GenAI – a leap forward

Artificial intelligence (AI) is the new buzzword at the moment, with business leaders touting its importance and the significant impact it will have on the way we conduct business. The reality is that AI has been around for a while, but in the past few years has taken a great leap in terms of its usefulness and accessibility for the general public.

AI is a blanket phrase for computers performing tasks that would usually require human intelligence to perform. It is exceptionally good at recognising patterns and making predictions and is being widely used already. For example, the facial recognition on your phone or the personalised ads you see pop up on the web are all a result of AI. Generative AI (GenAI) is an evolution of this, whereby it can use existing data and patterns to create completely new content. GenAI is what is causing such a stir recently, due to the broadness of its potential applications and how disruptive it could be for many industries.

According to PwC’s 2023 Emerging Technology Survey, 73% of US companies have already adopted AI into their business, with 54% using GenAI. With many firms creating their own GenAI chatbots, employees can use these to research legislation, summarise spoken meetings using speech to text, or craft an email from scratch. Broader use cases see programmers using GenAI to help them write code, product designers using it to evaluate new designs, or marketers to identify leads and develop marketing strategies. In the creative industry GenAI has been even more disruptive, with unique videos, pictures or songs being crafted from a simple chat prompt.

Every so often a new technology comes along that completely changes the way in which the world operates. In recent times, this has been things like the internet, or smartphones. Many are now claiming that GenAI will be the next big shift, and that its impact on the future will be unprecedented.

The first ever global summit on artificial intelligence was hosted in November last year, where 28 nations declared the need to work together to manage the risks associated with such powerful technology. Public figures like Elon Musk even described it as a ‘threat to humanity’, given the potential for AI to become more intelligent than its human creators.

While the threat of world domination is hopefully something on the far horizon, when it comes to AI, no one can really say how fast the technology will evolve, particularly when it is able to learn and teach itself.

With access to GenAI available to everyone through platforms like ChatGPT, now is the time to consider whether it can be helpful to you or your business.

Changes to GST for the platform economy

In March 2023, legislation in relation to the platform economy was passed, affecting the GST treatment of services made through an electronic marketplace from 1 April 2024. We saw something similar back in 2019, where the GST rules on imported goods were amended to treat operators of online marketplaces as liable for returning GST, as opposed to individual sellers. Now the rules are being expanded to include listed services, such as accommodation, ride-sharing services and food delivery services.

Previously, large market operators like Airbnb or Uber were not liable for returning GST on services that were supplied through their platform. Instead, the underlying supplier of the services (the home owner or driver) would only have to register for and return GST if their taxable supplies exceeded $60k per annum.

In order to ensure fairness with other operators in the economy, from 1 April 2024, the rules have changed to treat the market operators of these listed services as the supplier for GST purposes. For example, when someone books a holiday home through one of these suppliers, the market operator (the one facilitating the supply of the service) is liable to account for GST on the rental price to Inland Revenue. This applies regardless of whether the underlying supplier (the person that owns the accommodation) is registered for GST or not.

Essentially, the market operator will now be left with less cash from each transaction. It is likely that these market operators will either look to increase the listing price to the end consumer or reduce the net proceeds paid to the underlying supplier.

One of the fundamental aspects of the GST system is that GST can be claimed on goods and services acquired for use in making supplies. An underlying supplier that is not GST registered would not be able to do so.

To achieve a similar economic outcome, a flat-rate credit of 8.5% applies. This percentage was determined to be the average value of GST input tax deducted by taxi drivers and holiday home owners and must be taken as a deduction by market operators where the underlying supplier has not notified Inland Revenue that they are GST registered. The market operator must then pass on the credit to the underlying supplier. This has the effect of allowing underlying suppliers a standardised input tax deduction against the GST output tax liability.

There is further devil in the detail that should be worked through on a case-by-case basis, such as how the flat rate credit is treated for income tax purposes and to what extent should income tax deductions be claimed for costs that have a mixed purpose.

These rules are now in effect and should function to promote more equity across the economy, and might explain why the price of some holiday accommodation has just gone up.

Government reverses interest deductibility limitations

With the new Government now firmly settled in, legislation has been passed which reverses the interest deductibility limitation rules that were introduced by the previous government in 2021.

As previously introduced, the rules phased out the ability to deduct interest on loans drawn down before 27 March 2021 to purchase residential property over a period of five years. For loans drawn down after 27 March 2021, no interest deductions were allowed unless the property qualified as a ‘new build’.

Under National’s tax policy released as part of the election process the deductibility percentage was to increase to 50% for the 31 March 2025 year (as opposed to 25% under the then-current legislation), then phase it back in over the following two years. As detailed in the legislation, the restoration is being sped up, with the new rates as follows:

Date interest incurred% of interest claimable
1/04/24 to 31/03/2580%
1/04/25 onwards100%

This phasing applies to all taxpayers, regardless of whether their lending was drawn down prior to 27 March 2021 or not. This means those who are not currently entitled to deduct any interest will go from 100% non-deductible for the year ended 31 March 2024, to 80% deductible for the year ended 31 March 2025. Under the old rules, there were various exemptions which meant the rules did not apply to some taxpayers, the most common being a property falling under the definition of a ‘new build’. These exemptions continue to apply, with the rules being completely repealed from 1 April 2025 once all taxpayers are entitled to the same 100% deductibility.

Also under the old rules was a provision that would allow taxpayers to claim a deduction for any previously denied interest amounts, if the eventual sale of their property was subject to tax. Importantly, this provision still applies. This means that any taxpayers with denied interest amounts should continue to keep track of these if there is a chance the future sale of their property will be subject to tax.

The phasing back in under this regime should be relatively simple, with only a small amount of complexity existing for those with non-standard balance dates. For example, for someone with a 30 June balance date who has a pre-27 March 2021 loan, when preparing their 2024 income tax return, they would claim 50% of their interest from July 2023 – March 2024, then 80% of their interest for the remaining 3 months.

These changes see the treatment of residential property become more aligned with normal tax principles, reducing complexity and compliance costs for ‘Mum and Dad’ investors.

Repairs to rental properties not deductible?

A recent technical decision summary (TDS 24/02) issued by Inland Revenue involves a dispute with a taxpayer that purchased several residential rental properties. Soon after purchasing, the taxpayer conducted renovation work on the properties to various degrees, such as replacing kitchen units and carpet, adding dishwashers and heat pumps, and cleaning and repairing roofs.

Inland Revenue concluded that the capital limitation applied to the costs involved with the work completed, on the basis the renovation costs formed part of the cost of acquisition of the properties, and the work completed was beyond ordinary repairs and maintenance. The key facts considered in coming to this conclusion were the condition of the properties when purchased, whether the purchase price was discounted, and the cause of the need for the work. It was found that the properties were in average condition on purchase, and that the taxpayer renovated them to make them more attractive to higher paying tenants. This led Inland Revenue to assert that the purchase price was therefore discounted, as the vendor could have obtained a higher price had they conducted the repairs themselves before sale.

The taxpayer argued that the work was done to restore the properties to their original condition, with no real improvements being made. They asserted that the properties were fit for purpose at the time of purchase, evidenced by the fact that all but one property was tenanted. The less-than market purchase price was due to the fact that multiple properties were being purchased at once, hence a single transaction discount applied. Moreover, the taxpayer had attempted to negotiate a lower price with the vendor at the time of purchase due to repairs being needed but was unsuccessful. The taxpayer asserted that the photos Inland Revenue relied on to prove that the properties were unfit for purpose were not representative of the condition of the properties as a whole, as the taxpayer had used these selected photographs for negotiation purposes.

This has been a topic well covered by previous case law, but one that easily lends itself to interpretation. In this case there is room to disagree with Inland Revenue’s interpretation. One would have to assume that price is always impacted by the condition something is sold in. If one were to take a literal interpretation of the Inland Revenue’s view, any subsequent repairs made to a recently purchased asset would point to a discount being received on the purchase price and should therefore be treated as capital in nature.

Clearly there is a fine line to traverse in such situations, and we may not have seen the last of this particular case if the taxpayer takes the matter further.  

Snippets

Changes to bright-line rules

Along with changes to the interest deductibility rules, legislation has been passed which repeals the current bright-line tests, replacing them with a new (or old) 2-year test.

There were previously three separate bright-line tests which applied to the sale of residential land:

  • Land acquired on or after 27 March 2021 that is not a ‘new build’: 10-year test.
  • Land acquired on or after 27 March 2021 that is a ‘new build’: 5-year test.
  • Land acquired on or after 29 March 2018 but before 27 March 2021: 5-year test.

The changes repeal all of these tests and replaces them with a 2-year test applying to all residential land equally (no longer a different treatment between a new build and a non-new build). It applies to disposals that occur after 1 July 2024, i.e. a property purchased before 1 July 2022 and sold after 1 July 2024 will not be subject to the bright-line test.

The main home exclusion that required an apportionment between the time and area that the property was used as a main home is also repealed. Under the two-year regime, to qualify for the main home exemption the home must be predominately (more than 50%) used as such, both from a time and land area perspective.

Rollover relief rules are also extended to capture more types of transfers, allowing the transferee to obtain the original purchase date and cost of the transferor. For example, transfers can now be made between relatives within two degrees of blood relationship without triggering a bright-line disposal. Each of these changes revert the rules closer to their original intended purpose, which was to bring gains made by property speculators into the tax net.

Questionable spending?

Rates are rising across the country, with a recent economist’s report showing an average expected rise of 15%. This is the largest rise the country has seen since 2003, which begs the question, where is all the money going?

Inflated construction costs and widening responsibilities take the majority of the blame, but one can’t help but wonder if there might be an element of ‘questionable’ spending involved.

Across the world there are some compelling examples of spending that would be considered less than palatable to the ratepayer. The Gold Coast city council spent $2 million on an art installation consisting of street lights painted to spell the letters ‘Gold Coast’. The catch is, passing motorists couldn’t even make out what the lights were supposed to say. A vote to remove the lights has recently been passed, with an estimated removal cost in excess of $250,000.

Further afield, in Illinois, $98 million was allocated to a project to research and apply a solution for trains making noise as they come to a stop, after complaints were made from two former clients of the Illinois House Speaker. The city of San Francisco spent four years testing various trash can prototypes, some of which ranged in price from $11,000 to $20,000 each. The city of Liverpool spent over £300,000 on three public art installations depicting an elephant in a Viking boat, a tree with a giant frisbee in it, and a large chair with bird wings attached to the back of it.

Are there any similar examples in your city?

If you have any questions about the newsletter items, please contact us, we are here to help.

Business Payment Practices Act

The Business Payment Practices Act 2023 (‘the Act’) was enacted on 26 July 2023. It will require certain entities (‘reporting entities’) to publicly disclose specific information about their payment practices.

