Terry Baucher looks at how Government policy conflicts with IRD procedure when it comes to the tax treatment of rental insulation. And the IRD is caught glossing and sanitising its performance reports to Cabinet

Terry Baucher looks at how Government policy conflicts with IRD procedure when it comes to the tax treatment of rental insulation. And the IRD is caught glossing and sanitising its performance reports to Cabinet

Last week, I mentioned the issue of the FBT, fringe benefit tax treatment of double cab-Utes and I referenced a blog on the issue by Andrea Black.

It seems that social media really is widely read because Inland Revenue's ruling units,read Andrea's post and sent her a polite email explaining that in their words, "We have a couple of comments regarding double cab utes and the work-related exemption."

And what the Inland Revenue unit goes on to explain is that the work-related vehicle exemption is actually far narrower than suggested. It sets out the definition of the work-related vehicle and in particular, it refers to paragraph three of section CX-28 of the Income Tax Act 2007 which in Inland Revenue's words is often overlooked. Masterful understatement there.

That particular paragraph provides that if a vehicle is available for private use other than from travel from home to work or incidental travel, then it is not a work-related vehicle, even if it is sign written, and it is therefore subject to FBT and the Inland Revenue concludes the exemption is quite, actually quite narrow. Now this is really quite an interesting admission by Inland Revenue because although it's good to see that they are taking a proactive interest in the matter and monitor social media posts, (that's not surprising I have come encountered that situation elsewhere), it does beg the question, is if the FBT exemption for work-related vehicles is much narrower than people imagine, shouldn't we be seeing a lot more FBT being paid?

The figures don't seem to indicate that, and the anecdotal evidence is that this fringe benefit tax is being very largely ignored. Or casually applied perhaps might be fairer, by many businesses, particularly small, who would be probably a little loose in their application of the rules. And a good reason for that is simply these rules are highly complex. Andrea is one of the most experienced practitioners around, and even she with her formidable knowledge of the tax system had overlooked a rather critical exemption or paragraph, which really narrowed the whole exemption. But it does beg the question that if someone like that can get it wrong and I have to say that I had not actually seen that particular paragraph, and hadn't examined it in particularly great detail.

Well where does that leave your average tradie trying to run a business with all the constraints that apply in that business? In short, this is an example where FBT is really ripe for major reform.  There may be under compliance, or lack of compliance going on in this space, but the rules don't help and it's one of those things where I'd like to see Inland Revenue take a very close look at it all and come up with something which is practical and minimizes the compliance costs to businesses.

Insulation issues

Moving on. One of our clients today when preparing our tax return, we came across that they had installed insulation into one of their rentals. That as you may be aware, is something that has been required by law since 1st of July. Question that we were looking at was if that insulation deductible? And this is where it gets, as always, a little involved. Inland Revenue issued an Interpretation Guideline in 2012 on the deductibility and treatment of repairs and maintenance and its view on the question of repairs, insulation repairs was pretty straightforward.

If there was insulation already existing and you're just simply replacing it, and there's no change to the character or substance of the building, then it should be deductible. And that's example nine on page 38 of their Interpretation Guideline, 12-03.

However, if it is new insulation, the view is that this is capital expenditure because the addition of insulation to the house, improves the house and changes its character.

Now that's technically the right answer and that's what I expected and advised our client accordingly that these are the rules that would apply. However, if you step back and look at the wider policy picture, we have a desire to drive down emissions and one of the chief emissions that we have, greenhouse gas emissions is heating. Now improving insulation will lower heating costs for tenants and therefore by extension will also reduce greenhouse gases.

But here we have two government policies clashing and the bigger picture to me is a real need to reduce greenhouse gases. The deductibility of an insulation is yes, I know that there will be a fiscal cost in that for government. But equally we have a commitment, an international commitment to reduce our greenhouse gases. So, it seems to me that giving a deduction in issues around this where, by law, people now have to insulate properties fits a wider policy perspective rather than a narrow legal tax perspective.

And this is something actually by the way the Tax Working Group pointed out just that about fringe benefit tax. The fringe benefit tax rules basically exempted private parking, provided by employers, but taxed the provision of public transport. And again, those policy perspectives looking at greenhouse gas and the environmental issues are completely reversed.  You really should be giving an exemption for public transport use and taxing the private use of vehicles in a means of reducing emissions and that was a recommendation the Tax Working Group made.

