Report to the Treasurer and Minister of revenue - by a committee of experts on tax complianceBill Birch Treasurer
Report to the Treasurer and Minister of revenue
By a committee of experts on tax compliance
INVESTMENT SAVINGS AND INSURANCE ASSOCIATION OF NEW ZEALAND INCORPORATION SUBMISSION
8 July 1998
The Secretary of the Committee of Experts on Tax Compliance
P O Box 2198
REDUCING TAX COMPLIANCE COSTS - SAVINGS VEHICLES
- ISI Background
- The Investment Savings and Insurance Association of New Zealand Inc. (ISI) is an industry organisation which represents the vast bulk of the providers of collective investment savings vehicles in New Zealand. Members manage over $20 billion in savings on behalf of more than 1.5 million New Zealand investors and policy holders.
- ISI recommends that the Committee of Experts on Tax Compliance should review the host of different tax regimes applying to savings vehicles with a view to reducing both compliance costs and the unnecessary level of tax complexity. This would increase the economic efficiency of such vehicles and as a result increase the savings of New Zealanders, without decreasing total tax revenue.
- Summary of tax regimes for investment vehicles and other means of investment for the public
- At present there is a multiplicity of different tax regimes for investment vehicles and other methods of investment. ISI members as financial services enterprises utilise many of these vehicles or methods for their clients and/or are constantly migrating their clients from one vehicle or method to another with decisions in many cases being tax driven.
- Life Insurance regime - all gains on revenue account, taxed at a flat 33%, proceeds received exempt by inves-tors;
- Superannuation - status of investment gains determined by common law, employer contributions taxed, income taxed at a flat 33% and distributions not assessable to investors;
- Tax Credit System - draft legislation to introduce a tax credit mechanism to reduce the rate of tax on savings via superannuation and life insurance products to the marginal tax rate of investors who are on less than 33% - structure seen as likely to provide little direct benefit to electors over and above the cost of compliance to providers who are obliged to pass on that cost to electors;
- Unit Trusts - modified corporate regime with a flat 33% tax and imputation, status of investment gains determined by common law, no refund available for sur-plus imputation credits on distributions only on other in-come;
- Category A GIFs - regime as for unit trusts;
- Category B GIFs - qualifying trust regime with conces-sional treatment for certain trusts, charities and superannuation funds, (Note the Taxation Simplification and Other Remedial Matters Bill intends removing this con-cession for superannuation funds from 1/4/99), as well as concessions for certain investments restricted to New Zealand and Australian government bonds, money market instruments and first mortgages, investment gains determined by common law, no ability to retain income and therefore a necessity for expenses to be charged outside the fund by way of deduction from distributions;
- Index equity funds - typically either category B GIFs or wholesale superannuation funds with binding rulings confirming investment gains on capital account, and otherwise treated as qualifying trusts for superannuation funds (to 1/4/99) charities and certain trusts but as com-panies for direct investors, (i.e., category A GIFs);
- Master funds - either superannuation or unit trust vehicles with a range of different risk portfolios which in turn invest in specific investment risk situations using a series of unit trusts, superannuation funds or GIFs (as the case may be) no tax concessions facilitate their tiering;
- Wrap account - bare trusts for investors with an administrator and custodian and a menu of products (being typically collective investment vehicles both in New Zealand, Australia and UK) taxed to the investor like direct investment;
- Foreign Investment Vehicles
- Grey list countries (e.g., UK Investment Trusts and Australian unit trusts) treated as companies in New Zealand with distributions treated as foreign dividends to New Zealand investors;
- Non grey list - (i.e., FIF's) taxed on an accrued gain/loss basis typically by marking to market at balance date bringing to account all gains and losses on revenue account;
- Direct investment - status of investment gains determined by common law but rarely are individuals in busi-ness. Taxed at investor's marginal rate;
- Wholesale pools - no tax exemption, currently inefficiently taxed as unit trusts or GIF's unless direct tracing occurs (which is not economic to perform).
- Tax compliance
- There are two broad compliance issues which deserve detailed consideration. The complexity of having a number of different tax regimes for pooled investment and the costs and risks within each of those regimes.
