Report to the Treasurer and Minister of revenue - by a committee of experts on tax compliance

Bill Birch Treasurer

Report to the Treasurer and Minister of revenue

By a committee of experts on tax compliance

Chapter 5 -
Some Specific Concerns

Introduction

5.1 In this chapter, the committee makes some recommendations for reducing compliance costs. The recommendations are not intended to be a package of measures, nor to address comprehensively the compliance costs associated with a particular tax regime, but are individual measures that can be undertaken to reduce compliance costs. Important simplification measures, in areas such as tax collection and the issue of disclosure obligations, are dealt with in other chapters. Most of the measures noted here have arisen from submissions received by the committee.

5.2 When the committee began to address tax simplification issues, it was frequently asked: 'Why doesn't the tax system just ...' It is important, therefore, that taxpayers and their advisers have a good understanding of the reasons why some seemingly attractive propositions are unworkable. The answer is to be found in balancing the diverse requirements of a modern tax system, which focuses on more than simplicity alone. It strives also for equity, low deadweight costs of taxation and administrative feasibility. A robust tax system must balance all these considerations effectively. In addition, when compliance costs are reduced in one area, the costs in another area may increase. For example, the PAYE system reduces compliance costs for wage and salary earners, but increases the compliance costs for employers.

5.3 The committee recognises that compliance costs, even those voluntarily incurred, represent a loss of resources that society could employ elsewhere. So, for example, the introduction of complex rules for the valuation of motor vehicles would be welcomed by employers who would likely face a reduced tax bill, because the savings would outweigh the cost of asking a tax adviser to undertake the necessary calculations. But the dollar the employer considers that he or she is losing in this way is of real benefit to society. It is the money used to fund health, education and other government services. Moreover, the amount the employer spends on increased compliance costs, say in hiring an adviser, represents a real loss to society. The employer spends money on an activity that would not have occurred but for the tax system, and moves resources away from more productive activities.

5.4 The need to balance such matters has meant that some suggestions for simplification have had to be rejected. Some of these suggestions are nevertheless considered by the committee in this chapter, as the reasons for their rejection are important, and the committee hopes that its explanation will increase understanding and acceptance of the principles underlying the tax system.

5.5 In addressing concerns on compliance costs, the committee identified measures that could be justified only as part of a wider simplification initiative, with the focus on the collective effect of an overall package of proposals. The committee has noted this point where relevant in this chapter.

The tax treatment of expenditure on motor vehicles

5.6 Taxpayers and their advisers spend considerable time and money trying to identify and implement the most tax efficient structure for the ownership and use of a motor vehicle that is used partly in business, and used, or available for use, partly by a proprietor or an employee for their personal needs. The outcome will be influenced by such factors as the structure used to conduct the business, and the relationship between the owner of the vehicle and the person using the vehicle. The treatment affects the calculation of income tax, fringe benefit tax (FBT), goods and services tax (GST), and, indirectly, the accident compensation levy. Clearly, the fact that there are different ways of doing things adds to compliance costs and also represents a deadweight cost to the economy. The Inland Revenue Department is reviewing this situation at present, and the committee supports this work.

5.7 The committee recommends that the government should develop a universal approach to the tax treatment of motor vehicles. The policy that is developed and enacted should balance fiscal needs, equity between taxpayers, and compliance costs. The aim should be to ensure that, regardless of legal structure and ownership, the tax outcome is the same.

Fringe benefit tax

5.8 An employer who provides a motor vehicle for an employee pays FBT on the annual taxable value of a motor vehicle that is used, or is available for use, by that employee. The benefits to the employee lie in both the availability and the use of that vehicle. The value of those benefits is determined at 24 per cent of the GST-inclusive cost of the motor vehicle. When that rate was set86, it reflected the average cost of owning and operating a vehicle. The calculation was based on 16,000 kilometres per annum of vehicle usage over a five-year period87. A range of options was considered and was concluded that a formula-based approach was the most appropriate. The value of the benefits was intended to be based on the costs an employee would have incurred if the employee had bought and run the motor vehicle.

5.9 The submissions made to the committee exemplify that the primary concern is not so much the percentage rate to be applied, although, on occasions, this rate is said to be too high, but the fact that the rate of 24 per cent is applied each year to the original cost of the asset. This fact is perceived by many to be unfair.

5.10 The concerns expressed are largely based on a lack of understanding of the assumptions made in setting the rate. The committee considers that taxpayers need to understand why the present rate continues to apply, and why it remains appropriate to use the cost price of the motor vehicle as the base value each year.

5.11 There are a range of circumstances that could be taken into account in determining the base value of a motor vehicle for FBT purposes. Among these are the annual levels of total mileage, the proportion of business use to private use, the different ratios of vehicle annual operating costs to vehicle cost prices, the period of vehicle ownership, alteration in the level of expenditure through differing vehicle retention periods or higher or lower usage factors, and the different funding patterns and funding cost structures.

5.12 Taking all such factors into account would significantly increase compliance costs. The tax system would be chasing an increasing accuracy, relevant only to the group of taxpayers that sees the benefit from the additional complexity. Each marginal increase in accuracy achieved by incorporating one of these factors would increase compliance costs for all. While the FBT payable by some would be reduced, the change would increase the tax paid by others.

5.13 The committee considers that a case in equity might possibly be made for a reduction in the value of employee-related benefits from the use of a motor vehicle when the employer could demonstrate that the incidence of private use on particular days, or over time was relatively minimal. However, the committee has noted that under present government policy, 'availability for private use' is one of the criteria. The committee considers that this issue should be absorbed into the department's work on a universal treatment of the private benefits enjoyed by individuals in relation to business motor vehicles.

