- Business Tax Review released
- Proposed reform of taxation of savings investment
- IRD / GST numbers to get longer
Business Tax Review released
The New Zealand Government has released its much awaited discussion document entitled Business Tax Review. Readers of the discussion document may feel somewhat deflated – the hope was for a document containing proposals for reform that would be of benefit to businesses across the country, however, the reality is a document that contains very little in terms of details of proposed reforms and certainly contains nothing new.
Cutting company tax rate to 30%
The key proposal is reducing the company tax rate to 30%, from the current level of 33%. This would match the Australian headline corporate tax rate. Certainly, this would be a positive move – but it is hardly a novel suggestion and, by itself, does not go very far. In particular, reducing the company tax rate has no direct advantage for businesses that operate under another legal structure, for example, sole traders and partnerships, although these may benefit from the downstream effects as companies redirect the tax reduction into increased investment and spending.
Introducing targeted tax credits
The second proposal relates to introducing targeted tax credits. The discussion document suggests tax credits in three areas, being areas where it is perceived that investment by business will generate wider benefits to New Zealand. The three areas are:
- Research and development (R&D).
- Export market development.
- Enhancing skills in the workforce.
There may be merit in some in tax credits, provided that the spending which generates the credits is driven by commercial forces and is not dictated by securing bureaucratic approvals based on perceived benefits . However, targeted tax credits run the risk of distorting normal commercial forces. Anyone who remembers the incentive scheme for export market development and tourist promotion expenditure that existed in the 1980's under the Income Tax Act 1976 can be forgiven if the proposals give them a sense of déjà vu.
Other tax base and tax compliance measures
The other proposals contained in the discussion document are ones that, in our view, fall within the category of ongoing remedial matters, as opposed to being genuinely new reform proposals. These include:
- Deductions for blackhole expenditure.
Identifying blackhole expenditure (that is expenditure which does not give rise to either an upfront deduction or an ongoing depreciation deduction) and providing specific provisions to deal with the problem has been ongoing for some time. A recent example of this were the provisions introduced to deal with failed or withdrawn applications for resource consents. The discussion document notes two areas of blackhole expenditure, losses on sale or demolition of a building, and feasibility study costs. However, these have been identified as areas of concern for some time.
- Changing the depreciation loadings.
Most tax amendment acts contain changes of some form or another to the depreciation regime, so whilst looking at these is useful, it is not a new proposal to enhance business.
- Reducing tax compliance burdens.
Again, the suggestions in this area are not new; they mainly look at adjusting various thresholds, for example, the threshold at which low-value items can be expensed rather than depreciated, and the threshold for filing FBT returns on an annual as opposed to a quarterly basis.
Observations on the discussion document
The discussion document sets out the estimated 'cost' per year of the proposals, for example the reduction in the company tax rate is estimated to 'cost' $540 million per year. It is interesting that the government refers to this as a 'cost' – it would represent a reduction in the government's income, not an increase in its outgoings. In contrast, most businesses would interpret a 'cost' to be an outgoing.
One positive aspect of the discussion document is that introducing a payroll tax has been discounted. It has been recognised that this would impose an additional cost on employers and is unlikely to promote labour productivity.
The objective of the review is 'to provide better incentives for productivity gains and improved competitiveness with Australia'. Whilst that may be a worthwhile objective, it arguably is too narrow as a basis against which to consider tax reforms for business. Certainly, the discussion document does not address many issues confronting business, such as triangulation (the inability to benefit from Australian franking credits in New Zealand and vice versa), nor other issues relating to international tax (although these may be considered to some degree in the discussion document on Controlled Foreign Companies, which is due out later this year). Further, the discussion document simply states that personal taxation and taxation of trusts are outside of the scope of the review. However, these directly impact on business, as many businesses are conducted by sole traders or partnerships or conducted through a trust structure, and indirectly impact on business conducted in a company structure given that ultimately the profits will pass to the shareholders.
The discussion document arguably suffers from the same problem as the recent discussion document (and now Bill) on the taxation of foreign portfolio investment (discussed below), in that it attempts to look at a narrow aspect of the tax system in isolation. It has been suggested that a better approach would be to consider the fundamental principles underpinning the tax system as a whole and then propose reforms that promote those principles and that remove inconsistencies in the way those principles are applied, as between differing legal forms of taxpayers, as between various forms of investment, etc.
The objective of the review is described in the discussion document as 'a policy priority for the government and a key condition of the Confidence and Supply Agreements with United Future and New Zealand First'. A cynic could be forgiven for feeling that the discussion document fulfils that political requirement rather than being a comprehensive attempt to address the tax issues that hinder business in New Zealand.
Proposed Reform Of Taxation Of Savings Investment
The Finance and Expenditure Committee (FEC) is currently considering the 2006 May Tax Bill, or to use its correct title, The Taxation (Annual Rates, Savings Investment, and Miscellaneous Provisions) Bill. The Bill has received more media attention than most tax bills due to the reforms proposed relating to the taxation of savings investment and the fact that three Supplementary Order Papers to change the Bill were tabled before it even reached the FEC.