Making up over 97% of all businesses in New Zealand, small businesses often do not have the financial resources or market influence to cope with late or long payment times. Payment delays from customers can create significant cashflow problems. The purpose of the Act is to provide greater transparency in business-to-business payments and enable members of the public and other entities to access information about those payment practices, so that they can make informed decisions about who they want to do business with.

An entity will be a reporting entity and subject to the disclosure requirements under the Act if, at each of its two preceding accounting periods, it had (together with its subsidiaries):

  • total revenue of more than NZ$33m, and
  • total third party expenditure (excluding salaries and wages) of at least NZ$10m.

A reporting entity will be required to make disclosures every six months on a publicly searchable register. The first disclosure period runs from 1 July 2024 – 31 December 2024, with the second disclosure period running from 1 January 2025 – 30 June 2025. However, only reporting entities which had (together with its subsidiaries) total revenue exceeding NZ$100m at each of its two preceding accounting periods are required to disclose from the first disclosure period commencing 1 July 2024. This phased approach provides additional time for smaller reporting entities to transition to the new rules, for example, to change or put in place new processes and systems to be able to comply.

Reporting entities will have up to three months after the end of a disclosure period to file their disclosures.

The points below summarise the different types of information that will be required to be disclosed by a reporting entity every six months:

  • The average payment time for invoices (from when invoices are received to when paid in full).
  • The percentage of the total number of invoices paid in full within specified day periods.
  • The percentage of the total value of invoices paid in full within specified day periods.
  • Whether the reporting entity allows other entities to use e-Invoicing.
  • Whether the reporting entity uses standard payment terms and what those terms are.

There are a number of exclusions (i.e. information not required to be disclosed) from the disclosed information for items such as: salary/wages, tax, rent or lease, utilities charges, transactions not in NZD and intra-group transactions.

Penalties will apply for non-compliance, including up to $9,000 for failing to make a disclosure, and up to $50,000 for an individual or $500,000 for an entity for filing false or misleading information.

If your business meets the definition of a reporting entity, it is time to start considering what internal processes will need to be implemented to ensure compliance with the Act. For small businesses, it won’t be too long before you’ll be able to search the payment performance of some of your suppliers.

Tax pooling & provisional tax

For a standard 12-month year, provisional tax is due in three instalments. The instalments generally fall on the 28th day of the fifth, ninth and thirteenth months. However, this is varied in certain situations. For example, for a business with a 31 March balance date the instalments are due on 28 August, 15 January and 7 May. The second and third instalments being pushed out due to the Summer and Easter holidays, respectively.

Most taxpayers use the ‘standard uplift’ method where instalments are calculated based on the previous year’s (“year-1”) residual income tax (RIT) +5%, or the RIT from two years ago (“year-2”) +10% if the prior year tax return has not been filed.

Understanding the way provisional tax works is complicated by the fact there are different rules for the purpose of late payment penalties versus interest. This means it is possible to pay the required amount on-time, as calculated under the standard uplift method, and not be subject to late payment penalties. But then incur interest from that same point because the final liability for the year exceeds the provisional tax amounts paid.

Whilst the rules can be complex, concessionary changes over the past few years have made the regime less onerous and costly. For example, provisional tax used to be calculated as at a particular instalment date based on the most recently filed income tax return, whether year-1 or year-2. If profits declined across the two prior tax return periods, the provisional tax payable would not be reduced until the most recent return was filed and only for subsequent provisional tax payments.

Under current rules, the amount due at a past instalment is re-calculated based on the lesser of year-2 or year-1. This ‘lesser of’ approach means there is less risk in choosing to pay a lower amount of provisional tax based on the prior year’s estimated taxable income, even though the income tax return for that period has not been filed.

Finally, the practical effect of tax pooling means late payment penalties and interest based on punitive Inland Revenue rates should be a thing of the past.

To illustrate the way tax pooling works is to imagine a large company like Air NZ at the start of Covid. Things were looking up, then Covid hits and profit plummets. Any provisional tax previously paid would likely be spare and otherwise refunded by Inland Revenue at a low interest rate. Alternatively, if Air NZ paid its provisional tax to a tax pooling intermediary, that tax can be sold to other businesses ‘effective’ as at the date Air NZ paid it. Then let’s say another business has outperformed expectations and therefore has a large tax bill, but under the provisional tax rules, interest is being charged from its third provisional tax date of 7 May. It can go to Air NZ and purchase some of its excess tax that it paid on 7 May.

There is an interest  cost to tax pooling, but it is less than what Inland Revenue charges and Air NZ would receive interest that is more than what Inland Revenue would have paid. Everyone wins, well almost everyone…

At the extreme, if a business has a borrowing rate similar to the tax pooling cost, it could choose not to pay any provisional tax during the year and instead use tax pooling to purchase the exact amount required at each instalment date once their tax return has been filed. With the current interest rate on underpayments of 10.91%, tax pooling should be front of mind when the provisional tax dates roll around.

Australia's tax system compared

With the recent inflation driven surge in the cost of living, apparent increase in crime and seemingly constant complaints about the education and health systems, some New Zealanders are considering packing up and moving to Australia. But is the grass really greener – at least from a tax perspective?

Firstly, unlike New Zealand, Australia has a capital gains tax (CGT). The amount payable is tied to the taxpayer’s respective tax rate, and a person’s main residence should not be subject to CGT on sale. A 50% CGT discount is available where an Australian tax resident or Australian Trust has owned the asset for at least 12 months prior to selling. Companies do
not qualify for the discount.

Another tax imposed on property in Australia is stamp duty. This is a tax that is imposed when buying land (as well as other specific transactions). The amount of stamp duty varies by state and is imposed on top of a property’s purchase price. A $500,000 residential home in Queensland will trigger stamp duty of around AUD$16,000. For the same-priced home in Victoria, you’re looking at around AUD$25,000.

Like New Zealand, Australia also has a progressive tax rate system for individuals. The below table compares the two countries’ tax rates for individuals.

New Zealand (NZD)Australia (AUD)*
$0 - $14,00010.5%$0 - $18,2000%
$14,000 - $48,00017.5%$18,200 - $45,00019%
$48,000 - $70,00030%$45,000 - $120,00032.5%
$70,000 - $180,00033%$120,000 - $180,00037%
>$180,00039%>$180,00045%
*Australian tax rates exclude the 2% Medicare levy, which applies to most residents.

Although the highest personal marginal tax rate in Australia of 45% seems daunting, when comparing tax paid by low-middle income earners in each country, the results are surprising. The below table
compares the amount of tax payable in each country (excluding Australia’s 2% Medicare levy) if an individual earned the level of income in the first column (in the respective country’s currency).

Annual incomeTax on income in NZTax on income in Australia
$40,000$6,020$4,142
$80,000$17,320$16,467
$120,000$30,520$29,467
$200,000$50,320$60,667

At one end of the spectrum, the tax-free threshold skews the comparison for lower income earners, and the top rate of 45% skews the cost at the other end of the spectrum. But given such a small difference exists for the average salary/wage earner, it would be reasonable to assume a person’s tax bill in Australia will be higher as soon as stamp duty and CGT is incurred - but maybe you get what you pay for. 

Research and development regimes

New Zealand currently has two different tax concessions aimed at encouraging research and development (R&D). Namely, the Research and Development Loss Tax Credit (RDLTC) and the Research and Development Tax Incentive (RDTI).

The RDTI has been in effect for eligible R&D activities from the 2019/2020 income year and was introduced to support the then Labour Government’s target of raising the total amount of R&D performed in New Zealand to 2% of GDP by 2028.

If an entity qualifies for the RDTI regime, it is able to claim a tax credit calculated as 15% of its total eligible R&D expenditure. This tax credit can be refunded when the taxpayer is in a tax loss position.

The RDLTC has been around for longer than the RDTI – it applies to income years that commenced on or after 1 April 2015.

The RDLTC acknowledges that companies engaged in intensive R&D tend to have significant up-front costs, and as a result, tax losses in their early years. Hence, the aim of this regime is to assist with cashflow by allowing an eligible company to ‘cash-out’ (and forfeit) its tax losses in an income year, in exchange for a payment; RDTLC payment = eligible tax loss x corporate tax rate (28%).

The way the regime is intended to work, is that the payment is subsequently repaid as the company derives taxable income – as the company has forfeited its tax losses, it will repay the RDLTC through paying income tax on its taxable income.

Subject to meeting the eligibility criteria of both regimes, a business can claim both the RDTI and RDLTC under the same R&D activity. However, a few notable differences exist between the regimes:

  • Only New Zealand Companies can be eligible for the RDLTC, whereas partners, owners of look-through companies and members of joint ventures can also be eligible for the RDTI if certain conditions are met.
  • There are differing definitions of R&D - the RDLTC uses the accounting definition NZ IAS38 whereas the RDTI definition of eligible R&D is set out in the legislation.
  • The RDLTC expenditure can only be claimed for R&D expenditure incurred in New Zealand, whereas the RDTI can include foreign expenditure, up to 10% of the eligible spend.
  • To qualify for the RDTI, a business must have spent at least $50,000 on eligible R&D expenditure, whereas the RDLTC does not have a minimum expenditure requirement.
  • The RDTI is not required to be repaid, while certain events will trigger the repayment of the RDLTC (if it hasn’t already been repaid through the mechanism outlined above).
  • The RDTI requires that activities are approved before claiming the expenditure with strict deadlines applying. For the RDLTC the activities and expenditure are submitted together at the end of the financial year.

The type of activities that can qualify under the regimes are broad, hence if your business has or is looking at incurring expenditure on creating or improving processes, services or goods, even for internal purposes, it may be worth finding out if the regimes could apply.

Snippets

National’s tax policies - property

Given the outcome of the general election, we expect to see legislation that will make the following tax changes.

The ability to claim interest deductions on debt relating to some residential rental properties acquired before 27 March 2021 is being  progressively phased out. National’s tax policy promises to retain a 50% allowable deduction in the year ended 31 March 2025 (rather than reduce it to 25%), increase it to 75% in the year ended 31 March 2026, and fully restore 100% interest deductibility from April 2026 onward. From start to finish this means the interest deductibility on affected properties will be:

Date Interest Incurred% interest claimable
1/4/21 – 30/09/21100%
1/10/21 – 31/03/2275%
1/04/22 – 31/03/2375%
1/04/23 – 31/03/2450%
1/04/24 – 31/03/2550%
1/04/25 – 31/03/2675%
1/04/26 onwards100%

National also proposed to reduce the brightline period for residential investment properties from 10 years (or five years if the property is a ‘new build’) to two years by July 2024. As a result, properties acquired before July 2022 should not be subject to the brightline test on sale.

Given how complex the current rules are, there is a risk that unwinding them will be equally complex, hence we are unlikely to be out of the woods yet.

Covid fraud

Given the necessity of providing fast relief, the wage subsidy scheme provided during COVID in NZ was largely based on trust.

