For over 30 years the New Zealand Inland Revenue Department (IRD) has – with very limited exceptions – consulted closely with the public and the accounting and legal professions in relation to tax law reform. Whilst (obviously) submissions from interested parties will not always be accepted, there has been a strong willingness by IRD Tax Policy to engage with stakeholders with a view to ensuring that legislation is fit for purpose, well drafted, and does not create unexpected outcomes or result in retrograde changes.
There were massive tax reforms in the late 1980s in relation to the tax treatment of trusts, companies, portfolio investments and financial assets, introduced as part of the free market reforms of the Labour Government which was elected in 1984.
New Zealand presently has a centre-left Government comprised of the Labour Party and the Green Party, although Labour has a simple majority on its own and can govern without Green support. Unfortunately Labour’s approach to tax reform has been much more prescriptive and ad hoc, and the consultation that was a well regarded feature of the so-called Generic Tax Policy Process (GTPP) appears to have been disregarded on many occasions. Many of the tax changes canvassed in this article were pushed through under urgency with little opportunity for consultation between the stakeholders and IRD Tax Policy, and the changes were subsequently rushed through Parliament with little opportunity for debate or Select Committee consideration. It should be emphasised that this approach is driven by the Minister of Revenue, not IRD.
Typically, rushed legislation is most often bad legislation.
New Zealand’s personal income tax rates are not particularly high by most international standards; however the progressive tax thresholds kick in at relatively low levels. It has been pointed out in early 2022 that someone on the minimum wage would only have to work 43 hours a week to push the top part of their income into the 30 per cent tax bracket (compared to the lowest rate of 10.5 per cent on the first NZ$14,000).
This Government and its predecessor, a Labour/New Zealand First Coalition, have done nothing about the fiscal drag/bracket creep as incomes have risen.
The Labour government has also introduced a new top personal tax rate of 39 per cent on income over NZ$180,000 per annum. Previously the top personal rate was 33 per cent, which aligned with the trustee tax rate of 33 per cent. The corporate tax rate remains at 28 per cent, which in the current environment incentivises retention of corporate profits and/or the use of trusts as shareholding vehicles.
The Labour-led Government of Helen Clark (1999-2008) had previously increased the top tax rate to 39 per cent, which was subsequently reversed by the centre right National Government. As is to be expected, this encouraged individuals to retain income at trust level to avoid the new top tax rate. This response resulted in anti-avoidance action by IRD, and no doubt the new 39 per cent rate under the current Government will trigger a similar reaction.
The Labour Government elected in 2017 was very keen on introducing a capital gains tax (CGT), however this did not proceed partly due to its coalition partner – the New Zealand First Party – not being in favour, but also perhaps because the Prime Minister realised it might produce a very negative reaction at the next election.
At the time that the CGT was being promoted by the Labour Government there was a PR exercise undertaken to emphasise that what they were looking to tax was “capital income” (for example, increase in value of shares) – which is clearly misleading given that the fiscal distinction between income and capital gains is well-established, and seeking to treat such gains as a type of income was disingenuous.
Somewhat surprisingly the Prime Minister ruled out the introduction of a CGT whilst she remained Prime Minister. Ironically in 2020 the Labour Party won an outright majority (thanks to a “Covid election”) which would have given them the facility to introduce a CGT, but at this point the Prime Minister has not backtracked on her promise, and given declining popularity in recent polls, it is unlikely that she will do so in this term of government.
However, as a result of high levels of Government spending, borrowing and quantitative easing, there is certainly pressure on the Government to look to increase revenue to balance the books, over time.
Aside from the introduction of the new top rate of 39 per cent, two other measures are worth examining as examples of ad hoc and incoherent tax changes.
Because of very substantial increases in the price of residential property in recent years (which is particularly disadvantageous to first home buyers and those on more modest incomes), the Government extended the so-called “Bright-line Test” introduced by the National Government when it was last in power.
New Zealand does not have a comprehensive CGT, but it does have some specific statutory provisions which will treat what would otherwise be regarded as capital gains as income. These older provisions (particularly in relation to land) are entirely coherent from a tax policy perspective, as they capture gains which are on the cusp of being categorised as income according to ordinary concepts. For example: gains on the sale of a property purchased with the intention of resale; gains on subdivision or development projects which fall short of constituting a full business, and so on.
While the burden of proof is on the taxpayer, it can be difficult to establish if a taxpayer purchased a property with the intention of resale, and as a consequence the National Government introduced a Bright-line test which in essence deemed a person to have had that intention if they sold a property (excluding the taxpayer’s primary residence) within two years of acquisition. This was intended to discourage speculation.
It is questionable whether the two year Bright-line test achieved anything in terms of suppressing the increase in value of real estate, however the Government decided that they should go further and extend the Bright-line Test to a five year period. Subsequently they extended it again to a ten year period.
