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Week in Tax Special; the implications of increasing the income tax rate to 39% - encouraging rearranged income strategies, compliance risks for Trusts, and unanticipated (?) consequences for one-off lump sums

Week in Tax Special; the implications of increasing the income tax rate to 39% - encouraging rearranged income strategies, compliance risks for Trusts, and unanticipated (?) consequences for one-off lump sums
(c) Image sourced from Shutterstock

As promised, the Government has introduced the Taxation (Income Tax Rate and Other Amendments) Bill, which proposes to increase the top individual tax rate to 39% from the start of the next tax year on 1st of April 2021. This has been expected and will be passed under urgency in the next couple of days.

What's been interesting to see already from the related papers that have been released is the extent of the debate around the so-called integrity measures required to support the increased tax rate. Inland Revenue advised Cabinet that the trust tax rate should also be increased to 39%, in line with the income tax rate for individuals. This would be needed as an integrity measure based on Inland Revenue’s experience of what happened when the income tax rate was last raised to 39% in April 2000.

Inland Revenue estimated that the increasing trust tax rate to 39% would raise another $300 million dollars per year at a rough estimate. So there's already quite a bit of commentary already on this point about what's going on. And the Finance Minister has come out and said that if they are not satisfied with what they're seeing in terms of tax avoidance, if there is aggressive tax avoidance going on, then yes, they would raise the trust tax rate from 33% to 39%.

But the reason they're not doing that now is they want to see what behaviour actually eventuates. And as part of that, there is an integrity measure in the bill which hasn't yet attracted a lot of attention, and that is vastly increased information requirements for trustees when they file their annual tax returns. These will come into effect from the start of the 2021-22 tax year; that is, for most family trusts from 1st April 2021.

What Inland Revenue is going to ask for now is profit and loss statements, balance sheet items and other information as specified by the Commissioner.  For example, they might be wanting to know transfers to the trust by an associated person. Inland Revenue will also want information on distributions made during the year. Now, in addition to that, the powers of the Inland Revenue have been increased to allow the Commissioner to request the same information in relation to distributions financial statements, et cetera, for prior tax years, going back as far as seven years.

Not every trust will be required to provide this information, but this measure is to address what Inland Revenue regards as an information deficit relating to earlier years. And this is the integrity measure they're going to be paying most attention to, because the information for those earlier years will, “assist in understanding and monitoring the changes in the use of structures and entities by trustees in response to the new 39% rate.”

So this is quite a significant development, and obviously what they're looking to do is to counter people washing income through trusts. That is income that, if received by an individual, would be taxed at 39%. But because it's taxed in a trust at 33%, if the trust is a complying trust, it can then distribute that income tax free to because it's already been taxed to various beneficiaries.

So Inland Revenue and the Government are going to track what patterns have happened in the past and what patterns change, and that is how they will then apply the anti-avoidance rules to attribute that income to the individual rather than be taxed in the trust.

This is certainly one measure they're going to take. But if they see a lot of it going on, it appears they won't hesitate to actually go ahead and increase the trustee tax rate to 39%.

Now, both of these measures are going to increase the compliance costs for all trustees. So be aware that your costs are going to increase. And I would recommend to clients to be reviewing practices in prior years to ensure they have the records and ensure that there is a consistency of approach to distributions over the next few years and these are consistent with previous practices because that's what Inland Revenue be looking at.

The bill also increases the top tax rates for various other taxes that would be affected by a tax rate change, such as Fringe Benefit Tax which will go up to 63.93% if fringe benefits are supplied to people earning over $180,000. There'll be an increase in the resident withholding tax rate to 39%, but that will only come into effect on 1st October 2021 in order to allow the institutions time to change. And there will be an increase in the extra pay rate for lump sums to 39%.

And that leads onto the final point in today's bulletin, and that is that the increase in the tax rate magnifies a problem that exists already in the system, and that is the treatment of lump sum payments such as bonuses, back pay, redundancy, retirement payments or ACC arrears together with payments of large lumps of income, such as foreign superannuation scheme withdrawals.

