Changes to how SMEs pay tax

The Government has recently announced a package of proposed tax changes that intend to reduce compliance costs and make tax simpler for businesses. The package is part of the Inland Revenue’s big picture ‘Making Tax Simpler’ initiative that aims to modernise and simplify the tax system. While the proposals will generally apply to all businesses, the changes are expected to benefit small businesses the most.

Tax compliance costs are relatively high for small businesses who play a crucial role in the New Zealand economy. Approximately 97% of enterprises in New Zealand are small businesses, who employ around 30% of the workforce. For these entities, the question of whether ‘close enough is good enough’ is being raised, whereby simplifying the tax compliance process and reducing compliance costs could have wide-reaching benefits for many New Zealanders. The changes proposed within the Governments tax package are outlined below.

Changes to provisional tax

The changes propose to increase the existing use of money interest (UOMI) safe harbour threshold for individuals from $50,000 to $60,000 and allow it to apply to all taxpayers. This effectively means that all taxpayers who calculate and pay provisional tax using the standard or ‘uplift’ method would only be charged UOMI from their terminal tax date provided their residual income tax is below $60,000. Larger taxpayers, who fall outside the safe harbour threshold and pay tax using the standard option, would instead pay UOMI from their last instalment date.

Small Businesses (turnover of $5m or less) will be able to use an “Accounting Income Method” (AIM) to calculate and pay their provisional tax based on the income to date in their accounting software. Businesses registered for monthly GST returns will pay provisional tax monthly. However, businesses who file their GST returns on a two-monthly, six-monthly basis or who are not registered will pay provisional tax every two months.

Self-management and integrity

The changes propose to let businesses:

  • Allow contractors to elect their own withholding tax rate (minimum 10% for resident contractors, 15% for non-resident contractors),
  • Extend withholding tax to labour-hire firms, and
  • Introduce voluntary withholding agreements where contractors can agree to withhold tax as income is earned to manage provisional tax obligations.

Other changes

Other proposed changes include:

  • Removal of the monthly incremental 1% late payment penalty for new debt;
  • Increase the threshold for taxpayers to correct errors in returns from $500 to $1,000;
  • Remove the requirement to renew resident withholding tax exemption certificates annually;
  • Increase the threshold for annual fringe benefit tax returns from $500k to $1m;
  • Modify the 63 day rule on employee remuneration to reduce compliance costs; and
  • Allow small companies providing motor vehicles to shareholder-employees to make a private use adjustment instead of paying fringe benefit tax.

There are also a number of information sharing arrangements proposed in the changes, i.e. reporting of tax debts to credit reporting agencies and information sharing with the Companies Office.

Most measures are intended to apply from 1 April 2017, with the exception for provisional tax payment changes, which have a proposed implementation date of 1 April 2018. IRD is currently seeking feedback from the public, with submissions due by 30 May 2016.

Slammed for Gross Carelessness

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.

Compulsory Zero-Rating Of Land

The compulsory zero-rating (CZR) of land rules have applied since 1 April 2011. The rules were introduced to combat a pattern of transactions where Inland Revenue (IRD) was paying GST refunds to land purchasers, but there was no corresponding GST returned by the vendor.

Although simple in principle, mistakes are being made. To recap, the rules require a transaction that wholly or partly consists of land to be zero-rated if:

  • The vendor and purchaser are both GST registered; and
  • The purchaser intends to use the land for the purpose of making taxable supplies; and
  • The purchaser or a person associated with the purchaser does not intend to use the land as a principal place of residence.

The reduced rate applies not to just the land component of a transaction, but to the entire supply. For example, if zero-rating applies to the sale of land and assets, the assets are also zero-rated. Also, the supply of “land” is not limited to the transfer of freehold title, but also includes an assignment of an interest in land. For example, if a business sells assets and an assignment of a lease (of land), zero-rating is likely to apply.

