Address to the Deloitte Tax Seminar

  • Michael Cullen
Finance

Good Afternoon.

It is a real pleasure to be here with you to deliver the opening address in this tax seminar and also to answer any questions that you may have of me.

I know that it will be a very busy, fruitful afternoon for you all as the Deloitte Partners update you on the quite significant tax developments in New Zealand over the last 12 months and advise you on the practical implications of developments for your own operations.

Tax policy update

Governments develop their taxation policies with a view to the long-term interests of the country, rather than in response to the current state of the economic cycle.

And the main focus of the Government’s tax policy work programme over the last few years has been on measures designed to help to strengthen the economy, and the well-being of New Zealanders, over time.

These include tax measures to help increase productivity and growth, to make New Zealand businesses more competitive in the international market place and to increase personal savings and strengthen our national savings culture.

Tax policy alone cannot achieve these things. 

It can, however, contribute to their achievement, by, for example, reducing tax costs for businesses, removing tax obstacles to growth, and introducing tax incentives to encourage certain activities – such as business investment into R&D and saving for retirement.

That was the thinking behind the recent reforms that resulted from the government’s Business Tax Review.

They included the reduction in the company tax rate to 30%, an associated cut in the tax rate for certain savings vehicles, and the new 15% tax credit for R&D.

As you will know, the government has also carried out major reforms that produced KiwiSaver, the relief of over-taxation of people who save through New Zealand-based managed funds, the application of consistent tax rules to offshore portfolio investments in shares, and Working for Families Tax Credits.

Budget 2008 brought in a three-year, $10.6 billion programme of personal tax cuts that begin on 1 October this year. The lowest personal tax rate will be reduced from 15% to 12.5%, and the thresholds at which personal rates apply are to be raised progressively over the next three years.

Complementary changes to Working for Families Tax Credits increased the entitlement to the Family Tax Credit and raised the income threshold at which abatement starts.

Tax cut follow-up work

As I announced in the Budget, the current resident withholding tax rates on interest income – which are 19.5%, 33% and 39% – will continue to apply for the time being, while the government discusses the impact of the tax cuts with the banking and financial services sector. 

The PIE tax rates will also remain the same – at 19.5% and 30% – for the time being while the government discusses the impact of the tax cuts with the managed funds industry. 

That work has begun.  Tax policy officials have already started some preliminary consultation with interested parties on changing the RWT and PIE rates, in anticipation of formulating proposals for inclusion in a public consultation paper to be released in late August.  It is expected that any changes resulting from that process would apply from 1 April next year.

The tax cuts will have a downstream effect on other areas as well – including secondary tax codes – and these are also under consideration.

Some of the anticipated changes will obviously require a legislative fix, while others may be dealt with administratively.   

The Tax Bill

Budget 2008 also announced that a forthcoming taxation bill would reduce tax-related compliance costs for businesses by removing tax impediments to the offshore expansion of New Zealand-resident businesses, and by raising a number of tax thresholds.

That bill was introduced today and I will touch upon some of those reforms in the course of my address to you.

International

The main feature of the bill is the reform of New Zealand’s international tax rules, which represents a fundamental change in how we tax the offshore income of our controlled foreign companies. 

The bill will give effect to the first phase of changes to emerge from the continuing review of the rules.  The aim of the review is to improve the competitiveness of New Zealand’s international tax rules by bringing them into line with the relevant rules of our main competitors. 

These changes will enable New Zealand-based businesses to compete more effectively in foreign markets.

The central feature of the reform is the introduction of a tax exemption for active income from the offshore operations of New Zealand-based businesses.  That income is taxed under our current rules, except when it comes from operations in the eight grey list countries.

The proposed new rules will replace the grey list exemption with an Australian exemption.  That is a purely pragmatic measure, so that when New Zealand companies set up operations in Australia, which is usually where our smaller businesses start when they want to expand overseas, they will not have to face the compliance costs associated with meeting the active business test.

It is also consistent with Closer Economic Relations and with the rules for portfolio investors.  Furthermore, from the perspective of New Zealand’s revenue base maintenance, it is also more practical for us to monitor the Australian tax system than it is to keep tabs on those of other jurisdictions.

The continuing review has been the subject of extensive consultation over the last two or three years.  The next round of consultation is scheduled to take place soon, with the release of a consultative document on the tax treatment of non-portfolio foreign investment funds.