- These complexities have arisen as a consequence of the applicable of purist economic tax theory without regard to the purposes of collective investment, e.g., the application of the corporate tax model to unit trusts and as a consequence of adhoc piece-meal legislation reacting to product development, for example, the difference between category A and B GIFs.
- Over time investment dollars will always flow to the vehicles which are most tax efficient. Consequently in recent yeas we have seen a proliferation of passive index funds, a substantial increase in GIFs, and an ongoing inflow of investment dollars into foreign trusts which roll up income in 'grey list' countries.
- Investment dollars have constantly moved out of insurance savings products because they have the least flexible tax regime with all investments being on revenue account. Currently unit trusts have a slight preference over superannuation funds and insurance savings products, which are themselves disadvantaged over direct investment given the bulk of assets are on revenue account.
- The financial services industry in New Zealand is essentially characterised by too many different funds with overly complicated different tax regimes, relatively high administration costs (on an international comparative basis), few economies of scale and broad tax disadvantages over direct investment. This situa-tion is contributing to New Zealand's low rate of savings and the low average return on savings.
- Product providers spend enormous resources complying with all these different tax regimes and that cost is directly passed on to savers thereby reducing economic efficiency and discouraging collective investment as a choice ahead of direct investment.
- A major disparity and inconsistency is the treatment of investment gains and the retention of common law as the means of determining tax treatment, rather than clear concise legislation at the capital/revenue boundary. This has lead to the distortion of tax-exempt index funds at one extreme and the taxation of all gains in relatively passive unit trusts and superannuation funds on the grounds that they are carrying on a business at the other extreme, whilst direct investors largely do not pay tax on investment gains.
- The GST exemption for financial services has not kept up with the expansion of products in the financial services sector. The definition of 'financial services' singles out the management of superannuation funds as GST exempt and leaves management of the remaining investment products with little clarity. This inconsistency cannot be defended on policy grounds and increases compliance costs for no discernible purposes.
- Accurate measurement of 66% continuity for imputation credit carry forward is required in unit trusts and GIF's. In volatile markets investment cash flows move quickly often threatening continuity. Unlike companies these vehicles are open ended so investors move in and out freely. The effect is felt most dramatically in wholesale vehicles which target specific risk situations where changes in asset allocation can result in massive unit holder changes in short periods of time. The 66% requirement is totally punitive and unreasonable at this level and demands time wasting tracking to be carried out on a daily basis with no concessions, purely to replicate the corporate regime.
- Wholesale pools are used as a means of asset allocation into discrete investment risks for retail products. No accommodating tax regime exists for these vehicles. If they could be treated as pass through entities on the basis of fully distributing all income (i.e., a qualifying trust regime) there would be no reduction in tax take, but a substantial cost saving would pass through to retail investors. See attached article from the Independent dated 10 October 1997 by Paul Baker of National Mutual.
- The need for considerable simplification while at the same time achieving broad tax neutrality between collective savings vehicles and as against direct investment should be legislative guideline.
- ISI's recommendations
With a view to reducing tax compliance and eliminating tax distortions between collective savings vehicles, and as against direct investment, ISI recommends as follows:
- Roll up vehicles, such as superannuation trusts and life insurance saving products, should be dealt with under a tax regime which is a proxy for investors;
- Distributing vehicles such as GIFs and unit trusts can be accommodated with either a qualifying trust regime as the preferred alternative or an imputation regime, but it should be just one regime;
- The introduction of legislation or other methods to clarify the capital/revenue boundary for investment gains with a view to introducing certainty and neutrality;
- Wholesale investment pools for taxed savings vehicles should not be taxed on income distributed, (i.e., qualifying trust status should be available and this would require amendments to the definition of 'unit trust' in the Income Tax Act).
- The definition of financial services in the GST Act should be clarified to include the administration and management of all collective savings vehicles;
- The requirement for 66% continuity to carry forward imputa-tion credit balances in savings vehicles needs to be relaxed because of their open ended status (i.e., no restriction on the amount of units issued or redeemed unlike a company). At the very least wholesale vehicles should enjoy the same concessions as widely held trusts as they are most affected by volatility.