In practice, the standard form Auckland District Law Society (ADLS) agreement includes a statement that the purchaser completes for GST purposes and is used by the vendor to determine whether the sale should be zero-rated. The agreement also includes a question on the front page of the contract asking whether the vendor is registered for the purpose of the supply. A common error is for the question to be answered “no” because the transaction is the sale of a residential home irrespective of the vendor’s circumstances. If however, a property developer has built the house in the course of their taxable activity, GST will apply to the sale and the question should be answered “yes”.

A fundamental element of the contract is whether to express the price as “Plus GST (if any)” or “Inclusive of GST (if any)”. Disputes have arisen because a GST registered vendor understands the buyer is GST registered and the price is agreed as GST Inclusive. The rationale being that the transaction will be zero-rated and the price stated will be received ‘in the hand’ by the vendor. However, seeing an opportunity a purchaser might at the last minute, nominate a non-registered purchaser. The transaction does not then qualify for zero-rating and the vendor is required to pay GST at 15% to IRD, leaving the vendor ‘out of pocket’.

In practice, it is recommended the agreement includes warranties regarding the GST status of the parties and that vendors execute agreements on a plus GST basis. Contracting ‘plus GST’ provides the right to increase the cash price to fund an unforeseen GST liability, thereby preserving the net amount receivable.

A further pricing misconception is that a “GST inclusive” price means that GST is included at 15% and can be deducted for GST purposes. However, if the transaction is zero-rated, a GST inclusive price simply means there is GST, but the amount of GST is zero.

A GST registered purchaser might contract on a zero-rated basis, because they have failed to understand that they are not purchasing the land to make taxable supplies. For example, the purchase of a residential property by a GST registered purchaser is unlikely to qualify for zero-rating. In this situation, the purchaser would be liable for the GST that would have otherwise been payable by the vendor.

It is normal for a contract to be subject to ‘Solicitor’s approval’. Having a contract reviewed by your accountant is also worthwhile.

Changes To IRD Admin System

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.

Employer Provided Car Parks

Employers are required to pay FBT on non-cash benefits provided to staff. However, like most taxes, there are exemptions. It is important to be aware of the exemptions to ensure FBT is not overpaid. One such exemption provides that benefits (other than travel, accommodation or clothing) provided and used on the employer’s premises will not be subject to FBT. The provision of carparks fits within this exemption category.

Historically, what qualifies as “premises of the employer” has been uncertain. For example, if an employer is located next door to a carpark building and arranges and pays for six employees to have access to carparks in the building, do these carparks qualify as being provided on the employer’s premises?

The IRD has recently finalised two Public Rulings that include a change to its position on what qualifies as “premises of the employer” in this situation. Previously, the legal form of the car parking arrangement was the determining factor. For instance, carparks were required to be owned or leased by the employer to qualify for the exemption. Licence agreements did not satisfy the exemption requirements, even if the substance of the agreement was more akin to a lease.

In its Ruling, the IRD has softened its view and allowed a ‘substance over form’ approach. This will increase the number of situations that fall within the exemption by allowing license agreements to be regarded as being “on premises”, provided that the employer has a “substantially exclusive” right to use the carpark.

IRD has defined the phrase “substantially exclusive right” to mean that no one, including the carpark operator or any other third party, can use or control the carpark in a manner inconsistent with the employer’s substantially exclusive right.

The IRD provide a list of practical considerations which help to determine whether the employer has a ‘substantially exclusive right’. Although not definitive, the FBT exclusion is likely to apply if the employer has unrestricted access to the carpark, the carpark remains vacant when the employer is not using it, the employer may permit others to use the car parking space, if an unauthorised person parks in the space the employer has the right to tow the unauthorised vehicle and, the employer can decide how the car parking space is used.

What this effectively means is that the nature of the agreement, rather than the label on the document will determine whether the exclusion applies. In recognition of the change in position, IRD are allowing employers to request refunds of previously paid FBT where employers have relied on the old approach.

GST On Foreign Supplies

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.