In this article the author examines some of the tax changes announced in this year's budget. This article will look at the headline announcements and at the changes that are more technical in nature.
The head line grabbing material was that income tax rates will drop and GST increase to 15%. The cuts in income tax rates are across the board. Interestingly 73% of New Zealanders have an income under $48,000 and hence the tax rate cuts in the two income tax bands up to $48,000 will positively affect the incomes of 73% of the population. These rate cuts will kick in from 1 October 2010.
The corporate tax rate will fall to 28% from 1 April 2011. This is a full 3 years ahead of the planned Australian corporate tax rate cut. This cut means that the goal of alignment of the top personal tax rate, the trustee tax rate and the corporate tax rate is still some way off being realised. The differentials in these rates have been a significant driver in the motivating avoidance behaviour in the community.
Successive governments have been shown graphs of the number of people earning particular amounts of income. Those graphs have in the past shown enormous spikes around the income levels that correlate with the top marginal tax rate. They graphs ought to show smooth curves of diminishing numbers of people earning higher and higher incomes. The fact that they did not implied that income had been structured so as to be earned through companies or trusts and hence avoid the application of the top marginal tax rate. While the gap remains it had been 8% so the effect of lowering both the top marginal tax rate for individuals and the corporate tax rate is that the gap has been reduced to 5%.
Practitioners will need to be alerted to consequential changes to things like the maximum imputation credit ratio that will apply to the attachment of imputation credits to dividends in this lower rate environment.
The change to the corporate tax rate has also necessitated a change to the top PIE tax rate. It too will fall to 28% again with effect from 1 October 2010. The lower PIE rates will change to align themselves with the lower marginal tax rates.
The cuts in personal and corporate income tax rates have been partially offset by an increase in the GST rate to 15%. That increase will take effect from 1 October 2010, the same date on which the personal income tax rates drop. A working group has been appointed to assist with the implementation of the new rate of GST.
There has been criticism of the raising of the GST rate. That criticism is based on the fact that lower income earners tend to spend most of their income and hence most of their income will be subject to the 15% GST. Conversely, the more well-off spend a lower percentage of their income and tend to save the rest. Saving is not a use of money that attracts the imposition of GST. Hence less of their money is spent paying the 15% GST. The countervailing argument is that by investing the money not spent on GST, jobs are created that benefits the whole of society.
One expects the pressure for a larger list of exceptions to the GST Act to build with the increase in rate. In Australia there are numerous exceptions which have led to the most unedifying litigation. For example there has recently been litigation over whether a Greek pita bread product was bread or a biscuit. A different rate would apply depending on the classification. It is hoped that the Government will stand firm against the cries for more exceptions in the area of food and the like. Giving in to such demands will erode the simplicity of the tax and complicate its administration. While such a move would be good for tax litigators, it would be a detrimental step for tax administration generally.
A change to the rate of GST has not happened for a long time. Some provisions of the GST Act that practitioners have not read for ages will be looked at again. In this regard s 78 deals inter alia with the effects of changing the rate of GST. It is applicable where there are contractual relationships, typically which are long term and which straddle the tax rate change. Some contracts explicitly provide for what will occur when the rate of GST changes but where the contract does not explicitly do so s 78 provides for how the change is to be managed.
Another example is s 78A which provides for the filing of returns when there is a rate change part way through a GST return period.
Moving progressively to the less headline grabbing aspects of the budget, the Government has moved to deal with rental properties but not in the draconian way that some had feared. What the Government has done is to remove the right to depreciate buildings with an estimated useful life of 50 years or more. Thus most owners of rental property will no longer be able to claim depreciation in relation to the building. This is a principled change. There had been speculation that there would more radical changes like ring fencing the losses of rental properties so that they could only be offset against the profits that the property generated. Other speculations were that there would be a land tax.
Inland Revenue retains the ability to decide whether a type of building has an estimated useful life of less than 50 years or not. It can be expected that at least in the area of specialist buildings requests will be made to Inland Revenue for classification that the building has a useful life of less than 50 years and hence can be depreciated. One expects a cottage industry in such applications to develop.
