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The Week in Tax.  Inland Revenue is back on the case of people with overseas interests, the painful consequences of not keeping records, and the point at which tax debt becomes unmanageable

The Week in Tax.  Inland Revenue is back on the case of people with overseas interests, the painful consequences of not keeping records, and the point at which tax debt becomes unmanageable

A few weeks back, I referred to the OECD’s Secretary General's tax report to the G20 finance ministers and central bank governors in which he referenced the impact of the Common Reporting Standards on Automatic Exchange of Information.

The Secretary-General noted that during 2019, nearly 100 jurisdictions exchanged information automatically relating to 84 million financial accounts covering assets of almost 10 trillion euros. And as a consequence, tax administrations so far have been able to identify for collection 102 billion euros in tax.

Inland Revenue is part of the automatic exchange of information process. And it made its first exchanges during the year ended 30th June 2019 when it sent more than 600,000 account reports and received over 700,000 in return. Prior to the arrival of Covid-19, Inland Revenue had been working through those 700,000 information accounts that it had received and had started sending letters to people who held such accounts.

Then Covid-19 arrived, and everything went quiet. Inland Revenue is now back on the case because this week a couple of clients received letters from the relevant Inland Revenue section.

The letter explains that Inland Revenue is one of many jurisdictions involved in the automatic exchange of information and then goes on to say,

“We have received information from one or more jurisdictions for the 2018 and or 2019 years, which indicates that you may have an interest in a life insurance policy overseas… If you are a New Zealand tax resident and have an interest in a life insurance policy not offered or entered into in New Zealand, it may be subject to the foreign investment fund rules.”

Now, quite apart from the reactivation of this initiative by Inland Revenue, the other thing that stood out for me about letter this was the specific reference to life insurance policies. These are, as the letter notes, covered by the Foreign Investment Fund (FIF) regime and surprise, surprise, given the complexity of the FIF regime, few people are aware of that.

So, this is something probably similar to the initiative Inland Revenue started about 10 years ago now in relation to foreign superannuation schemes when it started looking at the taxation of such schemes.  At that time, they were within the FIF regime and Inland Revenue found most people were not complying, again unsurprising given the complexity of the FIF regime.

The recommendation I would have here for clients is obviously to make disclosures if you haven't already done so in relation to the life insurance policies. As it transpires, our clients have done so. And the other thing to be mindful of is that although the FIF regime has its problems in that you're being taxed on 5% of the value of an asset which does not necessarily provide a cashflow. However, that treatment is possibly more favourable long term than not being within the FIF regime.  This is because the rules on the tax treatment of the proceeds of such policies on maturity is not at all clear.

If Inland Revenue is going to bang the drum about compliance with the FIF regime in relation to life insurance policies, it probably should also come out and state what it considers is the tax treatment for policies which are outside the FIF regime. That's something we'd like, which would clarify matters greatly and probably ultimately encourage more compliance.

Why you must keep good records

As a tax agent, advising and reminding clients about the need to keep adequate records is a constant of our business. The consequences of not doing so can be extremely harsh, as Tower City Holdings Limited have just found out.

Tower is a property development company and was audited by Inland Revenue beginning in 2015.  Initially Inland Revenue was looking at GST returns and income tax for the year ended 31st March 2013. Ultimately, though, Inland Revenue issued an income tax assessment for the year ended 31 March 2016 amounting to just over $4 million in respect to the sale of three properties for a total of just over $32,180,000.

Now, this is where it gets interesting as the Commissioner also assessed Tower for a tax evasion shortfall penalty of just over $3 million, which is pretty much the maximum possible for a first-time offender on the amount of tax assessed. Clearly, this company had been paying it fast and loose on some matters.

Further default assessments were issued in May 2017. At this point, the total amount of the assessments was $7.6 million, with interest and late payment penalties starting to accrue now. So far, Tower had done nothing to pay this debt. And in fact, just after the audit began, it transferred a couple of a number of properties out of its ownership without applying any of the proceeds to its tax debts. In fact, the proceeds appear to have been applied for the benefit of Tower’s director and two other individuals involved with the management of the company.

Now, you can imagine none of this went down very well with Inland Revenue. The Commissioner of Inland Revenue filed an application for an order under Section 241 of the Companies Act 1993 to place Tower into liquidation. This cited a number of grounds, including Tower’s inability to pay its debt, its failure to keep proper accounting records and breaches of various directors’ duties.

This ended up in the High Court, which has now ruled that the company can be put into liquidation on the basis that there have been serious and persistent breaches of Section 194 of the Companies Act 1993, which requires adequate accounting records be kept at all times.

It emerged that Tower had never kept any ledgers, cash books or any other such documents which would have allowed its financial position to be determined at any one time. This was apparently a deliberate policy on the part of Tower. Not sure exactly what it thought it would achieve by doing that, because as anyone well knows, if you get into a dispute with Inland Revenue, the burden of proof is reversed. If you haven't been keeping records, it's going to be very hard to prove to Inland Revenue that what you say is non-taxable is in fact, non-taxable.

