The big news this week is the decision by Inland Revenue and the Government to pause implementation of two controversial proposals aimed at tackling potential tax avoidance around the 39% tax rate.
The first proposal was to treat sales of shares in the company, which had large amount of undistributed tax paid income as a dividend rather than a tax-free capital gain.
The second proposal was looking at the provision of personal services through interposed entities such as companies and trusts. Here Inland Revenue was proposing to broaden the range of situations where the income of the interposed entity would be deemed to be that of the individual actually providing the services. Now this proposal was criticised as going far too far and unfairly targeting tradespeople and independent contractors in particular.
Initially both proposals were to be part of legislation to be introduced in August and would have come into force from 1st April next year. But in the face of some robust criticism that the proposals went too far and concerns about unintended consequences they've been withdrawn for further consultation.
I think this is a wise move by the Government. Yes, the proposals were unpopular, but the Issues Paper seemed rushed and there were many concerns voiced by myself and many others that the scope of the paper went too far and there were bound to be unintended consequences.
My understanding is now we are likely to see a revamped issues paper for more consultation probably later this year. But notwithstanding the fact that there's been a pause put on these proposals, taxpayers should still be careful around attempts to minimise tax, either through share sales to related parties such as a trust, (I had no issues with the Government's dividend proposals in that regard), or to try and use a trust or another interposed entity to try and minimise income taxed at 33 or 39%.
An idea of some of the issues that are involved in this has come out in a recent Inland Revenue Technical Decision Summary. Inland Revenue has recently begun releasing technical decision summaries from its Adjudication Unit which gets involved when there are formal disputes between Inland Revenue and taxpayers. Although these technical decision summaries are not formally binding on Inland Revenue, they give people an indication of what might be Inland Revenue’s view on a matter.
And this particular adjudication decision summary involved income tax controlled foreign company issues and double tax agreement. It appears that at the heart of it was an attempt by a taxpayer to minimise the taxation of personal income through a pair of associated companies.
The taxpayer in question was a citizen of the United States and therefore is automatically deemed resident of the United States. As people may be aware US citizens have to file tax returns in the United States regardless of where they might actually reside. This particular person was employed as a CEO of a New Zealand company under an employment agreement. However, the taxpayer provided these CEO services through a US company (US Co) and another New Zealand company (NZ Co). The taxpayer was the sole director and shareholder of both US Co and NZ Co. There were various service agreements involved. Quite a bit going on here.
Inland Revenue investigated this arrangement and concluded that large withdrawals from a NZ Co bank account represented taxable income. It also saw similar withdrawals from US Co together with a series of deposits into US Co’s bank accounts. Inland Revenue considered the US Co expenditure to be private and non-deductible. It also considered the payments going to US Co as remuneration under a service agreement.
Inland Revenue ultimately held that US Co was a controlled foreign company and therefore the taxpayer had controlled foreign company income from that company. Furthermore, although the taxpayer as a US citizen had to file a US tax return, under the double tax agreement with the United States he was a New Zealand tax resident. This meant New Zealand had the sole right to tax the disputed payments.
The taxpayer lost every counterargument and for good measure, Inland Revenue slapped him with a gross carelessness shortfall penalty, which can be up to 40% of the tax involved in relation to the payments that were deemed to be remuneration and the attributed control foreign company income.
It's quite an interesting case because we don't often see decisions involving the double tax agreement in relation to the United States. It’s also interesting to see the sort of arrangements that Inland Revenue is keen to stamp out and will definitely be targeted in any revised proposals. I think it's quite possible, although it's not mentioned here, that the existing rules may have applied.
Anyway, this technical decision summary is a warning that Inland Revenue may have withdrawn some proposals, but it is still looking at these issues. You therefore need to have your ducks well lined up if you if it decides to investigate further.
Tax as a environmental change motivator
Moving on, the Government's first Emissions Reduction Plan was released in the run up to last month's Budget. The release was overshadowed by the Budget, but now we're past the Budget it’s interesting to take a look at the document.
The Tax Working Group spent some time talking about environmental taxation. But in the midst of the focus on the capital gains issue its commentary on environmental taxation was largely ignored.
The Tax Working Group’s conclusion was “there is significant scope for the tax system to play a large greater role in sustaining and enhancing New Zealand's natural capital”. Against that background it’s interesting to see what was in the Emissions Reduction Plan about the potential role of tax. And the answer would be at this stage, not much.
