The Week in Tax: Inland Revenue reminds tax agents about the bright-line test, responds to criticism. And the wealth tax debate continues

The Week in Tax: Inland Revenue reminds tax agents about the bright-line test, responds to criticism. And the wealth tax debate continues

About 11 o'clock on Tuesday morning, myself and what appears to be just about every other tax agent in the country received an email from Inland Revenue with the subject line “Clients meeting the bright-line test”.

The email began: “Our records show the following clients have sold or transferred residential properties that meet the bright-line rule. This means these clients will be required to pay income tax on any profit they have made on the sale of the property.

The email then set out the clients it believed were caught by the bright-line test rules. That is, they either sold property within two years of it being bought between 1st October 2015, and 28th March 2018 inclusive or within five years of it being bought on or after 29th March 2018.

Now readers and listeners will know that I have previously stated that we are aware that Inland Revenue has been gathering data in relation to the bright-line test. But this is the first time it's really flexed its muscles and its capability to show exactly what it knows about what's going on. And an insight into why Inland Revenue did that came the following Wednesday morning, when Stuff published a story under the banner headline “One in four property speculators dodging housing tax”.

Based on Inland Revenue data the story outlined that of 1701 property sales subject to bright-line test in the 2019 income year 1285 have paid up and complied, but Inland Revenue is looking at the other 416 taxpayers who appear not to have complied with the law. It's also looking at a further 3,758 sales for that year, where the bright-line test might apply.

This email initiative, as you might imagine, caused quite a bit of a stir amongst the tax agent community, and we know that all accountants from small companies like ourselves to major Big Four firms received these letters for their clients. Although the emails set out the client Inland Revenue believed was caught by the rules, they weren't any more specific than that.

This upset a few accountants because it means digging around to find out what's going on here. It also transpires that Inland Revenue may have been a little premature in its information release. Apparently, there is a follow up email coming next week, which will actually set out the address of the property in question so that we can then more accurately work out what's going on.

But there was a fairly lively debate about the matter on the Facebook page of the Accountants and Tax Agents Institute of New Zealand of which I'm a member.  And quite a few interesting snippets emerged about who had received emails and why.

Inland Revenue’s systems appear to have picked up any change in the registration of title. So that would include obviously sales where the title to the property passed to a new owner. But it also appears to have included changes in trustees because contrary to what a common misconception, trusts don't actually exist in law although they have a separate existence for tax purposes. But in law, the property is held by the trustees. So if you have individual trustees holding property and one retires, there has to be a change of registration on the title. And Inland Revenue systems have picked up a few of these and issued a “Please explain.” Overall, though, the majority of tax agents were reasonably happy that this was the sort of initiative that Inland Revenue should be doing.

I've said before that Inland Revenue has access to a lot of data but doesn't really make people aware of just what it knows. And these bright-line test emails are an example of it using the information it holds and making people aware of their obligations.  One or two accountants noted it was interesting to see a sale by that client because they never mentioned it to us. There was one particular case, I recall, where the client went ahead and did something which they thought would be outside of the bright-line test, but in fact the transaction was caught.  He was most crestfallen when he eventually spoke to me about the matter and I explained how the rules operated.

So this email initiative is the sort of thing that we can expect to see Inland Revenue doing more of and we can expect it to be fine tuning how it does these information releases. Yes, in some cases, such as those where there's just merely been a change of trustee, Inland Revenue has jumped the gun. Perhaps a little bit more thought around whether that particular transaction was caught would have saved some headaches and frantic calls between clients and accountants on the matter.

But when you consider the heat in the housing market and concerns everywhere amongst those locked out of the housing market and the desire for the government to raise revenue to fill the hole blown in its balance sheet by the Covid-19, it's not surprising Inland Revenue will be taking this initiative.  It reminds people, “Hey, these are the rules. We think you're caught. If not, please explain”. So, in summary, I think we'll see more of these initiatives further down the track

By the way, as a PR exercise, it does no harm. Firstly, it tells the new minister that it's on top of things and secondly, reminds those who think that Inland Revenue is big and dumb, that in fact, it has got access to a lot of information. And to borrow a line from Liam Neeson, it will find you and will, if not kill you, certainly tax you.

Communicating in public

Moving on, a couple of weeks back, myself and Andrea Black took a look at Inland Revenue Business Transformation programme, and we weren't terribly happy about some of what we found.

Well, on Tuesday, Sharon Thompson, Deputy Commissioner for Community Compliance Services, published a piece responding to our podcast.