And this case is also a reminder that Inland Revenue has plenty of powers. Every tax agent will tell you that, yes, some taxpayers can be a little slack around the matter although this is an extreme example of lack of poor record keeping. But the fact that Inland Revenue and the Courts can actually put a company into liquidation on the basis of poor accounting records is something that should make directors of companies sit up and pay attention.

The tax debt tipping point

And finally, this week the Inland Revenue report for June 2020 has not yet been released as I was expecting. Looking for it, I came across a report titled Identifying Sanction Thresholds among SME Tax Debtors: An Overview. Now, the PDF notation indicated it was a 2020 publication, so I thought,  good, some interesting new research. In fact, the report appears to be from 2012 and therefore the data in it is quite old and probably not directly relevant because Inland Revenue has actually been working very hard to keep its debt portfolio under control.

But looking through the report, something caught my eye that is really quite fascinating and is still very relevant. Inland Revenue’s research indicated that the median debt tipping point, at which point the taxpayer just gives up on trying to manage the tax debt, was just $10,000.

Now, that's way less than I or any other of my tax agent colleagues might have estimated.  Even allowing for inflation since 2012 it suggests that a similar tax tip tipping point today might be as little as between $15, and $20,000.  What that indicates is something that we did see on the Small Business Council, and that is that many SMEs are undercapitalised. And this is a point I think has started to emerge again in the wake of Covid-19.

Now, fixing that under-capitalisation in a pandemic isn't going to be easy, but maybe the banks, instead of lending freely on residential property, therefore adding fuel to a dangerously heated property market, might just want to direct their lending elsewhere into something more productive. That's just a random thought.

And on that note, that's it for this week. Thank you for listening. I'm Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Please send me your feedback and tell your friends and clients.  Until next week ka kite āno


This article is a transcript of the October 30, 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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6 Comments

Some things are just too hard and just aren't worth the hassle: for instance, I would never invest directly myself in overseas shares because of the FIF regime. It would be just another complication which would probably entail the use of an accountant which, in turn, would be more expense. I file my own annual return with just NZ shares; simple as! Although, I admit my portfolio is modest. At my age (nearly 73) I only select dividend-paying shares with 100% imputation and that enables me to get a modest tax refund each year.
I would leave all the hassle of FIF to Kiwi saver fund managers; and I'm well out of Kiwi saver myself.

Hi Terry, Re "And the other thing to be mindful of is that although the FIF regime has its problems in that you're being taxed on 5% of the value of an asset which does not necessarily provide a cashflow. However, that treatment is possibly more favorable long term than not being within the FIF regime."

I don't think it is ever more favorable to tax on 5% of value each year when it pays no cashflow than being like every other jurisdiction in the world and taxing at the end of the investment and on cashflows in the interim. The effective cost of 1.65% not being allowed to compound in any investment over a long period of say 20 years is massive. You end up with far more money if you just paid 33% at the end of the investment assuming no cashflows came from the investment. Its a different product but the cost for the average Kiwisaver investor is approx $150,000 less at retirement due to the FIF regime. A TET regime will always beat a TTE regime over a long period of time.

Does the FIF regime make the country better off in the medium term? Or does it have the perverse effect of encouraging people to speculate in leveraged NZ houses instead of overseas investments? Has any actual research been done to support what appears to be a classic bit of over regulation?

The purpose of FIF is presumably to discourage overseas investment by kiwis. This makes NZ's foreign investment position worse. Instead of encouraging enterprising kiwis to master international investing we are encouraged to buy housing. Is this the case or am I just seeing things and ranting?

I presume the idea is to incentivise investing locally over investing overseas?
Problem being that, as those very different characters Don Brash and Adrian Orr will tell you, it’s pissing into the wind persuading Kiwis to invest in something other than property.

It was a tax grab by Michael Cullen when Kiwi saver came in.
Previously the rules did not apply to investments outside a defined grey list being USA, Canada, Australia, Germany and a few more.
They did it to get a deemed guaranteed tax on 5% income on the value of all investments outside NZ and Australia.
Australia was also going to be taxed under the FIF rules but last minute lobbying got that changed. It makes zero sense to exclude Australia but then again the whole regime makes no sense.
Actually most kiwi saver has some exposure for foreign equities. They are just uneducated about how they are being taxed.
The NZ Super Fund some years has $550m in FIF tax on $500m received in actual dividends.
The last tax working group recommending reducing the FIF FDR rate to 3% but this was ignored.
The cost of loss of compounding on everyone's kiwi saver on tax when there has been no realization is massive all the while house gains are tax free.

The FIF tax is an utter disgrace, which creates huge distortions in the investment markets. It is astonishing that the NZ public accepts such a blatant, unfair and ultimately counter-productive tax grab. This can only be a symptom of the ignorance of many Kiwi investors when it comes to investing in assets rather than housing. Sadly, the average Kiwi investor's mindset seems to be something out of the 19th century, as investment has become almost synonymous with housing speculation. This FIF regime should be completely re-designed, if not abandoned for something more balanced.