Tax thresholds

As previously announced, the bill will introduce further amendments to reduce tax compliance costs for businesses by raising a number of tax thresholds.  Those changes are aimed at small and medium-sized business, in particular, which represent a large portion of the economy and tend to bear a disproportionate tax compliance cost burden.

Higher thresholds can translate into a reduction in the number of tax returns a business has to file, the data it must supply, or the calculations it must make – in other words, there may be fewer tax matters for individual businesses to deal with.

For example, the PAYE once-a-month filing and payment threshold will be raised from $100,000 to $250,000.  That will allow a greater number of small employers to file and pay their PAYE deductions once a month instead of twice a month.

The changes to be introduced shortly represent the first phase of the government’s review of ways of reducing tax compliance costs.   The second phase of the review will examine initiatives that represent more significant departures from the normal tax rules that businesses have identified as being worthwhile.  

Life insurance

The bill will also modernise the taxation of the life insurance business, a reform that has also been the subject of extensive consultation with the industry.

The current life insurance tax rules date back to 1990, and much has changed since then, in both the life insurance business itself and in the general commercial environment in which it operates. 

As life insurance products and business practices have changed over the years, legislative anomalies have developed in the tax rules.  For example, term insurance, which was a very small part of the business in 1990, and therefore not an important factor in developing what were then the new tax rules, has now become an important part of the business. 

The result is that, in many cases, term insurance profits are under-taxed, with profitable business often leading to tax losses. 

On the other hand, the income from savings through life products is over-taxed relative to that from savings through other vehicles under the recent savings reforms. 

The bill will introduce a framework of changes that taxes life risk business on actual profits in a manner similar to the way that other businesses are taxed, and it will extend the tax benefits of the PIE rules to all savers in life products.

Relocation payments and overtime meal allowances

The bill will also introduce legislation to remove long-standing uncertainty over the tax treatment of employer payments for employee relocation and overtime meals.  The lack of clarity arises over whether these payments should be considered as income of the employees who receive them, which would make them taxable.

The changes will ensure that these payments are exempt from income tax and, when relevant, from fringe benefit tax as well, provided they meet certain criteria.

From a business perspective, the changes are intended to help employers make efficient decisions that are not distorted by tax considerations and save them valuable time and resources.  

PIEs

The bill will also introduce a number of refinements to the new portfolio investment entity – or PIE – rules to ensure they work as effectively as possible.

The changes will not be of a fundamental nature – most will deal with technical problems that have emerged as the rules bed in, or will amend the rules to cater for differing circumstances. 

The main role of the PIE rules is to better align the tax treatment of people who invest through managed funds with that of people who invest in shares directly.

For PIEs that elect to be portfolio tax rate entities, investment income flows through to be taxed at a rate closer to the investor’s personal tax rate.  The top tax rate is now capped at 30%, down from 33%, which means PIEs are also providing benefits for investors on higher personal tax rates.  A further attraction is that PIEs are not taxed on realised gains on shares in New Zealand companies or listed Australian companies.

When PIEs were introduced last year the government was aware that they had the potential to change the landscape significantly for managed funds and other types of savings vehicles.

Less than a year down the track and it appears that New Zealand has embraced PIEs with considerable enthusiasm. 

For example, although the PIE rules were not specifically designed to cover cash and other income funds, the development of so-called “cash PIEs” appears to be a natural consequence of the new rules.

As well as holding shares and debt investments, PIEs can also directly own land, since passive investments in land can be an important part of a diversified investment portfolio.

However, weaknesses in the current PIE rules could allow land-owning companies that run active businesses to structure the land part of their business as a PIE, to reduce final tax on shareholder earnings.   That is against the policy intent of the PIE rules, and the bill will amend the rules to prevent it happening.    

The main areas covered in the PIE amendments will be the eligibility criteria for becoming a PIE; the calculation of tax liability, filing and information-provision requirements; and investors’ tax rates that are used by PIEs.

Associated persons

Also introduced in the bill are changes to strengthen and rationalise the definitions of “associated persons” in income tax law.

The definitions are used extensively in the Income Tax Act, primarily in an anti-avoidance capacity to counter transactions that are not conducted at arm’s length and therefore have the potential to undermine the intent of the law. 

There are a number of major weaknesses in the current definitions, particularly in the definition relating to land sales.  That definition contains some major gaps which allow land dealers, developers and builders to circumvent  the land sale tax rules by operating through closely connected entities.