5.14 Based on Table 3 as shown, the factor of 24 per cent is considered to be in the right order. Overall, the committee finds the global 'percentage of cost' approach a satisfactory compromise, taking into account the fact that the motor vehicle may also be used for business purposes. Table 3 includes an interest charge representing the opportunity cost of the capital committed to the motor vehicle. This charge is calculated on the basis of a capital outlay equivalent to the third year value of the motor vehicle, including charges such as insurance, and the interest the car owner would have received if that money had been invested in a bank. When an employer provides a motor vehicle, the new cost of the vehicle is the more appropriate measure of the capital outlay. This value continues to apply each year because the employee is not contributing to the reduction in the amount borrowed to purchase the motor vehicle. A more appropriate interest charge in this case would be the employee's cost of borrowing to buy that motor vehicle. At present, 10 per cent per annum would not be inappropriate. The results of this approach are displayed in Table 4. Again the results confirm the 24 per cent factor is not excessive.

Table 3: Car running costs
(based on 12,000 kilometres)
(Based on figures from the March 1998 issue of the Automobile Association magazine Directions)

Vehicle engine size

to 1300 cc

1300-1600 cc

1600-2000 cc

over 2000 cc

Original cost

$21,193

$26,809

$35,063

$42,116

Fixed costs per year (incl depreciation) $4,588

$5,639

$7,176

$8,484

Running cost per kilometre ¢/l

16.0

17.1

18.9

22.1

Cost per year

Annual kilometres plus fixed costs

8,000 $5,868

12,000 $6,508

16,000 $7,148

20,000 $7,788

24,000 $8,428

 

$7,007

$7,691

$8,375

$9,059

$9,743

 

$8,688

$9,444

$10,200

$10,956

$11,712

 

$10,252

$11,136

$12,020

$12,904

$13,788

Cost per year cost as a percentage of original cost

Annual kilometres

8,000 27.7

12,000 30.7

16,000 33.7

20,000 36.7

24,000 39.8

 

26.1

28.7

31.2

33.8

36.3

 

24.8

26.9

29.1

31.2

33.4

 

24.3

26.4

28.5

30.6

32.7

FBT rate

24%

24%

24%

24%

88 1982 equivalent summaried from McCaw Report

Annual kilometres
16,000

   
 
N/A
43.5
40.9
35.6

Table 4: Car running costs including full funding cost
(Based on figures from the March 1998 issue of the Automobile Association magazine, Directions, modified to include full funding cost)

Vehicle engine size

to 1300 cc

1300-1600 cc

1600-2000 cc

over 2000 cc

Original cost

$21,193

$26,809

$35,063

$42,116

Fixed costs per year (incl depreciation) $5,558

$6,879

$8,813

$10,461

Running cost per kilometre ¢/l

16.0

17.1

18.9

22.1

Cost per year

Annual kilometres plus fixed costs

8,000 $6,838

12,000 $7,478

16,000 $8,118

20,000 $8,758

24,000 $9,398

 

$8,247

$8,931

$9,615

$10,299

$10,983

 

$10,325

$11,081

$11,837

$12,593

$13,349

 

$12,229

$13,113

$13,997

$14,881

$15,765

Cost per year cost as a percentage of original cost

Annual kilometres

8,000 32.3

12,000 35.3

16,000 38.3

20,000 41.3

24,000 44.3

 

30.8

33.3

35.9

38.4

41.0

 

29.4

31.6

33.8

35.9

38.1

 

29.0

31.1

33.2

35.3

37.4

5.15 The committee undertook a number of other calculations based on motor vehicle use from 6,000 to 20,000 kilometres per annum to ensure the validity of the 24 per cent rate. These calculations also confirmed the committee's position that the 24 per cent factor is broadly right. Some who made submissions to the committee identified matters for which they considered relief should be available. Even taking these into account, 24 per cent of the cost price remains an appropriate value for FBT purposes.

5.15The law at present necessarily takes a broad-brush approach, and although not accepted by some, it remains an effective compromise between compliance costs and accuracy. The committee is satisfied that, on the basis of present government policies, the rate of 24 per cent that is applied each year to the original cost of the motor vehicle should not be changed. The committee recommends that there should be no change in the present formula for calculating the value of the fringe benefit of a motor vehicle.

The committee also recommends that the Inland Revenue Department should publish in the Tax Information Bulletin a full and informative explanation of the rationale underlying the use of the factor of 24 per cent of the original GST-inclusive cost price as a method for determining the base fringe benefit value of a motor vehicle.

GST on fringe benefits

A common omission made by small businesses is to forget to account for GST on certain fringe benefits, for example, subsidised goods provided to employees. This error is often identified only on audit and it can result in the imposition of penalties. While it may be the taxpayer's fault, the tax system should be designed to minimise the possibility of this type of omission. For this reason, the committee recommends that GST on fringe benefits should be returned on the FBT return rather than the GST return.

Use of money interest

5.19 When the annual level of gross tax deductions and specified superannuation contribution withholding tax deductions does not exceed $100,000, an employer may elect to account annually for FBT. When this measure was enacted the government considered it necessary that the cash flow advantage that had been provided along with the reduction in compliance costs should be balanced by an interest charge. However, this charge caused many employers with a low annual level of fringe benefits to decline to adopt the option of annual returns.

5.20 The committee considers that taxpayers who pay fringe benefit tax annually should be allowed to prepare an annual FBT return, and to make annual FBT payments without incurring an interest charge on deferred payment.

5.21 Research undertaken by the Inland Revenue Department indicates that taxpayers see the use of money interest provisions as a disincentive to filing annual returns. Of those employers surveyed who were eligible to file annually and did not, 24 per cent indicated that they filed returns quarterly to avoid use of money consequences, 23 per cent said quarterly filing provided a better cash flow and 19 per cent found it suited their accounting system. This research suggests that annual filing would be more favourably regarded if interest were not charged.

5.22 Officials advised the committee that the option to pay FBT annually without incurring an interest charge would reduce compliance costs by approximately $240,000, mainly through the completion of only one return instead of four returns. They also indicated that administrative savings of approximately $34,000 per annum would follow, through reductions in the distribution and processing of FBT returns.

