all that would be required is to ‘check and confirm’. Technology will be used more effectively to better manage both overpayments and underpayments of tax.
  • Social policy objectives would be met by using information that the IRD or the Government already holds, providing for timely payments on a more real-time basis, resulting in certainty for individuals and families. With faster, more accurate information, there should be less chance of people receiving too much and going into debt.

The IRD wants to make tax obligations part of the normal day-to-day business processes, making it quick, easy and harder to get things wrong.

Consultation closes on 29 May 2015.

The second discussion document ‘Making tax simpler – Better digital services’ outlines proposals for greater use of electronic and online processes. In particular the discussion document considers whether secure digital services can be delivered using the current policy and legislative framework and discusses options to move people to digital services, these include:

  • The IRD working with third parties such as banks and business software developers so that tax interactions are built into a customer’s regular transactions rather than managing tax separately at specific times of the year.
  • Non-digital services will need to be provided for those who still cannot use digital services.
  • A process would be developed for moving to a digital format those who could potentially use digital systems for some services – in circumstances where there would be wider benefits accrued.

Consultation closes on 15 May 2015.

These are the first two releases in a series of public consultations designed to modernise and simplify the tax system. Further discussion documents will be released over the next two years and public feedback is requested.

The significance of this process can’t be overstated. In an age where changes in lifestyle as a result of technology have moved at an explosive rate, the design, administration and technology associated with our tax system have not kept up.

Tax and Expenditure

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The “general permission” under the Income Tax Act broadly allows expenditure to be deductible if it is:

  • incurred in deriving assessable income, or
  • incurred in the course of carrying on a business for the purpose of deriving assessable income.

A recent Taxation Review Authority (TRA) case provides a strong reminder to us of the importance of ensuring there is a connection (‘nexus’) between the expenditure you deduct for tax purposes and your business or income earning process.

In TRA 008/13, a taxpayer entered into an agreement in 2006 to purchase a block of land for the development and sale of retail units and residential apartments. By June 2007 four deposit payments had been made totalling $1.9m. Before settlement occurred, a number of conflicts arose between the vendor and the taxpayer.

Following several failed attempts by each party to cancel the agreement, they eventually went through a disputes resolution process where they agreed to split the deposit between them. The taxpayer also agreed to pay the vendor’s costs ($70,047). The taxpayer subsequently entered into an agreement to sell the plans for the project, including resource consent, for $650,000; however the transaction was not completed.

The IRD sought to disallow $1.4m of expenditure (including the lost deposit) incurred after 24 July 2008, when the taxpayer ceased negotiations to resurrect the agreement. The taxpayer disagreed with the IRD and the case went to the TRA.

The taxpayer argued:

  • the expenditure related to a business that operated until at least December 2011,
  • the agreement was entered into for the purpose of purchasing the land to derive taxable income or alternatively to escape an onerous contract, therefore all expenses are deductible, or
  • the business was operating in 2007 (the IRD agreed) and the lost deposit was deductible because it was paid at that time.

The TRA decided in the IRD’s favour, concluding that from July 2008 onwards the taxpayer’s focus changed from advancing the settlement of the purchase, to pulling out of the Agreement. From this point the taxpayer ceased being in business, and there was no nexus between the taxpayer’s business and the expenditure.

The TRA also broadly concluded that in order to deduct expenditure to derive income, income must be derived and here there was none. It was further stated that the taxpayer intended to acquire and sell full legal title to the land. However, the taxpayer only acquired an equitable interest in the land. The implication being that the taxpayer’s intention when the due diligence clause was fulfilled was not to sell an equitable interest, therefore there was no requisite intention of resale in respect of the interest that was acquired.

The TRA took the view that the settlement amount was paid from the deposit monies held by the taxpayers’ lawyer as a stakeholder; it was not payment of the deposit.

The IRD not only denied the deductions, but also charged a $39,194 shortfall penalty for taking an unacceptable tax position.

Decisions like this are unsettling because at face value, it would seem reasonable to claim a deduction for the expenditure. Especially given, if income had been derived, the expenditure is likely to have been deductible.

The lesson here is to think carefully about situations that may be outside ‘the norm’. Even if intuitively an expense appears deductible, it may not be. In these situations, a quick phone call to your advisor would be a good idea.