And in particular, she addressed our suggestion the transformation hasn't been successful because cost savings haven't been reinvested into audit and investigation work. This was, “a narrow view of how Inland Revenue ensures tax revenue in New Zealand is as close as possible to what is required under our laws”. And our view that Inland Revenue’s current approach was incorrect is not supported by international research.

I think the phrase is “Shots fired!”, but it’s certainly intriguing to hear the Deputy Commissioner's response. One of the points she made in responding to the specific questions we raised about the level of spending on investigations and debt management, was “Our new system has dramatically increased and improved the data we have access to. And we can watch, often in real time, as taxpayers file returns. So, if they’re getting it wrong, accidentally or deliberately, we can see and intervene, reducing the need for post-return audit and investigation.

That is something I've heard from other Inland Revenue staff.  If you file a tax return through the Inland Revenue portal, the system tracks the keystrokes. And in one example given to me last year by an Inland Revenue officer, if there is a suspiciously large number of adjustments being made to get the just right amount, they will look into it.

Sharon goes on to comment that every return that can generate a refund is checked automatically and amended returns are checked and screened. For example, between 1st July 2019 and 30th June 2020, Inland Revenue identified approximately 23,000 returns across all tax types which had errors or it believed were fraudulent with a value of just under $200 million. Now, that's a good initiative and Andrea and I would not dispute that was a good result and also a good use of Inland Revenue resources.

However, Sharon's article did not address the concerns that I've expressed previously and alluded to in the podcast with Andrea about Inland Revenue’s relationship with tax agents. Tax agents are vital to the operation of the tax system. But many other tax agents and I have reservations about how the new Business Transformation programme has integrated tax agents into its system.

The initiative I talked about a few minutes ago is something we would welcome, and we should expect to see that.  Tax agents are actually Inland Revenue eyes and ears and so we do a lot of the pre-screening that Inland Revenue would otherwise have to do without us.

But we don't always get access to Inland Revenue as easily as we should. The phone line for tax agents was abruptly turned off and then reinstated, but with limited hours, for example. So although Inland Revenue may feel that Andrea and I were unfair in some of our criticism, but equally, some of the criticism we raised still needs to be addressed.

The role of tax agents is one where tax agents have a great deal of concerns about what Inland Revenue expects and whether, in fact, it wants to work with tax agents going forward. My belief is Inland Revenue does, but it’s not communicating that very clearly to us at the moment.

I still feel that the dramatic fall in investigation hours of almost two thirds over the last five years is a matter for concern. But we will be able to see how Inland Revenue has worked through the Business Transformation process and see more of the numbers when its annual report is published shortly. It's been delayed, apparently in part down to the Covid-19 outbreak.

Tax on wealth vs tax on work

And finally, the debate around taxation and housing and wealth taxes continues to rage all week. On Tuesday, Westpac published its Economic Overview for November,  in which it made the point that future governments will be forced to either reduce spending or increase taxes because of the fiscal pressures that are starting to build over superannuation and health care.

The Report goes on.

“The required adjustments to our fiscal position can't be delayed forever. Sooner or later, some form of consolidation will be necessary, though the precise form this takes will depend on which party is leading the government at the time.  Our pick is that a future government will introduce some form of tax on assets such as a land tax, capital gains tax or a wealth tax. Societal concern about increasing wealth and inequality is only going to intensify, eventually creating a large constituency for such a tax. And tax experts agree that broadening the tax base would enhance economic efficiency.”

Later that afternoon, I spoke to Wallace Chapman on Radio New Zealand's The Panel about this report and the ins and outs of a wealth tax. And in addressing the housing crisis, I made the suggestion that maybe a 10% stamp duty might be imposed on all investors or some measure like that.

Now, last week, I mentioned a Deutsche Bank report which suggested a working from home tax which unsurprisingly got pooh poohed. But the full report is actually quite interesting and actually has one of the more dramatic report openings to any bank report I've seen in a long time:

To save capitalism, we must help the young. Democratic capitalism is under threat as increasing numbers of young people view the system as rigged against them. The pandemic has only exacerbated their economic disadvantage.

Now, that's quite an opening for any report, let alone something from a bank, but the report goes on to talk further about some tax changes and these proposals mirror what was suggested by Westpac. Deutsche Bank suggests that, for example, there is a need to have a tax on a primary residence, which if you think about the hoo-ha we had with the idea of a proposed capital gains tax taxing everything except the primary residence last year, you can imagine just how big a fight would happen if we said actually, “We're taxing the main home as well.”