Today, MSD operates a Wage Subsidy Integrity and Fraud Programme aimed at ensuring the integrity of the payments and who received them. So far, 38 people have been brought before the courts in relation to wage subsidy misuse, 37 businesses have civil recovery action underway to recover payments and 11 cases of significant and complex alleged wage subsidy fraud have been referred to the Serious Fraud Office. By and large, businesses in NZ were sincere in their wage subsidy claims, but overseas there are some more extreme examples where this was not the case.

Each year, the Association of Certified Fraud Examiners selects the five most scandalous fraud stories of the year. One of those stories was the arrest of 47 people affiliated with a Minnesota based non-profit ‘Feeding our Future’, which defrauded USD$250 million in COVID relief funds through claiming to feed children during the pandemic. The elaborate scheme used various fake documents, invoices and shell companies to give the appearance of providing meals to children, while using the money to purchase luxury cars, jewellery and coastal property abroad.

If you have any questions about the newsletter items, please contact us, we are here to help.

Christmas / New Year Trading Hours

Office Closes: 12pm Friday 22nd December

Re-open:         8.30am Monday 15th January

Tax ourselves out of recession?

The buoyant covid subsidy funded days are behind us, New Zealand has entered a ‘technical’ recession. This was reinforced by the recent announcement that New Zealand’s corporate tax paid was almost 11% down in the 11 months to May relative to Government expectations.

A drop in the corporate tax take reflects the declining profits of businesses, coinciding with a decline in output. While profits have declined, there is little to ease the tax burden for businesses with no relief measures in place in a volatile market.

From all the industries feeling the pinch of economic downturn, the construction sector has arguably been hit hardest. As property prices decline, construction costs continue to rise sharply, impacting margins and the ability of property focused businesses to service debt.

Many builders and property developers will be holding land that has dropped in value within months of acquisition. By valuing closing stock at “market selling value” most businesses are able to claim a tax deduction for the drop in the value of their inventory prior to sale, as long as the value is supported by market data. However, as land is specifically excluded from the trading stock rules, businesses that derive income from the sale of land cannot deduct losses in value until the land is sold. The misalignment in treatment is arguably a kick to an industry that is already down.

One of the temporary tax measures introduced in response to Covid-19 enabled tax losses to be carried back to the prior year to recoup previously paid tax. A strong 2022 financial year followed by a volatile 2023 raises the question whether a similar loss carry back scheme could be implemented now to cash out current year losses when businesses need it most. With the next 12 months showing little signs of an economic boom, it could be a few years before some businesses can claim current period losses under the current tax rules.

With operating costs growing, investment in capital is being reconsidered and potentially delayed. The ability to claim an immediate tax deduction for small capital items could incentivise businesses to proceed with projects. The reintroduction of a higher threshold for low value assets at $5,000 or more is another option for the government to encourage investment in productive assets that create more opportunities. This could be further extended similar to the relief measures Australia provided where small businesses had the potential to temporarily write-off assets to the value of $150,000 encouraging investment at a greater scale.

While the timeframe for such write-off’s has ended in Australia, similar to New Zealand, these relief measures during the pandemic illustrated how tax can be used to drive business investment and reduce the tax burden on businesses during an economic downturn.

Tax policy from two sides of the political aisle

Given that either Labour or National are likely to enter into coalition agreements of some form with the Green Party and Act, respectively, and the tax policies of the two main parties are more ‘vanilla’, it is worth reviewing the tax policies of the two minor parties as this is where unexpected change may come from.

The Greens have taken the approach of increasing tax across the board. Their key policy is a 2.5% annual tax on net wealth above $2m ($4m for couples). This would apply to most forms of assets, with things like property and shares valued based on their market value. They have indicated that taxpayers would have the option to defer the payment of the wealth tax until the asset is sold, to assist those who don’t have the cashflow necessary to pay the tax. They also propose an annual 1.5% tax on all assets held in private trusts to ensure taxpayers cannot avoid the wealth tax through sheltering assets in a trust. No minimum asset value exists before the tax applies, meaning those who own an average family home in a trust would be caught by the tax, despite having net wealth below $2m.

In contrast, Act is looking to reduce taxes levied on assets. Act has opposed the bright-line test since National introduced it in 2015, with Seymour describing it as an “acorn of a capital gains tax”. Currently, any residential investment property that is sold within 10 years of purchase (that is not a ‘new build’) is subject to the bright-line test and any capital gain will be taxed. They plan to abolish the test, as well as reinstating interest deductibility for residential rental properties.

When it comes to marginal tax rates, the Green Party are looking to introduce a new top tax rate of 45% on income above $180,000, as well as reducing the brackets such that the 39% rate kicks in at $120,000. A tax free threshold would also be introduced between $0 - $10,000.

Act wants to simplify things, eventually reducing down to a two-tier system. Income from $0-$70,000 would be taxed at 17.5%, and all income above $70,000 would be taxed at 28%. They note this would result in low and middle income earners becoming worse off in many cases, so would also introduce a specific tax credit for these earners to offset this.

Other notable policies are that the Greens would increase the corporate tax rate back to 33%, and Act would divert emission trading scheme revenues into an annual tax refund for every New Zealander.

Looking at these policies, a clear dichotomy exists between the two parties. Execution of the policies will be tempered by their respective coalition partners, but as more voters stray from the centre who’s to say what will make it through to tax policy when the new government is formed.

Trust Tax Rate 39%

On 18 May 2023, the government introduced the Taxation (Annual Rates for 2023-24, Multinational Tax, and Remedial Matters) Bill. The Bill includes draft legislation that will see the trust tax rate increase from 33% to 39% from 1 April 2024, thereby aligning it with the top personal marginal tax rate.   

Between 2000 and 2010, the top personal marginal tax rate was also set at 39%. Throughout that period, the trust tax rate remained at 33%. The government has cited the recent re-introduction of the 39% top personal tax rate as the reason for the increase in the trust tax rate. The commentary to the bill states:

“Aligning the trustee and top personal tax rates at 39% would help ensure that trusts cannot be used to circumvent the top personal tax rate. This would improve the fairness and progressivity of the tax system, protect the revenue base from erosion, and improve the Government’s ability to raise revenue.”

Much like when the top personal marginal tax rate increased to 39%, taxpayers will no doubt consider ways to minimise their exposure to the 39% rate. However, unlike the top personal rate, the 39% trust rate will apply from the first dollar a trust derives. This means the scope of the change is likely to be broader without active planning. We are likely to see a significant increase in beneficiary distributions. It is common for trusts to distribute income to their beneficiaries to utilise their lower marginal tax rates. However, because the 39% personal tax rate doesn’t apply until $180,000, trusts could commence making large distributions to beneficiaries. When we consider that trusts often distribute to children, we could see many young adults receive distributions of up to $180,000. This will have flow on effects to student loan and provisional tax obligations.

Between now and the new rate coming into effect, there is still the outcome of the general election to be decided. This is likely to mean most people will wait until the outcome is known. However, if the new trust rate does come into effect, large dividends are likely to be declared to extract retained earnings from companies owned by trusts, at a rate of 33%, sheltering them from having to pay the 39% rate on these earnings in the future. A similar trend was seen prior to when the 39% personal marginal rate came into effect.

Some taxpayers will question whether this change disqualifies trusts as a viable structuring option. However, the reality is that the asset protection and succession planning advantages still exist, irrespective of the tax treatment.

Leaky home repairs concluded as not deductible

The leaky homes crisis represents one of the most severe problems faced by New Zealand’s property sector and continues to cause stress and anxiety for those affected.

Adding to the uncertainty for rental property owners has been the question of whether repair costs are immediately deductible as ’repairs and maintenance’ (R&M).

Inland Revenue has assisted by providing guidance on determining whether repairs are deductible. The 2012 Interpretation Statement ‘IS 12/03 Income - deductibility of repairs and maintenance expenditure - general principles’ includes specific examples, but the issue is very fact specific and a matter of judgement.

Illustrating the continued uncertainty, Inland Revenue recently released Technical Decision Summary 23/07: Whether expenditure to resolve weathertightness issues is deductible. The TDS covers a dispute regarding leaky home expenditure deducted by a taxpayer and the decision by the Tax Counsel Office (TCO).

The dispute concerned a taxpayer who owned a rental unit within a block of six units, which were all connected by inter-tenancy walls. The block was also a part of a wider complex, consisting of other similar blocks. The unit in question required remediation work to resolve weathertightness issues.

While the property was untenanted, the remediation work was carried out by the body corporate and paid for by the taxpayer via a special levy. Simultaneously, the taxpayer also incurred expenditure for their unit to be painted.

The question was whether the capital limitation applied to deny the deductions claimed by the taxpayer in relation to the remediation and the painting. Inland Revenue asserted that the entire cost (including the painting) was capital, as the remediation work involved a reconstruction of the whole asset, or at the least, changed the character of the asset.

Conversely, the taxpayer argued that the expenditure incurred was deductible R&M as the remediation work was mostly limited to certain portions of the inter-tenancy walls and decks, while the painting comprised ordinary repairs and maintenance expenditure.

The TCO considered three relevant elements:

  • Whether the work resulted in the reconstruction, replacement, or renewal of the asset, or substantially the whole of the asset?
  • Whether the work done had the effect of changing the character of the asset?
  • Whether the work was part of one overall project or was a series of projects that merely happened to be undertaken at the same time?

The TCO concluded that in the context of the remediation, the relevant asset was the block, given that the work was undertaken by the body corporate on a block-by-block basis and was not carried out solely within the boundaries of the unit. The work changed the character of the block due to the proportionally high costs, and the structurally significant improvements to the affected areas, which were important to the operation of the asset.

Hence, the capital limitation applied to deny a deduction for the remediation work. Conversely, the painting work was undertaken separately from the remediation work and considered deductible R&M.

Snippets

Retention money amendment

Legislation has recently been passed that will strengthen the protection subcontractors have that they will receive retention money owed to them should the head contractor become insolvent.

Retention money relates to money owed to a subcontractor that is retained by a head contractor, usually a percentage of the contract value, to ensure work is completed as per the contract. This retention would then be paid out on completion of the work or warranty period.

Minister for Building and Construction Megan Woods stated that the Construction Contracts (Retention Money) Amendment Act 2023 (Act), will “provide important protections for subcontractors so they can be certain their payment is kept safe, can’t be used for any other purpose, and will be paid out should the head contractor’s business fail.”

Under the Act, retention money will be required to be held on trust by the head contractor, and must be held separate from other money or assets; and hence not available for use as working capital. The head contractor must keep accounting and other records (as specified in the Act) of all retention money held for each party. This information must be made available for them to inspect and be provided as a report at least once every 3 months.