5.23 The committee noted that removing the interest charge from annual FBT returns is likely to create timing advantages for employers who file annually. It may also be an incentive to those employers to provide employees with fringe benefits rather than providing monetary remuneration, and could also indirectly affect the government's income support measures.

5.24 Balancing these concerns is the statutory ceiling, which limits the potential for abuse. The overall monetary cost to the government of the deferral associated with annualising FBT payments without interest recompense is, however, moderately significant. The Inland Revenue Department estimates that the removal of the FBT interest charge would cost the revenue approximately $1.25 million per annum. This estimate is based on the assumption that all taxpayers who are eligible to file annually will do so.

5.25 The committee recommends that the matter should be pursued in the context of the comprehensive review of the obligations of business taxpayers being undertaken at present by the Inland Revenue Department. If this review should not result in any reasonable simplification for small taxpayers who pay FBT, the committee recommends that the use of money interest charge should not apply to fringe benefit taxpayers who pay annually.

Provisional tax

5.26 While broadly happy with the provisional tax rules, the committee identified one matter for consideration. Provisional taxpayers who elect to use the safe harbour rules are not charged use of money interest on any underpaid provisional tax. Correspondingly, they are not paid interest on overpaid provisional tax. However, if such taxpayers file an election to estimate their income, they may leave the safe harbour and receive use of money interest on overpaid tax. This election may be made at any time up to and including the third instalment date.

5.27 In the committee's view it is undesirable that the payment of interest on overpaid provisional tax should be determined by such an election. The committee considered the cause of this problem and possible solutions.

5.28Under the provisional tax rules, a safe harbour is provided for smaller, less sophisticated taxpayers in order to reduce their compliance costs. If the use of money interest provisions applied to them, these taxpayers would probably incur greater compliance costs in estimating their income than the benefit both they and the government would gain from more accurate payment. Because the use of money interest rules do not apply to taxpayers in the safe harbour, prescriptive rules on the amount to be paid at each instalment date are required. Because these rules produce inaccurate results in some individual cases, taxpayers must have an option to leave the safe harbour and to estimate their provisional tax payments.

5.29 One option to deal with this problem would be to restrict taxpayers leaving the safe harbour. However, this restriction would be complex in legislative terms, and would also be administratively difficult. A second option would be to ensure that interest accrued only from the time of making an election to leave the safe harbour. While this option is feasible, it would result in complex interest calculations, which would in turn carry their own administrative and compliance costs.

5.30 A third option would be to pay interest on all overpaid provisional tax. Interest would be paid whether the notice of election to estimate income was filed or not. While this option would benefit taxpayers, it would entail a fiscal cost that would have to be recovered.

5.31 The different treatment of taxpayers who opt out of the safe harbour and those who remain in the safe harbour comes about through the use of two distinct approaches for ensuring payment by provisional taxpayers. Any measures to integrate these approaches would increase compliance costs. Nevertheless, this result is a concern. The committee recommends that the government should monitor the number of elections made, and if most taxpayers are found to be opting out of the safe harbour, the government should consider paying interest in all cases of overpayment of provisional tax, thus obviating the need for an election.

Resident withholding tax and back-to-back loans

5.32Tax issues arise when a taxpayer borrows funds from a financial institution to lend to his or her business or to another entity. The financial institution making the loan may prefer to lend to the individual rather than the company because of the credit risk involved, securing the loan over the individual's private assets. Together, the loan from the bank to the individual and the loan from the individual to the company are known as a back-to-back loan. In these circumstances, resident withholding tax (RWT) can create a cash flow disadvantage for the individual, because the individual is required, in effect, to withhold RWT from interest on the loan to the business, but to make gross interest payments to the financial institution. The individual must top-up the interest paid to the financial institution to the extent of the tax withheld.

5.33 To address the problems arising from back-to-back loans, the legislation at present gives the Commissioner a discretion to provide an exemption from deducting RWT. This discretion imposes compliance costs and is not comprehensive in nature. For example, only taxpayers with RWT credits that are likely to exceed their tax liability by more than $500 may apply for a certificate of exemption. Moreover, those applying for certificates of exemption must provide comprehensive details on their circumstances and provide accounts.

5.34 Considering this position, the committee was inclined towards some amendment. However, there are practical difficulties in designing such rules, which must at the same time provide the necessary revenue protection. The tax system relies on its withholding taxes, principally PAYE and RWT. Any measure entailing a risk to the integrity of the RWT system must be considered with caution.

5.35 Weighing both the need to pursue reductions in compliance costs and the need to protect the tax base, the committee concludes that sufficient justification exists for retaining the present treatment of back-to-back loans. The committee is unable to recommend a change.

Payment and refunds

Amalgamation of payment dates

5.36 There is a proliferation of due dates for payment of taxes, which particularly affects small employers. The committee saw some merit in considering the amalgamation of due dates.

5.37 PAYE is payable either monthly on the 20th of the month following the PAYE deduction or, if the aggregate of PAYE and specified superannuation contribution withholding tax deductions exceeds $100,000, on the 20th of the month and the 5th of the following month.

5.38GST is payable either monthly90, two-monthly, or six monthly91. Payment is due on the last day of the month following the end of the taxable period.

5.39 FBT is payable either quarterly or annually, or is aligned with the taxpayer's balance date. Quarterly payments are due on the 20th of the month following the end of the quarter. Annual payments are due on 31 May following the end of the income year. Taxpayers may also elect to pay by income year, in the case of a close company, in which case payment is due on their terminal tax date.

5.40 Several submissions to the committee identified compliance cost benefits that would arise from amalgamating payments. These benefits would include taxpayers' ability to address all tax obligations at one time, to write one cheque to cover all liabilities, and to exchange less mail with the Inland Revenue Department. Finally, the advantage of having one regular payment date would reduce the likelihood of a taxpayer forgetting to pay and having a late payment penalty imposed.