Arguably these measures have achieved very little, but the offensive thing about the extended Bright-line Test is that it is ridiculous to suggest that a person who sells a property within five or ten years of acquisition should be deemed to have had the intention of disposal at the time of acquisition. This presumption which underlies the Bright-line Test made some sense with a two year period, but not the longer periods.
Moreover, Bright-line Test creates an ‘all or nothing’ threshold – there is no pro rata reduction in the tax applied on, for example, a sale in year nine versus a sale after the end of year 10. Moreover, the tax rate applicable will in most cases be the top personal rate of 39 per cent, which would have to be one of the highest effective CGT rates in the world.
While there is an exemption for the family home, if individuals have to sell real estate (holiday homes, rental properties) because of a change of personal circumstances, they could face a very substantial tax penalty. Furthermore, there are no concessions in relation to internal transactions where there is no effective change of beneficial ownership – for example if an individual wanted to put the property into a trust, or if it was desired to resettle an affected property from one trust to another trust for the same family group.
The second example of incoherent tax policy in the residential real estate context was the decision by the Government to disallow deductibility of interest expense in relation to rental properties. It is obviously a bedrock principle of most (if not all) income tax regimes that there is an entitlement to claim a deduction for expenses of a revenue nature (including interest) which are incurred in the course of producing income. The Government alleged that interest deductibility was a “loophole” that needed to be closed.
The driver behind this was that individuals/trusts were buying residential rental properties and using leverage to minimise their tax, allegedly to the detriment of first home buyers and the like. This may be true but there was no principled basis for this particular change.
Aside from these changes in the residential property context, the Government has more recently introduced a new section into the Tax Administration Act 1994 (section 17GB) which gives the IRD much greater powers to gather information “…that the Commissioner considers relevant for a purpose relating to the development of policy for the improvement or reform of the tax system”. In other words, information collected need not be relevant to calculation of the taxpayer’s income tax liabilities.
These law changes were introduced under urgency without any consultation or Select Committee review that would normally be part of the GTPP. The scope for information collection is highly intrusive and has an impact on privacy, as well as imposing a significant compliance burden on individuals and trusts. The powers have (so far) been used for a “research project” IRD is undertaking in relation to high wealth individuals. It has notified about 400 high net worth individuals (HNWIs) who have been sent extensive questionnaires. There are presently legal challenges to this initiative being undertaken through the courts, presumably based on Bill of Rights or Privacy Law principles.
IRD has stated that the project will “help to create a comprehensive picture of the tax system and ensure future policy development is built on more robust evidence”. IRD has attempted to provide assurances that privacy and confidentiality of all information collected will be maintained and the information will not be shared with IRD staff in the compliance or investigation areas; and that the information will ultimately be destroyed. However, some commentators have noted that it may be that the information could be subject to a foreign information request under a double tax agreement or multilateral instrument.
IRD have stated: “The project seeks to fill a gap in our knowledge of effective tax rates in relation to economic measures of income, particularly for high-wealth individuals. The effective tax rates calculated will compare the amount of tax paid by an individual with different measures of income – including a measure of economic income. Economic income is a broader concept than taxable income”.
It is not difficult to see where this is headed.
There is a second initiative relying on hastily enacted provisions in the Tax Administration Act (sections 59BA and 59AB): a domestic trust reporting regime. It is beyond the scope of this article to examine this in detail, but it will place much greater obligations on trustees in terms of preparation and filing of accounts and filing of an annual return. It is quite intrusive in terms of information collected, which is not directly connected with determining the income tax position of the trust.
The new disclosure rules for trusts are still in part a work in progress, but when completed they will be retrospectively applicable from the income year commencing 1 April 2021. There will be some exclusions from reporting, and it may be that trusts will be restructured in certain ways to take trusts holding a family home or holiday homes into personal ownership or into a separate trust to simplify or reduce the level of reporting.
Aside from information about distributions, and the filing of accounts, there will also be a need to annually provide information on the amount and nature of settlements upon the trust, details of settlors and appointors/protectors, and so forth. For all connected persons, information required includes full name, date of birth, jurisdiction of tax residence, and Tax Identification Numbers.
IRD Tax Policy, to their credit, have done a sterling job of engaging with the professions in order to refine (as far as they can) the implementation of the domestic trusts disclosure regime, but they are constrained by the fact that the primary legislation is already enacted and there is no apparent scope for revision.
The expectation is that the information gathered through these two processes will possibly result in the Government increasing the trustee tax rate to match the top personal tax rate if they perceive that there is revenue leakage through the use of trusts. And CGT or other forms of capital tax (such as inheritance tax) may be reconsidered.
John has specialised in tax and trust law since 1984. John provides tax and trust advice to a wide range of New Zealand and offshore corporate and private clients, and not-for-profit organisations. The majority of his work is cross-border/international in nature. John is a frequent presenter at conferences in New Zealand and internationally and has authored numerous publications on tax and trust law issues. He was a part-time Teaching Fellow at the University of Auckland for the Master of Taxation Studies degree. John was Founding Chairman of the New Zealand branch of STEP and has served as a STEP Worldwide Council member.