The Report also suggested that there may need to be additional taxes on financial assets such as stocks, bonds, due to their gains from loose monetary policy. As maybe people are well aware, stock markets have actually boomed quite substantially this year. New Zealand’s stock market has been hitting record highs recently. The Deutsche Bank report, notes that in the 30 years to 2019, the S&P 500, that's the main index in the United States, gained over 800%, two thirds more than the return seen in three decades previously. The report suggests taxing such income on a basis similar to our foreign investment fund regime, and or remove exemptions and discounts and capital gains. Picking up my Stamp Duty proposal, the report suggests such duties are paid by the vendor and not, as is common, the purchaser.

Now, the point that the Report makes is the reason why it wants to increase the tax on capital is so as to avoid much higher income taxes, which are often cited as an argument against hard work. This is one of the criticisms of Labour's proposed tax rate increase to 39%. It is very narrow and hits income earners, whereas there’s a growing consensus that it’s the taxation of capital which needs to be broadened.

So this debate is going on all around the world. When banks like Westpac here and Deutsche Bank in Germany are making comments about broadening the scope of capital taxation you know a fundamental shift is happening in taxation thinking. How that will play out, we'll have to wait and see, and I'll bring you developments as we go.

Well, 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 regular podcasts. Please continue to send me your feedback and tell your friends and clients.  Until next week, ka kite āno.


This article is a transcript of the November 20, 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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35 Comments

You know something is up re:IRD when your accountant sends you an invitation for "Audit Insurance" membership. This will rattle a few cages.

Always a great read.

In the battle for unearned income (my long term prediction) property owners are sitting ducks. You could frame this around the principle of the low hanging fruit. As the taxable base is compromised government will look for the next easiest place for income. If it isn't labour, it will be assets. The most illiquid assets will be the most vulnerable.

It is only a matter of time.....

and the reason it has not happened yet is ?

JA

Good article... thanks for update

“To save capitalism, we must help the young. Democratic capitalism is under threat as increasing numbers of young people view the system as rigged against them. The pandemic has only exacerbated their economic disadvantage.”

Absolutely - if you’re under 30, capitalism is your enemy and socialist intervention in the ‘free markets’ benefits those who already have too much more than those who actually need it. But you get a sense that change is coming. You can only rig a game in your own favour for so long before the losers of that game decide to no longer play and throw it back in your face.

I think the under 30's refer to this as a "rage quit".

rage quit capitalism, load up communism.

This is something I see in a lot of my friends (I'm in my late 20s) and it's not good. Need Boomers and Gen X to front up so we can please avoid this system change. We all know how devastating it will be...

There's an old saying that you reap what you sow. I personally think young people are entitled to destroy this system as its not in their best interests for it to continue - actually, they would be stupid not to destroy it.

Agent provocateur. Nice.

The 'capitalists' are doing their own negative marketing of the system they support...just turn on the TV...why would anyone younger want this economic system to continue?

Are you advocating opting out or overthrowing the system?

Its got nothing to do with me personally so that is a misdirected question.

If it isn't significantly modified and very soon then the players of that system will reject it and a new game will start.

Imagine a xmas game of monopoly with people age 5-80. Those who are aged below 30 don't get a shot at owning anything...they just have to keep going around the board paying rent to those who already own everything....how long do you think they will want to play? At the moment young people are being nice and compliant because that is what they think they are supposed to do. When they realise they're being completely screwed with by the older generations of players, the natural animal response will be to throw the board at them. Patience is being lost and the social fabric that holds the system people have known the last 30, 40, 50 years is at risk of being pushed aside and a new system will take its place. Most people are just too ignorant and chasing self interest to see what is unfolding.

Monopoly...excellent. I'm going to redistribute that...you know...communism and all ;)

Front up with what? Jacinda said homes for all. I think it’s sad that some are losing faith.

The quick removal of the bright line test is a start by the govt. as well as keeping their promise not to touch the wealth tax ideas, with majority voters in hands. Regardless IRD view on this, suck up for more years to come for all these whingeingly new graduates, go to OZ first, dig few burrow and get back here with your small deposit.

I guess I need to listen to the podcast. I'd really like to know why Deutsche Bank thought having the duties paid by the seller and not the buyer were a better option. I would have thought that would cause sellers to hold out until the sale value was high enough that the expected duty to be paid could be ignored given the amount of capital gains to be had, even after taking into consideration that in Germany they pay 25% CGT on sale of property unless they've lived in it for 10 or more years.

It's fundamentally obvious. The seller is the one to have made the capital gain not the buyer.

No. It's not fundamentally obvious.

"Picking up my Stamp Duty proposal, the report suggests such duties are paid by the vendor and not, as is common, the purchaser."