5.41 However, the committee has identified some disadvantages for businesses. Less frequent, but more significant, tax payments could cause cash flow problems with the possible result that businesses with poor financial management or accounting systems could experience financial difficulties.

5.42 The degree of reduction in compliance costs that would be achieved is also questionable. The situation will differ from taxpayer to taxpayer. Compliance cost savings would be most likely for small, and small to medium businesses which rely heavily on external tax accounting support.

5.43 Many tax calculations occur regardless of the due dates for payment of the tax. For example, employers must deduct PAYE each payday from wage and salary payment, irrespective of the date on which it is paid to the Inland Revenue Department. Furthermore, if payment dates were amalgamated the number of tax returns would be reduced, but each return would be more complex. As an amalgamated return would cover more than one tax type, additional calculations would be required to ensure that the total tax liability equalled the tax payment. The work of preparing this amalgamated return, therefore, is peaked rather than spread.

5.44 Additional complexity would result if different individuals were required to meet the liability, such as the taxpayer, the taxpayer's adviser and a payroll company. Although, if tax accounting personnel are required repeatedly to access documents and files at different times over a period, some additional compliance costs are also incurred.

5.45 Balancing these factors cannot be done on a theoretical basis. It is an exercise that requires consideration of the preferred approach by all those affected - fewer payments but possible cash flow problems against more frequent, smaller payments. The committee considers public consultation is necessary.

5.46 The extent to which the government can separate tax payments from the need for information from tax returns is also a matter for consideration. This separation is easier with small, more stable payment profiles, such as FBT or duties, than with the larger more variable taxes, such as GST.

5.47 The committee has concluded that it is not possible to make a firm recommendation, because of the conflicting factors, but considers that a review of existing payment dates and the separation of the flow of information from the payment of tax has merit. The committee considers that a better overall outcome may be reached by considering the reform of payment dates as part of the comprehensive review of the obligations of business taxpayers. The committee, therefore, recommends that the government should publish a discussion document that sets out the debate on amalgamating payment dates and the separation of the flow of information from the payment of tax to allow informed public consideration of the issues and to provide for public submissions. The committee also recommends that the discussion document should clearly distinguish the needs and concerns of the small, small to medium, and large businesses.

Treatment of payments that fall due on a non-working day

5.48 Much uncertainty arises over the actual payment date when the payment day falls on a weekend. The exception is payment of GST, for which the legislation provides that the tax is due on the last working day of the month. The committee considers that compliance costs would be reduced if a universal statutory rule specifying the due date for payment of tax on those occasions when the actual due date occurs on a non-business day were clearly expressed.

5.49 The committee considered alternative proposals. First, that for all taxes, when the due date does not fall on a working day, the payment date should be the last working day before the due date for the tax. Secondly, that when the due date does not fall on a working day, the due date for the tax should move to the first working day after the due date.

5.50 The first approach does not meet the objective of reducing compliance costs. The confusion resulting from a rule requiring early payment in some cases could outweigh the benefit of a fixed rule. This approach is also not particularly intuitive: it assists taxpayers who know the legislation, while those unaware of the provision may find themselves liable to late payment penalties.

5.51 The committee considers that the second approach of delayed payment has benefits. While it would raise some cash accounting issues in years when the GST due date for June moves into July, officials have advised the committee that the measure raises no accrual accounting issues. As the government accounts are prepared on an accrual basis, the cash accounting issues are not significant. However, this measure would result in a revenue cost in terms of the time value of money, mostly accounted for by delays in the government receiving GST payments. Officials have advised the committee that this cost would amount to approximately $1 million per annum. It is not possible to quantify the offsetting compliance costs benefits.

5.52 The committee believes that in the wider scheme of things, the net overall cost of this measure is outweighed by the benefits, and therefore, considers that if the due date for any tax falls on a non-business day it should be moved to the next working day.

5.53 One hurdle to implementation of such a change remains. The Inland Revenue Department's computer systems would require relatively complex amendment to reflect the date changes, coming at a time when the department is extensively involved in implementing the government's initiative to remove the need for wage and salary earners to file returns. The committee accordingly recommends that the measure should be implemented at the first practical opportunity after completion of the systems changes to accommodate the government's return filing changes. This implementation may coincide with the changes arising from the initiatives focused on reducing compliance costs for businesses.

5.54 In summary, therefore, the committee recommends that the government should consider introducing a universal rule that when the due date for the payment of tax falls on a non-business day, the due date moves to the next working day. The committee also recommends that this measure should be implemented at the first practical opportunity.

Payment of refunds

5.55 The Inland Revenue Department's systems include a computer program to ensure that overpaid tax is not refunded to a taxpayer if the taxpayer has an outstanding debt in relation to another tax type. However, the transaction entries required by this program can result in compliance costs for taxpayers with different tax types with little, if any, reduction in the risk faced by the Commissioner. This problem mainly affects larger corporations.

5.56 The committee considers that the Commissioner should use some discretion in the application of this policy. The committee understands that the relevant program is fundamental to the system, and that any modification allowing the use of discretion in individual cases would impose administrative costs. Although this may be the case, this system does place a burden on affected taxpayers.

5.57 The committee recommends that the Inland Revenue Department should consider this matter with a view to finding and implementing a solution. The committee considers that the resolution of this problem should be addressed as part of the package of tax simplification measures at present under consideration.

5.58The Commissioner is required by section 6(2)(c) of the Tax Administration Act 1994 to extend equal treatment to all taxpayers. With this is mind, it may be appropriate to amend the law to allow the Commissioner to enter into arrangements with particular taxpayers. For example, in cases where the Commissioner considers that there may be an unacceptable element of risk if the existing policy is not applied, and yet accepts that it makes good sense to address the issue administratively in the interest of reducing compliance and administrative costs, the Commissioner should be able to ask the particular taxpayer to provide an appropriate insurance bond to cover the perceived revenue risk.

5.59 The committee recommends that the routine practice of applying refunds to meet outstanding debts should be modified to allow discretion in its application. The committee accepts the recommendation of officials that this change should be considered during the review of the obligations of business taxpayers.

