Budget 2010 will be remembered for its boldness, and for stealing a march on Australia.
The Australians plan to reduce their company tax rate to 28% on 1 July 2014. We'll be there on 1 April next year. Not enough to cause companies to cross the Tasman, perhaps, but a sign that the Government is serious about trying to close the growth gap between the two economies.
The budget represents the biggest overhaul of the tax system since 1987 and has the capacity to – finally – wean New Zealanders off their propensity to over-invest in property.
This Brief Counsel looks at the budget tax package and at the big budget numbers.
Personal tax rate reductions for all brackets. From 1 October the rates will reduce as follows:
Taxable income Current rate Rate from 1 October 2010 0 -14,000 12.5% 10.5% 14,001 - 48,000 21% 17.5% 48,001 - 70,000 33% 30% Over 70,000 38% 33%
- The corporate tax rate will reduce to 28% from the 2011/12 tax year (generally beginning 1 April 2011). This reduction will also apply to non-PIE superannuation funds.
- At the same time, the top tax rate on income earned through a PIE will reduce to 28% (in line with the corporate rate), and the lower two PIE rates will reduce to 10.5% and 17.5% respectively (in line with the personal rates).
- GST will increase to 15% from 1 October 2010.
- From the 2011/12 year, there will be no depreciation deduction on buildings with a useful life of 50 years or more – in other words, this change will apply to both already-owned and newly acquired buildings.
- The 20% loading on new equipment will be removed for assets purchased after Budget Day.
- The LAQC and QC rules will be changed so that income earned through these vehicles is in all cases taxed directly to the shareholders, from 1 April 2011.
- Significant changes are proposed to the calculation of Working for Families abatement. For Working for Families (WfF) purposes, and possibly other income tested benefits, income will be calculated on income gross of investment losses, and including income earned through trusts. Also, the abatement threshold will not be automatically indexed for inflation. These changes will apply from 1 April 2011.
- Rules limiting ability of foreign owned companies to deduct interest against NZ taxable income will be tightened, from the 2011/12 year. There will be no change to the rules for interest deductions for NZ groups with foreign subsidiaries.
The fiscal cost of these measures alone is estimated to be more than $1 billion in the first full year of their operation. In calculating an overall revenue reduction of only $90 million, the Government has also taken into account:
- the GST from additional household spending, fuelled by the tax cuts ($605 million)
- the increase in tobacco excise duty ($180 million), and
- increased tax from tax audits and investigations in the property sector ($210 million).
Over the next three and a half years, the total cost is estimated at a modest $415 million, but only after taking into effect aggregate macroeconomic benefits of $670 million.
The 2010 Budget is undoubtedly a bolder and more decisive affair than the Government's initial effort. By cutting income tax rates for companies and individuals, in favour of increased consumption taxes, it has created an environment which can credibly be presented as considerably more encouraging to investment and economic growth. While companies and individuals with significant property investments are also contributing to funding the tax cuts, a rational explanation has been given for that, which seems likely to meet with a good degree of popular acceptance.
No-one should mourn the passing of the 38% top personal tax rate. It was always a fraud, the cost of which was borne not by the wealthy but by those who earned personal services income which they could not shelter in companies or trusts. People with substantial assets (the real wealthy) were almost completely unaffected by it.
The steps the Government has taken will move us closer to a system where the appearance of progressivity and redistribution given by the personal tax rate scale is actually borne out in practice. In particular, the near-alignment of the personal, trust and company tax rates, the denial of depreciation deductions on buildings, the changes to the treatment of qualifying companies, and the changes to the abatement of WfF benefits, will ensure that the income on which people are taxed (or have their benefits calculated) bears a much closer approximation to the increase in their wealth over the year.
The cut in the lower income tax rates was necessary to compensate for the rise in GST. It is nevertheless an interesting reflection that the direct net tax burden on the average wage and salary earner without children is the second lowest in the OECD, and that if that person is the sole earner in a two child family, they will pay no tax at all, after taking into account WfF.