There's now a reasonable chance that some or all of these sums would be taxed at 39%, even though if you look at the person’s average income in normal years, their marginal tax rate would be below 39% or even below 33%. Now, this is a long-standing problem with the tax system which does not take into account average tax rates on earnings in relation to lump sums.  It particularly affects people on PAYE.

This is a well-known issue which Governments have been told about and they've just ignored the matter. It's an issue which re-emerged earlier this year with the application of these rates to redundancy payments in the wake of Covid-19.

So we’ll get to see more of this as the year progresses, as the new tax rate comes through. My recommendation is that if you or your clients are going to be affected write to MPs, make submissions to the Finance and Expenditure Committee.  Make them aware of this, because I think it's an unfair part of the tax system that overtaxes lump sum payments. And it's time something was done about it.

Well, that's it for this special edition of the Week In Tax. Next, I'll be speaking to Rod Spicer of Accountancy Insurance about how insurance can help ease the pain of Inland Revenue enquiries and audits.

In the meantime, I’m Terry Baucher and you can find this podcast on my website www.baucher.tax or wherever you get your podcasts. Thank you for listening. Please send me your feedback and tell your friends and clients.  Until next time ka kite āno.

 

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33 Comments

This would have been the correct decision if the lower brackets would have also been adjusted, in practice we have now everyone paying pretty much the same income tax regardless of their income and the percentage affected by this is going to be small and target just highly qualified professionals that earn their income on a daily basis.
Why not targeting unearned income like passive investments?

Targeting unearned income is taboo and for the 1% only

or anyone with a Kiwisaver ;)

All but local kiwisaver capital gains is taxed.

And the contributions are earned through the individual's labour.

And taxed

I don't think GV quite thought it through

Anyone with a Kiwisaver is indeed earning passive income, which is already properly taxed, on the other hand one might think if all this money would not do much better to our country invested in some productive economy instead of shares and other financial products.

The FIF rules see Kiwisaver funds taxed on an imputed income (not actual income) of 5% - so a capital tax rather than a capital gains tax. If you make a loss in a tax year, then part of your fund will be sold to pay the tax.

If they had any sense they would also do away with FBT and instead gross the value of the benefit into the wage of the employee.

16
up

We tax the highly skilled professionals more to discourage them from remaining in our economy. If the highly skilled leave or at least have their income generating activities and the ownership thereof leave NZ, our stats will show a reduction in inequality.

If you are a highly skilled innovator why continue to develop your product in NZ when foreign jurisdictions will not only tax you less but also pay you more. All this on top of there being more capital capable of supporting you overseas. The pursuit of equality is the antithesis of the capital accumulation which is required in order for productivity gains to be made.

The places with the greatest total wealth also tend to have large amounts of inequality because an inequality of input needs to result in an inequality of output or every one will generate only the bare minimum amount of input. New Zealand has a long history of sending our to talent and technology overseas as soon as they get any sort of traction.

Yeah I agree. NZ is a very backward country when it comes to encouraging productivity with high wage economies, which we need if we're to maintain high prices in our precious housing market. After all how are Real Estate Agents suppose to disguise all that money laundering if they can't brag about wealth wage earners in the Tech Industry pushing up the AKL housing market. Don't forget even the banks are downscaling here too and reducing staff numbers.

"We tax the highly skilled professionals more to discourage them from remaining in our economy"

Further these people are a threat to the property pyramid scheme. The last thing we need is Kiwi's starting to think that an economy is anything other than increasing property prices ad infinitum. The wealth effect is what defines our economy these days. All tech innovators/entrepreneurs should be pressured out of this country into the slum of Singapore.

You're right. We yet again penalise hard work and human enterprise while turning a blind eye to balancing that out by taxing unearned income. The entitlement mentality that drives our reliance on property for wealth wins again, and productivity loses.

Any news on whether we'll join the rest of the developed world in having a low-value asset write-off threshold that isn't pathetically low on a permanent basis? AFAIK the $5K limit runs out on the 26th of March 2021 - has this changed?