The Act also introduces penalties for non-compliance with fines for each offence of up to $50,000 for directors and up to $200,000 for companies. The Ministry of Business, Innovation and Employment, which will monitor and enforce compliance, will have the power to obtain information and apply for search warrants to carry out its function. The new requirements come into force from 5 October 2023, and will apply to new commercial construction contracts entered into, or contracts renewed, after the Act commences.

GST registration checks

A standard data policing check completed by Inland Revenue is to review taxpayer GST filing patterns to identify taxpayers that are GST registered, but perhaps shouldn't be.

In order to qualify for GST registration, a taxpayer needs to be conducting a “taxable activity”. This comprises a continuous or regular activity that involves making a supply of goods or services for consideration. This is a different test to whether a person is operating a “business” for income tax purposes, as it does not require an intention to make a profit.

A person is required to register for GST when the value of their sales exceed or are expected to exceed $60,000 in a 12 month period. But this issue is not about sales volume, because a taxpayer can voluntarily register for GST if sales are below this threshold.

The issue is whether the activity has stagnated to the point there is either no or very low activity levels, or sales have declined to the point where it suggests the activity has stagnated.

On deregistration, assets retained are deemed to be sold, which can give rise to a cash cost. But if reviewed by Inland Revenue there is a risk they may determine the GST registration should be cancelled at a past date or that the entity never qualified for GST registration – thereby requiring past GST refunds to be paid back.

Knowing that a ‘knock on the door’ might be coming, it is worthwhile to pre-emptively consider whether an entity you are responsible for should not be GST registered.

If you have any questions about the newsletter items, please contact us, we are here to help.

FBT on motor vehicles refresher

Calculating Fringe Benefit Tax (FBT) on motor vehicles can be complex, due to the various permutations that can exist depending on the use of the vehicle, its type and the approach adopted by the employer. As a result, it is very common for businesses to get the calculation wrong.

As a refresher, a fringe benefit will arise when an employer makes a motor vehicle available to an employee for their private use, in connection with their employment relationship.

Sedan, FREE Stock Photo, Image, Picture: Red Sedan Sport Car, Royalty-Free  Car Stock PhotographyThe amount of FBT payable depends on the value of the motor vehicle benefit. This is calculated based on either the cost price or depreciated value of the motor vehicle, multiplied by the applicable FBT valuation rate. The rate varies depending on whether the GST inclusive or exclusive cost or tax value is used - with the tax value method applying a higher percentage than the cost price method. As a result, the cost price method is typically used from ‘day 1’, while the tax value method becomes more favourable for vehicles that are held for more than five years.

The value of the fringe benefit is also apportioned by the number of days the vehicle is “available” for private use. It should be noted that the employee does not actually have to be using the vehicle for a fringe benefit to arise, it only has to be available for them to use. For example, if a vehicle is being repaired and is unavailable to the employee, this is generally considered an excluded day and would reduce the value of the benefit.

Other examples of exemptions from days counted as available for private are where the employee is away on a business trip with the car for longer than 24 hours, or they are required to attend an emergency call. However, if an employee goes on a private holiday and uses their work vehicle to get to the airport, parking it there for the duration of their holiday will likely to be subject to FBT unless the employer and employee have specifically agreed otherwise.

If a vehicle qualifies as a work related vehicle, travel between home and work and other incidental travel on work days is not subject to FBT. To qualify as a work related vehicle:

  • it must be sign-written,
  • cannot be designed to mainly carry passengers, and
  • employees must be notified in writing that the vehicle is not available for private use except for travel between home and work and travel incidental to business travel
  • Close companies may also chose not to apply the FBT rules to motor vehicles. This is allowed where the only fringe benefit provided is the provision of up to two motor vehicles to shareholder-employees for their private use. In this case, they may choose to apply the rules in subpart DE, where expenses can be claimed based on the proportion of business use of the motor.

Note: For most of our clients we calculate and record a private use adjustment to avoid the need to pay FBT.

Deductibility of holding costs for land

On 31 March 2023, Inland Revenue released a draft interpretation statement (PUB00417) addressing the deductibility of land holding costs - namely, interest, rates and insurance - and the relevance of whether the land is taxed on disposal. This had been an area of uncertainty since the introduction of the residential bright-line provisions in 2015, which can result in a disposal of land being taxable even if it was held on capital account or used privately.

Inland Revenue previously released a consultation document in October 2019, which considered three options in relation to a taxable disposal of land, where the land had been used wholly for private purposes (for example, a holiday home subject to the bright-line test):

  1. Apportion the holding costs between the taxable gain and private use of the land.
  2. Allow deductions for all holding costs, despite private use.
  3. Deny deductions for all holding costs for periods of private use.

While Inland Revenue conceded that apportionment would provide the most accuracy, they concluded that due to complexity, the preferred option was to deny deductions for holding costs for periods of private use.

Inland Revenue’s view on this issue remains unchanged from the initial 2019 consultation document. The draft interpretation statement reaffirms that land held on capital account will not give rise to deductible holding costs, even if the disposal is taxable. It was emphasised that there must be a sufficient nexus between the expenditure and the derivation of income from the taxpayer’s income-earning process, and that taxpayers must look at what the land was used for in the period that the expenditure is incurred. Consequently, holding costs will only be treated as deductible to the extent that there is income-earning use of the land. It is further noted that income-earning use can comprise holding the land for the purpose of resale or deriving rental income, but specifically excludes holding the land on capital account, even if it is taxable under the bright-line provisions.

The statement also clarifies that if there is both private use and income-earning use of the land, then holding costs will need to be apportioned. In the first instance, attention should be given to whether the mixed-use asset regime applies, in which case specific rules must be followed. Otherwise, general principles should apply, such as a time-based or space-based apportionment. To complicate things further, the interest limitation rules and the residential ring-fencing rules may also need to be considered.

Given the increasing scrutiny and tightening of legislation on residential property in recent years, Inland Revenue’s stance is somewhat unsurprising. However, for those who feel strongly on this topic, consultations are open until 31 May 2023.

Environmental correctness

The call for action regarding climate change and mitigating man’s negative impact on the planet is not new. However, there has been a shift in the last few years. It has moved from being a focus of ‘greenies’ and the ‘young’ to being accepted by the mainstream population as something that can no longer be ignored. It has evolved into a broader attitude encompassing Environmental, Social and Governance (ESG) issues. With it has come an expectation and pressure from all stakeholders - customers/clients, shareholders and employees alike – for businesses to prove they are taking ESG seriously and what actions they are taking.

It’s no secret that businesses have a large impact on the world's environmental state. Reports have found that 100 companies are responsible for 71% of the world's greenhouse gas emissions. To reduce this negative perception, global companies are betting big with sustainability investments. For example, international oil company BP have reformed their business by forming an ‘integrated energy company’ with a goal to reach net zero carbon emissions by 2050. They have created actional steps including developing offshore wind projects with capacity to power 5 million homes.

Realistic sustainable processes will vary depending on the nature and size of a business’ operations. Focus could start on the four low-hanging fruit of a company's operation - energy, water, material, and waste. Implementing change to reduce these elements not only addresses ESG expectations but can lower operational costs, as well as yield potential increases in revenue. For example, remote working has grown in popularity since COVID-19, and it has become an employee’s expectation that an employer will provide some form of flexible working. This offering is great for the environment, as fewer cars on the road equates to less carbon dioxide being emitted into the air. For paper items commonly used in the business place, look for materials made from post and pre consumer waste such as recycled products, which maintain a circular economy. There will be a portion of a business' carbon footprint that cannot be reduced through sustainable practices. For this portion, purchasing carbon offsets from carbon marketplaces can shift the needle to becoming carbon neutral.

Consumers are voting green with their wallets as they become educated about sustainability and ethical employment practices, causing buyers to reassess their purchasing habits. “Fast fashion” has become a well-known term – those who are lucky enough to afford it are doing their research about suppliers, to enable informed decisions when it comes to buying items such as clothes and shoes. People have become more willing to spend a bit extra for the peace of mind that they are not supporting unethical employment practices. In the same vein, existing and potential shareholders are increasingly scrutinizing a business’ non-financial results when making investment decisions.

While sustainability initiatives may not always deliver immediate benefits to the bottom line, a business that promotes environmental practices on the forefront of its business model may attract or retain clients and customers; while also connecting with its employees who value environmental sustainability at a personal level.

Trusts and distributions  (written pre the 18  May Budget)

Using a trust to manage and protect a family’s business and personal assets is common practice in New Zealand. However, the tax rules applicable to trusts also differ to that applicable to individuals and companies. With the top personal tax rate increasing to 39% from 1 April 2021 while the trust tax rate has remained at 33%, the differential provides a benefit in retaining income in a Trust to be taxed at 33%.

However, the nature of the trust’s activity, the assets held, the beneficiaries involved, and the costs incurred by the trust on behalf of its beneficiaries still need to be carefully managed. A common scenario is a trust being the sole shareholder of a company. A beneficiary of the Trust operates the company and pays themselves a salary. If the salary is intentionally set lower than market rates, with the remaining income of the company distributed to the trust in the form of a dividend, it could be deemed that a taxpayer has fixed the salary in an artificial manner to obtain a tax advantage and thereby is party to a tax avoidance arrangement.

Where taxable income derived by a trust is subsequently used to fund the lifestyle of beneficiaries there is a risk that IRD could take the view that the funds paid to the beneficiaries should be treated as taxable beneficiary distributions. When the top personal marginal tax rate and the trust rate was the same at 33%, there was no difference from a tax perspective and transactions were not subject to a high degree of review or scrutiny. Through this time, both trustees and their advisors may have taken a relaxed approach to how transactions were accounted for and documented. With income tax returns for the 31 March 2022 year now filed (by 31 March 2023), scrutiny by Inland Revenue is expected to increase, particularly if a beneficiary is subject to the top 39% tax rate.

If beneficiaries are reliant on dividend income that is derived by the trust, could Inland Revenue assert payment of the ‘dividends’ to the beneficiaries comprises taxable beneficiary income irrespective of the legal form of the payment. For example, if a trust owes a beneficiary $1m and a trust derives a dividend of $72,150 into its bank account and the same day that exact amount is paid to the lender – is it a loan repayment or the distribution of the dividend? If trustee resolutions reflect it is a loan repayment, will that suffice in the event of a review by Inland Revenue. What if there are no resolutions, what then? What if there is no loan to repay?

Issues like this have not been the subject of material scrutiny in recent years because the tax rates were aligned at 33%. But with the rates no longer aligned, care and due consideration must be applied to ensure tax outcomes are as expected and not open to challenge.

Snippets

Global tax rates

Inland Revenue made the headlines end of April 2023 with the release of its report on the amount of tax paid by our high-wealth individuals (HWIs). The findings were that HWIs’ overall effective tax rate when taking into account all sources of income, including unrealised capital gains, is 8.9%. The Treasury simultaneously released a number of reports which investigated the progressivity of New Zealand’s tax system. The Treasury found, using information from the Household Economic Survey, that an average middle-income New Zealander has an effective tax rate of more than double the HWI rate, at 20.2%.