Release of refunds

5.60 The committee considered the issue of the release of a refund when part of that refund relates to an amount not under dispute. Section 174A of the Tax Administration Act 1994, provides that part of a GST refund relating to a non-disputed matter is not held up pending resolution of the dispute. The committee considered expanding this provision to cover all taxes.

5.61 The benefits to taxpayers from extending this approach to taxes other than GST would be significant. It would mean that when disputes arise over possibly minor matters, there would be no impact on a taxpayer's cash flow. Therefore, the committee recommends that the government should consider expanding this provision to provide a refund in relation to any tax if:

    the Commissioner considers that there is no risk to the revenue in making the refund;

    the taxpayer generally complies with all return and payment obligations under the relevant legislation;

    the taxpayer is not in material breach of any other tax obligation;

    there is likely to be more than a modest delay in resolving the elements of refund subject to dispute;

    the taxpayer is not in default in facilitating the resolution of the dispute; and

    the taxpayer has paid to the Commissioner the amount which is subject to the dispute.

5.62 Finally, to prevent undue administrative costs the committee considers that an appropriate minimum threshold should be set. In this way, the Commissioner will not be burdened with unwarranted and undeserving requests for an interim refund.

5.63 While supporting the application of the partial refund provision to all taxes, the committee notes that there may be complications for income tax. Typically with individuals, difficulties may arise with the progressive tax rates, varying rebate entitlements, and a range of other elements (perhaps linked to social policy initiatives) which may require separate consideration for any interim refund calculations. For companies, there are other factors that may be relevant, for example, the incidence of group tax losses and foreign tax credits. There may also be consequential impacts on the activities of other entities, such as partnerships, loss transfers from loss attributing qualifying companies and so on.

5.64 Therefore, for income tax, the committee considers that when the other partial refund criteria are met, it would be necessary for the Commissioner to have a discretion to authorise a refund to the extent the Commissioner considers appropriate.

5.65 The committee recommends that taxpayers should be able to request a refund of an amount of tax not subject to a dispute provided the criteria set out in para 5.61 are met. For income tax, a refund would be subject to the Commissioner's discretion as to the calculation of the appropriate amount of refund.

Depreciation

5.66 The depreciation rules allow an immediate deduction for property acquired for $200 or less. However, the property must be capitalised if first, it is purchased from the same supplier at the same time as other property to which the same depreciation rate applies, that is a bulk purchase, unless the entire purchase is less than $200 or, secondly, it forms part of property that is depreciable, such as refurbishment schemes and other capital improvements.

Increase in low-value asset threshold

5.67 The committee considered whether the threshold below which assets may be written off was too low. The benefit of any increase would be a reduction in compliance costs because taxpayers would not have to capitalise and depreciate relatively low-value assets. Reducing the compliance costs associated with the depreciation rules would simplify one of the more significant compliance costs associated with preparing an income tax return.

5.68 Some costs would be associated with any increase. First, providing immediate deductibility for assets of some enduring benefit would cause economic distortions. It would result in income being considered too low in the year of purchase and too high in subsequent years. Officials provided the committee with a table, reproduced below, setting out the estimated revenue cost of increasing the present $200 threshold to $300 or $500. The calculations are approximate, having been compiled on the introduction of the present depreciation rules. They also incorporate some transitional effects. These costs represent accelerated deductions, and are equivalent to the government providing a loan at zero interest rate, diminishing in value as the asset should have been correctly depreciated. These fiscal costs are transitional. In the longer term, immediate deductibility would broadly be matched by reductions in depreciation claimed. The economic distortions, however, would continue, as each low-value asset which should be depreciated qualifies for immediate deductibility.

Table 5: Estimated Revenue Cost

Write-off
threshold

Fiscal
year 1

Fiscal
year 2

Fiscal
year 3

$300

$30m loss

$95m loss

$41m loss

$500

$115m loss

$405m loss

$117m loss

5.69 Secondly, an option already exists for assets valued between $200 and $2,000. This option is the pool method, which provides simpler depreciation rules and a compliance cost gain without a great revenue cost. However, this gain is less than might first appear, because the rate that is applied is the lowest depreciation rate for any asset in a pool. For this reason, the assistance of a pooling option may do little in some cases to ease the compliance cost burden for low-value items.

5.70 Thirdly, an increase in the threshold means that a greater amount may be deducted immediately, increasing the possibility that the write-off provision may be abused in some way.

5.71 Finally, compliance cost benefits from immediate deductibility would arise only if the taxpayer does not keep a detailed record of the assets for some other purpose.

5.72 Taking into account the revenue cost, it is not clear that the compliance cost savings would be equally significant. Moreover, a viable alternative, the pool account approach, exists. The committee, therefore, recommends that, at present, there should be no increase in the $200 threshold.

Assets purchased at the same time from the same supplier

5.73 The committee considered a possible relaxation in the rules when goods are purchased from the same supplier at the same time as other property, while recognising that any recommendations might entail base maintenance consequences. In recent years, schemes have developed in Australia to exploit more lax write-off provisions than those operating in New Zealand.

5.74 The difficulties the committee identified with the present threshold were, first, when two items are bought at the same time, for example two chairs costing $135 each, the cost of these items must be capitalised. This rule imposes compliance costs out of proportion to the cost of each chair. Secondly, purchasing one item, and then a short while later, on the same day, purchasing a second item, means the cost of both items can be immediately written off. This position can make the present threshold appear silly, suggesting that amendment is necessary.

5.75 The committee has already noted that an outright increase in the threshold from $200 to $300 or $500 created a large cost to government, and was thus unable to recommend any such increase (see para 5.68). The committee then considered a proposal to allow immediate deductibility if more than two items were purchased, provided the purchase price of individual items did not exceed $500.