We commented on the proposed reforms in the April NZ Tax Update, following the government's public announcement of these. The proposed reforms fall into two areas:
- The taxation of collective investment vehicles.
- The taxation of foreign portfolio investments.
The two areas of reform are distinct and unrelated when considered in the context of the overall structure of the income tax system. In other words, the reforms in one area can occur without the need for reform in the other area. However, the two areas have been intertwined in the government's statements promoting the reforms.
The taxation of collective investment vehicles
As noted in the April NZ Tax Update, the proposed changes include the adoption of a 'look through' tax treatment for collective investment vehicles (CIVs) that meet certain requirements. These are to be known as portfolio investment entities (PIEs) (referred to as qualifying collective investment vehicles (QCIVs) in the discussion document that preceded the Bill). In simple terms, the PIE will pay PIE tax that is calculated by reference to the tax rates of its underlying investors, rather than paying tax at the ordinary company rate of 33%.
The requirements to be a PIE are lengthy and currently include the following:
- Residence requirement: The entity must be a tax resident in New Zealand. Consequently, the PIE regime would not be available to, for example, an Australian unit trust that was resident for tax purposes in Australia.
- Income interest requirement: This requires all income from portfolio entity investments to flow through to the underlying investors.
- Independent management requirement: No underlying investor, or person associated with an investor, can influence the entity in terms of acquiring or disposing of an investment.
- Entity history requirement: This prevents entities which have ceased to be PIEs in the past from re-entering the regime in certain circumstances. If an entity meets the above requirements it can elect to become a PIE, in which case it must meet the following eligibility requirements also:
- Investor class requirement: Each portfolio investor class for the entity must include at least one of the following:
– Another PIE.
– A foreign investment vehicle (FIV).
– 20 or more unassociated persons.
A FIV is, in simple terms, an entity that is tax resident other than in New Zealand that otherwise meets the PIE requirements.
- Investor interest adjustment requirement: This requires the PIE to adjust the proportionate interests of its underlying investors each time it pays PIE tax.
- Investor interest size requirement: This requirement is to prevent an investor from having too high an interest in the underlying investment of the PIE. In short, the underlying investor's and their associates' interests must not be more than 10% of the total interest of investors in that portfolio investor class. This limit is increased to 20% where the investor in question is a qualifying unit trust that is a New Zealand resident, a group investment fund, a life insurer that is New Zealand resident or a superannuation fund. The restriction does not apply when the underlying investor is a PIE or a FIV.
- Investment type requirement: The PIE must have 90% or more of its assets available for use in deriving income from the owning or trading of interests in land, financial arrangements or accepted financial arrangements that are similar to loan securities, shares, futures contracts, currency swap contracts, interest rate swap contracts, forward exchange contracts, or forward interest rate contracts, or any right or option in relation to the foregoing. It is notable that this investment restriction would prohibit the PIE from investing in, for example, precious metals or collectable artwork.
- Investment value requirement: This requirement is designed to stop a concentration of the PIE's investments. The requirement only applies if the PIE holds more than 25% (of value) in a company that is not a PIE or a FIV. In such cases, the investment must be equal to or less than 10% of the total value of the PIE's assets and the total amount of the portfolio investment class investment in such types of investments must be less than 10%.
- Investor interest repurchase requirement: This requirement stipulates that the PIE must repurchase or offer to repurchase from investors all or any part of their investor portfolio investor interests upon certain events occurring.
Where a PIE fails to meet any of the requirements on two consecutive measurement dates, it is no longer eligible to be treated as a PIE. In that case, it will revert to being taxed on an entity basis rather than subject to PIE tax.
Our submission on the Bill raised questions with some of these requirements, as have the submissions filed by others. It is possible that these requirements will change prior to the Bill being enacted. Our submission also covered concerns with the extent of the statutory overrides which are proposed to deal with restrictions (arising under trust deeds or other legislation) that would otherwise apply to fund managers and trustees and prevent them from electing into the PIE regime.
Taxation of foreign portfolio investment
Some of our concerns with this area of the proposed reforms were set out in the April NZ Tax Update. Our submission on the Bill reflected on those concerns. The fact that the proposals in this area are being discussed in the media on an almost daily basis indicates the level of concern these proposals have generated. Overall, we anticipate it is not a question of whether changes will be made to the proposals, rather it is a question of how great those changes will be.
IRD / GST Numbers To Get Longer
As from 1 April 2007, IRD and GST numbers will change in length from 8 digits to 9 digits. Existing IRD and GST numbers simply will have zero added to the start, for example, the current number 98-765-432, will become 098-765-432. Newly issued numbers after that date will be 9 digits long.
This change may require some forward planning to be undertaken, particularly in relation to:
- Payroll systems – payroll software may need to be upgraded or modified to cope with the extra digit in the 'employee's IRD number' field.
- Pre-printed stationery – printers will need to be advised to update the GST number on pre-printed invoices and appropriate orders placed so that stock is on hand to enable compliant GST invoices to be issued as from 1 April.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.