When comparing these numbers at face value, it is no wonder the difference caused a reaction. However, without a comprehensive capital gains tax regime to tax the gains on sale of land and shares, the rate of 8.9% is not particularly surprising.

How do our tax rates compare to the rest of the world? Unfortunately, no other country has recently undertaken a similar exercise on the effective tax rate of HWIs, but it is possible to compare our other tax rates against the world’s heavy hitters:

  • Ivory Coast’s highest personal income tax rate (i.e. tax on an individual’s salary and wages) is an eye watering 60%. New Zealand’s top personal marginal tax rate increased from 33% to 39% from 1 April 2021.
  • The highest corporate tax rate goes to Puerto Rico, at 37.5% - higher than New Zealand’s corporate tax rate of 28%.
  • The highest sales tax is in Bhutan, at 50%. Our equivalent tax, GST, pales in comparison at 15%.
  • Denmark has the highest capital gains tax at a rate of 42%. At this point in time, New Zealand does not have a broad-based capital gains tax.

Proposed amendment to directors’ duty

One of the fundamental director’s duties within the NZ Companies Act 1993 (‘the Act’) is to act in good faith and in what the director believes to be the best interest of the company. This has traditionally been interpreted to mean decisions should be aimed at maximising shareholder returns. In September 2021, an amendment was proposed to make it clear that directors of companies can consider a wide variety of factors, such as:

  • recognising the principles of the Treaty of Waitangi (Te Tiriti o Waitangi),
  • reducing adverse environmental impacts,
  • upholding high standards of ethical behaviour,
  • following fair and equitable employment practices, and
  • recognising the interests of the wider community.

On 8 May 2023 the Select Committee recommended that the list above is not enacted, but instead replaced with the following: 

“To avoid doubt, in considering the best interest of a company or a holding company for the purpose of this section, a director may consider matters other than the maximisation of profit”

This addresses submitters’ concerns that the original drafting of the bill may create inconsistencies within the Act, as well as confuse directors about their responsibilities. Further, some submitters felt that the law already allows a director to consider non-financial factors when deciding the best interest of a company.

We will wait to see what is ultimately enacted.

If you have any questions about the newsletter items, please contact us, we are here to help.

Labour shortages

A new year’s resolution to grow your business is likely to require growing your team. It’s fair to say that the labour market is tight at the moment and seems to be getting tighter with each passing month. Recruitment for staff is taking much longer, with a reduction in both the number and skills of applicants. What is driving it? Is it a NZ issue only, or is there a wider global issue at play?

An obvious observation is the closure of our borders for over two years which prevented international employees from entering the NZ labour market. The hospitality industry in particular has been feeling the impact of this over the past year. Not being able to draw upon the pool of individuals travelling around New Zealand to experience their “OE” has meant it is rare to not see a “short of staff, please be patient” sign when dining out. The re-opening of our borders in mid-2022 has had the equal and opposite impact, with some skilled New Zealanders finally able to take steps to move and work overseas, thereby reducing the labour pool.

In an attempt to attract high-skilled workers from overseas for the long term, NZ’s “Green List” (previously known as the skills shortage list) was significantly expanded in December 2022. Roles added to the “straight to residence” tier include registered nurses and midwives from 15 December 2022, and registered auditors from March 2023, with secondary and primary school teachers being added to the “work to residence” tier from March 2023.

Another theory is that we have an overreliance on labour trained overseas, and that employers are reluctant to invest in the education of migrant workers to ensure they are ready for the NZ workforce, which means, often, they leave. This theory suggests that NZ’s labour shortages predate the pandemic, and that underlying fundamental changes need to occur in the way employers treat migrant employees in order to see any improvements.

Another popular suggestion is that we are currently undergoing a structural change in our employment demographic with a “retiring population”, which sped up due to the pandemic. Due to the various lockdowns and challenging work environments in recent years, experienced employees who had intended on working for several more years instead decided to retire early. In America, there are around 3.5 million fewer people in the job market compared to pre-pandemic, of which, 2 million has been attributed to this unexpected surge in retirements.

As the labour shortage lingers, employers will either need to think of creative ways to firstly attract and then retain valuable staff members, or decide whether they have no choice but to either pivot and automate a particular role or simply discontinue it.

Residential property – A class of its own

Despite recent reductions in property prices, there is little doubt that the passion New Zealanders have for investing in residential property will survive. However, the tax treatment of residential rental investments has increasingly become a tangled web of complexity due to changes in legislation over the past few years.

It used to be that ‘mum and dad’ would setup a look through company, purchase the property, all expenses would be claimed (including interest and depreciation) and the loss would offset against other income and be ‘exchanged’ for a tax refund. Years down the track when the property was sold, the profit was a non-taxable capital gain. Simple.

Roll forward to today and:

  • Excess tax losses are ‘ring-fenced’, carried forward, able to be offset against future rental income and offset against taxable income arising from the disposal of a residential property.
  • Depreciation is no longer able to be claimed on residential rental properties, even though it was re-introduced for commercial properties.
  • Interest on debt incurred to purchase a residential rental property prior to 27 March 2021 is currently being phased out. If a property is purchased on or after 27 March 2021, interest is non-deductible from 1 October 2021. However, if the property qualifies as a new build, interest remains deductible. The cost of increasing interest rates is being exacerbated by this change because a tax deduction would have otherwise been able to be claimed.
  • Finally, the ‘capital gain’ on sale may also be taxed under the brightline rule. This itself has been extended from an initial 2 year period, to 5 years and is now 10 years, while new builds remain under a 5 year period. This creates the need to not only examine the date of acquisition and sale to quantify the ownership period, but also work out which bright line period actually applies.
  • Where a tax loss on disposal is incurred within an applicable brightline period, it must be carried forward and can only be offset against income from future taxable land disposals.

A cynical person might suggest the next change will be to prohibit a deduction for accounting and legal fees incurred to navigate the rules.

The changes have altered the residential property landscape, placing residential properties into their own category by virtue of their tax treatment. It is now common for landlords to have an income tax liability, even though the property has not made a profit. Whether these changes have fed into the current challenges facing the residential construction sector is unclear, but it is unlikely that they have helped.

IRD - Whether a subdivision was subject to income tax and GST

In November 2022 Inland Revenue issued TDS 22/21, a Technical Decision Summary on whether the profit from a subdivision was subject to income tax and GST.

TDS 22/21 covered a dispute involving a subdivision by the taxpayer of land into two lots. The taxpayer had acquired the property for the purpose of renovating and expanding it to live in with extended family. The taxpayer and extended family moved in,
but after commencing renovation plans found that the existing dwelling had serious issues with drainage and asbestos.

As a result, the taxpayer decided to demolish the existing dwelling, subdivide the land into two lots and construct two new dwellings (‘House A’ and ‘House B’). While the subdivision took place the family moved into a rental and subsequently moved into ‘House A’ when it was constructed.  ‘House B’ was sold shortly after construction to a third party.

When determining whether a gain on disposal of land is subject to income tax, various land taxing provisions must be considered. If the taxing provisions don’t apply, or a specific exclusion to a taxing provision applies, then the gain should not be taxable.

Inland Revenue’s Customer & Compliance Services (CCS) team took the view that the following sections applied to tax the gain on sale of House B:

  • The taxpayer entered into an undertaking or scheme for the dominate purpose of making a profit (section CB 3).
  • The taxpayer acquired the property for a purpose or with an intention of disposing it (section CB 6).
  • The disposal was a more than minor scheme for development or division begun within 10 years of acquisition (section CB 12) and the residential land exclusion (section CB 17) did not apply.

The CCS team also argued that a taxable activity was carried out and the sale should be subject to GST.

The Tax Counsel Office (TCO) disagreed with these assertions, predominately due to the taxpayer’s intentions at the time of acquiring the property. As the property was acquired for the sole purpose of housing the taxpayer and their family members, the taxpayer had no intention of disposing of the property or making a profit at the time of acquisition and therefore both sections CB 3 and CB 6 did not apply.

Given the land was occupied mainly as residential land by the taxpayer and their family members before it was subdivided, the TCO found that the residential exclusion under section CB 17 was available to exclude CB 12 from applying. There was specific contention on the application of this exclusion, but it was noted that the exclusion is based on the taxpayer’s intended use of the land, and that, under this exclusion, there is no requirement for the taxpayer to reside on the land for more than 50% of the time of ownership – it is not a time-based test.

The TCO also found that the sale was not subject to GST on the basis that it was a ‘one-off’ activity, and did not constitute a ‘continuous or regular’ activity – one of the requirements to be subject to GST.

In this case we are left with the question, why did Inland Revenue enter into a dispute with the taxpayers at all? Based on the facts of the case it appears clear that neither income tax nor GST should apply. However, it’s good to see that the Tax Counsel Office, which itself is part of Inland Revenue, and made the decision, got to the right answer in the end.

Provisional Tax regime

In New Zealand the provisional tax regime is designed to help taxpayers manage their income tax obligations, by requiring certain taxpayers to pay tax in instalments throughout the year, instead of one large lump sum at the end of the year. This regime applies to taxpayers who have residual income tax (RIT) of greater than $5,000 in a tax year – RIT is the amount of income tax payable by a taxpayer after deducting tax credits (e.g. RWT, PAYE).

A provisional taxpayer has four different options available when determining the amount to pay at each instalment:

  1. Standard uplift – based on the previous year’s RIT + 5%. Where the prior year tax return has not been filed, the payment will be based on RIT from two years ago + 10%.
  2. Estimation – this option allows you to estimate what tax you think you should pay. This is often used where income is expected to be less than the prior year.
  3. Ratio – payments are calculated as a percentage of GST taxable supplies.
  4. AIM (Accounting Income Method) – payments are calculated through accounting software, which allows smaller amounts to be paid more frequently.

Where a taxpayer fails to meet their provisional tax obligations, they will be subject to interest and penalties on any underpaid tax. The current interest rate applying from 17 January 2023 is 9.21% on underpaid tax.

The provisional tax regime has been subject to several concessional changes over the past 10 years, for example:

  • As a result of COVID-19, the RIT threshold increased from $2,500 to $5,000, thereby reducing the number of taxpayers subject to the provisional tax regime. 
  • Where a taxpayer’s RIT is less than $60,000, and the amount of provisional tax paid during the year using the standard uplift method results in a shortfall, they will be not be charged interest or penalties provided the shortfall is paid by terminal tax date.
  • Where a taxpayer’s RIT is $60,000 or more, and
    they have paid provisional tax using the standard uplift method, they will only be charged interest from the final provisional tax instalment date. Historically interest and penalties could apply from each instalment date, even if a taxpayer had used the standard uplift method.