The full plan as published runs to 348 pages of the document. Tax is mentioned just four times, three of which are in passing. The only specific tax proposal is within Action 10.2.1 accelerating the uptake of low emissions vehicle which proposes investigating ‘how the tax system can support clean transport options to ensure low emissions target transport options are not disadvantaged.” And one of these areas would be the tax treatment of employers providing free public transport.
Given that the Tax Working Group put some emphasis on environmental taxation this is a surprisingly light approach. It is definitely worthwhile investigating what the tax system could do about not penalising clean transport options. But in my view, the Emissions Reduction Plan could have gone much further in and be more specific about particular tax actions.
For example, could we adopt the approach in Ireland and in the UK where fringe benefit tax on company vehicles is determined by the level of emissions? With regards to FBT it could be worth looking at how the work-related vehicle exemption is actually operating in practice and whether through people's misunderstanding it's accidentally led to the proliferation of high-emission twin-cab utes. Tightening the application of FBT around the provisions of car parks could be another option. There’s plenty to consider in this space.
Still on the environment, earlier this week the primary sector climate action partnership He Waka Eke Noa released its proposals for reducing emissions in the agricultural sector and how agricultural emissions should be priced.
It's proposing a farm-level-split-gas levy, which requires each farm to calculate the long- and short-lived gas emissions. This will then determine a levy cost for that particular farm. This split gas approach will apply different levy rates to long- and short-lived gas emissions. And if there is on farm sequestration going on, that will then that will be recognised and would offset the cost of the emissions levy.
Wisely in my view the levy revenue is to be invested in research and development. There’s also going to be a dedicated fund for Māori landowners. My view around environmental taxation is whatever is raised should be reinvested to help drive down emissions rather than fund general government expenditure. Anyway, there's some interesting stuff in these proposals. Listeners may recall I spoke to John Lohrentz a couple of years back about his proposal for a progressive tax on biogenic methane emissions. This seems to go somewhere along those lines.
The taxation of agricultural emission is highly controversial and there are already calls that what's proposed doesn't go far enough. I certainly think this is a topic which is not going to go away. The Tax Working Group was right to suggest tax could be used as a tool much more than it is currently. We should expect to see much more investment in this area and into exploring what the role of tax can be in helping reduce emissions.
BEPS reform stumbles in the US and EU
And finally, this week, a little bit more about the progress on the OECD's ambitious international tax agreement. Tax fundamentally is politics, and it appears that politics is, as I expected would happen, starting to come into play and delay moving this forward.
Inevitably part of this involves the United States although interestingly it appears the problem in the United States is the necessary legislation is getting held up because it's tied to spending proposals as part of the U.S. Government's budget. The tax proposals do not appear to be the issue. What particularly catches my eye at this point is it appears the Republicans are not doing anything to move it forward, but they're not actively doing too much to stop it at this stage. In other words, they seem to be prepared to help to allow these proposals to move through. You can imagine, though, that the likes of the companies affected, such as Google and Meta, the owner of Facebook, are certainly lobbying fiercely in the background.
Over in Europe the other political headache that's emerged involves Poland. Initially, the big objection was likely to happen there with the European Union obtaining the unanimous approval of its members would have been Ireland pushing back at the proposed minimum corporate tax rate of 15% as it is above its current rate of 12.5%. However, Ireland appears to have come round on that matter. Instead, it appears that Poland have decided to throw up objections. But these appear to be the Poles basically looking to use their objections as leverage in a dispute with the EU over receiving pandemic aid money.
Hopefully these matters will be worked through, and the deal will proceed because it is important for international tax. It certainly won't happen as quickly as next year as originally was hoped. I always thought that was ambitious, given the scale of these proposals and the requirement for 130 jurisdictions to get all the legislation lined up and ready to go by 2023.
And on that note, that's all for this week. ’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 and please send me your feedback and tell your friends and clients.
Until next time kia pai te wiki, have a great week!
*Terry Baucher is an Auckland-based tax specialist with 25 years experience. He works with individuals and entities who have complex tax issues. Prior to starting his own business, he spent six years with one of the "Big Four' accountancy firms including a period advising Australian businesses how to do business in New Zealand. You can contact him here.