It's one of these things about the devil is in the detail, but sometimes you have to step back and look at the wider policy and decide then to make the changes to suit that wider policy. We have to make changes to our greenhouse gas emissions.

Everyone has to chip in on this and I think in this particular case as a fiscal cost, there may be a fiscal cost for allowing a deduction for insulation. But is that overridden, is there not a wider gain from reducing our greenhouse gas emissions?

Calling Elvis or calling Inland Revenue

Inland Revenue’s Business Transformation program has been meeting mixed reviews amongst the tax agent community. As part of the transformation Inland Revenue issues regular reports to Cabinet and the latest one published on 4th of July is rather brimming with confidence when you read it.

But basically, they're saying quite a lot of interesting detail in here and the report summarises the progress and highlights of transformation for June 2019. It notes that as of 3rd July 2019 more than 1 million refunds had been issued totalling more than $443 million. Approximately 217,000 tax bills had been issued totalling under 80 million. A further 454,000 tax bills were written off. They apparently averaged about six or seven dollars each. Meantime, the automatic calculation processes now nearly completed. It says it expects to finish the last run of assessments by 12th of July.

This report was dated 4th of July. It is saying that Inland Revenue is continuing to see high volumes of “customer interactions”. Then it has this very interesting table, called Transformations Red, Amber, Green States.  Which improved to light amber overall this month and they're saying overall trends are improving.

Now there's a couple of interesting details in here that I wasn't aware of. Apparently, the Palmerston North Inland Revenue office had to be closed unexpectedly on 13th of June. I believe this is because of seismic issues and according to paragraph 29 of the report it has reduced the number of people have available to answer calls.  Inland Revenue shifted 40 staff to work out of the Ministry of Social Development site in Palmerston North. But it's interesting to see the little margins here. It appears that Inland Revenue’s processes seem to be running full stretch if something as unexpected as that could cause this level of disruption as is implied in this report.

They add that they took on an extra 40 staff from the temporary labour force. Despite this overall this report is fairly positive about how the matters are progressing, which isn't really the experience we tax agents are seeing.

I'll give you an example. Yesterday, a client rang, she had received several emails from Inland Revenue saying first on 23rd of July she owed $157 and pay immediately. The next email dated the 24th said it was $25.69. This constant bombardment, it provokes concern from clients. They want to be up to date and there's a bit of threat that we are at this stage of being about to go and deduct money straight from your account. This is a really fairly heavy-handed approach for absolutely insignificant amounts of money.

So, I log on and check out what's going on and in fact the home page shows that the client overall is in credit to the tune of $3. What we have an is an underpayment in one year, 2018 and an overpayment in 2020. That credit was a rebate credit that for some reason was sent to 2020. That is something we've seen a lot of this year. Rebate credits going to the wrong year or credits being passed off to the wrong year.

Resolving that required a call quickly to Inland Revenue. There's no such thing as a quick call. I was on hold for 36 minutes before someone finally answered and what should be a minute conversation, took 12 minutes to resolve.  Then I decided to ask about something in relation to my own practice about why a resident withholding tax return hadn’t been issued automatically. And that took a further 20 minutes to resolve.

Now, these are routine matters and the staff, the person I dealt with was absolutely fabulous, very patient, very even tempered. But you could sense that this was pretty much her day, the endless little petty frustrations as a system clunked away dealing with what is really a routine matter.

This business transformation has cost $1.5 billion. That's the number most oft cited. Yet the system couldn't pick up or match off that it had had a credit in one year and a debit in another year. Why not match and offset the two? We actually had to manually intervene to do that. Why? I don't know.

But there was this system which is supposed to be as whizzbang as all of that. You'd have thought that this offset would have been one of the first and easiest fixes to do.

So, I think there's a fair amount in Inland Revenue’s reports to ministers which paint a very glossy happy picture. But the reality on the ground is that there are a lot of frustration in issues such as I've just described. So someone somewhere has to square the circle and I think there needs to be a few more penetrating questions asked of the Commissioner as to what exactly is going on with the business transformation.

And on a related matter, I just note that the UK HM Revenue Customs has come under extreme scrutiny recently for some of its practices and as a result a new committee to review its practices has been set up.

Some of the stuff the HMRC has got up to in the UK is quite jaw-dropping and frankly, represents, in my view, a severe breach of civil rights. So, it's not surprising that's happened. Now, I'm not saying that Inland Revenue here is in the same position, but I do question how much overwatch it has been getting.