Parliament’s clear intent in 1973, when it enacted the current land sale tax rules, was that land dealers, developers and builders would be generally taxed on all gains on property sold within ten years of acquisition, and they could not claim to hold non-taxable investment portfolios.

A consultative paper released last year put forward a number of suggestions for closing the gaps in the definitions.  Those relating to land sales attracting a large number of submissions, many of which were concerned about the potential over-reach of suggested solutions.  As a result of consultation, the government has refined the proposals relating to land sales, to ensure that they do not apply more widely than intended.

The bill will generally make the associated persons definitions more robust. 

Petroleum mining

Earlier this year the government announced that it would introduce legislation to prevent New Zealand missing out on significant tax revenue from the local petroleum mining industry.

Exports of New Zealand crude oil have recently been making a significant contribution to New Zealand’s trade balance and they are expected to continue to do so over the medium term. 

Just to give you some idea of the value of these exports, receipts amounted to about $1.5 billion in the six months to March.  

Legislation ensuring that New Zealand has its proper share of the benefits from our petroleum resources is part of the bill. The changes will ensure that expenditure on petroleum mining operations undertaken through a foreign branch can be offset only against petroleum mining income from outside New Zealand.

The bill also contains a number of amendments updating the petroleum mining rules, to remove possible disincentives to further investment in oil and gas exploration and development in New Zealand. 

Non-disclosure of documents

To touch briefly on a topic that is dear to the hearts of accountants and has been the subject of much discussion, the bill will also introduce amendments to allow the right of non-disclosure of documents to apply to discovery and similar processes that occur in litigation with Inland Revenue.  The right already exists for the investigation and disputes phases. 

That change is intended to better align the treatment between lawyers and accountants with reference to providing information to Inland Revenue.

These, then, are some of the business tax changes that will form part of the bill that is to be introduced shortly. 

Mutual recognition of imputation credits

In a speech last month to the Australia-New Zealand Leadership Forum I  expressed the view that for the Single Economic Market to have benefits for both countries, and to remain relevant to business needs, it makes no sense to deny imputation credits when dividends are paid across the Tasman.

Mutual recognition of these credits is something that people in New Zealand, which undoubtedly includes some of you here today, have long been asking for. 

Such a system would involve each country providing tax credits to resident individuals who receive company distributions from across the Tasman, to compensate for tax paid in the other country.  To do that, New Zealand would need to make some adjustments to our imputation rules so that they fit more easily with the Australian rules, though that should not be a major problem for us.

If we cooperated in this way, both countries would be better off because a barrier to trans-Tasman investment flows would have been removed. Australian investment into New Zealand and New Zealand investment into Australia would both be encouraged, thereby boosting the efficiency of capital allocation in the combined trans-Tasman economy.   This would, in my view, lead to increased productivity and growth overall for Australasia as a whole.

There would, of course, be some loss of tax revenue to both countries, as mutual recognition would relieve one level of tax from what is now double taxation of trans-Tasman investment.

I do acknowledge that Australia has significant concerns that mutual recognition could create a precedent that would need to be extended to other countries. 

However, the logic of the Single Economic Market is to allow investment to flow as easily between countries as it does within our individual countries. 

I think mutual recognition is important and I look forward to discussing it with my counterparts in Australia in the coming months.

Rewrite – unintended law changes

I would like to conclude this speech with a comment about unintended law changes arising from the recent rewrite of the Income Tax Act, since one of the organisers of today’s event has suggested that it is an area of concern for some of you here.

I want to assure you that a process is in place for dealing with any unintended law changes that are identified.

With the completion late last year of the fourth and final stage of the 15-year rewrite of the Income Tax Act, and the resulting enactment of over 3000 pages of legislation, the terms of reference of the Rewrite Advisory Panel were modified to change its role to one of reviewing potential unintended law changes. The panel now has the core function of reviewing any submission that an unintended change in the law may exist in the rewritten 2004 and 2007 Acts and, where necessary, to recommend appropriate legislative action.

It is also to monitor and report back to Ministers on the 2007 Act and its continuing consistency with the objectives of the Rewrite Project.  That may include receiving submissions regarding the extent to which the Act’s drafting continues to be consistent with Rewrite objective.

The chairman of the Rewrite Advisory Panel, announced just last month, is Wellington barrister David McLay, and I am certain that he will be pleased to entertain any concerns you may have.

With that, I wish you a very successful seminar and am happy to take any questions that you may have of me.

 

Speech notes prepared ahead of address to the Deloitte Tax Seminar, Auckland