One other option that should not be overlooked is to use a tax pooling intermediary to manage provisional tax obligations. Tax pooling is a mechanism by which tax credits effective at a historic date can be purchased from another taxpayer at an interest rate that is less than what Inland Revenue charge.

Between the above concessionary changes enacted over recent years and the option of using tax pooling, the days of incurring large interest and penalty charges with Inland Revenue are in the past.

Snippets

Private school donations

Private schools will typically be registered as a charity. As such, parents will sometimes treat payments to the school as a charitable donation for tax purposes.

Inland Revenue are making it clear on its interpretation on this subject through the release in October 2022 of QB 22/09 – Income Tax – Payments made by parents to private schools and donation tax credits; which may impact the approach taken by some parents.

In summary, payments will qualify as a “gift” for donation tax credit purposes when all of the following apply:

  • the school is a donee organisation;
  • the payment is money of $5 or more;
  • the parent makes the payment voluntarily to benefit the school either generally or for a specific purpose or project; and
  • the parent or child gains no material benefit or advantage in return for making the payment.

QB 22/09 includes the below examples which Inland Revenue assert will not be eligible for a donation tax credit:

  • A “donation” which results in a discount on tuition fees, or the payer’s business being advertised in a school publication.
  • Contributions requested by the school with reference to its operating costs, number of students and each family’s circumstances.
  • A donation of a non-cash prize for the school to use in a fundraising auction.
  • The purchase of a ticket for a school event (e.g. quiz night), where part of the ticket proceeds will go towards a school project.

It would be wise to assume the circumstances surrounding a payment to a school will be reviewed by Inland Revenue if it is claimed as a charitable donation. 

Marginal tax rates

In New Zealand, a marginal tax rate system is used to tax an individual’s income, i.e. the tax rate increases as one’s income increases. As at today, the marginal tax rates are as follows:

Taxable income bracketApplicable tax rate
$0 to $14,00010.5%
$14,001 to $48,00017.5%
$48,001 to $70,00030%
$70,001 to $180,00033%
> $180,00039%

The first three thresholds have not changed since 1 October 2010, while the current top tax rate of 39% has applied from the 2021 / 2022 year.

With the rate of wage inflation being a hot topic at the moment, and a general election due later this year, we adjusted the marginal tax rates for inflation since October 2010 to see what they would look like – particularly given this is an election promise that might be made. The marginal tax thresholds would look something along the lines of:

Taxable income bracketApplicable tax rate
$0 to $21,00010.5%
$21,001 to $72,00017.5%
$72,001 to $105,00030%
$105,001 to $200,00033%
> $200,000 *39%

* Inflation adjustment since the rate introduced in April 2021.

The average salary in New Zealand is around $62,000. Under the current marginal tax rates, this results in $11,620 of income tax payable. However, applying the adjusted rates above, $9,380 would be payable – a difference of over $2,000. For someone on a $100,000 salary, the difference in annual tax payable between the thresholds is almost $4,400 a year.

If you have any questions about the newsletter items, please contact us, we are here to help.

Women with thumbs up

Retained earnings and imputation credits

A company is sometimes referred to as an interim taxing vehicle because the income of a company is first taxed when derived, but then taxed again when distributed to its shareholders. The benefit of the tax paid by a company is captured as imputation credits and able to be attached to dividends.

Ensuring that the amount of a company’s imputation credits is in-line with its retained earnings is akin to good housekeeping, and if the two are materially misaligned the reason should be known. This can happen for all sorts of reasons.

For example, take a company with $100,000 of net income, but $50,000 of non-deductible legal expenses. Because the legal fees are non-deductible, additional income tax of $14,000 is paid. If a fully imputed dividend were declared, the company should be left with imputation credits of $14,000, i.e. the imputation credits are of no value. In the absence of knowing why the ‘spare’ imputation credits arose, there is a risk that an overstated dividend would have been declared to utilise them all.This scenario is better than the contrary – a company left retained earnings and no imputation credits to attach to a dividend, AKA “unimputed retained earnings”.

The reason why this is so important is that when a company is wound up and its assets are distributed, its assets progressively fall into one of three categories, each with its own tax treatment, as follows:

  1. Available Subscribed Capital (ASC) – represents a company’s paid-up share capital and can be distributed tax-free to shareholders on liquidation.
  2. Capital gain amounts – are generally able to be distributed tax-free to shareholders.
  3. Remaining funds – to the extent that the distribution exceeds ASC and capital gain amounts, the balance comprises a taxable dividend. This is typically a company’s trading profits.

If insufficient imputation credits exist to attach to the remaining funds a comparatively higher tax liability will arise. This makes it very important to accurately record the income of a company, delineating between capital gains versus ordinary trading income. If non-taxable capital gains (e.g. gains on the sale of property, plant, equipment, shares etc) are accidentally recorded as retained earnings, the tax liability on wind up could be exaggerated. Step one is to ensure a separate capital gain account sits within the company’s trial balance, making it easy to distinguish between the two.

Earlier this year Inland Revenue released a discussion document regarding dividend integrity and personal services income attribution. It explores the fact that calculating ASC and capital gain amounts can be complex, and companies that don’t have sufficient records to substantiate the two do not satisfy their burden of proof.

The release of this document further emphasises the importance of undertaking annual imputation credit to retained earnings reconciliations to ensure any variance is explainable, and maintaining separate equity accounts to separate non-taxable capital gains from normal business profits.

A small amount of work each year, could pay dividends in the long run.

Update - GST on farmhouses and holiday homes

In 2017 Inland Revenue released an Interpretation Statement, IS 17/02, which formalised the long-standing practice of allowing a farmer to claim a portion of their farmhouse expenditure on the basis it is the “headquarters” of the farm. But then in 2020 Interpretation Statement IS 20/05 was released by Inland Revenue which overthrew the common practice of treating the farmhouse as not subject to GST. It concluded that, where a person has claimed a portion of house expenditure for income tax purposes, this demonstrates that the house has been used to make taxable supplies, and therefore a sale of that house would be subject to GST. Because the farmhouse is technically deemed to be a separate supply from the farmland meant that most farmhouses do not qualify for zero-rating, and hence GST becomes payable at 15%. This outcome has given rise to uncertainty and confusion.

The Taxation (Annual Rates for 2022-23, Platform Economy, and Remedial Matters) Bill (“the Bill”) first introduced on 30 August 2022 includes a welcome proposal to resolve the issue. The legislation is to be amended to enable registered persons to elect to treat the sale or disposal of goods (including land) as an exempt supply where the goods have a minor amount of use in making taxable supplies. The exemption is limited to tangible assets (e.g. land, dwellings, vehicles). From a practical perspective, the amendment will also enable assets such as a high-value Air BnB, or a residential house with a home office or workshop to be excluded from the GST net.

To qualify as an exempt supply under the proposed rule, the asset would have to satisfy the following requirements:

  • No previous GST deductions have been claimed on the asset by the person.
  • The asset was not acquired or used for the principal purpose of making taxable supplies.
  • The asset was not acquired as a zero-rated supply under the compulsory zero-rating of land rules.

These requirements are all quite reasonable in a farmhouse, home office and bach scenario. The proposal would generally apply retrospectively, from 1 April 2011, and the commentary to the Bill confirms that:

  • If a registered person had previously taken a tax position consistent with the requirements of the proposed new section, this tax position would become correct once the Bill is enacted.
  • In cases where an assessment has already been made for a taxable supply before the date of introduction of the Bill, that is, the registered person has returned output tax on goods they sold or disposed of before that date, the supply of those goods would remain a taxable supply.

Hence, there is no relief for taxpayers who have followed the conclusions in IS 20/05 and returned GST on their mainly private assets.

Travelling in a train

FBT updates

On 29 August 2022 Inland Revenue released a 49-page report: “Fringe benefit tax: regulatory stewardship review”, which reports the summary, findings and recommendations of a review of New Zealand’s current Fringe Benefit Tax (FBT) regime – a regime whose design and operation has not been subject to a full review for nearly 20 years.

The report found that although FBT is performing its task of taxing non-cash benefits and hence supports the tax system as a whole, it was inconclusive as to whether FBT functions well. Consistent feedback received from interviewees was that the tax is complex and imposes a high administrative and compliance burden on taxpayers relative to the amount of tax that is payable.

Further, inequity concerns were also raised around inconsistency with compliance of the regime by all businesses, and the lack of enforcement of non-compliance by Inland Revenue. The report recommended FBT should be included in a future policy work programme to enable a full consultation process to occur which could be approached in one of three ways:

  1. A fundamental reform that considers whether what is subject to FBT versus PAYE should be re-aligned and / or re-establishing the scope of FBT to better target benefits that relate to remuneration of employees.
  2. A targeted review of specific items, such as motor vehicles, business tools and the “on premises” exemption (in light of the growth of flexible and agile working practices).
  3. A remedial project focussed on updating thresholds and de minimis amounts.

On the same topic of FBT, in line with a recommendation made by the 2017 Tax Working Group, the recent tax bill first released on 30 August 2022 includes a proposal to exempt from FBT certain public transport fares that an employer subsidises mainly for the purpose of an employee travelling between their home and place of work.

Under current legislation, contributions an employer makes to an employee’s public transport costs for travel between home and the workplace (e.g. by way of voucher or use of business credit card) are classified as unclassified fringe benefits, and as such, FBT is payable on such contributions unless the amounts are less than certain quarterly and annual thresholds.

In contrast, employer-owned carparks which are provided to employees are generally exempt from FBT due to the application of the “on-premise” exemption. Given the cost of CBD carparks can be significant, this differentiating treatment could result in businesses being incentivised to encourage the use of one transport mode over another.

The proposal in its current form lists specific public transport modes where the exemption would be available, namely: bus, train, ferry, tram or cable car. The bill commentary specifically states that other transport modes such as air transport, taxis, shuttles and other services (such as bike-sharing, ridesharing and e-scooter hire) would not be covered by the exemption.

The alignment in this proposal is intended to produce a more neutral FBT outcome between the options of travelling to and from work by car and travelling by more environmentally friendly modes of public transport, hence should generally be positively received by employers. However, for the FBT cynics out there, the prescriptive list of eligible public transport modes in the draft legislation may result in further administrative headaches. A review of the entire system cannot come soon enough.

Eftpos purchase at market

GST 101

New Zealand’s Goods and Services Tax (GST) system is often praised for being a simple broad-based tax. But this doesn’t mean mistakes don’t happen. Going back to basics, if you carry out a taxable activity in New Zealand and your turnover is more than $60,000 in a 12-month period, you are required to register for GST. ‘Taxable activity’ is generally defined as an activity which is carried on continuously or regularly by any person, and involves the supply of goods and services to another person for consideration.