And very finally, check out the Herald, which will be running a story on tax and high wealth individuals. That is people controlling more than $50 million of assets. There's going to be some interesting stuff in that from my discussions with the journalist involved.

This article is a transcript of the July 26 edition of The Week In Tax, a podcast by Terry Baucher. This transcript is here with permission. You can also listen below.

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I'll be claiming my insulation cost as in all cases there was old insulation there previously. I'm out of luck when it comes to the heating and ventilation though.

If TOP had their way, wouldn't the insulation be taxed year after year, based on the value that it has added to the house? Hows that for a perverse outcome.

TOPs policy is that every asset has a deemed rate of return. If your actual return is greater than the deemed rate, eg because it is a rental property, then you pay tax on your rental profits as per normal and the deemed rate of return makes no difference to you whatsoever.

It is only for owner-occupied properties that you would pay tax under TOP's policy that you don't currently pay. Since there's no feasible way to accurately value everyone's properties, the deemed rate of return would be applied to your property's rating valuation. Those rating valuations don't change when you do minor things like put insulation in, change a light fixture or remodel a bathroom, so no, you wouldn't pay any additional tax under TOP's policy when you installed insulation. Only renovations that (presumably) require consents such that the council would update your rating valuation would result in greater tax burden under TOP's policy.

Have TOP said the rate of return would be applied to the property's rating valuation? Would be all sorts of loopholes and shortcomings associated with that.

This is as close as I can find to an official statement on it: https://www.top.org.nz/33_how_would_the_value_of_an_asset_be_determined

A lot of parts of the policy aren't actually nailed down, but it's pretty obvious that RVs would be a key component of such a tax, since they're already used for levying rates which are effectively local council taxes.

Edit - also this: https://www.top.org.nz/will_every_home_owner_have_to_file_a_tax_return

TOP don't give a definitive answer in the links above, but they do mention market values, RVs and insured values. If they went with market value you'd be paying ongoing tax on the value of the insulation if your deemed rate is higher than actual rate of return. TOP will want the deemed rate set high enough for this to be a definite possibility.

Using RV seems fraught. I did a $100K renovation that didn't require building consent a while back and this had no impact on the RV. The deemed return from this would go untaxed. The fact that the value could change significantly over 3 years is also an issue. These shortcomings apply to rates too, but I don't think this makes it OK. And rates are based on value relative to other properties, not actual value, so it is a bit different.

You could make an argument that additional tax will be paid due to the insulation under the current regime. Rents go up as a result of the insulation requirements, so tax paid on that rental income goes up.

Presumably if you did a $100k renovation you would have put your house insurance up to cover this, so (according to Gareth) IRD could track this change in your insurance and send a "please explain" letter.

I didn’t, and would probably be less likely to do so if I knew it would result in me being taxed on an additional $100k every year. I should probably update the insurance now that insulation, heat pumps etc are installed but probably won’t do that either.

The $500 threshold for asset value for tax is ridiculously low, causes heaps of compliance costs, and massive asset schedules. I can't remember it ever being raised? Insulation should be R&M.

How can the insulation not be deductible? No compulsory insulation, no rent. There is a direct link to earning income. The value of the property has not increased as everyone has to have it, the value of a property without insulation will decrease by the amount required to make the income legal. The bureaucrats have also dictated that a flexible heating solution will not be suitable and a fixed heater must be fitted. If I replace my three moveable heaters with an unmovable heat pump of similar output is the heat pump deductible? or is it seen as an "improvement"? The heat output is the same, maintenance goes up and flexibility is reduced. Is timing an issue? Do we have to wait until the law is enforced? or can the required, but unwanted heat pump be installed in advance?

On the insulation non-deductability issue. It could be reasonably argued that the insulation merely brings the building up to current minimum standards and is thus a repair and maintenance issue. Maintenance up to current minimum standards, that is. Surely a more reasonable and useful guidance than the psychopathic and abusive IRD one.

What is "fair and reasonable" under Common Law, not the dictatorial Roman Law interpretation so favoured by the bureaucrat.

Exactly the same stupidity and abuse of power as in the non-deductibility of earthquake strengthening and depreciation. Are kiwi building owners being encouraged to sell their NZ real estate to foreign owners and invest the money overseas? It certainly looks like it.

New Zealand is essentially anti-business in many ways, particularly in its dull, slow, stupid, heavy handed bureaucracy. Yet they wonder why productivity is retarded too.

NZ is consistently rated as being one of the easiest places in the world to do business. https://tradingeconomics.com/new-zealand/ease-of-doing-business