5.76 This threshold is more complex than either the present threshold or a $500 threshold. However, it brings a degree of common sense to bear. Principally, it substantially reduces the likelihood that a low-value asset purchased at the same time as another more expensive asset which has the same depreciation rate would be required to be capitalised and depreciated.

5.77 The revenue impact of any such change is impossible to quantify without a survey of taxpayers and purchased assets. Before proceeding with such a change, a survey of this type would be required to allow officials to quantify the impact and the offsetting reductions in compliance costs. However, the committee makes its recommendation subject to the revenue costs of the initiative being sufficiently mirrored by a reduction in compliance costs.

5.78 The committee recommends that the threshold should be increased to allow up to $500 in assets purchased at the same time from the same supplier to be immediately deductible, providing no asset exceeds $200 in value. The committee considers the recommendation should be costed to ensure matching of the reduction in compliance costs and the foregone revenue.

Safe harbour for assets of similar nature

5.79 The concept of a safe harbour approach to calculating and claiming annual depreciation deductions was suggested to the committee. This proposal could save taxpayers working through complex procedures to identify and apply correct depreciation rates through the creation of 'same genus' pools. The issue is whether the greater accuracy achieved would be in the wider economic interest of both the government and taxpayers.

5.80 The benefits of simplification are clear. At present, the rate and amount of annual depreciation deductions is determined on a line-by-line basis for each individual item of depreciable property, unless the taxpayer has adopted the pool approach for the asset in question. To identify the rate of depreciation applying to each item of depreciable property, taxpayers must work their way through a series of tests to identify which tables and what rate apply. This activity represents a compliance cost.

5.81 Additional issues arise. For example, the application of an incorrect rate could expose a taxpayer to the risk of a shortfall penalty, and even with depreciable property of apparent similar genus, different depreciation rates may apply91. A safe harbour for related assets, such a computer and allied equipment, office furniture and fittings, office equipment other than furniture, fittings and computer related items, and so on would seem to have merit.

5.82 While the benefits are clear, there are also disadvantages with this approach. The reason for the multiplicity of depreciation rates is that accuracy of depreciation is important in economic decision making. First, to the extent that rates are incorrect, they can cause significant distortions in economic behaviour. Lower than economic depreciation rates may lead to under-investment in capital assets, while higher than economic rates brings about the reverse situation.

5.83 Secondly, a revenue issue arises for the government and a compliance issue arises for taxpayers. Considering the significance of depreciation, it is likely that most taxpayers would have considered both the safe harbour option and the specific depreciation rate for an asset before determining which to apply. In effect, then, this approach increases compliance costs.

5.84 While compliance costs would decrease if taxpayers were required to use general depreciation rates rather than asset specific rates, the committee considers the resulting decrease in accuracy of depreciation rates could not be justified on economic or equitable grounds. Taxpayers would not welcome a measure which provided for a lower than economic depreciation rate in some cases, with the sole resulting benefit being a single reduction in the compliance costs associated with identifying a correct rate of depreciation for that asset.

5.85 The committee considered whether the compliance cost saving objective of any such safe harbour initiative might be met by increasing the threshold for adoption of the 'pooling approach' to depreciation. The committee was mindful that the original reason underlying the adoption of a pooling approach was to address the depreciation issue attendant on ownership and use of multiple assets of relatively low value. The focus of the pooling approach had not been on providing a safe harbour in the context of the general depreciation provisions. However, the committee was not able to identify any reason why the role of the pooling provisions could not be extended to perform much the same role as would safe harbour depreciation rates.

5.86 The committee initially considered proposing a pooling provision threshold increase to, say, $8,000 to $10,000. However, it occurred to the committee to ask whether there was a need to have a threshold at all. Moreover, it was unclear if a change were to be made, whether the business community, particularly small businesses, would actually make sufficient use of the pooling rules to provide a depreciation rate safe harbour. The committee considered that the matter deserved further analysis, and encourages officials to pursue this matter further.

5.87 The committee accepts that the line-by-line method of depreciating specific assets should continue. The committee recognises that the rules represent a balance between efficiency costs and compliance costs, with an emphasis on minimising efficiency costs. This emphasis is considered appropriate.

5.88 However, the committee recommends that the prospective benefits of increasing or even removing the present cost ceiling that limits the application of the pooling approach to depreciation should be evaluated with a view to allowing the methodology to be used as a depreciation rate safe harbour.

Goods and services tax

Threshold for payments basis for accounting for GST

5.89 An issue raised in submissions to the committee concerned the threshold for the automatic right to adopt the payments basis for accounting for GST, and whether it is set too low. Once taxpayers who are registered for GST exceed the threshold, they are required to adopt more complex accounting systems. A consequence of this requirement is a general increase in compliance costs imposed by the GST system.

5.90 The logical solution would seem to be an increase in the threshold. However, an analysis prepared by officials shows that increasing the threshold from $1 million to $2 million in turnover would provide a benefit to only 13,000 registered taxpayers, or 3 per cent of those registered. The present threshold allows up to 414,000 registered persons, or 92 per cent, to account for GST on a payments basis. In other words, while this measure would reduce compliance costs, the actual number of taxpayers who would benefit is small. An increase in the threshold would be warranted only with demonstrable compliance cost savings and no sufficient offsetting risk. There may also be a case for a small increase to account for inflation92.

5.91 The committee has identified some real risks associated with an increase in the threshold. Any increase would raise the potential for significant revenue risk through deferred settlement arrangements, that is, when the person acquiring goods or services pays on an invoice basis and the supplier accounts on a payments basis. The risk would be particularly acute with land transactions. The committee has also recognised the availability and sophistication of accounting systems which reduce the compliance costs imposed on people who account on an invoice basis.

5.92 Nevertheless, the committee inclines towards amendment in this area. One possible change that may not increase the risks identified, while still providing a benefit, would be to allow a longer time for the transition to the invoice basis for accounting.