ISI Tax Policy Committee
LIST OF REPORTS ON THE TAX SYSTEM
KEY TAX REFORM DOCUMENTS 1982 TO 1997
In this appendix, the committee lists the major tax reform documents that have been issued since 1982. Documents in italics are reports of external committees. All other documents were government statements of one kind or another.
- Report of the Task Force on Tax Reform (the McCaw report)
- Goods and Services Tax
- White Paper on Goods and Services
GST: The Key to Lower Income Tax
Benefits, Taxes and the 1985 Budget - Discussion Paper
Statement on Taxation and Benefit Reform
- Consultative Document on Primary Sector Taxation
Benefits, Taxes and the 1985 Budget: A Review and Summary
Statement on Government Expenditure Reform
Report of the Consultative Committee on Primary Sector Taxation
Discussion Paper on Taxation of Bloodstock Breeders
Consultative Document on Accrual Tax Treatment of Income and Expenditure
- Consultative Document on Petroleum Mining Taxation
Final Report on the Accrual Taxation System
Consultative Document on Full Imputation
Consultative Document on International Tax Reform
Further Report to the Minister of Finance of the Consultative Committee on Accrual Tax Treatment of Income and Expenditure on Comprehensive Tax Reform and Possible Interim Solutions
Discussion Paper for Review of Excise Duties on Alcoholic Beverages and Tobacco Products
- International Tax Reform - Part I of the Report of the Consultative Committee
Consultative Document on Superannuation and Life Insurance
Full Imputation - Report of the Consultative Committee
Report to the Minister of Customs on the Review of Excise Duties on Alcoholic Beverages and Tobacco Products (the Sullivan Committee)
International Tax Reform and Full Imputation - Part II - Annex: Draft Legislation - Report of the Consultative Committee
Tax Treatment of Superannuation - Report of the Consultative Committee
Discussion Document on Domestic Interest Withholding Tax
Report of a Committee of Consultants to the Minister of Revenue and Commissioner of Inland Revenue on the Effect of the Accruals Regime on Property Transactions
- Report of Consultative Committee on Life Insurance and Related Areas
Report to Minister of Finance and Minister of Social Welfare by Working Party on Charities and Sporting Bodies (the Russell report)
Consultative Document on Tax Simplification
Consultative Document on the Taxation of Income from Capital
- Interim Report of Tax Simplification Consultative Committee
Definition of Dividends under the Income Tax Act 1976 - A Discussion Document
Final Report of Tax Simplification Consultative Committee
Core Provisions of the Income Tax Act 1976 (Report of the Consultative Committee on the Taxation of Income from Capital - the Valabh committee)
The Taxation of Distributions from Companies (the Valabh committee)
- Tax Accounting Issues (the Valabh committee)
Taxing Income Across International Borders: A Policy Framework
Taxation of Distributions from Companies - Final Report (the Valabh committee)
Operational Aspects of the Accrual Regime (the Valabh com-mittee)
Key Reforms to the Scheme of Tax Legislation (the Valabh committee)
Discussion Paper on Livestock Valuation
- Final Report of the Livestock Valuation Consultative Committee
Final Report of the Consultative Committee on the Taxation of Income from Capital (the Valabh Committee)
- Working Party on the Reorganisation of the Income Tax Act 1976 - First Report of the Working Party
Working Party on the Reorganisation of the Income Tax Act 1976 - Second Report of the Working Party
The Taxation Implications of Company Law Reform: A Discussion Document
- Taxpayer Compliance, Standards and Penalties: A Discussion Document
Resolving Tax Disputes: Proposed Procedures - A Government Consultative Document
Rewriting the Income Tax Act: Objectives, Process, Guidelines
Business Compliance Cost Reduction - A Government Policy and Discussion Paper
- International Tax - A Discussion Document
Taxpayer Compliance, Standards and Penalties 2: A Discussion Document
Core Provisions: Rewriting the Income Tax Act - A Discussion Document
- Tax Reduction and Social Policy Programme: Details
Tax Simplification Issues - A Government Discussion Paper
- The Design of a Possible Low-Level Carbon Charge for New Zealand
Trading Stock Tax Rules - A Discussion Document on Gov-ernment Proposals for Change
The Taxation of Conduit Investment - A Government Discussion Document
