The Week in Tax An expensive and too common GST mistake, reporting overseas income, and more on Labour’s higher income tax proposal

The Week in Tax An expensive and too common GST mistake, reporting overseas income, and more on Labour’s higher income tax proposal
Vaikoovery / CC BY (https://creativecommons.org/licenses/by/3.0)

GST is frequently touted as a simple tax, and I think that's partly because there's only one rate and it applies across the board on almost all goods and services consumed in New Zealand. But like any taxes, it has a number of hooks in it which frequently trip people up.

Some of these hooks shouldn't be tripping people up because they've been known about for some period of time. But surprisingly, I still come across this particular issue time and again. And it's really quite concerning that it still does happen.

The issue will almost invariably involve land. And it is where someone has purchased land from an individual and then decides that it's perfect for a development activity or whatever, and then sells that across to a company or sometimes a trust which is registered for GST which then claims an input tax credit.

This is where things go off the rails.  The issue is that the supply from the individual/another company who initially purchased the property to another party which is “associated” with it means that for GST purposes, the GST input tax claim that can be made is limited to the amount of GST paid by the first person.

Now, this provision, section 3A of the GST Act, has been in place since October 2000. It applies to transactions between “associated persons” which given the wide definition in the associated persons rules is very likely applicable when there are common shareholders/trustees/settlors.

What section 3A is designed to do is to stop someone buying a property then on selling it at an inflated price to an associated GST registered entity, which then picks up an increased input tax credit. And the rule basically says that the GST input tax is limited to the amount paid by the original purchaser. And since that purchaser often purchases it off a non-GST registered person, that amount is nil.

And I see this quite a bit. I'm surprised some lawyers and accountants haven't really got across a measure which is now 20 years old.

The latest example I’m trying to unwind is that the individual purchased the property, and then after advice from a lawyer, that for asset protection and business purposes, it would probably be better that the land be sold to a company to carry out the proposed development. That itself is not unreasonable advice. Problem was the lawyer overlooked the impact of GST and the client who is new to New Zealand didn't get tax advice at the right time which is another common mistake.

The company actually did get an input tax credit and refund of $450,000. You might well ask why did the Inland Revenue let a GST input tax claim of that amount go through? Fair question but it's a complicated story.

Anyway, Inland Revenue then took a further look at it and then said, “Oh, no, you're not entitled to that refund”. So now the client has to find $450,000 dollars and pay it back. They're not best pleased which is understandable. And I think that is something that should provoke some fairly sharp questions between the client and their lawyer. But it is a common issue I keep seeing.

So, the golden advice here is get advice from your accountant and other advisors before you make the acquisition or get into the project. If you don't, because you're trying to save on professional fees, you might well find that trying to save two or three thousand dollars in advice has, like this particular client, just cost you $450,000. Get advice on any GST related transaction because GST has a lot more hooks to it than people realise.

I have a couple of other GST cases going on at the moment where people who said they were GST registered turned out to be not registered, or vice-versa and that has got lawyers at 10 paces throwing writs at each other over whose client picks up the GST warranty.

NZ residents must report global tax income

Moving on, another common error I come across is people misunderstanding their income tax obligations where they have assets in more than one jurisdiction. I frequently encounter a position where a New Zealand tax resident also has property or other income source in the United Kingdom, Australia, wherever, and has been complying with that jurisdiction’s requirements to file a tax return.

This often happens involving assets in the UK. A person might have to file UK a tax return because they've got a rental property over there. But although they've complied with their UK obligations, they overlook the fact that as tax residents of New Zealand, their income is reportable taxable on a global basis. So they should be reporting the UK income here as well.

And that's the bit that often gets forgotten about. Most people seem to be aware there’s a rule against double tax. And they seem to think that by filing a tax return in the country in which the property is situated, they have met their obligations and it's only taxable in the country in which it's situated. It's not, it's taxable worldwide.

Inland Revenue issued in July a very good Interpretation Statement 20/06 which sets out all the rules overseas rental properties. But I daresay this particular case won't be the last time I'll come encounter a situation where someone has reported income overseas, but not in New Zealand.

And it's a good insight into always try and catch up regularly with your clients and take the opportunity to ask questions, because more often than not, if you don't ask, you don't find out. And then something happens after which everyone is going “Oops!” and no one is terribly happy about how that plays out.

Labour's tax policies

And finally, last week, Labour announced their proposed income tax policy, increasing the top income tax rate to 39% for income in excess of $180,000. This has not been terribly well received, partly and very obviously from those who are likely to be affected. They're not going to be happy about that. And that's understandable. Who likes paying more tax? Let's be frank about it.

But also, more importantly, leaving aside partisan issues such as Labour activists saying it's too timid, the interesting issue to me is how other people have come out and said it really doesn't do anything to address the issues of inequality and distortions in the tax system. It's also been dismissed as just a drop in the ocean in terms of addressing deficits.