5.93 It is important that people who are registered for GST should not suddenly discover that they have exceeded the statutory threshold for the payments basis for accounting for GST. Once this level is exceeded, taxpayers are no longer eligible to use the payments basis of accounting. Even an inadvertent breach leaves a registered person liable to shortfall penalties. The committee considered that such people should be eligible to continue to use the payments basis for at least a further year, thus recognising that exceeding the threshold might not be immediately obvious. Also, an opportunity should be provided for people to take whatever steps are necessary to decide on and implement the necessary systems changes. While this delay may mean that some people do not move directly to accounting on an invoice basis when they are able to do so, it would provide an appropriate breathing space for most.

5.94 The committee recommends that a registered person who is no longer eligible to use the payments basis of accounting should be able to continue accounting in that way for a further year before being required to adopt the invoice basis of accounting. The committee also recommends that the government should consider an increase in the threshold to account for inflation.

GST tax invoices

5.95 All small businesses incur compliance costs in ensuring that the documentation they hold to support a GST input tax claim is a tax invoice, as required by section 24 of the Goods and Services Tax Act 1985.

5.96 Evidence shows that a high proportion of the documents held by small businesses which purport to be tax invoices do not meet the statutory requirements. If the recipient of a supply does not take the time to get a proper tax invoice, or to get the supplier's authority to make changes that will convert the existing documentation into a valid tax invoice, he or she risks penalties for making an input tax claim without valid supporting documentation.

5.97 The committee considered ways to reduce this burden. The key constraint is that, for the GST system to work effectively, an audit trail is required. Relaxing the requirements could result in difficulties for the Inland Revenue Department in its audit activity.

5.98 There is an overriding expectation that the issuer of a document purporting to be a tax invoice should ensure that the document meets the statutory criteria. However, the integrity of the system depends in part on the recipient of a supply checking the adequacy of the supplier's documentation. In a self-assessment environment, taxpayers are considered to be responsible for their own affairs. Accordingly, it is appropriate that the responsibility for ensuring an invoice meets the required standard lies with the user of that invoice.

5.99 However, the committee considers that some action is required and, therefore, recommends that the Inland Revenue Department should publish a statement on its operational policy on GST tax invoices, identifying errors that are considered significant and errors that are not. This statement would provide recipients of supply with far greater certainty and should emphasise the underlying principle that tax invoices must provide a clear audit trail. A clear establishment of the principles involved would reduce the risks associated with this proposal.

5.100 The committee is also aware of the proposal under the present GST review that the threshold for accepting an abbreviated tax invoice for verifying an input tax credit should be raised to $1,000. The committee supports this initiative.

Increase in the threshold for tax invoices

5.101 The committee considered whether it should recommend an increase in the $50 threshold for requiring tax invoices to reduce the compliance costs associated with issuing, ensuring receipt of, and storing documents that meet the requirements for a tax invoice.

5.102 There is a risk to the government of exposure to falsified input tax credit claims. Because of this risk, some countries do not have thresholds at all. The committee considered the balance between reducing compliance costs and a possible increase in tax evasion through claims for fictitious deductions. The committee noted that the relatively low inflation over the last decade has meant little inflationary pressure to increase the threshold. Further, if there were to be an increase, the next logical step would be $100.

5.103 In the end, the committee steered towards retaining the present threshold because of earlier recommendations on the increased threshold for simplified tax invoices, and because of the potential risk to the revenue resulting from increasing the threshold to the next logical level. The committee recommends that there should be no increase in the $50 threshold for tax invoices.

Private use adjustments

5.104 Many businesses, being GST registered activities, own and use assets which also are used in part by the proprietors for their own requirements. Similarly, many proprietors use their own personal assets for business purposes. While GST adjustments for this secondary use are required in each taxable period, the level of adjustment is almost always minor. For accounting purposes, more often than not, the corresponding adjustments are calculated or implemented after year end, as part of the annual accounting wrap-up after balance date. Having two different adjustments, one during the year and one at year end, seems to impose unnecessary compliance costs.

5.105 The committee considered whether registered persons should be allowed to make private use adjustments on an annual basis in the GST return corresponding with the date of the annual income tax return.

5.106 There is no question that secondary use adjustments should be part of the GST system, but the compliance costs that would be involved in monthly adjustments seems unduly high when compared with the resulting benefit. A precedent is available for moving private use adjustments to the period in which the annual income tax return is filed. The annual adjustment for GST on entertainment costs is made in this way.

5.107 While the committee considers this measure would not be subject to abuse, the possibility does exist, and the committee considers that an appropriate limit could be introduced to apply in cases where the collective annual adjustment exceeded a threshold, say $5,000.

5.108 The committee recommends that GST secondary use adjustments for private or exempt use should be moved to the period in which the annual income tax return is filed except when the adjustment involves the procedures available for acquisitions of items under $10,000.

Unit trusts

5.109 Unit trusts are trusts, but are treated by the tax system as companies. While legally trusts in form, the relationship between unit trust and beneficiary is very similar to the relationship between company and shareholder, as the trust units are purchased from the trust in the same way as company shares are purchased from companies. Thus, the two entities are closely substitutable.

5.110 In the case of ordinary trusts, the beneficial interests are created upon settlement, and the settlor and beneficiaries are different, that is, the trust corpus is contributed by someone other than the beneficiaries.

5.111 Tax treatment favours ordinary trusts because trust income is only taxed at one level in either the trustee's or the beneficiary's hands93. Company income is generally taxed at two levels, first, to the company as it is earned and, secondly, to the shareholders when it is distributed, with the imputation system preventing double taxation. However, when the company has not paid tax, it cannot attach imputation credits, and tax is then imposed on the distribution. Ordinary trusts are not taxed on the foreign-sourced income of non-resident beneficiaries. The scope of this relief is greater than the conduit tax relief recently enacted for companies.

5.112 It is because unit trusts have a commercial nature, and because they can generally be substituted for companies, that the government has chosen to apply the company tax rules to them to maintain the integrity of those rules, and to define exactly what tax treatment will apply when income interests, whether shareholder or beneficiary, are created by purchase or by capital contribution. Nevertheless, this treatment has created problems for managed funds, which face practical difficulties in applying company tax rules.