In general, GST should be charged on most taxable supplies. However, some goods and services are either zero-rated or exempt. Common exempt supplies include renting a residential dwelling and providing financial services, while exported goods/services and land transactions between GST registered persons are examples of zero-rated supplies. For most other goods and services, GST should be charged on the sale.

GST can be claimed on goods and services that are purchased for use in your taxable activity. This means there must be a connection between the taxable supply produced and the good/service a claim is being made on.

A GST claim can only be made to the extent that the goods and services are used to make a taxable supply, i.e. a supply to which GST applies, including a supply that is zero-rated. As a result, GST-registered taxpayers should be mindful as to whether the good/service they are producing or purchasing is an “exempt” supply or a taxable supply. Furthermore, no GST claim can be made for personal expenditure, as personal expenditure is not connected to a taxable supply. Take for example a company that has both a commercial investment property and a residential investment property. The supply of residential rental accommodation comprises an exempt supply. Because the company is simultaneously carrying on both a taxable and exempt activity, care needs to be taken to ensure GST is not claimed on expenses relating to the exempt activity, such as GST on the rates and insurance relating to the residential rental.

Where there is an element of both business and exempt use of an asset, the GST claimed on purchase should be apportioned based on the estimated business use. For example, where a phone is purchased in the business, an estimation should be made as how much it will be used privately, and the GST claim should be adjusted accordingly.

Examples of instances where GST is incorrectly claimed include payments for loan/mortgage principal, interest, personal drawings, construction of residential dwellings that will be held long-term as rentals, and wages.

On the other hand, a common missed opportunity is where a GST-registered person purchases a second-hand good from a non-GST-registered person for use in their taxable activity. In this scenario, a GST credit is claimable by the purchaser, even though GST was not charged by the vendor – e.g. the purchase of a business motor vehicle off TradeMe.

Even though it is called simple and broad based, having your GST returns periodically independently reviewed is a good idea.

Key in letterbox

IRD and close relationship transfers

Inland Revenue recently issued a draft interpretation statement regarding bright-line and its application to certain family and close relationship transactions. The publication relates to the 5-year bright line test for residential land purchased between 29 March 2018 and 26 March 2021, with a subsequent publication to be issued for the 10-year test applying from 27 March 2021. However, the expectation is that the conclusions reached will remain unchanged.

In essence, the publication confirms that no additional roll-over relief will be provided for close relationship transfers. Where there is a legal change in ownership taking place within the bright-line period, the sale will be taxable to the person disposing of it. Furthermore, all family and close relationship transactions that occur at below market value are deemed to have been transferred at market value. This may give rise to situations where tax is payable on an amount of income that was not actually received by the recipient. For example, where parents dispose of residential land to their child within the bright-line period, the sale will be taxable to the parents based on the market value of the land, regardless of how much the child paid for it.

Similarly, where a person wholly-owns land and wishes to become co-owners with their partner, a sale within the bright-line period is taxable but only to the extent that the land is changing ownership i.e. no tax is payable on the share held by the original owner. As a result, parents wishing to assist their children with buying residential property should carefully consider the ownership structure and alternate options before settlement – for example, could a loan be provided instead, or should nominee/bare trustee legal documentation be executed prior the original purchase to reflect the nature of the arrangement?

lollies

Is it confectionary or ingredient?

Here in New Zealand, we value simplicity and we call things as we see them. A spade’s a spade and a marshmallow is confectionary. However, over in the UK, things are a bit more complicated. Value Added Tax (VAT) is charged on goods and services (like GST is in NZ) but is subject to a number of fiddly and somewhat subjective exemptions. For example, supplies of food used for cooking are zero-rated, meaning no VAT is charged on these products. On the other hand, confectionary is subject to VAT at the standard rate, except for cakes and non-chocolate covered biscuits, which remain zero-rated. Clear as mud so far, right?

Innovative Bites Limited (IBL) is a UK supplier, distributor and wholesaler of candy. One of their products is called a ‘Mega Marshmallow’, a large marshmallow measuring 5cm x 4.5cm. According to the wholesaler, the product is supposed to be roasted over a fire, or put between two biscuits to make a s’more. Between 2015 and 2019 IBL sold these marshmallows with no VAT, on the assumption that their intended use fell within the “food used for cooking” exemption.

After being told they owed £470,000 in VAT, IBL appealed to the tax tribunal, asserting that their marshmallows were not confectionary as they were supposed to be consumed with other foods, or cooked before eating. When taking into account the packaging, the size of the product and where it was positioned in the supermarket aisle, the tribunal eventually agreed that the marshmallows were in fact not confectionary. In his conclusion, the judge stated that if a consumer wanted to eat marshmallows as a snack, they would likely eat smaller, regular ones.

Christmas / New Year Trading Hours

Office closes: 12pm Friday 23rd December

Re-open : 8.30am Monday 9th January

All the team at Biztax wish you and your family a Merry Christmas with good health and safe travels over the holiday season.

Short process rulings

It is inevitable that at some stage a person will undertake a transaction where the applicable tax treatment is complex or unclear. This could be due to a complex factual scenario, new legislation, new Inland Revenue commentary, or the existence of complex or poorly drafted legislation.

An option to mitigate risk and acquire certainty is to apply to Inland Revenue for a ruling in which Inland Revenue agrees, on a binding basis, how the law will apply to a specific situation. There are a few different types of rulings. Prior to 1 October 2019, businesses would typically apply for a private binding ruling. However, with an Inland Revenue cost of around $10k - $20k (depending on the issue), plus advisor fees to prepare the application they are more commonly acquired by large businesses or wealthy individuals and involve large tax amounts.

This changed from 1 October 2019 when the ‘short-process ruling’ was introduced – these make for an interesting proposition. Inland Revenue charge a set amount of $2,000 for a short process ruling. This makes the cost very reasonable and in some cases could be less than what a tax advisor would charge to advise that a matter is unclear.

A key question in recent months has been how long interest deductions will last for new builds. As per the draft legislation, interest on new builds will remain deductible for 20 years from the issue date of the CCC. Furthermore, interest will remain deductible for subsequent owners throughout the 20-year period, abandoning the potential requirement of being an ‘early owner’ outlined in the June discussion document.

There are eligibility criteria to satisfy:

  • The applicant must have an annual gross income of less than $20m.
  • If the applicant is a company, that is a member of a group of companies, the gross turnover of the group must be less than $20m.
  • The tax involved in relation to the subject of the short-process ruling must be less than $1m.

There will also be the cost of preparing the application and responding to any questions Inland Revenue raise as they work through the matter. But overall, the cost and the process is not onerous.

This only leaves the question of whether to apply for a short process ruling. There are both strategic and emotional elements to this question.

If the question is whether a tax deduction is available for a particular expense, a person has the option of taking the deduction anyway, knowing it is unclear, and knowing Inland Revenue may challenge it if they identify it. That is an ordinary commercial decision. However, a short process ruling application may be successful and will provide peace of mind that the deduction can be claimed and cannot be challenged later. The downside though, is that if Inland Revenue take a conservative view of the law they may decide the tax deduction is not available. Now in that scenario a person could withdraw the ruling and take the deduction anyway, but the deduction is being taken with the knowledge that Inland Revenue disagree and there may be a greater risk of review by virtue of the short process ruling being applied for in the first place.

Notwithstanding the pros and cons of applying for a short process ruling, they provide a very cost effective way to resolve uncertainty and should always be considered an option.

Inflation pricing pressures and consumer engagement

From initial fears of a prolonged economic slump due to Covid-19, the global economy has seen a resurgence led by unprecedented demand. To experience such strong activity following months of lock-down where key industries cut back on activity to reduce costs, a backlog has been created such that global supply chains may take years to catch-up. Coupled with skill shortages across all industries, the past 12 months have seen inflationary pressures reach a new high for the 21st century.

Faced with increasing input costs, businesses have had little choice but to pass these costs on to consumers. Price increases are however an uncomfortable conversation in all business settings. How much of this cost can the business assume? How will consumers react? What are our competitors doing? These are just some of the questions to cause a headache. Moreover, with the power of social media, consumers can have more of a say on price surges than ever before. Hence, the reaction of consumers and the impact on business reputation can have long term consequences if changes are not communicated clearly.

Considering the consumer reaction to price rises, businesses must evaluate how the long-term impact on customer relationships will be managed. With the increased emphasis on environmental, ethical, and social factors impacting a consumers decision making process, society values transparency and businesses who maintain a strong dialogue with the community in which they operate. An open dialogue explaining the reason why prices are increasing will more likely assist with a consumer associating themselves strongly with the business and made to feel an integral part of its success. In a volatile market, poor communication poses the greatest risk to a customer switching to a competitor. Not having the opportunity to consider or discuss upcoming changes can create a shock to consumers which can harm the relationship.

Disruption historically leads to innovation. Inflationary pressures encourage consumers to seek alternative solutions. Businesses must either provide these alternatives or risk consumers going elsewhere. Hence, although the current environment is challenging, investment into technology and new skills is more crucial than ever.

Businesses that can innovate and increase the value proposition are in turn more likely to establish a customer base which will not get deterred by price, and instead focus on the value being delivered. Value based pricing could enable businesses to shift the focus from inflation to future growth.

Tax due diligence when buying or selling

The summer break is a time for reflection on the year that has been. For business owners, this break is an opportunity to evaluate their future strategy and consider whether it is time to exit, or conversely, grow by purchasing someone else’s business. Whether buying or selling, it is a demanding exercise.

A business sale can either be in the form of a share sale, where the shares in the company that owns the business are transferred, or an asset sale, where the underlying assets of the business are transferred. If the transaction is by share sale, the purchaser takes on the past risks and obligations of the target company. It is therefore important to understand if there are any ‘skeletons in the closet’. This risk is mitigated by undertaking ‘due diligence’. This same risk does not arise in an asset sale, because the vendor’s ‘history’ is not transferred to the purchaser.

For the vendor, due diligence might subject the business to a level of scrutiny not experienced before. For the purchaser, a large volume of information may be presented and it will be important to remain focussed on information that is material and relevant.

From a tax perspective, due diligence is aimed at confirming whether the target company has satisfied its historic tax obligations and therefore no risks exist that a tax liability might arise in relation to a period prior to the change of ownership. There is both a qualitative and quantitative element to this process.

The tax return filing history will be reviewed to confirm that there are no outstanding returns and to what extent past returns have been filed on time. Not just income tax returns, but also GST, FBT, PAYE, etc. Past tax advice will be requested and reviewed to determine whether the positions taken are correct and reasonable. The general business profile will be reviewed to identify what tax adjustments need to be made and this will be cross checked against the tax position taken to ensure there is alignment.

Common risk areas will be reviewed, for example a business that engages contractors may be scrutinised to ensure these individuals are not actually employees. The treatment of Covid subsidies could also be reviewed. Has non-deductible capital expenditure been identified and adjusted. Does the target have a large number of vehicles on its fixed asset register, if yes, how have they been treated for FBT purposes… the list goes on.