In the UK, stamp duty is paid by the purchaser, not the seller. And the seller in Germany is already paying 25% CGT, so why would they be paying stamp duty on top of that? That's what I wanted to know.

Why is something that is making lives miserable for ever increasing numbers of people worth saving? That's what I would like to know.

Thanks for all the comments, always welcome to see your feedback. A quick point on the Deutsche Bank stamp duty suggestion. They suggest the seller pays "rather than the current system in many countries where buyers pay and, for mortgage applicants, it is effectively an enormous tax on their deposit". But also as someone notes, it's the vendor who is realising a capital gain. The current resident land withholding tax rules do require non-resident vendors to withhold tax on sales subject to the brightline test. So the idea isn't completely outside the current tax regime.

If similar effort to increase the tax take which in my opinion is already peak tax were made in waste reduction both in Govt local & national and in large corporations the improvement in NZ economic position would be significant.My suggestion the next right leaning Govt reduce all central Govt expenditure by $5 Billion and restrict Local rates to increases of 1/2% less than CPI with a proviso that councils proposing larger increase be required to resign and offer themselves for re election based on the increased rates. Govt expenditure is approx $119 Billion so $6 Billion is significant and would provide for debt & tax reductions reductions the latter which has been shown to increase revenue, add in local rates reductions and you have a base for NZ to shoot out of the coming recession like a rocket. Wont happen under this Govt of clowns of course but perhaps the opposition - ACT - will pick up and run with the idea.

If similar effort to increase the tax take which in my opinion is already peak tax were made in waste reduction both in Govt local & national and in large corporations the improvement in NZ economic position would be significant.My suggestion the next right leaning Govt reduce all central Govt expenditure by $5 Billion and restrict Local rates to increases of 1/2% less than CPI with a proviso that councils proposing larger increase be required to resign and offer themselves for re election based on the increased rates. Govt expenditure is approx $119 Billion so $6 Billion is significant and would provide for debt & tax reductions reductions the latter which has been shown to increase revenue, add in local rates reductions and you have a base for NZ to shoot out of the coming recession like a rocket. Wont happen under this Govt of clowns of course but perhaps the opposition - ACT - will pick up and run with the idea.

Banks create money out of thin air aided and abbetted by Orr..Billions at stake, to Aussie..mostly..Then they charge you Interest for the Priviledged. Then the Priviledged get a Renter to pay their way. Then the Under priledged get a Hand Out via Social Welfare. A complete Mugs Game. To get an idea, it used to be illegal to rort money, now it is a Gift.

Oh and mostly Political Favouritism....cos they is Rorting their own con-stituants.

A lot of assumptions there - that you are highly taxed, that all government is wasteful, that your rates are already sufficient to cover costs, that tax reductions lead to growth and that everyone under 50 thinks like you do.

All I see here is someone pulling the ladder up after them, wanting lower taxes on their hoarded wealth and refusing to pay the cost to fix ailing infrastructure and services because your generation was too fat to build anything...plus some mumbo jumbo about “trickle down”. I’m surprised there was nothing in your spiel about mining or oil exploration - or is climate change just a hoax from those socialist academic types?

There should be no debate. This stuff is pretty simple. Bringing back land value tax is the only solution.
https://en.wikipedia.org/wiki/Progress_and_Poverty

Stamp duty is a terrible idea. It just means landholdings become more entrenched, with people less likely to sell land that they own. Land changing into the hands of more suitable owners should be encouraged. It doesn't matter who pays stamp duty, it always comes out of the market price of the property at the time of the sale.

The main thing about CGT is in the eyes of many people a revenue gathering exercise. Its not for stopping property bubbles as overseas jurisdictions, Oz for example have had property bubbles with CGT. I view it differently as a investment decision equalising option. We already have a form of CGT by stealth, the bright line test, the FIF and FA? tax regime on unreleased capital gains for shares. I'm not opposed to CGT but the devil is in the detail and if its the wrong detail then I'm will be opposed to it.
There are likely to be better options than stamp duty on residential investment property, preferably at the purchase stage, rather than in arrears at the selling stage. Stamp duty in my book is solely a revenue gathering exercise and not an investment option leveling mechanism with the intention to quell residential property investment. I bought a house to live in it not as an investment. Quite frankly if residential property only went up close to CPI I'd be quite happy.

" I'm not opposed to CGT but the devil is in the detail and if its the wrong detail then I'm will be opposed to it." - exactly .. and it was certainly wrong detail as proposed last time round.