The Tax Credit System: Taxing superannuation funds and life office savings through tax credits - A Government Discussion Document
Rewriting the Income Tax Act: Parts C, D and E - A Discussion Document
Simplifying Taxpayer Requirements - A Government Discussion Paper on Proposals for Change
The Taxation of Financial Arrangements - A Discussion Document on Proposed Changes to the Accrual Rules
- Legislating for Self-assessment of Tax Liability - A Government Discussion Document
RECOMMENDATIONS OF THE FINAL REPORT
OF THE CONSULTATIVE COMMITTEE ON THE
TAXATION OF INCOME FROM CAPITAL
GOVERNMENT ACTIONS UP TO DECEMBER 1998 IN RELATION TO THE VALABH COMMITTEE'S RECOMMENDATIONS
The Valabh committee made 148 separate recommendations in its Final Report, the majority of which have been acted on. The following sets out the status of these recommendations, cross-referenced to the chapters in the committee's Final Report.
Chapter 2 - Core Provisions
All of these recommendations were considered and discussed in the lead-up to the various 'Rewrite' discussion documents. New core provisions were enacted by the Income Tax Amendment Act 1996 (No 67).
Chapter 3 - Taxation Avoidance
The government has not adopted the redrafted general anti-avoidance provision proposed by the committee. When the committee's report was released, the government stated its concern to ensure that the general anti-avoidance provision was not weakened. The issue has since been under consideration by the Davison Commission and the Committee of Experts.
Chapter 4 - Scheme and Drafting of Legislation
The government established a working party chaired by Arthur Valabh. Its recommendations resulted in the reordered Income Tax Act 1994.
Chapter 5 - Partnerships
The government did not agree with the committee's detailed recommen-dations. However, it did agree to a general review of the tax laws relat-ing to partnerships, but as a non-priority issue. Other matters continue to have a higher priority on the government's tax policy work programme.
Chapter 6 - Administration Aspects
The committee's observations on advance rulings, the assessment and dispute resolution process and penalties have been incorporated in the reviews of these areas. The recommendation on the criteria that should govern the Commissioner's discretions is being included in the project the department is undertaking on legislating formally for self-assessment. A discussion document on legislating for self-assessment has been released. The recommendation on adjustments required conse-quent upon incorrect accounting practice has yet to be acted upon.
Chapter 7 - Interest
Consideration of the committee's recommendation to allow non-private or domestic interest costs to be deducted was deferred until the Davison Commission had reported. This issue has now a high priority on the tax policy work programme.
Chapter 8 - Tax Accounting Issues
The government has introduced legislation covered by the committee's recommendations on trading stock reform. The committee's other rec-ommendations covering: cost apportionment, non-market transactions, asset classification, isolated transactions, land transactions and long-term construction projects are being considered as part of, or in tandem with, the rewrite of parts C, D and E of the Income Tax Act 1994.
Chapter 9 - Operational Aspects of the Accruals Regime
The government has carried out a comprehensive review of the accrual rules, which included consideration of the Valabh committee recom-mendations. This review resulted in a public discussion document and a bill which is currently before the House.
Chapter 10 - Debt Remission and Bad Debts
The recommendations on debt remission were rejected at the time the Valabh committee made its recommendations, and were rejected again in the recent public discussion document on the accrual rules. However, the bill proposing the revised accrual rules, which is currently before Par-liament, contains some minor provisions relating to debt remission that have the objective of closing down some tax avoidance opportunities.
The bill does not contain any provisions relating to bad debts. Bad debts were discussed in the public discussion document, which highlighted the difficulty of making significant changes without a broader review of bad debts throughout the Act. Such a broader review is not currently on the government's work programme.