The next tier of detail is the changes to the Qualifying Companies (QC) and Loss Attributing Qualifying Companies (LAQCs). These regimes enabled closely held companies with 5 or fewer shareholders to be treated effectively as partnerships in the sense that the tax of LAQCs losses could be passed to the individual shareholders just as they would in the case of a partnership. The quid pro quo is that the shareholders have to agree to be personally liable for their share of the tax. The actual profits of the company are currently taxed at the 30% corporate tax rate. Imputation credits are attached to dividends and the shareholders are then taxed on those dividends at their marginal tax rate. Capital gains can be distributed tax free without the need for the company to be wound up as is the case with ordinary companies.
One effect of the LAQC aspect is that there is a disparity in that income is taxed to the company at the 30% corporate tax rate but the allocated losses are being used by the shareholders effectively at their marginal tax rate. Thus an LAQC loss can be worth 38 cents in the dollar in the sense of sheltering a high income earning shareholder but the income earned by the LAQC is taxed at only 30%.
To deal with this inequality of tax outcome the Government has with effect from 1 April 2011 made both the income and the expenses of the LAQC flow through to the shareholder. This means that the shareholders will now be taxed on their share of the profits at their marginal tax rate. To effect this LAQCs will be excluded from the definition of "company" in the Income Tax Act but be included in the definition of "partnership".
The implications flowing from this change in classification are first that, as mentioned above income and losses will pass through to the shareholders in proportion to their shareholding. Secondly, the rules that relate to the disposal of interests in partnerships will apply to the disposal of shares in QCs. Thirdly, the whole concept of dividends will not apply to QCs. Fourthly, the partnership rules that limit the amount of a loss that can be offset against other income to the extent of the shareholders' investment in the QC. Finally, a qualifying company will file a partnership tax return rather than a company tax return and the shareholders in the QC will include the allocated income and expenses in their own income tax return. This would seem to eliminate the difference between a QC and a LAQC.
There will be consequent tightening of the eligibility criteria for QC status. There will be only one class of share permitted. This is to staunch the practise of potentially streaming dividends to the shareholders best able to utilise any losses.
The changes to the depreciation of properties and to the QC and LAQC regimes are in part to prevent tax avoidance. A practice had developed of people with large assets or incomes in trusts claiming family support tax credits and the like in part because of the losses that were produced by rental property operations. Another anti avoidance measure is the steps announced with respect to what is colloquially known as "phoenix fraud".
That is a type of fraud that can occur particularly in the property development area. It involves a company buying land usually with 100% mortgage finance. Input tax credits are claimed on the land and the construction costs. The building is sold often to another company that the underlying developer is connected with. The selling price may be at market prices. The selling of the building triggers GST output tax. This output tax may be returned for GST purposes by the company but is often not paid. The entity is then wound up by Inland Revenue but there are no assets left to dispose of. Meanwhile the new company has claimed an input tax credit on the acquisition of the land from the former company and the cycle continues.
To combat this, transactions between registered persons of land will be zero rated for GST purposes with effect from 1 April 2011.
Another less well publicised change is the lowering of the thin capitalisation thresholds, with effect from the 2011/2012 income year. The thin capitalisation rules are concerned with domestic interest deductions with respect to inbound capital from non-residents. Their purpose is to proscribe(or do you mean prescribe?) limits as to what interest can be safely deducted and prevent the practice of non-residents loading up New Zealand business with debt as opposed to equity. Debt of course gives rise to a tax deductible expense in the form of interest but equity does not have that feature. The new threshold is 60% now down from 75%.
There have been changes with respect to research and development space but not in the form of a return to the issue of credits. Rather the Government announced that there will be significant increases in funding to medium and large sized businesses that can demonstrate that their research activities will benefit the country. Where the eligibility criteria are met then the Government will contribute 20% to those organisations' anticipated research and development budgets. The contributions will be for 3 years and up to a ceiling maximum amount. The amount that is available for this initiative is $189 million.
There are also some less significant measures like $20 million allocated for what is called "technology transfer vouchers". The idea here is to encourage the transfer of technology to entities that do not have the requisite in-house research and development capabilities. Relatedly there will be $24 million available to assist in the transfer of technology from research organisations to businesses and $11 million for setting up a network of centres to assist with the commercialisation of the results of research and development initiates.
Finally, more money has been provided to Inland Revenue to enhance compliance and debt collection functions. As a rule of thumb the Government works on the assumption that every $1 spent of compliance produces $5 of extra tax. Thus by allocating an extra $110 million it is expected that in excess of half a billion dollars in extra tax will be collected.