Ever since Muldoon and Douglas put NZ on a different tax path to the rest of the world, NZ has ignored mainstream economic theory and standard OECD practice and promulgated a tax and retirement income system that entails large intergenerational transfers from young people to older people. Unfortunately the IRD, the Treasury have cared so little about this situation that they have never bothered to create the standard "overlapping generation" economic models that are used in the rest of the world to estimate the size of these transfers. The last Tax Working Group, comprising people over 40, largely ignored intergenerational issues, and basically argued that today's young people should pay increasingly high taxes to support older people.
They adopted IRD sloganeering "broad-base low rate" and "different types of income (except housing income) should be taxed at the same rate" rather than the standard economic tax principles espoused by Nobel winning tax economists such as James Mirrlees or Peter Diamond.

Fortunately there are plenty of high income countries with progressive tax systems that already raise a lot more in taxes than NZ that can provide examples of more intergenerationally neutral tax systems than NZ. Examples include Norway, Sweden, Germany etc etc. These countries already do a lot of things differently than NZ.

Urban land taxes would almost certainly help redress some of the intergenerational inequity baked into NZ's tax system. Moving towards a save-as-you-go retirement income system would also help, either on contributory principles (which allow intergenerationally neutral and incentive compatible taxes) or by imposed higher taxes on middle aged people to more rapidly build up funds in the NZ Superannuation Fund. However, I suspect the country first needs to recognize how unusual NZ's current tax and retirement income systems are, and start questioning which of the tax policies adopted in the 1970s, 1980s and 1990s may have been (ex post) poor decisions. The last Tax Working Group and the government response to it showed there is still little appetite to investigate whether NZ's highly unusual tax system may be part of NZ's economic problems, including the large intergenerational costs our system imposes on young people.

Thanks to high immigration levels ( love them or hate them .. not the point ) NZ has and will have very different age demographics from the countries you put up as examples of more intergenerationally neutral tax systems ( Norway, Sweden, Germany etc etc.) .
Does this not make a direct comparison moot ?

Yes, NZ has a much younger age profile now than these countries; and it is expected to have a younger age profile in the future as well. But our future age profile will look something like these countries have now, so we can probably learn from their current experiences about tax systems that work well when a country has an older population.

One of the reasons why average taxes are lower in NZ than most European countries is that we have fewer old people and more young people, but the extra amount we spend on education is smaller than the smaller amount we spend on health and pensions. (I am afraid this statement is from memory, but I pretty sure it is still true. NZ pays more on average for education because of the young population, but the difference with the average OECD country is less than 1% of GDP.)

Of course, it could be the case that we have a great tax system, and the rest of the world is wrong to do what they do. Given most OECD countries have higher incomes than us, think how much further behind we would be if they adopted our system!

I am not so much arguing whether NZ tax system is "better" or "worse" - that is above my pay grade / knowledge of economics .

My point was more that whatever 'standard "overlapping generation" economic models that are used in the rest of the world to estimate the size of ..intergenerational transfers ' would probably produce quite different effective / per capita results when applied to NZ situation compared to the countries you have put up as examples.

Again, this is correct: a model needs to tailored to local conditions. The "overlapping generations" models are just economic models with different- aged people in them, each person doing different things at the different stages of their lives. The total effect depends on the number of people in each stage. For instance, older people (say age 60) tend to live in larger houses than younger people (age 30), so if you have an increase in the number of 60 year olds you would expect to need more large houses: this is likely to be one of the reasons why there has been an increased demand for large houses in NZ. Some of the results, like this one, are fairly common sense; other results are less so, because the feedback effects are complex. These models are useful precisely because they give a better idea of the feedback effects when people from different generations interact with each other. This is why it is so disappointing that neither the Treasury nor the IRD have bothered to develop these models: NZ has such different tax and retirement income policies to the rest of the world, as well as a different age structure, that it cannot be expected that the models developed by other countries are that relevant to the NZ situation. As a country we have adopted very different tax policies than other countries without being able to properly estimate the intergenerational effects of these policies. The models that have been developed overseas all suggest the type of policies we have cause large intergenerational transfers away from young people, but their effects have not been comprehensively investigated.

(As a disclaimer: a decade ago I developed somewhat simplified "overlapping generation" models of the NZ tax and retirement system. These models also suggested that our tax and pension system leads to structural intergenerational burdens on young people, a result consistent with overseas literature. So I am not a disinterested player in this literature, and obviously think they are more important than most NZ economists or tax analysts. If you are interested, the leading models are by Laurence Kotlikoff from Boston University, Alan Auerbach from Berkeley, and Larry Summers from Harvard. Kotlikoff has written several popular books about the intergenerational implications of different tax and retirement systems.)

Without trawling back through the Interest article archive, have you considered a full-length Article along the lines of this comment?