There’ve been two such articles in the past week that raised these issues. The first was from Jonathan Barratt a senior lecturer in taxation at Te Herenga Waka — Victoria University of Wellington. And he basically said that both Labour and National are really not doing anything to address questions of inequality. The tax base is too narrow, it benefits the wealthy and punishes the poor. And his key point was that neither major party seems to want to do anything about it.

I do have a view that the “Four legs good, two legs bad approach” to discussing taxation over the last 30 odd years hasn't helped any constructive conversation in this matter. Also, property has become such an important asset for so many people where sometimes the untaxed growth in the value of the asset exceeds a person's annual earnings, it's therefore understandable people are reluctant to have that precious nest egg taxed.

Also coming out and having some fairly harsh, but fair, commentary on Labour's tax policy was Geof Nightingale, of PWC, who's been a previous guest of the podcast, but more importantly was a member of the last two tax working groups.

And he begins his article by calling it “Brief and predictable, but disappointing”. And he goes to point out the 39% rate turns us back to the tax settings at the end of the 20th century when we last increased the top tax rate to 39% rate. The policy “makes the existing equity and efficiency distortions in our tax system worse and will have no significant impact on income or wealth inequality”.

Now, Geof was one of those who backed the introduction of comprehensive capital gains tax. What he's pointed out here is that the increase in the tax rate to 39% is a progressive move but only in relation to employment and personal services income. It's quite possible if you've got investment income, which is in a portfolio investment entity it’s taxed at 28% and it's held in a trust it's going be taxed at 33%.

I really do struggle to understand why Labour is not looking closely at the trust tax rate. It was known to be an issue the last time the top tax rate was 39%. But I suspect they may well come back to that if they get re-elected. There are anti avoidance measures in place, as Geof has said. But the whole point is that the zero percent rate on capital gains still applies and investment returns and capital gains because of the amount of money sloshing through the system now are likely to increase.

So, as he said, one solution is, of course, a capital gains tax, which in his view and mine spreads the tax burden more equitably across the economy. And it could also allow lower personal tax rates. What’s often forgotten in the wake of what happened at the end of the Tax Working Group, that lower tax rates were part of the whole package including capital gains tax. National of course will not do anything in that space. It's saying it's sticking to opposing capital gains tax and ruling out tax increases.

So Geof's article was really quite swingeing in its criticism and fair enough in that regard. He concludes

Here we are then, a government that wants a second term faced with a major fiscal crisis but backed into the dead end of a 20th century tax policy. Predictable but disappointing.

Well, that's it for this week. I'm Terry Baucher. And you can find his podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. And please send me your feedback and tell your friends and clients. Hei konei ra!


This article is a transcript of the September 18, 2020 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission and has been lightly edited for clarity.

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10 Comments

On raising the top income tax rate to 39%, why not match that for the trust tax rate? Or raise the trust rate to 39% and leave the income tax rate alone.

I'm all for a CGT but it HAS to be across all asset classes and no exemptions not even the family home so everyone has skin in the game !

I’d love to see that being proposed by the likes of Labour before an election - many of the home-owner lefties that were so keen to nail investors will suddenly go rather quiet. Will start to advocate rollover allowances for themselves but not investors, which essentially means family homes are exempt. The virtue-signalling sort tend to be quite generous with other people’s money, but not so much their own.

Heard a classic quote the other day... "Socialism is a virtuous and altruistic undertaking - until you run out of someone else's money".. couldn't agree more

"The virtue-signalling sort tend to be quite generous with other people’s money, but not so much their own." And the investor class are the first to cry poor despite the costs of financing and maintaining a property being deductible for them, but not for the owners they are bidding against - yet they remain a protected species.

Totally agree. And it would need to be set at a person's marginal tax rate, not some random smallish rate that still advantages property. However the govt couldn't rely on such a tax to generate much revenue b/c the purpose of such a tax would be to destroy capital gains attained by doing nothing other than speculating. If you want capital gains you need to work for it just like working for income.

“However the govt couldn't rely on such a tax to generate much revenue b/c the purpose of such a tax would be to destroy capital gains...”

Oh really?

https://i.stuff.co.nz/business/property/107359055/capital-gains-tax-woul...

https://taxworkinggroup.govt.nz/sites/default/files/2018-09/twg-bg-39985...

The problem with CGT.
I wish to sell my house as I am transferred. My house sell for $800k, I purchased it for $500k. I'm taxed on $300k at say $90k.
I go to the new city, my new home equivalent is still $800k but now I need a mortgage of $90k.
How do you feel now?
Like you've been robbed I bet!

Most CGT regimes have some form of Roll Over Relief. So if you buy the same asset in a set period of time the CGT event is Rolled Over into the new asset and no CGT is paid unless you cash out and don't buy another property. Interestingly the Tax Working Group did not recommend this. Nor did they recommend indexation so your not paying CGT on the inflationary amount.

GST is a tax on already taxed income, basically taxing it twice, apart from being unfair since it is applied at the same rate regardless the individual incomes. Many countries compensate this by having a reduced tax for first-necessity goods such as bread, milk of female care products, we do not, on the other hand luxury assets are taxed higher than usual, here we have none of that, even worse financial services and income in rental properties pay no GST.