Generally, Inland Revenue is able to reassess a tax return if it was filed in the past four to five years (the time bar period). Hence, due diligence is typically undertaken on the four most recently filed tax return periods.

Finally, the qualitative element comes into play. The team performing the due diligence will form a view of the target company’s approach to tax compliance based on what they have seen. For example, if a company files its income tax returns late, does not use an external accountant and does not seek advice on material transactions, a negative view will form.

This, along with other issues identified, may ultimately lead to more comprehensive warranties and indemnities, a portion of the sales price being placed in escrow or, at the extreme, a reduced price for the business.

Broader effects of Covid-19

Over the last two years most of us have had to deal with working from home in some way, shape or form, and for those who are parents, added difficulties arose with trying to entertain and educate children whilst also fulfilling employment duties.

Employers have helped employees as much as possible, in some cases providing specific time to deal with home pressures with no impact on the employee’s income. But after initially focussing on continuing to work and operate during lockdowns, emphasis has increasingly started to shift to how Covid-19 has impacted children and the broader family unit.

Globally, children have had to live through an average of six months of required and recommended nationwide lockdowns since early 2020 when the Covid-19 pandemic began. Venezuelan children have had to endure one of the longest periods, with intermittent lockdowns preventing children from attending school for up to 16 months. Although New Zealand schools were not closed for this length of time, it would be naïve to think that the months spent at home away from friends and routine during our level 3 and 4 lockdowns have not had an impact.

A survey was undertaken in May 2020 involving nearly 2,500 10 and 11 year-old New Zealand children. On a positive note, eight in ten children reported very good to excellent health. Nearly 80% reported having a good time with their family in lockdown. Children living in a larger bubble (six or more people) during Alert Level 4 were more likely to experience better health and wellbeing. However, mental health was impacted with around 40% of children showing symptoms of depression and anxiety, due to reasons such as concern about their family’s financial situation. Māori and Pacific children recorded lower depression and anxiety, which was attributed to greater family connection.

An Argentinian study undertaken in mid-2020 found that 62% of the participants showed sleep disorders, girls more than boys, with the percentage increasing with age. The majority of the children (62.4%) spent less than 30 minutes a day reading, and 36.2% spent less than 30 minutes a day undertaking physical activity. Most of the children communicated with their friends/family outside of the household at least once a day via WhatsApp (65.5%), social media (32.2%), or online gaming (38.1%), and this percentage increased with age. Social media was used by 14.1% of the children and 19.5% played online games constantly or on-and-off throughout the day, especially boys. Almost half (47.1%) of the parents were worried about getting/transmitting Covid-19 and 27.9% were afraid to leave the house for essential activities such as work or essential shopping. Besides, 59.1% reported being worried about their children's screen time, and 68.4% found it stressful to keep children entertained during lockdown. Also, 16.6% of the parents felt lonely, 18.8% did not feel capable to help their child with school homework and 45.1% did not have time to play with their children.

A significant amount of research has been undertaken that generally suggests there has been a negative impact on children’s mental health. More research is needed to understand the long-term effects of the lockdowns, not just on mental health, but also development, learning, academic and eventually on future work-place behaviours. Perhaps today’s children will become known as Generation C.

Purchase price allocation

After undergoing over a year of consultation, the purchase price allocation legislation is now in effect.

At a high-level, the purpose of the legislation is to ensure vendors and purchasers allocate consistent prices to business assets for tax purposes when selling and buying assets.

For a vendor, the prices allocated will determine the extent to which taxable income might arise. For a purchaser, the purchase price allocation will determine the future tax profile of the items acquired, such as the depreciable cost base of fixed assets and the amount of the deduction for trading stock.

Prior to the legislation being introduced, parties could sometimes adopt different amounts giving rise to inconsistent treatment and loss of tax revenue to the government.

When introduced as draft in June 2020, the intended application date was for sale and purchase agreements entered into (conditional or unconditional) from 1 April 2021. However, due to the amount of time taken to consult on the draft legislation, the effective date was extended to 1 July 2021. This allowed more time for advisors and taxpayers to upskill themselves on the new rules, and to allow the Auckland District Law Society (ADSL) and Real Estate Institute of New Zealand to update their template sale and purchase forms.

Another change between the draft and final legislation was the introduction of a de minimis threshold for residential land – the rules do not apply to residential land and chattels where the total consideration is less than $7.5m. The draft legislation included no such provision, but during the consultation period it was acknowledged that the tax treatment of residential property (e.g. 0% depreciation rate for residential buildings) means there is much less scope for revenue manipulation than other transactions.

There are now three template ADLS addenda available for the sale and purchase of real estate, the sale and purchase of a business, and for real estate sales by tender to incorporate the purchase price allocation legislation. Such addenda are available for use and set out further terms and schedules addressing purchase price allocation to be attached to and form part of sale and purchase agreements entered into on or after 1 July 2021. However, they are not considered practicable for the sale of real estate by auction and mortgagee sale agreements.

The object of each addendum is for the parties to mutually agree a purchase price allocation before filing their respective tax returns. It also precludes either party from notifying an allocation to Inland Revenue without first agreeing it with the other party. The legislation otherwise gives the vendor the right to unilaterally determine a purchase price allocation that would bind the purchaser; hence the addendum provisions prescribe a more balanced process for the parties to reach mutual agreement, with the provision to obtain expert determination if need be.

In the Finance and Expenditure Committee’s final report, they recommend the new regime be kept under review, and for the Minister of Revenue to consider in the first twelve months whether the rules are working as intended and without unduly increasing the burden on taxpayers, with any necessary adjustments to be proposed promptly. Hence, we will watch this space to see if any significant amendments are made!

Snippets

Online reviews – what might they reveal

Engaging with customers is always important and in the current environment, online interaction with customers has become exponentially relevant. In a 2017 survey, 87% of people said that a business needed an online rating of at least 3 stars for them to use the business, and 84% trusted online reviews as much as a personal recommendation. The same survey reported that on average, one negative review can cost a business 30 customers.

However, sometimes online reviews are not always as they appear. A review by a Texas man on Speartip Security Services’s (‘Speartip’) Google page was made just days before multiple arrests were made.

The review read as follows: “Speartip is very professional and on top of it. They get the job done in an expedited time. Couldn’t imagine using anyone else!!” To which Speartip responded: “Thank you for the kind words. Always a pleasure working with you.”

Although the interaction appears innocent enough, the reviewer was apparently referring to assistance in helping orchestrate a double murder, involving the review writer’s former girlfriend and her current partner.

An individual who was also suspected of being involved with the murders had left a review on Speartip’s Google page eight months earlier, praising the business for being “very professional” and for responding quickly to their concerns and “immediately” covering their needs.

Next time you’re reading a customer review, there might actually be more than meets the eye.

Common error – claiming GST on FBT

For those of you who prepare and file FBT returns on behalf of a GST-registered employer, you will be familiar with the GST on FBT adjustment that forms part of the FBT return.

The adjustment itself is straight-forward and involves calculating GST on the gross taxable benefits that are subject to GST, and including this as part of the FBT payable. However, a very common misunderstanding is that this GST amount is then able to be claimed in the GST return.

A benefit provided to an employee (e.g. a Christmas Gift) is deemed to be a taxable supply for GST purposes (akin to a sale). The GST adjustment in the FBT return is the mechanism by which the GST on the deemed supply is paid to IRD. Another way to think of it – when the employer originally acquired the Christmas gift the GST was claimed on purchase. However, because the gift is consumed privately (i.e. not used in the business) the GST shouldn’t be claimed and the GST on FBT adjustment is the mechanism to reverse the original claim.

It is common to see the words “GST” and split the total FBT payable between the two taxes for coding purposes, resulting in the GST being re-claimed in the next GST return. But this is incorrect – it is akin to claiming GST on a sale.

On the 23rd March 2021 the Government announced that it would make a number of changes to the taxation of residential property to address the issue of increasing housing un- affordability. Legislation has been enacted implementing some of the announced changes, whilst the balance are to be consulted upon before further legislation is drafted.

Legislated changes - The bright-line test taxes the sale of residential property if it is sold within a prescribed period of time, subject to specific exclusions such as for the family home and farmland. The new legislation prescribes that a residential property acquired on or after 27 March 2021 will be subject to a 10 year bright line test, i.e. if it is disposed within 10 years of acquisition (generally the date a binding sale and purchase agreement is entered into) any capital gain will be subject to income tax. For transactions part way through completion as at 27 March 2021, guidance has been released by Inland Revenue to assist in determining whether the new 10-year period applies or not.

The exclusion for the ‘main home’ has also been modified. Under the old rules the bright-line test applied on an all or nothing basis, i.e. if the property was ‘predominantly’ a main home it was not taxable on sale. This exclusion has been amended. For property acquired from 27 March 2021, if the main home is not used as the owner’s main home for more than 12 months at a time during the bright-line period, the profit on sale will be partly taxable based on the period it was not a main home. If the property was purchased before 27 March 2021 the main home exclusion continues to apply on an all or nothing basis.

Changes to be implemented - Although legislation has been passed increasing the bright-line period to10 years, as outlined above, it has been proposed that the pre-existing period of five years will continue to apply to ‘new builds’. However, at this stage what comprises a new build has not been defined.

You are probably aware that Inland Revenue allow you until 7 April of the following year to pay the balance of tax owing – just over a year of credit. Further, if your Income Tax liability for the year is under $60,000 IRD do not charge interest on this tax deferral.

However, this is subject to some provisos and the important ones are that:

If these conditions are not met, the whole year’s tax is taken out of the “safe harbour” arrangement and the interest clock is started. The interest is not only charged on the late payment itself, but will be charged on the

Terminal Tax which would not have been subject to interest had the above conditions been adhered to. The practical effect is that you can pay interest which is well out of proportion to the actual amount, or time, of the late payment.

Fortunately there is a remedy. This is in the form of purchasing tax credits through a tax pooling intermediary. We use Tax Management NZ (TMNZ) for this purpose. This allows you to retrospectively purchase a tax credit at an earlier date. This is then fed into the IRD system at the due date and is treated as being paid on time, thus restoring the interest free status of the remaining tax.

There is some interest payable to TMNZ but it is typically around 4.50 % pa (lower than IRD interest) with no further fees charged by them.

The key to effective use of TMNZ is to contact us when a short (or late) payment situation has occurred so we can establish payment through TMNZ. Do not make the payment directly to IRD. If this is done the payment will be recorded as late, with the consequences as set out above.

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.

How can we help you today?

At Biztax we have the expertise and experience to deal with, and advise on, most business ownership options and their accounting and tax implications.

© 2011 - 2024 Biztax Chartered Accountants Limited
Duotone Design and Communication Limited
crossmenu