The alignment of the personal and trust rates will remove a considerable area of uncertainty in the area of tax avoidance. The tax benefit of restructuring a dental practice as a company owned by a trust, for example, will be significantly reduced (a maximum saving of 5% instead of 8%, and no saving at all on distributed income). While estate planning and commercial considerations may still make it a good idea, there would seem to be much less incentive for the IRD to attack it as tax avoidance.
The tax package represents a significant reduction in the tax paid by households, at least those which do not own a lot of rental property. The net amount of the GST increase is $1.65 billion, whereas the tax cuts are worth $3.685 billion.
The reduction in the corporate tax rate is perhaps the boldest part of the package. The change is significant as a signal, as well as economically. By seizing the opportunity to make this change ahead of Australia, the Government has indicated, both to equity and debt investors, the relative strength of its finances, and a desire to encourage investment.
The 5% differential between the top individual rate and the top PIE rate means that investment income can still be taxed at a significantly lower rate than labour or entrepreneurial income. However, if the PIE rate had not been reduced, there would have been a real incentive for savings to be conducted through vehicles taxed as companies. The income would then have been taxed at 28%, with the 5% top-up avoided by way of share buy-backs (as was the case before the PIE regime).
The removal of depreciation loading on new plant and equipment is overdue. Most commentators were surprised that it was not removed in 2003, when the Government moved to allow double declining balance depreciation.
The denial of depreciation on non-residential as well as residential buildings is surprising. The case for denial is based on evidence that buildings do not, over time, depreciate. The evidence for this may not be as strong outside the residential sector. Moreover, there is no doubt that the change was also motivated by a desire to curb New Zealander's enthusiasm for investment in (relatively unproductive) residential renting. The denial of depreciation on a wider class of buildings will have a much broader, and less business-friendly, impact.
The Government is to be commended for not adopting measures such as ring-fencing residential losses, or introducing a capital gains tax on short term gains. These measures would have been met with a wave of tax structuring activity, of the kind which the near-alignment of the rates seeks to avoid.
Counterbalancing the loss of depreciation is the benefit of the lower corporate tax rate. For the commercial and office property leasing sector, there may also be a benefit from an increase in CPI adjusted rental streams.
The budget numbers in brief
- Growth is expected to rebound to around 3% on average this year and through the next three years.
- Inflation will peak at 5.9% in the year to March 2011 (reflecting the rises in GST, ACC levies, tobacco excise tax and the impact of the ETS scheme), before falling back to a projected 2.4% a year.
- The budget is projected to return to surplus in 2015-16, three years ahead of the forecast in Budget 2009 but still later than the Australians' projection of 2012-13.
- Net debt is projected to peak in 2014-15 at 27.4% of GDP, 10% lower than projected in Budget 2009.
- The deficit track over the next four years is for deficits of $6.9 billion this year, $8.6 billion next year and $5.4 billion, $4.4 billion and $3 billion over the following three years.
- Despite the budget's frugality, spending is projected to increase $5.9 billion this year and by around $3 billion a year in subsequent years reflecting demand driven items such as NZ Super, welfare benefits and debt servicing costs.
The Government has reaffirmed its commitment to maintaining a $1.1 billion cap on new budget initiatives in next year's budget, saying that any "favourable surprises" to the fiscal position will be dedicated to faster debt reduction. This is an ambitious objective – particularly in an election year.
- The Government has kept broadly within its $1.1 billion limit.
- $800 million of the $1.1 billion is directed to health, education and innovation (the already announced $321 million package).
- A further $1.8 billion over four years of existing expenditure has been redirected to higher priority spending.
- The public sector has clearly absorbed the austerity message. Only 30 requests were lodged for budget increases this year compared with 714 in 2008.
The capex budget
- The budget devotes $1.45 billion to new capital projects.
- The largest proportion of this - $957 million – goes to infrastructure projects, including the $500 million for the electrification of Auckland commuter rail, a further $200 million (in addition to the $200 million in last year's budget) for the broadband roll-out, $190 million for schools, $1 billion for roads and the already announced $250 million boost for rail.
- $82 million will be invested in improved IT solutions for border control and archiving.
- The leaky homes offer under which the Government will meet 25% of homeowners' costs will reduce capex allowances for the next four budgets to $1.39 billion.
The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.