Goes to $1k after the $5k expires. Better than $500, but room for improvement.

Reading this it almost sounds like the IRD thinks it's a bad thing if trustees suddenly start making large distributions to beneficiaries? That's a completely legitimate action if the trust deed allows. Also what seems to be overlooked is the tendency of this tax increase to incentivise purchasing of negatively geared real estate. I mean there's only so much maintenance that you can do, roves that can be replaced etc before you run out of expenses to mop up the trustee income.

Those that savvy enough, will use their dosh to avoid being detected. As not many in Labour govt upper echelon will acknowledge that the 'same funding $ subsidy' will be given for expensive medication to those patient that needed, the differential in their wealth thus tax contribution is irrelevant. Just ask for mOrr $ to be printed, done

It's taking money out of the economy any way you cut and slice it.

What a bunch of baloney. Where do you think the tax revenue goes - into motorways, contracts for construction companies, healthcare and teachers’ salaries. The money stays in the economy and does useful things, it doesn’t end up buying another rental property an imported Audi or a boat.

The only reason NZ still has an ‘economy’ this year was because government pumped it up with wage subsidies and public infrastructure spending - using up today’s tax dollars and into the future.

It goes into inefficient govt spending, gets taken off people who actually earning it creatively. Gets spent on into areas with unknown benefit.

Flat tax used to sound like a stupid idea. Reading this column makes it sound like not a stupid one, if still not a progressive oone.

Taxing the first 10k at 30%, the next 10k at 20%, the third lot of 10K at 10% and then having the rest tax free would still be a progressive tax system with a progressive tax rate. Albeit one where everyone contributes fairly instead of only a few paying all the tax.

The idea is that everyone get just as much benefit from the police and hospitals and schools, so they should all contribute to those services. Once you’ve paid your share of the costs plus a small margin, you are free to do what you will with the rest of the money you earn.

You're disregarding that the business owner is benefiting from the healthcare his workers are receiving. He has healthier workers which makes his profit higher.
Hence, he should pay more tax to support his workers and thus his profits.

A portion of the wages he pays his workers goes to tax which pays for their healthcare.
Additionally in any sort of economy with any level of unemployment he should be able to get replacement workers from the unemployment pool even if his workers were denied healthcare. (I am still a fan of government subsidised healthcare, just pointing out that your argument does not make sense)

You're disregarding that the business owner is benefiting from the healthcare his workers are receiving. He has healthier workers which makes his profit higher.
Hence, he should pay more tax to support his workers and thus his profits.

A portion of the wages he pays his workers goes to tax which pays for their healthcare.
Additionally in any sort of economy with any level of unemployment he should be able to get replacement workers from the unemployment pool even if his workers were denied healthcare. (I am still a fan of government subsidised healthcare, just pointing out that your argument does not make sense)

Flat tax with UBI would work really well. Would still be progressive, but more importantly, super simple. We could massively downsize IRD and MSD and save an absolute bucket load of pointless bueracratic costs involved in figuring out if one should pay $5012 in tax or $5015. Or whether an individual should get $141 in WFF and $1 accommo supplement or $140 in WFF and $2 accommo supplement. All become simple to calculate and administer under a flat tax and UBI arrangement.

A flat dollar tax is the definition of regressive. Do you perhaps mean a flat percentage tax (which near as I can tell would be neutral?)

Ahh yes, more idiocy from the gubbmint. Tax highly productive people to pay for unproductive asset growth. Brilliant.

The give away of bad policy, is
1. the bully threat to raise other tax on other activities.

2. The unforgivable fishing trip investiative powers.

New Zealand has been washing income for years. The classic is the New Zealand small business owner who puts his wife on the payroll so he can reduce his income and pay the wife the balance and avoid the high tax bracket. The wife typically never turns up to work except to bring in the occasional morning tea treats or help with a stock take.

If couples were allowed to split household income between them, this would be non-existent though. Keeping up with the Joneses and the requirement for both parents to work just to make ends meet as a result has probably done more damage to NZ than we can quantify or measure. Childcare battery farms are booming, but at what cost?