Foreign unit trusts

5.113 Difficulties arise in relation to foreign unit trusts. It may be suggested that New Zealand should apply the trust rules to unit trusts that have all non-resident beneficiaries and earn only foreign-sourced income. The trust income would not be taxed, as it should not be, because it is all foreign-sourced income earned on behalf of non-residents. Such treatment would act as an incentive for unit trusts to be managed in New Zealand.

5.114 While this may be the case, the system would then be faced with the difficulty of having to differentiate between unit trusts and companies. The pure flow-through treatment could raise the concern of New Zealand's tax treaty partners that New Zealand was being used as a tax haven, particularly if such unit trusts sought to use tax treaty benefits. This concern could affect New Zealand's negotiating position in tax treaties. While the committee accepts there are some potential benefits in using trust tax treatment for unit trusts, it also recognises that a legitimate concern arises with this approach in the terms of the integrity of the company tax rules and the reaction of tax treaty partners.

Financial arrangements

5.115 The qualified accruals rules are extremely important. However, for most people, they have proved very difficult to comprehend and apply. While changes to make the rules more accessible were included in the Taxation (Accrual Rules and other Remedial Matters) Bill, the committee considered two issues aimed at simplifying these rules.

Alternative approach to valuing financial arrangements

5.116 The committee was advised that work had been undertaken by officials on a year-end based valuation approach to accounting for financial arrangements, similar to the approach taken for trading stock. Under this approach, the valuation of financial arrangements would be based on the discounted value of future cash flows, with the income or expense for a given period based on the difference between opening and closing values adjusted for acquisitions and disposals.

5.117 The analysis of this option by officials found that substantial changes would be required to the Income Tax Act to accommodate this approach. On this basis it was concluded that the costs outweighed the benefits of a possible change in approach to accounting for financial arrangements. Officials were also concerned about the delays that any detailed analysis of this option would cause. This concern among other matters unfortunately meant that this issue could not be considered for inclusion in the Taxation (Accrual Rules and other Remedial Matters) Bill which was introduced in November 1998.

5.118 The complexity of the issues involved and the time available to the committee restricted its consideration of this approach to valuing financial arrangements. However, on the face of it, this approach may have merit. The committee recommends that this approach to valuing financial arrangements should be considered as part of the rewrite of subpart IH of Income Tax Act 1994.

Priority for the rewriting of accrual rules determinations

5.119 The committee in paras 2.191 to 2.196 considered the role of the accrual rules determinations under the qualified accrual rules. The committee concluded there that most determinations need to be rewritten.

5.120 When considering possible simplification measures for inclusion in this chapter, the committee identified the fact that the recommended rewriting of the determinations would represent a significant simplification measure. The committee therefore recommends that rewriting the accrual rules determinations should be given a high priority. While it recognises that the government must prioritise the use of its resources, the committee concludes that the determinations should be rewritten in the same style as the accruals legislation recently introduced into the House.

Administrative issues

Readability of customer assessments and statements

5.121 To address an often-stated concern about the readability of Inland Revenue forms, the committee sought information on taxpayers' assessments of the readability and comprehensibility of statements and notices. The committee was particularly concerned about the quality of the existing statements of account. These statements can be confusing even for tax practitioners who frequently use them.

5.122 The information provided by the Inland Revenue Department gave the committee some confidence that the department is actively working to improve its statements and notices. A guide to the preparation of Inland Revenue forms is attached at appendix 4. The committee considers the list in that guide has merits, and that the Inland Revenue Department should apply these principles to all statements as soon as possible.

5.123 The reverse page of the statement of account should provide meaningful information on what taxpayers can or should do if they do not understand or agree with the position disclosed. Although not all matters in dispute will necessarily come within the disputes resolution process, the information should include some cautionary note about the time frames required in that process.

5.124 The committee recommends that priority should be given to the redesign of statements of account, the nature of the data disclosed, and the manner in which it is disclosed.

Internet access to Inland Revenue Department forms

5.125 The committee considered whether Inland Revenue forms should be made available on the department's website. The benefits of being able to download the forms when required would be considerable. The Inland Revenue Department has begun work on this goal, and the committee supports this work.

5.126 Some forms, however, such as the new employer monthly schedule and the various tax returns, require an actual Inland Revenue form to be filed for smooth administrative processing. For these forms, special inks and pre-coded items are used to facilitate electronic processing.

Taxpayer education

5.127 The committee considers that the Inland Revenue Department should publish more tax booklets targeted at specific industries94, and at specific common transactions95. Under self-assessment, this detailed information must be provided to taxpayers if they are to meet the standards of behaviour required by the rules governing compliance and penalties.

5.128 The committee recommends that Inland Revenue Department should publish booklets for specific industry groups, advising taxpayers of their tax obligations and the tax treatment of specific transactions.

Footnotes

86 The rate of 24 per cent was proposed in the Report of the Task Force on Tax Reform (the McCaw Report), April 1982, pages 152-160.
87 This calculation assumes a depreciating motor vehicle value averaged over the five-year period. 89 Voluntarily, except in the case of registered persons with turnover exceeding $24 million.
90 Turnover must be less than $250,000. 91 For example, desktop PC = 40%; printer = 33%; and so on. 92 The threshold was increased from $500,000 to $1 million with effect from 1 October 1990. Inflation adjusting the threshold based on September quarter Consumer Price Index information up to Septem-ber 1998 would increase the threshold to $1.16 million.
93 If trust income vests in a beneficiary in the income year in which it is earned by the trust or within six months after the end of the year, it is taxed to the beneficiary. All other trust income is taxed to the trustee. Subsequent distributions to beneficiaries of income which has been taxed to the trustee are generally not taxed.
94 For example, the restaurant trade, the building industry, the publishing industry and the retail sector.
95 Such as investing in a property offshore.